Generation Y Investor » The Basics

How Long Will This Rally Last?

Stephen Kline — Sat, 22 Aug 2009 15:01:03 +0000

The markets have been in a sustained rally since hitting the March lows. Since that time, the S&P 500 has climbed more than 50% from the bottom. While we’ve seen some noticeable improvement in the economy since than, there are still many ominous signs that make me weary.

Firstly, second quarter earnings were largely viewed as a success. The majority of S&P 500 companies managed to beat analyst’s earnings estimates. This is a good thing. However, the majority of these earnings beats were due to cutting costs rather than better than expected revenues. All in all this isn’t necessarily a bad thing, provided that top-line revenues begin to increase in the upcoming months. If revenues don’t begin to increase, than one had to question how long firms can continue cutting costs to drive earnings.

My second reason for being cautious right now is the high degree of bullishness on the housing market. Recent data has indicated home sales have increased significantly month over month and many have claimed that the housing market is beginning to bottom out. This bullishness seems unwarranted to me because only the low priced homes are seeing an increase in sales/price (think foreclosures). The mid to high end of the housing market is still stagnant and prices have nowhere to go but down.

Another reason to be bearish on housing is the first time homeowners credit. Towards the peak of the housing bubble our country saw the greatest percentage of Americans in history own their own home. Put in a different perspective, we had the fewest percentage of potential first time buyers in history because everyone who wanted a home had already purchases one. Yes there is a good portion of people right now who were/are looking to purchase a home. However, most of these people are rushing to close on homes right now in order to take advantage of the government credit.

At first you may think this is a good thing. But in reality all the first time buyers credit is doing is front-loading all the potential demand for housing that’s left (aka stealing from future demand). I wouldn’t be surprised to see housing take another leg down starting in November/December after the credit has ended and demand from first time buyers wanes. (Note: A similar argument can be made about the cash for clunkers program front-loading demand for new vehicles).

My final reason to question the extent of this rally is that it’s being fueled largely by hedge funds and institutional buyers who are being forced to buy stocks because they were under invested at the bottom. When you’re running a hedge fund or mutual fund your investors are always comparing your returns to those of other hedge funds and mutual funds. Therefore, if you were sitting in cash and missed the huge rally since March you’re going to desperately try and catch up to your peers who have benefited from the rally.

So despite some improvement in the economy since the lows, I still feel the need to advise caution. I wouldn’t recommend selling all your stocks and hiding under your bed. Just as I wouldn’t recommend jumping full steam onto this rally. Make sure you have a proper asset allocation that matches your risk tolerance. Also, take a look at your current asset allocation and make sure it’s inline with your target allocation. The big rally of the past few months may have caused your portfolio to become over-allocated towards stocks. If this is the case, rebalance your portfolio by selling some stocks and buying bonds or redirect new contributions into your fixed income investments.

Above all, remain vigilant and cautious about this or any other rally in the stock market. Remember, risk goes up as stock prices increase. Don’t become complacent.

Are You Financially Fit?

Stephen Kline — Thu, 16 Apr 2009 01:06:03 +0000

I stumbled upon this tool on CNN.com that allows you to enter personal finance information about yourself and then proceeds to give you a grade on how you’re doing. It covers categories like emergency savings, retirement savings, debt and housing payments.

Overall it’s a pretty good tool but it does have a few problems. First of all, you can’t enter an age lower than 25. This is somewhat annoying but it didn’t deter me from entering my info. I figure with me being 24 and 7 months old I could go ahead and round my age to 25.

Once this was done I proceeded smoothly through the different sections on retirement savings, emergency savings and housing expenses ect. Everything seemed to be up to par until I reached the life insurance section. Here I received a failing grade for not having life insurance that amounted to 10 times my annual income. In my opinion this is another flaw the tool has. For a young Gen Yer that doesn’t have children or dependents I really see no need for having life insurance. Perhaps it would have been better if the tool asked if I had reasonable health insurance?

Anyway here’s the link to the CNN finance tool. If you’re in the mood to kill 5 minutes it’s probably worth a look.

Advice For Young Investors

Stephen Kline — Thu, 19 Mar 2009 00:16:22 +0000

Here’s a pretty good article from Business Week that’s geared towards Gen Y Investors (if there are any of them left)…

The article covers a plethora of personal finance topics including emergency funds, insurance and home ownership.

Has Investor Risk Tolerance Changed Forever?

Stephen Kline — Sun, 22 Feb 2009 20:28:41 +0000

The historic drop in the markets that has taken place over the past year has even the most seasoned investors shaken. Very few investors have ever seen a bear market of this stature during their investing careers, and one has to wonder whether overall risk tolerance has changed for good.

Personally speaking this bear market has reinforced the idea of having a proper asset allocation. I’d say even the most aggressive investors with long time horizons would benefit from having a minimum of 10% of their portfolios in bonds to lessen volatility. For those investors closer to retirement, a portfolio consisting of 40-50% bonds would be more appropriate. A proper asset allocation won’t prevent you from taking losses during severe bear markets, but it will ensure that you live to fight another day.

Here’s an interesting piece from the New York Times that examines how our current crisis is changing the way investors look at risk.

Price Matters When It Comes to Stock Returns

Stephen Kline — Sat, 21 Feb 2009 01:40:18 +0000

I found this interesting article that compares annual returns from the stock market vs the P/E ratio at the time of purchase.

Below is a chart that shows the various returns vs P/E. Hopefully, it will give you a little bit of confidence during these trying times about the future.

P/E ratio	Annualized returns
5 to 9.9	10.8%
*Current level 10-14.9	10.3%
15 to 19.9	5.7%
20 and higher	1.1%

Here’s What Insider Trading Looks Like

Stephen Kline — Fri, 23 Jan 2009 01:38:22 +0000

Alright, despite what the SEC or anyone else tells you, insider trading is quite prevalent in today’s financial markets. In fact, if you’re paying attention and know what to look for you can probably spot it yourself.

Yesterday, I was keeping an eye on shares of Energy Transfer Partners (ETP) when I noticed something odd. The whole day ETP had pretty much been trading in lock-step with the oil & gas index. Then all of a sudden at about 3:30 pm, Energy Transfer Partners and the index started trading in the complete opposite direction. As you can see from the chart, ETP went on to finish the day at its lows, while it’s index and the broader markets in general finished the day at their highs. This was strange to say the least…

During the last half hour of trading, (when the sell off occurred) there was also a dramatic spike in volume. If you look at the volume section of the chart below, you’ll see that moments before the final bell rang over 200,000 shares exchanged hands. This is clearly an outlier since nowhere near that many shares had been traded the entire day. It’s important to keep in mind that there was no news release that would have explained the increase in volume and late day sell off.

Now typically these two oddities above wouldn’t necessarily have me up in arms complaining about insider trading. It’s perfectly possible that a mutual fund or hedge fund wanted to sell some shares into the day’s rally. This would perfectly explain the volume spike and sell off.

However, about 12 minutes after the markets closed, ETP issued this press release. The press release states that ETP will be selling about 5 million new shares in order to raise capital. When a company issues new shares it dilutes the value of all the other outstanding shares. This usually causes the stock to sell off. In my opinion, (and I’m no expert) it looks like someone got their hands on this information and either shorted ETP or sold a long position they had been holding. Either way they traded and profited from information that wasn’t yet public… and that my friends is illegal.

I’m fairly certain the SEC will not look into this matter. I personally don’t have much faith in them. All I will say is that it’s pretty sad that a 24 year old with a computer, yahoo finance and no experience can spot possible financial shenanigans like this occurring regularly in the market.

Be Weary Of Leveraged ETF’s

Stephen Kline — Wed, 07 Jan 2009 01:24:19 +0000

Over the past year or two the popularity of leveraged ETF’s has increased tremendously. These ETF’s seek to double or triple the returns on various stock indexes. Leveraged ETFs function by using financial derivatives, such as options, swaps, and index futures to magnify the returns on a particular basket of stocks. (Sometimes leveraged ETF’s will even seek to return double or triple the inverse of an index)

I was planning on writing a whole post about the pitfalls of these funds. However, it would have been too hard for me to explain their dangers without getting into complicated compounding math. This video explains why these ETF’s don’t give investors the returns they may be expecting…

The bottom line is leveraged ETF’s aren’t a good choice for long-term investors. These funds are meant to be used by professional traders with short term holding periods. I’d highly recommend that amateur investors stay away from them.

Forbes Chirp Index Predicts Possible ‘09 Recovery

Stephen Kline — Wed, 31 Dec 2008 02:32:03 +0000

As an investor, it’s important to pay attention to economic indicators. These reports give investors the data needed to make informed investment decisions based on where we are in the business cycle. There are three types of economic indicators: leading, coincidental and lagging. Leading indicators tend to be the most useful for investors because they usually anticipate changes in the economy. Anticipating changes in the economy is an important aspect of successful investing since the stock market usually leads the economy by 6 to 9 months. For example, the stock market generally begins to recover well in advance of the economy during a recession. Conversely, the market may begin to decline before we even see any troubling economic data.

The Conference Board’s index of leading economic indicators (LEI index) is one of the most widely followed leading indicators. This index tracks a group of 10 data points including… the money supply, consumer goods orders, weekly unemployment claims, capital goods orders, stock prices, average hours for manufacturing workers, the 10 year/fed funds rate spread, building permits, vendor order delivering performance and consumer expectations. (As you can see, it’s a pretty complicated blob of data). The LEI index does a good job of predicting how the economy will perform a few months down the road; however, one critism of the index is that it’s too sensitive. It often predicts more recoveries and recessions than actually happen. With this in mind, the LEI index is still a helpful piece of information and definitely worth keeping an eye on.

Now that I’ve got my informational piece out of the way, I’ll get down to business. Every so often I see an economist or financial website come out with their own version of an economic indicator. These homemade indicators will track anything from luggage sales to Starbucks customers hoping to predict the future of our economy. Usually, I’ll find something about the indicator that I think is flawed and I’ll write it off. This wasn’t the case with the Forbes Chirp Index. This index tracks an interesting mix of data that includes insider stock purchases, the spreads on bond yields, road congestion and the use of the word “recession” in the media. What’s more interesting is that the index is predicting a possible economic recovery sometime next summer. Check out the video below and make your own judgment. (I apologize in advance for the economist’s tie in the video)

Multinationals – Your Solution For A Weak Dollar

Stephen Kline — Tue, 23 Dec 2008 16:35:07 +0000

The Federal Reserve has the printing presses running full speed. They need to keep cranking out dollars to reinflate our sluggish economy and pay for the endless corporate bailouts. Consequently, the value of the dollar has been declining steadily in the past month. It appears as though this trend will continue into the future as there no sign Ben Bernanke plans to stop the printing presses.

Dollar Index – 1 Month

If the dollar’s decline is smooth and orderly then it could have a positive affect on the U.S. economy. The weakening dollar makes American products cheaper to foreign buyers so it should help fuel American exports. American manufacturers and their employees will directly benefit from this increased international demand. Be warned, however, if the drop in the dollar is more sharp than anticipated we could see increased inflation and higher commodity prices.

One way to protect yourself from the weak dollar is to buy the stocks of U.S. multinational companies. Multinational companies have operations all over the globe, and when they sell their products they receive their revenue in the local currency. However, when it comes time to report earnings these businesses need to convert all their international revenue into U.S. dollars. If the dollar weakens vs. the Euro, Yen, or other currencies than the company receives a foreign exchange benefit that boosts earnings. Some blue-chip companies that do a significant amount of business overseas include Coca Cola (KO), Procter & Gamble (PG) and Heinz (HNZ).

Yield Wealth Through Dividends

Stephen Kline — Fri, 05 Dec 2008 03:31:06 +0000

In my previous post I discussed the basics on dividends. I left off telling you that the large majority of stock market returns over the past century have resulted from the reinvestment of dividends. In this post I’ll tell you why dividend paying stocks outperform their non-dividend paying counterparts, and how you can begin yielding wealth through dividend investing.

Why Dividend Paying Stocks Outperform

1. Strong Financials - Companies that pay dividends tend to be more financially stable than non-dividend payers. In order to payout dividends, a business must have the free cash flow and financial strength to support the payments. This means that dividend payers usually have robust profits and manageable debt levels. A long history of consistent dividend payment is a good sign that a business is fiscally fit. Likewise, watch out for companies that have stopped or reduced their dividends; as this is a sign of financial distress.

2. Shareholder Friendly Management – When making an investment in a stock, it’s important to remember that the quality of the company’s management is almost as important as the business itself. Decisions by management have an enormous effect on the value of your stock. This is why it’s vital that the firm’s executives have it’s shareholder’s best interest at heart. Executives that squander cash on frivolous spending and unwise acquisitions do a disservice for shareholders. While, companies that distribute a portion of their cash flow in the form of dividends are constantly rewarding their shareholders. Dividend payments (especially increasing ones) are a good sign that your company has a shareholder friendly management team.

3. Buffer In Bear Markets – Dividend paying stocks tend to outperform non-payers even more during bear markets. The reason for this is because as the price of a stock falls, it’s dividend yield increases. This effectively increases the stock’s attractiveness to investors. For example, a $50 stock paying $2 per share in dividends yields 4%. If the price of the stock falls to $40 than the stock is now yielding 5%. During market selloffs there comes a point where investors looking for income will begin buying up shares in high yielding stocks. As a result, dividend payers tend to fall less than non-dividend payers in bear markets.

4. Dividend Growth – Many companies that pay dividends are the market leaders in their industries. This allows them to grow revenues and profits year after year. As their profits grow, the amount of dividends they payout per share tend to increase as well. Investors holding shares for many years benefit from this because the yield on their investment increases and compounds.

For instance, let’s say you purchased 100 shares of Procter & Gamble (PG) at $61.25. In the first year you would be paid $1.60 per share for a yield of 2.6%. Now lets assume that over the next decade PG increases it’s dividend by 9% per year. (PG is famous for increasing their dividend annually so this is reasonable). In 10 years the dividend would have more than doubled to $3.79 per share and your investment would be yielding you more than 6% each year. Keep in mind that this is only a simple example of the power of dividend growth. Here’s another great example.

Begin Yielding Wealth

Now that you know the advantages of dividend investing, you can begin using it as part of your investing arsenal. Start looking for companies with long histories of increasing their dividends. Also make sure any company your buying into has the cash to keep paying it’s dividend in good times and bad. You can ensure this by researching the stock’s dividend payout ratio.

To get you started you may want to check out the S&P 500 Dividend Aristocrats. These are the top dividend paying stocks that have increased their dividends annually for the past 25 years. As for my recommendations, I personally own the following dividend payers… Diageo (DEO), Philip Morris International (PM), Heinz (HNZ), Procter & Gamble (PG), and Nike (NKE). As always, remember to do your own research before investing.