Japan 1-2-Three

Japan’s three back-to-back crises are causing turmoil in a market that had run up about 25% from the lows of August before topping out in late February. I’m not saying that the market in February was “priced for perfection,” but clearly investor fears of being out of the market stuck in low yielding cash, replaced a fear of stocks. Encouraged by mounting evidence of economic recovery, the market at one point had climbed nearly 7 percent in 2011. Now it is back down close to breakeven on the year. Roughly half of the decline, thus far, happened prior to the crisis in Japan, probably as a result of international struggles elsewhere and the rise in oil prices that they precipitated. So Japan didn’t cause the sell-off, but it is making it worse.

First Japan had an earthquake. Then a tsunami hit. Third, the tsunami triggered a nuclear meltdown crisis. SmartMoney’s Brett Arends blog post is probably right on target. While tragic in the loss of life and serious in its economic implications for the Japanese economy and elsewhere, the economic impact of the quake and tsunami should be relatively short-lived, especially for U.S. investors. In fact, the markets took the first two events in stride, with the U.S. market closing up on the Friday that the news first hit.  Fidelity's research group seems to have drawn a similar conclusion in its recent special report.

It is the nuclear crisis that hit the market hardest. As of mid-day on Wednesday, the plants have not experienced a Chernobyl-like disaster. There’s something in it for both sides of the nuclear power debate. The General Electric designed technology has thus far, generally speaking, contained the meltdown. Proponents of nuclear power will probably argue that the engineers are able to design plants that came through a severe and rare earthquake/tsunami disaster and generally contained the dangers within. Opponents of nuclear power will note that for the past few days, the world economic system has been set on a precipice as we all wait to see whether the meltdown spirals out of control.

To me, the market has over-reacted to the meltdown. While Jim Cramer’s observation that “nuclear energy is dead in the United States” may or may not be true, he was surprised that the utility companies weren’t selling off more, while I am surprised that they’ve sold off the way they have. Companies can be valued in different ways, but two of the most basic are based on assets (liquidation value) or on cash flow (earnings). If utilities are being based on assets, then I would agree that those with nuclear plants are probably worth less after the Fukushima Baiichi meltdown than before. However, the earnings power of existing plants probably isn’t impacted much at all, unless the market is forecasting some expensive retrofit – which isn’t the case as far as I know. Generally, I think that utilities are valued based on earnings power, and the sell-off they’ve had is unwarranted.

Much of this week’s market turmoil, I think, settles out over time. Indeed, the market was toppy, having moved up 25 percent in six months, and the market was looking for reasons to take a breather. As long as the Fukushima plant doesn’t go all Chernobyl on us, I think that the market will use the crisis as an excuse to flatten out a bit, as stock prices give the real economy a chance to catch up, and nothing more.

The most interesting question, to me, is whether the Japanese can fund the stimulus that they’ve committed themselves to providing. In the past few years, Japan has transitioned from a nation of savers to a net borrower, at least at the government level. Having promised the financial sector nearly $200 billion in funding, so companies don’t have to sell off assets in order to fund reconstruction, an interesting question is, “who will buy that paper?” John Mauldin is a much followed strategist who describes Japan as “a bug looking for a windshield.” As Europe continues to wrestle with its own bad debt issues, and with the U.S. borrowing money like there’s no tomorrow, who is left to finance Japan’s spending?

Mohamed El-Erian, who is widely quoted about international fixed income markets and as PIMCO’s CEO makes a lot more money than I do, feels comfortable that Japan can fund its promised stimulus efforts. Hopefully, he’s right. To me, the most interesting question isn’t, “what’s the future of nuclear energy,” which is a sector that can easily enough be avoided. In fact, our portfolios’ gas holdings have fared relatively well as more people move into the “gas as clean energy” camp.
 
To me, the most interesting question is, “what’s the impact on global interest rates,” because if this is the trigger that sends all sovereign interest rates higher, the problem will be very widespread and will definitely impact global equity markets. 
 
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Recent Portfolio Moves Focus On Risk Reduction

In mid-February the portfolio eliminated international funds as a discrete holding in the model portfolio. Most international funds were having a tough time keeping up with the soaring U.S. market, with U.S. financial sector stocks moving up in particularly strong fashion.

After adding insurance stocks to the investment model in mid-February, the model eliminated computer hardware investments after the industry fundamentals deteriorated. The sale was made just as the U.S. market started weakening. At the time of this post, no replacement fund has been selected, so the model portfolio has built up roughly a 10 percent cash weighting which has helped cushion the portfolio in the post Japanese tsunami sell-off.

We were surprised by the discipline’s move out of Asia. Although many countries are represented by the model’s investment in gold companies, other holdings have more than a few international stocks as well. A portfolio “X-Ray” still shows a notable international company presence in the portfolio, but the model owns no “international” funds at this point in time.

The insurance sector investments were added, but they are “on a short lease.” Essentially, the holdings have to perform well immediately, or they likely won’t be held for long. Individual stock work on companies in the insurance sector appear to show many companies with very reasonable valuations, and there have been very few asset classes that have been able to keep up with the U.S. equity market in 2011. To maximize the U.S. exposure, but still maintain a reasonable degree of diversification, financials (via the insurance sector) were added to the portfolio a bit early, this time. If they can’t continue to outperform, we won’t be able to justify holding them very long.

A few weeks later, in early March, investments in the computer hardware sector were taken out of the model portfolio. Research showing that new hardware orders are declining, and hardware inventories are growing, is the main culprit. The hardware industry can be a cutthroat environment when inventories get out of hand and price cutting spreads. Profit margins can crumble in a hurry, so the model portfolio’s investment in that sector was eliminated even though the tech sector has been one of the better places to invest in 2011.

Coincidentally, the market had started showing signs that it had finally moved a bit ahead of itself by the end of February. During the preceeding 6-month period, U.S. stocks had shot up over 20 percent. Although corporate profits have been strong, the market has been stronger. Investor fears seem to be evaporating and we’re not at all sure that the market was prepared for anything but continued ebullience.

Since markets rarely remain problem-free for long, and in fact seemed to be weakening, we have decided against immediate reinvestment of the proceeds from the sale of the computer hardware investments. The cash may not remain for long. At this point, we’re not certain. However, even going into the Japanese tsunami crisis, the markets didn’t seem to be priced for disappointment.

Interestingly, we’re not focusing on risk reduction because of some top-down strategy. In fact, U.S. economic news has been very positive. May-Investments forecast a healthy economy in 2011, and news continues to support that prediction. Just like “good companies” and “good stocks” may be two different things, strong economic news does not always and consistently translate into making money in the stock market. We’re hoping that the market just got a bit ahead of itself. But we’re “listening” to the market as it rotates, in this case out of international while some sectors are beginning to face some new hurdles.
 
The market seems to have narrow leadership. Only a few sectors are doing better than average, and generally those sectors are pretty volatile. Commodities, technology, and financials are doing well – but money can be lost quickly in all of those areas. It might not hurt to be selective, even though money sitting on the sidelines is getting virtually no return, for the near-term while we take some time to evaluate where to allocate capital next. 
 
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Focus Groups Seek Clients’ Views About Financial Products

The first in a series of customer-centered focus groups conducted by Retirement Outfitters and May-Investments was a resounding success.

“It was a lively discussion,” says Barbara Traylor Smith, president of Retirement Outfitters LLC and investment advisor representative for May-Investments. “I believe we got honest, fairly clear feedback.”

More focus groups are planned in future months, and although they all will deal with financial topics, the particular focus of each discussion will vary.

“The idea is we get a group of people together, and we ask for their feedback on a topic,” Barbara says. “The topics will change from meeting to meeting.”

The February focus group centered on fixed indexed annuities. Barbara says clients first were asked for their expectations and assumptions about the annuities. After clients wrote answers to the questions, Barbara presented more information about the investments, and clients were invited to discuss whether the investments would meet the needs and expectations of different investors.

The focus groups help Barbara and Kim Last, financial adviser and owner of Kimberley A. Last Financial Services Inc., discover clients’ beliefs and uncertainties about various financial products. Then, those client concerns can be addressed.

“I want to know ahead of time what my clients’ fears are so I can address them,” Barbara says.
 
Focus group participants will be selected from the firms’ clients or people who have attended educational seminars sponsored by the firms. Participants must be between 55 and 75 years of age and have at least $100,000 of investable assets.

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Cameron Place Offers Fresh Veggies and Connection to the Land

A cold March wind blows into Palisade directly from the snowy slopes of Grand Mesa, chilling the dormant orchards and fields.

But inside a cozy greenhouse east of Palisade, broccoli seeds are sprouting in 80-degree soil, getting a head start on this year’s growing season. In April, the broccoli will be transplanted outdoors. In May, it will be ready for harvest by people who have signed up for a share of the crop grown at the Cameron Place CSA, a farm on the cutting edge of a trend in which some consumers are going back to the land to get much of their food.

“CSA” – the letters that are part of the Cameron Place name – stand for “Community Supported Agriculture.” To Thomas Cameron, a longtime peach grower who started the CSA farm seven years ago, CSA is more than a marketing tactic.

“It’s not just another way to sell farm produce. It’s about a community,” Cameron says. Consumers who buy a share of produce from the farm also pledge to contribute a couple of hours of sweat equity during the season, helping out with the farm chores or administrative tasks of running the operation. As a result, they feel some kinship with one another, a sense of community produced by their involvement with the farm. In addition, they begin to understand the connection between the food they consume and the land where it grows.

Cameron learned about CSA farms while on a trip to Europe, where such operations are scattered throughout the countryside. He came home and tried to find a similar operation in the area – one that grew a variety of herbs, fruit, and vegetables and sold crop shares to people who live nearby – but there were none. So he started his own.

Since then, the Cameron Place has developed a loyal following in the Grand Valley. Its patrons understand the vital connection between food and the land.

“A big reason people become part of our farm is they want to be attached to the land where their food comes from,” says Ben Wilke, the CSA’s garden manager who is in his third year of working at the Cameron Place.

Crops at the Cameron Place are sustainably grown using natural pest control and other low-impact methods of farming. Shares include a variety of crops grown on the farm’s four and one-half acres, including herbs, tomatoes, potatoes, squash, green beans, peppers, cucumbers, broccoli, and melons. The shares are distributed at the farm’s Palisade location and in Grand Junction as the crops mature.
 
The Cameron Place CSA is seeking share buyers for this year’s season. Spring is in the air.  It's time to start thinking about your garden again - and maybe, this year, you'll have someone else to help you raise those fresh vegetables.  Various sizes of shares are available at various prices and this is the time of year to get started. For more information, visit http://www.cameronplacecsa.com/ or call 402-8364.

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Upcoming Workshop on New Estate-Tax Law

At the end of 2010, Congress passed a new law that changed the way inheritance taxes are levied in the United States for the next two years. The changes in those wealth-transfer taxes – which include estate tax, gift tax, generation-skipping tax and income tax that results from capital gain on inherited property – appear to be extremely friendly to taxpayers.

But some dangerous pitfalls exist in this complex new law, and it’s safe to say that it’s a trap for the unwary and a boon for those who are wary enough to plan carefully. A little knowledge can be your salvation.

Estate-planning attorney Steve Gammill has scheduled a workshop about the new law from 7 to 9 p.m. Thursday, March 31, at the new Fruita Community Center. If you’re interested in attending, please contact May-Investments at 263-5126 for more details.

The workshop will focus on several aspects of the new law. For example, the new law:

• Allows personal representatives of people who died in 2010 to choose between paying estate tax or passing capital gain tax liability on to the kids.

Question: What about those who already chose no estate tax before knowing there would be a choice? What are the real ramifications of the capital gain recognition choices?

• Allows a surviving spouse to utilize the unused portion (if any) of the deceased spouse’s tax exemption.

Question: Does this really mean a large exemption and no need to set it up in planning documents? Does it survive a change in the law lowering the exemption in two years?

• Establishes a $5 million exemption for gift tax.

Question: Should you gift a large amount now in case the exemption is lowered in two years? What happens if you die when lower gift and estate tax exemptions are in place?

• Reunifies the gift and estate tax exemptions.

• Establishes a $5 million exemption for both estate and generation-skipping tax.

• Will expire in two years unless a new law is passed, which would usher in another period of uncertainty for estate planners and their clients.

Question: What happens to your tax plan if it provides for today’s exemptions and you are still alive in two years when the exemptions may be lowered?

Steve Gammill is a Fruita-based estate-planning attorney who teaches nationally to attorneys and other professionals in the estate and business planning field. He has presented on the topics of irrevocable life insurance trusts, business and investment asset protection, marketing, business succession and exit strategies, and disability planning. His practice is limited to estate and wealth strategies planning, including legacy planning, business exit and asset protection planning, and family and business strategic vision planning.
 

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A La Mode – A Sweet and Savory Experience

Spring is in the air, and with that comes the sweet smell of flowers, a gentle rain, and … dessert?

Well, it certainly can include the scent of dessert – all you have to do is make plans to attend Horizon Sunrise Rotary’s A La Mode event on the evening of April 7, 7:30 p.m. , at the Doubletree Hotel. This annual event features chefs from around the Grand Valley, who will roll out their best in a sampling that is sure to delight. I caught up with Claudine Bogart, President of Horizon Sunrise Rotary, to get the scoop on this year’s event, appropriately themed “A Sweet and Savory Experience.”

“We currently have 11 chefs participating, with room for 15,” Claudine explained. In the past, they have facilitated a competition between the chefs, but this year they will have a People’s Choice Award only, keeping it light and fun. The cost per ticket will be just $25 with proceeds going to support five different causes: CASA, Rotary’s Third-Grade Dictionary Program (which provides dictionaries to third-graders throughout the valley), Spellbinders, The Grand Junction Imagination Library, and Medicine Arm in Arm.

Claudine seemed excited about the programs they will be able to support through this, pointing out that it is the first year they have included an international cause (Medicine Arm in Arm). “We are providing a sterilizer for a dental clinic in Swaziland, Africa,” Claudine explained. The sterilizer will make it possible for dentists to see more children in a shorter period of time.

And if the dessert alone isn’t enough to tempt you, the band “In Flux” will provide entertainment – a touch that might be called the cherry on top!

May-Investments is again helping sponsor the 2011 event.  CASA is an incredible organization, and the roots of the A La Mode fundraiser were in helping CASA raise operating funds.  If you would like to learn more about this upcoming event or are interested in purchasing tickets, you may do so online at http://www.alamodegj.com/, or by contacting Claudine Bogart at 270-5898. A special thanks to Claudine for taking the time to share the details of this special evening with us, and for her efforts this year as President of the club.

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Fidelity Report Says Strong Sales Growth Reflects Possible Economic Shift

A recent report by MARE (Market Analysis, Research and Education), a unit of Fidelity Management and Research Co., concluded that strong corporate sales growth in the fourth quarter of 2010 reflected a possible shift in the economic climate.

Many companies’ earnings exceeded expectations in the fourth quarter, possibly foreshadowing an increase in corporate spending. Companies that experience strong sales typically are more willing to spend capital on business growth, and such spending is a vote of confidence in future prospects. However, higher spending raises costs and can reduce growth in profit margins. Although the U.S. economy remains strong, MARE expects earnings growth among large U.S. companies to moderate this year, compared to last year’s strong, broad-based earnings performance.
 
For those who want to take a closer look at this interesting analysis, you can find it at http://www.Fund-Scout.com/Papers/Q42010.

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New Adviser Disclosure Brochure Coming Your Way

With the recent passage of the Dodd-Frank Wall Street Reform Bill (long name, even longer bill), it has become necessary for May-Investments to update and change our Adviser Disclosure – commonly known in the industry as an ADV.

For those of you not familiar with the ADV, the purpose of the form is to provide information about how we perform our business: who we serve, our fees, how we manage our accounts, invest money, and so on. The ADV is given at the time a client comes on board, and is made available and offered to clients on an annual basis.

Diane Gigliotti, May-Investments Office Manager, has been hard at work revising our current ADV (alongside Doug) so that it is compliant with the new law. She explained some of the changes. “The new law states that the ADV should be clearly written and current, with a meaningful disclosure of our business practices. Plainly put, the new form should be more user-friendly.” And while the form will maintain much of the same information, it will add more extensive data about the background of the firm’s adviser and advisory personnel.

For those of you who are scratching your heads at this point trying to remember what your ADV said, don’t fret, you will soon have the chance to find out! Where the old law required that we offer the ADV on an annual basis, the new law requires that we provide the ADV on an annual basis – so all clients will receive a copy of the new ADV in the near future. In the meantime, we still have the old ADV available for anyone looking for late-night reading material. We’ll provide the ADV, but you have to provide the cookies and milk!

Should you have any additional questions concerning the new ADV, please don’t hesitate to call the office at 263-5126 – we are always happy to help.

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Get Fit and Get Healthy

Monica Cullinane is on a mission.

She cites statistics that say more than half of Americans are overweight or obese, and she says that by making a few simple changes in lifestyle and diet, many people could drop their extra weight and live healthier lives.

“Most of the time, (poor health) is the result of diet and sedentary lifestyle,” says Cullinane, a Grand Junction health and nutrition coach who presented a recent program on healthy living to interested clients of May-Investments/Retirement Outfitters. Making small changes in behavior – such as scheduling regular exercise and removing unhealthy foods from your diet – tend to last a long time because small changes are easier to incorporate into your lifestyle.

“Think about your life and how important it is to make little changes,” says Cullinane.

She offers several ways of increasing your energy level. Among those suggestions are reducing or eliminating caffeine, which can cause dehydration and can contribute to fluctuations in blood sugar. Changes in blood sugar lead to fatigue and mood swings.

Cullinane also suggests that adding more dark leafy green vegetables to your diet can increase energy. Green, leafy veggies are rich in nutrients and can help improve circulation and strengthen the immune system, she says.

Cullinane saves special criticism for sugar. Added sugar in foods can go by several names, including high fructose corn syrup, fructose, sucrose, “natural sweeeteners,” and “juice sweetened.” Just check the ingredient list of most foods in the supermarket, and you’ll find at least one of those terms.

“The marketing is very tricky,” she says.

Regardless of its name, added sugar in foods is harmful to human health. It can contribute to diabetes and obesity, increase cholesterol, and cause cardiovascular disease, Cullinane says. Buying sugar-free products isn’t any healthier, since many of them contain chemical sweeteners – such as aspartame – whose effects on health have been questioned.

Cullinane suggests adding more whole grains to your diet. Whole grains do not spike blood-sugar levels, and they can make some great-tasting foods.

“Your life depends on your choices,” she says.

For more information about Cullinane’s nutrition and health coaching services, visit http://http//www.integrativewellnesstoday.com.

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"Relative P/E Investing" April 5 Educational Workshop

Can I teach readers how to buy a stock, in eight paragraphs, really? No. But I can briefly describe what I look for in selecting stocks for our portfolios. It’s not the only way to buy stocks, but it’s what we do.

We are looking for “undervalued” stocks – but who isn’t? For us, a stock’s intrinsic value is based on its demonstrated earnings power. We are likely to miss high potential companies that aren’t projected to make money anytime soon, but have the potential to be great. My boys and I stopped by the Tesla Motors gallery in Boulder when it opened in 2009. Tesla makes beautiful cars with exciting technology. It might be a wonderful investment. However, to pick a stock, first I want to be able to put a number on its intrinsic value. Without current earnings, it is tough for this analyst to place a value on the business. To me, current earnings power is one thing that separates the speculative bets from more conservative investments.

Contrarian investors tend to buy stocks with low absolute Price/Earning ratios. I cut my teeth in a contrarian shop. In today’s market, for example, Merck sells at about 8-times its projected earnings power. The inverse of the P/E ratio is the Earnings Yield. For Merck, it’s nearly 12.5%, quite a bit higher than what banks are paying depositors. Merck only pays out a portion of its earnings to stockholders in a dividend. The annual dividend yield is 4.7%, still better than a bank account, but well below the company’s earnings yield.

In the late-1990’s I converted from a deep value contratian to “Relative P/E” investing. Instead of being limited only to stocks with the absolute lowest P/E ratios, relative P/E investors value a stock relative to where it normally trades. This takes a bit of research to determine what the normal P/E ratio is for a particular stock or industry, but it opens the portfolio up to faster growing stocks. A technology company that normally sells at 20-times earnings but is now selling at only 10-times earnings might be a much better bargain than a slow-growing utility company that is currently priced at a lower absolute P/E ratio of 9, but has a normal P/E ratio of 10-times.

A return to a normal P/E ratio takes time, of course. How long it takes is a key variable. An untimely stock might take five years to right itself and return to a more normal valuation. Stocks that are more timely might already be in the process of being revalued back to a more normal level. The quicker the stocks return to normal, the higher the investors’ rate of return. So after comparing the intrinsic value of a company (based on its normal P/E ratio) to the current price in order to estimate appreciation potential, investors should estimate how quickly stocks can reach target in order to calculate the annualized estimated rate of appreciation on each potential investment.

Finally, dividend yields do matter. Merck pays investors waiting for the stock to go up 4.7% per year. Tesla owners earn nothing. For each of the stocks in our portfolio, and for a set of potential purchase candidates that sit on our “watch list,” we have calculated the total expected return, which is the estimated annual capital appreciation plus the current dividend yield.

After that, portfolio construction takes on much more of a macroeconomic feel. Which industries have strong economic fundamentals and are likely to be timely investments? How much diversification outside of the U.S. stock market makes sense. Should investors reduce portfolio risk by putting bonds or cash into what is normally an all-stock portfolio? These asset allocation decisions are crucial, but once the macro characteristics of the portfolio have been determined, stock selection mostly boils down to picking the stocks in each sector that have the highest expected return.
 
The best thing about having a discipline (almost any discipline!) is that it reduces the impact that emotions play in investing. Interviewing management creates emotional bonds. Falling in love with cool products can lead to disaster. I love Boston Market restaurants, and have ever since I started taking my fiancé to them for a cheap date in the early -1990’s. My devoted patronage didn’t stop the company from going bankrupt, however. But having a quantitative basis for buying a company, establishing a target price, calculating expected return, determining timeliness, and buying, selling or holding an investment takes out some of the emotion and can lead to better portfolio performance. 
 
On April 5, May-Investments will host a workshop on "Relative P/E Investing" at our offices.  Starting at noon, lunch will be served and Doug will spend the next 60 minutes talking about the stocks in the Timely & Undervalued individual stock portfolio, and how they were identified by the relative P/E methodology for inclusion in the portfolio.  Workshop attendees might want to bring a company of their own if they want to see the method applied to a stock of particular interest. 
 
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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