Wednesday, June 27, 2007

Saving for healthcare costs

Fidelity Investments estimates that retirees need to save about $215,000 just to pay for healthcare costs during retirement.

Assuming that a couple, age 65, retires in 2007 with no employer sponsored coverage, the husband will have a life expectancy of 17 years while his wife's life expectancy will be 20 years - to age 85. The study excluded such variable costs as over-the-counter medications, most dental services, and long-term care. The 2007 estimate is a +7.5% increase over last year's estimate.

Health Savings Accounts (HSA's) are one tool that can be used to manage this expense. Because healthcare expenditures are not spread out evenly throughout retirement, those lucky enough to go several years without a significant expense can save money tax-free in a HSA account. Families can set aside $5,650 annually. Unused funds can accumulate, tax-free, for later-year obligations. An HSA is paired with a high-deductible insurance policy to insure against the risk of major medical expenses.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.


Friday, June 15, 2007

Market Digesting rate rise

The economy, though continuing to struggle in many areas, has remained remarkably resilient on the jobs front. This has been a blessing for consumer spending, since few Americans monitor business and market events and set their confidence levels and spending habits accordingly. Most consumers gauge their spending to their immediate job market. They don't cut back until they, or someone they used to work with, loses their job. At the moment, even in spite of a continued decline in the housing sector, very few workers are experiencing that hardship.

With consumer confidence still strong, consumer spending has held up. This week's retail spending numbers were legitimately strong. In fact, most of the economic releases in the past couple of weeks suggest that those who fear a recession is around the corner (and that has included me) may be in for a pleasant surprise.

The downside of all this good news is that the bond market, too, has been expecting a recession. A short while ago, short-term rates stood higher than long-term interest rates, which is unusual, except as a foreshadowing of a recession. As recession fears lift, the shape of the "yield curve" resumes a more normal structure. Long-term rates have increased precipitously and short-term rates have dropped a little.

So far, the stock market loves this latest development. Inflation sensitive energy and materials stocks are leading the market higher. Higher interest rates, however, send bond prices lower. Conservative investors, who have shunned high-risk stocks for the safety of bonds, are losing money and purchasing power. So far, the stock market has the upper hand. It will be a real test of this economy, though, to see if consumers can withstand record high gas prices, rising mortgage payments, and a continued decline in the residential construction sector. That's a lot of bad news for any market to digest.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.


Saturday, June 9, 2007

More Red Flags for Yield Hogs

The market loves "high yield" stocks, which used to mean cautiously picking a few real estate investment trusts with 10% yields, but now means loading up on those same names with 4 - 6% yields. Looking at energy sector stocks a few days ago, the most expensive stocks in the sector seemed to be Master Limited Partnership (MLP) assets with a 20 multiple (Price/Earnings ratio) versus traditional companies in the sector which regularly sport valuations half that level. The draw, of course, is that the MLP's pay out huge dividends, sometimes in excess of their true earnings power, while the traditional "C" Corporations have lower dividend yields. Today's post-Enron investors have learned not to trust earnings statements - which are frequently be re-stated back several years as a result of option dating scandals and other derivative-based shenanigans. Given the sad state of the corporate suite, where the CEO supported by his hand-picked directors is systematically looting the company, being skeptical about the true state of earnings is a lesson well learned. However, the notion that dividends are an infallible indicator of stock market opportunity is a stretch, to say the least.

Barron's "The New Math of Oil and Gas" article by Dimitra DeFotis gives a close look at Denver-based Forest Oil (FST). Commenting on the disparate valuations between the MLPs and traditional companies, DeFotis writes that, "in the limited partnership market, a company's daily energy production usually is valued at about $200,000 per barrel. But Forest Oil's production is valued at just $60,000 per barrel." The MLP's pay out all their earnings (and them some, at times) so investors don't mind paying more than 3 times the going rate for those assets. Overpaying in "market B" for assets that cost less than as third as much in "market A" is not a great strategy for making money, but investors chasing yield are taking that risk.

The real estate market is in a similar conundrum. Barron's Andrew Bary wrote "High-Risk Realty" about how the national REIT market has been bid up to interesting levels. Writing about the sector's most recent buyout - of Archstone-Smith (ASN), a national company with many tight-market apartment properties, the buyout group is buying properties with a yield of 4% on the real estate assets being acquired, and will be paying 6% on the debt used to acquire the properties. Negative cash flow is sometimes a fact of life in the world of real estate. It can be offset by price appreciation of the underlying assets. But in today's world of fast-growing foreclosure rates, rising residential housing inventories, and falling real estate valuations - such a leveraged bet on future price appreciation might not be a good deal. Chances are, the buyout group may have an idea of where they are going to lay off these properties and pay down that debt. In a recent Equity Office Properties buyout, some of the target properties were turned around and re-sold even prior to the EOP deal closing. Just hope that those Archstone apartment buildings aren't being turned around and sold to some private real estate syndicated deal that's going to end up in your portfolio, courtesy of your local bank or wirehouse broker, whose marketing departments are cooking up these "new" diversification strategies and plugging them into client portfolios just as the real estate market is beginning to turn down.

Keep your real estate deals local. Western Colorado is in the midst of an energy led boom that is contra-cyclical to the rest of the country.

And don't pay too much, just to chase a high-yielding security. Earnings yield is just a portion of the total return equation. Don't forget to keep a close eye on your principal as well!

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.


Wednesday, June 6, 2007

Leuthold Group downshifts to Neutral on stocks

Steve Leuthold is the Chief Investment Strategist for the Leuthold Group, a research boutique and mutual fund manager who charges pension fund and hedge fund managers thousands of dollars for his research. In business since 1981, his "green book" is a combination of original, thematic oriented technical and quantitative analysis, and some of the best jokes in town (for good measure). His core mutual fund (LCORX) was launched in 1987 and since 2000 has outshined its category average in 7 out of the last 8 years. It beat 98% of its peer group over the pat 3-year, 5-year, and 10-year time periods. Leuthold's Core Investment Fund has a very flexible investment mandate. It is a balanced fund, so it typically has some bonds in it to reduce risk, but Leuthold is willing to commit money to a wide variety of investment ideas, and typically looks nothing like the Vanguard Index 500 Fund, so Morningstar has it classified as a "high risk" fund.

I think manager flexibility is a good thing, particularly when your manager's insights are good enough that other fund managers will pay him thousands of dollars for his insights, so it doesn't bother me that the portfolio refuses to be a closet index fund. I figure that clients are paying him a fee to exercise discretion, but the Morningstar analysts see things differently.

(This wouldn't be the first instance where I have rejected conventional wisdom in setting Scout Partners investments discipline.)

In last weekend's Barron's interview, Leuthold notes that as a result of the recent run-up in the stock market, against a backdrop of rising interest rates and a slowdown on the consumer side of the economy, Leuthold lowered its stock allocation to neutral. Defensive a year ago, late last year the strategists warmed to stocks so they were able to benefit from 2007's run-up in the market.

More recently, though, he has written in his Green Book about some parallels to 1987. In 1987, leveraged buyouts were taking shares out of the public market, so Wall Street was talking about a "shortage of stocks" as valuations ran higher. Interest rates, too, were rising in 1987, although at much higher levels than at present. Inflation was rising, and the economic expansion was getting long in the tooth.

Leuthold notes that Leveraged Buyout (LBO) teams are paying 33% to 40% more to take over companies in 2007, based on cash flow, and commented wryly that "everybody and his brother is running screens as to who the next likely leveraged buy-out candidate will be." He wasn't so concerned that these private equity deals will cause a problem, but they represent a lot of potential equity issuance in the future that could cap any sort of future market recovery.

From my point of view, the LBO teams are making a classic end-of-cycle mistake, loading up on equities using borrowed money, just because market and economic conditions, at present, remain positive. Buying on margin after the market has already appreciated 50% isn't how the smart money gets rich, typically.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

Friday, June 1, 2007

Encana Leads Local Stocks Higher

The Scout Partners Index of Western Colorado Stocks rose in May, gaining 4.8% versus a 3.5% monthly gain for the widely followed S&P 500 stock index (total return including dividends). The 25 stock index focuses on large companies whose operations have a significant impact in Western Colorado. It includes major Mesa County employers such as Wal-Mart, Halliburton, Kroger (City Markets), StarTek, CRH (United Companies), and the Union Pacific Railroad. Though Encana led the energy sector higher, Arch Coal, Halliburton, Williams Companies, and Royal Dutch Shell all saw their stock prices beat the market during the month of May.


Rising 17.0% in the month, Encana (ECA) ended the month at $61.40 and rose to above $63 about 10 days before month-end, the first business day after natural gas prices peaked for the month at $7.88/MMbtu. “In addition to being a great company in a rising sector,” Doug May, President of Scout Partners, LLC observed, “Southeastern Asset Management’s Mason Hawkins, manager of the Longleaf Partners Fund, disclosed that he had started adding Encana shares to his portfolios. He runs a concentrated portfolio and a lot of people watch what he’s doing, so that helped the stock.” A few days later, an analyst from Citibank’s Smith Barney brokerage unit upgraded Encana from a “sell” recommendation to a “hold.” Encana is up 35% since the beginning of the year.

Safeway Stores (SWY) was the worst performer in the index, returning -4.99% during the month of May in spite of comments at the end of April that earnings would be on the upper end of previous guidance, and despite efforts by the company to boost the stock price by raising the dividend 20% to 6.9 cents per share in an attempt to make the stock more attractive to income oriented investors. “Its contract negotiation time,” May said. “Wall Street is worried that management will have to give away the store to avoid another strike like they had in 2004.” Some 65,000 members of the United Food and Commercial Workers union (UFCW) have been negotiating since early March. The companies are negotiating an extension of the 2004 contract which was signed after a 141-day-long strike, the longest supermarket strike in history. The 2004 agreement had left some workers feeling betrayed by the UFCW negotiators who were representing them.

Scout Partners equal weighted Index of Western Colorado Stocks is comprised of 25 stocks that hope to reflect, to some degree, business conditions in

Western Colorado. Reflecting the local economy, the index has a large (over 30%) concentration in the energy sector, which tends to drive index performance. The next largest sector concentration is in industrial stocks, which comprise over 20% of the portfolio. Local stocks are up 11.7% for the year while the overall market has returned +8.8% over the same time period.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.