Friday, August 27, 2010

Give Me Cash and Stocks, No Bonds.

"How do you invest in a slow-growth environment?" That's what Michelle Caruso-Cabrera of CNBC asked me on Power Lunch yesterday. I recommended a barbell approach focused on cash and equities.

I told her I would avoid bonds because the yields are much too low. I know that cash pays nothing, but why would I settle for almost nothing from bonds, tie my money up for several years, and take the risk that interest rates suddenly rise? Instead, I'd rather keep cash on hand to take advantage of any major sell-offs in equities when they occur.

As for the other end of the barbell, I would focus on non-cyclical companies that pay dividends and show some evidence of dividend growth. That way, I can earn a yield equivalent to bonds and be able to participate in capital appreciation. As I explain in my most recent Forbes column, dividend paying stocks outperform non-dividend paying stocks over the long term. A new study shows that the difference in performance is even greater during economic recessions and down markets.

One company that fits this mold is Hormel Foods (HRL), the maker of SPAM. It's a stock I recommended in my newsletter, Forbes Special Situation Survey last October. The stock currently yields 2% and has a long history of dividend increases. I'd rather hold a stock like HRL than the 10-year Treasury note.

Tuesday, August 24, 2010

The Plunge in Housing Must Continue

Last spring, we saw some strength in the housing market. I warned at the time that the strength may not last once the tax credits expire. That turned out to be quite an understatement.

If you recall, in order to help prop up the sick housing market, the government began offering tax credits to first time homeowners. It soon decided that wasn't enough. So it extended the tax credits to all home buyers. Basically, the government did everything it could to boost demand for houses.

What government officials did not realize is that they could not prevent the housing market from reaching equilibrium. They could delay the process, but could not prevent it.

The housing market is sick for a good reason. There are simply too many homes in America and not enough demand. Home builders went absolutely nuts during the turn of the century. They were building houses like crazy. Back in 2004, I took part in a panel discussion about housing. Much to the chagrin of the other panelists, I questioned the wisdom of buying stocks of home building companies. Home ownership rates were at all time highs and home prices were reaching levels I believed were unaffordable for most Americans. I asked, "Where is all the demand going to come from for new homes? Will everybody in America own a second or third home? How can people afford to buy these homes?" Demand, I was told, would come from immigration. As for financing, I was told that new kinds of mortgages would make money available for just about anybody who wanted to buy a house.

Well, we know where that kind of thinking got us. Today, we found out that the housing market's long delayed march toward equilibrium is back on path. Existing home sales in July plunged 27.2% from June and 25.5% year-over-year to a seasonally adjusted annual rate of 3.83 million. Single family home sales plunged to their lowest level since 1995. Inventory surged to a twelve-and-a-half month supply. Of course, the inventory figures do not account for the so-called shadow inventory. Think of all those people who would like to sell their houses, but haven't listed them because they don't think they could get a good price right now.

It's truly amazing to think that the housing market could be so troubled at a time when mortgage rates are at all-time lows. Here's a news flash for policymakers: People cannot afford to buy houses when they don't have jobs. Even if mortgage rates turn negative, many people would not be able to make the monthly payments necessary to service the mortgage.

There are only two possible solutions to this problem: Either the employment market must start improving tremendously, or housing prices must go lower than they already have. Given the misguided government policies already implemented to try and address the economic recession, I suspect the latter is the most likely outcome.

Sunday, August 15, 2010

For-Profit Education on the Skids

In my column in the August 9 issue of Forbes magazine, I warned of a double-dip recession and talked about the importance of investing in stocks with growing dividends in a down market. I gave Washington Post (WPO) as an example of such a stock. The stock, however, has gone lower ever since.

In fact, all for-profit education stocks have been hit. Other examples include Corinthian Colleges (COCO), Apollo Group (APOL), American Public Education (APEI), Strayer Education (STRA), DeVry (DV), Career Education (CECO), Grand Canyon Education (LOPE), Bridgepoint Education (BPI), Education Management Corp. (EDMC), and Lincoln Education (LINC). Not surprisingly, the catalyst for the sell-off is proposed government regulation.

The for-profit education industry has grown in leaps in bounds. An estimated two million students are currently enrolled in such programs. That's about 10% of all students eligible to receive federal financial aid, and that's where the problem lies.

The Department of Education is concerned that at least some for-profit educational institutions are not on the up-and-up. They may be aggressively encouraging students to enroll and borrow money to pay for tuition without offering them any real prospect of finding jobs and paying back their loans. Not unreasonably, the government wants to see evidence that former students are able to pay back their loans and are actually doing so. To be specific, to meet the new guidelines, at least 45% of former students must be paying back principal on their loans, or the average debt burden of former students must be less than 8% of total income or 20% of discretionary income.

Having spent 12 years as a professor at traditional (i.e., not-for-profit) educational institutions, I am in favor of introducing market discipline to higher education. For-profit educational institutions have grown in popularity because they have proven their ability to deliver quality education at a fraction of the price that traditional colleges charge. Too many traditional universities are bloated with highly paid administrators and tenured faculty members who spend little time in the classroom and produce research of only marginal value.

While the profit motive can introduce efficiency and discipline, it can also result in corruption. Yet there is plenty of corruption at not-for-profit institutions as well. The Department of Education should monitor both groups closely. It is perfectly reasonable to ask all for-profit and not-for-profit educational institutions to provide evidence that they are admitting students on a selective basis and teaching them skills that result in gainful employment. Otherwise, we will end up with yet another tax-payer funded bailout.

Disclosure: Vahan Janjigian currently has a long position in Washington Post (WPO).

Tuesday, August 03, 2010

Don't Fall for the Rally. Economy is Still Sick

The following is Vahan Janjigian's commentary from the August issue of the Forbes Growth Investor:

On the last trading day of July, the Bureau of Economic Analysis (BEA) announced that GDP growth for the second quarter of the year was 2.4%. While this was less than the consensus estimate, I thought it was surprisingly strong. I was expecting a figure somewhat less than 2.0%. Keep in mind that this is just the BEA’s first estimate, the so-called advance estimate. A month from now it will publish a more accurate estimate. That second figure could be higher or lower than 2.4%. In any case, it is encouraging to see any amount of real economic growth taking place.

The biggest contributor to growth last quarter was private domestic investment, especially investment in equipment and software. Personal consumption expenditures were also a major contributor to GDP growth last quarter, but to a lesser extent than they were in the first quarter. However, net exports subtracted almost 2.8 points from GDP growth as the increase in imports far exceeded the increase in exports.

Government stimuli, both direct and indirect, were largely responsible for much of the growth in the second quarter. Without all those incentives, the economy would have likely dipped into a second recession. Of course, without those incentives, the budget deficit and the federal debt would not be nearly as large as they are now.

For the most part, corporate earnings reports have been strong. Unfortunately, revenues are still anemic. Companies are doing an excellent job of cutting costs, but headcount is one of those costs. Until they are absolutely convinced that sales will grow steadily, corporate managers are not going to resume hiring. In the meantime, corporations are piling up large amounts of cash. This bodes
well for those hoping for dividend increases. Many companies are also taking advantage of almost unbelievably low interest rates by refinancing higher rate obligations. They view this interest rate environment as a once-in-a-lifetime opportunity.

The same holds true for mortgages. With sales and prices down, this is a great time to finance the purchase of a house with a long-term mortgage—at least for those who can get approved. The national average for a 30-year fixed-rate mortgage is about 4.5%. Five years ago home prices and interest rates were much higher, but back then, just about anybody could get approved for a mortgage. Today, prices and rates are way down, yet lending standards have been tightened. If lenders had been this diligent in the years leading up to the housing bubble, we would not be in this mess to begin with.

In the meantime, the S&P 500 keeps gyrating between 1,025 and 1,125, rallying whenever there is a hint of economic recovery and selling off on any prospect of another recession. It seems that on some days, investors can’t even decide if a particular bit of news is good or bad. Traders are making good money on the big swings. Investors, however, are getting nowhere.

I continue to believe the economy is still sick. GDP growth is being artificially generated by a large government deficit and corporations are creating profits by squeezing costs. In the meantime, home foreclosures keep rising and jobs remain scarce. While stocks could rally strongly on any given day, I see nothing yet that makes me more bullish for the long term.