The Time is Ripe for Value

November 22nd, 2012
in contributors

Investing Daily Article of the Week

by Roger Conrad, Chief Investment Strategist, Investing Daily

Thanks to all the Personal Finance readers who joined our “post-election analysis” teleconference on Wednesday afternoon. For those unable to participate or whose questions we didn’t have time to answer, this issue expands on our discussion.

If you own stocks, the 8 trading days since the November 6 vote have been disconcerting to say the least. More than a few investors appear to have decided that all is lost, and the result has been broad-based selling.

Even companies that recently reported strong third-quarter results and increased dividends haven’t been immune from the carnage. Among the biggest losers: Energy stocks (especially coal producers), the Canadian stock market and high-yield stocks in general.

Follow up:

Investors have their reasons for punishing these sectors the most. High-dividend stocks, for example, are supposedly in for devaluation, due to the likelihood of an increase in taxes on dividends.

Canadian companies have taken hits on skepticism about dividends, as well as concerns the US government will plunge off the “fiscal cliff” and thereby trigger another North American recession. Energy stocks are down for the same sentiments. Coal stocks, meanwhile, are succumbing to investor worries that the environmental lobby will somehow succeed in outlawing the black mineral.

In the past few issues of this publication, I’ve tried to tackle each of these issues based on the facts. And I’m more convinced than ever that we will see a deal on the federal budget by January 1, and that it will raise tax rates only modestly and not trigger any long-term devaluation of dividend-paying stocks.

Today’s situation still looks a lot like 1993. That’s the last time a flood of money the Federal Reserve had pumped in the system for several years to combat deflationary pressures finally caught fire and ignited the long moribund US economy.

In addition, I still see no hard evidence of an impending tax on master limited partnerships, or that the Obama administration’s approach on coal will shift from tighter regulation to annihilation. The industry will still have to operate under much tougher conditions than it did under President George W. Bush, but coal remains an integral part of the US electricity generation mix. In fact, it’s making a comeback in some parts of the country as natural gas prices have recovered.

The same level of regulation of the past four years is also in store for companies in other federally regulated industries, including telecom, health care, defense and the power sector.

Every re-elected administration ushers in some new faces, and this one will likely have new secretaries of Defense and State. In terms of business and economic policy, however, there’s no indication of any radical new measures that will undermine American capitalism and make life miserable for businesspeople and investors. Rather, investors can expect continuity, as the president and his allies pursue the same objectives they did in the first term.

Indeed, House Speaker John Boehner recently extended a political olive branch to President Obama, feeding hopes that a deal on the fiscal cliff could be in the offing. That said, a long-term agreement (or even short-term fix) to the nation’s fiscal problems is far from nailed down, which means market action could get wilder over the next several weeks.

The Lessons of 1937

Failure to forge a deal would leave the current situation looking less like 1993 and more like 1937.

In 1937, the battered US economy seemed to be on the mend, prompting Congress and the Roosevelt administration to make a fatal error. They decided that bringing down the deficit and supporting the US dollar with austerity was more important than fiscal and monetary stimulus. These economically contractionary actions nipped the nascent recovery in the bud and plunged the nation into a second leg of the Great Depression.

It appears unlikely that those in power today will make the same mistake, especially since Federal Reserve Chairman Ben Bernanke is a student of the Great Depression and he believes that the Fed’s tight monetary policies in 1937 exacerbated the economy’s problems.

To be sure, investors must gird themselves for more volatility and possible downside, particularly those who own energy stocks and high-yielding fare. However, today’s emotionalism in the markets isn’t likely to be matched by similarly dramatic action in Washington or the economy.

As long as your companies stay healthy, their stocks will recover. I’ll even go further out on the limb. This is a great time to buy selected high-quality stocks, particularly in energy and the high-yielding sector.

The longer the post 2008-09 recovery endured, the more attention investors paid to market momentum and less to measures of real value such as earnings, assets and dividends. The further stocks rose, the more momentum-focused investors piled in and drove the price up.

What we’re seeing now is the converse of that dynamic. Regardless of the actual news related to a particular company, investors have automatically assumed a falling stock means the day of doom is at hand. Rather than trust their eyes that the company is worth more than its current price, they’ve simply bailed out, driving the share price down even further.

Is that rational behavior? Yes, in a limited sense. The memory of 2008-09 is still fresh in investors’ minds. However, the lesson most have drawn is not that stocks of good companies eventually recovered from that crash, but to get out of the market any time there’s the hint of another debacle.

Ironically, that’s one reason why another 2008-09 isn’t likely for the foreseeable future. The worst credit crunch/market crash/recession in 80 years was only possible because enough people were leaning the wrong way with leverage. This time around, investors, corporations and even the government are hunkered down with considerably less debt. There’s scant leverage and yet, the bulls are scarce.

However, as we saw in autumn 2011 and spring 2010, selling momentum can wreak havoc over the near term, even if what ultimately happens doesn’t come close to another 2008. That means prices could certainly go lower from here, including super-safe names such as PF Income Portfolio holdings Dominion Resources (NYSE: D) and Enterprise Products Partners LP (NYSE: EPD)—both of which are selling at their lowest prices in months.

A growing number of high-quality companies are starting to trade at astoundingly low prices. And if you’re light in any of them, now’s the time to pick them up. One investor’s fear is another investor’s opportunity.

Admittedly, that advice is based on a bias for value and a general disdain for those who blindly follow momentum. But buying value when the stock market has dropped, even in the middle of the 2008 crisis, has made a lot of people considerably wealthier.

When I first began writing for Personal Finance as a junior editor in the mid-1980s, our main marketing pitch centered around the “billionaire’s secret”—a statement by the legendary J. Paul Getty that it always paid to “buy when there’s blood in the streets.

Mr. Getty was saying that the best time to buy stocks or any other asset is when the “average investor” is most afraid to. Not every company will survive let alone thrive over the coming year, even if there is no fiscal cliff and the global economy roars to life.

But today, the markets are rife with fear. In some sectors, the angst is thick enough to cut with a knife. And that’s the time to load up your portfolio with as many values as you can. To paraphrase the aforementioned President Roosevelt: Investors’ biggest fear right now should be fear itself.

Read other articles by Roger Conrad.

About the Author

roger-conradRoger Conrad is the preeminent financial advisor on utility stocks and income investing and a Featured Expert at Investing Daily. He is the editor of Big Yield Hunting, Australian Edge, and Canadian Edge, as well as Utility Forecaster, the nation's leading advisory on electric, natural gas, telecommunications, water and foreign utility stocks, bonds and preferred stocks.

Mr. Conrad has a track record spanning three decades, delivering subscribers steady double-digit gains of 13.3% annually since 1990. And he’s done it all with a focus on capital preservation and risk minimization by investing in big dividend stocks including Canadian Income Trusts, high-yield REITs, MLP investments, among many others.

Mr. Conrad has a Bachelor of Arts degree from Emory University, a Master's of International Management degree from the American Graduate School of International Management (Thunderbird), and is the author of numerous books on the subject of investing in essential services, including Power Hungry: Strategic Investing in Telecommunications, Utilities and Other Essential Services.

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