Absolute Returns – Washington DC October 27, 2011
Absolute Returns Reports.
October has been another volatile month for the markets, but the swings we saw from day to day and week to week, were less violent than they were in August and September. It is also encouraging that the major indices look to be ending the month on a positive note and, for the most part, are in positive territory for the year. It is too soon to know for sure, but the economy may be on the mend.
If so, today’s bargains in blue chip stocks won’t last much longer. With interest rates as low as they are now, stocks that pay good dividends look especially attractive for a variety of investors. An even dozen good ones are listed below.
In many cities rental housing can also pay a nice return. If you are willing to be a landlord for a few years, we think a recovering real estate market will make those investments well worthwhile. A rental strategy is detailed for your review.
Consider the Following
Earnings are up for Many Companies
The mood among investors is becoming a bit more optimistic thanks largely to encouraging third quarter corporate earnings reports. McDonalds (MCD) had a 9% increase for the period. Chipotle Mexican Grill (CMG) left Big Macs in the dust with a 25% jump. Earnings rose an impressive 18% at General Electric (GE). Microsoft (MSFT) scored a 6% increase. The list of winners is impressive, and good numbers are still coming in.
The biggest gainers were the multinational blue chip companies that are tied to the global economy, which is much stronger than in the U.S. We think the positive earnings trend will continue, especially for companies with significant operations in Asia.
Investors are also pleased to hear that Washington is discussing ways to entice U.S. corporations to bring more of their foreign earnings home. As it is now, many successful blue chips are leaving most of their profits offshore to avoid onerous U.S. taxes. Either a one-time tax break or something more permanent for repatriated earnings would be good for the economy and good for investors. We think there is an excellent chance it will happen.
The Economic Outlook is a Bit Brighter
The moribund U.S. economy is also beginning to show a few tepid signs of life. Unemployment numbers improved a smidgeon earlier this month and there was a small increase in factory activity. Consumers are also spending a bit more money on retail goods. The improving numbers are still weak, but they are moving in the right direction for the first time in months.
Several U.S. companies have also said they expect to see a modest economic increase. The predictions by FedEx (FDX) and Caterpillar (CAT) are especially important because both companies are very sensitive to changes in growth.
What we notice while going about our daily activities may tell us more about the economy than government statistics and corporate projections. The mood in the community seems to be a bit brighter than it was a few months ago. The smile “index” is up, people have clearly been buying some new clothes, store checkout lines seem longer, roads are a little more congested, and so on. These observations don’t reflect the poll results that show a declining consumer outlook.
The most important measure of the economy will be the amount of money people spend during the holiday season. If sales are up from last year, we think growth in 2012 will be in the 2% area instead of the anemic 1% we have today.
Confidence will be the Key to Growth
The biggest factor currently holding growth down isn’t an economic or monetary deficiency, it’s a lack of confidence in the future.
Despite the slow economy and high unemployment, most consumers have discretionary money they can spend. Corporations have more cash than they have had in decades. Banks have ample funds to lend. However, few people will write big checks or take out loans because they aren’t willing to take chances during these uncertain times.
But confidence builds upon itself. If the holiday season turns out well, we think people and businesses will feel more optimistic about the New Year. If so, it should prove to be a self-fulfilling prophesy.
The bottom line is, the economy may do better going forward than is generally expected. That’s assuming the European default crisis can be controlled. If not, all bets are off.
The Search for Income is Becoming More Difficult
Millions of Americans rely upon bonds to supply the income they need. Unfortunately, the Fed’s decision to encourage economic growth by lowering interest rates has made good returns from fixed income investments hard to find. Ten year Treasury bonds are now only paying about 2%. That’s creating serious problems for many people, especially those who are retired.
To put the low interest rates into practical terms, consider someone with $1 million in fixed income securities. When interest rates were 5%, the annual return on a million dollars was $50,000. That was enough for a retired couple to enjoy a frugal but comfortable life, especially if their home was paid off.
At 2%, however, the return on a million dollars is only $20,000. That’s barely $5,000 above the official poverty level for two people. Who would have ever guessed that a couple with a million dollars would have a hard time getting by in America?
Dozens of Blue Chip Stocks Pay More Than Bonds
But all is not hopeless on the income front. We wish to remind readers that people in need of income should consider buying blue chip stocks that pay regular dividends. Many excellent companies have yields in the 4% to 5% range, and some are higher. In addition, the blue chips offer excellent prospects for long-term capital gains.
Several world-class blue chip dividend stocks we have been recommending in recent months have attractive yields, and good long term track records for paying them. Here are a few that look particularly good to us:
Yield on Cost: A Payoff Worth Waiting For
The leading blue chip stocks are rarely as cheap as they are now. In more normal times, institutional investors bid the prices of top stocks up to levels that make them unattractive. So, why are the biggest investors willing to pay so much?
The reason is, good companies usually increase their dividends over time which raises the effective return for investors who bought the stock earlier.For example, if you buy a $50 stock that pays a 2% dividend, you will get an annual check for $1. That’s not much to be excited about. But if over the course of a few years the stock rises to $100, and the company keeps the yield at 2%, you will get a check for $2. But since you only paid $50 for the stock, your effective yield (sometimes called “yield on cost”) will be 4%. If the stock reaches $200 and the yield is still 2%, the effective yield for you will be 8%. No bond will deliver such a nice kicker over time.
In Many Areas, Rental Housing is Attractive
Rental Housing has been a reliable long-term investment for thousands of years. The Roman commentator, Pliny the Younger, wrote about his profitable income properties in several letters to his friends.
Today, rentals look good in many areas because buying a home is not possible for many people. They either don’t have the higher down payment the banks require or they lack the sterling credit scores that lenders want to see. Other people are waiting to buy until house prices stop falling. There are also many former homeowners who had their properties foreclosed.
Whatever the reason may be, more people are looking for apartments and rental homes now than we’ve seen in several years. As a result, there is a shortage of available units in many cities. It’s a landlord’s market and rents are high.
Since house prices have fallen so far, and mortgage rates are at 50 year lows, rental housing will often “pencil out.” That means the rents they generate will cover the mortgage payments, taxes and maintenance costs – plus provide a positive cash flow for the owner. All in all, this appears to be an excellent time to get into the rental housing market.
Absolute Returns Closing Comments
The stock market continued its wild ride in October but without as many extreme moves as a month ago. More importantly, the bulls put in a stronger overall performance than the bears. As a result, the Dow and the NASDAQ are up this month 6.4% and 6.8% respectively. The good performance was a welcome change from earlier disappointments.
Alternatives abound for positive cash flows…look at dividend paying blue chips or rental housing. There’s a way to make “Absolute Returns” in just about every kind of market.
|Posted by the Research and Editorial Staff of
The Association for Investor Awareness, Inc.
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