Absolute Returns: Washington, D.C.-February 7, 2012
Absolute Returns Reports…
There’s no doubt about it now…the market has made up its mind which way it’s headed, and it looks like the bulls are leading this parade. Since we published our November 2011 letter, the Dow and the Nasdaq gained 14.3% and 15.8% respectively. Those are exceptional two-month absolute returns.
The gains are even better when the market’s performance is measured from its October low. From that dismal level, the S&P 500 is up more than 25%. For the present, at least, the bear is nowhere in sight.
Detailed below is a recap of the portfolio we suggested for late 2011 and 2012.
Topics to Consider:
*The Economy is Showing Some Real Signs of Life
*Growth Stocks Should Benefit the Most
*The Outlook from Here
*It’s Time to Start Nibbling at Housing Stocks
*The Bottom Line
The Economy is Showing Some Real Signs of Life
Stocks are doing well because the long-moribund U.S. economy is finally beginning to inch its way off the mortician’s table. Nothing is happening that would lead anyone to think that a full recovery is in the works. However, manufacturing, consumer spending, and home sales in some regions, are ticking up.
Although the economic increases are modest, after three years of recession, the gains are significant. Not only do they mark a reversal from the norm, all three indicators are moving up at the same time.
We must caution readers that it is too soon to break out the party hats and kazoos. Overhanging the U.S. economy and the stock market is the precarious sovereign debt crisis in Europe. Since that part of the world consumes about 20% of America’s exports, if it slips into recession the U.S. economy will soon follow.
The same will be true if China’s growth slips much more. A war with Iran, higher oil prices, and other worries could also hurt the economy. But if they don’t occur, we think 2012 could be a better year than seemed likely a few months ago.
Growth Stocks Should Benefit the Most
When an economic improvement begins, the stocks that have the biggest gains are those that can make the most of the tailwind. The group includes many of the large-cap companies that we have been recommending.
The “Select Portfolio for Late 2011 and 2012” tells the tale. Here is the table again showing the performance of the stocks from November 18 to January 23.
Our traditional growth stocks lead the pack: Alcoa, Deere & Company, Caterpillar, and General Electric are all up. So is Goldman Sachs, the mega-bank and investment company that always benefits from improving economic growth.
On the other hand, defensive stocks that hold up when the economy is weak, are lagging. That list includes Colgate Palmolive, Johnson & Johnson, and Procter & Gamble. Two of the three made small gains.
Two of our income stocks, Consolidated Edison and Eli Lilly, also lagged the market. The exception was Kinder Morgan Energy Partners that is benefiting from high energy prices. Ditto for ExxonMobil.
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A Select Portfolio For Late 2011 and 2012
For An Emphasis On Current Income:
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The Outlook from Here
We think our growth stocks have further to go. Turnover on the S&P 500 is at its lowest point since 1997, which suggests that most investors have not yet joined the rally. If the gains continue for another week or so, we think many of them will come off the bench and give the upturn an added boost. If not, the rally will probably end.
As long as the economic uptick continues, the defensive stocks should continue to underperform the market. However, we urge investors to hang onto their defensive stalwarts because there is no guarantee that the economy will continue to expand. If the outlook turns dark once again, the defensive sector will regain its luster.
We also think our income stocks should be held. With interest rates remaining on the floor, the high yields these stocks pay make them very attractive no matter what the economy may be doing.
Because of the threats to growth that we mentioned a minute ago, we urge investors to protect all their stocks with stop loss orders. Stops are easy to place and they don’t cost anything unless the market falls far enough for them to be activated. At that time, only normal selling commissions apply.
It’s Time to Start Nibbling at Housing Stocks
After five years of utter despair, the housing sector is also showing some signs of life. As with the broader economy, a full rebound isn’t on the way anytime soon. However, in many regions of the country the sound of hammers can be heard once again, and some prices have started to move back up.
The biggest question we need to ask ourselves is, should we buy housing stocks at such an early stage of the recovery. We think the answer is yes. History strongly suggests that investors who take early bird positions in an upturn are almost always its biggest winners.
With that in mind, here are two housing investments that we think will do particularly well over the next few years:
Lennar (LEN): The changing outlook for housing is starting to show up in the balance sheets of a few successful homebuilders.
We think the best of the lot is Lennar, a company that has been in the black for seven quarters. In the most recent quarter, new orders for homes rose 20% compared to the same period last year. In addition, the company’s order backlog rose almost 38% to $560 million. Those are remarkable achievements in an industry that has been spouting red ink for many years.
One of the reasons that Lennar is doing well is the company has been using the housing downturn to invest in distressed properties. In the most recent quarter the division’s revenues more than doubled to $46.5 million. With property values continuing to remain low in most parts of the U.S., we think the distressed investment business will remain strong for several more years.
Lennar also made good use of the few regions where real estate remained in relatively good shape. Two such areas were Portland and Seattle where the company purchased 650 lots late last year.
We think this well managed company will reward investors. The small dividend it pays should add to its appeal.
Equity Residential Properties (EQR): The rental property business is also doing very well. Houses are still too expensive for millions of Americans who have no alternative except to rent. Foreclosures are also increasing the number of renters. In addition, the children of baby boomers are continuing to move away from home and need places to live.
At the same time, the supply of rental housing is tightening. Monthly starts of multifamily properties has yet to keep up with demand. As a result, rents are rising in most cities.
We think Equity Residential Properties should benefit from today’s housing trends. The REIT owns 421 developments in 15 states. In total, the trust owns 119,743 individual units.
The company also looks good because it focuses on higher growth markets where rents are near the top of the scale, and vacancies are near the bottom. Properties include such landmarks as Trump Place in NYC, Harbor Steps in Seattle, City Pointe in Los Angeles, and West End in Boston – to name only a few.
In addition to the capital gains we expect to see from Equity Residential, the REIT pays an attractive 4.10% dividend.
Absolute Returns Bottom Line
The economy started to show some signs of life late last year and the stock market was quick to respond. Although we doubt that the upturn marks the start of a new bull market, the rally may last another few weeks. Investors who participate in the bounce, but who are smart enough not to think it will last forever, should do very well. To help prevent being caught by a sudden end to the party, we urge readers to put stop loss orders on all their purchases.
Looking best of all are the classic growth stocks that benefit from increasing economic activity. Alcoa, Deere, Caterpillar, and General Electric all look good to us, as does Goldman Sachs.
We also like the long term outlook for the housing industry that appears to be in the very early stages of a recovery. Lennar and Equity Residential Properties should make good use of the welcome change in one of America’s largest sectors.
Posted by the Research and Editorial Staff of
The Association for Investor Awareness, Inc.
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