Why Most of the Investment Advice You’ve Heard is Wrong

Why Most of the Investment Advice You’ve Heard is Wrong

by Alexander Green, Investment U Chief Investment Strategist
Friday, January 20, 2012: Issue #1691

A conversation with a friend last week sounded numbingly familiar.

“I just can’t seem to win for losing in the stock market,” he confessed. “Five years ago, my broker had me fully invested in stocks and I took a drubbing. Then when things were bottoming out a couple years later, he talked me into making my portfolio more conservative. As a result, I didn’t get much of a pop on the rebound. Now he’s trying to get me to reshuffle again. But I’m too scared to do anything.”

Since he was a friend, I felt obliged to tell him the truth: He’s getting lousy investment advice. Not because his broker failed to outguess the market… but because he’s guessing at all. As if that wasn’t bad enough, there’s a good chance that the advice he’s getting is tainted by self-interest.

Here’s what I mean…

It still astonishes me that the vast majority of investors – even ones who have been active for decades – still don’t understand that stock market success has nothing to do with figuring out the economy.

Look back at history. There’s no correlation between economic growth and stock market performance from year to year. Equities routinely plunge during the good times and rally during the bad. If you know this – and truly understand it – why would you invest your money based on someone’s economic forecast?

The same is true of market timing. It’s easy to look in the rearview mirror and see when you should have been in the market and when you should have been out. But when you look ahead, it is always a blank slate. No guru or trading system can change that.

Even if you could somehow divine what the stock market was going to do next – which you can’t – you still wouldn’t know which stocks would outperform and which ones would lag.

The only way to determine that is to look at business fundamentals. Companies that are doing all the right things – increasing sales, compounding earnings at high rates, growing market share, improving operating margins, paying down debt, buying back shares – will post superb returns, regardless of what the economy or stock market are doing. And those that are doing the opposite – experiencing flat or negative sales, lackluster earnings growth, small margins, high interest costs and diluting existing shareholders with new stock issues – will be laggards.

In short, stock market success is about analyzing businesses not investing in some self-styled expert’s macroeconomic forecast. Yet that’s exactly what the mass media and much of the investment advisory industry encourages people to do every day.

The media does it to attract viewers – and thus advertisers. The advisory industry does it sometimes out of ignorance but often just to justify its fees. This is especially true when you have a transaction-based relationship with an advisor where the more you trade the better he or she is compensated. Trust me. That doesn’t generate satisfactory long-term returns.

Every time you hear a pundit talk about “the new normal,” the rally just ahead or the prolonged economic slump we’re likely to endure, understand that you’re listening to opinions that are no more helpful than a weather forecast for three weeks from Sunday.

Both pieces of advice are worthless. But one is a lot more expensive – and harmful – than the other.

Good Investing,

Alexander Green

The One Place to Invest for Growth, Income… and Safety

The One Place to Invest for Growth, Income… and Safety

by Alexander Green, Investment U Chief Investment Strategist
Monday, November 14, 2011: Issue #1642

Eight weeks ago, I wrote an Investment U column pounding the table for dividend stocks. Since then, they’ve ratcheted higher, but I still see plenty of upside ahead.

Someone who shares my enthusiasm for high-yield stocks right now is my friend and former colleague Rick Pfeifer, Senior Portfolio Manager at Fund Advisors of America, a  Florida-based money management firm.

On a recent trip to the sunshine state, I stopped into his office to hear why he, too, feels this is one of the best places to put your money to work today.

Q: Rick, there’s an awful lot of fear and anxiety about the economy and the stock market right now. Investors are confused and uncertain about what to do with their money. What is your take on things?

A: In a market as volatile as this, you have to spread your bets. But my take is this: If you’re looking for growth, buy dividend-paying stocks.

If you’re looking for income, buy dividend-paying stocks. If you’re looking for safety, buy dividend-paying stocks.

Q: Why?

A: The first question every investor has to ask himself is, “How should I divide my money among stocks, bonds and cash?”

The average money market fund currently pays two one-hundredths of one percent. At that rate, you will double your money in just 3,600 years.

Q: Not terribly attractive.

A: Definitely not.

And Treasury yields won’t make you jump up and click your heels, either. The 10-year guy is yielding two percent, which translates – at best – to a zero-percent yield after inflation.

Q: Tough to meet your investment goals that way.

A: Right.

In my view, dividend stocks are a good place to be right now for several reasons. Let’s talk about safety first. When the Dow traded at these levels 11 ½ years ago, it sold for 47 times earnings. Today it trades at less than 14 times earnings. Stocks are cheap right now on the basis of sales and earnings.

But even during market declines, dividend-paying stocks hold up better than non-dividend-paying stocks and sometimes fight the broad trend and rise in value. The reason is obvious. These tend to be mature, profitable companies with stable outlooks, plenty of cash and long-term staying power.

Q: U.S. companies are sitting on a record amount of cash now, too, right?

A: Correct.

U.S. companies currently hold more than $2 trillion in cash, a record. Thanks to this economy and the current Administration (don’t get me started), companies aren’t hiring and they’re not boosting spending. So a lot of this cash is rightfully going back to shareholders.

The Dow currently yields more than bonds. And dividend growth among U.S. companies has averaged 10 percent per year over the last two years, more than double the long-term dividend growth rate.

Q: Okay. Dividend stocks are less risky than non-dividend payers and currently pay more than cash or bonds. But how do you think this group will perform in the years ahead?

A: We can only use long-term historical performance as a guide, but the numbers are pretty darn encouraging. Over the last 50 years, for instance, the highest 20 percent yielding stocks in the S&P 500 returned 14.2 percent annually.

That’s good enough to double your money every five years – or quadruple it in 10. And if you were even more selective, say investing only in the 10 highest yielding stocks of the 100 largest companies in the S&P 500, your annual return would have been even better, 15.7 percent.

Q: We should add the standard caveat here about past performance and point out that there are risks with dividend stocks, too, right?

A: Indeed. You have to be selective. An investor would be foolish to plunk for a stock just because the dividend is large. The market is full of “dividend traps,” troubled companies that pay hefty dividends to keep investors from bailing out.

Q: How does an investor avoid those?

A: Mainly, by doing his or her homework. You need to look at prospective sales and earnings growth. You have to examine the balance sheet and make sure that the company isn’t too highly leveraged.

You have to note cash balances. And, perhaps most importantly, you need to analyze whether the payout ratio is sustainable.

Q: So can you give us a few examples of high-yielders that have you been buying in your managed accounts lately?

A: I’ve been nibbling at Windstream Corp. (Nasdaq: WIN), a well-run communications and networking company with an 8.3-percent current yield. I like oil and gas producer Enerplus (NYSE: ERF), with its high operating margins and 7.7-percent dividend.

And – this one is a bit different – I’ve been picking up a 10.3-percent yield with the Gabelli Global Gold Trust (AMEX: GGN). There are plenty of other attractive high-yield situations out there, too. They should be owned, of course, as part of a more broadly diversified portfolio.

Q: I agree, Rick. Thanks for your time. Let’s chat about this sector again in a few weeks.

Good investing,

Alexander Green

How to Beat “the Mania of Pessimism”

How to Beat “the Mania of Pessimism”

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, September 12, 2011: Issue #1598

Two weeks ago, I opined that the biggest obstacle a stock market investor faces today is “headline risk.”

That is, relentless media negativity.

The idea seems to be gaining traction. On last week’s “This Week” on ABC, Pulitzer Prize-winning columnist George Will said, “The very least the media should do right now is not detract from the nation’s understanding or add to the synthetic hysteria.”

In the September 17 USA Today, James Paulson, Chief Investment Strategist at Wells Capital Management, said, “We are in the middle of a mania of pessimism. The nation is suffering from “Armageddon hypochondria.”

Again and again, the media reminds us about the weak dollar, high unemployment, the soft housing market, problems in the Euro Zone, political dysfunction in Washington, trouble in the banking sector, and the down-and-out consumer. After a few hours of this, you’d expect to walk outside and see bread lines and angry mobs.

That’s not what you see, however. What you see instead are ordinary people going about their everyday business – and getting bombed periodically with media sensationalism calculated to attract viewers and sell advertising.

It works, too. In fact, it works so well that few people see all the positives that exist today.

“Positives?” a friend asked me the other day, genuinely perplexed.  “What positives?”

Exactly. We’ve gotten to the point where people have had so much downbeat news dripped on them for so long that they can’t even imagine there is a positive side to recent events or that any logical case can be made for owning stocks to meet their financial goals.

So let me take a stab at it now.

For starters, realize that it is not possible for anyone to accurately and consistently predict economic growth or stock market performance. But here’s an insight you can take to the bank: Share prices follow earnings. (Earnings, of course, are the net profits of a business.)

In the third quarter of last year, the companies that make up the S&P 500 reported all-time record earnings. In the fourth quarter, those record earnings were exceeded, as they were again in the first quarter of this year… and yet again in the recently reported second quarter.

If you didn’t hear that we’re in a period of all-time record corporate profits, you really ought to think twice about who’s delivering your newsworthy information. Or at least who’s providing your investment guidance.

As investment legend Peter Lynch once noted, “People have all this data and yet they look at all the wrong things… It’s about earnings. They need to follow the earnings.”

Of course, just because corporate earnings have hit an all-time record four quarters in a row, it doesn’t mean they will continue. And, conversely, it doesn’t mean that they won’t.

If you can’t imagine why stocks would rally from here, just imagine what will happen if the much ballyhooed double-dip doesn’t appear.

• There are plenty of good reasons to be bullish on stocks right now. But if you’re developing your investment perspective from gloom-and-doom media reports, you may not recognize the positive factors. So I’ll tick off four big ones for you now:

• Interest rates are at historic lows and inflation is negligible. That isn’t likely to change any time soon.

• Energy and food prices are moving lower and Ben Bernanke has pledged to hold short-term rates at zero for two more years.

• Valuations are cheap.  When the S&P 500 traded at these levels eleven years ago, it sold for 44 times earnings. But because profits have hit new records lately, the S&P 500 today sells for just 13 times trailing earnings, well below the long-term average of 16.4.

• Investors are anxious and afraid. This may seem like a negative but it’s not. Investor sentiment is an excellent contrarian indicator, especially when accompanied by low valuations. Think back to the market low of March 2008, when the consensus was that the world was coming to an end and the Dow briefly traded below 6,500. From that point the market put on an impressive rally, essentially doubling in two and a half years. As investment pioneer John Templeton rightly said, “Bull markets are born on pessimism, grow on skepticism, peak on optimism and die on euphoria.” Do you know anyone who’s feeling euphoric right now? Not me.

• Mutual fund investors have yanked money out of stocks over the past six weeks. It may seem counter-intuitive but that’s yet another positive. A 25-year study published last year in the Journal of Financial Economics found that if you had simply invested in the S&P 500 when equity fund flows were negative (redemptions exceeded new investments) and into 90-day Treasury bills when fund flows were positive (new investments exceeded redemptions) you would have substantially outperformed the market while spending nearly half the time in riskless T-bills. In other words, it pays to buck the consensus.

Don’t get me wrong. More bad news from the Euro Zone and political wrangling here at home will still push stocks around from day to day. That’s not important. What is important is whether you’re confident – as The Oxford Club is – that the companies you own are set to report dramatically higher profits in the weeks ahead.

You may be reluctant to invest in stocks. I understand. It takes nerve and resolve to go against the trend and invest in times like these. But you should.

FDR was wrong about some things. But he got one big thing right. The only thing you have to fear… is fear itself.

Good investing,

Alexander Green

Is It Different This Time?

Is It Different This Time?

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, August 22, 2011: Issue #1583

Investment legend John Templeton famously said that the biggest mistake an investor can make is to say “this time it’s different.”

In some ways, this statement may seem a little strange.  On the surface, every market correction is different. For example, when the stock market imploded on October 19, 1987, falling over 22 percent in a single session, that was unexpected. After all, no government failed that morning. No currency collapsed. No President was shot. To this day, pundits still argue about why the stock market crashed.

Or how about the bear market of 1990? No one foresaw Saddam Hussein rolling into Kuwait that August, taking over the country and its oil fields. Investors worldwide speculated that the Middle East would go up in flames. (And, indeed, many Kuwaiti oil fields did.) That was certainly different.

Then there was the collapse of hedge fund giant Long-Term Capital in 1998. Fed Chairman Alan Greenspan feared that unwinding the fund’s highly leveraged positions would turn the bond market upside down. He worked behind the scenes to get major Wall Street firms to help bail out the fund. That was something new.

Or how about the March 2000 to October 2002 bear market that started with the collapse of technology and Internet stocks? It was the end of an era, the deflating of a bubble. We hadn’t seen anything like that in modern history.

Or how about 9/11? Who woke up that day suspecting that a group of zealots would fly planes full of people into buildings? Not me.

The mania for residential real estate six years ago was something curious, too. And so was the collapse of sub-prime mortgages. That led to an unprecedented financial crisis and a harrowing drop in the Dow. You don’t see something like that every day.

So was Templeton out of his mind when he declared it foolish to say “this time it’s different?” Of course not. Templeton well understood that the particular events that cause a market decline will always vary. What shouldn’t vary is the way you respond to it as an investor.

If you bought into the market crash of 1987, you did very well over the next few years.  After the bear market of 1990, stocks went on a remarkable 10-year run. If you bought into the secular bear market of 2000 to 2002, you also made out handily over the next five years. And, of course, the market almost doubled from the lows of the financial crisis in 2009.

Here we are today and the stock market has swooned again, this time due to sovereign debt problems here and in Europe. Nothing like this has happened in recent history.

So the question you face now is whether to take advantage of the sell-off and buy great companies at bargain prices or… to insist “this time’s it’s different.”

The choice is yours.

Good investing,

Alexander Green

A Solid Investment Strategy For a Shaky Market

A Solid Investment Strategy For a Shaky Market

by Alexander Green, Investment U’s Chief Investment Strategist

Monday, June 6, 2011: Issue #1528

As you may have noticed, the stock market is acting hinky again. That makes now a good time to review your investment foundation.

Here’s what I mean…

We keep past issues of our Oxford Club Communiqué – which includes our Trading Portfolio – posted on our website. A few months ago I received a letter from a new Oxford Club member who went back through the past couple of years and was astonished by what he found.

“You were heavily invested in top-performing stocks before the financial crisis, then went totally into cash early in the meltdown, then profited from the enormous market rebound that followed. How in the world did you get it so right? How did you know what would happen?”

The short answer is we didn’t know, never will know and neither will anyone else.

What will happen in the future to interest rates, currency values, and stock prices is always an open question. This is especially true when you throw in unforeseeable geopolitical events, thousands of pages of government legislation (and their unintended consequences) and a large dollop of fear, greed, and hope.

Accept the truth. You will never know what the future holds. And that’s okay because you don’t have to…

Taking Advantage of Stock Market Uncertainty

What you need instead is an investment system that allows you to take advantage of the uncertainty inherent in the markets.

Start by looking back at history. You’ll notice two important things.

1. Owning profitable businesses is the best way to preserve and build wealth.
2. Over the past two hundred years, the stock market has gone up more than three-quarters of the time.

Over the long term, shareholding is a winning game. Trying to time the market’s ups and downs isn’t. So we buy great companies – those we believe will post the biggest earnings surprises in the months ahead – and don’t worry about the tone of the market.

Protect Winning Positions With Trailing Stops

Yes, bear markets (which are normal) are nasty and will take your stocks way down. We don’t want that to happen. So we don’t let it. Instead, we carefully protect our winning positions by using trailing stops. As long as our holdings are trending up, we’re happy to stick with them. But when any stock pulls back 25 percent from its closing high, we bid it adieu.

That’s exactly what happened in the financial meltdown a couple years ago. When things started coming apart at the seams, our trailing stops protected our profits and raised cash. By October 2008, we had sold all 44 positions in our portfolio for an average gain of 28 percent. (Not bad for a year when the S&P 500 fell 36 percent).

Since we are not market timers, we started gradually rebuilding our portfolio and were able to profit handily all over again. We currently have 27 positions in our Oxford Trading Portfolio. Twenty-five of them are profitable. And our average short-term gain is 43 percent.

Yet here’s what millions of other investors did over the last few years instead:

• They watched their profits evaporate and didn’t buy much while things were cheap.
• They panicked, switched to cash and missed the rebound or
• Worst of all, they rode their stocks down, panicked and sold, waited too long to invest and only recently bought back in. Now they’re starting to feel nervous again.

Get Rid of the Fear and Anxiety of Stock Market Investing

Fear and anxiety are natural when you don’t know what the heck you’re doing with the money you intend to live on some day. But you can get rid of the fear by dumping an investment approach that doesn’t work.

Please understand, we couldn’t possibly have known how everything was going to unfold. And neither could anyone else. But we used – and still use – an investment system, for our Oxford Club subscribers, that allows us to profit in good times and protect our capital in the bad.

Now that the market is acting jittery again, the question to ask yourself is “Am I using a system that allows me to capitalize on the uncertainty that is inherent in the markets? And, if not, why not?”

Good investing,

Alexander Green