Many Excellent Stocks Are Oversold – The AIA Advocate Newsletter

In This Issue:

The Economy, The Economy, The Economy
The Poor Numbers Don’t Fit What We See
There Is No Shortage Of Cash
Confidence Is Everything
All Eyes Are On The Fed
Inflation Is Baaaaaack
Many Excellent Stocks Are Oversold
The Bottom Line This Month

In our last issue we wrote that stocks were “primed for a big move” depending on how well, or badly, American and European politicians handled their economic emergencies. Judging from the stock market plunges on both sides of the Atlantic, investors gave their leaders big red “Fs” in problem solving. Maybe we all need better officials.

From when the market plunge began on July 21 to its low point on August 10, the Dow and the Nasdaq dropped 14.7% and 15.4% respectively. Two indices then bounced back a bit and now stand 10.0% and 12.3% below their July peaks. The decline qualifies as a correction, but it stopped short of being a bear market. Of course, there is still time for the bruin to show up.

The Economy, The Economy, The Economy

What has investors concerned the most are the revised economic numbers from the first two quarters of 2011. Instead of the puny 1.8% growth that was first reported, the GDP may have only increased a miniscule 1%, or even a little less.

The slide is all the more worrisome because it happened while Washington’s head economic alchemist, Ben Bernanke, was happily stimulating growth with his QE2 program. But if growth was only 1% during QE2, what level will we have now that it’s over? On Tuesday, the Wall Street Journal reported that we might see only 1% during the second half as well.

With growth so close to the zero line, it would not take much of a shock to push the economy into another recession. Pessimists believe it may have already started.

The Poor Numbers Don’t Fit What We See

We have not been to every part of America, but in the cities we visited this summer the economy was doing quite a bit better than the official numbers suggest. Granted, we didn’t find any evidence of a boom anywhere. Neither did we hear a chorus of pounding hammers announce that the housing industry is reviving.

However, the roads we traveled had many new cars, everybody seemed to be well dressed, and the mood was cautious but not depressed. We know it was just a thumb in the wind type of measure, but nothing we found made us think the economy is on the ropes.

There Is No Shortage Of Cash

Besides what we saw while traveling around the country, there are other reasons to think the economic outlook isn’t as bad as the GDP data suggest.

In the first place, we are not having the credit crunch that almost always precedes a recession. Banks have plenty of money and they are willing to lend it to worthy borrowers. But people and businesses are so nervous about the future, they don’t want to take any risks right now. So the bank’s ocean of money is just gathering dust in their vaults.

Corporations also have oodles of cash. The blue chips especially have been raking in the profits from the global economy, and they have been packing the money away. Like everybody else, most companies are too nervous about the future to spend much of their loot to expand operations or update their equipment.

Consumers aren’t anywhere near as flush as big businesses, but neither are they as hard pressed as many analysts believe. Joe and Sally MidAmerica are also worried about the future, so they are just as tightfisted as everybody else.

Confidence Is Everything

We think the lack of confidence in the future is doing more to hold the economy back than any financial limitation. That’s not surprising given all the bad news that everyone is being subjected to on a daily basis.

The debt ceiling fiasco did the most to dampen the public’s outlook. Besides being disgusted at their politicians' behavior, the public now doubts that the government will be able to do anything about the budget, Social Security, Medicare, and other serious problems our country faces. That’s not a situation that makes people feel comfortable enough to reach for their checkbooks.

Fortunately, optimism has always been part of the American culture. It would not take very much good news to turn the public mood around. So far, that news seems elusive, but when it arrives we think the economy and the stock market will make big jumps.

All Eyes Are On The Fed

One possible source of increasing optimism may come on Friday when Fed Chairman Bernanke makes his annual speech to America during the agency’s symposium at Jackson Hole, Wyoming. Many analysts expect the chairman will announce another stimulus program, just as he did last year when QE2 was introduced. The anticipation of a Fed boost pushed stocks up 3% on Tuesday.

But, as we indicated a minute ago, QE2 didn’t accomplish much. In addition, the Fed doesn’t have the resources available it had in the past. Nevertheless, hope springs eternal that Mr. Bernanke will find something that will give investors cheer. If he doesn’t, we think stocks may give the 3% back, and then some.

Inflation Is Baaaaaaack

Despite all the money the Fed created to stimulate the economy over the past three years, inflation has remained low. Now the grace period may be coming to an end.

After remaining under 2% for the past two years, inflation just jumped to what corresponds to a 3.5% annual rate. The actual increase for the typical American family will be higher because the Fed removed food and energy prices in its calculations. If the grand pooh bahs in Washington would get out of their limos and do some shopping for themselves, perhaps they would put some reality back into their inflation formula.

The biggest price hikes are being found in the supermarket. Drought in some parts of the world, and floods in other parts, have pushed corn and wheat prices up. Since both crops are used to fatten livestock, and are used in many other food products, the price hikes are rippling throughout the economy.

The need to hold the line on inflation is another reason the Fed must act cautiously. Any stimulus program that causes prices to rise further may do more harm than good.

Many Excellent Stocks Are Oversold

Speaking of stocks dropping lower, many of the finest multinational companies are cheaper than they have been in many years. We think investors who have the courage to buy the top companies that others are selling will enjoy excellent returns down the road.

The secret to success is to buy companies that have a long history of bouncing back from difficult conditions. That’s true of almost all the blue chips that make products that nearly everyone uses. Energy, food, healthcare, and consumer staples all sell well even when the economy is slow.

This time around the economic cycle, the outlook for the blue chips is even better than in the past. Most companies in the Dow earn about half their profits outside the U.S. where growth is stronger than it is at home. That’s one of biggest reasons most large companies have fat cash reserves.

You can stack the odds further in your favor if you choose companies that have a history of regularly sharing their loot with their stockholders. Since what a company is worth is ultimately based on the returns it generates, investors will eventually price its stock appropriately. It may not happen until today’s scare melts away, but fundamentals always win in the end.

Stocks that pay attractive dividends look especially sweet right now because the returns on cash are abysmal. Short-term T-bills are essentially paying 0.0%. Even 10-year Treasuries are only paying about 2.0%. With inflation running about 3.5%, today’s fixed income securities can only offer investors a guaranteed loss.

Stocks that fit the criteria include:

Company PRICE P/E YIELD LINK
Abbott Labs (ABT) $50.51 15.4 3.90% http://finance.yahoo.com/q/bc?s=ABT
Coca-Cola (KO) $69.06 12.9 2.80% http://finance.yahoo.com/q/bc?s=KO
Colgate Palmolive (CL) $87.01 17.8 2.70% http://finance.yahoo.com/q/bc?s=CL
Consolidated Ed (ED) $55.38 15.2 4.40% http://finance.yahoo.com/q/bc?s=ED
Deere (DE) $72.66 12 2.40% http://finance.yahoo.com/q/bc?s=DE
ExxonMobil (XOM) $73.66 9.7 2.70% http://finance.yahoo.com/q/bc?s=XOM
General Electric (GE) $15.54 12.2 4.00% http://finance.yahoo.com/q/bc?s=GE
General Mills (GIS) $36.75 13.6 3.40% http://finance.yahoo.com/q/bc?s=GIS
H.J. Heinz (HNZ) $51.44 16.8 3.70% http://finance.yahoo.com/q/bc?s=HNZ
Johnson & Johnson (JNJ) $64.97 15.5 3.60% http://finance.yahoo.com/q/bc?s=JNJ
Kraft Foods (KFT) $34.09 18.1 3.59% http://finance.yahoo.com/q/bc?s=KFT
McDonalds (MCD) $89.53 18.1 2.80% http://finance.yahoo.com/q/bc?s=MCD
Procter & Gamble (PG) $63.02 16 3.40% http://finance.yahoo.com/q/bc?s=PG
Wal-Mart (WMT) $53.21 11.3 2.80% http://finance.yahoo.com/q/bc?s=WMT

The Bottom Line

Stocks plunged this month when officials in Europe and America failed to adequately address their country’s most pressing economic problems. In the U.S., growth also dropped to a miniscule 1% while inflation jumped to 3.5%.

But the biggest threat to stock prices is a lack of confidence in the future that’s causing businesses and individuals to hold onto their cash. Until that changes, growth is unlikely to pick up significantly.

Wise investors who have been around the economic track a few times are buying high quality stocks that are likely to bounce back once conditions improve. It’s the best way to profit from the downturn.

Until Next Month

The AIA "Advocate For Absolute Returns", a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time ...


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Copyright 2010 The Association for Investor Awareness, Inc. All Rights Reserved

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Posted 08-25-2011 2:54 PM by Research & Editorial Staff