Tuesday, July 26, 2011

Buying Citi (or Driving on the Wrong Side of the Road)

If you are American or continental European and you have ever been unfortunate enough to drive a car in the United Kingdom or another of the very few places on earth that force you to drive on the left side of the road, you will be familiar with the following gut-dropping feeling: for a moment, just a split second, after you have finally become comfortable with the idea of driving on what is for you the wrong side of the road, your mind suddenly reverts to its former state of consciousness, and you are convinced that you are now driving on the wrong side, the left side, which is, of course, the correct side in England. Sometimes the reflex reaction to return to the right-hand side of the road is so strong that you nearly swerve into oncoming traffic. Investing in the banks after a global financial crisis results in the same unpleasant feeling.

I have recommended recently the purchase of Bank of America (BAC) at what will turn out to be exceptionally low levels in hindsight. Now I would like to recommend a financial company that is even more hated than Bank of America. I can hardly read a paper or listen to a financial media broadcast without hearing some reference to too big to fail, which is an expression that has become mainstream largely owing to one company, a company so large and intricately involved in the global financial system that it was too big to fail in the following sense: if Citigroup (C) or Citi, as it is usually called now, had failed, the official unemployment rate would have topped out at 20% rather than at 10%; instead of talking about the great recession from which we are currently dragging ourselves, we would be talking about another Great Depression, or, as I claim, a Greater Depression because the world would have taken decades, rather than years, to recover.

The past few years have been painful enough, and that is why I find it infuriating when the Adam Smith purists proclaim that we should have let Citigroup fail; these financial zealots are rather like those Armageddon hopefuls who are disappointed that humanity wasn’t all violently exterminated on the prophesied date. I have owned shares of C for a long time, and, yes, I owned them through the global financial crisis as part of my (nearly) permanent portfolio. I watched my shares drop to a buck and then rally (if you want to call it that) back to $4.00. Now it trades at about $39, but only because of a 10-to-1 reverse-split fake-out. I think of the shares as priced at one-tenth of their current value to undo the fake-out factor. Therefore, the shares today would trade at a level of about $3.90. I added to my C position at about $1, which was a very difficult purchase to make. It seemed that the whole investment community was praying for Citi to go under, as Lehman was failing, but I figured that regulators knew more than puritanical traders about the catastrophe that would have resulted.

When I bought shares of Citi at a buck, I had that driving-on-the-wrong-side gut drop. During the past few years I have had the unpleasant feeling a few more times as I’ve watched not only the financials but also the broader market dip to absurdly low levels. Each time I would say to myself, “What if I am wrong this time? What if the stock is signaling that the company is truly spiraling into bankruptcy?” And that diffidence I felt about the market or an individual stock invariably turned out to be unfounded. The career traders were wrong. Now I treat that gut-drop as a good sign, that I am actually making the correct investment choice when I purchase the shares of a good company when everyone else, it seems, is selling them---that is, when I drive on the wrong side of the road.

Now back to Citi. Professional traders and capitalism zealots hate Citi so much because the U.S. Treasury and the Federal Reserve stopped the company from failing. Forget why Citi was saved or whether it should have been for a moment. The simple fact is that the U.S. Government kept Citi from going under, which is the major reason for professional investors’ profound hatred of the stock. As purists, they cannot invest in a company that took government help. Now even U.S. bank regulators hate Citi, and all U.S. banks, forcing them to adopt stricter capital reserve requirements and threatening fines and fees and lawsuits. Also, with such strict new regulation, the financial media has piled on and currently refers to U.S. banks a nothing more than regulated utilities. Still, the U.S. government will grow tired of running the banks eventually, and banks, like Citi, need to succeed in order for the economy to grow. Without the participation of the banks, any long-term rally is doomed.

With the broader market more or less trading range-bound this summer as professional traders take their vacations and as sovereign debt difficulties in the U.S. and in Europe work themselves out, C has been toggling between $38 and $40 (now we’re talking about the stock price after its reverse split fake-out). The stock has strong support at $38 and, unfortunately, strong resistance at $41; however, when C breaks through that resistance level, the shares will shoot up in price, because all the traders are watching that level and will not commit until the stock breaks out. If you would like to trade C, you could buy it near $38 because the shares have rebounded nicely from that level; then you could sell it as it fails to break through resistance under $41. If, however, the stock holds above $41, stick with it for a year-end rally in the bank stocks.

Still, I prefer Citi as a long-term holding, not as a trading vehicle because of its status as one of the most-hated stocks in history. If you are willing to hold shares for more than five years, the probabilities are on your side for an impressive return, especially when the company reinstates its once-substantial dividend.

Tuesday, July 19, 2011

The (Nearly) Permanent Portfolio: A Case for Stocks

I collect antique clocks and currently own 15 of them. I have a vague idea of how much I paid for them and, for the most part, I believe that they are now worth more than I paid for them; yet, I wouldn't be surprised to find out that they have depreciated in value since I bought them or that I paid too much for a few of them. I never worry about losing money on my clocks. I'm not sure that I'll ever sell them.

What if we apply the techniques for collecting clocks or books or paintings or baseball cards to collecting shares of stocks? We will be as smart as we can be about which stocks we buy and when we buy them, but once we have purchased them, let's make a pact that we aren't going to check our portfolio balance many times per day (yikes, I'm guilty of that one), and let's not worry about whether our stocks decline in value, because we plan to keep them, as I plan to keep my clocks, forever (almost). If the stocks we own go down in value, we might just add to our positions. Holding onto stocks despite short-term fluctuations in the markets was the popular investment strategy during the past couple of generations, and it worked pretty well for long-term wealth building. It used to be called buy-and-hold investing, and if you pay attention to the financial media, you would know that buy-and-hold is dead because of the lost decade for stocks, when we had two painful bubbles, the Internet and housing disasters. Those are scary things, right?

When most investors think that buy-and-hold is dead as an investing technique, it's the best time for us to employ the strategy anew. Sure, I love to trade on the intermediate time-frame, which for me means weeks or months; still, I have a group of stocks that I bought at what I think are fair valuations, and I plan to keep them forever (almost). Some of the stocks in my permanent portfolio are Bank of America (BAC), Alcoa (AA), Cisco (CSCO), the utility PP&L (PPL), and General Electric (GE). I bought all of these stocks in layers, building up a position by buying a few hundred shares at a time and over the course of several months or even years to ensure that I bought the shares at a reasonable average price. They all pays dividends, and all will probably increase those dividends over the next few years. I bought the shares when stocks were largely out of favor, so I am almost guaranteed capital appreciation over the long term. I am still buying these stocks when I can on dips to add to my (nearly) permanent portfolio.

Now what do I mean by nearly permanent and almost forever? Let's go back to my clock collection. What if suddenly, strange as it might sound, everyone wanted antique wall clocks? Suppose that someone came up to me and offered for my clock collection double or even triple what I thought it was worth. I like my clocks, but I would sell them, let the market for clocks calm down a bit, and then start collecting again. That's exactly what we should do with our (nearly) permanent portfolio. Eventually, and I mean maybe not for ten years, there will be a new bubble in stocks. Your mechanic, your hair-dresser, your child's school teacher, your neighbor, and people you meet walking their pit bulls in your neighborhood will all be talking about stocks, and their voices will tremble with maniacal excitement. When everyone is enthusiastic about buying stocks (not just a few of us, as it stands now),  I will sell my (nearly) permanent portfolio, just as I would my clock collection in a similar scenario. I will put my money in bonds or cash and wait for the bubble to pop; then I will start all over again.
PPL is a solid utility company that you can own for years.


Perhaps I will say a few words about the stocks in my (nearly) permanent portfolio. I have written previously about GE, BAC, and AA. Cisco Systems (CSCO) is a formerly-beloved, now-thoroughly-hated tech stock that provides the infrastructure for the Internet; it currently pays a pathetic quarterly dividend of 6 cents, but the dividend and stock price have plenty of room to grow. PP&L Corporation (PPL) is a utility that currently trades around $28 and boasts a quarterly dividend of $0.35, which amounts to, at the current share price, an annual yield of 5%. Both CSCO and PPL deserve more of our time, but we will save those words for a different day.

Have you noticed that most people aren't investing in stocks now? People look at you funny if you talk about stocks, as though you should not be talking about money when so few have enough of it after the great recession of the past few years. That disdain for building wealth will fade in the coming years, and when people become interested in saving for retirement again and the stock market is reaching new all-time highs, you'll want to make sure that you already own the shares that you will gladly sell them.

Tuesday, July 12, 2011

Love Your Pit Bulls, Not Your Stocks

Many years ago in Baltimore, the pet of choice among the widespread criminal element became the pit bull, because, among other marvels, it is a scrappy dog that can fit easily into a duffel bag full of cash. Noticing that criminals were enamored of the breed, regular folks, aspiring to be like the criminals, also began to adopt pit bulls as their representatives of man's best friend; finally, a few of the criminals went to jail or died in gun fights, and many of the regular folks who had pit bulls as family pets lost their homes or could no longer feed those big, hungry mouths. Now pit bulls roam the alleys of Baltimore as strays, waiting to be adopted by the few people who do not already own too many pit bulls. I have heard that your pit bull will steal your heart, and I agree that a pit bull might steal your still-beating heart with its angry jaws someday and swallow it with a quart-of-warm-blood chaser.

I suppose there should be an economic indicator that measures the number of stray dogs in cities across the U.S. With that statistic perhaps we would find a positive correlation between numbers of strays and economic stress felt by families. At the risk of mistaking correlation with causation, I would like to suggest that I have received fewer emails lately from neighbors and friends about stray dogs and, in particular, pit bulls. My sense is that in my city the economy is improving modestly in Baltimore, and if it is improving here, perhaps the economy is also improving around the country, where people also love their pit bulls.

I have never loved the stock Pfizer (PFE), but I have like it well enough. Wall Street hates Pfizer. I first traded PFE about 6 years ago when the company had fallen out of favor with investors because of the looming patent expirations of blockbuster drugs like Viagra and Lipitor, the former in 2012 and the latter later this year. Investors priced into the stock the loss of earnings on those drugs early. I bought PFE at an average purchase price of $24 and sold it at about $28, so the trade was a positive one but nothing to get too excited about. When the stock dipped again soon thereafter, I bought again and have held the stock ever since. The stock is hated and has been for about seven years or more. I like that part; the more hated a stock is by the investment community, the more, in general, I like the stock. A hated stock is always under-owned, and we want to buy stocks that are under-owned and then sell them back at a profit to the fickle traders who sold us the shares. Currently, PFE trades at around $20 and dipped into the mid-teens as recently as summer 2010.

What I find interesting about PFE is its under-owned status and its potential to generate dividend income for its investors. The quarterly dividend is $0.20, about 4% annually at the current share price. The company had to cut its dividend years back from $0.32 to complete the mammoth purchase of Wyeth. Since then Pfizer has been interested in raising its dividend as quickly as possible; it won't return to $0.32 any time soon, but we may be surprised by what future blockbuster drugs Pfizer will patent. Wall Street has been trading Pfizer as though the company will never again produce a significant drug, which is a ridiculous assumption. Furthermore, Pfizer has been restructuring and cutting costs to ensure that the dividend will increase or, at the very least, remain steady, and that will help the share price.

There are a few technical hurdles, however, for Pfizer with respect to its stock chart. For example, the chart shows the stock may be stuck under $21 for a few months at least. A double top is when a stock reaches a certain stock price, the top, then falls back only to make another attempt at exceeding the top again but fails and falls back again. Of course, you can have triple tops and quadruple tops and many-many-uple tops. The higher the uples, the more difficult the stock will have breaking out above that top, and that's bad for you if you own the stock because the top serves as a cap for the stock's price, especially in the short term. Why do we know this? Statistics. A double top decreases the probability that the stock will break out above the established top's resistance. A triple top decreases the probability further, and the higher the number of the top, the more difficultly the stock will have overcoming it from the standpoint of probability. See if you can see the tops in Pfizer's recent chart.

PFE's three-month chart looks terrible, but the company's prospects are improving.


Oh, so many tops. There is resistance at and below the $21-level. Here is another reason traders won't touch this stock: the more-than-triple top, a death knell for a stock according to traders. Still, using tops to identify resistance for a stock can be misleading. For example, the statistics only holds the stock below an established top if there is no big news to drive the stock past the resistance. For example, if Pfizer released news next week of FDA approval of a new potential blockbuster drug, the stock would pop and break through this $21 resistance level. Also, good news for the overall market might also help PFE over the $21 hurdle, but with the many worries we face near the end of the summer (for example, the U.S. debt ceiling, the European debt woes, etc.), a general stock market surge is unlikely until closer to the end of the year.

But there's a benefit to tops that many traders ignore, namely, that a stock tends to try to break its resistance at significant tops many times before it actually succeeds, so PFE presents an excellent short-term trading opportunity if it dips significantly below $20. You can buy the stock, for example, with a 19-handle and then sell it when PFE tries to break $21 again. If you had used that strategy many times during the past few months, you would love PFE, perhaps more than your pit bull. If PFE ever drops to the $17 or $18 level, I will add to my position significantly. Otherwise, I will hold the stock and collect 4% annually waiting for the stock to blow its top, which will happen, I think, within the next two years.

Tuesday, July 5, 2011

If Loving Gold is Right I'd Rather Be Wrong

I just finished a unit on finance in a math-for-non-math people course I'm teaching this summer. In the finance unit we cover some models and equations that determine the future value of investments, and after class, over several days, three different students asked me what I thought about gold as an investment. One student told me that her uncle was converting all his savings into gold. I blinked hard, twice. Recently, almost every other commercial on Sirius-XM's CNBC channel urges you to buy gold directly from a company that will ship it to your door or help you convert your savings to gold stored in one of their vaults. More than once during the past three months I have talked to someone who is converting a meaningful part of his 401(k) to gold. Gold, gold, gold. With the governments around the world printing so much money, shouldn't we just buy gold, gold, gold? Everyone is doing it! 

We should not do it precisely because everyone is doing it.

I had a boss in 1997 whose only investments were shares of Apple (AAPL) and gold ingots in his safety deposit box, two assets that, at the time, had been left for dead by the investment community. Well, if he still has those assets, he has done quite well on both. If he bought gold for about $300 per ounce, he is up about 400% versus about a 20% gain in the stock market, if that. My former boss knew precisely when to buy gold (or any investment): buy it when no one else likes it, when everyone scoffs at it. Ha, ha, investors said in the mid-nineties, I won't dirty my hands with gold. Yet, gold runs in long bull-market cycles, decades long; however, my claim is that even if gold doubles from $1500 to $3000 per ounce over the next three years, you are still better in stocks, many of which will do better than that. The steepest part of gold's run we've already seen.

What does gold really do? Gold is primarily used as a hedge when investors fear currency will loose its value because of inflation, but inflation is not always bad. A little inflation is actually good for investors. After all, it's ugly cousin, deflation, destroys wealth by reducing the value of all assets. A little inflation lifts the value of most asset classes. It's hyperinflation that we don't want. My claim is that we won't see hyperinflation (think Weimar Republic in the 1920s), which would force us to use scientific notation to order a coffee.  Still, the truth is that even in moderate inflation, stocks do well, especially stocks that can pass on their input costs to consumers. If you hold cash or bonds during inflation, you loose money at a very fast rate. 

Most people think that the U.S. Federal Reserve's current monetary policies are too loose and are introducing too much money into the system; that flood of currency, most claim, has forced commodities like oil and gold to shoot up in price. I disagree. If there were truly too many U.S. dollars in the system, gold and oil would not be going up in value in terms of other currencies as well. The Federal Reserve is introducing money into the system in order to replace all the dollars that went to money heaven during the economic disaster of the last few years and hasn't come close to replacing all that lost money; finally, oil is high because fear of future unrest in the Middle East (or whatever other fear you want to insert; oil traders are a panicky lot) and because of too much oil speculation by investors, not inflation. So inflationary fears have caused the appearance of inflation, not real inflation. Gasoline costs so much, in part, because people like us can trade oil futures, and that is scary. Gold costs so much because investors and citizens alike are afraid of inflation; hence all the commercials urging us to buy gold.

This gold bar is worth about $600,000 at today's gold price.  
Now I'd like you to imagine that you did what my student's uncle is doing, namely, convert your savings to gold. How big a nugget would you have? The picture above shows a gold bar that is worth roughly $600,000 using today's market price. Do you have $600,000 to invest in this gold bar? Would you be satisfied putting this in your safety deposit box? It won't pay you dividends; it may increase in value but probably not at the same rate it has over the past several years. It is pretty, though, I guess.

Here's what I'm buying instead of gold: the not-so-shiny metal aluminum---or, actually, Alcoa (AA), a producer of aluminum. If the Federal Reserve is creating inflation, then AA shares will increase in value. If the inflation we think we're seeing is just the expectation of inflation, brought about by speculators, then AA will also increase in value. The stock trades at around $16.00 and has run up a bit too much in recent days because of an oversold bounce in the stock market in general. But you'd be safe initiating one quarter of a position in AA at these levels and waiting for pullbacks this summer to add to that position and, therefore, lower your average purchase price of the stock. The stock with a 14-handle or below is a clear buy.

A one-year chart of Alcoa. I will be adding to my position on any pullbacks.

You see, Alcoa, historically has been a cyclical stock that trades in the lower teens in a recession and then trades in the mid-thirties when the economy is roaring. I plan to collect many shares of AA in the low teens and then sell them at thirty or beyond in a few years. I may not even get the chance to wait that long. If the global economy takes off again in a few years, which I believe is the case, a large international miner or industrial company may buy Alcoa, paying us shareholders a nice premium on our shares before the cyclical top of the economy. Furthermore, the company typically increases its dividend as the economy starts to grow. Right now the dividend is a paltry 3 cents per share. When the stock traded around $40, Alcoa paid a quarterly dividend of $0.17. As the economy and earnings improve, Alcoa will want to return more cash to shareholders, which will boost its share price.

Gold doesn't pay a dividend. It's just shiny, and the only reason gold stores any value is that we've all agreed to let gold store value. My bet is that by next summer aluminum will outshine gold.