March 2007 Issue
Relaxing at Pepe’s…
| Top 10 Common Stock Countdown |
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It was 3:30 on a sunny afternoon at the outdoor patio at Pepe’s, a long-time Key West locals’ favorite for its Mexican Roast Oysters, Black
Bean Soup, and Steak Smothered in Pork Chops, as well as for its funky atmosphere. Pepe’s is proud to call itself the Eldest Eating House in
the Florida Keys and pours as its draft beer Yuengling Lager, brewed in the oldest brewery in America. On this particular afternoon, Pepe’s
owner had converted the garden patio into a recording studio for his friend, folk music legend Tom Rush, who was in town for a concert. Even non-folk-music
fans like me remember the historic shows Tom Rush put on back in the ’60s at Club 47 in Harvard Square in Cambridge.
Under the Mahogany Tree
Debbie and I were sitting under the shade of a mahogany tree at a table within spitting distance of this amusing, talented performer, thanks to friends
of ours who own the local and very great Restaurant Supply Store. Tom Rush invited his friend Jonathan Edwards (J.E. wrote “Sunshine”) to
join him for a number of songs. Two talented musicians, whose bantering and joking were as good as their music, provided a terrific time. We were fortunate
to be able to hear Tom Rush in such an intimate setting and talked later with lots of Key Westers who wished they had known about Tom’s impromptu
recording session at Pepe’s.
Being at the Right Place
Like so many things, you need to be at the right place at the right time. Timing is everything. In our case, living only a few blocks from Pepe’s,
being long-time supporters of Pepe’s, and getting a call from friends with whom Jonathan Edwards was staying didn’t hurt the cause. All in
all, a nice blend of factors keyed our good fortune and timely opportunity to see the legendary Tom Rush.
Good Timing Required
Most often, good timing is not just a matter of luck. Rather, good timing is the product of good fortune. One makes one’s own good fortune by
creating the right environment to allow good things to happen. It’s amazing how great your timing can be when you take a consistent approach to
engaging in activities that in the end put you in a position to allow good things to happen to you. And the reverse is also the case, often to a greater
degree.
On the back page of your enclosed Economic Analysis, you will find my regular monthly feature, What’s Up & What’s Down. If you
used What’s Up as your investment shopping list last year (and for that matter the year before and the year before that!) as I did, you must be
pinching yourself today at your good fortune. Talk about great timing.
.955 Batting Average
There are 38 funds listed. Over the last three years you have had 112 chances to invest for profit. How’s the batting average? Overall the average
is .955, as 107 out of 112 chances provided winners. Not to be boastful, but .955 is a darn tough record to match. And last year, 16 out of the 38 names
listed gave you a gain in excess of 20%. That’s the gist of it. Over 42% of the names on the list gave you a gain of 20% or more. Compare that
to an 11% advance for the unweighted Value Line Index, the best measure of overall stock market activity. The cherry on the cake for the Monster Master
List in 2006 was the one-two punch of eight 30%+ gains and two 40%+ gains. Over the entire three-year period, with112 opportunities, there were only
five potholes (negative numbers), and none of the five caused any loss of sleep.
Your Precious Metals Savior
Some quick math shows that a $100,000 investment only 24 months ago in Vanguard’s Precious Metals & Mining Fund (VGPMX), one of my
own biggest holdings, would have ended 2006 with a value of $193,000. I invest in Vanguard Precious Metals & Mining as a defensive anchor. If VGPMX
declines, I can be pretty certain most everything else I own will go up. And I’m happy for years (it won’t happen often) when this gem of
an anchor fund and a whole spectrum of market-related funds roar upward in unison. Talk about a doubleheader bonus. I’ve often written that, at
the top of the portfolio, Vanguard Precious Metals & Mining is loaded with platinum stocks, which is one of so many reasons to own VGPMX. Unlike
gold, the world’s central banks are not loaded with platinum reserves that can be dumped on the market at a moment’s notice.
Your Great Start in 2007
For 2007, you are yet again off to a spectacular start. There already are lots of big winners YTD, including Vanguard REIT, T. Rowe Price
Real Estate, iShares Singapore, iShares Hong Kong, and, of course, Vanguard Precious Metals & Mining. I own each and
advise each for you. As I often write, 100% of my own money goes into positions I advise for you in these letters, and I encourage you to invest right
along with me. I’d better be right. I write about what I’m doing in the spirit of full disclosure and am not aware of any other financial
advisor who does the same.
As you can see from What’s Up, you and I have had three awesome years in a row. Per last month’s disclosure, I will shortly be adding to
current positions in (1) iShares Switzerland, (2) iShares Singapore, (3) Third Ave. International Value, (4) Fidelity Canada,
and (5) Fidelity International Real Estate.
Fidelity Nordic Countries Fund
Along with a modest position in iShares Malaysia (and T. Rowe Price Emerging Europe & Mediterranean Fund), I have added Fidelity Nordic
Countries Fund for my own account. I am just getting into full swing with this fund and am planning to make it a sizable position. I advise the
same for you. Fidelity Nordic Countries invests primarily in Sweden, Norway, Finland, and Denmark. Norway, for example, has a huge current-account
surplus, as well as a jumbo budget balance, as a percent of GDP. And the fund’s #1 holding, its Swedish positions, is underpinned once again
by a large current-account and budget surplus versus GDP. Finland, Denmark, and Switzerland also have positive current account and budget surplus balances
versus GDP. In contrast, the U.S. has a sizable current account deficit along with its budget deficit.
Love Sweden and Norway
Neither Sweden nor Norway is part of the euro, nor are Denmark and Switzerland (also part of the Nordic Countries Fund). For max currency diversification
from the US$ (a must), you want to concentrate on stable countries with positive current-account and budget balances. Norway, Sweden, and Switzerland
are tops on my list, followed by Canada, Hong Kong, and Singapore. I also include Japan, even though Japan runs a budget deficit.
Your Map to the Future
Now let’s look at the underpinnings of the U.S. economy. Stocks love economic prosperity and hate business downturns and, worse yet, full-blown
recession (two negative quarters of GDP back to back). If you feel that the economy is on course and not headed for recession, you can sleep a whole
lot better. My chart set will help make you comfortable that, at least for the immediate future, all is well.
(1) Recession will be at the door following a big run-up in the coincident/leaders ratio. Chart #1 shows modest uphill activity. (2) Once workers’ hours
get cut, look out. Chart #2 shows that it is full-speed ahead for the guys on the shop floor. (3) A collapse in capital goods non-defense new orders
would send negative vibes through the economy. Well, Chart #3 still points to a nice uptrend. (4) As you see in Chart #4, there is long-term downtrend
in consumer confidence. That’s because so many Americans are tapped out with ridiculous adjustable mortgages, bled-out home equity lines of credit,
sizzling credit card balances (American Express won’t take these folks.), little if any money in the bank, and no idea what retirement planning
is all about. The recent snapback indicated in my chart points to a little steam still left in the kettle. (5) Chart #5 shows that conditions continue
to tighten on the factory floor. This is not the type of environment in which recession thrives. (6) Chart #6 shows the surge in manufacturing, machinery,
and equipment plus business construction expenditures. Do you think this has the look of recession? Nope. Everyone is going bonkers about the housing
fall off. (7) But check Chart #7, which shows there is loads of precedent for such a cyclical drop off. I wouldn’t get too exercised yet about
housing. (8) Chart #8 shows how corporate profits have exploded. Since I started in the investment business at Clayton Securities at 147 Milk Street
in Boston in April 1964 (Thanks, Ed), there is no precedent for such a surge.
The Bush tax cuts have resulted in a tidal wave of supply-side revenues for Uncle Sam. And the budget deficit, far from widening, has sharply contracted.
As it stands now, Bush’s lower rates tax will expire in 2010. This simply cannot be allowed to happen. Congress must make these cuts permanent—no
ifs, no ands, no buts.
Now that you are good to go on the economy, let’s look at some stocks you can buy today. There is a lot I like.
1) Jardine Matheson, Ltd. (US ADR: JMHLY) I want you to concentrate on beefing up your non-U.S. asset base, and the place to start is Asia-based
conglomerate Jardine Matheson. You will be investing along with a stable of the world’s best value investors, including Franklin Mutual, Third
Ave, and Wintergreen Advisers. My chart shows Jardine’s consistent power versus the U.S. S&P 500. Buy.
2) Barrick (NYSE: ABX). This major gold producer is at the bottom end of a solid upside channel.
3) St. Joe (NYSE: JOE). I’ll no longer hold my old favorite during hurricane season, but you are OK here in February. Buy.
4) Valero (NYSE: VLI). My pipeline favorite, after a nasty correction, is now back on track, as I show you in my chart. Your yield is over 6%.
Buy.
5) Plum Creek (NYSE: PCL). One of my longest running favorites. Plant seeds, harvest trees, and then offer investors a nice dividend. Great story.
My chart shows an upside breakout. Buy.
6) Citigroup (NYSE: C). Conservative CEO Charles O. Prince finally got tired of flamboyant wealth-management head Todd Thomson and gave him the
boot. Perhaps it was Todd’s 50th floor penthouse office featuring a working fireplace. Despite the Thomson shuffle and the whining about expenses
by Saudi Prince Alwaleed, Citigroup’s largest individual shareholder, I still like the stock. Further big changes are in the offing. Buy.
7) GE (NYSE: GE). As my chart shows, GE finally looks like it is awakening from its long nap. Buy.
8) ConAgra (NYSE: CAG). Orville Redenbacher is arising from the dead (digitally) with popcorn ads. ConAgra’s stock has been hot for a year,
but as my chart shows, it remains well below trend. Buy.
9) Kinder Morgan Energy Partners (NYSE: KMP). After a year-long correction, my high-yielding pipeline system favorite, as my chart shows, has
regained its footing. Buy.
10) Coca-Cola (NYSE: KO). As my chart shows, the #1 brand in the world is still available to you well below trend. Buy.
More Monster Master List Stocks
ExxonMobil (NYSE: XOM) remains a buy. The shares are up nearly 16%, even though oil prices peaked last July. Remember, lower oil and gas prices
(raw materials in the chemical business) help ExxonMobil’s huge chemical operation. And XOM is one of the lowest-cost oil producers in the world.
Caterpillar (NYSE: CAT) remains a hold. We project a solid 2007 and a timely re-entry point for CAT during the first half.
McDonald’s (NYSE: MCD). Does the company’s spin off of Chipotle Mexican Grill have anything to do with the freeze on taco prices
in Mexico? It’s a puzzler. No matter your wild guess, McDonald’s stock remains habanero hot. Buy.
Sturm, Ruger (NYSE: RGR). The company has announced a $20 million stock repurchase program. Dressing the bride? Buy.
Harley-Davidson (NYSE: HOG). My favorite company in the world just reported a modest 6% increase in worldwide unit shipments for 2006. A note
of caution: 66.7% of the increase was export sales. A double caution note: In the 4th quarter, 97.9% of the increase was export. In the 4th quarter,
HOG sold only 109 more Twins domestically than in the 4th quarter 2005. Yikes! I posted a temporary sell on HOG in IR at $72/share. I am awaiting a suitable
price for a re-buy.
Annual Q&A, Part II
This year’s annual Q&A was the best yet. The quality of the questions you sent in was outstanding. Starting with this year’s annual
Q&A, I have decided to cover your questions in two parts.
Q. In the January 2007 issue, unfolding trends #6, you state, foreign currency-denominated assets, including the Canadian dollar, Swiss franc, Singapore
dollar, and Japanese yen will serve as a nice hedge to a structurally weak U.S. dollar. Are iShares Singapore and Fidelity Canada foreign currency-denominated
assets?
A. Both funds are foreign currency denominated and neither fund hedges away currency risk. T. Rowe Price Japan, iShares Switzerland, Fidelity Nordic,
iShares Australia, and iShares Malaysia are also foreign currency-denominated assets.
Q. For preferreds, how far down on the rating scale are you willing to go?
A. It depends on where we are in the credit cycle and my outlook for the issuer’s business. When the economy is strong and banks are eager to
lend, you can dip into BBB+ issues, but avoid anything lower. Lower rated issuers often avoid default when they have access to credit. As the credit
cycle turns, banks tighten lending standards and the default rate on lower quality issues starts to increase. As the cycle starts to turn, rotate out
of lower quality issues. How do you know when the cycle is beginning to turn? The junk bond spread, the difference between the yield on junk bonds and
treasuries, is a leading indicator of turns in the credit cycle. Rapidly rising spreads signal a flight to quality is underway.
Q. While short-term trading should not be encouraged, can we make an exception for accounts which have no tax consequence (IRA)? For example, while
my regular account follows your MM List advice (and I am quite pleased with the results), in my IRA I have moved from Apache to Inco to Wrigley and
now to Sturm, Ruger. Your advice is priceless.
A. In tax-deferred accounts, you can afford to be a little more active, but remember, transaction costs are not limited to taxes. You still have to
pay bid-ask spreads and commissions. The round-trip cost, excluding taxes, on thinly traded stocks can approach 2%. If you are going to make short-term
trades, do it in tax-deferred accounts, limit your trading money to a small portion of your overall portfolio, and stay away from stocks with large bid-ask
spreads.
Q. On your Top 10 Common Stock Countdown you will recommend a stock like McCormick that has a P/E of greater than 25, but in your Economic Analysis
you state that stocks over 16X P/E are overpriced. Why would you recommend a stock so overpriced in your top 10?
A. Good question. In the Economic Analysis Report, I’m talking about stocks in general or the stock market average. There is a big difference
between the P/E on the stock market and the P/E on McCormick. The P/E on the stock market represents the earnings multiple of the average business. McCormick
is the leading spices company and it generates significant and stable cash flow. A premium multiple is warranted.
Q. Should I hang onto Kinder Morgan Energy Partners and Buckeye Partners?
A. Yes, midstream master limited partnerships are great businesses with outstanding yields that are largely inflation protected. Midstream MLPs own
the tanks and pipes that store and transport crude oil, gasoline, and heating oil. Oil and gas storage and transportation is a simple business with great
economics. Buy some pipes and tanks, stick them in the ground, and charge a volume-based usage fee. The barriers to entry are high, labor intensity is
low, and asset maintenance is manageable. Continue to add to your shares of Kinder Morgan Energy Partners, Buckeye Partners, and Valero in taxable accounts.
Q. I started Roth IRAs for my two young daughters several years ago. How would you allocate $20K in money market assets among your listed funds on
the back page of your monthly report listing? Thanks for a great 2006! I’m with you all the way!
A. With $20,000 and a long time horizon, I would invest 25% in Third Avenue Value, 25% in Dow Diamonds, 25% in Dodge & Cox International, 12.5%
in New Era and 12.5% in T. Rowe Price Real Estate. This allocation will provide you with a fairly diversified portfolio with exposure to my favored market
sectors.
Q. How do I go about contacting a Swiss bank as you suggested in your Jan. newsletter? How much wealth should a person have to open a Swiss account?
A. If you are of substantial means (minimum liquid assets of $1,000,000), I advise a Swiss banking relationship. The U.S. is the most litigious society
in the world, and Swiss banks are unreceptive to American lawyers looking to chase Swiss bank clients and their assets. It would be an expensive, lengthy,
and most difficult process for an American court to have much sway in Switzerland. The cheapest way to protect your assets is a simple Swiss bank account.
Establishing a Swiss banking relationship firsthand is not an e-mail or phone call type of thing. Travel to Geneva or Zurich and meet with a few local
banks. What banks might you visit in Switzerland? The biggies are Credit Suisse and UBS. You might also wish to visit with Julius Baer, Vontobel, and
Banque Privée Edmond de Rothschild. All are substantial, well-known, and highly respected. A number of smaller Swiss banks also offer an ideal
option. Be sure you report your Swiss banking relationship to the IRS. You will have no issues as long as you do not attempt to hide your activities
from the tax man. Remember here, your goal is not to avoid U.S. laws and taxes. Your goal is to erect a formidable barrier against those who would come
after your life savings.
Q. I was intrigued by your 10 unfolding events in the last issue—particularly #3. What is a boutique-registered investment advisory firm and
could you mention some that currently exist?
A. A boutique-registered investment advisory firm is a small independent company that offers proprietary management and research abilities to high-net
worth individuals and businesses. The boutique-registered investment advisory business model is an ideal fit for many investors. Boutique advisors offer
a client-friendly fee structure and proprietary asset management programs that are centered around an investment philosophy.
The fees at boutique advisory firms are based on a percentage of assets under management. Boutique RIAs share in the success or failure of your portfolio.
To most wire-houses, insurance companies, and RIAs charging more than 1%, the success, or more often failure, of your portfolio is a distraction.
Boutique RIAs recognize the benefits that consistency and discipline bring to the portfolio management process. Investment programs are centered on
an investment philosophy. Prospects who do not share that philosophy are turned away. Qualifying prospects based on a shared investment philosophy create
long-term relationships. Long-term relationships with clients allow boutique advisors to spend more time on investment management and less time worrying
about marketing and client retention.
Q. This has to do with the Federal government’s gigantic accrued deficit. According to the Office of Management and Budget’s recent report,
the unfunded liability of the federal government is $50 trillion, a mind-boggling number. Further, the comptroller declares the current fiscal path “unsustainable.” The
usual way out for governments is to simply inflate the money supply. The actual alternative—higher taxes and cuts in social programs, is much
less politically savory. Oughtn’t a wise investor move much more (say, 80%+) of his/her assets out of the U.S. dollar and into Swiss francs or
something else not subject to this gigantic fiscal time bomb?
A. A good portion yes, but 80% is too high. If you live in the United States, all of your liabilities are in U.S. dollars. On the off-chance that the
government passes some entitlement reform and our current account position improves, the “fiscal time bomb” may end up being a dud. A stronger
dollar would likely follow. If 80% of your assets were in non-dollar-denominated securities and the dollar strengthened, you would end up a whole lot
poorer. Limit your foreign currency exposure to no more than 50% of your total portfolio. With that 50%, make sure you are exposed to more than one foreign
currency. Ideally, you will want exposure to at least three foreign currencies.
Q. I invested in St. Joe five years ago and though I didn’t get out at the high I have done okay. I love the key real estate, but 65 times
earnings makes me feel like a speculator, which I am not. Is JOE still a good investment?
A. The price-to-earnings ratio is a simple metric that can be used to value many companies, but not all. The P/E ratio has limited appeal for cyclical
companies and real estate companies, among others. St. Joe is in the business of real estate development. An investment in Joe is an investment in an
asset—Florida real estate. A better metric to value St. Joe, and the one that Young Research uses, is estimated net asset value. Net asset value
is simply assets measured at market value minus liabilities. Our net asset value estimate for St. Joe is $68 per share, versus today’s stock price
of $58.
Q. Do you recommend zero coupon bonds?
A. I still recommend zeros. The current interest-rate environment hasn’t presented an opportunity for a change in strategy with zeros in some
time. I continue to recommend that investors keep maturities under five years. I will advise you when an opportunity presents itself for a change in
strategy with zeros.
Q. What are your recommendations for high dividend-paying stocks?
A. Kinder Morgan Energy Partners (6.6%), Valero L.P. (6.0%), Buckeye Partners (6.2%), Conagra (2.8%), Rayonier (4.4%), Plum Creek (4.0%), BP (3.4%),
Unilever (3.0%), Citigroup (4.0%), and Natural Resource Partners (5.8%). These 10 will give you an average yield of 4.6%. Be sure not to purchase Kinder
Morgan, Valero, or Natural Resource Partners in tax-deferred accounts.
Q. Why should anyone buy a bond fund yielding 5%–6% when we can earn around 5% in money market funds (substitute T-bills or CDs) with no risk
to principal?
A. If you invest all of your money in T-bills, you are taking on excessive reinvestment risk. Reinvestment risk is especially important for retired
investors who rely on income from their portfolio. Assume that you retire today with $1,000,000. The 3-month T-bill is yielding 5.1%, and intermediate-term
bond funds are yielding 5%. If you invest in T-bills, you will earn more interest with zero principal risk. What happens if T-bill rates drop from 5.1%
today to 1.7% next year? Your income will drop 66%. If you buy intermediate-term bond funds and rates decrease, your income will stay the same for a
couple of years and provide you with valuable time to make alternative income plans. Doesn’t sound realistic? T-bill yields dropped from 5.9% on
12/31/2000 to 1.7% on 12/31/01.
Fixed Income
GE Capital Corp has come out with an AAA-rated preferred yielding about 6% (no symbol yet). Load up on this one. Your broker may have been in the underwriting
group. A mix of Dodge & Cox Balanced and Wellesley Income offers you fortress-like protection (50% fixed income) as Chart #52 in my
Economic Analysis shows.
Your Counterbalanced Self
If you are retired, or soon to be, I’d like you to be, depending on your needs, 30% to 75% fixed income. And as a goal, I’d like everyone
to be at least 30% international. This goal will take time for many of you, as it will for me. I’d sell your Canadian General Investments and
replace it with Fidelity Canada. I’m more comfortable with Fidelity Canada’s disclosure policies. Be certain your iShares Singapore and Switzerland positions are each about 5%
of your total portfolio. I’ll steadily add more global names to the Monster Master List. Nestle and Jardine should be part of your 32-stock
portfolio. Also on the fund side, continue to build your position in Fidelity International Real Estate (up 42.9% last year).
Don’t let inertia defeat you. Make your portfolio adjustment calls now while the matter is fresh on your mind. You will be the big winner at the
end of the day. Make it a good month.
Warm regards,
Richard C. Young
P.S. Dow Transports are a tick away from confirming new highs for the DJIA. Confirmation would be a most powerful and welcome signal for better times
ahead.
P.P.S. I am looking hard at ways to participate in two off-the-radar countries with great promise—Vietnam and Argentina. Stay tuned for upcoming
developments.
P.P.P.S. Iran’s Ayatollah Ali Khamenei has apparently suffered a cerebral stroke. In the past, the Ayatollah has said Iran would not give up its
nuclear technology. He will now be replaced, at least temporarily, by the apolitical Ayatollah Mohammed Reza Mahdavi Khani. On the surface, this is potential
good news for the U.S. I wonder how many Americans know that our new #1 man in Iraq, Lt. General (and Ph.D.) David Petraeus, is the Army’s #1 expert
on counterinsurgency and is considered as perhaps the smartest active duty U.S. general.
Coming Next Month: Coal stocks and basic metal stocks—dump them or load up the dump truck and buy them?
Websites to Hit: YoungResearch.com for this month’s Essential Music and Babys.com for the killer coffee I’ve been ordering
from Baby’s. It’s called Testaroasta, an outstanding Italian roast. Baby’s has a 3-lb special for you.
A Book Not to Miss: Coronary by Stephen Klaidman. Shocking is the word that applies best here. If you or any member of your family has
heart problems, you want this book.
Breaking News: Go to my IR Website or YoungResearch.com for all the info on a brand-new, aggressive stock strategy service now available
from Young Research for the first time.
Richard C. Young’s Intelligence Report® (ISSN 0884-3031) is published monthly by ACP Phillips Investment
Resources, LLC, 9420 Key West Ave., Rockville, MD 20850. Please write or call if you have any questions. Phone: 301/424-3700 or 800/301-8968. E-mail: service@intelligencereport.com.
Web address: . Editor: Richard C. Young; Group Publisher: Michael Bell; Associate
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year. © 2007 by ACP Phillips Investment Resources, LLC, Founding Member of the Newsletter Publishers Association of America. Photocopying, reproduction
or quotation strictly prohibited without the written permission of the publisher. While the information provided is based upon sources believed to
be reliable, its accuracy cannot be guaranteed, nor can the publication be considered liable for the investment performance of any securities or strategies
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