May 2007 Issue
The Dawning…
| Top 10 Common Stock Countdown |
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The Age of Aquarius rumbled into high gear on Friday 16 June 1967, at California’s Monterey County Fairgrounds. Thanks to the vision of John Phillips
(Mamas & the Papas), Lou Adler, Bill Graham, Ralph J. Gleason, Andrew Loog Oldham, and Derek Taylor, the pop music industry exploded with a tidal
wave of enthusiasm and activity.
1967’s Summer of Love
This June is the 40th anniversary of the Summer of Love, a California phenomenon of amazing worldwide musical and financial significance. Monterey International
Pop Festival, with its theme of music, love, and flowers, was rock’s first major festival. Monterey was the first pow wow of the love crowd. The
psychedelic subculture was in full bloom, launching the careers of the Grateful Dead, Jimi Hendrix, Janis Joplin, and The Who. And Monterey was the first
time Otis Redding had ever played before a large, mostly white audience.
A Financial Catalyst and Explosion
Monterey was certainly the first time pop record honchos were awakened to the breadth, power, and blazing commercial potential of the new Aquarius Age
music. On the heels of Monterey, where the musicians played for free, every major sector of the pop music industry instantly hit the big time. Talk about
a catalyst. The checkbook was out! Record sales (you remember records) soared. Ticket prices for concerts jumped, FM radio stations got a super-charged
boost. Advertising revenues soared. And the golden age of rock ballrooms unfolded (think Bill Graham, RIP).
Sgt. Pepper’s #1
The Beatles’ Sgt. Pepper’s Lonely Hearts Club Band, released in Britain just weeks earlier on 1 June, hit the runway with full thrust and
went on to sell over 11 million albums, remaining on the charts for over 160 weeks. Rolling Stone, the National Association of Record Manufacturers,
and Dick Young rank Sgt. Pepper’s as the #1 rock & roll album of all time.
Ah, what a summer 1967 was. As Dennis Hopper (Easy Rider) said about Monterey, “To many of us it was the first and the last. I can’t think
of anything as special as that moment in my life.” And Tommy Smothers, one of the emcees, affirms, “I was fortunate to have been there and
to have been a part of something that doesn’t happen very often. In fact, it was so exceptional, nothing like it has happened since that time.”
Catalysts & Supercycles
The Monterey International Pop Festival was the catalyst for a financial tidal wave in the pop music industry that would last for a decade. My 2008-based
Big Idea, hitched to the luxury goods supercycle, is the same, if not a whole lot more. The first babyboomers (over 75 million) turn 62-½ in mid-2008.
Social Security and retirement beckon. Millions of this crowd will be in the chips, ready to buy summer and winter second homes or perhaps to relocate
to warm-weather states (think Florida, S.C., Arizona, and Texas first). Lots of disposable income will be available to pursue interests of ones youth,
such as collecting, motorcycling, boating, snowmobiling, as well as flying, and on and on.
The Luxury Goods Supercycle
Loads of companies will be primary benefactors as the luxury goods supercycle kicks in with my 2008 Big Idea babyboomers retirement. One company I wrote
about last month is American Express (NYSE: AXP), a sure-fire beneficiary. High-end buyers carry the American Express Black or Platinum card—period.
And babyboomers who like to travel (will be ecstatic) over the great services and benefits provided by American Express’s Business Platinum Travel
Service. If your target is globetrotting, that’s where the Business Platinum Travel Service really kicks in (1-800-553-9497). With this service,
you can buy a first-class or business-class ticket, for example, to Zurich, and your spouse receives a complimentary companion ticket. You are looking
at big-time savings here.
If you require ground transportation while in Zurich, AMEX Business Platinum Travel is at your beck and call with its first-rate limo program. Want
to fly Delta or Cathay Pacific or Emirates or Swiss International or LAN or Virgin or Lufthansa? Well, AMEX Business Platinum Service can hook you up
with all, plus plenty more. How about a fabulous once-in-a-lifetime Windstar, Holland America, Cunard or Crystal cruise? You’re all set. Need a
small villa for a couple of families or a group of friends in, say, Tuscany or the West Indies? Well, AMEX Business Platinum Travel Service can set you
up. How about a Yangtze River tour, the Orient-Express, a custom tour to Bangkok and Singapore, or perhaps just a little spa resort vacation in Bora
Bora? AMEX Business Platinum Travel Service has you covered. And there is more, much more that can come your way as a result of your Platinum or Black
card hook up with American Express.
Retirement Compounders +21.8%
The power of American Express to deliver as the luxury goods supercycle unfolds is driven home by the following shocker. U.S. American Express card
members charge nearly four times as much on their American Express cards as they do on competitors’ cards, such as MasterCard and Visa. There is
simply no comparison between the luxury goods supercycle power of AMEX and its competitors. I’ve been a consistent supporter of AMEX and have strongly
advised the shares. And I’ve explained in the past how AMEX has been a building block for our family investment company and for Young Research’s
Retirement Compounders program. Last year alone, Young Research’s Retirement Compounders program was up 21.8% (unaudited). My chart on AMEX portrays
the consistent upside power in AMEX’s stock this century as well as the fact that today the shares are available to you at an attractive point
in AMEX’s stock price cycle. Buy AMEX and hold the shares as a cornerstone in your retirement portfolio.
Gulfstream Is the Key
I want you to buy General Dynamics (NYSE: GD), a new name to the Monster Master List this month. My reason is singular. Gulfstreams are the absolute
crème de la crème of the international executive aircraft fleet. Today, Gulfstream is owned by GD. Prior to its General Dynamics hookup,
I was an avid adviser of Gulfstream in my monthly letters to you. I think Gulfstream would be better off today if it were once again independent of big
brother GD. A parting of the ways would benefit both companies. Check out my enclosed chart on GD showing its relative price action versus the S&P
500. You’ll see that GD has been getting the job done. Today, GD sells for $78/share. Tomorrow it will sell for much more. And perhaps you will
once again be able to own Gulfstream as an independent company.
My Executive Jet Theme
Executive jets of all types are a central part of my 2008 Big Idea. And investing with General Dynamics today at $78/share gets you a seat on board.
Don’t be left behind. Don’t let inertia defeat you. Remember, my best advice is that you take action with at least one idea from each issue
of IR. This rigid discipline will help you defeat inertia and keep you current as events of the world change. Adding General Dynamics to your list this
month is a quick and easy way to pass “my monthly action test.”
Now a quick note about Young Research’s charts. Each month before I write, I go through our four-chart set on every Monster Master List stock.
I then evaluate the four-chart set in relation to the value numbers calculated by Young Research’s research director Jeremy Jones, CFA. Each chart
and stock gets a grade. No Monster Master List stock is bypassed. You get my latest views on every Monster Master List name. Even if I don’t mention
a particular name in IR, you’re still covered.
We’re on the Same Team
As you know, I do not invest a dime of my own money beyond what I write about to you in these letters. I guess you could say that I am 100% comfortable
that there is no need for either of us to look elsewhere. When you consider the 21.8% gain (unaudited) of Young Research’s Retirement Compounders
stocks last year in concert with the bonanza record of the mutual funds and ETFs as outlined in What’s Up & What’s Down, the results
have been staggering. If you have been only half paying attention, you’ve enjoyed eye-popping results and much comfort and consistency as well.
Monster Master List Funds
Most of today’s available ETFs offer little compelling reason for purchase. Young Research regularly scans the ETF universe for new offerings
for you as well as updates to the Monster Master List. Today, we have a dozen ETFs on our buy list, which we will be adding to little by little. You
will not need to go beyond these letters for your ETF investments. Most recently, I have purchased iShares Malaysia and iShares Hong Kong.
I use country ETFs as counterbalancers in my own portfolio and advise the same for you. The Dow, S&P 500, and NASDAQ have not provided much boost
YTD. Improvement will come later in the year. Once again, our specific counterbalancing funds have won the day for you, as they have for me. The yen
and the Japanese stock market presently offer top-flight value. Call and buy the T. Rowe Price Japan Fund while the matter is fresh on your mind.
Japan is just plain cheap, and new rules make the takeover business in Japan a meaty target. Don’t get left on the sidelines.
I’m aggressively building my position in iShares Switzerland, iShares Sweden, and Fidelity International Real Estate. Make
certain all these are on your own roster.
Won’t Pay the Bills
Starting in 2008, many babyboomers will become uncomfortably aware of the arithmetic of retirement income. It is vital that you become an expert on
the opportunities and strategies of fixed income. My max recommended withdrawal rate is 4%, but for many babyboomers, a 4% draw is not going to pay
the bills. Instead of tying on the orange apron at Home Depot—or dare I say the blue one at Wal-Mart—many boomers will reach for yield,
a strategy fraught with risk.
High-Yield Illusion
Where will these yield-reaching investors turn to pick up additional income? High-yield bond funds are a popular choice among the retired generation
in desperate need of income. Yields are over 7.5%. Intermediate-term treasuries yield 4.7%. To the uninformed, high-yield bonds are the magical solution
to all their income problems. Retired investors purchasing high-yield bonds will often draw the entire 7.5% and assume principal will remain intact.
Many investors have been sold high-yield bonds as a permanent component of a diversified fixed-income portfolio, but historical returns do not support
this strategy. Investors are not considering defaults or loss of purchasing power via inflation. High-yield bonds pay high yields for a reason: a portion
of high-yield bonds will default and principal value will plummet.
The Black Army
Yield-hungry retirees are not the only group of investors reaching for income. There is an entire army of pension and hedge fund managers doing the
same thing. I refer to this crowd as the Black Army. Today, yields on all assets have declined to levels that many institutional investors find unacceptable.
Easy monetary policy in all of the major economies of the world forced interest rates to a two-decade low in 2005. My chart on world government real
bond yields shows that real yields, while off the lows reached in 2005, are still at the low end of their 20-year range. For decades, institutional investors
have built return expectations around bond yields that are much higher than they are today. Rather than accepting lower returns, many investors have
sought higher yields without properly evaluating risk.
The Squeeze Is On
My chart on the high-yield quality spread shows the amount of additional yield over treasury notes that investors demand in order to purchase high-yield
bonds. When the spread is wide, investors are skeptical of high-yield bonds. When the spread is tight, investors jump through hoops to buy high-yield
bonds.
Watch the Yield Spread
The high-yield quality spread moves in lock-step with the default rate on high-yield bonds. When default rates are low, spreads are tight. When default
rates are high, spreads are wide. Today’s 2.8% spread is at the low end of its 10-year range because default rates are low.
Here’s some back-of-the-envelope arithmetic with default rates and recovery rates to help provide insight on the quality spread. The default rate
is the percentage of outstanding high-yield bonds that stops paying interest. The recovery rate is the percentage of face value that an investor gets
back on a defaulted bond. The default rate multiplied by one minus the recovery rate should equal the expected principal loss on an investment in high-yield
bonds. In order to compensate investors for the expected principal loss, the high-yield quality spread, of course, must be greater than the expected
principal loss.
Your High-Yield Guide
Since 1980, the historical default rate on high-yield bonds has been 4.4%. The average recovery rate has been 40%. My back-of-the-envelope formula says
to multiply 4.4% by 1 minus 40%. The resulting 2.64% is the minimum quality spread an investor should require to purchase high-yield bonds. Minimum quality
spread only indicates that the return for high-yield bonds would be the same as for treasuries. But remember, high-yield bonds are far riskier than treasuries.
To compensate for this additional risk, add an additional 2% to 3% to our 2.64% to equal 4.64% to 5.64%.
A Nasty Stew
Default rates are a vital consideration. The current default rate of 1.6% is close to its normal cyclical low. The only direction default rates can
now move is up, which is bad news for investors. My chart on the high-yield default rate shows what can happen when the credit cycle turns. Default rates
shoot up. And when default rates increase, recovery rates fall. This combo is a nasty stew for high-yield investors. The quality spread widens sharply
and the value of high-yield bonds plummets. In such a condition, investors could be faced with double-digit losses. Today, an investment in high-yield
bonds is an ill-advised wager that super-low default rates are here to stay.
Young Research has created a series of charts to evaluate the performance of high-yield bonds versus full-faith and credit U.S. treasury notes. The
Merrill Lynch High-Yield Master Index has been used as a proxy for high-yield bonds, and the J.P. Morgan 3- to 5-year Treasury Index has been used as
a proxy for treasury notes.
Understand Credit Cycles
High-yield bond performance should be evaluated over a full credit cycle. A full cycle runs from peak to peak or from trough to trough. The high-yield
default rate can be used to find peaks and troughs in the credit cycle. There have been two true credit cycles in the last 20 years. The first cycle
was in the early 1990s and the second in the late 1990s.
Two Cycle Peaks
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My first chart compares the cumulative percentage performance of high-yield bonds to treasury bonds from the credit cycle trough in 1991 to the trough
in 2002. High-yield bonds returned an annualized .25% more, but with substantially more risk. My next two charts compare the performance of high-yield
bonds and treasuries from peak to peak. The first peak is May 1989 and runs to the next peak in February 1995. During this time, high-yield bonds outperformed
intermediate treasuries. The second peak-to-peak cycle runs from February 1995 until today. High-yield bonds have outperformed intermediate-term treasuries
by a fair amount, but not without substantial volatility.
Gut-Wrenching Volatility
Pay attention here. The marginal benefit earned by investing in high-yield bonds over the entire credit cycle is not worth the gut-wrenching volatility.
Remember, high-yield bonds can be as volatile as stocks. Over a full credit cycle, however, high-yield returns are only similar to the returns earned
on full-faith-and-credit U.S. treasuries. Where’s your yield payoff for accepting additional volatility/risk?
Don’t be a Yield Hog
High-yield bonds should not be used to reach for income or be a permanent part of a fixed-income portfolio. A tactical approach is desirable. Buy high-yield
bonds at the trough of the credit cycle and sell them at the peak. This tactical/cyclical strategy will make you a winner. I’ll keep you updated
regularly.
Vanguard #1
Until the credit cycle turns, I favor high-quality, short-duration, ultra-low expense ratio bond funds. In today’s low-interest rate environment,
the management fee you pay for fixed-income mutual funds must be examined under a microscope. Vanguard’s Short-Term Investment-Grade and GNMA funds
feature ultra-low expense ratios of 0.21%. Vanguard Short-Term Investment-Grade has an average duration of 2.2 years, an average credit rating of AA,
and a yield of 5.04%. Vanguard GNMA has an average duration of 3.5 years, an average credit ration of AAA, and a yield of 5.24%.
To round your fixed-income mutual fund portfolio, I’d like to see you use Dodge & Cox Income, with its average duration of 3.5 years,
average credit rating of AA, and yield of 4.95%. If your fixed-income portfolio is in need of additional yield, I’ve long advised that you buy
NYSE-traded investment-grade blue-chip preferreds. You can buy in 100-share lots, just as you would ExxonMobil (NYSE: XOM). Unlike a lot of fixed-income
investments, you’ll know exactly what commission you pay. Today, you can average 6.3% with blue-chip preferreds. I like Barclays Bank 6.625% (NSYE
BCSpr) rated Aa3/A+, yielding 6.26%; the Royal Bank of Scotland 6.25% (NSYE: RBSprP) rated A1/A, yielding 6.12%; and General Electric 6.45% (NSYE:
GER) rated Aaa/AAA, yielding 6.16%.
Agricultural Update
Last month, I recommended a mini-agricultural commodities portfolio. I advised you to buy equal amounts of Alico (NASDAQ: ALCO), Cresud (NASDAQ:
CRESY), Syngenta (NYSE: SYT), and the Powershares DB Agriculture Fund (NYSE: DBA). If you have followed my advice, you are already off
to a great start, as my mini-portfolio is up over 7% in just a few short weeks. The best performer in the group has been Florida-based Alico. My chart
on Alico shows a powerful share price surge in recent weeks.
Alico’s 1898 Beginning
Alico was originally incorporated in 1898 as a subsidiary of The Atlantic Coastline Railroad. The company’s name is an acronym for Atlantic Land
and Improvement Company. Alico’s primary asset is its 136,605 acres of agricultural land in Florida.
The outlook for farmland remains positive. High agricultural commodity prices and record crop plantings are supporting farmland values. Alico is not
as cheap as it was when I recommended it last month, but an investment in the company still buys you Florida farmland for $3,100 per acre. In a study
based on 2005 farmland values, the University of Florida estimated that the value of agricultural land ranges from $2,700 for unimproved pasture land
and farm woods in the northwest region of the state to $10,000 for orange groves in the central and south regions of Florida. All of Alico’s land
is in the central and southern regions of Florida. The stock still offers great value at the current price. Buy Alico.
Alico’s Government Grant
Alico is also a play on ethanol. In early March, the company was selected by the U.S. Department of Energy (DOE) to receive a grant that could total
as much as $33 million. The DOE grant is part of the Bush administration’s plan to support scientific breakthroughs in bio-fuels.
For the past two years, Alico has been investigating the use of the ethanol production technology developed by Bioengineering Resources Inc. (BRI).
BRI’s process can efficiently and economically co-produce ethanol and electricity from a wide array of carbon-based wastes (agricultural waste,
forest waste, used tires, plastics, and even hazardous waste). For the past six years, the company has been proving its technology in a pilot plant.
BRI claims its technology is twice as efficient as cellulosic technologies because BRI’s technology uses 95% to 98% of plant materials, while cellulosic
technologies use only 50% of plant materials.
Seven different insiders at Alico have recently made open market purchases of the stock. Follow their lead, and continue to buy Alico as well as Cresud,
Syngenta, and the Powershares DB Agriculture Fund.
Monster Master List Stocks
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Harley-Davidson (NYSE: HOG). My favorite company in the world has an upcoming quarterly analysts meeting. My guess is that the meeting will offer
a concern or two for analysts. Look at my 2006–07 Harley price chart to see my last buy and sell points. You are out at $72/share and awaiting
a re-buy at my circled points on my other two Harley charts. Last month, with the stock at $63, I wrote, “Next stop: $55/share.” We’re
closing in. Have patience.
Sturm, Ruger (NYSE: RGR). The bride looks just about dressed. As my chart indicates, something’s doing. In just a few months, you’re
already up 35% this year.
First National Bank Shares of Florida. The Naples banking group was a big takeover favorite of mine in 2004. The takeover came, and, as my chart
shows, the gain was about 47%. Go to www.IntelligenceReport.com/yrds or YoungResearch.com if you would like info on Young Research’s
aggressive new micro-stock strategy service on Distressed Securities and Takeover Candidates (DSTC).
Citigroup CEO Charles Prince, going way out on a limb, says he is going to cut 15,000 jobs. When you consider that annually 30,000–50,000 Citi
employees split of their own volition the Citigroup scene, it’s hard to see how Mr. P’s back is to the wall here. The Street does not like
what C.P. brings to the table. And there is a pretty beefy lobby in favor of spinning off a unit or two. Meanwhile, the stock shuffles along OK, gives
you about a 4% yield, and, as my chart shows, is trading at a pretty stable base point relative to the S&P 500 crowd. And our family investment company
has been keen on Citigroup’s yield prospects for a long time, as should you. Buy Citigroup (NYSE: C) now.
Newmont Mining (NYSE: NEM). I like gold as a powerful counterbalancer. And I like the price range Newmont stock is in relative to the S&P
500 menagerie. Buy Newmont.
Federated Investors (NYSE: FII). Starting in mid-2008, retiring and retreating boomers will begin retooling and retrofitting portfolios to return
a relatively much greater level of reliable income. Federated is income management heavy and will be a reliable source for the boom crowd. As my chart
shows, there’s a nice base versus the S&P 500 contingent. Buy Federated now.
Quick Takes: (1) Both Alcoa (NYSE: AA) and Alcan (NYSE: AL) have the aroma of takeover candidates. Buy each. (2) What’s brewing
at Black Hills (NYSE: BKH)? My charts indicate something is. You can add this nice South Dakota utility name. (3) Polaris (NYSE: PII) and Pepsi
Bottling (NYSE: PBG) are also Top 10 Countdown names this month and belong in your shopping cart today.
New Monster Master List Names
Along with General Dynamics (NYSE: GD), I’m adding Archer-Daniels-Midland (NYSE: ADM), Garmin (NASDAQ: GRMN), Tiffany (NYSE:
TIF), and Bombardier (TORONTO: BBD.B) to my Monster Master List. Each has a part in my Big Idea/luxury goods supercycle concept. Next month, you’ll
get all the details.
Big Idea Catalyst
The 1967 Summer of Love Monterey International Pop Festival would prove to be the last time the original Mamas & the Papas would perform together.
Today, only Michelle Phillips is still with us. The rarified days of California Dreaming are gone forever, but the Summer of Love’s power as a
catalyst lingers on four decades later. The powerful catalyst I’ve been setting up for you over the last year is the 2008 confluence of a boomer
retirement tidal wave, the Chinese Olympics, the U.S. presidential election, an explosion in U.S. broadband, and the commercial awakening of very light
jets/light executive jets (see the Lear 31A, 35A and 40). My Big Idea will intertwine with (1) the once-in-a-lifetime investor tidal wave shift from
a capital appreciation focus to an income focus and (2) the hurricane force of the luxury goods supercycle. Coming issues of my monthly letters will
focus on showing you how to craft a complete investing/lifestyle strategy to benefit. You won’t want to miss a single advice-packed letter. By
investing in American Express and General Dynamics, for example, you get off to a great start, so make your calls. And make it a good month.
Warm regards,
Richard C. Young
P.S. Why do you suppose Mr. Michael “I/Me” Eisner would buy Topps and make it a private company? Maybe to avoid the howl of public stockholder
protest should M.E. announce a complete set of Michael Eisner memorial trading cards. Mike Love, lead singer (of sorts) and the last Beach Boy, really
needs to take his long-of-tooth show off the road, but his basketball-playing nephew Kevin may prove to be the best-passing big man in college basketball
history. Great news for UCLA fans. Benetti yachts, founded in 1872 and the world leader in superyachts, figures to be one of the prime benefactors of
the luxury goods supercycle. There’s still time to reserve your very own six-story superyacht and your spot at Chub Cay (chubcay.com) in the Bahamas’ Berry
Islands.
P.P.S. I’ve been emphasizing international counterbalancing in my own portfolio and for your portfolios. I’ve posted at YoungResearch.com my
performance guide of key countries for 2007. My eclectic little menu of goodies will really help you understand more fully the international investment
world. Enjoy.
P.P.P.S. Also at YoungResearch.com, you’ll get info on my first-ever aggressive micro-cap stock strategy service as well as my essential
music postings. I’m featuring my favorite rock & roll band from the 1970s. Perhaps not surprisingly, the band is from California, and it is
still going strong today.
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; Associate Editor: Deborah L. Young;
Managing Editor: Kenneth L. Washington; Research Director: Jeremy Jones, CFA; Research Associate: Rebecca L. Young; Marketing Manager: Jim Brinkhoff;
Group Publisher: Michael Bell; President: John J. Coyle; Sr. Vice President: Christopher Marett; Business Manager: David Bishop; Subscriptions: $249
per 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
mentioned. Subscribers should review the full disclaimer and securities holdings disclosure policy at /disclosure.php or
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Tags: 2008, Alcan, Alcoa, Alico, American Express, AMEX, aquarius, barclays, Barrick Gold, Big Idea, Black Army, Black Hills, Bombardier, catalyst, citigroup, Coke, Cresud, default, Dodge & Cox income, ExxonMobil, Federated Investors, Fidelity, First National Bank Shares, Garmin, General Dynamics, general electric, harley-davidson, high yield, iShares, Japan, jet, Newmont Mining, peaks, Pepsi Bottling, Polaris, pop music, Powershares, Retirement Compounders, Royal Bank, ruger, St. Joe, Sturm, supercycle, Syngenta, Tiffany, Unilever, vanguard, yield spread
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