Monday, March 19, 2018

Investor Fatigue

These weeks of 1,000 point swings are going to continue.  Investors are getting fatigued.  Other factors way on our psyche.

  • Interest rates are going up
  • Price to Earnings ratios are high
  • Domestic uncertainty is evident every day
  • Investors are locking in profits

Rising Interest Rates

The big boys who manage big money and the professional investment pundits worry about interest rates.  After a 35 year bull market in bonds, things have changed.  Their reasoning is that increasing interest rates and its first cousin inflation have a negative effect on stock prices.

The graph above, courtesy of shows interest and stock prices since 1962.  This graph cannot begin to tell the real story because during the entire period of time interest rates were going down and stock prices increased.   

You might notice that stock prices have been up and down over the past 20 years and interest rates were pretty steady.   

Closer inspection using the period 2010 through 2012 is more revealing.  Again from marketoracle the graph below comparing interest rates and stock price reactions.

For me, the interest rate argument does not affect my stock picking at this time.  I am starting to ladder some certificates of deposit but I have not yet bought any new corporate bonds.  Just taking this move steals assets from the stock market so perhaps interest rates do have an effect if only to be competitive.

High P/E Ratios

I look all the time at stocks that have been good performers in the past and I see them over priced.   Look at Caterpillar, symbol CAT.   Caterpillar is one of only a couple of stocks that I added twice in any single portfolio year.   The portfolios that I publish have to hold but I don't.  

I lost CAT to a call at $120 and it is now trading above $150 and has been as high as $173.  Truly lost opportunity, right?  So does the $150 a share seem like a bargain?  No.  Why? Because CAT has a P/E ratio of 120.  Will, CAT ever be back to $120, I don't think so. But I cannot invest in an income stock with a P/E of 120.  

Sticking with CAT as an example, if their earnings improve as they are predicted to do so and the price stays basically the same, the forward expected P/E ratio is about 15.5 (source  Moreover, they will finally have returned to earning more than they pay out in dividends.  What if those earnings don't show up?

This is the biggest conundrum, I believe.   The stock market is priced to expect very significant earnings increases. Those stocks that deliver will be rewarded.  Those that do not will be punished.  Some that are punished will unfairly suffer if their previous quarter was good and the expectations are just too much to ask for.    These are stocks I will be looking at.

Current S&P 500 P.E. ratio is 25.99 which is quite high.  See the table below (again from marketoracle) showing long term P/E ratios.

Domestic Uncertainty

CNBC reported during the end of trading today, they thought there was rotation into international stocks.  Investors do think the U.S. is a bad place to invest.   They rotate because they think the international market is better at this time.  

Trade and tariff issue are in the news hourly.   Clearly it was a trade and tariff issue that culminated in the colonies leaving the Crown so trade issues cannot be ignored.  Look at Whirlpool, symbol WHR.    The government gives them a carrot by restricting cheaper Asian washing machines then hits them with a stick by increasing the cost of the metal they need to make their washing machines by putting tariffs on imported, cheaper steel.

They always say the market can handle good new and bad news, it cannot handle uncertainty.  We have uncertainty and this is one of the catalysts leading to investor fatigue.  Investors have not pulled totally out of the market.  There has not been the "c" word:  capitulation.   Investors, especially income investors are just going to sit and wait until a real opportunity is revealed.

Taking some Profit off the Table

I bought a few stocks a few weeks ago when the market had a bit of a correction.  Most of the stocks I bought were for income and income growth but I did play a little on some growth stocks. I sold calls on the growth stocks and they were all taken last Friday, thank goodness.

Now I look at stocks like XOM and WMT and I am underwater on the shares I added during the "correction."    I am not interested in selling these stocks as over time I still believe they will deliver the mail box money I need.  But I am not interested in buying more at this point.  I will reinvest dividends during these weak times.

Also during this time, I sold calls on some very good stocks that have tepid dividend yields and high P/E's such as AMGN.   AMGN has a P/E ratio of 71.   I was glad the call buyer took about half of my shares.  I am totally willing to lose AMGN.  However, should AMGN correct enough while growing its earnings enough to lower the P/E, I will be back in.

In the meantime, I am holding onto the cash generated by having call options exercised.   I actually am putting it in 30, 60, 90 and 180 day paper.    This relieves some of my investor fatigue.  

M* MoneyMadam

Disclosure:  Long CAT, XOM, WMT and AMGN with calls