The Economics of Luxury: Apples and Googles

I have a wealthy friend who asked the following question today:  What are the odds of Google and Apple hitting $1,000/share, respectively, in the coming 18-30 months?

I don’t have a clue, but it doesn’t seem too far fetched.  Which stock will get there first?  No idea.  This is a great topic to remind ourselves about luxury goods from Econ 101.  Between Google’s IPO in 2004 until 2007, investors couldn’t get enough – it outpaced the tech-heavy NASDAQ 100 index by 3-4x over that period.  The higher the price went, the more investors demanded shares of GOOG. 

This price action was no different than what you see with Louis Vuitton purses, Rolex watches, Ferraris, and trendy art.  But in 2008, GOOG changed its behavior and began trading like a technology stock rather than a sought-after purse.  Over the past three years, AAPL has traded in similar fashion with similar results.  This week even as Eurozone worries returned to the forefront of market action, AAPL seemed to defy gravity.

High net worth folks (politicians call them the 1%) around the globe flaunt their Apple shares at parties like a gold Rolex or red Ferrari.  Look at me, look at me.  The more AAPL stock makes up of your liquid net worth, the cooler you feel now.  This has nothing to do with ratios or earnings or any fundamentals at all since these folks could care less about them – this is about being cool and envied.  I don’t know how to time when AAPL stops acting like a luxury good, but I bet it will someday sooner than later.  Sadly, there just isn’t any reason to bet against it for now.  When it stops acting special, you will know.

Meanwhile, I take the road less traveled.  So long as the bull market is in place for 2012, I choose to own QLD or TQQQ which offer 2x or 3x the daily return of the tech-heavy QQQ ETF, respectively.  Because AAPL is the single most influential stock inside the QQQ ETF now, these leveraged ETFs will better mimic its potential for continued ascent.  If it loses its luxury luster along the way, even better.

3 Bull Market Buys – Asset Management

If you’re optimistic that stocks will rise this year like I am and you believe some money will FINALLY rotate out of bonds into stocks to boot, buy asset management stocks.  It’s a great way to play the financials sector if you dislike banks for what they did to your fellow Americans and still feel gun-shy about a real estate comeback over the next 1-3 years. 

These businesses directly benefit from a rising stock market and the more it goes up, the more fees they earn, the more their client list grows.  Plus they benefit from compounding just like you and I, which is amazing.  These are pure, simple stock market plays – they are not brokers, they don’t fund private equity, and they are not venture capitalists.  The following businesses have been beaten down 60-80% over the past 10 years, all have quality investment professionals and they deserve a good look from investors like you and I:

1. AllianceBernstein Holding LP (NYSE: AB).  This is a great way to play a unque, independent asset manager that might get gobbled up by a big firm like Morgan Stanley or UBS as markets improve.  This is also a baby boomer play since their market is older, high net worth individuals.  The stock is down 82% in five years to a market capitalization of $1.7 billion with a very cheap P/E of 11.

2. Legg Mason, Inc. (NYSE: LM).  This company provides services through a number of asset managers, each of which generally markets its products and services under its own brand name and, in many cases, distributes retail products and services through a centralized retail distribution network. They employ great people and manage tons of retail and institutional money.  The stock trades at 19x earnings and has lost 74% over the past five years down to market capitalization of $3.8 billion.

3. Janus Capital Group Inc. (NYSE:JNS).   Janus is a household name born out of the technology bubble.  The firm survived and now thrives with a market cap of $1.6 billion even after a 59% haircut over the past five years.  It trades at an attractive P/E of 11.

Buy all three proportionally for your portfolio’s financials exposure or pick one or two.  I left the nitty gritty details out so you can do your own reading about them online and see if you find one more attractive than the other.  It’s best to diversify within a specific sector in my view, but you make your own call.

Portfolio Checkup and Facebook Musings

It’s February and the weather in Southern California is reminiscent of spring.  Birds are singing, the ocean is glassy, and the sky is blue – it’s a nice feeling.  This is appropriate given the spring awakening stocks enjoyed so far in 2012.  Luckily there remain many negative headlines and bearish doubters out there, so we may have some room to run with this rally before an inevitable correction a.k.a gut check. 

My timing isn’t always great, so if you’re just now diving into stocks, it may be wise to hold off for a meaningful correction.  The fears that caused me to reduce equity exposure last fall perfectly coincided with the bottom in global equities so I still feel a little pain from that error.  But I followed my gut that if things didn’t play out as I expected by the end of 2011, I had to admit error and return to a more bullish positioning.  Now 2011’s tiny gain in the S&P 500 Index is followed up so far year-to-date with a 7% pop , but beaten-down European shares are up a few extra percentage points over US stocks, the tech-heavy Nasdaq 100 is up 11% along with small cap US stocks (Russell 2000 Index), and risky emerging markets are up over 15% (MSCI Emerging Markets Index).  Gold is mostly keeping up with the broad stock indices much to my chagrin.

The news is chalk full of headlines about individual investors sitting on the sidelines, waiting.  I love that.  If you wait for your neighbor to tell you how great his portfolio is doing, you missed the boat or at least part of it.  I also enjoy reading about how February is a bad month for stocks over 50% of the time.  Pay no mind – this is no different than the sucker bet on black in a game of roulette after three or four red bets pay off.  Summer of 2011 is starting to fade into history much like the summer of 2010’s 20% drop.  That one took six months to fade from memory and make new highs.  This time shouldn’t be much different from the smell of it. 
 
Is a Eurozone financial panic and debt default still a risk?  Sure and it’s enough to keep my nose mostly out of their stock market.  But the economic picture is getting brighter in the US with steadily rising output and employment.  A slowdown in corporate earnings may well be in effect, but the powerful leverage achieved via massive layoffs during the recession can only last so long. 
 
Stay the course with your equity investments.  When meaningful pullbacks occur, I use leveraged ETFs (exchange traded funds) to add a little pop to the portfolio.  I like TQQQ (3x leveraged daily Nasdaq 100) and EDC (3x leveraged daily Emerging Markets).  These 3x ETFs should not be used as the basis of a portfolio, but rather to add some juice to returns after a 4-5%+ pullback occurs at any given time.  When this happens you can swap out a 10-15% position in a boring index fund like SPY or IWM for one of these little rockets and see how you do.  Don’t hold them over 30-60 days as leverage can be very painful when the index moves in the opposite direction of where you need it to go.  These ETFs even have inverse brethren so you can profit when markets slide.  I am a terrible short seller and I avoid these like the plague.  Use them at your own risk.
 
Republican primary coverage is constantly on television.  Obama was smiling during the debates, but now has reason to giggle a little.  The financial wizards at the Fed are helping make sure he wins a fresh 48 months in the White House.  The Fed is helping Europe push off implosion to never or at least 2013 with quasi-QE3.  Don’t worry about what that means, just know they are pumping tons of liquidity to European banks.  Employment and GDP numbers smell like roses and Bernanke promised Wall Street near-zero interest rates through 2014.  Love or hate Newt and Mitt, their whining about the economy may start to sound like a broken record in a little bit.  Is all this action artificially inflating stock prices?  Let’s not worry about that and enjoy the ride.  We can revisit this issue at year-end. 
 
Obama’s dinner buddy Mark Zuckerberg (Facebook CEO worth $20+ billion) is about to make thousands of new millionaires via their IPO.  They will buy toys, homes and pay taxes on their very public earnings.  That’s great.  Should you buy the stock when it finally trades?  Sure, why not, just don’t go crazy with the actual amount of stock you buy relative to your net worth.  A more interesting play is to figure out what public firms Facebook will buy after it gets that multi-billion-dollar cash infusion. Zynga is an obvious choice and its stock is already shooting higher.  I like LinkedIn (LNKD) as a takeover idea.  I’m not crazy about the site and its business model, but I have an account and I don’t belong to the cult of Facebook.  Mark will have to buy me and my ilk to earn our eye balls and dollars.  And I think he will do just that.

Necessary Pep Talk; Aside on Skyrocketing Home Builders

All that glittered before darkness hit last August is shining again in the new year.  Technology stocks up 6%, emerging markets up over 8%, even gold up over 6%.  All the hot stuff from the rally off the 2009 bear market bottom is sizzling and that gives off a warm and fuzzy feeling like the sun is out and flowers are in bloom.  Don’t get sell-trigger happy.  The volatility of 2011 makes you want to sell this rally and that would be a mistake.  As we move higher, any material pullback that could make 2012’s chart look like a V or W on renewed European default or earnings concerns is a buying opportunity.  Reread our 2012 outlook below for more ammo on staying invested.

I wish our small gold short position would drop some more, but we remain confident this will break our way as 2012 develops and the dollar gains traction along with the broad US stock market.  Foreign developed markets are lagging US stocks which is a positive for our US-centric portfolio at the moment.  Our small emerging markets position added a little juice to year-to-date performance, which is a nice bonus. 

Despite so much negative punditry on the topic, Eurozone stocks are positive for the year so far and climbing a wall of worry as tall as the empire state building.  I am not a buyer yet to be clear, but it’s a good sign for the global stock market looking forward.  If you have a lot of time on your hands to watch CNBC or read WSJ, you probably see home builders rocketing higher with no remorse.  Wow, what a move!  Toll Brothers (NYSE: TOL) up 15%, Lennar (NYSE: LEN) up 17% and Pulte Homes (NYSE: PHM) up almost 26%.  That doesn’t even cover the fact that most of these stocks were up over 50% from October through the end of 2011.  Our instinct as humans is to jump on this bandwagon.  Some of you want to dive head first with all your money.  Dip your toe to the tune of 3-5% of your portfolio if you can’t help yourself, but know that the reversal may be very fast and very violent… you will feel immense pain that will make you forget the ride to the top. 

D.R. Horton, Inc. (NYSE: DRI) is the largest home builder in the US with a market capitalization of over $4 billion.  It has a trailing P/E ratio of 62.  The hedge funds that got in early on this rally have now shared some profits with news reporters and TV talking heads who carried the torch to you, the individual investor.  Who will get stuck holding the bag after buying high and selling low?  I am going to guess it’s not SAC Capital, but rather average Joe investor.  Act accordingly.  Accredited, seasoned investors with a strong risk appetite can start looking at long-term puts on some of the biggest gainers.

Q4 2011 Summary and 2012 Outlook

I know, I know, I have been quiet.  But for good reason.  The market is behaving like a roller coaster and investors have indigestion from the volatility.  Talking heads only add to it.  My September 12, 2011 call for a significant easing off the investment accelerator pedal has felt right, wrong and anywhere in-between so many times I should feel dizzy.  That day I said “The market may be giving a signal that a sharp drop is ahead and risky assets could drop 1.5-3x more than the broad market.”  We have had three valleys, two peaks and lots of up and down in little more than three months.  Europe and the global banks underperformed at first, but are now outperforming other sectors and countries.  One bright spot has been my gold call: “Another theory is that gold is reflecting future relative dollar strength to a basket of global currencies.  Either way, it probably makes sense to get out of its way.”  Avoiding it or being short one of the gold ETFs has been profitable and offset pain elsewhere.  The issue at hand is what to do now and we shall get to that.

While the broad US stock market will end 2011 darn near flat to up a little, most investments that outperformed in the bounce since the bear market bottom performed poorly.  Emerging markets and developed markets outside the US fell 15-20%. Europe and its euro currency were the worst offenders.  Technology stocks lagged the broad market.  The volatility since August has been so potent I heard a man in his sixties complain about it to a clerk at my local grocery store.  Buy and hold investors with a mostly US-focused portfolio have done just fine so far, but the traders among us are just about ready to throw up.  Hedge funds are feeling the pain the most as they are whipsawed from low to high, to subsequent low, to the next high.  They are at the mercy of psychology and trend-following no less than the average investor/trader.

If you followed my advice, you should have ~25% cash to burn at this point.  Stop day trading (you know who you are) and add a bit to those broad, large and small cap US index funds you own and keep your now reduced exposure to emerging markets and non-US developed markets in case a bounce happens.  As I said in September, “Poor stock market performance in the fourth year of a President’s term is rare as can be.”  Please don’t think for a second the volatility is over.  A plausible scenario for 2012 is a W shaped year with one or two shocks causing steep drops in the first and second quarters, followed by a nice rally into the election and an overall 10-20% S&P 500 return.  I expect the market to trick us into believing 2012 is like awful 2008, an anomaly for a fourth year in the election cycle, at least a few times in the near future.  But 2012 will buck the trend because stocks hate the uncertainty that goes along with legislation which creates winners and losers.  Losers hate losing more than winners like winning – this keeps stocks from rising when the prospect of big legislative change is at hand.  Election years like 2012 yield little in the way of change and President Obama has no real competition at this point.  Regardless of your political leanings, Romney is no more a contender for President than John Kerry two elections ago. Fourth years for lame ducks are even better historically.  There is good reason to believe Obama is essentially a  lame duck to his own second term, especially if you watched the Republican debates so far.

Europe could throw a monkey wrench into our plans for a good year and help create a W chart, but the US should continue to do better than foreign markets if for no other reason than the strength of the US Dollar.  Our economy is also recovering nicely from the recession, but not fantastically.  Beating expectations is a win even if your wallet doesn’t feel as high and mighty as it did in 2005-06.  Hedge funders like SAC Capital are even betting on a real estate stock rebound in 2012 which seems a tad premature.  Tech stocks should gain leadership once again as risk appetites return, but don’t bet on that in the first half of next year.  A strengthening USD should keep gold prices falling as speculators exit their long-held positions to lock in profits.  If some brainy solution to European banks’ sovereign debt problems arises out of the blue, we could see things reverse with the US lagging again and gold moving up.  Until then, maintain an 80-90% allocation to stocks with the remainder short gold or in cash.

Good Luck and Happy New Year!!!

The Market Speaks… Listen Up

Watching stocks daily is a loser’s game, but as we come to the end of September, it’s high time to pay attention.  Study after study shows individual investors time their buy and sell decisions poorly, buying high and selling low.  There are, however, those moments when a decision can change the long-term course of portfolios.  

Equities and commodities may be sending a signal not to be ignored for the rest of 2011.  Recession fears are the wrong reason to sell any portfolio holding now – this is the oldest news around.  The US was somewhat insulated from declines in Europe and emerging markets so far this month, but we are retesting August’s lows.  Even gold is making new lows.  The market may be giving a signal that a sharp drop is ahead and risky assets could drop 1.5-3x more than the broad market. 

US stocks, especially our favorite technology names, enjoyed some level of insulation this month from worries over the health of the Euro currency and the survival of European banks.  Investors may be concerned about US banks now too after the Fed shared its innermost thoughts with us common folk today.  Bernanke’s crew fears it has no more tools left to fix the economy aside from long-term bond purchases.  Such purchases mean lower long-term bond yields and that can mean a heap of trouble for banks.  Banks make money by borrowing near zero now at the short end of the yield curve and lending at the long end.  When the long end falls, so do banks’ profit margins.  Meanwhile, Republicans and Democrats are very publicly fighting over tax increases and markets hate that regardless of the eventual outcome.  Whether taxes on millionaires and government program cuts matter or not, nobody wants to go out and spend while their income and benefits sit on a giant chopping block. 

Should’t gold be going up now?  Investors who profited from gold’s rise may be freeing up cash to meet future potential margin calls or make quick investments as a rare opportunity presents itself at some point in the intermediate future.  Another theory is that gold is reflecting future relative dollar strength to a basket of global currencies.  Either way, it probably makes sense ot get out of its way.

Poor stock market performance in the fourth year of a President’s term is rare as can be.  And there is no reason to panic over 2012 just yet.  But it’s time to make prudent decisions about the remainder of 2011.  Taking 25-50% of your risky assets (financials sector, non-US equities, gold, commodities) off the table is probably wise.  This may be accomplished with inverse ETFs that go up when markets drop, index put options, or simply holding more cash.

Real Clear Markets

http://www.realclearmarkets.com/ is an excellent site reposting the day’s headlines relevant to global markets from a variety of media outlets.  From time to time, I will repost articles I believe to be particularly relevant, impactful and/or ridiculous with my own commentary.  Here are a few: 

  1. Richard Salsman’s dog and pony show for a return to the gold standard: http://www.forbes.com/sites/richardsalsman/2011/08/16/gold-reagan-and-the-reds-from-degraded-dollar-to-downgraded-debt/3/.  Life is immitating art:  remember the movie “Lord of War,” where the African dictator asks the arms dealer character played by Nicholas Cage for a solid gold machine gun?  The 007 series also comes to mind with a shadowy New World Order set to control the globe’s currencies and natural resources.  I say ask the Treasury Department to hold endangered species as collateral for currency.  I think the dollar is worth its weight in black rhinos, giant pandas, and beluga sturgeons.  Caviar is the new black gold. 
  2. http://www.realclearmarkets.com/articles/2011/08/17/gov_rick_perrys_red-hot_bernanke_slam_99198.html.  A blurry picture is forming of the 2012 competition for leader of the free world.  Governor Perry says “Printing more money to play politics at this particular time in American history is almost treacherous, or treasonous, in my opinion.”  Mr. Perry is certainly no economist.  And Mitt Romney reminds me of John Kerry with a more obscure religious profile.  Doesn’t look like Barak and Michelle need to worry about packing up just yet.  Whether you approve of the President’s performance or not, Mr. Obama is more camera shy than he was during his first year.  What has he accomplished so far?  I recall something about healthcare reform and a promise to pull back from global conflicts; and oh yeah, he said he would fix the economy and create jobs.
  3. http://www.nytimes.com/2011/08/17/opinion/why-we-should-end-homeownership-subsidies.html?_r=2&ref=opinion.  The NYT proposes we kill GSEs Fannie and Freddie currently financing the vast majority of US home purchases at a time when private investors want to sit on the sidelines.  Let’s assume these are good ideas.  Unfortunately, stories like this are used by nasty politicians to argue for crazy notions like removing mortgage interest as a tax deduction.  This article says GSEs cost $700 billion in lost revenue over five years, whatever that statistical mumbo jumbo means.  That is the tiniest of fractions in relation to our aggregate spending on the military industrial complex.  Where would you rather cut?
  4. http://www.nakedcapitalism.com/2011/08/bank-of-america-death-watch-unloading-non-core-assets-aggressively.html.  This story would not be worth discussing were it not for what transpired in the US financial sector over 2008 and 2009.  Words sometimes equate to Chinese water torture.  Each word holds little weight, but add them up over time and Bank of America could end up in the hands of a competitor for pennies on the dollar.  There are only seven and a half dollars left as of this writing, so caveat emptor.  This is not some gloom and doom prediction, but confidence is key to market stability.  Just remember that Wall Street is even better at spreading rumors and manipulating feelings than making money and political contributions.

 

The Consumer Discretionary Sector: Nice Pair of “B”s

The Consumer Discretionary sector is important.  It makes up 10.55% of the S&P 500 Index including companies from industries such as media, retail, hotels, restaurants, leisure, textiles, apparel, luxury goods, household durables, automobiles, and other consumer services.  It came out of the economic storm of the past three years a shining star, rising an annualized 11.7% per year versus just 0.65% for all 500 stocks in the index and handily beating the remaining nine sectors.  Over the past 12 months, this sector has maintained its momentum and outperformed all others except Energy.

S&P 500 index sector breakdown courtesy of Standard & Poors as if August 15, 2011:
Sector Breakdown

Bulls on the stock market may simply choose to remain overweight the Consumer Discretionary sector within portfolios using a simple Exchange Traded Fund (ETF) like XLY.  Those with the desire and resources to attack portfolios with a scalpel, may choose to own individual securities within this sector. 

Best Buy Co., Inc. (Public, NYSE:BBY) and Bed Bath & Beyond Inc. (Public, Nasdaq:BBBY) are two companies investors visit during their weekend trip to the local strip mall.  Both are classified Consumer Discretionary stocks, but only one is currently in the good graces of investors and consumers alike.  BBBY is up 46% in 12 months and 10% year-to-date.  BBY is down 25% in 12 months and 28% year-to-date. 

One sells electronics and appliances to average Joes while the other sells infomercial novelties and various bed/bath trinkets.  The story isn’t too surprising, given that households have held off on durable goods purchases like TVs and washing machines.  Instead, they line up at BBBY to buy a $50 hand mixer or steak knife.  These impulse buys satisfy the consumer inside us without breaking the bank.  Given the massive divergence in performance, some may argue it’s time to switch gears and move from one position into the other.  

My last Saturday visit to BBBY wasn’t great: empty parking lot; shoppers in checkout line had very few items in their hands; too many gimmicky products.  I didn’t like what I saw at BBY either: empty stores; too much free financing shows weakness; terrible customer service both on the floor and within Geek Squad.  Management for the worse performer of the two, BBY, is no bunch of dummies.  They are capable of fixing what’s wrong as the market picks up for their products.  BBBY’s chart looks like Mt. Everest so perhaps it’s seen its best days, but fear of heights isn’t a great quality in an investor.  There is lots of room for debate here!

Plenty of investors remain sidelined and may not be ready for a Consumer Discretionary bet despite the overwhelming evidence presented by this sector’s performance over the past few years.  They may want to explore the sophisticated “pairs trade” commonly executed by institutional investors like hedge funds.  You simply buy one stock long and sell the other short in identical dollar amounts.  You buy the stock you think will outperform looking forward, and sell the one you think will lag.  Your net exposure to the sector and overall stock market remains zip, zero, zilch.  But you now benefit if the stock you like does better than the one you think is a dog.  This should be a fairly easy experiment to test out with a small portion of your portfolio.  It’s also a great way to stay active when you have an idea about two stocks, but wish to remain on the sidelines with respect to the sector or the stock market as a whole.

Sector Weights and Limo Drivers

Fearful down days are an excellent opportunity to think through events going on below the surface of world headlines.  IMPORTANT: If your portfolio holds more than 25% financials and at least half of them happen to be European, perhaps you have some important decisions to make so get busy.  Otherwise, read on.

Now on to something below the surface.  Thanks to the Wall Street Journal for summarizing what’s happening at Macy’s and Ralph Lauren today here http://online.wsj.com/article/BT-CO-20110810-713062.html.  This is important.  Strong sales and earnings growth at mid-level retailers is a good sign that the folks shopping at Marshalls and TJ Maxx feel comfortable moving up a notch.  But nobody on Wall St seems to care much today.  Why you ask?  I once wandered into the suit section of Macy’s San Francisco flagship men’s store.  I asked the salesmen for help with a tuxedo for my cousin’s bat mitzvah.  He showed me many tuxedos that didn’t look so great, but were priced around $100-200.  When I asked why people bought these suits, he remarked they sell to service industry folks like limo drivers and waiters.  Your average hedge fund analyst or small time portfolio manager would never walk into this kind of store.  Their bosses have everything custom made.  Macy’s is a strange, foreign land to them.

Now back to the point I made about financials sector weight in the first paragraph.  Standard & Poors offer an excellent web page describing their most important index for individual investors, the S&P 500, found here http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–.  This is a properly constructed, diversified stock market index.  As you can see, Financials make up less than 15% of the index.  If you want to behave like a portfolio manager, base your own portfolio’s financial sector weight on this number.  Optimists might overweight it by 10% while pessimists might only hold a 5-10% position.  The Dow Jones, on the other hand, is a poorly constructed index of just 30 companies – nobody should pay attention to it.  Foreign indexes have different sector weights, but start with the US for now and I will discuss foreign weightings in future posts.