CWS Market Review – August 12, 2011

As dramatic as the markets were last week, things got even more frenetic this week. Over the past four days, the Dow closed down 634, up 429, down 519 and up 423. On Thursday, the S&P 500 closed at almost exactly the same level it closed at two days before. It’s like watching some crazy football play where the running back scampers all over the field only to wind up back at the line of scrimmage.

In this week’s issue of CWS Market Review, I want to break down what’s happening and why, but I also want to tell investors what’s the best strategy to do with their money. The silver lining in all this crazy volatility is that there are some impressive bargains right now on our Buy List.

The big story of this past week, outside the down/up/down/up market, was Tuesday’s Fed meeting. Over the past several months, these FOMC meetings have been snoozefests. After all, what can you do when interest rates are already at 0%? This time, however, the Fed actually made some news.

In the post-meeting policy statement, they added important new language:

The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

Bear in mind that central bankers are bred to speak in understated tones, so this statement is a pretty big deal. What Bernanke & Co. are saying is that the economy and inflation will be soft for at least two more years (which includes Election Day, by the way). Many folks in the market had suspected this was the case, but this is the first time we’ve heard the news right from Big Ben himself.

What’s happening is that S&P’s downgrade of our debt, while a bit silly in my opinion, is having major repercussions, though interestingly, not on the market for our debt. The S&P downgrade took the idea of further fiscal stimulus off the table. In other words, don’t expect Congress to act. More stimulus spending takes political will and that simply no longer exists.

Without the possibility of fiscal stimulus, all responsibility is placed on monetary policy—meaning the Federal Reserve. As a result we’ve been experiencing this odd combination of soaring Treasuries and soaring gold combined with weak and highly volatile stocks. Everyone is running for cover. Gold is soaring because it acts as a hedge against real short-term interest rates. As long as short-term rates are running below inflation, gold is poised to do well. It’s as if Bernanke gave commodity investors the green light—or perhaps the gold light.

What also made this past Fed meeting interesting is that there were three dissensions to the Fed policy statement. The Fed isn’t like the Supreme Court. They work very hard to get the effect of the broad consensus. If someone disagreed, then they really didn’t like the policy. The vote for the last policy statement was 7-3. There are currently two vacancies but we do have to wonder if it’s possible for Bernanke to be overruled at some point by the inflation hawks. That hasn’t happened to a Fed chair in 25 years.

What’s really stood out in my mind is the dramatic volatility of the past few days. I have a slightly different view of volatility than you often hear in the financial media. Volatility isn’t necessarily bad for the market. I think periods of high volatility reflect the violent clashing of multiple views on what’s driving the market. It’s as if two schools of thought are fighting for supremacy.

The bone-on contention is what shape the economy is in right now. Some investors think we’re headed right back for another recession. Personally, I think it’s too early to say. However, I do believe that it’s best for investors to lighten up on their economically-sensitive stocks. I also think we’ll see this crazy volatility begin to fade once traders get back from the beach after Labor Day.

Many financial stocks have come in for an especially severe pounding this month, but I think that’s become overdone, especially for the high-quality ones. In the CWS Market Review from four weeks ago, I said that I was “particularly leery” of financials like Citigroup ($C), Bank of America ($BAC) and Morgan Stanley ($MS). Since then, those three banks have fallen 22%, 28% and 14% respectively. As bad as they are, every stock has a price.

On our Buy List, I think financials like JPMorgan Chase ($JPM) and AFLAC ($AFL) are very good buys. Not only is Nicholas Financial ($NICK) a great buy but I think the recent Fed news actually helps them since short-term rates will continue to be very low for some time. NICK makes their money on the spread between short-term rates and what they lend out to their customers.

For investors, the important lesson is that when times get difficult, you always want to look at dividends. Accountants can do crazy things with a balance sheet, but dividends tend to be very stable. Even during the past recession, once you discount the financial sector, most dividends hung in there. That’s why I want to highlight some of the top yielders on the Buy List.

Abbott Labs ($ABT), for example, is now yielding 3.7%. Even Johnson & Johnson ($JNJ) is yielding close to 3.5%. AFLAC ($AFL) is over 3% and Medtronic ($MDT) isn’t far behind. Tiny Deluxe ($DLX) saw its yield come close to 5%. Most of these companies can easily cover their dividends, and a few have paid rising dividends for decades.

On Monday, Sysco ($SYY) will be our final earnings report of the second quarter. From what I see, the company is in pretty good shape. Wall Street expects earnings of 57 cents per share which is exactly what SYY earned a year ago. I think that’s a bit low. My numbers say that Sysco earned 60 cents per share, plus or minus two cents.

I think it’s interesting that the recent market pullback has impacted a non-cyclical stock like Sysco far less dramatically than it has the rest of the market. Even in this market, Sysco currently yields 3.6% which is a very good deal. The company has increased its dividend for the past 41-straight years and I think they’ll make it 42-straight in November, although it will probably be a one-cent increase. Still, that’s not bad in an environment where a 10-year Treasury goes for just over 2%.

That’s all for now. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

Posted by on August 12th, 2011 at 11:25 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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