by Alexander Green, Investment U Chief Investment Strategist
Monday, January 02, 2012: Issue #1677

Investors are scared right now and it’s not hard to see why.

Economic growth is anemic. Unemployment is high. Banks are saddled with toxic assets. Problems in the Eurozone continue to fester. Residential real estate is sinking in a mire of short sales and foreclosures. And both federal and state governments – not to mention consumers themselves – are drowning in a sea of red ink.

We have all heard these negatives repeated daily and cycled endlessly in the national media.

However, these reports often leave out or play down the good news: Inflation is low. Short-term rates are near zero. Energy and food prices are declining. Emerging market economies – which are end markets for the developed world – are still booming. Corporate profits are at an all-time record – and have been for seven quarters now. And stock valuations are low. (The S&P 500 has historically traded at an average of 16 times earnings. Today it’s less than 14 times earnings.)

Last year I shared another key insight with you. It has always been a positive indicator for stocks when the Dow yields more than Treasury bonds.

This makes sense when you think about it. Shares are riskier than bonds. Investors should demand a higher yield. Yet almost never since 1958 have stocks yielded more than Treasuries. Today they do, however. The 10-year bond yields just two percent. The Dow yields 30 percent more.

If you’re still not convinced that equities are a good place to be in 2012, let me draw your attention to one of the strongest indicators of all…

Contrarian Investing Works

It’s a truism that no one consistently predicts the stock market. (That’s why money manager and Forbes 400 member Ken Fisher calls it “The Great Humiliator.”) However, there’s a straightforward system that offers a reasonable prospect of timing the market reasonably well in the future.

A 25-year study published last year in The Journal of Financial Economics found that if you had simply invested in the S&P 500 when equity fund flows were negative (redemptions exceeded new investments) and into 90-day Treasury bills when fund flows were positive (new investments exceeded redemptions) you would have substantially outperformed the market while spending nearly half the time in riskless T-bills.

In other words, contrarian investing works. This system would have you do the very inverse of what the great mass of investors is doing. (It turns out they have god-awful instincts, so it pays to buck the consensus.)

Bear in mind, if you’d followed this system, you wouldn’t just have earned higher returns than being fully invested. You would have done it with far less risk, spending nearly half the time in riskless T-bills.

I mention this because the Investment Company Institute recently reported that investors are yanking billions out of equity funds virtually every week and pouring the money into ultra-low-paying money market accounts. The Wall Street Journal further reports that “investors have continued to consistently pull money from U.S. equity funds since August.”

I’m trying to contain my glee. Who says no one rings a bell in the stock market?

The fear and pessimism about both the economy and the stock market are way overdone and fully discounted in current stock prices. If you can’t be stirred by low interest rates, low inflation, low valuations and record profits, you really should ask yourself two important questions:

1. Is logic or emotion governing my decision making about my portfolio?

2. If I don’t invest in stocks – the greatest wealth creator of all time – how am I going to meet my long-term financial goals?

We’ll talk more about these issues in the weeks ahead. But, for the record, I think 2012 will be a good year for the stock market and – although virtually no one expects or believes it – perhaps even a barnburner.

Good Investing,

Alexander Green

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, April 25, 2011: Issue #1498

“Buy Japan now?” a friend asked recently. “Are you nuts?”

His sentiment is understandable. Aside from the unfathomable human suffering in Japan over the past several weeks, there have been enormous economic setbacks as well.

Sendai, the biggest port in northeast Japan and a major exporter of auto parts, machinery and marine products, was virtually wiped off the map. Half a dozen oil refineries in the same area, representing a third of the nation’s entire refining capacity, are shut down. Roads, bridges, railways and other major infrastructure have been destroyed. And the Japanese economy – already limping along for most of the past two decades – is also beset with the world’s highest public debt relative to GDP (225%) and a rapidly aging population.

Why would anyone want to invest here?

In my experience, those words accompany virtually every great buying situation. But it takes more than just a lack of interest to create a true contrarian opportunity. Both sentiment and valuations have to be at an extreme.

And that’s certainly the case here…

Japanese Stock Prices Are Less Than Book Value

The average Japanese stock is selling for less than 14 times its annual profit. That’s cheap, and Japanese accounting methods also tend to understate earnings. An even better indicator is found in book values (assets minus liabilities). Stocks around the world (including the United States, Europe and China) currently sell for approximately two times book value. In Japan, they sell for less than book value. By this measure, U.S. stocks are twice as expensive as Japanese stocks.

What will turn Japan’s market around? For starters, the enormous rebuilding that will be required over the next few years. Devastated areas account for seven percent of Japan’s economy and a substantial portion of its land mass. A lot of businesses will receive substantial contracts as a result of the catastrophe.

History shows that Japan is adept at rebounding from catastrophe. (Take World War II or the 1995 Kobe earthquake as examples.) And when Tokyo enters a bull market, it can look like the Silver Spurs Rodeo. For example, if you invested $10,000 in the S&P 500 in 1970, two decades later it would have been worth more than $76,000. Not bad.

But the same amount invested in the Nikkei 225 would have turned into more than $600,000.

How to Buy into Japan’s Advanced Economic Power

Although China’s economy has now eclipsed Japan’s in size, Japan is still Asia’s most advanced economic power, with world-leading technologies and an unmatched infrastructure.

The cost of doing business in Japan has decreased dramatically in recent years, as well. Land prices, office rents and labor costs have come way down. So have taxes and tariffs. And the government has instituted serious banking reforms.

The nation also sits on a mountain of personal financial assets – more than $100,000 for every man, woman and child. After a decade of negative stock market returns, most of this capital is sitting in low-yielding bank deposits. Even a small fraction of these assets returning to the equity market could give it a serious jolt.

So how do you play a rebound? Consider a Japan ETF or some of the country’s unloved blue chips like Toyota (NYSE: TM), Mitsubishi Financial (NYSE: MTU), Canon (NYSE: CAJ), or NTT DOCOMO (NYSE: DCM).

The healing there will take time, of course. But just as the U.S. stock market rebounded from the recent financial crisis quicker than almost anyone expected, things in Japan may look dramatically different in six to 12 months from now.

Of course, very few people believe that. But, in one sense, that’s a good thing. Negative sentiment and low valuations are the defining characteristics of contrarian investing.

Bottom fishermen, cast your nets.

Good investing,

Alexander Green

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, December 6, 2010: Issue #1401

Patrick Henry famously declared that he knew no way of judging the future but by the past.

So if you’re putting together a long-term investment portfolio, it might be wise to look at the historical returns for various types of assets. Not just for the past few years, or for several decades, but for the past couple centuries.

When you do this, you’ll notice something interesting:

• Owning a portfolio of businesses (stocks) has generally been much more rewarding than making loans to corporations or Uncle Sam (bonds) or sticking your money in the bank (cash).
• Look closer at the clear winner (equities) and you’ll also find that value stocks have outperformed growth stocks over the long haul and that small-cap value has beaten large-cap value by a substantial margin.

It therefore follows that an investor seeking maximum capital appreciation might focus on identifying undervalued small-cap stocks.

But there’s only one problem with this: It won’t work for most investors, even if the future is very much like the past. Here’s why…

Beware the Value Investing Trap

Value stocks require something that growth stocks don’t: Patience.

When a stock – either large or small – is in the cellar, it’s there for a reason. Typical ones are that the company is:

• Losing market share…
• Seeing its margins fall…
• Is losing money…
• Or is experiencing flattish sales and declining profits.

As a value investor, you don’t know when these state of affairs will end, but you might be tempted to invest in a company if it’s relatively cheap in relation to sales, earnings or book value (i.e. net worth) in the hope that management will set things right.

The problem is this can take quite a long time. Or it may never happen at all. As the stock gets cheaper and cheaper, you may believe it’s becoming an even better bargain. This is the classic “value trap.” And if you keep buying a stock on the way down, it may very well have your name on it when it hits rock bottom.

Dead Money With Decent Dividends

Even if a value stock is destined to generate a good return over, say, a three- to five-year horizon, most investors won’t be around to enjoy it.

How do I know this? Because as a former money manager, I’ve dealt with thousands of “typical investors.” And regardless of what they say in their initial interview about their willingness to stay the course and think long-term, it all goes out the window for 90% of them when the road gets bumpy. Or if things don’t kick into gear right away.

A client who sits on a stock – or even a stock fund – for six months and doesn’t see a spark will remind you with every conversation that he or she is sitting on “dead money.”

No argument there – they are (at least temporarily). But value stocks often pay decent dividends that help compensate for this. Early in my career, however, I got tired of holding hands and counseling patience and switched from a value to a growth methodology.

It was a good move. If you want action, you should have it…

There’s No Shortage of Excitement with Growth Stocks

Buy the best growth stocks you can find. Given that they tend to be twice as volatile as the market (and twice as expensive), there is generally no shortage of day-to-day excitement.

But if you use a trailing stop, you can generate results that are much better than historical long-term returns (which always assume a buy-and-hold approach) and with less risk because your positions are fully protected.

So unless you have the patience of Job – and most investors don’t – you’re better off owning growth stocks than value stocks and, of course, using a trailing stop.

In my next column, I’ll demonstrate why small-cap growth – historically the worst-performing long-term equity class – is the very best place to find blockbuster stocks.

Good investing,

Alexander Green

When the Dow bottomed near 6,500 in the thick of last year’s financial crisis, few investors thought it was a good time to buy stocks. Sentiment was overwhelmingly bearish.

So when the market bounced higher, the consensus was that it was a “dead-cat bounce,” a bear-market trap. But it wasn’t.

As the rally gained speed, investors began to think that perhaps the worst of the financial crisis was indeed over and they would buy some stocks on a retracement or when the market tested its lows.

But that didn’t happen either. In fact, the Dow didn’t tire until it crossed 11,000 in May. By then, the market was up over 70% in just 14 months.

That was pretty depressing to investors sitting on the sidelines, earning microscopic yields on their cash. Many were so busy licking their wounds from the sell-off that they made little or no new investments during the rebound.

So what should you do now?

Investing in Stocks: Follow the Earnings

Since the market high four months ago, the Dow has lurched back and forth. But the primary direction has been down. No surprise here. After a rally of this magnitude, a correction is not unusual.

But don’t be like last year’s investors and miss the next rally. Now is a good time to put money to work in high-quality stocks.

In fact, the market is almost as cheap today as it was during the depths of despair in March 2009.

How is that possible when the Dow is more than 3,500 points higher?

Because a stock or index price doesn’t tell you anything about valuation. What matters are earnings and the multiple that the market puts on them.

Three Reasons Why You Should Buy Stocks Today

When measured by profits, the market is almost as cheap today – at 14.9 times trailing earnings and 12.2 times prospective earnings – as it was in March last year.

That’s because earnings are up. Way up. Second quarter profits at U.S. companies hit an all-time record.

A year and a half ago – when investors should have been buying stocks – the media was busy telling them about The Great Recession and how the world was coming apart at the seams.

Today, it provides saturation coverage of home foreclosures, personal bankruptcies and endless political carping. And because we’re blanketed with bad news, few investors see the positives. Consider, for example:

• The Fed has taken interest rates to near zero. That makes it cheaper for consumers and businesses to borrow. It also makes ultra-low-yielding cash a horrible investment.

• Inflation – the great bane of both stock and bond investors – is M.I.A. With the consumer price index showing virtually no increase, businesses don’t have to battle rising costs.

• Around the globe, most stocks are unloved and undervalued. Historically, when the P/E of the S&P 500 has dropped dramatically – as it has since the highs of May – it isn’t long before the market puts on a significant rally.

A Leaner Corporate America Could Drive the Next Rally

I know analysts are saying that earnings won’t be anything great. But they could be wrong – yet again – for two key reasons.

1. Businesses have tightened up their cost structure, laid off unnecessary personnel and refinanced debt at lower levels. Even a modest uptick in sales could deliver surprisingly good bottom-line growth.
2. It’s so cheap for businesses to borrow right now that I expect we’ll see many of them issuing debt to buy back their own shares. This could lead to robust growth in earnings per share, even if growth in gross earnings is less dramatic.

The bottom line?

Investing in Stocks: The Ultimate Contrarian Indicator Right Now

Stocks today are almost as cheap as they were when the Dow hit 6,500 18 months ago. And the macro-economic picture – while always cloudy – is a heck of a lot better now than it was then.

As an investor, look at your options. Cash pays next to nothing. Treasuries yield little more and could easily drop precipitously. Real estate is a non-starter, due to illiquidity, a flood of foreclosures and tough new lending rules.

But stocks offer excellent potential. And if you know anything about contrarian indicators, the fact that so few believe it only confirms it.

Good investing,

Alexander Green

by Alexander Green, Chief Investment Strategist
Tuesday, May 18, 2010: Issue #1262

Last week, I spoke at a special conference on value investing at the beautiful Driskill Hotel in Austin, TX.

Virtually every stock market investor talks about “recognizing value.” I’ve found that interest in value investing ebbs and flows depending on the market. No one wants to overpay for a stock, or keep holding one if the price gets nutty.

And that leads to a basic question: How do you find value in the stock market?

It depends whom you ask…

The Fathers of Value Investing

The fathers of value investing, of course, were Ben Graham and David Dodd, two teachers at Columbia Business School who wrote the investment classic, Security Analysis.

They argued that value investing is about buying companies that are selling below their intrinsic value.

How do you determine that? According to Graham & Dodd, that means buying companies that…

• Trade at significant discounts to book value.
• Have high dividend yields.
• Have low price-to-earnings (P/E) ratios.

Buying this way is not only supposed to lead to higher returns. It’s also designed to provide a significant “margin of safety.” The idea is that if you buy a security right, your downside is limited.

A number of academic studies have shown that if you follow the principles of Graham and Dodd, you should do very well over the long term.

But there are potential problems with this approach…

Don’t Let a Cheap Stock Suck You In

First of all, stocks are rarely as cheap as they were back in the 1930s when Security Analysis was written. Or even as cheap as they were back in 1982 when the typical stock sold for less than book value and eight times earnings and yielded more than 6%.

And if you sat out the last 28 years out because stocks were too expensive, you missed an awful lot of opportunities.

When you do find a stock that does meets Graham and Dodd’s stringent requirements, you also need to be patient. Why? Because companies that are very cheap are out of favor for a reason. Sales are often flat or down. Earnings are weak. Profit margins are low.

You can’t succeed just by buying a company that’s cheap. (It can always become cheaper.) You have to buy a company that will someday – and perhaps not too far off – be dear to others. Otherwise, when will you take profits?

So maybe Graham and Dodd’s message needs modifying. (Warren Buffett, Graham’s most famous student, has certainly found ways to modify it.)

The Problem With Defining “Value”

I’ve found that the definition of value and the tools to achieve a margin of safety are flexible. And The Oxford Club has found successful ways to bend them.

To my mind, any stock that goes from $10 to $50 was a “value” at $10. I don’t care what the P/E or price-to-book was at the time. With the luxury of hindsight, it was clearly a bargain. Why quibble?

But die-hard value investors will argue that if the stock was “overvalued” at $10, it’s only more grossly so at $50 – and therefore, you’re at great risk holding it.

I disagree. If you use our customary trailing stops, your upside is unlimited and your profits fully protected. As long as a stock keeps trending up, we’re content to hold on – no matter what the valuation. When the stock eventually turns, as all do eventually, our stops will keep the profits from slipping through our fingers.

As for value analysis, quite frankly, we don’t spend a lot of time poring over P/Es and book values. We’re just interested in identifying companies that are likely to show dramatic, better-than-expected growth in the quarters ahead. These stocks tend to be more expensive than average, just as companies that will show little or no growth tend to be cheaper than average.

This method works, too…

Do You Have the Key Traits to Profit From This Approach?

The independent Hulbert Financial Digest has ranked our Communiqué among the top five newsletters in the United States for 10-year performance.

And our approach has one significant advantage over value investing. It works quickly.

• Growth stocks tend to sprint.
• Profits often come sooner rather than later.

As someone who spent 16 years as a money manager, I know that most investors don’t have the patience to be good value investors. (John Templeton, for instance, held companies in his flagship Templeton Growth Fund an average of 7.5 years.)

Yet clients will start to grouse if a stock doesn’t move for six months. They call it “dead money” and start itching to move it elsewhere.

I understand this instinct. But deep value investing and rapid trading don’t mix.

If you’re a patient, truly long-term oriented investor, value investing can work wonders. If you’re not, you’ll be better off searching for companies that are set to smash estimates.

When a stock doubles or triples – or rises 50-fold or more like Apple (Nasdaq: AAPL) and Amazon (Nasdaq: AMZN) – don’t worry, other investors will concede it was a “value” before.

Good investing,

Alexander Green

P.S. If it’s value you’re looking for, look no further than The Oxford Club. For just $79, you’ll receive a whole year’s worth of our experts’ top stock recommendations, investment ideas and strategies that you can use to amass profits and build wealth.

You’ll see exactly why The Hulbert Financial Digest has ranked The Communiqué newsletter in the top five in the United States over the past 10 years and have a portfolio of your own that can weather the market’s storms, but thrive, too.

Take the guesswork out of the investing process and let some of the best, most successful analysts do the work for you. Sign up (risk-free) to The Oxford Club today.

by Alexander Green, Chief Investment Strategist
Thursday, May 6, 2010: Issue #1254

Being a contrarian is a lonely business.

If you’re a regular reader, you’ll know that ordinarily, I am market neutral on stocks, bonds, currencies and commodities.

The truth is that markets are reasonably efficient. So most years, I don’t stick my neck out and make any market calls on any asset class.

That’s because the vast majority of the time, most assets are neither grossly undervalued, nor wildly overvalued. Rational, self-interested investors keep prices close to true value.

But I am not an efficient market theorist. Investors are always self-interested, yes. But they are not always rational. And I most certainly do not believe that all publicly traded securities are efficiently priced all the time.

That would be lunacy…

Anomalies develop (and opportunities alongside them). Sometimes, these anomalies develop into outright bubbles. When that happens, you will always see eye-popping valuations paired with extreme sentiment. (In other words, sky-high prices and unbridled optimism or rock-bottom prices with extreme pessimism.)

What surprises me is how few investors recognize a bubble, even when it’s right under their nose and they have many thousands of dollars at risk…

Bubble Watch

For example…

• When I warned about the dangers of Internet stocks over a decade ago – I actually quit my Wall Street firm to take possession of my soaring pension shares – most respondents told me I was clearly ill-equipped to recognize the nature of opportunities in “the New Era.”
• Readers similarly scoffed at my warnings about the housing market five years ago. “Real estate always goes up,” they reminded me.
• At $150 a barrel, I wrote a column calling oil “The Mother of All Bubbles.” Demand was already waning and supply was rising as oil hit a new all-time high on various “peak oil” theories. It then quickly lost nearly two-thirds of its value.
• Five months ago – again, right here in Investment U – I predicted that the much-maligned dollar would soar against the euro. And yet again, my readers insisted that I was grossly mistaken and that a weaker dollar was “the ultimate no-brainer.”

Except it wasn’t…

Europe’s Monetary Policy Mish-Mash

Today, the euro hit a 14-month low against the dollar ($1.2689) on increasing recognition that Greece’s fiscal problems are bigger than expected, more expensive than expected and potentially contagious.

Trust me, this is far from over. The 16-member states in the Eurozone are about to start bickering like an old couple that has locked the keys in the car.

Understandably, weaker states don’t like having their economic policies dictated from Frankfurt. And stronger states don’t like spending billions to bail out their profligate brethren from years of fiscal mismanagement.

“Preposterous” Expectations for the Euro Against the Dollar

When the euro was born on January 1, 1999, skeptics rightly worried that the then-11-member states were too divergent to share a single currency and monetary policy.

These fears were well-founded. And the euro promptly plunged on world currency markets to well under $0.90. Today, we know that problems among member states aren’t just possible… not just probable… but right here, stinking to high heaven on our doorstep.

Yet the euro is still trading around $1.27.

Expect it to hit $1.10 by the end of this year – and trade at parity with the dollar sometime next year.

Sounds preposterous? Yes, so I’ve heard.

Good investing,

Alexander Green

Editor’s Note: Find out how The Oxford Club’s “market neutral” investment approach, combined with a keen eye for lucrative contrarian recommendations, led the Hulbert Financial Digest to rank the group’s Communiqué in the top five investment newsletters over the past 10 years.

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