In The Playbook from Gravitational Edge on July 18, we discussed that investors seem to have a conse...
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06/03/2005 12:00 am EST
"Dividend, dividends, cash flow, bonds," says Neil George in summarizing his market outlook. "I’ve been looking for that silver lining in the dark clouds over the last few years, but I’m increasingly seeing some major challenges." Despite his caution, he still sees some opportunities.
"The first major challenge I see is in the stock market. The S&P, the Dow, and even the NASDAQ are still dominated by a collection of stocks that are extremely overvalued. We’re looking at these companies and their sales aren’t growing by any great measure. Yet, the valuations are still at multiples of their sales. I also think a lot of these major companies will find it challenging to increase their profits. One crucial factor that will create a lot of problems within a lot of the big companies will be the mandatory expensing of stock option grants. That will start showing up as we get quarterly reports in the summer and the fall and that will weigh on the stock market.
"Meanwhile, the indices themselves have not fared all that well for the past 12 months. Indeed, we’ve seen fairly crummy returns relative to the risks and volatility. With the general markets more challenging, it will be that much more difficult for us to buy and hold good companies—even if they are good, solid companies with great revenues— because they will be overshadowed by these negative general market trends. Therefore, from my perspective, we need to focus on dividends. It’s the cash that we get paid month after month after month that can help us to deal with that environment.
"The second major challenge that will be facing us throughout the rest of the year is the ongoing changes in the interest rates. We’ve watched short-term interest rates rise quite precipitously since last May. I’d emphasize that many investors incorrectly believe the Fed is responsible for setting interest rates. But it is the market. The Fed simply reacts to the general market. And the market has shifted short-term rates up, roughly about 2% on short-term money. That has really caused concerns in the financial community and the media.
"What has been making money over the last 12 months has been intermediate bonds, both Treasuries, foreign governments, and corporates. And that’s contrary to the advice you’ve been getting from the financial community. So the challenge is to dismiss the rhetoric regarding the interest rate environment, and instead look at the facts. Our recommended closed-end bond investments in our growth portfolio over the past 12 months have generated an average total return of over 28%, which is far above the stock market. And I wouldn’t be too surprised if we’re not going to see similar performance going forward.
"In sum, the stock market is going to be challenging, and therefore, we’re going to focus on dividends. The bond market is not facing Armageddon, but really will be presenting opportunities and the focus will have to be on getting paid, making sure that dividends are coming in, because that is what is going to make our portfolios work for all of us for the rest of the year. We consider dividend payments to be the low hanging fruit in this market environment.
"When it comes to the emerging bond markets, I differentiate between emerging markets that are ‘stuck in the stone age’ and those that are going through positive transitions. You can’t just throw money at an index. You have to be very choosy. I would point to Templeton Emerging Market Bond Fund (EMF NYSE) and the PIMCO Strategic Global Bond Fund (RCS NYSE). Both funds are investing in what I see as key positions and buying issues that I would be recommending if I were looking for individual bonds. To me, with these funds, we get the best of both worlds. You gain exposure to some of these great potential moves within an investment vehicle that can easily be bought on the NYSE. Those funds have been rewarding us and I think they will continue to do so for the rest of the year.
"Regarding stocks, one of the things that I think will always be there is our need for infrastructure for the US and around the world. It was recently published that Europe and the US are facing a capacity issue for transmission in the power grid. Demand has been increasing about 2.3% and the actual capacity is only increasing about 1%. The estimate right now is that we’re going to have to spend about $16 billion over the next several years. One of the companies in our portfolio that is a leader in electricity generation as well as transmission equipment is a big German company called Seimens (SI NYSE). One of the major conflicts we have right now in the generation business is nuclear power. It is one of the primary turnkey operators in terms of nuclear power capability. They basically have a lock on the newer technology of cleaner, more efficient power generation.
"Another core area that I’ve been ‘stomping on’ is water. Importantly, however, most utility companies don’t own a drop of water. They simply transmit water under licenses. What I’m really big on is companies that actually own water as well being in the water purification and treatment businesses. One of our cornerstones is another big German company, RWE (RWEOY Other OTC). It is one of the largest water companies in the world, in terms of actually owning the water and the treatment facilities.
"Meanwhile, in the media, there has been a lot of attention to pending highway bill legislation. The House already passed the bill, which will spend billions on highway projects. Now they are going through another version n the Senate. One company that is an easy pick in terms of overall infrastructure and roadwork construction—as well as refineries— is Fluor (FLR NYSE). If you want to step out a little bit beyond bonds and income investing, then infrastructure is an area to look at."
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