11/04/2005 12:00 am EST
Jim Stack is one of the most consistently successful advisors around, using his in-depth knowledge of market history to prudently position his portfolio for long-term changes in the market’s direction. Here’s his outlook and some favorite stock ideas.
"Historically, if you look at bull markets, it’s not what you would expect from the decade of the 1990s. The ‘90s was the longest running bull market in history. It lasted nearly ten years without a 20% drop. Historically, however, bull markets on average last for 2.6 years. That’s the median bull market lifespan. And this bull market is already three years old. The important point here is not that this bull market has to end, but that it is already a maturing bull market. I think a growing number of stocks out there may have already seen their bull market highs, particularly in the interest rate sensitive area and in some of the technology sectors.
"If you look at the warning flags that are appearing, they are the typical ones that appear in an aging recovery. They are caused by imbalances – a shortage of labor in many areas, wage inflation, commodity inflation that is spilling over into pricing, a dramatic rise in purchasing managers reporting higher prices. Some of this may be due to energy, but not all of it. If those at the earliest stage of the manufacturing cycle are seeing higher prices, we have to ask what that will mean for consumer inflation three to five months down the road. That’s what concerns me. The pressures are still there on the Federal Reserve to continue raising interest rates.
"The other warning flag that we are watching most closely right now is long-term interest rates. The Fed has raised short-term rates 2.75 points. There have now been 11 rate hikes. Normally, that would be enough to kill a bull market. But two things have happened in this case. One, they are bringing rates off of historic lows, so there is not as much of an impact. Secondly, long rates have held very steady. The 30-year T-bond yield is trading with basically the same yield that it was two years ago.
"This is what is known as Alan Greenspan’s conundrum. The conundrum may be starting to change. For the first time this year, we are seeing a breakout in long term bond yields to the upside. If you are going to watch any bear market warning flag going forward, watch the long term bond yield. The 30-year bonds are yielding 4.7%. If it climbs to 5% or higher, it will start to pull the rug out from under this bull market.
"Two years ago we were 95% invested. Last year, we averaged 80%-85%, and while the market averages were flat, our managed accounts were up close 15%. This year, through the third quarter, we are up 10%, but we have cut back our allocation to the point where we are 70% invested and 30% in cash. That is our highest cash position since the unwinding of the bubble after the peak in 2000.
"In our portfolio, we are focusing on holdings that are more defensive, that will be more insulated from rising interest rates, rising inflation, and from a possible downturn in the housing boom. We still hold some energy stocks, although we have pulled our profits off the table. But we are still holding Devon Energy (DVN NYSE) and ConocoPhillips (COP NYSE). Going forward from here, with the pressure in energy prices, I think it is just prudent to have a portion of your portfolio in the energy sector, if nothing else, just for defensive purposes.
"Meanwhile, one stock I would recommend in this investment climate is PepsiCo (PEP NYSE). Basically, it has a strong balance sheet with a very low debt to capital ratio. It has over $4 billion in cash sitting out there. Another one would be Aflac (AFL NYSE), with its quacking duck. Aflac is the largest underwriter of supplemental cancer insurance. It has a large market share in Japan, but still a small share – less than 10% – in the US. So it has significant room for growth here. And its earnings have been growing at a 16% rate over the past five and ten years."