You may see a recommendation to "overweight" a stock or sector. An analyst is bullish on a stock or group and feels buying more than usual will be rewarded. It may or may not come true. While it's a good idea to overweight at times, it should never be done in excess, to a point where you're putting too much of your portfolio in one stock or group of stocks. That's when overweight turns into speculate.
A rational approach to building a portfolio is to have at least five different sectors, ones that aren't correlated. There are different definitions of sectors but there are usually between 10 and 15, depending on what publication or expert you use. These sectors are categorized into broad groups, such as Healthcare, Technology, Manufacturing, etc. Within each sector are many industries. Value Line defines 98 different industries, ranging from Coal to Auto Parts to Water Utility to Beverages. Healthcare, as one example of a sector, has pharmaceutical companies, hospitals, medical devices, anything associated with health. Technology has a broad spectrum as well, encompassing everything from computers to wireless communication.
One outstanding opportunity in a stock market hammered as hard as this one is that great stocks are on sale. Many of the best known, best-earning companies are trading at valuations not seen in decades. That's the good news.
The bad news is that many stocks most of us own are way down, trading at levels well below where we bought them. In order to buy anything else, we have to sell what we have for a loss. Most of us can't do that, can't stand the pain. Get over it. Sell some of your worst losers and buy some of the great names.
I can hear many of you now: But Ted, you don't understand. I bought this stock at $10 a share and now it's trading at $1. I'd lose 90% of my money. I do understand. I've done it. Several times. That biotech I was sure was going to cure (pick one): cancer, malaria, the common cold, bursitis, arthritis, dandruff, ear wax, split ends, etc. Somehow they never came through except in their need for more money. They were always so close. Management just needed a little more time and a lot more money.
Preferred stocks are much like squirrels. They don't live on the ground. They don't fly in the air. They're always somewhere in between. A preferred is like that. It's not equity in a company. It's not debt of a company. It's always somewhere in between.
That state of being, being in between, sometimes pays handsomely to investors. Other times, it leaves them totally isolated, with nothing to show for their investments. Here's how preferred stocks work, and why they're really for institutions, not individuals. Still, individuals may find them irresistible when they see some of the yields these hybrids offer.
There are clearly some banks, thrifts and other financial institutions doing better than others. That became clear in the most recent earnings releases. Wells Fargo & Co. (NYSE: WFC) showed a profit. True, lower than last year but that was expected. What wasn't expected was better revenues and lower losses. JPMorgan & Chase & Co. (NYSE: JPM) had a similar story. So did Bank of America Corp. (NYSE: BAC). Citigroup (NYSE: C) gave better than predicted numbers. Those were the good announcements.
Not doing so well is Wachovia Bank (NYSE: WB). That loss was much larger than analysts projected. The bank cut the dividend, as expected. The stock gave up more ground.
We are heading for a crisis of confidence, confidence in the core of the U.S. economy, the capitalist way of life, starting with financial institutions and permeating every other industry from autos to homebuilders. Investors wonder if institutions as we know them will survive. Will foreign firms buy every American company? Or will they dry up and blow away? Will all the banks shut down? Stock prices suggest many investors are thinking maybe all of these will happen.
And why not? Ford Motor (NYSE: F) announced it won't introduce a new F-150 truck, the best selling truck of all time. The reason: there are acres and acres of old F-150s sitting on dealer lots that no one wants. GeneralMotors (NYSE: GM) is shutting truck plants longer than usual since very few of its big moneymakers are moving off lots. Homebuilders are showing huge losses and all of them say there is no light at the end of this dark tunnel. Bank news gets worse each day, with headlines screaming that we aren't near to knowing how bad this mortgage and credit crisis really is.
There is no shelter in this storm. Everywhere investors look, they see more dark clouds. Most of them believe that it gets darkest just before it get pitch black. Is the American dream gone, turned into an economic nightmare, the likes of which we haven't seen since the Depression?
Hardly. During the depression, over 30% of the workforce wasn't working. Prices were constantly going lower as fewer and fewer goods were sold. All the banks were shut for a "Bank Holiday" for three days shortly after Roosevelt was elected. People were roaming the country, looking for a job, anything to keep food on the table for their families. If the American dream were going to die, it would have done so in the late 30's and early 40's. But it didn't.
Last week I wrote about what might happen if gas continues its seemingly inevitable march upward, maybe reaching $10 a gallon. There will be changes in our lifestyles, major changes. Some companies will benefit greatly, others will simply go away, unable to evolve with the new reality. Here are more industries that will be affected.
The airlines, at least the ones left, will fly smaller planes, more fuel efficient. They'll be full, every one, every time. They may not take off unless they are. Some cancelled if they're not booked up 12 hours in advance. Expect more hassles at the airport, more charges and fees for whatever airlines can imagine. (How about charging by the pound? Passengers get on a scale, then pay at the counter based on their weight.) Seat space will get even smaller.
Things are different now. Gas is more expensive, way more expensive. You used to fill a car for $20 (way back in the '60's it was $5). Now it easily costs $80 and is going higher. What does this one thing suggest will happen, not only in the U.S. but globally? The ramifications are huge. Some companies will benefit. Others will be crunched under the wheels of evolution as the inevitable occurs.
First, let's go to extremes. Say gas costs $10 a gallon. It's already close to $5 here in California. Give it a few more weeks, especially around the 4th of July. It'll break $5 and keep going. Some people have already started to adapt to the new reality. They're buying cars that get better gas mileage, dumping SUVs or big cars that slurp gas like it's a buck a gallon. So the first group of companies to benefit will be the ones making the most fuel efficient cars. That started happening about a year ago as Toyota couldn't make enough Priuses to keep up with demand. Now GM and Ford are trying to move as fast as possible to get out electric cars and/or hybrids. Do they have enough capital to make the transition?
Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started. Merrill, Lynch (NYSE: MER), Lehman Brothers (NYSE: LEH) and Morgan Stanley (NYSE: MS) are on the watch list at Standard & Poor's, the ratings agency that can make raising money very expensive for companies that get downgraded. Of the three, Lehman appears the most shaky with many expecting it to report a loss for the first time since it went public. Word is that the firm is trying to raise $3 billion to $4 billion to keep its capital base healthy. It's out there competing with many banks and insurance companies working on the same thing. Merrill Lynch already has its money in the bank but may need more.
The real problem all these firms have, along with all financial institution money raisers, is that they are loaded with securities they can't sell. They're called mortgage-back securities or Collateralized Debt Obligations (CDO's) or SIV's (Structured Investment Vehicles) or some other acronym. They all mean the same thing: no buyers anywhere at any price. It reminds me of the high inflationary days of the 70's when selling a 30-year bond was impossible. The joke was: What's the difference between a long term bond and VD? You can get rid of VD.
Consumer Confidence came out. It's at a 16-year low. Oil is taking a breather as this is written, off its all-time high of $133 recently. No one thinks it's going back to $100 or lower. Not ever. There's too much demand from China, India and Brazil for that. Housing stats are enough to induce stomach problems with first quarter prices down 14.4% from the same quarter last year. They were accelerating downward as the quarter ended, setting up for a miserable number for this quarter.
On the political front, the Democrats are locked in a battle over their nominee, both of whom want out of the Iraqi war but also want to raise taxes on higher incomes. The Republican nominee wants to stay the course in Iraq but wants to keep taxes low. It's the usual splits about taxes, government vs. private enterprise. It doesn't matter who wins, change is coming. Most likely the candidate that can offer resolutions for the high cost of gas and food will get most of the votes. Neither problem is easily or quickly solved. And certainly not by a legislative fiat. But incentives can come from Washington.
While lenders and builders have been cruelly battered by a real estate market that seems to have no bottom, there's another industry group that suffers as much if not more: the newspaper business.
First, newspapers were hit by the Internet, taking readers faster than rebate checks are spent. Now it's real estate ads, and their complementary advertisers such as home furnishings. Another weak advertiser: automobiles. All ads have decreased to a point where some publishers are laying off employees every month, trying to cut costs fast enough to offset lower revenues.
I read an article that was explaining some of the credit problems financial institutions have. It went into the mortgage mess, the concerns for coming credit card collections and home equity loans. It was good and helpful to anyone interested in knowing more about potential problems for banks and thrifts. Then I read one of the reader's replies: More big picture stuff, just tell me what to buy tomorrow morning.
This one reader speaks for many others. Every investor would love to know what to buy now. They just want the name of a stock that will go up. And they don' want to have to research it or know anything else about it. Just a name. Give me a name. Ah, if it were that easy.
Some of the smartest investors, or at least ones who made a lot of money in the past, are buying financial stocks. Big time. They're the ones who bought a large chunk of Washington Mutual (NYSE: WM) and Wachovia Bank (NYSE: WB). Some $7 billion worth in WaMu, $8 billion in Wachovia coming soon. (Wachovia raised $3.5 billion through preferred stock only two months prior.) But these sharp investors didn't buy stock on the open market. They got theirs in negotiated deals with each bank. And they're not done buying.
Banks are teetering on the edge of a precipice. Without new capital their losses threaten to wipe out the capital base required to stay open. That forces many of them to consider selling to another, stronger bank or raise more capital to replace the losses. While not strictly a bank, Bear Stearns (NYSE: BSC), an investment bank, was leaning heavily over the edge when JP Morgan Chase (NYSE: JPM) threw it a rope and reeled it in. Originally at $2 a share, now at $10. The building that Bear owns is said to be worth at least $2 a share, so JP Morgan's life line came at a very high cost.
Mutual funds are great ways to invest. They offer professional management and risk diversification, especially if it's a general fund such as large cap growth and income. The diversification is less if it's specialized such as healthcare, but there is still lower risk because the fund buys many different stocks in a sector. Many investors believe they're at a higher level than fund investing, one where they pick individual stocks and make better returns than mutual funds. That may be true, but most likely not for every investment.
By that I mean there is no way you can invest in China with a diverse group of stocks and know much about each company. And even if you can get information on a company, it's usually at least six months old. Imagine how much changes anywhere in six months, much less in a volatile economy like China. The initial reaction might be that things are even better now. But not necessarily for your company. Or when things do change, as every economic cycle does, you may be the last to know that the bubble burst six months ago for the sector in which your company operates.
The banking industry is in difficult times. After years of poor lending practices for mortgages by many banks and savings and loans, they're reaping the rewards for stupidity and greed. Those mortgages are being abandoned by borrowers because they can't make the monthly payments. The houses behind the mortgages are empty, reverting back to the lenders. As more and more houses are put up for sale, prices go lower and lower. The banks lose money on the loans as they sell homes to recover as much as possible. Many sales don't pay off all of the loans. The difference will be a loss for the lender.
That's what's happening all over the country. It's a mess, an expensive mess, created by the lenders by and on themselves. But keep this in mind: the banking industry is fundamental to the economy. Loans are what make new companies go, allow qualified buyers to purchase new and used homes, move cars off lots, etc. Lending money is fundamental to the U.S. economy. Without loans, growth would slow, inventories would rise, jobs would be lost. The banking industry has to function well for the U.S. in general to do well.
Any investor looking to the Fed to bail out current credit problems is looking at part of the answer. The Fed can only do so much. It can lower interest rates. It can add money to the economy. But that isn't going to be enough to cure all the bad mortgages or delinquent credit card payments. And if the Fed adds too much money to the economy, it feeds inflation. The Fed needs help from Congress and the President and mostly business, particularly the banks and thrifts that made the loans.
Here's the essence of the problem: even if rates go much lower, if people don't have jobs, they won't borrow money because they don't have the means to pay it back. Furthermore, banks won't lend money to the unemployed or underemployed. They've already done that. That's why we're in this mess. And they should be the ones to pay for it, not taxpayers. The lenders need to face these problems squarely and take the necessary measures to work them out.
Ted Allrich is the founder of The Online Investor and author of: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.
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