A Company That Performs in all Markets

Bill Hall, editor of The Park Avenue Society and Weiss Family Million-Dollar Portfolio, presents his weekly afternoon edition podcast. Click here to listen. Below is an edited transcript of that podcast. Mike Larson’s afternoon column will return tomorrow.

Bill Hall: Hello, everyone. This is Bill Hall for Money and Markets. It is Wednesday, September 3 and I am pleased to bring you this market insight.

Personally I am really excited to be on this podcast today and that is because traditionally the week after Labor Day marks the beginning of the run to the finish line for the year on Wall Street. That is because most senior traders on Wall Street tend to take the month of August off. They are on vacation so it is hard to draw any significant conclusions into August market actions.

Now what we did see and it surprised me a bit was we saw the U.S. stock market as measured by the S&P 500 climb almost 4 percent in the month of August and 4 percent is a big gain considering that we are up 10 percent year to date on the S&P 500. So a big, big piece of that 10% gain so far that we are seeing on the S&P 500 or in the U.S. stock market occurred during the month of August and it will be really interesting to me to see if we can hold on to that.

Okay, let’s jump right in here and look at our first slide and see what is going on in the market. Let’s start off this run to the finish line for 2014 with the big picture perspective and the big picture perspective is that the world’s central bankers are in complete charge of the world’s financial markets. That is because they have had to make so much liquidity available to make the real economy function, that the markets are reacting to that. And much of that easy money is spilling over as we all know into the world’s financial markets.

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Now let’s look at our second slide and if you listened to last week’s podcast, you will know that I told you about this way of looking at the stock market in last week’s podcast and what it shows is it shows that there are three and only three components of stock market returns:dividends, earnings growth, and change in the P/E multiple.

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That is right.There are only three components to all of this that you hear about in terms of the stock market. So at the end of the day, you need to distill all of the information you hear and understand how it affects these three variables: number one, dividends; number two, earnings growth; and number three, stock market valuations as measured by the change in the P/E multiple.

And in last week’s podcast, what I emphasized was the dividend component of measuring total stock market returns when I focused on business development companies and talked about how dividends could drive stock returns on that particular asset class. What I am going to talk today about is the thing that is most important to driving long-term returns and that is growth and so that is why I have earnings growth capitalized here on this slide.

Earnings growth is what you need over the long term to drive the stock market higher and keep it moving forward at high levels. So far what we have had is we have had a change in the P/E multiple or the price that people are willing to pay that has propped up the stock market, not real honest to goodness earnings growth.

So if you look at our third slide, what you will see is, taking 2013 — that was a year ago, I know, but it is easy to look at 2013 and then I will quickly talk about 2014 in terms of our stock market return model — and what we see is that in 2013 we had a phenomenal year. The market increased 32 percent but only 5 percent of that came from earnings growth. We got a little bit from dividend, about 2 percent. But the majority of it was the fact that people were just willing to pay more for stocks at the end of 2013 than they were at the beginning of 2013.

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It is no different than going to the store and seeing a pound of hamburger sitting there and paying a premium for it over what you were willing to pay at the beginning of the year. It is no more complicated than that. So what we had was that generally speaking and loosely speaking on a price per pound basis, people were willing to pay 25 percent more for stocks in 2013.

So you may be saying so, Bill, what does that have to do with 2014? I do not have a slide on this but if you looked at 2014’s returns you will see that about half of the 10 percent return, that is 5 percent of it, has come from the fact that people are willing to pay more for stocks.

So, the fact that the market has increased a whopping 42 percent over the last 18 months, most of that is due to the fact that people are just willing to pay more for stocks and that is something that can go on for a while butit cannot continue. It is not sustainable. It will not hold the stock market at its lofty levels.

So let’s take a look at our last slide and you say, what is an investor to do? What should an investor do in a slow growth environment? And what I am recommending investors consider are companies that can grow their earnings in all types of economic environments, especially the difficult slow growth world that we face today and a company that you should consider adding to your portfolio is PepsiCo.

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Here we have one of the world’s leaders in carbonated beverages. In fact they are a market leader in beverages of all types. They are a market leader in salty snacks. PepsiCo’s stock is up about 13 percent year to date and what you get when you buy PepsiCo is you get earnings growth of about 10 percent which is a very strong rate of growth in a world where the U.S. GDP is only growing about 2 percent to 2.5 percent. You get a dividend just under 3 percent, so if you get no market revaluation, you could probably look at 13 percent going forward and then if we get some benefit of a bump in terms of the P/E multiple, you could be looking at a 13-15 percent return and at 13% to 15%, your money will double every five and a half to six years and it really does not get any better than that in the markets.

So that is Bill Hall for Money and Markets. Have a great week and I look forward to speaking with you next week.

Last week’s column received a lot of comments that are still valid this week. Many of the responses concerned the news out of Ukraine, a crisis that is still in the news today (see below). Many people debated whether Ukraine should be fast-tracked in to NATO.

Reader Bruce said: “I think we have done enough damage to Ukraine by our unfulfilled weapons promises. We cannot get into action in all of the wars currently being fought. No, Ukraine should not be allowed into NATO.”

Reader Robert said we do have an obligation to Ukraine, based on past agreements. “In 1994, the U.S., United Kingdom and Russian Federation signed the Budapest memorandum with Ukraine. In exchange for giving up its nuclear weapons, Ukraine was promised that its territorial integrity would be respected and protected. The Russians are in clear violation of this agreement. NATO’s response should be that we give the Ukrainian government everything they need to defend themselves. NATO troops should be stationed in nearby countries so that they can respond to a Russian invasion. When we give our word, our word is our covenant, just like the Ten Commandments.”

Meanwhile, a column by Mandeep Rai on margin buying received many responses. Most cautioned against buying on margin.

Reader Ron warned about the pitfalls of buying on margin. “Margin trading is strictly for pros who fully understand the risks, and that is why they trade with the utmost precision of timing. If not, then chances are they will lose even if their original bet was right. I made my first fortune trading silver futures in the ’70s. I got out when the market got crazy before the Feds put the clamp on silver futures trading by tripling the margin requirements, which brought about a horrendous crash which has not recovered in 35 years. Today, I do not trade on margin as I intend to keep my money from evaporating.”

Reader Donald pretty much agreed. “Buying on margin should only be done if you have the funds available to pay the total price in case of a margin call. If you have the funds to meet any margin call, why not pay in full and save the interest expense? I will never buy stocks on margin. Instead, I sell puts on stocks that I would like to own but at a lower price and always have the funds to cover the cost of the stock if it assigned.”

You can add your views to these or any other issues by clicking here.

 Markets got an early boost after word overnight about a cease-fire agreement between Ukraine and Russia. The basic plan calls for the separatists to end their offensive against Ukrainian forces near the cities of Donetsk and Luhansk, while Ukraine would pull its forces back ‘to a distance that prevents the use of artillery and rockets against population centers,’  Putin was quoted as saying. Still unclear is whether the pro-Russian rebels would be left in control of the areas they now hold. U.S. and Western officials remained cautious, as conflicting reports surfaced about the cease-fire continued to confuse matters.

The news of an agreement moved the markets higher this morning. What is your view? Does the quickly changing situation in Ukraine really affect your investment strategy? Do you buy and sell daily with the changing fortunes, or do you wait for longer-term trends in global crises? Share your views by clicking here.

 Another cyber breach has apparently hit an American retailer.The Home Depot Inc. (HD) said it was investigating reports that customers’ credit and debit card information was stolen from its systems and were being put up for sale on the Internet. The company said it was working with law enforcement and banks on the possible breach. If it is true, the company will be the latest in a long line of hackings among retailers and other companies. One report put the total number of consumers affected by all of the data hacks as one-third of the U.S. population.

 More Americans than ever are taking out loans to buy cars, especially used cars, a report by Experian said today. Reuters reported that in the second quarter, 85 percent of new car purchases and 54 percent of buys of used cars were financed. The size of the loans continued to increase, the report said. Since mid-2013, the average used-car loan rose 1.9 percent to $18,258, and the average monthly payment on those vehicles rose 1.1 percent to $355, an all-time high. Worries have increased by some regulators and analysts that banks’ willingness to lengthen car-loan terms and to lend to consumers with lower credit ratings could lead to credit problems in the future. What do you think? Does all this lending remind you of the subprime crisis in the real estate sector? Or does the relative low cost of vehicles compared with housing prevent a major crisis from surfacing? Click here to add your view.

 Another sign that the rich aren’t suffering too much these days:Luxury home builder Toll Brothers Inc.’s (TOL) profit doubled and revenue rose more than 50 percent in the third quarter. Toll Brothers said third-quarter revenue was $1.06 billion. The company delivered 1,444 units for the quarter, a 36 percent rise. Toll’s CEO said he sees pent-up demand that has yet to be unleashed and that he is especially pleased with the company’s performance in markets like Coastal California, Texas and urban New York City.

Feel free to comment on these or any other issues by clicking here.

Best wishes,

Bill Hall

P.S. Martin will host his 2nd video briefing tomorrow at 12 noon EST! Please click here now to watch! AND if you missed his first briefing you will be able to catch up on that as well!

Bill Hall is the editor of the Safe Money Report. He is a Certified Public Accountant (CPA), Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP). Besides his editorial duties with Weiss Research, Bill is the managing director of Plimsoll Mark Capital, a firm that provides financial, tax and investment advice to wealthy families all over the world.