Tag Archives: seeking-alpha

Demographics Will Drive Future Investment Decisions

Summary Society is getting older and will need more healthcare. Fewer younger people and they have different tastes. The wise investor should pay attention to these changing demographics. Bob Dylan sang “the times they are a-changin'” in 1964, and he couldn’t have been more right. Things are indeed changing. Society is aging, every day 10,000 more people turn 65, and fewer babies are being born, the average fertility rate is now less than 1.9, almost a 50% drop off from the peak in 1959. More older, and retired, people means more spending on healthcare and leisure activities and fewer younger people means less spending on homes, cars, and other big ticket items. And the young crowd has different tastes and are more health conscious regarding food than their parents or grandparents. Demographers are saying that these trends probably will be with us for a long time, likely out to the year 2050. How will this turn of events affect investors going forward? Hint: those holding shares of companies such as Johnson & Johnson (NYSE: JNJ ), McDonald’s (NYSE: MCD ), and Universal Health Realty Income Trust (NYSE: UHT ) should pay attention. Older and wiser Pharmaceutical giant Johnson & Johnson supplies prescription drugs, consumer health items, and medical devices, which all should be in great demand for the foreseeable future. A well-performing management team has steered the company through both good and bad times by employing a successful acquisition strategy and top-notch R&D effort that has helped keep the drug pipeline stocked with a seemingly never ending supply. As of April, there were 15 different drugs in the late stage U.S. and E.U. approval phase. As soon as those patent-protected products head to market, investors can expect to start reaping the benefits, which will probably include more dividend hikes. The company, one of the few with a pristine AAA credit rating, has raised the dividend payout every year since 1963 and has been growing it at a 6.5% annual rate over the last half-decade. Shares currently yield about 2.9%, well above the rate on 5- and 10-year Treasury notes. There is plenty of room to keep the dividend flowing and growing. The payout ratio of less than 50% is modest. Johnson & Johnson will probably continue to generate consistent cash flow from operations, it was $14B last year alone, and has a low (0.2) long-term debt to equity ratio. Analysts project that earnings and cash flow will continue to increase. EPS has averaged a double-digit growth rate over the past three years, a time when many companies have struggled. Universal Health Realty Income Trust is a REIT that owns medical office buildings, urgent care facilities, and other healthcare-related properties. The company has been increasing revenue at a double-digit pace for the past half decade. Over the past year, UHT has assumed a minority interest in several other real estate firms and added four new buildings to its portfolio which should help continue the trend. Universal Health pays a quarterly dividend of $0.64 per share and the stock currently yields about 5.0%, double that of the average Dividend Aristocrat and well above what you can find in most investment-grade bonds. The company has traditionally generated adequate “funds from operations,” or FFO, a metric commonly used in the REIT industry, over the years. A recent quarterly filing indicated that adjusted FFO increased 3% to $0.72 per diluted share. The stock is not without risk. The current price/sales ratio of about 10.6 could mean that shares are a bit pricey right now. Changing tastes With fewer younger people around, companies that previously catered to this segment of the population probably will be impacted. Shareholders of retail outlets, home builders, and even auto manufacturers could see a lot of red over the next few decades. And the younger crowd has different tastes than the generations that came before them. For one thing, they want a healthier brand of fast food. This could impact old school companies, such as McDonald’s. The Oak Brook, IL-based burger giant has reported less foot traffic and lower same-store sales over the past few years. In a bid to reverse this trend, the company had to make radical changes to both its menu (for example, adding all-day breakfast and reducing the number of items) and to management (earlier this year a new CEO took over). I recently wrote an article that concluded that so far the improvements have helped stabilize things at least but will the company be able to withstand three decades of demographic headwinds? Conclusion Demographic trends indicate that up to the middle of the century things could be dicey for some companies like McDonald’s, as a smaller number of younger people spend their money in different ways than before. However, the aging of society might be a boon to the healthcare industry, which would make investors of Johnson & Johnson and Universal Healthcare Realty Trust happy.

Don’t Be This Guy

Take a look at this picture, which I took a few years ago, on a Friday afternoon, on a New York/New Jersey ferry. After a long and stressful work week (it was 2008), the gentleman in the photo was more than a little inebriated (i.e., could barely stand up), probably the victim of an early happy hour. Now, you should also know that these ferries are fast, and the winds on the river are strong – the wind is often strong enough to blow glasses off your face. This poor soul had urgent business that was unable to wait for the trip across the river, so he walked to the front of the ferry, unzipped, and relieved himself over the bow-directly into what was probably a 35-knot headwind. Though this happened a while ago, the lesson and the aftermath made a lasting impression (probably more so on the people who did not see it coming and did not step out of the spray). Though few of us might commit the Technicolor version of this error, financial commentators do it all the time, in other ways. I spent some time this weekend doing a lot of reading – everything from social media, “big” media, gurus and pundits, and paid research. It was interesting to see the commonalities across the group (a less kind assessment might be “groupthink”), but I saw one error repeatedly: Attempts to catch or call a trend turn with no justification. This error can be hazardous to your financial health, so let me share a few thoughts. Why we are always looking for the turn I think there are good reasons why traders are always looking for the end of the trend. Many of us who do this are competitive and contrary in the extreme. I joke with people that I could have a conversation like this: Me: “Look at the pretty blue sky.” You: “Yes, that really is a pretty color of blue.” Me (now concerned because I agree with someone else): “Well… is it really blue? Isn’t it more blue green? And we know it’s essentially an optical illusion anyway…” This tendency is natural and pretty common among traders. On one hand, it’s a very good thing – you will do your own work, be naturally distrustful of outside opinions and cynical about information, and will work to think critically about everything. But it’s also a weakness because it makes us naturally inclined to see any market movement and think that the crowd is wrong. The crowd is not always wrong; often, they are right and they are right for a very long time. I think this is a simple reason why so many of us are always looking for the turn – many traders (not all) are simply wired to be contrary and to think in a contrary way. We are different, and we want to stand apart from the crowd. For many of us, this is a part of our personality and we must learn to manage it, and to understand that it is the lens that can distort everything we see. Trading lessons and psychology Beyond this element of personality, there are also some trading and market related reasons why we are always looking for a turn. There’s a misguided idea that we have to catch the turn to make money. Decades of trend following returns (for example, the Turtles) have proven that you don’t have to catch the turn; it’s enough to take a chunk out of the middle. There’s also a natural inclination to be angry and distrustful of a move we missed – if we see a long, extended, multi-month trend in which we are not participating, it’s natural to be scornful of those who did participate and to look for reasons the trend might be ending. Many classical chart patterns are taught and used out of context. Any trend will always show multiple “head and shoulders” patterns, and inexperienced chartists will not hesitate to point these out. The problem with poorly defined chart patterns (out of context) is that you can see anything you wish to see in a chart – it’s always possible to justify being long, short, or flat a market, so it’s always possible to find evidence to support whatever you want to do, at least in the absence of clearly defined trading rules and objectives. Another problem is that many traders use tools that are supposed to somehow measure extremes. Overbought/oversold indicators, sentiment indicators, ratios, bands – the problem is that these all measure the same thing, in a different way. If I get an oversold signal from sentiment, RSI, and some Fibonacci extension, I do not have three signals – I only have one because the tools are so tightly correlated. This is important to understand – if we don’t understand this (the correlation of inputs into a trading decision), then we will have false confidence in our calls, and performance will suffer. Better to know you don’t know than to think you know more than you do. Commentators and asymmetrical payoffs If a trader places a trade, she makes money if the trade is profitable and loses money if it is not. This is simple, logical, and just. However, for a commentator (blog writer, research provider, TV personality, guru, etc.), the payoffs are very different – the public remembers the times we are right, and very quickly forgets the times we are wrong. The fact there even are permabears (people who have been bearish stocks for decades) who are called to be on TV and in the paper when the market goes down is proof of this fact. It’s possible to run a newsletter or blog business for years making outrageous claims that never come true such as “end of the financial world,” “the coming crash,” “how to protect your assets from the coming seizures,” etc. The crazier and more outlandish the forecast, the better: If someone says the S&P is going down 500 points tomorrow and he’s wrong, no one will long remember because it was a dumb call. If, however the S&P should, for some reason, go down 500 points, that person is, instantly and forever, the expert who “called the crash.” In fact, if that forecast doesn’t come true but there’s some mild decline in the next few months, creative PR can still tie the forecast in. Why does this matter? You can read blogs and listen to commentators, but read with skepticism. Realize that the person writing has a reason for calling ends of trends and turns. Your trading account, however, has a different standard: If you lose more on your losing trades than you make on the sum of your winners, that’s going to be a problem, in the long run. Finding ends of trends I’ve written about this before, so I will just point you to the relevant posts. One way I have found to avoid the situation where I’m going against the trend is to require some clear signal from the market that the trend might have ended. There are specific patterns that can help: (exhaustion, climax, three pushes, failure tests, price rejection), and then seeing the change of character (new momentum in the other direction) to set up a pullback in the possibly new trend is key. (Start reading here for ideas on evaluating and catching a possible turn.) In the absence of that sequence: 1) something to break the trend and 2) new counter-trend momentum and change of character, the best bet is to not try to fade the trend and to wait for clear signals. Let me leave you with a few charts of current markets, with only one question: What direction is the trend in each of these markets? Most of the time, that’s all the commentary we need. And that guy back at the top of this post? Yeah, don’t be that guy.

Technically Speaking: The Real Value Of Cash

With the ” inmates running the asylum ” during a holiday-shortened trading week, the upward bias to the market is set to continue. However, as I addressed last week: ” As we progress through the last two months of the year, historical tendencies suggest a bias to the upside . This is particularly the case given the weakness this past summer which has left many mutual and hedge funds trailing their benchmarks. The need to play ‘catch-up’ will likely create a push into larger capitalization stocks as portfolios are ‘window dressed’ for year end reporting . This traditional ‘Santa Claus’ rally, however, does not guarantee the resumption of the ongoing ‘bull market’ into 2016. The chart below lays out my expectation for the market through the end of the year. ” (click to enlarge) ” With the markets currently oversold on a very short-term basis, the current probability is a rally into the ‘Thanksgiving’ holiday next week and potentially into the first week of December . As opposed to my rudimentary projections, the push higher will likely be a ‘choppy’ advance rather than a straight line. ” So far, the analysis over the last several weeks has continued to play out as expected. However, and this is crucially important, a near-term expectation of a bullish advance due to the recent correction and seasonal tendencies is not the same as long-term bullish outlook . As stated above, while seasonality likely holds the cards through the end of this year, projecting much beyond that window is foolishness. The Real Value Of Cash This brings to mind a call I had on the radio show recently discussing his advisor’s reluctance to hold cash . The argument against holding cash goes this way: ” If you hold cash, you lose value over time to inflation .” This is a true statement if you hold cash for an EXTREMELY long period. However, holding cash as a ” hedge ” against market volatility during periods of elevated uncertainty is a different matter entirely. As I discussed previously: ” I have written previously that historically it is relatively unimportant the markets are making new highs. The reality is that new highs represent about 5% of the markets action while the other 95% of the advance was making up previous losses. ‘ Getting back to even’ is not a long-term investing strategy . ” (click to enlarge) In a market environment that is extremely overvalued, the projection of long-term forward returns is exceedingly low. This, of course, does not mean that markets just trade sideways, but in rather large swings between exhilarating rises and spirit-crushing declines. This is an extremely important concept in understanding the “real value of cash.” (click to enlarge) The chart below shows the inflation-adjusted return of $100 invested in the S&P 500 ( using data provided by Dr. Robert Shiller ). The chart also shows Dr. Shiller’s CAPE ratio. However, I have capped the CAPE ratio at 23x earnings which has historically been the peak of secular bull markets in the past. Lastly, I calculated a simple cash/stock switching model which buys stocks at a CAPE ratio of 6x or less and moves back to cash at a ratio of 23x . I have adjusted the value of holding cash for the annual inflation rate which is why during the sharp rise in inflation in the 1970s, there is a downward slope in the value of cash . However, while the value of cash is adjusted for purchasing power in terms of acquiring goods or services in the future, the impact of inflation on cash as an asset with respect to reinvestment may be different since asset prices are negatively impacted by spiking inflation. In such an event, cash gains purchasing power parity in the future if assets prices fall more than inflation rises. (click to enlarge) While no individual could effectively manage money this way, the importance of “cash” as an asset class is revealed. While cash did lose relative purchasing power, due to inflation, the benefits of having capital to invest at lower valuations produced substantial outperformance over waiting for previously destroyed investment capital to recover. While we can debate over methodologies, allocations, etc., the point here is that ” time frames ” are crucial in the discussion of cash as an asset class. If an individual is “literally” burying cash in their backyard, then the discussion of the loss of purchasing power is appropriate. However, if cash is a “tactical” holding to avoid short-term destruction of capital, then the protection afforded outweighs the loss of purchasing power in the distant future. Much of the mainstream media will quickly disagree with the concept of holding cash and tout long-term returns as the reason to just remain invested in both good times and bad. The problem is that it is YOUR money at risk. Furthermore, most individuals lack the ” time ” necessary to truly capture 30- to 60-year return averages. For individuals, trying to save for their retirement, there are several important considerations with respect to cash as an asset class: Cash is an effective hedge against market loss. Cash provides an opportunity to take advantage of market declines. Cash provides stability during times of uncertainty (reduces emotional mistakes) Importantly, I am not talking about being 100% in cash. I am suggesting that holding higher levels of cash during periods of uncertainty provides both stability and opportunity. With the fundamental and economic backdrop becoming much more hostile toward investors in the intermediate term, understanding the value of cash as a ” hedge ” against loss becomes much more important. As John Hussman recently noted: ” The overall economic and financial landscape, then, is one where obscene valuations imply zero or negative S&P 500 total returns for more than a decade – an outcome that is largely baked-in-the-cake regardless of shorter term economic or speculative factors. Presently, market internals remain unfavorable as well. Coming off of recent overvalued, overbought, overbullish extremes, this has historically opened a clear vulnerability of the market to air-pockets, free-falls and crashes. ” As stated above, near zero returns do not imply that each year will have a zero rate of return. However, as a quick review of the past 15 years shows, markets can trade in very wide ranges leaving those who ” rode it out ” little to show for their emotional wear. Given the length of the current market advance, deteriorating internals, high valuations and weak economic backdrop; reviewing cash as an asset class in your allocation may make some sense. Chasing yield at any cost has typically not ended well for most. Of course, since Wall Street does not make fees on investors holding cash, maybe there is another reason they are so adamant that you remain invested all the time. Just something to think about.