Mrs. Magoo, Deflation, and Commodity Woes

By Tony Sagami 

Did you read my September 22 issue? Or my July 14 column? If you did, you could have avoided the downdraft that has pulled down stocks all across the transportation sector or even made a bundle, like the 100% gain my Rational Bear subscribers made by buying put options on Seaspan Corporation, the largest container shipping company in the world.

Don’t worry, though. Transportation stocks still have a long ways to fall, so it’s not too late to sell any trucking, shipping, or railroad stock you may own—or profit from their continued fall through shorting, put options, or inverse ETFs. This chart of the Dow Jones Transportation Average validates my negative outlook on all things transportation and shows why we’ve been so successful betting against the “movers” of the US economy.

However, the bear market for transportation stocks is far from finished.

Federal Express Crashes and Burns

Federal Express, which is the single largest weighting of the Dow Jones Transportation Average at 11.6%, delivered a trifecta of misery:

1. Missed on revenues
    
2. Missed on earnings
    
3. Lowered 2016 guidance

I’m not talking about a small miss either. FedEx reported profits of $2.26 per share, well below the $2.46 Wall Street was expecting. Moreover, the company should benefit from having one extra day in the quarter, which makes the results even more disappointing.

What’s the problem?

“Weak industry demand,” according to FedEx. By the way, both Federal Express and United Parcel Service are good barometers of overall consumer spending/confidence, so that should tell you something about the (deteriorating) state of the US economy. Oh, and Federal Express announced that it will increase its rates by an average of 4.9% beginning in January 2015. Yeah, I bet that rate increase will really help with that already weak demand. The decline is even more troublesome when you consider that gasoline/diesel prices have fallen like a rock this year.

Speaking of Falling Commodity Prices

Oil, which dropped by 23% in the third quarter, isn’t the only commodity that’s falling like a rock.

• Copper prices plunged to a six-year low.
   
• Aluminum prices have also dropped to a six year low.

• Coal prices have fallen 40% since the start of 2014.
   
• Minerals aren’t the only commodities that are dropping. Sugar hit a 7-year low in August.

Commodities across the board are lower; the Thomson Reuters CoreCommodity CRB Index of 19 commodities was down 15% for the quarter and 31% over the last 12 months. Since peaking in 2008, the CRB Index is down 60%.

That’s why anybody and anything associated with the commodity food chain has been a terrible place to invest your money. Just last week:

Connecting the Dots #1: Caterpillar announced that it was going to lay off 4,000 to 5,000 people this year. That number could reach 10,000 by the end of 2016, and the company may close more than 20 plants. Layoffs are nothing new at Caterpillar—the company has reduced its total workforce by 31,000 workers since 2012.

The problem is lousy sales. Caterpillar just told Wall Street to lower its revenues forecast for 2016 by $1 billion. $1 billion!

How bad does the future have to look for a company to suddenly decide that it is going to lose $1 billion in sales? “We are facing a convergence of challenging marketplace conditions in key regions and industry sectors, namely in mining and energy,” said Doug Oberhelman, Caterpillar chairman and CEO.

Like the layoffs, vanishing sales are nothing new. 2015 is the third year in a row of shrinking sales, and 2016 will be the fourth. Caterpillar, by the way, isn’t the only heavy-equipment company in deep trouble.

Connecting the Dots #2: Last week, UK construction machinery firm and Caterpillar competitor JCB announced that it will cut 400 jobs, or 6% of its workforce, because of a massive slowdown in business in Russia, China, and Brazil.

“In the first six months of the year, the market in Russia has dropped by 70%, Brazil by 36%, and China by 47%,”said JCB CEO Graeme Macdonald. Caterpillar, the world’s biggest maker of earthmoving equipment, cut its full-year 2015 forecast in part because of the slowdown in China and Brazil.

Connecting the Dots #3: BHP Billiton announced that it is chopping its capital expenditure budget again to $8.5 billion, a stunning $10 billion below its 2013 peak. Moreover, BHP Billiton currently only has four projects in the works, two of which are almost complete, compared to 18 developments it had going just two years ago.

Overall, the mining industry—according to SNL Metals and Mining—is going to spend $70 billion less in 2015 less than it did in 2012. And in case you think metals prices are going to rebound, consider that the previous bear market for mining lasted from 1997 to 2002, which suggests at least another two years of shrinking budgets and pain.

Repeat After Me!

I have said this many, many times before, but repeat after me.....ZIRP (zero interest rate policy) and QE are DEFLATIONARY!

The reason is that cheap (almost free) money encourages over-investment as well as keeping zombie companies alive that should have gone out of business. Both of those forces are highly deflationary, and unless you think that Mrs. Magoo (Janet Yellen) is going to aggressively start jacking up interest rates, you better adjust your portfolio for years and years and years of deflation.

While the rest of the investment world has been struggling, here at Rational Bear, we’ve been doing just fine.

Here are the results of six recent trades: 38% return from puts on an oil services fund, 16.6% return from an ETF that shorts industry sectors, 200% return from puts on an auction house, 50% return from puts on a jeweler, 50% return from puts on a social media giant and 100% return from puts on a container shipping company.

And we still have more irons in the fire. It’s time to be bearish, so I suggest you give Rational Bear a try—like it or your money back.

Tony Sagami

30 year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here.

To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

The article Connecting the Dots: Mrs. Magoo, Deflation, and Commodity Woes was originally published at mauldineconomics.com.

Get our latest FREE eBook "Understanding Options"....Just Click Here!

Income Inequality? American Savers Treated Like Dogs

By Tony Sagami

One of the hot political topics these days is income inequality, but one of the groups of Americans that’s the most mistreated by Washington DC is the millions of Americans who have responsibly saved for their retirement.

When I entered the investment business as a stock broker at Merrill Lynch in the 1980s, savers could routinely get 7-9% on their money with riskless CDs and short term Treasury bonds.

In fact, I sold multimillions of dollars’ worth of 16 year zero coupon Treasury bonds at the time. Zero coupon bonds are debt instruments that don’t pay interest (a coupon) but are instead traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value.

At the time, long term interest rates were at 8%, so the zero coupon Treasury bonds that I sold cost $250 each but matured at $1,000 in 16 years. A government-guaranteed quadruple!

Ah, those were the good old days for savers, largely thanks to the inflation fighting tenacity of Paul Volcker, chairman of the Federal Reserve under Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987.

Monetary policies couldn’t be more different under Alan “Mr. Magoo” Greenspan, “Helicopter” Ben Bernanke, and Janet Yellen. This trio of hear see speak no evil bureaucrats have never met an interest rate cut that they didn’t like and have pushed interest rates to zero.

The yield on the 30 year Treasury bond hit an all time record low last week at 2.45%. Yup, an all time low that our country hasn’t seen in more than 300 years!

These low yields have made it increasingly difficult to earn a decent level of income from traditional fixed-income vehicles like money markets, CDs, and bonds.

Unless you’re content with near-zero return on your savings, you’ve got to adapt to the new era of ZIRP (zero interest rate policy). However, you cannot just dive into the income arena and buy the highest paying investments you can find. Most are fraught with hidden risks and dangers.

So to fully understand how to truly and dramatically boost your investment income, you absolutely must look at your investments in a new light, fully understanding the new risks as well as the new opportunities. There are really two challenges that all of us will face as we transition from employment to retirement: longer life expectancies; and lower investment yields.

Risk #1: Improved health care and nutrition have dramatically boosted life expectancies for both men and women. We will all enjoy a longer, healthier life, which means more time to enjoy retirement and spend with friends/family, but it also means that whatever money we’ve accumulated will have to work harder as well as longer.

Today, a 65 year-old man can expect to live until age 82, almost four years longer than 25 years ago; the life expectancy for a 65 year old woman is also up—from 82 years in the early 1980s to 85 today.

The steady increase in life expectancy is definitely something to celebrate, but it also means we’ll need even bigger nest eggs.

Risk #2: Don’t forget about inflation. Prices for daily necessities are higher than they were just a few years ago and constantly erode the purchasing power of your savings.

The way I see it, your comfort in retirement has never been more threatened than it is today, and it doesn’t matter if you’re 20 or 70.

The rules are different, and you only have two choices:

#1. spend your retirement as a Walmart greeter (if you’re lucky enough to get a job!); or

#2. adapt to the new rules of income investing.

Today, the new rules of successful income investing consist of putting together a collection of income focused assets, such as dividend paying stocks, bonds, ETFs, and real estate, that generate the highest possible annual income at the lowest possible risk.

Even in an environment of near zero interest rates and global uncertainty, there are many ways an investor can generate a healthy income while remaining in control. Income stocks should form the core of your income portfolio.

Income stocks are usually found in solid industries with established companies that generate reliable cash flow. Such companies have little need to reinvest their profits to help grow the business or fund research and development of new products, and are therefore able to pay sizeable dividends back to their investors.
What do I look for when evaluating income stocks?

• Macro picture. While it’s a subjective call, we want to invest in companies that have the big-picture macroeconomic wind at their backs and have long-term sustainable business models that can thrive in the current economic environment.

• Competitive advantage. Does the company have a competitive advantage within its own industry? Investing in industry leaders is generally more productive than investing in the laggards.

• Management. The company’s management should have a track record of returning value to shareholders.

• Growth strategy. What’s the company’s growth strategy? Is it a viable growth strategy given our forward view of the economy and markets?

• A dividend payout ratio of 80% or less, with the rest going back into the company’s business for future growth. If a business pays out too much of its profit, it can hurt the firm’s competitive position.

• A dividend yield of at least 3%. That means if a company has a $10 stock price, it pays annual cash dividends of at least $0.30 a year per share.

• The company should have generated positive cash flow in at least the last year. Income investing is about protecting your money, not hitting the ball out of the park with risky stock picks.

• A high return on equity, or ROE. A company that earns high returns on equity is usually a better-than-average business, which means that the dividend checks will keep flowing into our mailboxes.

This doesn’t mean that you should rush out and buy a bunch of dividend-paying stocks tomorrow morning. As always, timing is everything, and many—if not most—dividend stocks are vulnerably overpriced.

But make no mistake; interest rates aren’t rising anytime soon, and the solid, all weather income stocks (like the ones in my Yield Shark service) will help you build and enjoy a prosperous retirement. In fact, you can click here to see the details on one of the strongest income stocks I’ve profiled in Yield Shark in months.


Tony Sagami

30 year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here.

To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

The article Connecting the Dots: Income Inequality? American Savers Treated Like Dogs was originally published at mauldineconomics.com.

Get our latest FREE eBook "Understanding Options"....Just Click Here!