If you’ve read my work, you probably know that my grandfather was my inspiration for getting into this business. He did well in the stock market, and his enthusiasm for investing rubbed off on me.
My grandfather lived by his own homespun version of Peter Lynch’s advice to “buy what you know”; he had a strong preference for the shares of local companies.
Well, as it happened, my grandfather lived in Fort Smith, Arkansas, and there was a certain local company up the road in Bentonville that was shaking up the retail market in the 1970s.
You might have heard of it… goes by the name of Walmart (WMT)!
My grandfather never retired. Working was such an important part of his identity that he continued to go to the office until the very end. But the modest investment he made in Walmart shares ended up paying for my grandmother’s retirement, my college education, my sister’s college education, and my mother’s modest retirement today.
The funny thing is, that was never his plan.
He never expected to hit a home run like that in the stock market. He owned a small warehouse downtown, and he always imagined that, once he was gone, my grandmother’s expenses would be taken care of with the rental income from that property. (He owned that property free and clear of any mortgage, I might add…)
Renting out the warehouse ended up being more trouble than it was worth. My grandmother sold it, and she ended up living on her Walmart dividends, bond interest, and Social Security.
There are some important lessons we can learn here – they are the foundation of what we do in Peak Income.
To start, capital gains are nice, but you can’t assume they’re going to be there when you need them. That’s not something you can control.
As a man who lived through the Great Depression, my grandfather knew that. If you lived through the markets of the 1970s or 2000s, you might have gotten a similar lesson. Between 1968 and 1982 and from 2000 to 2013, the S&P 500 Index went nowhere.
If you’d been counting on capital gains to meet your retirement expenses during those stretches, you might’ve had to move in with your kids.
Second, diversification is critical – and “diversification” doesn’t mean owning five slightly different mutual funds. It means owning assets that don’t rise and fall together.
For my grandfather, this meant tying devoting significant capital to his small businesses and keeping his liquid assets divided roughly evenly among stocks, bonds, and cash.
For me, in today’s market, “diversification” means keeping my assets divided among complementary short-term trading strategies, longer-term income strategies, and income-producing real estate.
For you, the mix might be different. The key is making sure the pieces of your portfolio move independently of one another. It does you no good to save for a lifetime if it all gets flushed down the toilet in a major bear market.
And, finally, make sure you’re getting paid in cold, hard cash. It seems so “old timey” now, but my grandfather carried around a money clip with a big wad of cash in it. I don’t remember ever seeing him use a credit card.
Hey, times have changed. The only people carrying around wads of cash today are drug mules. But that doesn’t mean that cash isn’t king.
Investments that generate regular cash payments allow you to realize gains without having to sell anything. It’s like the old analogy of slaughtering a cow for meat versus keeping it alive for milk. (Remember, my family’s roots are in rural Arkansas…)
With the former, you eat well for a bit… but then it’s gone. With the latter, you can enjoy fresh milk for a lifetime… and you still reserve the right to slaughter the cow for meat later.
Dividend-paying stocks, REITs, MLPs, and other income investments are the same. You enjoy the milk every quarter… and you can still have your steak later if you ever decide to sell.
And, while you’re waiting, that cow just fattens up and produces more milk…
This article first appeared on Sizemore Insights as How to Build “Old School” Wealth
The following is an excerpt from Best Stocks for 2019: LyondellBasell Is Set for a Strong Second Quarter
As we near the end of the first quarter, the competition is fierce in InvestorPlace’s Best Stocks for 2019 contest. Cannabis product maker Charlotte’s Web Holdings (CWBHF) is leading the pack, up 67% at time of writing, but onshore oil and gas producer Viper Energy Partners (VNOM) isn’t far behind at 29%.
Against this competition, LyondellBasell Industries (LYB) and its modest 4% would seem to be getting left in the dust.
But it’s still early, and we still have a lot of 2019 left to go. And I’m expecting LyondellBasell to make it a competitive race, come what may in the market.
LYB Stock Valuation
I’ll start with valuation.
A cheap price is no guarantee of investment success, at least over short time horizons. But it certainly creates the conditions to make outsized gains possible. LyondellBasell trades for 7.2 times trailing earnings and just 0.83 times sales.
To put this in perspective, LyondellBasell’s P/E ratio was over 16 in late 2012; by this metric LYB stock is trading at less than half its valuation of seven years ago despite price/earnings multiples expanding prodigiously across most of the stock market over that same period.
Likewise, LYB’s price/sales ratio has been bouncing around in a range of 1 to 1.4 since 2013. Today’s 0.9 takes the stock’s valuation back to early 2013 levels.
Again, a cheap stock price doesn’t guarantee a hefty stock return, at least not over any specific time horizon. But it certainly creates the conditions that make outsized returns possible.
To read the full article, see Best Stocks for 2019: LyondellBasell Is Set for a Strong Second Quarter
This article first appeared on Sizemore Insights as LyondellBasell Is Set for a Strong Second Quarter
The following is an excerpt from “How to Use the Price/Earnings Ratio for Investing.“
Despite the analytical strength of the P/E ratio, this number has its limits.
“When you’re at the top of the economic cycle and profits are booming, a stock can seem artificially cheap, as the denominator – the ‘E,’ or earnings – is inflated. At the same time, near the bottom of the economic cycle, when profits are depressed, a cyclical stock can look expensive in P/E ratio terms because the denominator is temporarily depressed,” says Charles Sizemore, portfolio manager at Interactive Brokers Asset Management.
Those limitations underscore the benefits of using the Shiller ratio with a longer term earnings period. That smooths out the earnings number.
Additionally, it’s difficult to use the P/E for comparison across industries, as the metric can be industry specific. Software stocks usually have higher P/E ratios than slow-growing utility companies. So it’s best to compare P/E ratios within industries, Sizemore says.
Finally, it’s widely accepted that earnings can be manipulated. When that occurs, the P/E ratio may be less reliable.
Ultimately, the P/E ratio is a solid place to start an investment analysis for a quick valuation check of a market or stock. For best practices, add the P/E ratio to a more complete analysis of individual companies, industries and the economy.
The following is an excerpt from What to Do Now If You’re Losing Sleep Over the Stock Market, originally published by Kiplinger’s.
As discussed ad nauseam in the financial press and in mutual fund literature, stocks “always” rise over the long-term.
This may very well continue to be true. But you also should remember that you have limited amounts of capital, and your cash might be better invested elsewhere.
Stocks are not the only game in town.
Even after the recent selloff, the S&P 500 still trades at a cyclically adjusted price-to-earnings ratio (“CAPE,” which measures the average of 10 years’ worth of earnings) of 27, meaning that this is still one of the most expensive markets in history. (Other metrics, such as the price-to-sales ratio, tell a similar story.)
This doesn’t mean that we “have” to have a major bear market, and stock returns may be soundly positive in the coming years. But it’s not realistic to expect the returns over the next five to 10 years to be anywhere near as high as the returns of the previous five to 10 years, if we’re starting from today’s valuations. History suggests they’ll be flattish at best.
It’s not hard to find five-year CDs these days that pay 3.5% or better. That’s not a home run by any stretch, but it is well above the rate of inflation and it’s FDIC-insured against loss.
High-quality corporate and municipal bonds also sport healthy yields these days.
And beyond traditional stocks, bonds and CDs, you should consider diversifying your portfolio with alternative investments or strategies. Options strategies or commodities futures strategies might make sense for you. Or if you want to get really fancy, perhaps factored accounts receivable, life settlements or other alternative fixed-income strategies have a place in your portfolio. The possibilities are limitless.
Obviously, alternatives have risks of their own, and in fact might be riskier than mainstream investments like stocks or mutual funds. So you should always be prudent and never invest too much of your net worth into any single alternative strategy.
Just keep in mind that “investing” doesn’t have to mean “stocks.” And if you see solid opportunities outside of the market, don’t be afraid to pursue them.
To read the rest, please see What to Do Now If You’re Losing Sleep Over the Stock Market
This article first appeared on Sizemore Insights as What to Do Now If You’re Losing Sleep Over the Stock Market
The following is an excerpt from The 5 Best Investments You Can Make in 2019
Everyone is looking forward to 2019 if only because 2018 has been so ugly. But investors will have to mentally sturdy themselves: Before we can talk about the best investments to make in 2019, we have to quickly explore what has gone wrong in 2018.
The year started with a bang. The Standard & Poor’s 500-stock index returned nearly 6% that month following an epic 2017 that saw the index pop by 22%. But after that, it got rocky. Stocks stumbled in the first quarter, rallied for most of the second and third quarters, then rolled over and died again in October. It hasn’t gotten better since, and investors have had plenty to digest the whole way.
Much of the massive gain in 2017 was likely powered by investors looking forward to the profit windfall following the corporate tax cuts at the end of last year. But that’s a year in the past. Going forward, we’ll be comparing post-tax-cut profits to post-tax-cut profits as opposed to higher post-cut to lower pre-cut. Meanwhile, stock prices are still priced for perfection. At 2 times sales, the S&P 500’s price-to-sales ratio is sitting near all-time highs, and the cyclically adjusted price-to-earnings ratio, or “CAPE,” of 29.6 is priced at a level consistent with market tops.
Fortunately, the new year provides an opportunity to wipe the slate clean. So what might we expect in the new year? Today, we’ll cover five of the best investments you can make in 2019, come what may in the stock market.
It’s difficult to beat the stock market as a long-term wealth generator. At roughly 7% annualized returns after inflation, the market has historically doubled your inflation-adjusted wealth every 10 years. No other major asset class has come close.
Still, you shouldn’t put all of your money in the stock market.
To start, there is no guarantee that the future will look like the past. The stock market as an investment destination for the masses is a relatively new concept that really only goes back to the 1950s, or perhaps the 1920s if you want to be generous. You can’t credibly say that the market “always” rises with time because, frankly, we’re writing history as we go.
Bonds have a longer track record, but bonds are also priced to deliver very modest returns in the years ahead. Adjusted for inflation, the 3% yield on the 10-year Treasury looks a lot more like a 1% yield.
Investors should consider alternative strategies as a way to diversify while not sacrificing returns.
“Alternative” can mean different things to different investors, but for our purposes here we’re taking it to mean something other than traditional stocks and bonds. Alternatives could include commodities, precious metals and even cryptocurrencies like Bitcoin. But more than exotic assets, an alternative strategy can simply use existing, standard assets in a different way.
“The vast majority of options contracts expire worthless,” explains Mario Randholm, founder of Randholm & Company, a firm specializing in quantitative strategies. “So, a conservative strategy of selling out-of-the-money put and call options and profiting from the natural “theta,” or time decay, of options is a proven long-term strategy. You have to be prudent and have risk management in place, as the strategy can be risky. But if done conservatively, it is a consistent strategy with low correlation to the stock market.”
That’s a more advanced way to skin the cat. But the key is to keep your eyes open for alternatives with stock-like returns that don’t necessarily move with the stock market.
To continue reading the remaining four investments, see The 5 Best Investments You Can Make in 2019
This article first appeared on Sizemore Insights as The 5 Best Investments You Can Make in 2019
With one quarter left to go in 2018, there are three things on investors’ minds: the Fed, the coming mid-term elections and the ongoing trade war. Thus far, the market has mostly shrugged off these concerns, though income-focused investments such as bonds, REITs and dividend-paying stocks have had a hard time gaining traction.
Sizemore Capital’s Dividend Growth portfolio, which invests primarily in higher-yielding securities, has also had a hard time gaining traction in 2018. The portfolio returned 0.14% in the third quarter and 0.53% in the year-to-date through September 30. This compares to 7.2% in the third quarter and 9.0% year-to-date for the S&P 500 and 5.1% and 1.6% for the S&P 500 Value. [Returns data calculated from the performance of Sizemore Capital’s Dividend Growth model at Interactive Brokers; past performance is no guarantee of future results.]
Given its focus on attractively-priced stocks paying above-market dividend yields, I consider the S&P 500 Value to be a more accurate benchmark than the standard S&P 500. And frankly, it’s been a difficult market for value strategies.
Value vs. Growth
Over time, value strategies have proven to outperform.
This is not my opinion. This is empirical fact. In their landmark 1993 paper, University of Chicago professors Eugene Fama and Kenneth French found that value stocks outperform over time. More recent research by BlackRock found that in the 90 years through 2017, value has outperformed growth by a full 4.8% per year.
Figure 1: Value vs. Growth
But while value trounces growth over time, 90 years is a long time to wait. And there are stretches – sometimes long stretches – where value underperforms badly. We’re in one of those stretches today.
Figure 1 illustrates this in vivid detail. The graph shows the ratio of the Russell 1000 Value index divided by the Russell 1000 Growth index. When the line is declining, growth is outperforming value. When the line is rising, value is outperforming growth.
Value massively outperformed growth from 2000 to 2007, but it has struggled ever since. This has been particularly true over the past two years as the “FAANG” stocks – Facebook, Amazon, Apple, Netflix and Google (Alphabet) – have completely dominated the investing narrative.
I would love to tell you the exact date when the market will flip and value will start to dominate again. For all I know, by the time you read this, it might have already happened. Or that day might still be years away.
That’s not something I can control. But I can stay disciplined and focus on high-quality companies that I believe to be temporarily underpriced. And because my strategy has a strong income component, we don’t necessarily need prices to rise in order for us to realize a respectable return. The average dividend yield of the stocks in the Dividend Growth portfolio is 5.65% at time of writing. [This yield will change over time as the composition of the portfolio changes.]
As we start the fourth quarter, I am particularly bullish about some of our newer additions, such as Macquarie Infrastructure Company (NYSE: MIC) and Ares Capital (Nasdaq: ARCC).
Macquarie Infrastructure lowered its dividend earlier this year, which led investors to dump it in a panic. The shares dropped by over 40%, giving us a very attractive entry point.
Ares Capital, like many BDCs, has found the past decade to be difficult. But after a long, six-year drought, the company raised its dividend in September, and I expect further dividend hikes to come. At current prices, the shares yield a whopping 9.0%.
I also continue to see value in some of our long-held energy infrastructure assets, such as Energy Transfer Equity (NYSE: ETE) and Enterprise Products Partners (NYSE: EPD). Energy Transfer, in particular, is attractive due to its planned merger with is related company Energy Transfer Partners (NYSE: ETP). I believe this could be the first step to an eventual conversion from an MLP to a traditional C-corporation, which would potentially lower ETE’s cost of capital and allow for greater ownership by mutual funds, institutional investors and retirement plans like IRAs. CEO Kelcy Warren has indicated that this is the direction he ultimately wants to go.
I see the greatest risk in the portfolio coming from our positions in automakers General Motors (NYSE: GM), Ford Motor Company (NYSE: F) and Toyota (NYSE: TM). I consider all three to be wildly attractive at current valuations, but all are also at risk to fallout from the escalating trade war. As a precaution, I lowered our exposure to the sector earlier this year by selling shares of Volkswagen. But given the potential for a rally in the shares following a favorable resolution to the trade war, I feel it makes sense to hold our remaining auto positions and potentially add new money to them on any additional pullbacks.
All Eyes On the Fed
The Federal Reserve raised rates again in September, which was widely expected. But it was a subtle change to their statement that raised some eyebrows. They dropped the language saying that its policy “remained accommodative.” Does this mean that the Fed believes easy money is already over and that they’re not much more tightening to be done? Or does it mean that they’re about to get even more hawkish?
The statement was ambiguous. But it is noteworthy that the Fed is still forecasting another hike before the end of the year and three more in 2019. And Powell’s statements following the official statement suggest that he’s eager to continue draining liquidity out of the market.
There are limits to how aggressive the Fed can be here. If they follow through with raising rates as aggressively as they plan, they will push short-term rates above longer-term rates, inverting the yield curve. I don’t see the Fed risking that, as an inverted yield curve is generally viewed as a prelude to a recession.
Figure 2: 10-Year Treasury Yield
Meanwhile, bond yields have finally pushed through the long trading range of the past six years. The 10-year Treasury yield broke above 3.2%, a level it hasn’t seen since 2011.
I do not expect yields to rise much above current levels, as I do not see such a move justified by current inflation rates or growth expectations. But this is something I am watching, because the Dividend Growth portfolio, given its yield-focused strategy, is sensitive to changes in bond yields.
Looking forward to a strong finish to the year,
Charles Lewis Sizemore, CFA
Asness is the billionaire co-founder of AQR Capital Management and a pioneer in liquid alternatives. For all of us looking to build that proverbial better mouse trap, Asness is our guru. My own Peak Profits strategy, which combines value and momentum investing, was inspired by some of Asness’ early work.
Unfortunately, he’s been getting his butt kicked lately. His hedge funds have had a rough 2018, which prompted him to write a really insightful and introspective client letter earlier this month titled “Liquid Alt Ragnarok.”
“This is one of those notes,” Asness starts with his characteristic bluntness. “You know, from an investment manager who has recently been doing crappy.”
Rather make excuses for a lousy quarter (Asness is above that), he uses his bad streak to get back to the basics of why he invests the way he does.
As I mentioned, Asness specializes in liquid alternatives. In plain English, he builds portfolios that aren’t tightly correlated to the S&P 500. They’re designed to generate respectable returns whether the market goes up, down or sideways.
You don’t have to be bearish on stocks to see the value of alts. As Asness explains,
You do not want a liquid alt because you’re bearish on stocks or, more generally, traditional assets. That kind of timing is difficult to do well. Plus, if you’re convinced traditional assets are going to plummet, you want to be short, not “alternative.” In other words, liquid alts are a “diversifier” not a “hedge.”
You should invest [in a liquid alt] because you believe that it has a positive expected return and provides diversification versus everything else you’re doing. It’s the same reason an all-stock investor can build a better portfolio by adding some bonds, and an all-bond investor can build a better portfolio by adding some stocks.
I love this, so you’re going to have to forgive me if I “geek out” a little bit here. My professors pretty well beat this stuff into my head when I was working on my master’s degree at the London School of Economics.
When you invest in multiple strategies that aren’t tightly correlated with each other, your risk and returns are not the average risk and return of the individual strategies. The sum is actually greater than the parts. You get more return for a given level of risk or less risk for a given level of return.
Take a look at the graph. This is a hypothetical scenario, so don’t get fixated on the precise numbers. But know that it really does work like this in the real world.
Strategy A is a relative low risk, low return strategy. Strategy B is higher return, higher risk.
In a world where Strategies A and B are perfectly correlated (they move up and down together), any combination of the two strategies would be a simple average. If A returned 2% with 8% volatility and B returned 16% with 11% volatility, a portfolio invested 50/50 between the two would have returns of 9% with 9.5% volatility. That is what you see with the straight line connecting A and B. Any combination of the two portfolios would fall along that line (assuming perfect correlation).
But if they are not perfectly correlated (they move at least somewhat independently), you get a curve. And the less correlation, the further the curve gets pushed out.
Look at the dot on the curve that shows an expected return of about 8% and risk (or volatility) of 10%. On the straight line, that 8% curve would have volatility of about 14%, not 10%. And accepting 10% volatility would only get you a return of about 4% on the straight line.
This is why you diversify among strategies. Running multiple good strategies at the same time lowers your overall risk and boosts your returns. The key is finding good strategies that are independent. Running the basic strategy five slightly different ways isn’t real diversification, and neither is owning five different index funds in your 401k plan. Diversification is useless if all of your assets end up rising and falling together.
This article first appeared on Sizemore Insights as Why You Shouldn’t Put ALL Your Money into an Index Fund
The following is an excerpt from Best ETFs for 2018: This Isn’t the Year for Emerging Markets (DVYE).
Well, I should probably start this by mentioning that I no longer personally own the ETF I recommended in InvestorPlace’s Best ETFs for 2018 contest.
I recently sold my shares of the iShares Emerging Markets Dividend ETF (DVYE). While I still believe that emerging markets are likely to be one of the best-performing asset classes of the next ten years, it’s a minefield in the short-term. As I write this, the shares are down 4% on the year. That’s not a disaster by any stretch, but it is a disappointment.
There are a couple reasons for the recent underperformance in emerging markets. To start, the U.S. market remains the casino of choice for most investors right now. Adding to this is dollar strength. While dollar strength is good for countries that sell manufactured products to the United States, it’s bad for commodities producers, as a more expensive dollar by definition means cheaper commodities.
President Donald Trump’s trade war isn’t helping either. While it’s hard to argue that anyone truly “wins” a trade war, Trump isn’t incorrect when it says that our trading partners need us more than we need them. In a war of attrition like this, you “win” by losing less.
Of course, these conditions are not new, and virtually all of them were in place when I made the initial recommendation of DVYE. None of these factors would be enough for me to punt on emerging markets just yet. No, the problem is a greater risk that has only recently popped up: the twin meltdowns in Argentina and Turkey.
To continue reading, please see Best ETFs for 2018: This Isn’t the Year for Emerging Markets (DVYE).
This article first appeared on Sizemore Insights as Best ETFs for 2018: This Isn’t the Year for Emerging Markets (DVYE)
The following is an excerpt from Best Stocks for 2018: Enterprise Products Is a Keeper.
A 14% return is nothing to be ashamed of in a year where the S&P 500 is up only 8%. Yet it looks awfully meager when my competition in the Best Stocks contest is up 144%.
As I write, my submission in InvestorPlace’s Best Stocks for 2018 contest — blue-chip natural gas and natural gas liquids pipeline operator Enterprise Products Partners (EPD) — is up 14%, including dividends, as of today. Yet Tracey Ryniec’s Etsy (ETSY) is up a whopping 144%. Chipotle Mexican Grill (CMG) and Amazon.com (AMZN) take the second and third slots with returns to date of 71% and 68%, respectively.
So, barring something truly unexpected happening, it’s looking like victory may be out of sight this time around.
Can’t win ‘em all.
While Enterprise Products may finish the contest as a middling contender, I still consider it one of the absolute best stocks to own over the next two to three years. Growth stocks have dominated value stocks since 2009, but that trend will not last forever. Value and income stocks will enjoy a nice run of outperformance — and when they do, Enterprise Products will be a major beneficiary.
To continue reading, please see Best Stocks for 2018: Enterprise Products Is a Keeper.
This article first appeared on Sizemore Insights as Best Stocks for 2018: Enterprise Products Is a Keeper