InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
JUNE 6, 2018
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
In the June issues of IntelDigest, we will continue our Look Ahead at the Economy-To-Come … planning for the transition from the 9-year Bull Market to leaner times ahead. We will discuss Credit Cycles, as well as the role of Debt in the Unraveling to come.
We will also examine the following topics over the course of the Summer:
* China, from several angles, over a series of issues
* U.S. Taxes – updates on changes in the law and regulations
* Work in America – a re-examination
* Robotics and Autonomous Vehicles
* Blockchain – new developments
Today, we’ll talk about Investing Fundamentals – important considerations when investing in a Bear Market.
The Unraveling
We pointed out, in our May 23 issue, that The Federal Reserve has been tightening the money supply since late last year. The Fed’s unwinding of its massive bond portfolio has continued at a rate of $10 Billion per month in U.S. Treasury securities and $3 Billion per month in mortgage securities.
Equities markets rolled higher and higher over the last nine years on a tide of ultra-low interest rates and “Quantitative Easing” concocted by central bankers, including The Federal Reserve in the U.S. The Fed has reversed course with the new regimen of tightening, draining liquidity from the system, along with the prospect of gradual raising of short-term interest rates. With access to cheap credit drying up, the financial “tide” is now rolling out.
Investing in a Bear Market
We are transitioning from a historic Bull Market … when it was relatively easy to earn profits on stocks across-the-board … to a slowly unfolding Recession and Market Downturn. Many will want to sell all their stocks and hide under the bed by next year. Prudent investors, on the other hand, will want to hold onto the best, income-producing stocks in their portfolios.
However, investing in stocks during a Bear Market requires selectivity and discipline. So, here are some important guidelines to anchor your portfolios in the coming lean years.
* Protecting Capital
When Selectivity is an important element of your investing approach, you should seek conservative stocks. The time for speculation is past; minimizing threats to your capital is paramount.
You want to own shares of companies which offer true value, and will pay you regularly for your ownership. That means dividend-paying stocks. As your payments add up, you can worry less about the price movements of the stock, especially when the markets in general are sagging.
This is a time to be patient with the markets, and avoid overpaying for any stock. Don’t chase stocks higher; set your price target, and wait for the stock price to come back to your target.
If you pay the right price for a company, there’s a good chance that the stock will trade higher when other investors realize the value of the company.
* Investing for Growth
Selectivity and discipline require research. You (or your advisor) must explore the history of your target companies … have they grown profits, dividends, free cash flow on a consistent basis? If a company’s cash flow and profits are not keeping up, it may have to cut the dividend.
Stock Prices during a Bear Market can be stuck in the mud for years, so you want companies which can make stable payments to you over several years, and continue growing those payments over time.
* Seeking Yield
We still live in a low-interest-rate world, so finding opportunities to earn a decent yield can be a struggle. Bank deposits will continue to be low-yield for a few more years, and the corporate bond market is risky, especially as we head into a Credit Crisis in 2019-2020.
The best bets for a safe yield in the coming years will be (1) income-producing real estate, and (2) stable dividend-yielding stocks. This is the safe middle ground.
Also, high-yield dividend-paying stocks will attract the attention of other investors, which would support the share price. We want to be ready to move into high-quality stocks early in the Recession, after the initial breakdown of the stock market; or, if we already hold them, be prepared to hold fast during the initial crash
By taking an early position in (or, holding on to) solid dividend stocks, we have a good chance of earning an attractive yield, from both a rebound in the stock price and regular payments from dividends.
* Understanding the Business
Just as you want to avoid speculating during a Bear Market, you should also avoid uncertainty. You should not invest in a company if you don’t fully understand how it makes money.
Again, proper research is necessary. It is well worth your time to learn about the products or services which a company offers, who are its customers and competition, how it earns its profits, and which units of a company are profitable or may be behind the competition.
If you understand a business well enough that you can clearly and succinctly describe the business to your friends or family, then you will be better equipped to make an investment decision.
* Finding Quality
After the research referred to above, you can make the threshold decision: are you comfortable committing a portion of your net worth to a certain stock? Are you convinced that the investment represents an exceptional opportunity? You shouldn’t invest your hard-earned money in anything less.
You want to be sure that you’re buying a high-quality business, and its financial “attributes” make it a good investment. That could mean that the company is highly capital-efficient; has pricing power or dominance in its industry; or, features a stock value which is low relative to its asset value.
If you have confidence that a company offers an excellent potential return on investment, then you will have the courage of your convictions when the markets are in a sluggish or declining mode.
* Settling In for the Long Haul
Warren Buffett famously wrote, “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes. (Berkshire Hathaway 1996 letter to shareholders)
Investing in a Bear Market requires a long time horizon. In that same letter, Buffett advised investors to “… Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”
In a Bear Market, you should be ready and willing to commit to holding your stocks for 10 years. Over the long run, stock prices are highly correlated with earnings growth. Focus on durable, growing franchises. You will want to hold businesses which you feel confident will be bigger and better in the years to come.
Following the Guidelines
The purpose of these Guidelines is to get you to concentrate on only the most stable opportunities during the lean times of a Bear Market … to eliminate marginal ideas from your portfolio. This is the mind set of private-equity professionals.
Thinking like a whole-business owner will help ensure that you own strong, enduring businesses … businesses which you know well and are comfortable holding through the storm.
Plan now to have your financial house in order so that you’re playing a strong hand during the lean times. Pay off debts. Build positions in Cash and Gold. Follow the trailing stops in your portfolios over the remainder of this year.
When the storm hits, you will be in the best position to weather it. This will allow you to sleep at night, focus on the big picture, and make better investment decisions in the years to come.