1. Barron's Article on Electric Utility Stocks: Barrons did have a favorable article on electric utility stocks in this week's issue. The main points are obvious ones. The average yield on these stocks is around 2 to 3% above the current 10 year treasury yield of 3.3%. And, many are capable of churning out a slow and steady rate of earnings growth. This article mentions one of my core electric utility holding, Consolidated Edison (ED), as "low-risk" since it has sold most of its generation and is allowed to pass through its purchased power costs. The dividend yield is also around 6% at its closing price on Friday of $39.63. .ED Stock Quote - Consolidated Edison Inc Stock Another one of my core holdings, Duke Energy (DUK), is simply mentioned as one of the safer ones due to most of its revenue being derived from regulated utility operations. I also own Pepco (POM), Pinnacle West (PNW), Progress Energy (PGN) and Great Plains (GXP). Of those positions, Pepco is on the bubble for a possible sell due to worse than expected earnings over the past two quarters, but I will probably keep it as long as the dividend is not cut. Of the other utilities mentioned in the article, I have under consideration for possible purchase Dominion Resources (D) (the old VEPCO), Southern Company (SO) and Entergy (ETR). I still own a first mortgage bond issued by an Entergy subsidiary, Entergy Louisiana (EHL).
I would not agree with the Bernstein analyst quoted in this article that higher interest rates and inflation are baked into the current prices. I seriously doubt that treasury and corporate bonds, or electric utility stocks, have priced in any significant increase in inflation and interest rates. A serious up move in inflation would be an unanticipated event now or even in the next several years. The current inflation forecast, which is baked into the breakeven yield of the 10 year TIP (i.e. the difference between the real TIP yield and the nominal yield of the non-inflation protected 10 year) is just 1.78%, as a forecast of the average rate of inflation per year over the next ten years. While it is just my opinion, an unexpected rise in inflation may be near the top of my list of the most likely events to occur which are currently not anticipated in the pricing of securities.
2. TRUE BELIEVERS GATHER IN WASHINGTON: I watched some of the TB gathering in Washington over the weekend, led by Dick Armey with Joe Wilson's spirit in tow and Glen Beck as their intellectual Godfather. At least Joe Wilson has moved on from his fight to fly the confederate flag over the South Carolina's capitol. ISS - Rep. Joe Wilson My congressional representative, Marsha Blackburn, was one of the featured speakers.
I heard one gentleman say that he made the trip to protest the "communists" in charge of our government.msnbc.com I heard another say that we are losing our freedom day by day. One woman claimed that she had met several people from Russia and they were frightened by what is happening today. CBS News Video Well, I had no idea things were so bad. I was trying to think about the freedoms that I have lost so far during the Beanpole's Presidency, and have not been able to identify anything yet.
Obama was not getting much love from this group, with signs comparing him to Adolf Hitler by painting Adolf's famous mustache on the Beanpole's likeness. CBS News Many carried signs that read "Bury Obama Care with Kennedy" or "Parasite in Chief" NYTimes.com A few confederate flags flew proudly as the crowd shouted "Liar, Liar" over and over again, not in reference to Joe Wilson apparently. Another favorite sign was Obama made to look like the Joker with the caption of "socialism". My favorite sign was "You Can Not Fix Stupid" and who could disagree with that sentiment. Many as you would expect referred to the Obama Health care plan as "socialism". washingtonpost.com (I would hope that the TBs will forfeit their Medicare benefits to protest against that "socialist" governmental program.) Senator Jim DeMint from South Carolina said that the gathering was not a bunch of radical right-wingers.
I had a vision of the TBs at this gathering before watching several videos of them. My vision was that they would be white, mostly overweight and middle aged, and extremely loud and angry. Maybe I need to hang a shingle out to make some coin for my visions since that one proved to be eerily on target.
LB thought that many of the TBs were confused about the current state of affairs in Russia and the meaning of communism or any other "ism" for that matter. Communism refers to an economic doctrine involving common ownership by the state of all property and businesses, from an apartment building to a steel mill or a grocery store. Authoritarianism or totalitarianism is primarily political. A country may have an authoritarian political system controlled by one person or a small group, with the media firmly under their control, without being a communist economic system. Russia, or the former Soviet Union, was both since the times of Lenin until recently. The economic system is no longer properly classified as communist. The main characteristic of Russia's current economic system is Corruption, with a mixture of Capitalism and Cronyism. The story from Saturday's NYT about Ikea's difficulties of operating a store in Russia is worth a read. Ikea Ikea, a Swedish retailer, would have had to pay a bribe to get the lights turned on, so it opted to use generators and then ran into more "alleged" corruption with that option. IKEA turned to the Russian legal system, and the end of that story was more of the same. Over Putin's term, Russia has not moved back toward communism, but moved back more toward authoritarianism tinged with widespread corruption.
3. Debt and Growth/Divorcing Price for Products and Services from Responsibility to Pay for Them: I have been asking myself recently how much of the last secular bull market in stocks which started in 1982 was financed by ever increasing levels of debt, along with substantial leaps in productivity directly linked to technological advances. I do not think that it was merely coincidental that the increasing willingness of both the U.S. government and its citizens to spend borrowed money started at about the same time as the bull market. And, it is not a coincidence that the natural end to that boom occurred with the implosion in the credit system. I previously referenced charts showing the explosion of consumer debt starting in the 1980s. ( www.invescoaim.com/pdf Item # 1: What Will Produce Growth after the Age of Leverage? ) And President Reagan ushered in an era of thirty years of ever increasing deficit spending by the federal government. The national debt did more than triple under Reagan. Reaganomics - Wikipedia The TBs were not complaining about deficit spending back then. LB has been consistent on this issue irrespective of the particular Tribe in power. (I found an article written by the economist Roubini about supply side economics in 1997 where he pointed out how experience discredited the Laffer curve theory: Economics)
Once there is a separation of demand for a service or product from responsibility to pay for it then there will be an artificial increase in the price. The most salient example from recent times is the parabolic increase in home prices. Prices could not have gone parabolic without the improvident extensions of credit and the advent of the funky mortgage products. Price fed on the increasingly liberal extensions of credit which in turn fed on the lack of responsibility for the loan. Investors far removed from the origination of the loan ultimately become the ones holding the bag in many cases where the homeowner put nothing down, received an interest only loan, frequently with a teaser rate, and sometimes even part of that interest would be added to the principal of the loan rather than paid currently. If there was responsibility at the origin of the loan, then the loan would not have been granted, the home would not be bought, prices would not have risen out of the reach of most families and the basic laws of supply and demand would have most likely resulted in modest home price gains of 3 to 5%, rather than 20% compounded for a few years.
Another example would be medical costs. There is no relationship between demand for the service and responsibility to pay for it. This would be true with advent of private insurance since WWII and Medicare/Medicaid since the mid 1960s. While I certainly approve of Medicare, I at least recognize that any system of private and/or public insurance will cause the price of what is covered to go up due to increase supply of funds to pay for that service unconnected to the persons generating the demand for the service. Medical costs have generally been increasing at rates faster than inflation since insurance became widely available. What would medical costs be if we were back to a system before insurance, where everyone would be responsible for their own medical costs? Would costs be higher or lower than they are now?
Another example would be costs to send a kid to college now. This is another area where costs have generally risen at rates greater than the inflation rate for decades now. When I started Tulane in 1969, the total cost was less than $5,000, including tuition, room and board and other expenses. Today, at Northwestern, I suspect the costs this year school year for Tyler will run close to $60,000. While the pool of money in scholarships is not the primary fuel for increase in college costs, the increased availability of scholarships and Pell grants do provide pools of money that allow for increases in costs at rates greater than would otherwise be possible. So, I would agree with the WSJ editorial cited in a Post yesterday that whatever increase is made by the Democrats in Pell grants will just be funneled to increases in tuition and other costs by the universities. The student is merely the funnel.
I am basically making an observation. Large pools of money can distort market price. As responsibility for paying the price is removed further from those responsible for the demand of the product or service, the likelihood of a greater distortion in price occurs which then increases the cost of providing it, in a vicious circle. Eventually, an ability to pay the price is compromised and the edifice collapses. Freedom From Responsibility Most of my discussions about this topic have involved the mortgage meltdown, which I now view as the natural end of the process started in the 1980s. The bull market sowed the seeds of what caused the current bear market, the vast extension of credit and debt, along with the concomitant reductions in the savings rate, until the foundation crumbled on top of itself.
I'm following your discussion of economic and market cycles with appreciation. I'm curious to see what the next driver of economic growth (or even economic health!) will be. If your thesis holds, logically we should be able to look back and see the seeds of the next bull market that were being sown ... today. Maybe you can harness that vision power of yours to hone in on those seeds right now!
ReplyDeleteSpeaking of seeds, Norman Borlaug, the father of the "Green Revolution" who is widely credited with saving more than a billion lives by breeding wheat, rice and other crops that brought agricultural self-sufficiency to developing countries around the world, died Saturday in Texas.
Borlaug
It made me wonder if the conditions in which such miraculous and hard-won breakthroughs can happen are gone forever. Or do we unknowingly stand on the edge of similar breakthroughs in energy, water purification, or medicine, that would be a boon to humanity and create productive work for many?
Cathie: My concern now is that there is no engine to drive GDP growth once the impact of the worldwide economic and fiscal stimulus wears off, which will happen near the end of next year. Government spending has replaced to a limited degree a falloff in private demand for goods and services, which is the role of government in a major economic downturn. Most of the stimulus money will be spent next year, and there will be an upturn in our economy during the second half of 2009 and into 2010, due to the fiscal and monetary stimulus, a restocking of inventories, and a resumption of some demand from the private sector particularly in Asia. But, I still see the American consumer, generally responsible for 70% of the economy, as tapped out and up to their eyeballs in debt. I do not expect significant changes in that problem for several years. So, some new avenues of growth need to occur that are not reliant on the Federal government incurring trillion plus deficits and the American consumer borrowing even greater sums that they can not afford to pay back. I do not see any major breakthroughs on Green technology, more like incremental progress. Some of the stimulus money is going to be spent on research in that area, what I call potentially transformational spending. But, you can throw billions of dollars at something and not receive any significant payoff, while some person working with no budget in their garage generates another leap forward. I would call that kind of transformational event a White Swan to be distinguished from Taleb's Black Swans.
ReplyDeleteSo, the bottom line is that I am worried about 2011, a lot right now. In fact, I was discussing today with my brother paring exposure to stocks during the second half of 2010 based on what I see as likely or reasonably possible events thereafter. Sorry, that is sort of a bummer outlook.
Cathie: The NYT had a long article about Borlaug's contributions in yesterday's paper:http://www.nytimes.com/2009/09/14/business/energy-environment/14borlaug.html?_r=1&ref=business
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