Stock Markets - May 2013

          Six years ago, almost to the day, the Dow Jones Industrial Average (DJIA) traded at 18.3 times earnings and the S&P 500 index at 16.7.  Today, the DJIA is at 16.75 times earnings while the S&P is at 18.55, probably it’s all time high.  During 2007 the DJIA set 27 new daily record highs.  This year there has seen over 20 already.  The S&P set 5 new daily highs in 2007.  So far in 2013, the count is at 12.

          If history is to repeat itself, then we are either at the top, or within a few weeks of it.  Our reasoning is that corporate earnings are not growing as fast as the stock markets, nor will they for the rest of 2013 and 2014, and the markets are in expensive territory.  Furthermore, a good chunk of the growth in profits is paper, realized by share repurchases, rather than organic revenue growth. 

          When a company repurchases its shares it is spreading the profit over fewer shares, resulting in higher earnings per share (EPS).  For example; company A earns a profit of $100, and there are 10 shares outstanding.  As a result, the earnings per share is $10.  The company then decides to use some of its profit, or borrow funds, to purchase 2 shares.  Assuming the company made the same amount of profit, the earnings per share would be $12.50, or 25% higher.  Share prices usually increase as a result of the increased EPS.

          The Baltic Dry Index is off 14% from its 2012 high.  The index has been flat for most of 2013, a signal the world trade is doing very little.  In April 2010 the Index was trading around 3096.  For almost all of this year the index has been under 900, with it recently trading at 841.  This is a bad sign as it confirms what we have been reporting for months; there are surpluses of just about everything we produce. 

          The CRB Index has been flat for the past year which accurately foreshadows the world economy.  This is probably the best gauge for the world economy and how it is performing.  The CRB indicates the world economy is going nowhere for the rest of this year.

          Stock market gains this year are based on the attraction of some high yielding shares, low interest rates, as well as the hope that the American, European, Japanese and the Canadian governments will get their acts together and finally tackle what is destroying their countries’ economies. 

          Real estate is too expensive even with zero interest rates.  Plus, around the world there remains a surplus in all forms of real-estate.  Mutual funds are always a disaster for the investor.  Have you ever met someone who got rich holding mutual funds?  Hedge funds are too expensive.   Hedge and mutual funds are designed solely to transfer one’s wealth into the manager’s coffers.  With money market funds, one is lucky to break even after taxes.  After-tax wage gains are slightly positive, but probably less than 1%.

          Sadly the stock markets are the only game in town.  This alone is a negative because it is luring the inexperienced and the desperate hoping to make a little extra.  History proves these people make poor choices and end up losing because they buy horrible companies, and they panic sell, adding further downward pressure to sell offs.

          Dividends have saved us, but only because we bought at the right time and held the shares for years.  If we had not, we would be lucky to get a 4% yield today.  Most good quality companies yield 3% or lower.  Our recommendations are returning over 10% annually based on our purchase prices, one of the highest returns in the world for investing.  Some subscribers have told us they made over 10% last year.  My father’s Tax Free Savings Account, holding only this newsletter’s recommendations is up 92% in just over 4 years.

Poland announced their gas fields, believed to be the largest in Europe, will not be developed for some time due to cost and competition from Cyprus’ reserves.  Between the two countries they will be fighting for market share, along with Russia, the biggest supplier.  Russia is trying to take over the Cyprus field, so they control Europe’s needs for years to come.             However, today Russia is worried.  They have decades of reserves already (probably over 200 years worth), but the gas would end up staying in the ground for decades if Poland and Cyprus both develop their fields.  We suspect Russia has bribed Poland not to develop their field for a few decades, because Russia and their mafia are in desperate need of cash flow.  Russia’s elite have robbed their country for years and continually need a fresh source of money, which shale gas provides in sales to Europeans.            If gas prices hit $1.50, which we believe will happen, it will be a financial disaster for Russia.  As a result, they will do everything in their power to keep the price from falling further.  Unfortunately for the corrupt nation, they will be unsuccessful at this because of the growing glut of reserves across the globe.  Continue to avoid the Natural Gas market.

          There are no buying opportunities available today.  In my father’s 48 year career, he has never sat on the sidelines for so long and held so much cash.   We do not believe in buying at the peak of the market, which we feel is where we are at today.  Stock markets are in expensive territory.  By the numbers, all stock markets are vulnerable to a sizeable correction.  Today we must wait for the stock market to come to us, which they will.  It might be a week from now or 6 months away, but it is coming.  The coming sell-off will be quick and substantial.   In the meantime we will be collecting all those lovely dividends each month and know we have X amount locked in safe money market vehicles.

Keep cash in money market investments, with no term longer than one year.