Stock Market Investment Ideas

At Home in Their Range



IN THIS ISSUE: My Evening With Chuck Akre: Part 1 by Jim Fink
An ETF Broadcasts PIMCO’s Latest Move by Benjamin Shepherd
Oil Prices: At Home in Their Range by Elliott H. Gue
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Historic Oil & Gas Profits Here Today.

The global energy map is being withdrawn – away from the unstable Middle East and to the West. Away from the tough and expensive oil extractions to “unconventionals” like shale oil and oil sands. The Wall Street Journal says, “The U.S. is at the forefront.” A brand-new U.S. royalty trust is quietly amassing hundreds of well sites in the oil-rich sands of Oklahoma. Savvy investors will tap into 50% or more profit on those wells. Although underreported, this trust is already yielding 16.4% for its unit holders. More to come.

Details here.


Oil Prices: At Home in Their Range
by Elliott H. Gue
3/6/2012

Readers often ask about my forecast for crude oil prices in 2012, likely because opinions in the popular press diverge widely: Some pundits call for crude oil to hit $200 per barrel because of an outbreak of hostilities in Iran; others expect oil prices to collapse because of weakening global demand.

Neither scenario is likely. Brent crude oil should average between $110 and $115 per barrel in 2012, while West Texas Intermediate (WTI) should average $100 per barrel. Based on this outlook, both Brent and WTI have approached the top of their respective trading ranges.

Weak economic growth should keep a lid on oil prices, while omnipresent geopolitical risks and a tight supply-demand balance will limit downside.

The Demand Side

Demand for oil remains weak in the developed world. Although the US no longer drives growth in global oil demand, the economic power is still the world’s largest consumer.

US economic data have surprised to the upside since last summer, and the recent dip in initial jobless claims suggests that the domestic labor market has started to heal. Nevertheless, US consumers have reacted to elevated oil prices by taking steps to conserve fuel. Check out this graph tracking the four-week moving average of US demand for oil and petroleum products.


Source: Energy Information Administration

US oil demand never fully recovered from the 2007-09 Great Recession, in part because elevated prices have curbed gasoline consumption.  

General Motors (NYSE: GM) recently announced that weak demand had prompted the automaker to halt production of its gas-electric hybrid vehicle, the Volt, for five weeks. In February 2012, General Motors sold only 1,023 Volts, well off the pace needed to meet annual sales of 45,000 cars.

Critics have trotted out this failure as evidence that Americans don’t care about buying fuel-efficient cars. Nothing could be further from the truth; check out this tracking US truck sales as a percentage of total vehicle sales.


Source: Bloomberg

Americans in recent years have stepped up their purchases of small cars. Consumers’ growing preference for fuel-efficient automobiles suggests that purchasers are factoring in rising energy prices when selecting which type of vehicle to buy.

Subpar economic growth, coupled with the recent spike in gasoline prices, could cause US oil demand to surprise to the downside in 2012. This outlook represents a bit of a departure from the second half of 2011, when I consistently argued that the US economy was in better shape than many investors believed.

Although the US is unlikely to slip into recession in 2012, the recent rally in the stock market suggests that investors have grown to bullish about the economy’s growth prospects. My forecast calls for the US economy to expand at an annual rate of 2 percent to 3 percent for a prolonged period. Sluggish growth will weigh on US oil demand.

Meanwhile, the economic situation continues to deteriorate in Europe; we expect the EU to suffer a mild recession in 2012, as fiscally challenged governments rein in spending. According to the International Energy Agency (IEA), Western Europe’s oil demand in December 2011 tumbled 4.7 percent from year-ago levels, led by a 7.6 percent decline in Italy’s oil consumption and 7.4 percent drop in Spain’s oil demand. This weakness should persist into 2012.

Japan remains the one center of demand growth in the developed world, primarily because the country idled most of its nuclear reactors after the March 2011 disaster at the Fukushima Daiichi power plant. To offset this lost capacity, Japan has leaned heavily on petroleum- and natural gas-fired power plants.

Although the developed world accounts for much of global oil consumption, China, India and other emerging economies will continue to drive aggregate oil demand. In 2011, for example, oil demand surged by 1.27 million barrels per day in the developing world, more than offsetting 530,000 barrels per day of lost consumption in developed nations.

Global oil consumption will grow in 2012, albeit at a relatively modest pace. Emerging markets will lead the way, but China and other major oil consumers deliberately slowed their economies over the past year to quell inflationary pressures.

Moreover, the outlook for global economic growth weakens with each week that Brent crude oil goes for $130 per barrel; higher oil prices inevitably lead to some demand destruction. As I explain in the Feb. 24, 2012, issue of Personal Finance Weekly, Rising Oil Prices Threaten the Economy–But Don’t Panic, Brent crude oil has approach prices that historically have caused economic growth to soften meaningfully.

Bottom line: Modest growth in oil demand limits the likelihood that Brent crude oil will eclipse $130 per barrel.

The Supply Side

Although weak demand growth should constrain oil prices, limited supply increases should prevent crude oil from becoming much less expensive.

The IEA’s current forecast calls for global oil consumption to climb by 830,000 barrels per day in 2012 and for non-OPEC oil production to increase by 900,000 barrels per day. In January 2012, non-OPEC oil output declined on a year-over-year basis.

Robust production growth in North America, especially in unconventional oil fields such as North Dakota’s Bakken Shale and Texas’ Eagle Ford Shale, accounted for a good portion of the IEA’s projected growth in non-OPEC oil supply. These output estimates include volumes of natural gas liquids (NGL) such as propane, ethane and butane, which can’t replace oil in all applications. (NGLs are a common substitute for oil derivatives such as naphtha in the petrochemical industry.)

At the same time, geopolitical tensions in the Middle East could inhibit supply growth. Although EU sanctions against Iran won’t go into effect until summer 2012, some customers have already started to source their oil supplies from elsewhere, disrupting the flow of crude oil from the nation.

If a military conflict were to break out in Iran and threaten oil shipments from the Persian Gulf, crude oil could soar to $200 per barrel overnight. These fears should continue to support oil prices.

Meanwhile, OPEC’s spare productive capacity–incremental oil supply that could be brought online to offset supply disruptions–hovers around 3 million barrels per day, a thin buffer in a global oil market that consumes 90 million barrels per day.

These supply factors should prevent Brent crude oil from slipping to less than $100 per barrel and WTI from tumbling to less than $90 per barrel.


Australia Takes to the Clouds

An Australian telecommunications company is currently launching the most ambitious cloud-computing platform in the world. Their client list is growing as fast as their broadband network. There’s also a 9% dividend.

Microsoft, Google, and Amazon are racing to catch up…


My Evening With Chuck Akre: Part 1
by Jim Fink
3/7/2012

In last week’s article How to Make 50% Per Year in the Stock Market, I suggested that all you need to do is buy companies that have historically generated high returns on invested capital and haven’t required much capital expenditures to do it. A back-tested version of this strategy may work for mechanical investing quants that trade frequently, but for long-term buy-and-hold investors, a one-time stock screen is not enough. If it were that easy, everyone with access to a Bloomberg terminal could make 50% per year.

Chuck Akre is a Great Small-Cap Growth Manager

I was fortunate to attend a Washington Association of Money Managers (WAMM) lecture by Chuck Akre, manager of the Akre Focus Fund (AKREX). Akre managed the FBR Focus Fund (FBRVX) for almost 13 years before striking out on his own in August 2009, leaving behind a great long-term track record of 8.4% annual outperformance versus his Russell 2000 index benchmark. FBR Focus performed in the top 1% of small/mid-cap growth funds in 2002, 2004, and 2006, as well as the 2nd percentile in 2001 and the 6th percentile in 2008. Not bad for a guy whose college major was English literature!

Although Morningstar classifies him as a small-cap “growth” manager, Akre’s investment philosophy is really a mixture of both growth and value. I would characterize his philosophy as similar in outlook to both Buffett and legendary fund manager Peter
Lynch
(page 219), who espouse growth at a reasonable price (GARP). But strong profitability and above-average earnings growth are definitely Akre’s first and foremost investment criteria. Akre started last night’s lecture by asking the following rhetorical question:

What is the value of a penny that has doubled each day for 30 days?

The answer is an unbelievable $10.7 million! Akre’s point is that high rates of return compounded over time produce amazingly high numbers and are the “holy grail” of investing.  He provided the following chart to demonstrate the importance of long-term compounding to wealth creation:

Years of Compounding

4% Annual Return

8%

12%

16%

20%

10

$148,024

$215,892

$310,585

$441,144

$619,174

20

$219,112

$466,096

$964,629

$1,946,076

$3,833,760

30

$324,340

$1,006,266

$2,995,992

$8,584,988

$23,737,631

40

$480,102

$2,172,452

$9,305,097

$37,872,116

$146,977,157

Compound Interest is the 8th Wonder of the World

Peter Lynch is famous for coining the phrase “10-bagger” (page 240), which refers to a stock that appreciates in value by ten times. Chuck Akre is more ambitious: he is looking for 100-baggers! Back in the early 1970s, long before Peter Lynch became a public figure, Chuck read 100 to 1 in the Stock Market, a book written by a Wall Street security analyst named Thomas Phelps. This book had a lasting
impression on Chuck, because it demonstrated that the special stocks in market history that had been able to increase their share price by 100 times or more all shared common characteristics. The most important shared characteristic Phelps discovered was these companies’ ability to generate high returns on invested capital over long periods of time.

A growth investor was born! Akre become convinced that through the simple but powerful math of compounding, significant wealth creation will occur. The key is to find investments that generate these high compounded growth rates. Which investments produce this high growth is clear: stocks.  Look at Akre’s next table, which shows the annual rate of return for different asset classes over the past 85 years between 1926 and 2010:

Investment

Annual Rate of Return

Small Stocks

12.1%

Large Stocks

9.9%

Long-Term Corporate Bonds

5.9%

Long-Term Government Bonds

5.5%

Intermediate-Term Government Bonds

5.4%

U.S. Treasury Bills

3.6%

Source: Ibbotson SBBI 2011 Classic Yearbook

Based on the above table, it’s understandable why Akre focuses on small-cap growth stocks! It’s also clear that fixed-income investing yielding 4% to 5% annual growth won’t make you rich. This is why my free report on asset allocation recommends that your investment portfolio include a substantial allocation to stocks, even after retirement.

Earnings Growth and Stock Price Appreciation Go Hand-in-Hand

Since the S&P 500 index represents large stocks and large stocks have returned on average 9.9% per year, Akre says that the way to outperform the S&P 500 over time is to invest in stocks that appreciate faster than 9.9% per year.  In his opinion, over the long term a stock’s price appreciation directly correlates with its earnings growth, as measured by return on equity (ROE). So, the key to outperforming the market is to invest in stocks that generate an annual ROE far above 9.9%. Specifically, Akre looks for companies generating an ROE of 20% or higher. This is very similar to the 20% or higher return on invested capital criterion I used in the stock screen to mimic Warren Buffett’s investment advice.

The Big Question: Sustainability

But finding fast-growing stocks is just a starting point for Akre. The next step involves asking what he calls the “big question:” what is causing the company’s high returns on equity and – most importantly – ARE THESE HIGH RETURNS SUSTAINABLE? The worst thing an investor can do is buy a stock priced high based on its great past growth, only to discover that the past growth cannot be sustained and the stock price collapses.

Next week, I will explain how Chuck Akre discovers the answer to his “big question.” Stay tuned.


Unstoppable Glo-Mo!

It’s a technological tsunami of epic proportions. Billions of people demand Internet access via their phone! By decade’s end, they’ll have it! Two companies will make sure of it.

Details here.


An ETF Broadcasts PIMCO’s Latest Move
by Benjamin Shepherd
3/7/2012

Despite the fact that Bill Gross’s flagship PIMCO Total Return (PTTAX) mutual fund had a tough 2011–he infamously bet against further gains in US Treasury bonds, particularly longer-dated issues–he remains one of the most respected investors in the world. Almost any fund with his name attached to it is going to do well in the marketplace.

As a result, the March 1 launch of the PIMCO Total Return ETF (NYSE: TRXT) has been one of the most anticipated exchange-traded fund (ETF) launches in years. The ETF will be actively managed by Gross himself, employing the same basic strategy as the mutual fund while offering more transparency and lower costs. The ETF carries an annual expense ratio of just 0.55 percent versus 0.90 percent for Class-A shares of the mutual fund. And PIMCO said that it will disclose the ETF’s portfolio holdings on a daily basis.

But the Total Return ETF isn’t exactly a carbon copy of the Total Return mutual fund. The biggest difference will be that because the Securities and Exchange Commission is leery regarding derivatives, the ETF won’t use futures, options or swaps like the mutual fund does. That will limit Gross’s flexibility to employ trading tactics which, in the past, have worked out well for the mutual fund and may create some tracking error between the ETF and the mutual fund. As such, it will be interesting to see the variance in performance between these two securities.

That difference isn’t likely to hinder the ETF in terms of garnering assets, however. Investors hold Gross in high esteem. And while the ETF’s tactics may differ from the mutual fund, the ETF’s strategy will still benefit from Gross’s top-down perspective, which will be visible in almost real time. In the past, investors had to wait months to learn the details of how Gross had managed his mutual fund. On that basis alone, PIMCO Total Return ETF will quickly become one of the most watched ETFs on the market.

Aside from offering greater insight into Gross’s investment strategy, the launch of PIMCO Total Return ETF is a watershed moment for actively managed ETFs generally.

So far, most mutual fund managers have been hesitant to transition their strategies into an ETF wrapper precisely because of the high level of transparency it requires. They want to avoid broadcasting their moves to the market for fear that some investors could exploit this information by copying their trades while not paying anything in management fees. Similarly, they don’t want their competition to profit from knowing the full details of their strategy. The fact that Gross is not afraid to embrace greater transparency could inspire other well-known fund managers to enter the ETF marketplace.

PIMCO’s move into ETFs is also recognition of the changing investment landscape. While ETFs have become a trillion-dollar industry, mutual funds have been experiencing slow, but steady outflows for years now. By launching the ETF, PIMCO will absorb some of these outflows instead of ceding that opportunity to other ETF sponsors. Indeed, this will likely be the first of many ETF launches from PIMCO.

But the death knell hasn’t sounded for mutual funds quite yet. For one, the 401(k) channel is still largely closed to ETFs, so investors who own shares of the PIMCO Total Return fund through their company’s plan are unlikely to switch to the ETF. And the institutional class of the mutual fund is actually 9 basis points cheaper than the ETF, so institutional investors will likely favor the mutual fund over the ETF.

But investors in the mutual fund’s retail share class and financial advisers who don’t have access to the cheaper institutional shares will likely contemplate a change. Investors with smaller portfolios who can’t meet the minimum required investment for traditional mutual fund shares might also be enticed by the ETF since it doesn’t require a minimum investment.

While Vanguard’s line of ETFs are essentially share classes of its existing mutual funds, look for other large mutual fund companies to take a play from Bill Gross and PIMCO in the future, especially if PIMCO’s experiment with ETFs proves successful.

In Other News

The Vanguard Group may insist it’s not firing another shot in the ETF price wars, but it slashed expenses on six of its ETFs last week.

Vanguard MSCI Emerging Markets ETF’s (NYS: VWO) annual expense ratio was cut from 0.22 percent to 0.20 percent, reinforcing its position as one of the cheapest emerging market ETFs available. Vanguard High Dividend Yield Index ETF’s (NYSE: VYM) annual expense ratio dropped from 0.18 percent to 0.13 percent, while the cost of Vanguard FTSE All-World ex-US ETF (NYSE: VEU) fell from 0.22 percent to 0.20 percent.

The broad market Vanguard Total International Stock Index ETF (NSDQ: VXUS) saw expenses fall from 0.20 percent to 0.18 percent, while the annual expense ratio of Vanguard Total World Stock Index ETF (NYSE: VT) declined from 0.25 percent to 0.22 percent. Finally, the annual expense ratio of Vanguard FTSE All-World ex-US Small Cap Index ETF (NYSE: VSS) fell from 0.33 percent to 0.28 percent.

What’s New

In addition to the long anticipated launch of the PIMCO Total Return ETF, State Street Global Advisors launched two new SPDR funds.

SPDR MSCI ACWI IMI ETF (NYSE: ACIM) offers broad global exposure by holding about 730 names from both developed and emerging markets. Still, the fund has a definite tilt toward safety, with US equities accounting for roughly half of its portfolio’s assets, followed by the UK (8 percent), Japan (8 percent) and Canada (5 percent). Emerging markets such as China (2.2 percent), India (0.9 percent) and Russia (0.8 percent) receive only minimal allocations.

From a sector perspective, financials receive a 19.3 percent weighting, while information technology has a 12.5 percent weighting and industrials an 11.6 percent weighting. Those are followed by energy (11.2 percent), consumer discretionary (10.9 percent) and consumer staples (9.3 percent).

With an annual expense ratio of 0.25 percent, the fund is an inexpensive option for investors looking to add some global exposure to their portfolios. But if your portfolio already includes substantial exposure to US and European equities, an investment in this ETF could create an inadvertent overweighting of the developed markets.

SPDR MSCI EM 50 ETF (NYSE: EMFT) holds the 50 largest companies of the MSCI Emerging Markets Index. From a geographical perspective, the fund is well diversified, with South Korea and China receiving allocations of about 18 percent each, followed by Brazil (16 percent), Russia (11 percent) and Taiwan (10 percent). For the most part, sector exposure is spread out, though financials receive a 23 percent allocation and energy has a 21 percent allocation. The fund has a 0.50 annual expense ratio.


Big, Safe Yields Ahead?

Treasuries are a joke! 3% or so. But one class of income investments is doing extremely well. Safe yields of 8%, 9%, 11%, possibly more. That’s much higher than the average corporate yield.

These companies pay great dividends today … and they will pay you great dividends tomorrow. We tell you the three keys to unlock these hefty, low-risk yields.

So what do you think? Do high, safe yields have a place in your portfolio? Let us know.


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Learn more about the Investing Daily editorial team:

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David Dittman

Benjamin Shepherd

Elliott Gue

Jim Fink

Yiannis Mostrous


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