On the business channel today there was an interview with three leading hedge managers. Each was given a minute or so to discuss his outlook on the market and strategies in the current environment. One said that he was buying insurance in case of a market drop, another said we should be market neutral and that the beta of his longs should match his shorts and the final guy said it doesn’t make sense to be structurally short in this this market any longer (I neither have any idea how to be structurally short nor do I know how to match the beta of my longs to my shorts for that matter). I wish these gentlemen would just be honest and say they have no idea what the future brings. Their mumbo jumbo talk reminds me of Warren Buffett’s famous quote “Benjamin Graham (value investing) may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising ‘Take two aspirins’?”
The future is uncertain, so let’s not waste time trying to predict what will happen next. Instead of worrying about the next event that will spook the market, I need to focus my attention on the “knowns” and use these facts to determine what, where and how to invest today.
Here are the “knowns” that I think investors should pay attention to at the moment:
1) S&P 500 companies had cumulative earnings per share of $96.44 in 2011. At today’s level, the S&P 500 is trading at a Price Earnings ratio of 14.2 times, a discount from post -World War II levels and way down from the 30 P/E level seen at its peak. S&P 500 cumulative earnings were the highest ever in 2011
2) The Federal Reserve/Bank of Canada is maintaining an accommodative policy and interest rates are at or near historical lows.
3) The Dividend yield on the S&P 500 is above the 10 year Treasury yield. Aside from early 2009, which happened to be the best buying opportunity in a generation, we haven’t seen this phenomenon since the 50’s.
4) More on dividends: Like the S&P 500 cumulative earnings, S&P 500 dividend dollar payments are at their highest level ever. Dividend cash payments for S&P 500 companies increased 16% in 2011.
5) North American economies are growing. While growth may not be robust, the evidence from rising employment, increasing corporate earnings, growing rail car loadings and port traffic, and expanding manufacturing and service indices is overwhelmingly positive.
Put it all together and you get a reasonably cheap stock market that offers dividends higher than risk-free assets in an improving economy. With these facts in hand I can leave the worrying about unknowns to the hedge fund managers, and I can look to create a portfolio of companies that are trading at earnings multiples that are less than the overall market, have sustainable competitive advantages and a track record of rising dividend payments. We are finding no shortage of companies with these characteristics.