Home Improvements

Sometimes I think that the best strategy for improving one's home is just to get away from the place for a while. The more time you spend at home, the more you are going to notice that bathroom that needs remodeling or those kitchen cabinets that need to be upgraded. And maybe this just isn't a good time to have your kitchen or your bathroom--or your wallet--torn up, so you live with it, even as those flaws hold your attention like a piece of old spinach stuck in the teeth of your dinner companion. If you plan your escape, you might realize the benefits of an "out of sight, out of mind" experience, and, upon your return, you might gain a new appreciation for your familiar environs, imperfections and all.

Getting away is exactly what my wife and I did back in January, when we spent an extended weekend at the Alluvian Hotel and Spa in Greenwood, Mississippi. If you're not familiar with the place and think a small town in the Mississippi Delta seems an odd location for a destination vacation, I'll point out that the Alluvian is owned by the Viking Corporation, the maker of high-end kitchen equipment, which has its headquarters right there in Greenwood. When I was conducting a little research for our trip, I learned that Viking was being bought by Middleby Corporation (MIDD, $181). Mibbleby is not a household name, because the stuff they make is not likely to turn up in your household. The company is a leading manufacturer of commercial kitchen equipment, and the Viking purchase gives the company a new presence in the residential market. Owing, at least in part, to the company's visionary CEO, Selim Bassoul, Middleby's stock is up some 280% over the past five years (gaining 80% over the last year alone). With a market capitalization of $3.4 billion, MIDD is a "mid-cap" stock that has probably escaped the attention of many investors. I have only rarely heard it mentioned by the talking heads on CNBC, a lack of attention that I take as a big plus.

My fanciful concept of home improvement aside, what literal home remodeling and vacations have in common is that they are both forms of what economists call consumer discretionary spending, aptly named because such expenditures can typically be postponed. This part of the economy stands in contrast to the consumer staples sector, which is characterized by continued buying of consumables such as food and household products. Pampers diapers and Tide laundry detergent from Proctor and Gamble (PG, $80) will probably still find their way into consumers' shopping carts regardless of the state of the economy, as will Raisin Bran and Corn Flakes from Kellogg (K, $67). It is worth noting, though, that some of these staples stocks have done quite well of late, with PG up 23% and K up 41% over the past year. Some market observers think such strength in a recovering economy is unusual (investors tend to favor such stocks in a faltering economy), but one explanation may be that it is this sector that has historically offered good dividend yields, with dividends that are both reliable and growing. Faced with the meager yields in the bond market, investors have bid up the prices of these stocks as an alternative source of income. With the higher stock prices, the dividend yields are lower now than they were a year ago, with PG now yielding 2.99% and K 2.75%; that's still better than the 2.57% yield on 10-year Treasuries.

Mr. Bernanke and the Fed have pushed interest rates to historic lows to encourage all sorts of spending, but there's no guarantee that this will work. John Maynard Keynes once noted that stimulative monetary policy could be like "pushing on a string," but I prefer to think of it as a classic example of the "leading a horse to water" problem. No matter how low interest rates may be, you're not likely to borrow money to start adding on to your home if you think you may be out of a job in six months. The cavalry riding to the economy's rescue here may be the wealth effect, the tendency of people to spend more if their investment portfolios are rising in value. This doesn't mean that people are cashing in their stock gains to fund increased expenditures directly--it just means that people are more willing to rev up the Visa card for that trip to Disney World if they've got a higher net worth to back them up. An increase in portfolio value from $500,000 to $600,000 (+20%) is a pretty powerful enticement to spend, even if you're not tapping a single penny of that money. This cavalry, though, is quite a few horses short of a full battalion because not everyone is fortunate enough to own stocks. The stagnant wage growth that has characterized the economy for some years now might lead some to think that the approaching cavalry is actually the Horsemen of the Apocalypse, delivering yet another reminder of what we have considered here many times as our "Tale of Two Cities" economy. That's one reason why a middle-market retailer like J.C. Penney (JCP, $16.50) has seen its customers move to the lower-end discounters. If you pay a visit to discount retailer T.J. Maxx (TJX, $52), you might just encounter part of the J.C. Penney diaspora browsing the clothing racks. Accordingly, we would expect any boost in consumer discretionary spending to be skewed to the higher end. As Willie Sutton supposedly said when asked why he robbed banks: "That's where the money is."

A measure of cynicism about the economy's lethargic pace is certainly understandable, but the fact is that things are at least moving in the right direction. The Federal Reserve would not be signaling a potential tapering of its bond-buying stimulus if its radar array of economic models and statistics weren't picking up a glimmer of something on the horizon--maybe those AWOL cavalry members. And we can say right now that the consumer sentiment and confidence numbers have been encouraging. Another plus is the housing sector, which now seems firmly on the mend after the bruising it took in the recession. What's important to remember is that investing is all about the future, and the market anticipates and discounts what conditions are likely to be some time hence. It may seem like a gloomy disconnect that stocks rally amid the sluggishness in the economy, but that's actually good news--or at least the market strength presages better news. The arrows, for the most part, are pointing in the right direction.


The consumer discretionary part of the economy includes a number of sub-sectors--apparel, restaurants, hotels, and automobiles, to name a few. Probably no company covers as much of the waterfront here as Visa (V, $192), because they collect a toll every time someone swipes of one their credit or debit cards. Last week Visa reported earnings and sales numbers that beat expectations, and the company offered upbeat guidance for the rest of the year. The stock, which traded at a new 52-week high of $196 after the report, is up about 48% over the past year. If we are looking to this sector for stock ideas, we have to find companies that have something going for them other than just being positioned to benefit from the trend of increased spending. If the overall pie is growing slowly, then our companies need to be able to take a bigger slice of that pie. The other part of the Visa story, what we see as the secular or longer-term trend, derives from the fact that a majority of the world's transactions are still paid for with cash. That may seem surprising when the person in front of you at the convenience store pulls out his Visa debit card to pay for a $6.00 pack of Marlboro, but we're really looking at the global situation here. That gives Visa a pretty long growth runway, over and above how it will benefit from a cyclical recovery in spending.

In the retail apparel sector, we might take a look at Urban Outfitters (URBN, $42), the trendy clothing store aimed at the younger demographic. Personally, I'll have to say that whenever I see a group of women dressed in these clothes, I am tempted to ask them if they are auditioning for roles as extras in the next production of Les Miserables. However, I learned a long time ago not to let my fashion taste influence my investment decisions (and Brooks Brothers isn't a publicly-traded company). The company also owns Anthropologie and Free People, both with plenty of room for more locations both domestically and internationally. It's not just about locations here, though, because, unlike some other bricks-and-mortar retailers that have suffered from the juggernaut of online shopping, URBN seems to have leveraged its online presence to its advantage. You might want to get in touch with your inner hipster and conduct more research--nose piercing not required. Also hitting a new 52-week high after a stellar earnings report last week was Starbucks (SBUX, $72). The company is not content to rest on its laurels and merely welcome back the customers who once again are ready to pay $5.00 for a latte. They have plans for a greater variety of food and drink items, designed to get people in their locations beyond the peak latte-sipping hours. CarMax (KMX, $48) is a specialty retailer I find interesting, with its hassle-free and haggle-free approach to buying and selling cars. If you were in the market for a "previously-owned" vehicle, you'd probably find yourself spending a great deal of time perusing the locally-owned used car lots, each of which may not offer much of a selection. There you might encounter a salesman who wants to "friend" your daughter on Facebook with the idea of taking her out for a gourmet dinner at Applebee's and a test drive in his 1975 Eldorado with a cooler full of Pabst Blue Ribbon tall boys. KMX just might spare you that nightmare.

As we wrap this up we'll take another look at Middleby, and note that the calculus for buying a piece of commercial kitchen equipment is different from the considerations involved in selecting a residential stove or oven. While MIDD is not in the consumer discretionary sector, the connection is that the demand for its products is a derived demand--derived, that is, from the consumer demand for eating out. Restaurants don't buy new ovens to impress the neighbors, but to better and more efficiently serve their clientele. That means cooking food faster and keeping it at the right temperature until it is served, and this is where Middleby's investments and innovations have paid off for both its customers and its shareholders. Maybe its purchase of Viking is not a game-changer, but it keeps MIDD on the growth path with a new market.

In the lobby of the spa building at the Alluvian sits a gleaming, stainless steel Viking cooking machine the size of a Chevy Suburban. This beauty was tempting, but about six months before our trip to the Alluvian, my wife and I did replace our 25-year old stove top, and in the interest of full disclosure I'll tell you that we bought the Wolf brand. They had just come out with a modular stove top that better suited our needs and our counter space. We selected four gas burners, a grill, and a steamer. I wanted the deep fryer instead of the steamer, but my wife said no way was I going to turn our kitchen into a grease-soaked chamber of horrors. So, we're currently in the market for a Fry Daddy. As the wife says, "Take it outside!"

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of MIDD, PG, K, TJX, V, URBN, SBUX, and KMX. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Only The Strong Survive

When it comes to the litany of life's frustrations, or at least the frustrations of investing, few experiences rank higher than losing money. Seeing one's treasure evaporate, as almost all investors witnessed during the market and financial meltdown of 2007-2009, makes for an ulcer-inducing angst all its own, where the only palliative is a bottle of scotch emptied in the company of misery. But what about the frustration of failing to make money in a market that is soaring? The most intense frustration, after all, is the one you're dealing with today, even if past frustrations were of greater consequence. So, if the market is jumping like Richard Simmons (pictured above) at a caffeine-fueled aerobics class but your stocks can't seem to get out of bed, that's going to be a problem--and you're probably not going to feel comforted by the reminder that it's not 2008 all over again.

Very often the conventional investment wisdom tells us that the antidote for such under-performance is patience, and this is valid to an extent.  We can't expect our stocks to go up immediately after we buy them. In fact, our case for owning any particular stock likely is based on our assessment of the company's future potential--a potential that is not currently reflected in the stock price. We may have to wait some time before the market recognizes such potential. That is all well and good, but we also need to remember that where patience is supposedly a virtue, the conditions that try our patience are assumed to be temporary. If your spouse comes home from work every night to knock back a fifth of Jack Daniels and kick the dog, then the dog, at least, is not going to appreciate your patience. Or, as Albert Einstein once observed, one definition of insanity is doing the same thing over and over again and expecting different results. So, in the interests of preserving our sanity, let's take a look at some situations where patience might not be a virtue.

First on the list of usual suspects is the possibility that we have been lured into a value trap with some of our stocks. As we've reviewed here previously, it's called a trap because the stock looks cheap on some traditional measures of valuation, but is actually cheap for good reasons. My "poster child" value trap stock has been Radio Shack (RSH, $3.00), which a number of research sources were calling a "buy" at $15, then at $12, $8, and all the way down to its current price. One didn't need to be a Chartered Financial Analyst (CFA) to know that selling consumer electronics in a bricks-and-mortar retail store was not exactly a growth business with strong competitive advantages. Furthermore, a stock trading at a price-to-earnings (P/E ratio) multiple of 10x may look cheap, but it's not so cheap if earnings are growing at only 5%. Likewise, a stock with a P/E ratio of 30x is not necessarily expensive if earnings are growing at 25%. A commentator on CNBC recently remarked that "Valuation in itself is not a catalyst." That quote should be taped to every investor's computer screen as a reminder that without some positive catalyst down the road, a stock can languish--and appear cheap--for a very long time. These stocks are likely to be a drag on your overall performance, because even a consistently rising market is not likely to bring them out of the dumps. Investors may be more tempted by such stocks in a soaring market, because the natural tendency is to eschew the strongest stocks and seek out something that hasn't participated in the rally. This is sometimes a mistake. The idea of finding a discarded diamond while rummaging through trash bins sounds intriguing, but the reality is that the vast majority of what you'll find is indeed there for a reason.

Patience is appropriate in more legitimate value cases, where a company with a solid business and strong competitive position has hit a rough spot, or has at least been out of favor. As an example, shares of Coca Cola (KO, $41) are up only about 5% over the past year. The company has a nice dividend yield of 2.75%--if you have to wait for performance, it's good to be paid for your patience. Ebay (EBAY, $53 ) took a hit this week after reporting earnings that slightly missed expectations. A big part of the investment case here is PayPal, which is making inroads with its payment processing services. I also find Scripps Networks Interactive (SNI, $72) interesting. The company owns HGTV, Food Network, Travel Channel, and has the Internet presence to go with them. The stock is up 33% over the past year, but still, in my opinion, offers value.

Another possible culprit in under-performance is really not so much a culprit as a circumstance of timing.  Different  sectors in the market are strong at different times, and being in the wrong place at the wrong time can be a drag on shorter term returns. Consider, as an example, the oil refiners, which are not really growth stocks in the traditional sense. Marathon Petroleum (MPC, $68) rose from about $43 last summer to a high of $93 early this past spring, and if you owned the right companies in this sector during that time frame, they would have contributed significantly to your outperformance. The market's love for these stocks has largely been due to what is known as the "crack spread"--the difference between what refiners pay for crude oil and the price they can get for the refined product (gasoline, for instance). New supplies of oil here in the United States have kept the price of what is known as West Texas Intermediate Crude relatively low compared with the price of Brent North Sea Crude. The refiners have been in the sweet spot of paying the former price while the price at the pump is supported by the latter, higher price. Lately this crack spread has been narrowing, and with it the benefit to the refiners. So, what helped your performance for a time is now detracting from it. The home builders have followed a similar track. They are not typical growth stocks, either, but they have seen tremendous increases in earnings coming out of the housing bust. Ryland Group (RYL, $41) rose from $23 last summer to a high of $50 this spring, but then Mr. Bernanke started talking about tapering the Fed's bond buying. Higher interest rates may not kill the housing recovery, but they won't help it, either.

Now, let's step back for a minute and recognize one important thing. We need to evaluate our investment performance over longer periods of time, and no one is likely to beat the market averages every single quarter. The shorter term numbers are a regular test, not the final exam. But, if we don't have infinite patience to own Coca Cola and aren't nimble enough to catch Marathon Petroleum at just the right time, then what is the answer? Most investors understand the importance of diversification, but many of them may miss diversifying across varying investment styles. Certainly it is important to own good value stocks and to have the patience to stick with them, but it also helps to devote a portion of one's portfolio to true growth stocks--and the best of the best growth stocks are going to exhibit strong relative strength. This means that they are not going to look cheap, and, in a perverse bit of reasoning, they are probably not worth owning if they do look cheap. Intuitive Surgical (ISRG, $373), the maker of robotic surgical systems, was a darling of growth stock investors for a time, but has more recently been plagued by slowing growth and some supposed safety concerns. You would have done quite well owning the stock from 2010 until the first quarter of 2012, when the shares went from around $300 to almost $600, but the relative strength has been suffering since then. Now this week the stock is down again on the heels of more disappointing results, even setting a new 52-week low at levels not seen since 2011. If you want to take a round trip, take it to Tahiti and not in your stocks. The point, though, is that the declining relative strength gave you some time to abandon ship--you are more likely to sell these types of stocks on the way down, not on the way up. Does this make ISRG a value stock now? Nobody knows, because the market has always valued the company as an aggressive growth stock. Investors who buy it here may well be adding more risk to the burden of patience.

Experience shows that such growth stocks can be very powerful and profitable, but only the rarest ones will continue their outperformance over more than a few years (think Microsoft in the 1990s). Experience also shows that such strength is important to own, in measured doses, in a strong bull market. If we're hunting for strength today, here are some stocks that may fit the bill: Cree (CREE, $68), a maker of those new LED light bulbs; Celgene (CELG, $135), the biotechnology company that is on a roll with new treatments and plans for earnings to reach the $13-$14 range by 2017; Netflix (NFLX, $265), which has transformed itself from a mail-order dvd rental company to a video streaming service and now to a content provider with a boatload of recent Emmy nominations; Lions Gate Entertainment (LGF, $32), with the Hunger Games and Twilight franchises; and LinkedIn (LNKD, $201), the Facebook for grownups. What all of these stocks have in common is that they have had tremendous runs already and thus will likely fall the hardest in a general market decline or with any disappointing company-specific news. No risk, no reward--no guts, no glory.

The final point I'll make today is to emphasize that the companies mentioned above are not for all investors, and no investor should buy only the strongest stocks in terms of relative strength. So, consider how much risk you need to be taking. Someone with 20 years until retirement might want to own some Celgene shares, for example. But if your daughter is a high school senior and you're thinking about putting her college fund in LinkedIn or Netflix to gain some quick extra bucks, then while you're at it you'd better pick up a job application for her at Hooters. Because that's how she might end up paying her college tuition. The market may occasionally do what we expect it to do, but you can bet that it will never do what we need it to do. So tread carefully and be careful out there. And be strong--but don't dress like Richard Simmons.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of KO, EBAY, SNI, CELG, NFLX, LGF, MPC, RYL, SNI, and LNKD. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security. Stock prices are as of noon, Central Daylight Time, July 19th, 2013.

Gunfight At The Wall Street Corral

Major market declines, such as the drop we experienced in June, can cause investors to lose their appetite for risk just as watching the movie Django Unchained (starring Jamie Foxx, pictured above) during dinner might ruin your appetite for that plate of spaghetti and meat sauce that someone just served you. Those market swoons serve as a reminder that, yes, stocks can go down, something that investors might not be too concerned about since the averages have essentially gone straight up since the end of 2012. Whether the carnage is brought on by jittery investors all headed for the exits at the same time, or delivered by Quentin Tarantino in a burst of blood and guts, the results can be pretty messy--and cause us to check our risk exposure and the safety on that gun. So, just what caused the market to reverse its advance, even if that just turns out to be a pause?

There is a showdown on Wall Street now, and to understand it we need to go back to some basics. In very simple terms, a stock's price is a function of two factors: the company's profits, or earnings per share, and the price that investors are willing to pay for those earnings (expressed as the price-to-earnings ratio). As for earnings, a major worry in the market is that the lackluster economic growth we've had since coming out of the Great Recession will hamper corporate profits--and, ultimately, take a toll on stock prices. In the latest round of quarterly earnings reports (commencing again in July), we saw evidence of the economy's sluggish but positive growth in the sales (revenue) numbers, which often came in below expectations even as the profit numbers were beating expectations. Corporations have become quite adept at cutting costs, and the weak labor market has taken wage pressures out of the equation as a problem. Even modest economic growth (that is, we are not in a recession) can pave the way for stocks to do well if companies can take more of each revenue dollar to the bottom line.

On the other side of the gunfight is the value that investors will place on those earnings, a value that is strongly influenced by interest rates. A dollar a year from now is worth more when interest rates are at 2% than when rates are at 4%, for example. The Federal reserve, chaired by Ben Bernanke, has been pumping liquidity into the economy to keep interest rates at rock-bottom levels. One way to look at it is to say that the Fed doesn't want you keeping too much money in the bank, so it's going to create conditions where you are not rewarded for doing so. The Fed wants you to buy a house or start a business, or otherwise go out on the risk curve to put that money to work so that the economy will kick into a higher gear. A stronger economy means more jobs, and the Fed has stated explicitly that it wants to see the unemployment rate lower by about 100 basis points (a full percentage point). Mr. Bernanke and his crew exert this power over interest rates by buying up a slew of bonds--and paying for those purchases with money that they create out of thin air. So the Fed ends up with a bunch of bonds on its balance sheet and the economic system ends up with the cash--cash that didn't really exist before. This has been a big positive for stock prices, as investors seek out the higher returns that can come from taking on more risk (this is known in current jargon as the "risk-on trade."). The June market decline was ushered in by Mr. Bernanke's comments suggesting that the Fed might slow down its bond buying. The prospect of rising interest rates is a headwind for the stock market, often referred to as the Fed "taking the punch bowl away from the party."

Wouldn't it be nice--Nirvana, actually--if we had a strengthening economy to propel earnings and falling interest rates to place a higher value on those profits? Sure it would, but that's not the way the economy works. The Fed is not going to keep pushing down interest rates once the economy really gets going, so if the Fed continues its aggressive monetary accommodation, that is a sure sign that the economy is not getting any better. So, there's the set-up for the showdown that will influence the direction of stock prices. A strengthening economy would be good news, of course, and more robust growth likely would mean better earnings all around. The trade-off, though, is that higher interest rates usually come with the package.

There are a couple of points worth making here amid all of the media chatter about the consequences for the stock market. First, all that talk is about the stock market overall, what we might expect from the average stock. As investors, we are not seeking out the average stock--if that were our goal, we could buy index funds instead of engaging in the meticulous research of true stock-picking. It is true that a bad environment for the stock market is likely to hurt all stocks, but we can at least put the odds in our favor by careful stock selection. As an example, let's take a look at Tile Shop Holdings (TTS, $30), a specialty retailer of manufactured and natural stone tiles that is up 200% over the past year. If you want tiles for your home, you can either go to Home Depot for their selection and probably save some money, or you can go to a professional designer and likely pay a lot more. TTS has created a niche in the middle as a specialty retailer that carries a wide variety of such products, priced above what the big box home improvement stores offer but below the high end. Part of the reason for the strength in the shares is no doubt the improving housing sector, which has made for a nice tailwind. The other reason, though, is that the company has a long growth runway with only 72 stores in 23 states--and plans for a total of at least 100 locations. An intriguing growth story, but rising interest rates could put the housing recovery at risk. So there's the showdown in microcosm--will the growth of TTS be able to overcome the waning of investor enthusiasm for everything tied to housing?

Another point to consider is that the Fed is talking about "easing up on the gas" of monetary stimulus, not "slamming on the brakes" (more jargon!). You might think that this is a critical, finer point that investors have missed--but not so fast. Interest rates may not rise dramatically anytime soon, but it is hard to envision a scenario where they will fall from here, absent another full-blown recession. The issue is not that rates are going sky-high, but rather that we have probably seen the lows in rates for this cycle--and maybe for a very long time. That is not good news for holders of long-term bonds, because the only way to see bond prices appreciate is with falling interest rates. Bond investors who think rates are headed higher should keep their maturities short, so that they can invest maturing proceeds at higher rates.

We'll take our stock gains however we can get them, but I would rather see my stocks propelled by their own earnings prospects rather than by the opiate of falling interest rates. People always ask me if I think the market will go up from here, but they soon catch on to the fact that I am incapable of giving a "yes" or "no" answer. The better question is whether we will continue to see an environment that is favorable for owning equities. Perfection doesn't happen often for the stock market, but a combination of interest rates that don't rise dramatically and an economy that shows better growth would likely keep the rally going. That's a lot to hope for, and unexpected outcomes in either direction could give us Wall Street Unchained, with either blood in the streets or champagne in our glasses.

On another note, I'll acknowledge that it has been some months since I last posted to this blog. I express my sincere thanks to my readers who have told me how much they miss reading these installments. The good news here is that I have been extremely busy engaged in the activities that generate the thoughts and ideas for this space, so expect more regular posts going forward. Thank you.

Life is short. Get busy.

Jim


Disclosure/Disclaimer: My family members and/or I own shares of TTS. Individual stoks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as advice to buy or sell any security.