Investors have incredibly short memories. In the blink of an eye, they've quickly forgotten many of the lessons of the two most recent stock market crashes, namely the dot-com bust and the subprime blowup.
Think back to the dot-com era. Stocks like eBay
Well, as we now know, the Internet did change the world. Can you imagine life without it? Without the Internet, how would we find the answers to such questions as "Daddy, if the Earth is round, how come we don't fall off it?"
But what the Internet didn't change were the fundamentals of investing. Sure, it made it much easier for us to gather timely information about a particular company, read annual reports, and listen to conference calls, but it didn't change the two core tenets of investing, namely ...
- Buy low.
- Sell high.
Did you buy stocks at the height of the dot-com bubble? If you did, hopefully you learned a very valuable lesson. Valuation always matters.
The same greedy mistake
Fast-forward to the subprime crash. This one was a little different and somewhat harder to predict. Precrash, many stocks, including financials like Citibank
But the warning signs were there. House prices had peaked in 2006. Adjustable-rate mortgages had begun to reset at higher rates. Subprime borrowers were unable to refinance. Delinquencies were soaring.
Then, in mid-2007, Bear Sterns announced that two of its mortgage investment funds had collapsed, wiping out more than $1.6 billion in capital.
Yet, despite a wobble in the face of the first Bear Sterns shock, the stock market continued on its merry way. The Dow peaked at just over 14,000 in October 2007 and was still over 13,000 in May 2008.
Collectively, we ignored what was staring us right in the face. Were we stupid? Or naive? Or just plain greedy?
I say we were greedy. And I also say, right now, we're in danger of making the same greedy mistake.
A market riding for a fall
Since its March 2009 bottom, the S&P has jumped more than 35% higher. Stocks like Bank of America have positively flown into the stratosphere, up more than 400% in the same period of time. In short, it has been a fantastic time to be invested in the stock market.
But the easy money has already been made. Now comes the really hard part: making money in a stock market I think could be riding for a fall.
My reasons are simple ...
- Valuation. The S&P 500's price-to-earnings ratio based on expected 2010 as-reported earnings is over 25. Just like the dot-com boom, valuations are expecting an awful lot of good economic news some way into the future.
- Unemployment. It's still running at 10%. Worse, when the calculation includes people who have stopped looking for work and people who work part time but want to work full time, it stands at over 17%. With unemployment riding so high, I expect the economic recovery to be tepid.
- Interest rates. Although the Fed rate remains effectively at 0%, 10-year Treasury yields have recently jumped from 3.2% on Nov. 30 to just over 3.8% -- a significant 19% increase in only five weeks. Continued rising interest rates will likely dampen any economic recovery.
Margin of safety
Lest you think I'm a big, bad grizzly bear without a bone of bull in my body, let me assure you otherwise.
I'm bearish on the economy, yet still bullish on certain stocks. Not all stocks, mind you. For example, I'm steering well clear of economically sensitive sectors like financials and most retailers.
I'm also steering clear of highly valued stocks, even if they are quality players like Amazon.com
Juice your returns
Where I am seeing value is in higher-yielding stocks. For example, take a look at these "boring" value stocks ...
|
Stock |
P/E Ratio |
Dividend Yield |
|---|---|---|
|
Altria |
13.2 |
6.7% |
|
Merck |
10.7 |
3.7% |
|
Vodafone |
12.5 |
5.7% |
|
Johnson & Johnson |
14.0 |
3.0% |
Source: Google Finance.
In this low interest rate environment, the dividend yields alone set my pulse racing, although admittedly that's not difficult for this middle-aged man.
But it gets even better. Over at Motley Fool Pro, we're using options to further juice our returns. Specifically, we're selling covered calls on some of our portfolio stocks to potentially (a) generate even more income or (b) sell our stocks at what we believe to be attractive prices.
And when used with already high-yielding stocks, covered calls can really boost your investment returns. We see it as a strategy ideally suited to today's unique stock market and economic conditions.
If you'd like to learn more about Pro and how you too can use covered calls to juice your investing profits, simply enter your email address in the box below.
