The Economy Isn't As Bad As You Think, Money Magazine

In this month's Money Magazine.  Some good advice.  I will detail my own "What to Do With 10,000K" in my own article soon, but I think these are good ideas.  Money Magazine and SmartMoney are always on point for Financial Advice.  BioPharma Investor Approved. 

Dan Fuss and Loomis Sayles Bond and Pimco are good 401K planners.  Dan Fuss believes in Corporate Bonds and Foreign Treasuries.  Sounds good to me. 

Also mentioned in the What to do with 10k article, it discusses a Bond Ladder.  Bond Ladders layer out the maturities over the years and reinvests into other treasuries.  Not a bad idea.  That way you always have a bond maturing in the future. 

Why it's time to be bullish

Paul J. Lim, senior editorOctober 21, 2010: 5:34 AM ET

(Money Magazine) -- On paper, this seems like a hospitable environment for the bulls on Wall Street to roam. The recession that began in late 2007 has officially been declared over. Interest rates and inflation are at historic lows, and stocks are up more than 70% from their low 18 months ago.

But when you flip on CNBC or turn to your paper's business section, it's all gloom and anxiety. The talking heads are warning that the economy could be headed for a double-dip recession or maybe something worse.

Meanwhile, mutual fund managers are sitting on cash, and a recent survey of investment newsletters found that bearish advisers vastly outnumbered bulls for the first time since the market cratered in March 2009.

Individual investors have caught the pessimism bug too: At the end of August, only 21% of individual investors described themselves as being bullish, vs. about 50% who said they were bearish.

That spread between optimists and pessimists hasn't been so wide since the credit crisis nearly two years ago. Since the start of 2009, $70 billion has been yanked out of U.S. stock mutual funds while more than half a trillion dollars has gone into bonds.

"Sometimes it feels like I'm the last optimist standing," says University of Pennsylvania professor Jeremy Siegel, whose book Stocks for the Long Run was the bible of '90s bulls.

Check out Money Magazine's:   What to do with $10,000 now

Now a puzzle: If investors are feeling so crabby, why aren't stocks cratering? It could be that they're caught up in the market's mixed signals. It's unclear right now whether you can consider the broad market cheap or dear.

So while there's no obvious rationale to sell just now, it might just take a little bit of bad news -- such as a surprisingly bad earnings report -- to send investors running. But there's also a strong counterargument that the dearth of bulls is a good sign. Four reasons not to listen too closely to the bears:

1. Investor sentiment often points the wrong way

Right now there's an overhang of fear in the market that's not justified by companies' fundamentals. People's anxiety about their own jobs and the economy is probably spilling over into their portfolios.

And David Kotok, chief investment officer of Cumberland Advisors, says investors are still gripped by "financial post-traumatic stress disorder" left over from the 2008 crisis.

But as a group, investors' emotional weathervanes very often point the wrong way.

For example, at the end of the bear market in March 2009 the pessimists outnumbered the optimists by nearly 2 to 1. Yet in the 12 months that followed, the Standard & Poor's 500 index soared more than 60%.

Similarly, in October 2002 the number of bearish investors greatly outnumbered the bulls just as the stock market was about to enter a five-year rally. And on the flip side, asks Siegel, "How many bears could you find in tech stocks in March 2000?" Not many, but that was just before the Internet bubble burst.

How to play it: This adds up to a case for sticking by your stock allocation. But recognize that fragile investor sentiment could lead to a short-run market drop. That would be a timely occasion to book some profits in bonds and recommit that money to stocks.

2. Corporate balance sheets are strong

"If you focus solely on the economy, you could get bearish," says Ronald Muhlenkamp, manager of the Muhlenkamp Fund. "But when you look at the health of companies themselves, it's very easy to get bullish."

For one thing, after getting out from under debt over the past two years, corporations are now sitting on more than $1 trillion in cash.

Ironically, a big reason investors are so worried about the economy is that corporations are doing too good a job sticking to their financial diets. As companies both big and small have gotten rid of debt at a record pace, they've simultaneously cut back cold turkey on spending and investing, which is one reason cash reserves are soaring.

The good news is that some of this cash is starting to come off the sidelines and is being deployed in ways that could benefit you.

For instance, as merger-and-acquisition activity has begun to pick up recently, stock prices have also begun to rise. In addition, companies in the S&P 500 have boosted their dividend payments by nearly $14 billion so far this year, after slashing their payouts by $37 billion in 2009. Dividend-paying stocks have returned more than 10% this year, three times the return of the broad market.

How to play it: First, take a look at tech stocks. The sector, which used to shun dividends, now accounts for nearly 10% of the S&P's payouts, as industry titans like Intel (INTC, Fortune 500) are kicking back more cash to their shareholders.

In May, Intel said the company would double its earnings over the next five years. Even if the company can't achieve this through simple growth, it has enough cash to buy back stock and double per-share profits. "Meanwhile, you're getting paid a 3.3% yield to wait," says Robert Turner of Turner Investment Partners.

If you'd rather invest in tech via a fund, Technology Select Sector SPDR (XLK) is an exchange-traded fund with a focus on larger companies. For a more diversified play on dividends, consider Vanguard Dividend Growth (VDIGX). Unlike many dividend funds, it doesn't just buy stocks with the highest yields, but includes newly emerging -- and faster-growing -- dividend payers.

3. The economy isn't as bad as you think

At least the global economy isn't. Take Europe, for example. While southern European countries were walloped by a debt crisis earlier this year, the region appears to have addressed many of those concerns.

In September, the European Commission nearly doubled its forecast for the region's growth this year, from 0.9% to 1.7%. Beyond Europe, the global economy is expected to grow at least 3.5% a year through 2014, which is about a third faster than projections for the U.S.

How to play it: Think European-based multinationals. Though European stocks are rebounding, they're still cheap. Historically they've traded at a 15% premium to the S&P; today they're even.

4. Parts of the market are attractively priced

Kotok likes Siemens, which is based in Germany, one of the region's strongest economies. The giant diversified manufacturer is growing 15% a year but trades at a P/E of less than 12. If you prefer funds, Vanguard Europe Pacific ETF is a MONEY 70 choice with two-thirds of its stake in Europe.

While there's great debate whether the broad stock market can be viewed as cheap, it's still easy to find attractively priced stocks right now. Bill Miller of Legg Mason Capital Management, a famous bull from the 1990s, argued in a recent commentary that some of the biggest high-quality U.S. firms are as cheap as they've been since 1951.

How to play it: Following a maverick like Miller is risky. His main fund lost big in 2008 as he stuck by financial stocks. But he also has a record of spotting huge opportunities others have missed, and his case for Exxon Mobil (XOM, Fortune 500) is intriguing. He notes it's cheaper now than it was during the financial panic.

Dan Fuss seeks bargains in a bond bull market

By Carolyn Bigda, writer
October 13, 2010: 8:00 AM ET

(MONEY Magazine) -- These are scary times for the economy, and the bond market has remained very focused on today's bad news. Dan Fuss, co-manager of Loomis Sayles Bond, is inclined to take a longer view.

That's no surprise: He's been investing for more than half a century, and his record is among the best. For the past 15 years his fund has returned an annualized average of 9%, trumping 87% of competitors in the multisector bond category. Fuss has twice been named bond manager of the year by the fund analysts at Morningstar.

Unlike most bond investors lately -- including Pimco's Bill Gross -- Fuss and team haven't fled to Treasuries in search of safety. They're continuing to bet on the higher yields of corporate bonds, with Fuss arguing that the economy isn't as bad as many fear.

Fuss's contrarianism can get him into trouble: Loomis Sayles Bond was creamed in 2008, losing 22%, when the financial crisis had panicky investors worried that firms might not make their bond payments. But he stuck to his position and made back those losses, and then some, when corporates rallied again.

Now, Fuss says, we are about to enter a long period of rising interest rates, which will be challenging for investors in all kinds of bonds. He spoke with staff writer Carolyn Bigda; edited excerpts follow.

Treasuries have been the market's hot investment lately, but you own zero. Why?

We've been focusing on corporate bonds. That's given our fund an average yield to maturity of 5.3%. The yield on a 10-year Treasury is 2.7%. So we have nearly twice the yield. That's meaningful. As a matter of fact, that's very meaningful to somebody who's living off the dividends on the fund.

But are the yields good enough to justify the extra credit risk you face with corporates?

The balance sheets and income statements for U.S. corporations have really just remarkably improved. Now, they're probably not going to get better for a while, but they've already recovered a lot. And corporate cash flows are very, very good. When the fear comes into the market, money goes into U.S. Treasuries. But whenever the fear passes, the money goes elsewhere.

Sounds like you are cautiously optimistic about the economy.

We had a period like this from 1957 to 1963, but without the real estate trauma. It was actually a recession, a recovery, and another recession, followed by a recovery. So these things can take a long time, and I expect this one will too.

But it's not going to be as long as that six-year period in the 1950s and 1960s. The world economy is growing -- we're part of a bigger thing.

What about the concerns others have voiced about deflation triggering a deeper recession?

Oh, I'm worried about it -- I just happen to think the odds are pretty low. Maybe it's a bad analogy, but if I were getting on an airplane to fly and it looked cloudy and stormy, I'd say, "Odds are it will be a rough ride, but, hey, we're going to get there." Because that's how things normally play out.

To get deflation, essentially what you have to do is destroy the money supply. Inflation destroys the value of money; deflation comes when you take down the amount in circulation. That can happen when a population shrinks.

You start to see empty housing units because of a lack of people to live in them. That's possible in Japan, but in North America the population is not shrinking. It's slowing down its growth, but not shrinking. I've done my part: We have six kids. I have a great-grandson now.

Do you see interest rates going back up soon?

A major cause of low rates right now is that the Federal Reserve is buying Treasuries. As long as they do that, rates are going to stay down. We have sort of an administered market right now.

Still, I think we're close to a secular turning point in interest rates. Of course, I also thought that in 2003 and in 1963. I was right in 1963; I looked right for a few years after 2003 too, and then down they went.

But I think a couple years ahead rates will start to rise really impressively. They're going to go up for 20 years with cyclical interruptions. [As rates rise, investors earn more income, but see the value of bonds they already own decline.]


Because the government has to pay the bills, and as the economy gets growing again and companies look to produce more, competition for funds will have to drive up rates. Treasury yields will go up three percentage points, corporate yields up 2.5 percentage points.

Could it be worse? What if the so-called bond vigilantes start to dump Treasuries because the debt is high and Fed policy is loose?

There's no shortage of money looking to buy bonds now -- the buyers are lined up. At some point people will more seriously evaluate the risk of rising inflation, but that's a ways ahead of us. And the evaluators will not be in the U.S. They'll be offshore -- including the Chinese central bank, which owns a lot of U.S. debt. And what choice do they have? None.

Some foreign investors may start to incrementally move away from U.S. bonds if they worry about the dollar and put money in places like Canada, Australia, and New Zealand. But China's hands are tied. Their economy has a symbiotic relationship with the U.S. economy. And who are they going to sell all those Treasuries to?

You seem to be describing a market where there aren't many bargains.

In the fall of 2008, Treasury yields were ridiculously low, like they are now. [When yields are low, that means prices are high.] But corporate yields were really high, so you could run out and buy those. Now you look around the market and you're saying, "Yields are low." End of sentence. There are individual things you can do, but there's not one large area of the market where you find bargains. It doesn't exist.

But right now you prefer to face the credit risk that comes with corporates rather than the higher interest rate risk of Treasuries.

You have to be careful analyzing the company that issues the bond when rates are going up. The stronger firms can continue to get money, continue to expand, continue to invest in new facilities, and they can get the money and make a profit on it. But the more middle-of-the-road companies -- and those below -- sometimes can't.

How about junk bonds? Are they yielding enough?

As a general class, probably not. It's a close call. From a very long-term viewpoint, if we don't hit another patch like '08, then I would say, "Yeah, sort of." Now, if you can choose selectively among those bonds, you can find some better values. Not remarkably so, but they look okay.

You also have to watch your maturities. If a problem hits and you have a 30-year bond, you've had it.

Another chunk of your portfolio is in foreign government bonds. What makes them preferable to Treasuries?

Nearly all the developed economies, including ours, have one thing in common: They all have this system where young folks support us old folks. But in Australia, Canada, New Zealand, and Scandinavia, they have actually funded this obligation in advance, much as a corporate pension fund hopefully would. And in New Zealand they have yields that are quite a bit higher than the U.S.

Foreign bonds also diversify your currency exposure. We guess that we're in currencies that will give us some appreciation relative to the U.S. dollar. Now, when you write this up, please be sure to say that I used the word "guess."

What about bonds issued by emerging-markets countries?

Like high-yield bonds, they look okay here and there. But as those areas have become more familiar to investors either via mutual funds or exchange-traded funds -- prices go up. And they've gone up a lot.

If bonds don't offer many deals, should investors be turning their attention back to the stock market?

If interest rates go up, then all other things being equal, the market will demand lower P/E ratios and higher dividend yields on stocks; that holds down prices. That's normally the way to bet.

But some companies will benefit from rising rates. The companies with dominant market shares and growing markets will still be able to access funds. They'll be able to expand. Meanwhile their competitors can't. And the dominant players turn into very profitable operations, despite the fact that interest rates are going up.

That's the old-style definition of a growth stock. You need to be able to spot them a long time in advance. But if you can do that now, at a time when you don't have to pay much for them, then that's a very good thing to do. And bonds can't compete with that.

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