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Summary The quarter’s first full earnings week treated the Generation Portfolio kindly with the exception of Wal-Mart, whose unexpectedly dismal report blew a hole in the entire retail space. I took the sympathy weakness in big box retailers to add some Target Corporation shares, given that it is a recovery play whose situation is unrelated to Wal-Mart’s issues. Looking ahead, the Fed appears to be on hold for the time being, which is affecting the REIT and banking sectors. Background This is a weekly column that I write about an account that I manage for others, which I call the Generation Portfolio . I also discuss the current trading environment, my general investing philosophy, and any other ideas that seem relevant. Last week , for instance, I threw out some ideas about the herd-like mentality that has taken over the market due to the growth in index funds . To summarize that discussion, I have nothing against index funds in theory, and in fact own a few myself . In practice, though, the mass popularity of index funds tends to create distortions in the market. They are not quite the panacea that many would dearly love to believe they are, though they serve many investors well. The Generation Portfolio is built of stocks, not funds, because I find stocks to be easier to analyze and better suited to my cash flow objectives. So far, that strategy has worked as intended. The Importance of Cash Flow Regarding my income objectives, I have written about my own views of the importance of cash flow before . My theory is that a portfolio should be run like a business, with the cash that it generates reinvested into the enterprise whenever possible after you take out whatever expenses you need to cover. Thus, it is essential for a portfolio to generate enough cash flow to fund continuing operations – which, in the context of a portfolio, means the addition of new sources of cash flow which will keep the business thriving. It is a variation on the “buy low, sell high” mantra. The objective, in fact, is not to buy low and sell high, though of course that’s always preferable. I think that confuses some people, as not having as your objective the sale of what you buy at a higher price seems vaguely un-American or something. So, let me explain what I mean by that. The “buy low, sell high” objective is for speculators, or to use another word that annoys some people, “gamblers.” Nothing wrong with gambling, and life itself is a gamble. Some people are very good gamblers, and everyone has their own talents. However, for most people, you need to arrange matters to give you better table odds than they typically give you in Vegas (or the market) if you want to succeed at investing. My own view is that if you speculate enough and don’t have a good dollop of luck or some edge, you will speculate all your money away eventually. I’ve heard enough stories from people who have blown out accounts to reinforce that view. The speculator table is tilted against you because powerful, well-funded market interests collectively have more of whatever it is that you, the individual investor, can ever bring to the table – knowledge, brains, experience, capitalization, research tools, anything that makes a difference. They can outlast you, they have research and algorithms you’ve never heard of, and they can react faster than you. You may beat them sometimes because everything in the market is about probabilities, and even the biggest investment firms can’t control those. Those victories, though, just encourage you to continue onward until you aren’t quite so lucky. The odds are always in the house’s favor, though by a slim margin. Those with the odds in their favor are the ones with the fancy office buildings and slick marketing tactics. Some folks just learn that too late, or deny it forever. So, instead, if you want to win, the objective (as I see it) for the core of a prudent portfolio (there is always room for some fun speculation) is not to buy low and sell high, because that game is for likely losers. As the classic poker saying (repeated by Warren Buffett) goes, “If you don’t know who the patsy at the table is, it’s you.” Instead, my objective is to buy growing, dependable, and in other words quality cash flow cheap and then keep it so long as it remains quality. If you do that, the “selling high” part will take care of itself. And, best of all, you may not need to sell at all. However, you will have to ride out the shifting currents and forget about current prices except in a grand strategic fashion. That’s tough to do. There are many ways to build cash flow, and some investors just don’t like dividends. Those folks usually have studies from this, that or the other place to back up the theory that it is better to sell part of your portfolio to generate cash flow rather than rely on dividends for it. It’s a valid strategy, though I could spin out all sorts of issues with it. Whatever works for you is terrific. My preference is to generate cash flow by collecting dividends from Quality Stocks . Dividends are automatic and don’t require any transactions or thought, and the less thought I have to devote to a mundane task, the better. If you have sufficient funds to diversify across and even within sectors, that also is a good strategy to put into practice to minimize risk. Thus, the Generation Portfolio pursues an income strategy across companies and sectors that is designed to generate reliable and growing cash flow and minimize damage from random stock disasters. “It is a market of stocks, not a stock market.” If you’ve been following the market long enough, you have seen someone go on one of the financial channels and grandly announce, “it is a market of stocks, not a stock market.” Broadly speaking, my interpretation is that people who say that mean to emphasize that stock picking is still important. I tend to agree, because someone has to choose among and between stocks. Plus, there are so many index funds these days that advising someone to buy an index fund is pretty meaningless. If everyone simply bought the same index fund, there wouldn’t be much of a stock market left, and different index funds can have vastly different performance. If everyone buys different index funds, that creates the same type of performance differentials between them that individual stocks themselves offer. Ultimately, the whole rationale behind index funds collapses and you get a market of stocks, um, funds again. As the monastery leader in James Hilton’s “Shangri La” said, “moderation in all things.” This week was a good example of the need for such moderation. The herd was moving one way – the broader market was up – but parts of the herd went the other way (down). The biggest part heading lower was being led by a mad cow, and if you had all your calves in that particular group, your family wound up in the prickly bushes. Ultimately, the misled followers will rejoin the main herd, but it’s a painful experience until they do. I think you’ll figure out what I mean by all that by reading on. The Week That Was The market dipped slightly in the middle of the week. Ultimately, though, it surged higher despite some earnings weakness. The move higher was likely due to growing consensus that the Fed will not raise interest rates in the current weak economic environment. The market now has been up for three straight weeks, but the losses of August and September have not been fully recovered. The Nasdaq is up 3.2% this year, but the Dow is down 3.4%, and the S&P 500 is down 1.3%. Transactions I prefer to buy on weakness and the overall market didn’t provide much of that this past week. I did pick up some Target Corporation (NYSE: TGT ) due to its price decline following a terrible Wal-Mart Stores, Inc. (NYSE: WMT ) earnings report. Target is recovering from its Canadian discontinued business charges, but its core operations appear sound. Generation Portfolio to Date Below are the transactions to date in the Generation Portfolio. The Generation Portfolio as of 17 October 2015 Stock Purchase Date Purchase Price Latest Price Change Since Purchase WFC 8/25/2015 $ 51.75 $ 52.88 2.18% DIS 8/25/2015 $ 98.75 $108.16 3.26% BMY 8/25/2015 $ 59.75 $ 64.49 7.93% MFA 8/25/2015 $ 7.05 $ 7.03 0.28% OHI 8/31/2015 $ 33.95 $ 36.28 6.86% CVX 9/02/2015 $ 77.90 $ 91.20 17.19% PG 9/03/2015 $ 69.95 $ 74.90 7.08% CYS 9/04/2015 $ 7.68 $ 7.93 3.26% KO 9/09/2015 $ 38.50 $ 42.02 9.14% MPW 9/10/2015 $ 10.89 $ 11.73 7.71% WMT 9/10/2015 $ 64.40 $ 58.78 (8.56%) VTR 9/10/2015 $ 52.80 57.09 7.90% KMI 9/11/2015 $ 29.95 $ 32.43 7.55% WPC 9/14/2015 $ 56.75 $ 61.46 8.30% T 9/17/2015 $ 32.50 33.78 4.09% VZ 9/17/2015 $ 44.95 44.80 (0.56%) MMM 9/18/2015 $139.90 $148.66 6.29% JPM 9/22/2015 $ 60.89 $ 62.43 2.87% PX 9/23/2015 $101.30 $109.43 8.03% VER 9/25/2015 $ 7.87 $ 8.34 5.97% WMB 9/28/2015 $ 39.48 $ 42.28 7.09% MAIN 9/28/2015 $ 27.47 $ 29.32 6.73% PFE 9/28/2015 $ 32.69 $ 34.41 5.26% TGT 10/16/2015 $ 75.15 $ 75.05 (0.13%) Latest prices and percentages are those supplied by the broker, TD Ameritrade, as of the close on 16 October 2015. A large legacy position in Ford Motor Company (NYSE: F ) and some other small legacy positions are omitted. There currently are 21 positive positions and three negative positions in the Generation Portfolio (I go strictly by the broker’s calculations of gain and loss, as they know best). According to a spreadsheet that I maintain, the Generation Portfolio overall currently is up between 5-6%, just as it was last week. That does not include dividends received to date, and some of the positions may have gone ex-dividend but not yet paid the distributions. Dividends One of the aims of the Generation Portfolio is to generate dividends, hence the name. Some will hit the account this week, but there was no change from last week. Dividends Received To Date Stock Date Received Type VTR 9/30/2015 Ordinary KO 10/01/2015 Qualified CYS 10/14/2015 Ordinary VER 10/15/2015 Ordinary MPW 10/15/2015 Ordinary WPC 10/15/2015 Qualified For now, at least, I am receiving the dividends in cash and will use them opportunistically as they accumulate. Analysis of Holdings While there were many earnings reports delivered during the week, the only one that really rocked the establishment was Wal-Mart’s on Wednesday. In some ways, that one should have been the most foreseeable, but it took everyone by surprise. Wal-Mart is the country’s largest private employer , and giving even a fraction of its workforce a raise will always have consequences for its bottom line. Those consequences did show up in its lowered guidance for the next few fiscal years. Wal-Mart gave no updates to its guidance before earnings to suggest this, which puzzled some analysts. Wal-Mart is the best possible example of why I keep individual positions relatively small and diversify. Since Wal-Mart dragged the entire big box retail sector lower, I decided to take advantage of the lower prices and add some Target. It may not have been at an ideal price, but Target’s issues are completely different than Wal-Mart’s. I had to ignore headlines such as “Wal-Mart’s Disappointing Sales And Earnings Forecasts Spell Doom For The Industry,” but someone has to provide goods to communities across the country. I wrote up an article on my reasons for adding Target here . Aside from Wal-Mart, my personal biggest surprise of the week was how well oil/gas energy stocks held up after their bonanza performance a week ago. Just goes to show how oversold the entire sector was. The REITs also are moving higher, which is gratifying. I’ve spent the past year studying them, and they appear to have stabilized for now. The banks had some difficult moments during the week after Generation Portfolio stock JPMorgan Chase delivered a sketchy earnings report . As I have written elsewhere, my view is that REITs and banks will tend to move in opposite directions . Bank weakness was in part due to the growing belief that the Fed will remain on hold at least until next year; banks want higher interest rates to increase their spreads. However, another factor behind their stability was simply that banks were already oversold and haven’t really recovered like some other sectors since the August sell-off. General Discussion This is the section where I basically just ramble on about what I am seeing in the investing world that might affect my investments. I don’t expect everyone (or anyone) to agree with my perspective, but it is how I see things right now. There is growing saber rattling in the world. Events in Syria are in flux, Putin is on the loose, North Korea is making its usual noises. Defense stocks have been showing some life recently. That also, in my opinion, is why oil stocks have recovered a little ground despite the continuing supply/demand situation; good sectors to be in if things get worse. The key to the next Fed move in my view lies in the next two jobs reports. If those reports are strong, the Fed may gather up its courage and raise rates. In my humble opinion, that would be the wrong move, but they typically don’t ask me. However, I don’t expect strong reports and don’t expect the Fed to raise rates. Taking a more strategic perspective, in my opinion, the next Fed move is completely up in the air now. Everyone assumes that the Fed will raise rates. However, the market has forced treasury yields lower recently, not higher. That is not a good environment for the Fed to raise rates, because they would be fighting the market. That can lead to an inverted yield curve, as in 2004-2006, which can be a precursor to a recession – as in 2004-2006. (click to enlarge) As the chart shows, the 10-year Treasury bond yield has fallen recently. It currently sits at 2.04%. Not only is it down from the heights of the summer, but it is even down slightly from its 2.06% rate at the end of the third quarter just a few weeks ago. I can’t tell you how many times over the past year someone has said to me with great authority that rates are headed higher, and soon. The simple fact is that, at least so far, they’re not trending higher unless you cherry-pick dates. Whenever I see someone state with great confidence that the Fed’s next move must be to raise rates, because everyone says that and we are all supposedly waiting in great trepidation of the great event, I like to pose a simple question: what if the economy weakens further? What does the Fed do then? Raising rates in the teeth of a weakening economy or, knock on wood, a recession would be foolhardy. It’s simply unrealistic at the moment. If the economy does weaken for whatever reason, the Fed doesn’t have a lot of tools left to fulfill its dual mandate of stable prices and full employment. It does have one that it could always resort to again that nobody seems to expect: another round of quantitative easing. Since nobody is talking about it, it can’t happen – right? We shall see. Returning to energy stocks again, I find it amusing that now some folks are starting to question the viability of the entire solar sector. This is one of those hot-button cult areas that invites negative comments whenever I go near it, but I like to provide alternate viewpoints and welcome them in comments. Solar has its place, but it is not quite the end-times panacea its proponents wish. Back in 2014, when I wrote my positive article about Hawaiian Electric – shortly before it rose about 50%, that is – people were predicting the doom of the entire utility sector and lambasting me for questioning the inevitable hegemony of solar and the temerity to recommend a dinosaur utility in a Mesozoic-era industry. Now, strangely enough due to events in Hawaii , that wheel has turned. Go figure. Actionable Ideas l have been watching defense stocks such as LMT and RTN closely, and would add one on a buying opportunity. I also have a couple of more high quality REITs on the radar screen, there still are some good values in the sector. The healthcare sector also still has some opportunities, though the Generation Portfolio has a couple in there already. Still, I’m not averse to over-weighting a defensive sector that is undervalued. I am watching a few other stocks like Honeywell International Inc. (NYSE: HON ), which sold off despite a fairly decent earnings report, and a few other big names. So far, earnings reports for the third quarter have been a touch weak, which fortunately were somewhat expected . The market can handle anything, it just doesn’t like unnecessary surprises (Wal-Mart). We’ll see how the coming week’s earnings go, led by IBM (NYSE: IBM ), Google’s parent Alphabet (NASDAQ: GOOG ), Microsoft (NASDAQ: MSFT ), Boeing (NYSE: BA ), GM (NYSE: GM ) and Caterpillar (NYSE: CAT ). Of particular interest to the Generation Portfolio will be: Verizon Communications on Tuesday before the open; Coca-Cola Company on Wednesday before the open; CYS Investments, Inc. after the close on Wednesday; 3M Company on Thursday before the open; and Procter & Gamble Co. and Ventas, Inc. before the open on Friday. Conclusion It was an upbeat week for the market despite some weak earnings reports from industry bellwethers. A dismal earnings report from Wal-Mart sent it sharply lower and induced sympathy selling in other big box retails. I took the weakness as an opportunity to add some Target stock $10 below its very recent price. Looking ahead, the Fed appears to be on hold for now, which should give some strength to interest-sensitive sectors such as REITs. Overall, the Generation Portfolio had another good week despite the Wal-Mart disaster, and dividends are starting to accumulate. Scalper1 News
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