Sept. 25, 2014: Globe Investor:
Don Coxe to Investors: This Is A Time For Caution
—Not Despair.

If an investor were only to look at the sky-high S&P 500’s performance this year, then complacency would seem in order.

If that investor were only to look at the news stories of wars in Ukraine and the Middle East, and the new aggressiveness of China toward its neighbours on land and sea, fear would seem in order.

If that investor were to look only at the improving news on the U.S. economy, and the Fed’s hints that normal interest rates are coming soon, then buying U.S. stocks and selling bonds would seem in order.

If that investor were to look only at the Canadian economy – and not feel great concern about real estate prices in Vancouver, Calgary, and Toronto – then buying Canadian stocks would seem in order.

Six years after the crash, global economic growth is slowing, led by the euro zone’s dismal performance, and diminished growth in both the United States and China. Yes, Wall Street forecasters and the Federal Reserve keep telling us that the U.S. is about to experience strong growth – but they have been telling us that since 2010. The Fed’s own GDP growth forecasts have proved over-optimistic for four straight years. That’s why short-term rates remain near zero. Nobody predicted that near- free money would still be available from both the Fed and the European Central Bank. The Bank of Canada has stuck to its 1 per cent rate far longer than anyone thought in 2010.

What no one other than a few enthusiastic U.S. oil companies predicted in 2011 was that the U.S. would once again become the world’s No. 1 oil producer, after more than four decades back in the pack behind Russia and Saudi Arabia. Result: oil prices are down sharply year-over-year – but oil producers’ profits are soaring
Finally, almost no one predicted sensationally perfect weather in major grain- growing regions, boosting production of corn, soybeans and wheat to record peaks this year, and crushing grain prices to levels that would have seemed impossible a year ago.

Cheaper foods and cheaper fuels come from large-scale application of production technologies vigorously opposed by global elites: genetically-modified seeds and fracking. Those scientific advances have been boons to consumers and stimuli to economic growth across the world, but have recently become somewhat problematic for investors in oil and agricultural stocks.

This week, global elitists have been demonstrating in Wall Street and other locations internationally against global warming. They demand that the world abandon coal, oil and even natural gas to save the planet. The stars have been rich Rockefellers, announcing they are abandoning all oil and gas investments, and urging pension and endowment funds to dump their investments in companies fouling the planet.

These new Quixotes love windmills, while ignoring their horrendous slaughter of birds and bats. Far-Left Naomi Klein enriches herself with interviews in Vogue and Rolling Stone to promote her book explaining why we must ban all fossil fuels NOW. She doesn’t mention that the world’s temperatures haven’t risen (according to leading agencies and scientists) in 16 years, during which time the world pumped more carbon dioxide into the atmosphere than had been produced since the onset of the Industrial Revolution.

So what’s a Canadian investor to do?

We think caution – not despair – is in order.

Consider that seemingly indestructible S&P: According to an article in the Harvard Business Review, in the past five years, the big companies in the S&P 500 have spent 91 per cent of their earnings buying back their own stocks and paying dividends. Since they’ve also done a great job in lowering their costs, they have been able to grow per-share earnings even with modest top-line growth because of those buybacks.

The new species of capitalist beast looks rumbustiously robust from the results of swallowing its own tail.

However, this tail-swallowing feeding of per-share earnings growth cannot last forever. Recently, the insiders have slashed their purchases of their own shares. Perhaps they realize that their companies have not had the free cash to invest strongly in future growth. The high P/E on the S&P (16 times earnings) is justifiable only if future growth becomes robust.

The post-Cold War global economic boom was based, in significant measure, on annual peace dividends. But geopolitical risks are now the highest in decades – and Wall Street shrugs them off. Almost no prominent Wall Street forecasters have suggested that investors should factor the bad news about confrontations, rebellions and wars into equity valuations. Almost no prominent Wall Street forecasters have suggested that investors take significant overweights in defense stocks – because that would imply that the peace party might be over.

We doubt that elitists who want to ban fossil fuels will give up flying in their jets or driving their BMWs and classic cars. More importantly, global oil demand keeps rising: China ostentatiously avoids joining in the UN’s crusade to ban carbon: Xi Jinping’s goal is a wealthier and stronger China, and that won’t come from a return to bicycles and the Long March.

Nasdaq enthusiasts thought it would climb back this year to the 5,000 level it reached in 2000. By 2008, it had bottomed at 1,400. Since then it has had a great run, but Silicon Valley’s era of global dominance is threatened: the tech sensation this year is Alibaba, and a recent survey claims that nearly 40 per cent of all employees in Silicon Valley toil for companies with no earnings. Cisco, briefly the world’s most valuable company, borrowed $8-billion this year to buy its own stock – and thereafter fired thousands of employees.

For investors, enthusiasm can be productive – or perilous.

If you believe peace will surely return soon, and that the economies of the U.S. and Europe are destined to strengthen dramatically, keep an overweight in big-cap US stocks. If you believe fossil fuel companies will soon be fossils, sell your oil and gas stocks and feel virtuous.

If you, like me, reject both those assumptions, be overweight in your equity portfolio in well-managed oil and gas companies and reasonably-exposed to good companies with good business models that aren’t goosing their stock performance by over-enthusiastic stock-buying.

And if you, like me, worry about all that money the central banks printed to give us this haltingly slow growth, and that global tensions will increase, not disappear, then you will want to have good exposure to gold stocks – and defense stocks.

And if you, like me, think the central banks will not be raising rates soon, invest in longer-term, high quality bonds. They will give you income now, and will give you capital gains when the S&P finally caves in to Stein’s Law: if something cannot go on forever, it will stop.

This article, published by The Globe & Mail is also made available for our subscribers.

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