Jubak's Journal
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A portfolio built for gloom, but not doom
Follow these five principles and ride out the bad news I expect in the next few years. But my Pessimist's Portfolio isn't designed for disaster -- because I don't think that will happen.
By Jim Jubak
I'm pessimistic about the state of our economy and the long-term direction of the U.S. stock market. But like many of my fellow citizens, I don't have the luxury of wallowing in woe-is-me. I've got a mortgage to pay, college tuitions to put aside and a retirement to prepare for.
In other words, I need my money to make money even if I believe we're facing tough times. My solution is something I call The Pessimist's Portfolio
My pessimism pits me against both the raging bulls and the raving doomsayers.
On the one hand, along with Warren Buffett (see my last column "Whom to believe -- Buffett or Greenspan?") I think we're headed for trouble. I believe that the huge U.S. trade deficit matters. The money we owe to overseas investors is a growing tax on our economy that, over time, will lower our growth rate, raise interest rates, fuel inflation and take a bite out of our living standards.
None of that, especially the lower growth and higher interest rates, will be good for the stock and bond markets. We could be looking at a replay of the stagnant 1970s. From 1970 to 1979, the Standard & Poor's 500 ($INX) returned an annual compounded rate of 5.9% and long-term government bonds returned an annual 5.2%, according to Ibbotson Associates. Inflation ran at an average rate of 7.4%. In real terms, for a decade, investors in both stocks and bonds lost money.
Back to the '70s?
On the other hand, the world didn't come to an end in the 1970s and I don't see it ending in the next decade, either. The 1970s were tough years if you were looking for a job or trying to buy a house or simply trying to balance a household budget. But my parents managed to put two kids through college during that decade -- although I don't remember that they took a single vacation in those years. I bought my first car during that decade -- granted it was a 10-year-old VW Bug with a rebuilt engine. My first full-time job paid less than $10,000 a year and came to an abrupt end after just three years -- but after a very painful four-month job search, I did find another.
And while most investors didn't, you could have made money during that tough decade if you owned the right assets. During the decade, small-company stocks had an annual compounded rate of 11.5%, almost twice the return of the S&P 500 and 4 percentage points a year above the rate of inflation.
So yes, over the next decade the economy will, in my opinion, dish out a lot of pain and unhappiness as the consequences of our fiscal folly comes home to roost. And, yes, the stock and bond markets as a whole aren't likely to deliver much in the way of returns over the period thanks to rising interest rates. But none of that will bring the world crashing down around our heads, and with the right portfolio an investor should be able to make money even if the markets in general go nowhere.
Guiding principles
Here are five general principles for building a money-making Pessimist's Portfolio along with 10 stocks that I'd buy now -- to sell and replace as circumstances change -- to get your Pessimist's Portfolio started.
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At the end, I'll discuss some non-stock assets to investigate, as well as some financial planning strategies for the decade ahead.
Energy, energy, energy. If I could pick one sector to overweight now and for the rest of the decade, it would be energy. The huge populations in a developing India and China don't have to increase their energy use by much to keep global demand tight and prices moving upward. And since oil, which is priced in dollars, will keep climbing in price as the dollar falls, the commodity is a natural hedge against a weak dollar.
My picks right now would be BP (BP, news, msgs), because with its development projects in Russia and the Gulf of Mexico, it looks set to increase its recoverable reserves faster than it pumps them; Canadian Natural Resource (CNQ, news, msgs), because with oil above $40 a barrel the company's huge oil sands deposits become very profitable to develop despite higher costs; and Talisman Energy (TLM, news, msgs) because this relatively small energy company has promising projects in the neighborhood of the big energy growth markets of China and India.
Grown right here in the U.S.A. A weaker dollar and rising living standards in the rapidly developing economies of Asia and China are likely to bring boom times for U.S. producers of agricultural commodities, a field in which U.S. economies of scale more than compensate for lower labor costs in countries such as China. For example, U.S. apple growers face huge competition from Chinese producers because of the relatively small scale and labor-intensive nature of apple harvesting. But U.S. corn producers, thanks to their huge scale and heavy mechanization, don't.
My suggestions here are Corn Products International (CPO, news, msgs), because a weak dollar will help the company increase the world's appetite for corn sweeteners, and Smithfield Foods (SFD, news, msgs), because while this company's factory farms are a huge environmental problem in states such as North Carolina, Smithfield Foods' integrated operation can take a pig (and increasingly a cow) from animal to prepared chops more efficiently than just about anyone else in the world. (And that's before the company's new low-cost operations in Poland produce their first squeal.)
Timber. Another grown-in-the-U.S. commodity faces a huge surge in demand thanks to the developing economies of China and India. As incomes increase, people consume more paper. Now, the United States isn't the only country that grows trees. But a falling dollar will give U.S. timber the edge on price, and over the next decade the unsustainable mining of tropical rainforests will gradually reduce timber supplies from that source (as the forests get turned either into wood pulp or into forest preserves).
Stocks I like in this sector include Rayonier (RYN, news, msgs) and Plum Creek Timber (PCL, news, msgs). Why these two over bigger timber players such as Weyerhaeuser (WY, news, msgs)? Because of their real-estate kicker, which provides extra profits as these timber companies sell some of their land for residential development -- which leads me to the fourth principle on my list.
Retirement downsizing plays. If the U.S. economy slows and prices start to edge higher, an aging U.S. population that's staying healthier longer will look to cash in on its major asset, real estate, to fund retirement. How do you get your hands on that cash and still wind up with a place to live? By selling your house in expensive (and, with the exception of California, colder) real estate markets and moving to places where land and houses are cheaper.
I think that means an acceleration of the retirement real-estate booms in places like the Ozarks, North Carolina and the rest of the non-Florida Southeast, and Nevada. Ways to profit from this trend include banks in growth areas (such as Georgia Carolina Bancshares (GECR, news, msgs)) and service businesses in the sweet geographic and demographic niches (such as Station Casinos (STN, news, msgs)).
Modest earnings growth at the right price. My pessimistic scenario isn't without all earnings growth. Growth is just hard to come by and, thanks to higher interest rates, it trades at a lower price-to-earnings ratio in the stock market. So it becomes even more critical to buy growth low so you can sell modestly higher.
The Pessimist's Portfolio puts extra emphasis on finding potential growth stocks that are currently in investors' doghouses. Like Sara Lee (SLE, news, msgs), a stock that trades at just 12 times trailing 12-month earnings (despite paying a yield of 3.7%) but that brought in a new CEO who has pledged to return the company to its roots in the food industry. I'll be adding Sara Lee to Jubak's Picks with this column.
Looking beyond stocks
I've paid so much attention to the stock portion of the Pessimist's Portfolio here because Jubak's Journal is, after all, a column about stocks. But that doesn't mean I think you should ignore other asset classes in building this portfolio. For example, if the dollar is in for further declines, investors should add non-dollar denominated bonds. Currencies to consider include the Canadian, Australian and New Zealand dollars, and the South African rand. The bonds and CDs for three out of four (the exception is Canada) pay higher yields than do comparable U.S. instruments and, as the currencies of commodity economies, all four are likely to outperform the dollar. (For CDs in these currencies, see EverBank.com.)
Commodities in general are a good hedge against a falling dollar -- as long as global growth doesn't take too big a hit (admittedly a big "if"). Individual investors should steer away from trading for themselves in the commodity markets unless they're willing to climb a very steep learning curve. But there are mutual funds and exchange-traded funds (ETFs) that will give you the exposure you want. Or you can buy shares of a company like Rio Tinto (RTP, news, msgs) or BHP Billiton (BHP, news, msgs) with exposure to a broad spread of commodities. Gold, I think, will do best if my pessimistic scenario proves to be too optimistic, but a little gold exposure as insurance is prudent here.
Expecting bad news -- but not disaster
From experience I know that the most heated e-mails I'll get in response to this column will be from readers who think I haven't gone far enough. "The dollar is headed for collapse and the economy to recession," they'll write, "and you're picking stocks? That's like rebalancing a portfolio on the deck of the Titanic, isn't it?"
Well, no. Because I think the odds, while tilted toward my pessimistic view of the future, run heavily against financial and economic disaster.
In my next column, I'll explain why the dollar isn't headed for collapse and why the voices of doom are wrong. (Short of the kind of accident I described in my column, "The crash, five years later.")
We've got friends, you see, in unexpected places.
Changes to Jubak's Picks
Buy Sara Lee
This trade didn't exactly set my portfolio on fire when I last tried it in November 2003. (I sold with a 0.4% gain, thanks only to the stock's dividend.) But this time it's different. I've got the catalyst that I lacked in 2003 to get this stock moving. New CEO Brenda Barnes, formerly president and CEO of PepsiCola North America, has announced that the company will spin off its apparel business, which includes brands such as Hanes and Playtex, to shareholders in 2006. In addition, the company will sell off its European meats business, its European apparel business and its U.S. retail coffee business. That will leave a core focused on the company's traditional strength in frozen and fresh baked goods. The plan should increase Sara Lee's (SLE, news, msgs) margins, since the coffee and apparel business are those facing the worst profit squeezes from rising commodity prices. The focus on the company's food brands should also lead to more predictable earnings, and that would boost the stock's very low price-to-earnings multiple of 12. I'm adding these shares to Jubak's Picks with a March 2006 target price of $26 a share.
New developments on past columns
The best odds in Las Vegas
Ho hum. Another hike in guidance from Station Casinos (STN, news, msgs). On March 15, the company raised its earnings guidance for the first quarter of 2005 to 66 cents to 68 cents a share from the previous range of 56 cents to 62 cents. By my calculations, that pushes the company's earnings per share for the full 2005 year to near $2.40. The company's bet on the local Las Vegas economy shows no signs of fading, with same-casino sales projected to climb 9% to 13% for the quarter. With Phase I of the company's new Red Rock project now scheduled to open in the first quarter of 2006 and with Phase II scheduled for completion by the end of 2006, the opportunity for continued growth looks strong. Thanks to zoning restrictions that limit the number of new casinos that can be built, I don't see any real challenge to Station Casino's dominant 55% share of the market for local gamblers. The company is now scheduled to report earnings on April 25. As of March 18, I'm raising my target price on Station Casinos to $74 by June 2005 from the previous target of $69 by July 2005. (Full disclosure: I own shares of Station Casinos.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Canadian Natural Resources, Corn Products International, Georgia Carolina Bancshares, Rayonier, Smithfield Foods, Station Casinos and Talisman Energy. He does not own short positions in any stock mentioned in this column.
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