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Investment Ideas and Plans for 2018

Investment Ideas and Plans for 2018
By Dave Dyer

1. Last year I predicted that at least one of the major averages would be up 20% in 2017. Man, was I right. In 2017 the S&P 500 was up 19.4%, the NASDAQ was up 28.2%, and the Dow was up 25.1%. In the interest of protecting my perfect record, I modestly predict that at least one of the major averages will be up at least 15% in 2018.

2. Passive investing is a paradigm of “dumb money.” Stocks are bought and sold based on a single characteristic…membership in an index. Nobody, other than the people who select the members of the index, take the time to understand the fundamentals. The index moves the price of the member rather than the other way around. I like to focus on stocks that are not in any major index because it is still possible to find insights from fundamental research that will be rewarded in the market.

3. There will soon be almost as many ETFs as there are stocks. I don’t expect this to work out well. I prefer closed end funds over ETFs because the CEF does not have to go out in the market to buy or sell more stock to meet new demand. The contents of the fund are already in place and this might be of value if the markets become volatile. Also, CEFs often trade at a discount to the net asset value of the stocks in the fund. This mysterious situation allows you to buy a basket of stocks at less than you would pay for them individually. For example, BDJ, which represents a basket of 100 large dividend paying stocks, is currently trading at an 8% discount to the NAV of its shares and also pays a whopping 6.1% yield which is enhanced with some leverage. I can’t explain it but I made 13% on it last year, plus the big yield, without being able to explain it.

4. Various establishment media players will be trying to convince people that the tax cuts will do nothing to help the economy. This is just wishful thinking on the part of people who want America to be more like Cuba. Don’t worry; letting businesses keep more of the money they make can only be good for business.

5. The best innovations don’t just do a better job of doing something that is already being done; they do something that could not be done before. For example, the cell phone let people do things they could not do before; creamier peanut butter is just a better form of peanut butter. Look for things that are fundamentally different, that do new things, not just do old things better. That is why I am not so hot on driverless personal cars…people can already drive. However, driverless trucks allow trucks to run 24 hours a day and get more utilization from the fixed cost of the rig.

6. Apartments should still be good investments because there are various drivers of new demand:
a. Higher interest rates will make it harder to qualify for a home loan
b. An improving employment scene enhances the value of being a mobile apartment dweller rather than someone tied down to a house
c. Retiring baby boomers are healthier than ever and not ready to shuffle off to Applesauce Acres. They want to travel and have more care free lives; they don’t want to pay taxes and mow the lawn. High-end apartments are ideal for them.
d. The new tax bill takes away some of the tax benefits from owning the more expensive homes. This can only benefit high-end rentals.

7. Apartment REITs like MAA and IRT should benefit from this trend.

8. Real estate has good momentum going into 2018. Sales volume is up while supply is down. Home starts are increasing to meet demand, but there are long lead times. Values are increasing and since homes are the most commonly owned investment, this will translate into over-all investor optimism.

9. The proposed tax plan probably had an unusual effect on the 2017 market. Everyone knew it was coming but nobody knew what would be in it or, more importantly, whether it would be retroactive. That made it hard for big money managers to decide to sell. Should they sell now in the higher tax environment and hope the plan is retroactive? Probably not. No point in taking the risk of having an unhappy client who was the last guy to pay high taxes. This curtailed selling pressure in the market and is part of the explanation of why the market went up on decreasing volume. The bad side of this is that there is probably a lot of pent up selling pressure that could show up after the tax bill is passed.

10. No, I’m not investing in Bitcoin. It has become such a hot investment that it has lost its intended purpose as a currency. Does anyone really use it in transactions? I heard one guy on TV say that he keeps his access code on a flash drive in a safe, and he has 3 copies in different places. How convenient would it be to use it in a transaction? However, the good thing about Bitcoin is that it shows that animal spirits are alive and well in our species. This is a good sign. Investors can still get excited over something new.

11. Current valuation is a lot less important than many people think. You don’t necessarily make money when you buy an undervalued stock. Future valuation is the key focus. It can be fully valued now and still worth more in the future. Stocks are not static entities…they change over time.

12. Corporations (US) are sitting on $2.3 T of cash reserves. And they will soon have more with lower taxes and repatriation of the perhaps $2 to 3 T trapped overseas by our foolish tax policies. Where is that money going to go? Almost any answer is good for the market.
a. Stock buybacks raise prices by adding new demand.
b. Increased dividends make stocks more attractive.
c. Investment in R&D improves the competitive status of the company.
d. Acquisitions normally provide a large, quick boost to the price of the company being acquired.
e. Higher salaries, even for executives, add purchasing power to consumers and can raise values for companies that provide consumer products.
f. Paying down debt makes companies more stable and less risky.
g. About the only thing companies could do with the money that would not help the market would be to donate to politicians.

13. Interest rates are still low and will probably stay low because all the money in the system reduces the demand for loans. Corporations with lots of cash have less need to borrow.

14. The low bond yields make bonds unattractive when compared to stocks. The prospect of slightly rising rates (the Fed may increase short term rates 3 times in 2018) makes investors worry about losing principle if they buy bonds now, and that also is good for stocks.

15. Investors seeking income can buy dividend stocks, preferred stocks, REITs, or BDCs and do better than they would with bonds.

16. Investor attitude and confidence is returning. For 8 years under the Obama administration, the business sector felt like they were the enemy. They withdrew, laid low if possible. After one year with Trump, that fear of government has decreased. The new tax bill is living proof that the government wants the private sector to grow. As confidence returns, money circulates and companies feel safe in expanding.

17. Keep in mind that we are not yet in the last stage of my bubble bath theory of bull markets.

18. I had three very profitable insights last year and I intend to stay with them in 2018.
a. Hotels will see any economic changes first because they re-price their products every day. If you think the economy will grow, they should be the early movers. MAR has been super and should continue to be. Various hotel REITs like SOHO, CLDT and CHSP are good bets.
b. I don’t know who will win the electric car market, but they will all use lithium in their batteries. SQM, a major lithium producer from Chile, was a big winner and should continue. ALB, as an American company has been popular with the fund managers, but SQM is more of a pure play and has outperformed with a relative strength rating of 93 compared to 81 for ALB.
c. If you are looking forward to having a colonoscopy, you should probably stop reading this and turn yourself in at the nearest emergency psychiatric facility. EXAS has eliminated the need for a colonoscopy for the vast portion of the population that is at average risk. Their non-invasive test is just as accurate and cheaper. Soon, insurance companies will require it in place of a colonoscopy. It is already FDA-approved and covered by Medicare. With no real competition and a huge market, EXAS is almost ideal as a growth stock. OK, so it was up 400% in 2017…have you ever met anyone who wants to have a colonoscopy?

19. Where is the market risk for 2018?
a. There is little risk of recession with lower taxes, abundant energy, and improved prospects for world-wide economic growth.
b. Higher interest rates are not likely to kill the bull market. The Fed has done a masterful job and shows no signs of changing. We have been raising rates gradually without any serious damage.
c. We are not yet at excessive exuberance. Investors who are out of the market are still fearful and that is good for the market.
d. Lots of money is still on the sidelines waiting to be converted into investments. And perhaps several $T that have been trapped overseas will be returning to US shores with the new tax bill.
e. The biggest risks are probably political. The anti-Trump Democrats are eager to ruin the boom so that Trump can’t get credit for it and they may find some way to do it even though they have not been able to do that so far. And that fat nuclear-armed dictator in North Korea reminds me of Hitler on crack cocaine but with less charm, if possible. It would take about 10 minutes to push the button to take him out, and somebody may have to do it. It would be good for the world but not good for the markets.

20. Some people are predicting a big crash based only on the fact that the market has gone up quite a bit for quite a while. I find these predictions unconvincing. The market is just not so simple and one-dimensional that you can make these predictions with any confidence. Look at the last two crashes, 2000 and 2008. They both had one set of characteristics in common: there was a “magic” sector that guaranteed an easy profit and that sector was highly leveraged. In 2000, the “magic” sector was technology and in 2008, it was real estate. I don’t see such a narrow focus in our current market. This has been a broad-based rally that has involved many sectors and has rotated leadership between sectors. This looks to me like a healthy market with more money chasing good investments across a wide horizon. It just feels sustainable, unlike the belief in “magic.”

Another good year is ahead.