July 2007

Portfolio Comments

Market View

Dorato Services

The Library: articles by Steve TeSelle

Portfolio Comments

Have you ever gone through your portfolio and looked for stocks that haven’t gained much? It’s tempting to do; and it’s particularly tempting to think you should get rid of those stocks. But looking only at price performance is not a terribly helpful approach to managing a portfolio.

I think we get a bit anxious about performance at times. We also get colorful sayings from the world of stock brokers that make us think we should do something rather than just sit there. Brokers are quick to tell us some stock we own is “dead money” (as opposed to vivacious money, I guess). But brokers have a saying for everything, so if you tried to live by their sayings you’d be going several directions at once.

Rather than worrying about whether your money has a pulse, the question should be: ‘going forward, is this company a good investment?’ Even if a stock hasn’t appreciated in a decade, it might make a very good investment from that point on. Take General Electric for example. If you bought it in 1998, you probably don’t feel particularly perspicacious. Using only price performance for the last decade, money invested in GE has been as dead as an office party. Yet GE’s earnings have continued to grow. And, from this point forward, it looks like a solid investment.

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 Market View

Longer-term US interest rates are finally starting to inch up. The yield curve is still pretty flat – you get an extra 0.25% per year for buying a 30-year Treasury versus a two-year Treasury – but at least the yield curve has a positive slope to it. What’s made investors jumpy is that the curve is steepening without any moves by the Federal Reserve. People seemed to be betting that the curve would get steeper by the Federal Reserve cutting short-term rates, rather than that bond investors would drive longer-term rates higher.

It’s not that I’m necessarily a fan of higher long-term rates; they can pinch. They’ll hurt housing through higher mortgage rates. They may squeeze companies with high debt levels, especially companies with floating rate debt. And they will put a dent in private equity plans for taking companies private, since that requires issuing a lot of debt. Those are probably some of the reasons the stock market shuddered when the 10-year Treasury rate rose above 5%.

Still, if higher long-term rates pinch too much, the Federal Reserve would probably lower those short-term rates. And then, voila, we end up with an upward sloping yield curve, which is generally a good sign for future economic growth.

The noise surrounding sub-prime loans has diminished, but I wouldn’t be too surprised to see other nasties come out of the debt markets. Banks seem to have a breezy confidence that they’ve passed on the risks of their loans by securitizing them and selling them off. And whoever is buying these risks seems to think they’ve hedged it away with other financial instruments. So that leaves very few people who are focused on loan quality right now. Invariably, when everybody thinks they’ve insured themselves against risk, that’s when bad things happen. All Dorato portfolios have some exposure to the financial sector, but it’s a lower percentage than for the S&P500 index (our benchmark).

The dollar has held relatively steady for the last couple of months. I still expect it to decline a bit further. A crisis would be good for the dollar because the dollar is where people go in times of trouble. But absent a crisis, slow economic growth and a gaping trade deficit should send the dollar lower.

Foreign stocks are doing well, generally in the same range as US stocks. Everyone’s talking about the Chinese stock market, which is up a couple hundred percent in the last year or two. But that market has a casino feel to it right now, with opaque financial disclosure from companies and frenzied investing from small investors.

US stock indexes (except NASDAQ) are near all-time highs. This makes me pause for thought, but doesn’t necessarily get me worried. There’s no law of gravity that says stocks have to fall when indexes reach a new high. I’m more focused on the prices of stocks relative to  earnings and cash flows. By those measures, stock prices look a bit expensive, but not outrageous.

And let’s not forget about risk. You may think I remind you about risk simply to cover my tail, as we live in an assiduously litigious society. But that’s not it. The reason I always include risk is that you can’t talk about return without talking about the risks you’re taking to get that return. Some risks you can imagine; some are obvious only in hindsight. With stocks, you have to have your stomach prepared for ten, twenty, or even thirty-percent drops. It’s happened before. The less you’re surprised by such moves, the more likely you are to stick with your investment strategy.

Sources: Economist, Wall Street Journal, Value Line

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To provide separate account management that meets the needs of each investor, and to educate and inform both clients and the general public about investment and financial issues.

Dorato Services:

• Separately managed stock portfolios
• Allocations for retirement accounts
• Small business retirement accounts
• Retirement planning
• Advice on stock options
• Assistance with tax questions
  

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The Library: articles by Steve TeSelle:

• College Savings Options
• Retirement: What's the Target?
• Fun Facts About Taxes
• Understanding Your Finances
• Risk, Anyone?
• A Primer on Asset Allocation
• Debt, Friend or Foe?
• Life Insurance Basics
• Calculating a Return
• Estate Planning
• Index Investing
• Financial Checklist

To read them online, simply click on the title. To obtain a printed copy, please call us at 303-733-4999, or e-mail me at steselle@doratocapital.com.

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"I don't understand most of what my broker says, but I really like it when he calls something a 'dead cat bounce.'"

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