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‘Twas a Famous Victory But Caution Lies Ahead

Home prices rise slightly while the market is the bigger winner


Well, Ben Bernanke has finally won a big one for Middle America.  His massive buying of mortgages has lifted house prices—a whopping 1.2% from a year ago according to data released by Case-Shiller. Now homeowners can join the legions of stockholders celebrating the New Prosperity.

Stocks, of course, have benefited far more than houses from the Federal Reserve’s largesse.  Even after Tuesday’s setback, the S&P 500 index has soared 113% since the major bottom in March 2009.

But that doesn’t make our job as investors any easier.  Past gains are past.  What counts is what lies ahead.  By artificially inflating the price of capital goods (stocks are a legal title to productive or “capital” assets), the Fed is suppressing future returns for today’s buyers.

Thus, we must exercise utmost care to ensure that we build in an adequate return on any stocks we purchase today.

Generally speaking, I require an expected return of at least 12% in the coming year before I’ll buy even the most conservative blue chips.  For riskier stocks, I may insist on an expected year-ahead return of 15%, 20% or more.

Why such high thresholds?  Because everybody makes mistakes.  Me, too!  I aim for a high enough return on all my stocks to compensate for the investments that don’t work out.  In other words, a high return threshold is a critical part of my “margin of safety.”

And that’s the fly in the honey pot right now.  With the market hovering near multiyear highs, there aren’t many high-return stocks left (at least not among companies that present an acceptable level of business risk).

So an extra measure of selectivity — and patience — is the order of the day.  Don’t chase stocks that run up and out of our buy ranges.

One of the few names that meet my rigorous value criteria is Coca-Cola (NYSE:KO).  Thanks to the marketwide selloff today, this classic global franchise pulled back below our $38 buy limit.  Keep buying at or below that point.  Current yield: 2.7%.

I’m also favorably inclined toward the pair of tax-deferred limited partnerships written up in our October issue:  Enbridge Energy Management (NYSE:EEQ) and Kinder Morgan Management (NYSE:KMR).

If the Bush-era tax rates on investment income expire January 1, as I now think very likely, demand for these vehicles could go through the roof.

These two partnerships, you’ll recall, pay quarterly distributions in stock rather than cash.  Your current implied yield, based on the value of the stock dividends, stands at 7% for EEQ and 6.6% for KMR.

Treasury bonds performed their hedging job superbly today, with the long bond tacking on about 1% as stocks skidded almost exactly the same amount.  We’ll resume buying iShares Barclays 20+ Year Treasury Bond Fund (NYSE:TLT) on dips to $121 or less.  For now, watch and wait.

P.S.  Gold appears to be running into some significant overhead resistance.  I don’t think we need to trim our sails quite yet in the metals complex, but I’m monitoring my indicators closely.  To stay technically healthy, the price of spot gold shouldn’t drop below support at $1,700 an ounce.


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