Long-Term Demand for Energy
Global economic growth is the major force behind the demand for energy. The globalization trends are strongly in place. The global economy will likely grow 4% in 1997 versus 2.6% in 1996. In the U.S., recent unemployment numbers have pointed to above-average growth. Japan’s GDP rose at a 12.7% annualized rate in the first quarter, and loose credit conditions and weaker currencies should lead to a recovery in Europe. Investment spending and exports have accelerated in Germany and France, which represents about 40% of the European Union’s total output. Developing countries that now represent 45% of the global economic picture are growing at twice the rate of the richer nations; thus they are garnering an increasing share of the global economy. By the year 2002, emerging nations will overtake the developed economies as a percentage of global economic output. Asia remains on a strong growth course and Central and South America, as well as Central Europe, are poised to rebound soon. All this growth and economic activity will require energy. The relatively low price of oil is itself a worldwide stimulus to demand.
Oil consumption is increasing more than twice as fast in the Pacific Rim as in the world as a whole. Demand for oil is growing at a 4% rate in the Pacific Rim, compared with a 1.5% to 2% rate worldwide. Much of this strength in the Far East is the direct result of urbanification, an increase in automotive transport, and a growth in aviation volume. Asia’s urban population is projected to rise by more than 200 million people between 1995 and 2000, and to grow by more than one billion people over the next 20 years
The Beginning of Oil Trade
In August 1990, President Bush ordered American soldiers to Saudi Arabia to deter the military takeover by Iraq of the world’s major oil exporter. As Americans sat transfixed to their televisions, the price of oil on the international market surged upwards. Gasoline prices in the U.S. soon followed. As the troops shipped out, the popular press rediscovered U.S. dependence on foreign petroleum and our resulting economic vulnerability.
During the 1970s, the American public and physicists, in particular, were bombarded by information on energy technologies, supplies, and use. The high price of oil brought about by the actions of OPEC (Organizations of Petroleum Exporting Countries) nations shocked the country into an awareness of coming shortages of fossil fuels. You might still remember seeing on television the long lines in the major cities for gasoline, particularly in Los Angeles, where cars are deeply rooted in the culture. Federal agencies and state governments financed a number of crash programs to develop energy sources and new fossil fuel development. Not much has changed in 20 years; except, of course, our growing dependence on fossil fuels.
Prior to Iraq’s invasion of Kuwait, the price of oil on the international market had dropped dramatically and the energy crisis seemed to have disappeared from public consciousness. Certainly the food of information on new energy technologies and new fuel sources, alternative and traditional, crossing the desk of nonspecialists has decreased to a trickle. Funding for energy research has also declined dramatically, along with tax incentives for energy conservation measures and the development of new energy sources.
At the same time, the public has been growing increasingly aware of the social and economic costs of unrestrained energy se. The recent rash of well-publicized oil spills and their environmental effects has raised public consciousness of the dangers of petroleum production and use. Yet oil consumption is on the rise, and the U.S. now imports at least half of the petroleum it uses. The spiraling national trade deficit raises concerns over the expense of importing large amounts of oil. The military crisis in Saudi Arabia has underscored how politically vulnerable our foreign sources of petroleum are.
So what opportunities exist in the energy sector for the astute investor? Let’s explore some interesting global developments.
While the reentry of Iraq into the oil market may put some downward pressure on oil prices, the long-term trend is up at least through the next decade, Many experts are anticipating a synchronized recovery in the industrialized nations in 1997; many also believe that the emerging nations will grow tat more than twice the rate of the developed countries for the foreseeable future. As developed countries enter a period of economic growth, demand for energy from both consumers and commercial users increases. Rom the increased use of our automobiles to massive production increases b industry fueled by new consumer spending, the demand for oil and its by-products could begin to rise rapidly.
The average American uses eight times as much energy as an average person anywhere else in the world. For example, there are 50 million more automobiles on the roads today versus 20 years ago. Also, today many people are driving gas-guzzling vans or trucks.
In less developed countries, like Asia, such demographic shifts as major population movements from the country to the city are placing increased demand on energy supplies. Additionally, the huge growth in aviation in this region will drive energy demand to record highs. Engineering and construction companies and power equipment suppliers are in a position to benefit from the need for additional refinery and power-plant capacity, and the potential exists for a classic energy construction cycle to develop over the next 5 to 10 years.
Settling on a stock-picking strategy
Every investor has a unique investment strategy for spinning straw into gold. Usually the best approach is a combination of several strategies to achieve the right balance of risk and return while efficiently and effectively reaching the investor’s goal.
Any general in the military can tell you that strategies don’t always unfold as planned on the battlefield, but not having a strategy in place is pure folly. Develop the best strategy possible, but keep in mind as you move forward, that you may need to adjust it.
The following are some semi-famous strategies that investors have developed for picking dividend and blue chip stocks for their portfolios:
The Dogs of the Dow: In 1991, Michael O’Higgins proposed an investment strategy called The Dogs of the Dow based on the fact that a dividend stock’s yield rises whenever its share price drops. Proponents of this theory believe that the components of the Dow Jones Industrial Average with the highest dividend yields have the greatest potential for capital appreciation in the coming year.
The Geraldine Weiss Approach: Geraldine Weiss, editor of Investment Quality Trends (www.iqtrends.com), is a leading expert on dividend investing who promotes buying high-yield blue-chip stocks. The overall strategy is to buy high and sell low — that is, buy when dividend yields are at the historic highs and sell when the dividend yields hit historic lows. Sticking with blue-chips helps avoid financially troubled companies.
Relative Dividend Yield: Developed by money manager Anthony Spare, this approach rates blue chip stocks by comparing a company’s dividend yield to that of the average yield of the S&P 500. In his book Relative Dividend Yield: Common Stock Investing for Income and Appreciation, 2nd Edition (Wiley), Spare recommends giving careful consideration to stocks with a dividend yield that’s more than double the average on the S&P 500.
Dividend Achievers: Dividend Achievers identifies companies that have an outstanding track record for increasing dividend payments every year. To make it on the U.S. Broad Dividend Achievers Index, U.S. companies must have at least ten consecutive years of increasing regular dividends, be listed on the NYSE or NASDAQ, and have a minimum average daily cash volume of $500,000.
Exploring sectors where dividend stocks hang out
Companies in certain industries, such as utilities and telecoms, are more likely to pay dividends than companies in other industries, including technology and bio-tech. The biggest reason for this tendency is that some industries have larger, more established companies, compared with industries that have a higher concentration of smaller, growth-oriented companies.
As you begin investing in dividend stocks, blue chip stocks you may want to focus your efforts in the following sectors;
Utilities: Electricity, water, and natural gas (suppliers, not producers)
Energy: Oil, natural gas (producers, not suppliers), and Master Limited Partnerships (MLPs)
Telecoms: Carriers (U.S. and international) and wireless
Consumer staples: Food/beverages, prescription drugs, household products, tobacco, and alcohol
Distinguishing dividend stocks
Wherever you find blue chip stocks, you can find dividend stocks:
Google Finance at www.google.com/finance
Yahoo! Finance at finance.yahoo.com
Various personal finance magazines and Web sites
The Wall Street Journal
Financial Times
Many blue chip stocks, listings include both a dividend column and a dividend yield column. If the company hasn’t paid a dividend, you see something like 0.00 or a hyphen (-). Some listings show only the previous and current share price and the single-day and year-to-date gain or loss. In that case, you need to dig deeper to find out whether the company pays dividends and the amount of the most recent payment.
Understanding why companies pay dividends
Successful companies are profitable companies, as well blue chip stocks. They earn money, and they can use that money in several ways:
Reinvest it: Companies usually invest a good chunk of their profits, if not all of them, into growing the business.
Pay down debt: If, in addition to selling shares, companies borrowed money to raise capital, they may use profits to pay down the debt, thereby reducing the expense of their interest payments.
Buy back shares: Companies may use profits to buy back shares that they feel are undervalued, or for other reasons. In some cases, they initi- ate buybacks to artificially inflate the share price and improve investor confidence in the company.
Pay dividends: Paying dividends is a form of profit sharing spreading the wealth among the company’s owners, the shareholders.
A company’s dividend policy generally reflects the board of directors’ and shareholders’ preferences in how to use profits. Two schools of thought govern their decision:
Pro growth: This school believes a company is better off reinvesting its profits or using profits to pay down debt or buy back shares. This strategy makes the company more valuable, and the share price rises accordingly. Shareholders benefit when they sell their shares for more than they paid for them.
Pro profit-sharing: This philosophy stems from the belief that shareholders own the company and should share in its profits.
Other factors can also influence dividend policies. For example, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), which lowered the maximum tax rate on dividends from 39.6 percent to 15 percent, boosted dividend payments on the S&P 500.
Modern Portfolio Theory
Modern Portfolio Theory describes how asset classes can be combined into diversified asset mixes. In March 1952 Harry Markowitz published the landmark article titled “Portfolio Selection,” in the Journal of Finance, which first described the efficient frontier. He was subsequently awarded the Nobel Prize in Economics for this concept.
Modern Portfolio Theory assumes that:
- Investors are rational and act to maximize the performance of their blue chip stocks investments given their risk tolerance.
- Investors choose portfolios according to the expected return and risk characteristics.
- Rational investors prefer less risk and more return.
- Expected return is defined as the total return including income plus capital appreciation.
- Risk is defined an uncertainty. It is an estimate of the possible variability around the expected return. The statistical measure of risk that is commonly used is standard deviation.
Portfolio optimization
An efficient portfolio is defined as a portfolio that has a maximum expected return for any level of risk or a minimum level of risk for any expected return from blue chip stocks.
Portfolio optimization is a mathematical technique for quickly identifying efficient portfolios. It takes into account the expected return and the risk (standard deviation) of each asset class, as well as the correlation of returns between different asset classes in the portfolio.
The important factor in gaining diversification in an asset mix is the correlation between the asset classes. The general mathematical technique of portfolio optimization is called quadratic programming. It is an iterative process that must be repeated many times for each level of portfolio risk to fine the asset mix that provides the highest level of expected returns.
Your wallet can be a leading economic indicator
Consumers account for two-thirds of America’s spending, and it’s easy to understand why it is worth listening to us. Our plans to spend, to save, and to invest are shaping economic trends. This knowledge will help you forecast changes in the economy.
In 2008, the Consumer Expectations Index documented a drop in consumer confidence that reached a low point. Now the economy was in a recession. Consumer expectations and confidence forecast fell for the long recession before the official onset of the economic recovery in December 2008.
Why is consumer confidence so reliable a forecast to invest in blue chip stocks marke? It’s because we, as consumers, rely on personal experience. We are the ones who have to balance our checkbooks every month. We see what is happening to interest rates when our CDs mature. It’s not the prime rate we care about; it’s the mortgage rate. It’s not the national unemployment figures that affect us; it’s whether we lose our jobs, or anyone in our immediate families or neighborhoods loses theirs. These factors are much more important to consumers than the abstract figures reported in the newspapers.
In early 2009, it’s clear that consumers are increasingly concerned about the economy. It seems that we are hoping the worst is over, and we are expecting improvement in the year ahead. But we don’t anticipate a roaring recovery. We are paying off debts, saving a little more, and spending a little less.
Reading the financial pages will keep you aware of unusual opportunities for profit from blue chip stocks investment. You can buy or sell against the emotions of the crowd.
Guide to the economy and the stock market
By reading the financial pages of the newspaper daily, an investor can be well informed about blue chip stocks. He should focus on four fundamental news subjects: the business cycle, inflation, liquidity, and interest rates. These key indicators will help investors understand economic influences on the stock market.
1. The business cycle describes the expansion or contraction of the economy as a whole; it has an important influence on the earning’s trends of most companies. The business cycle affects profitability and cash flow, which is a key in corporate dividend policy and is an element influencing the fluctuation of the inflation rate. Thus the business cycle affects the return on investment.
2. Inflation is the hidden tax we all pay because of the dwindling purchasing power of our dollar. Inflation causes prices to rise and is generally caused by excessive government spending. Inflation should be monitored, because it is tied to the business cycle. Inflation has a direct impact on investing. A rising or falling inflation rate affects the shift of cash between stocks, bonds, or other alternative investments.
Economists have studied the relationship between the inflation rate and the stock market over long periods of time. They have discovered that the two tend to seek a norm of 20, obtained by adding the market’s P/E ratio to the current inflation rate.
When the combination of P/E and the rate of inflation exceeds or is less than the norm of 20, it suggests that there will be an adjustment in the market.
3. Monetary policy, mainly through the Federal Reserve Board decisions on the money supply liquidity, can make the economy grow faster or put a brake on economic growth.
There are several indicators of money supply, but the most useful one for investors to follow is M2, the amount of money in savings and checking accounts. Liquidity and the stock market tend to move together. When M2 grows faster than the economy, stock prices rise. As an example, in the early 1980s the economy declined sharply, the money supply surged, and the stock market took off.
4. Interest rates and the stock market move in opposite directions. When interest rates decline, the market does well. When the interest rates rise, stock prices tend to decline. You can always find winning stocks, but it’s dangerous to move against the relationship of stocks and inter- est rates.
How do investors know which direction interest rates are headed? Look at the Federal Reserve Board (the Fed); it monitors and directs the interest rates in the American economy. Look for major turning points in Fed policy, such as the continued discount or interest rate cuts, like those we saw in 2008. Don’t concern yourself about the minor midcourse adjustments.
Inflation and the markets’ P/E add up to approximately 30. That means that any rise in inflation could send the market downward. A further drop in the inflation rate could give the market an upward bias.
Liquidity is positive. If the money-supply growth rate accelerates, stocks could move even higher. Still, if it declines, investors should expect stocks to drop from their current lofty levels.
Federal Reserve Board Chairman Ben S. Bernanke has in the past moved several times to bring interest rates down. The stock market attracts more investors due to the current interest rate. Investors have to keep informed by reading the newspapers and stay tuned to the direction of any major Fed policy. This is how they work today.
Common stocks would move lower if the economy slipped back even further and stock earnings declined. If the worst is behind us, and the economy is indeed turning around, higher earnings could be ahead.
Certainly, market cycles are different. The extent to which current events will affect the stock market remains to be seen.
Being informed of the four major market indicators and knowing what they mean will help investors through the years ahead. But the unknowns (politics) are enough to keep things very interesting.