In Search of the Perfect Investment

Personally, I’m optimistic for stocks — especially the right ones.

Not everybody is. Here’s a piece from The Wall Street Journal that says we’re going down. It sums up the “logic” floating around (and especially after last Thursday). (My bolding.)

Three Signs That Point to a Stock-Market Tumble Ahead
Indicators That Preceded Past Downturns Are Flashing Now

by Mark Hulbert, Aug. 1, 2014 1:25 p.m. ET

Over the past 45 years, the stock market has lost more than 20% each time three warning signs flashed simultaneously.

After a selloff this past week dragged the Dow Jones Industrial Average into negative territory for the year, it’s worth noting that all three are flashing today.

The signals are excessive levels of bullish enthusiasm; significant overvaluation, based on measures like price/earnings ratios; and extreme divergences in the performances of different market sectors.

They have gone off in unison six times since 1970, according to Hayes Martin, president of Market Extremes, an investment consulting firm in New York whose research focus is major market turning points.

The S&P 500’s average subsequent decline on those earlier occasions was 38%, with the smallest drop at 22%. A bear market is considered a selloff of at least 20%, with bull markets defined as rallies of at least 20%.

In fact, no bear market has occurred without these three signs flashing at the same time. Once they do, the average length of time to the beginning of a decline is about one month, according to Mr. Martin.

The first two of these three market indicators-an overabundance of bulls and overvaluation of stocks-have been present for several months. As long ago as December, for example, the percentage of advisers who described themselves as bullish rose above 60%, a level Investors Intelligence, an investment service, considers “danger territory.” Its latest reading, as of Wednesday, was 56%.

Also beginning late last year, the price/earnings ratio for the Russell 2000 index of smaller-cap stocks, after excluding negative earnings, rose to its highest level since the benchmark was created in 1984-higher even than at the October 2007 bull-market high or the March 2000 top of the Internet bubble.

The third of Mr. Martin’s trio of bearish omens emerged just recently, which is why in late July he advised clients to sell stocks and hold cash. That’s when the fraction of stocks participating in the bull market, which already had been slipping, declined markedly.

One measure of this waning participation is the percentage of stocks trading above an average of their prices over the previous four weeks. Among stocks listed on the New York Stock Exchange, this proportion fell from 82% at the beginning of July to just 50% on the day the S&P 500 hit its all-time high.

It was one of “the sharpest breakdowns in market breadth that I’ve ever seen in so short a period of time,” Mr. Martin says.

Another sign of diverging market sectors: When the S&P 500 hit its closing high on July 24, it was ahead 1.4% for the month, in contrast to a 3.1% decline for the Russell 2000.

How big of a decline is likely? Mr. Martin’s best guess is a loss of between 13% and 20% for the S&P 500, less than the 38% average decline following past occasions when his triad of unfavorable indicators was present. The reason? He expects the Federal Reserve to quickly “step in to provide extreme liquidity to blunt the decline.”

To be sure, Mr. Martin focuses on a small sample, which makes it difficult to draw robust statistical conclusions. But David Aronson, a former finance professor at Baruch College in New York who now runs a website that makes complex statistical tests available to investors, says that this limitation is unavoidable when focusing on past market tops, since “by definition it will involve a small sample.”

He says that he has closely analyzed Mr. Martin’s research and takes his forecast of a market drop “very seriously.”

Mr. Martin says that expanding his sample isn’t possible because most of his current indicators didn’t exist before the 1970s and “the comparative math gets very unreliable.” But he says he does use several statistical techniques for dealing with small samples that increase his confidence in the conclusions that his research draws.

He says stocks with smaller market capitalizations will be the hardest hit in the decline he is anticipating, in part because they currently are so overvalued. He forecasts that the Russell 2000 will fall by as much as 30%.

Also among the hardest-hit stocks during a decline will be those with the highest “betas”-that is, those with the most pronounced historical tendencies to rise or fall by more than the overall market. Mr. Martin singles out semiconductors in particular-and technology stocks generally-as high-beta sectors.

He predicts that blue-chip stocks, particularly those that pay a large dividend, will lose the least in any decline. One exchange-traded fund that invests in such stocks is iShares Select Dividend, DVY +0.04% which charges annual expenses of 0.40%, or $40 per $10,000 invested.

The average dividend yield of the stocks the fund owns is 3%; that yield is calculated by dividing a company’s annual dividend by its stock price. Though the fund’s yield is higher than the S&P 500’s 2%, it nevertheless pursues a defensive strategy. It invests in the highest-dividend-paying blue-chip stocks only after excluding firms whose five-year dividend growth rate is negative, those whose dividends as a percentage of earnings per share exceed 60% and those whose average daily trading volume is less than 200,000 shares.

The consumer-staples sector has also held up relatively well during past declines. The Consumer Staples Select Sector SPDR XLP +0.77% ETF currently has a dividend yield of 2.5% and an annual expense ratio of 0.16%.

If the broad market’s loss is in the 13%-to-20% range that Mr. Martin anticipates, and you have a large amount of unrealized capital gains in your taxable portfolio, you could lose in taxes what you gain by selling to sidestep the decline. The larger losses he anticipates for smaller-cap stocks could be big enough to justify selling and paying the taxes on your gains, however.

–Mark Hulbert is editor of the Hulbert Financial Digest, which is owned by MarketWatch/Dow Jones. Email: mark.hulbert@dowjones.com

This is Gilead. We all own it. It’s been good for us.

Will it continue to be good for us? My belief  is yes.  But there’s controversy around its price, not its effectiveness — which is really good. Here’s an excellent explanation, excerpted from yesterday’s New York Times Business Section:

Is a $1,000 Hepatitis Pill Really Too Much? 

Sovaldi costs $1,000 a pill, a concern to critics and insurers. It cures around 90 percent of patients who take it.

A new drug for the liver disease hepatitis C is scaring people. Not because the drug is dangerous – it’s generally heralded as a genuine medical breakthrough – but because it costs $1,000 a pill and about $84,000 for a typical person’s total treatment.

A Washington advocacy effort has sprung up overnight, largely devoted to objecting to the cost of this one medication, Sovaldi. Members of Congress have started a joint investigation into how its maker, Gilead Sciences, settled on its price.

“Clearly, $1,000 a pill strikes people as completely unreasonable,” said John Rother, president of the National Coalition on Health Care, an advocacy group that has been raising an outcry about the drug’s price as “unsustainable.” Gilead “stepped in it when they decided to go for that cost per pill, because people can’t imagine why that could be justified.”

But maybe we are looking at the costs of Sovaldi in the wrong way. One reason it is causing such angst among insurers and state Medicaid officials is that treatment costs are coming all at once.

First of all, there is pent-up demand. There are a lot of people with hepatitis C – an estimated 3.2 million in the United States – many of whom have been waiting for a good treatment. Second, unlike drugs for most chronic diseases, like diabetes or H.I.V./AIDS, for which treatment continues over many years, Sovaldi can cure most patients’ hepatitis in just a few weeks, with the bill soon to follow. The lifetime cost of treating someone with an H.I.V. infection is around $380,000, according to estimates from the federal Centers for Disease Control and Prevention, but the annual bill is much smaller.

Think about AIDS treatment as paying a mortgage. Sovaldi is like buying a house with cash.

The United States health insurance system works better for costs that are spread out and predictable. People change insurance frequently, discouraging insurers from making a big investment now that might pay off later. That does not mean that our health care system is not expensive – it is – but we are more used to costs that pile up slowly over time. Expensive one-time treatments like Sovaldi can be a shock to the system.

Hepatitis C slowly destroys the liver. Over decades, many infected people will end up with liver damage and complications, including joint pain and kidney disease, while a smaller number will get cirrhosis or liver cancer, and a tiny fraction will end up needing liver transplants. People used to get the virus from blood transfusions; now, it is contracted mostly by intravenous drug users who share needles.

Until now, doctors would mostly treat hepatitis C patients’ symptoms. Some drugs attacked the virus itself, but they did not work very well. And most had side effects, including fever, depression and anemia, that about half the patients were not healthy enough to tolerate.

Those drugs were also expensive – the most effective drug cocktail before Sovaldi cost about $70,000 – but because few patients chose them, the price tag did not cause a big reaction. Sovaldi is different. Patients want this drug, with its high success rate and smaller list of side effects. That means a big financial shock to the health care system all at once.

“With a product like Sovaldi, it’s a new price to the system,” said Gregg H. Alton, Gilead’s executive vice president for corporate and medical affairs. He said the company priced the drug to be competitive with existing therapies, adding, “It’s a new cost they weren’t paying for before.”

The accounting firm PricewaterhouseCoopers estimated that this single drug could bump up employer insurance premiums by half a percentage point next year. Researchers at the Kaiser Family Foundation, a health care research group, estimate that it could increase premiums for Medicare’s drug benefit program by 3 to 8 percent next year, even if only a fraction of eligible seniors were to seek the treatment.

Insurer-sponsored studies are estimating even higher costs. Express Scripts, a company that manages drug benefits for insurers, prepared a worst-case situation: It said that states alone could be on the hook for up to $55 billion if every Medicaid patient or state prisoner with the disease was treated.

“We think a perfect storm is arising out there,” said Dr. Steve Miller, a senior vice president and the chief medical officer at Express Scripts, who helped prepare its estimates.

The drug, which came on the market last year, has been a bona fide blockbuster for Gilead, which earned $3.48 billion in sales of Sovaldi in the last quarter alone. That puts it ahead of nearly every new drug introduction in history and in striking distance of the record for annual drug sales: the $12.9 billion for Pfizer’s Lipitor in 2006. …

By law, state Medicaid programs, which insure poor and disabled residents, are legally required to cover any drugs that are approved by the Food and Drug Administration. Medicaid gets a mandatory discount of at least 23 percent on drugs. But many states, terrified about the budgetary impact of Sovaldi, are testing strategies to limit access. Oregon, which has a special legal waiver from the usual rules, has said it would give it only to Medicaid beneficiaries with advanced liver disease. Illinois announced similar restrictions last week.

But for all the panic, the crisis may soon wane. New, effective drugs are about to enter the market to compete with Sovaldi, offering other options with high cure rates and low side effects. And a more competitive market is likely to drive down the drug’s price, once payers can choose to cover only the drug that is the best deal.

The pent-up demand of patients who have been waiting for a cure will work itself out over the next few years. The PricewaterhouseCoopers estimates show big costs for treating hepatitis C over the next two years, then a sharp decline as the untreated population dwindles.

Do the math. $84,000 x 3.2 million equals $268.8 billion. Quite incredible market opportunity for Gilead. You can read the entire article here.

And now for Whole Foods? I’ve written how the competition has cottoned onto WFM’s secret sauce — pricey, organic, food.

The Journal picked up:

WholeFoods Market; Victim of success

A peddler of pricey organic and natural foods finds it has competition

THE colourful chalkboards and baskets of fruit that greet customers at the entrances of Whole Foods Market’s shops paint a rosy picture. Yet shares in the American seller of organic and natural food have fallen by more than 40% since hitting a peak last October, in a period when stockmarkets have been strong.

It is not that the retailer is in immediate crisis: its latest quarterly figures, on July 30th, showed sales and profits both up a bit. And it is not that people are going off the idea of paying more for food produced without chemical fertilisers, pesticides or additives: the International Federation of Organic Agriculture Movements reckons that the industry’s worldwide revenues were a record of $63 billion in 2012; and Techsci Research, a market-research firm, predicts that the American market for such foods-the world’s largest-may grow by 14% by 2018.

The problem is that at Whole Foods, shoppers have been paying way over the cost of regular produce, and its success in getting them to do so has now attracted a lot of competitors, from rival organics chains like Sprouts and Trader Joe’s to mass-market retailers like Walmart and Costco. As a result, the price premium for organic produce is crashing down. On a recent shopping trip, a pound of organic apples cost $2.99 at Whole Foods but just $1.99 at Sprouts and even less at Costco.

The firm has been trimming costs to keep its margins up, but the slump in its share price reflects investors’ expectation that this cannot continue, that profits will suffer and that Whole Foods’ dominance of the market is coming to an end.

That the company has had to recall a number of products-in late July it and other grocers recalled plums and peaches suspected of contamination with Listeria bacteria-has made it harder to maintain an air of superiority over its competitors. Organic foods’ claim to superiority is questionable anyway. Both Britain’s Food Standards Agency and the Annals of Internal Medicine, a journal, concluded after reviewing the extensive studies on the issue that there is no substantial difference in the nutritiousness of organics and non-organics. In some respects organics may be bad for the environment, because growing them uses land less efficiently than non-organics.

As for “natural” foods, there is no official definition of this, in America at least; so the label, which Whole Foods also applies to many products, is close to meaningless. Alan McHughen, a botanist at the University of California, Riverside, argues that the whole industry is “99% marketing and public perception,” reeling people in through a fabricated concept of a time when food, and life in general, was simple and wholesome.

If true, the trick has worked nicely for Whole Foods. But its success has attracted so many imitators that it is losing its uniqueness. Even recent speculation about a takeover bid has failed to lift its shares. It may insist its food is sustainable. But it seems its prices are not.

Not my favorite cartoon. But it does sum up what we’re dealing with.

New York investment bank’s serious problem, solved

One day the chairman of a New York investment bank called in the newest, most junior executive.

He entered the office to find the chairman and eight directors seated solemnly around a table.

Suddenly the chairman turned to the young man and asked: Have you ever slept with Miss Foyt, my secretary?

“No.”

“Are you absolutely sure?” persisted the chairman.

“Absolutely. I’ve never laid a finger on her.”

“You’d swear to that on a stack of bibles?”

“Yes, I swear I’ve never had a sexual relationship with your secretary.”

“Excellent. Then you fire her.”

Harry Newton who has always referred to his favorite granddaughter. He had only one — Eleanor. But next month there’ll be another — code name Mitzi. Favorite daughter visited on weekend.

Talk about glowing when you’re pregnant. Claire gives glowing a whole new meaning.