Monday, June 6, 2011

The World After QE2

Things were not pretty for the stock market after the end of QE1.

Some are bracing for the same kind of thing with the end of QE2 fast approaching.

I'm not in the business of guessing what the market will do. If the market goes down substantially I buy good businesses at a discount. If it goes to the other extreme, may sell some things that get expensive. That's the extent of my interest in predicting what the market will do.

Having said that, the following article argues that there are some reasons to think that the end of QE2 may not necessarily be a repeat of what happened after QE1.

From Michael Santoli's article in the latest Barron's Magazine:

What's in store post-QE2?

"Hopefully, not much," says Michael Darda...He and others see important differences in the macro backdrop...

At least compared to March of 2010. Some of those important differences...

Credit Spreads Remain Narrow
Darda takes crucial cues from the credit and interbank money markets, both of which are rather unperturbed...

Commercial-Loan Production, Money-Supply Now Growing
A year ago, the banking system was still suffering declines in commercial-loan production, whereas business lending now has turned higher.

The article points out that we now have far more positive money-supply growth. So it would seem the end of QE2 isn't likely to end up being the real problem. It, at least, appears that there is more of a cushion to absorb shocks than there was a year ago, but Santoli points out it makes sense to keep what Mike Tyson once said in mind:

"Everyone has a plan, until they get hit." But the blows, should they come, probably will be from some financial accident in Europe or elsewhere, a downshift in global growth or another shot to corporate confidence—not the end of QE2.

Santoli also points out that the stock market may be higher than a year ago but, in fact, corporate-profit growth has outpaced shares price increases. So stocks in general are not expensive.

I partially agree.

The article highlights companies with clear pricing power in a deflationary arguing that they should do well.

Specifically, it mentions stocks like Philip Morris International (PM), Union Pacific (UNP), Kansas City Southern (KSU), and Schlumberger (SLB). I certainly like Philip Morris International (it has been in the 6 Stock Portfolio and Stocks to Watch since inception) and to a lesser extent Union Pacific, but both of the stocks have gone from being bargains to, if not expensive, certainly not cheap.

Consider that Philip Morris International had a single digit price to earnings multiple when it was first mentioned on this blog as being a good investment at prices available back in April of 2009.

After the rally, from a share price that was back then in the high 30's to where it trades now in the high 60's, that multiple is now in the mid-teens.

It is still a great business, and if held for a very long time returns will be just fine, but these days there are shares in other companies selling at bigger discounts to intrinsic value in my view.

If it ever gets cheap again (and you don't mind owning a tobacco company) those shares are well worth owning as a long-term core holding.

Adam

Long PM and UNP


 
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