Market Update and thoughts about SPG, GEO, HPQ, OEC

The SPX has stayed above the 70 wk average. We are in bullish mode... still. With the FED backing, I wouldn't fight the FED. However, just how "expensive" are we? Kind of. But don't forget, the market is split between "the new world" stocks where some tech stocks have soared, and stocks that require people to travel or go out that some are trading at significant discounts.

This post is to give you hard data so that you won't be swayed only by the headlines. As you know, headlines can cause us emotional responses. I spoke to another professional investor the other day who told me that he sold at absolutely the wrong time and was depressed.

I hope this post helps a little to get a different point of view.

There are two variables to think about: 1) The sentiment of the market participants and 2) when reality about the new future becomes clearer.

You see, I feel that we have gone too far in terms of how many people think COVID19 has changed the world. When tech / cloud stocks that haven't turned in a profit yet trade at 50x PE, what people are saying is that we have a new normal. People must be thinking that there will be less offices in the future, less travel, less sports ... and people will develop businesses or work from home - hence the great demand for tech. Have we gone too far? Human nature is mean-reverting. As time passes by, I think people will go back to malls, travel and the like. The question is ... when? And, the better question is, when will the majority of investors realize this is happening?

Today, I think New World stocks are very expensive, and Old World stocks very discounted (some of them). I don't know when the market will reprice this, and funds will sell off their big profits from tech, and because of super low interest rates, have to put them in earnings and dividend yield stocks.

1) Dumb money is too happy. However, Smart Money is ... kind of neutral. This fits in with the narrative that some funds were too late getting in and are looking for a way to get in. Although the broad markets are getting lofty, there could be still some more in the tank... but chasing after those surged stocks are likely like picking up pennies in front of a train. Maybe not so dramatic.. how about the risk reward is such that you probably wouldn't want to bet the house.

However, there IS a lot of money sitting on the side lines. The only time there was money on the side lines close to this high was in 2009, at the GFC. So long as there is no financial crisis or long severe recession, this money has to go somewhere.

I write this article with the mid-long term investor in mind.

Old world stocks have different degrees of risk and cheapness. I have attached the relative yield spread between REIT dividend yields and the 10-year treasury yield. Toady, we have the highest spread since the GFC. The yield spread then was so high because REITS were overlevered, because it was a banking crisis, the banks had problems refinancing. Today, this is far from the case. Many banks have passed the stress test, and many REITs are capitalized to survive more than 1 yr before having to refinance debt.

An idea:

SO the whole market is expensive but has room to go farther. But certain sectors are lagging, like the financials and REITs.

If you have too much cash lying around and feel you want to deploy some of it, perhaps you can consider those lagging stocks. Take SPG for instance, they recently cut their dividend but announced a $1.30 quarterly dividend. That's about $5.20 a year. This means about a 8.5% dividend yield right now. Don't forget that this quarter is their worst quarter because it took into account April, May and June. And their shopping centers were closed for more than a month. They have reported that traffic is getting better. So this 8.5% yield is potentially the bottom. They should raise their dividend over time. It should get better as long as COVID doesn't cause another full shutdown ... I don't think this is likely.

Some people also don't realize that those shops that didn't pay rent are not forgiven, but deferred. Eventually, they have to pay those months back. Sure, maybe a couple more shops default but eventually others will take their place. If you have prime assets, people will go to those places when healthy. I went to a major shopping center today... it was very crowded (in Perth).

Another REIT that is going ex-dividend very soon (16 July) is GEO.

They announced a $0.48 quarterly dividend which translate to 14% annually. Like what I suspected, they aren't as affected by COVID as other store businesses since they are paying the exact quarterly dividend as last quarter! The technicals look reasonable for a short term entry. The MACD looks it could be turning up.

However, I must caution that you have to be able to stomach political noise on this one. The narrative on the Left is that private prisons are evil places and one shouldn't support such a business. Pardon my honestly, this is horse-****. Here is why:

1) Prisons are necessary institutions, just like schools. Criminals need to be placed somewhere... there is nothing evil about that. It's a correctional institute as well: people also get corrective training there too. Some policemen are racist and brutal. Majority are not. You won't disband the entire police force because of a few bad eggs that enhanced out of proportion by media ... you still need the police force. They are the ones protecting you from crime.

2) If the government doesn't contract such private prisons to do it, it means they have to do it. They will take tax payer money, build their own prisons, hire folks to manage this prisons. The COST of doing it themselves is more expensive that letting professionals do it. And, there is no guarantee that the quality of their correctional care is better than a private company. Statistics are opposite: when companies compete in the market, they have to be more efficient to survive. When they are listed on the stock market, they are scrutinized more and have to report every quarter to shareholders. These people are very mindful of their reputation and will work harder to do it well.

3) Prisons are correctional facilities. They house prisoners are punishment, and have programs to rehabilitate. A private prison vs government prison is the same as a private school vs public school. Private schools tend to be better than public schools, why? Because when you are a for-profit enterprise, you hire the best teachers, have the more efficient system and usually take more pride in your work. You want to be the best school.

In the US, because of government regulation and unions, the best teachers are not rewarded fairly and the worst teachers cannot be sacked. Students suffer. Similar to private vs public prisons. Bad employees can be sacked much faster than government employees who are bad at their work. As a private and listed company, your image matters... they are not going to risk any scandal and will be quick to squash bad practices.

4) There is nothing wrong making money off prisons just like there is nothing wrong making money off universities and schools. If you do your job well and better than the alternative, the extra profit is your reward.

All that being said, the politics of the LEFT is powerful because they control the mainstream narrative. People don't realize that major news like CNN and industries like Hollywood all work together to paint a message. What they paint as evil convinces many that those are evil, even if they are not. Years ago when i was an analyst, I determined that SodaStream was a great company. It was fairly cheap, had a good product and was the best at what they were doing. They have a great business moat too... no one does it better. But, they were unfairly sanctioned by BDS that accused them of profiting off Palestinian workers. (They were a Israeli company that had a production site near Palestine.) The ironic thing is, they were a positive in that region because they employed equal amounts of Palestinians and Israelis and made sure all of them got paid the same amount. The reality is that the Palestinians wanted to work there because they got paid more than anywhere else. As I read all the reports and their financial statements, it was obvious they were a net good to the region. But BDS continued to paint them as evil.

The point being is that the share price remained depressed for the 2 years I was an analyst ... until on the 3rd or 4th year, they were finally bought over by PEPSI and the stock price finally surged big time.

Here's the rub.

After Pepsi bought over SodaStream... all the BDS activism slowly died down. Why? If they hated them then, they would still hate them now. It's still the same business. Even more, they got bought over by a big business! How come they suddenly stopped? Is it a coincidence that Pepsi has been a strong ally to Hollywood and the Left? I suspect it's similar with GEO. On a fundamental basis, GEO is a net good. Government prisons likely cost more to the taxpayer, AND the care the prisoners get is likely worse. Private prisons are better for both the taxpayer and the prisoner then the alternative. It's hard to tell when this narrative will finally end, so the stock price might not surge for quite awhile, but it's obvious that the stock is cheap, and you'd be collecting good dividends while waiting. It's unlikely private prisons are going away despite who gets into office. The people in power know private prisons are necessary.

This is just my take.

Other stocks to look out for would be HPQ , OEC and WFC. They are in-between Old and New World. HPQ: in both worlds, you need PCs and printers, whether you work at home or office. They have good cash flow and it's a matter of time before they continue on their ambitious share buyback plan. OEC: you will still need engineering carbon black, especially for new cars. There is less flying, but there is robust driving. WFC: 30% discount to book value. Earnings are depressed this year. But they passed the stress test well. Risk-reward looks favorable on the long term.

Those listed above are value stocks. There is money on the sidelines. Also, if people take profit from their leader stocks, will they sit in cash, or put some into value?

If they do, some will pour into these names.

Cheers!

Ken

Bible Corner:

The Bible stresses the importance of diversifying your holdings, and making sure you don’t place too much risk in one basket.

"Invest in seven ventures, yes, in eight;you do not know what disaster may come upon the land... Sow your seed in the morning, and at evening let your hands not be idle, for you do not know which will succeed, whether this or that, or whether both will do equally well." -Ecclesiastes 11:2, 11:6

I would add to know those 7 or 8 well enough so that you do not overly panic or get overly happy on price movements. If you know your companies well enough, it will make you buy when should be buying and selling if you should be selling. It's when we don't know them enough makes our risk management and trading decisions worse.

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