JR Snell Capital Management, LLC

Utility Stocks (as a group) have forsaken me this year by advancing only about one-fifth of the amount of the S&P 500… which can act as a real short-term boat anchor in your portfolio if you own any quantity at all. Yet, my passion for the sometimes stodgy “dividend machines” still burns hot.

Why?  First, there’s the cash flow.  My favorite utilities ETF, the Utilities Select Portfolio (XLU) is spinning off a 4.31% dividend yield in an environment where a half a percent is doin’ good on your money market. That’s worth taking a little bit of market risk.

Then there’s long term performance. The Dow Jones Utility Index has outperformed the S&P 500 by 4.4% PER YEAR over the last 10 years. This puts the DJUI in positive territory for the last 10 years, whereas the S&P 500 is down almost 20% for the same period. And we are supposed to be long term investors, right?

Then… What’s the problem? Why the dismal performance?

To answer the questions, I think we have to look at it in context of what utility stock underperformance might be saying about the economy in general. The last time we emerged from a recession, the utility averages advanced about 25% in the first year of the recovery (2003). This time, they have only advanced about 4%. My opinion is that there’s nothing wrong with utility stocks per se, but they might be telling us that there is still something wrong with the economy.

Mix this in with the failing dollar, gold hitting all-time price highs, and oil’s recent jump back to the $78 per barrel neighborhood and there’s plenty of evidence afoot to suggest that all is not “right” in the realm.

There are so many variables out there that even Helicopter Ben doesn’t have a real clue. Bernanke (at the moment) must be contented to just dump cash on the U.S. economy and hope for the best… while walking the tightrope.

We have the early indicators of inflation that gold, oil and utility stocks might be showing us on the one hand while we have the deflationary pressures that come with collapsing employment, a housing value slam with a possible double-dip and consumer spending that has all but evaporated.

So, I think utility stocks really ain’t misbehavin’… I think they’re trying to tell us something about the economy. And if I’m hearing them correctly, I think I’d rather lie with my lovable dogs (of late), than to be all loaded up on or still chasing after “recovery” stocks.

Should we have an opinion about the stock market, or even about the direction of the economy? Is it important to set a firm course of action based upon our expectations of what we think will occur in the coming months?

Most readers when asked, would think these questions a bit silly. They’re a bit silly because everyone “knows” you must have an opinion to be a successful investor. Or do you?

Of course, being who I am, I would tend to think just the opposite. Did you ever think that the investors who have a firm opinion about what they believe will occur in the future are taking a risk with their flexibility? They’re messing with an essential investing skill that is the ability to change and adapt to a very fluid and dynamic situation?

Take, for example the annual Barron’s survey from a year ago about what 12 prominent strategists thought would be the course of the economy and the market for 2008. First, not a single one of them predicted a recession even though we were already in a recession at the time of the survey (December 2007). Second, their ending estimates for the S&P 500 were between 1525 and 1750. The S&P 500 closed 2008 at 903.25. That’s an embarrassingly huge miss!

Rather than throw these collective strategists into the “idiot-pile” for their lousy foresight,  I’m more inclined to think them fools for even attempting it. And so publicly too! Oops.

Of course, it would be a bigger shame if they managed or advised others based upon an unflinching adherence to their predictions. That’s a portfolio-wrecking miscalculation and strategy. And this isn’t just one “strategist”… it’s all of them.

So, it’s pretty obvious that it’s a fool’s errand to try to predict the future for any reason, let alone the stock market. This is why it doesn’t matter what I think about the future. The good news is that when I’m stacked up against some of the greatest economists in the world, I figure I’ve got about the same odds as them as being right. The bad news is that those odds are somewhere between slim and none.

What to do?

I think that it is more important to imagine a number of potential scenarios and their corresponding courses of action. From this brainstorming session, you could put together a number of “if-then” statements, much like a computer program would be written. Then you can develop a written plan for the future of your investments in a sequence of decision statements. Maybe a statement would go something like, “If interest rates decrease to below 2%, I will sell my Treasury bill investments.” [This is not advice, only an example.]

As I advise clients and manage portfolios I’m always playing this little “game” with myself. I never make an investment for myself or others without an “if-then” rundown… and right now I’m playing it with the stock market.

Here’s the playbook from my mind at this moment:

1. IF I see that a short term rally is developing, THEN I will invest about 50% of my clients’ growth stock capital.
2. IF any of these stocks loses 10% of their value, THEN I will liquidate the position.
3. IF any of these stocks gains 30%, THEN I will exit the stock and take my (our) profits.
4. IF I see that the rally is coming to an end, THEN I will sell any of these new positions at the slightest weakness.
5. IF I see that the short term rally has turned into a new Bull market, THEN I will commit the second 50% of my client’s growth stock capital to the market.

For the record, I’m still waiting for #1 to be True. I have some other “if-thens” that I’m playing with Treasuries, Investment Grade Bonds, our Utilities Select Strategy and the Dogs of the Dow Plus Strategy but I don’t want to annoy you with the incessant squeaking from my mental squirrel cage.

For everyone who is anxiously awaiting a new “buy” signal for the stock market, I still have no news. Things, believe it or not, are about the same as my last post about market timing. For the more technically-oriented investors… or those that feel like they need a little more detail about the “whys” of what’s happening at the moment, here is the complete description of exactly where we are.

Click to enlarge

The situation at present is that we have broken a minor, valid downtrend line (yellow downtrend line) and then gone on to form a couple of minor, higher lows (green up arrows). Recently, we’ve hit our heads on the 10 week moving average (blue line). The last time that this happened, it spelled trouble for the markets (yellow down arrows).

Today’s million dollar question is how this will resolve. Are we setting up for another leg down or will we hold the line and ultimately move higher? As it is right now, I can say that we are firmly on the fence.

Also, don’t forget that I’m talking about a short to intermediate term possible turnaround here. Everything needs to be considered in the context of an overall bear market as I have been discussing.

I’ll let you know when that changes.