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Market bubbles and Tesco revival
January 16, 2013


January 16th, 2013

  • Bubbles galore – are you worried?

  • Tesco’s reversal in the make?

Dear subscriber

Are you feeling good, secure and sure that you are facing a prosperous future?

You are certainly not alone!

Why?

Well . . . total collapse seems to have been averted in Europe, in the USA and China, at least for now. Even shares in countries at the EU periphery are showing good gains, albeit from very low levels.

Investors are feeling increasingly ‘good’ and ‘positive’ as measured by Wall Street’s famous “fear index” – the so-called VIX index – which has fallen to a five and a half low, touching a low of 13.2 points last week.

The VIX Index tells you whether or not the markets have reached an extreme position one way or the other. More often than not this tends to be a sure sign that the markets are about to stage a reversal.

The idea behind using the VIX index as a ‘contrarian’ signal is that if a wide majority believes the markets are heading into one direction, i.e. ‘up’ or ‘down’ they pile in or sell off. However, in many cases, by the time that happens, the market is usually ready to turn the other way.

The ‘smarter’ money often uses the VIX Indicator as a contrarian sign. If "the crowd" is feeling very bullish i.e. the stock market is/has gone(ing) up in a relatively straight line, it is definitely time to think about getting bearish and potentially exit.

When the VIX index is below 20, as it is now, this is generally considered to be a bearish signal, indicating that investors have become overly complacent. In comparison, when the index reaches a level of greater than 30, a high level of investor fear is implied, that is bullish from a contrarian point of view. Is that making any sense?

Look at this one year chart and draw your own conclusion.

Silence before the storm?

The Financial Times of January 10th worded it as follows:

“Fund managers and strategists said the low Vix reflects the fact that central banks are seen as backstopping financial markets, lessening demand for downside protection”

“Signs of tentative rotation by investors out of bonds and back into equities have further bolstered optimism”.

This time it is different?

Nope.

Don’t forget the stock markets are being kept afloat on a flood of central bank liquidity based on unusually low interest rates.

Realise that share prices have NOT gone up because of companies’ turnover and results have increased at above inflation rates while costs have gone down; instead, egged on by the media, investors are increasingly moving their money out of low yielding bonds (funds) and savings accounts into higher yielding stocks and shares (funds).

In the meantime, companies are using low interest rates to secure loans in order to buy back their own shares to ‘magically increase' their earnings per shares results.

Also, don’t forget the USA could reach its $16.4 trillion debt limit in a month’s time. Just imagine what if the Republicans and Democrats haven’t been able to agree a deal by then, or, even a month later?

By then the US can’t pay its bills anymore, i.e. the USA will technically be in default – remember Ireland and Greece – stock markets will fall savagely and interest rates will go up a lot (to attract dollars). Higher inflation will soon follow. By then, the VIX index will have moved up substantially.

So, in order to keep abreast with the market direction, it may be a good idea to look at the VIX index occasionally.

Where do we go from here?

It shouldn't surprise you that I am rather bearish on global markets, because there are still several bubbles that need (substantial) deflating. Earlier, I briefly mentioned the bond bubble, the ‘inverse’ interest bubble, the dollar bubble and the stock market bubble.

When these all come together stock markets around the globe will have a tough time. It may not happen next month but it will happen at some point. Personally, I believe it’s inevitable.

And when it happens, once again, we will be ready for Mr Market to sell us the shares of the high quality dividend paying companies we want to buy at well below historically undervalued prices.

In the meantime, while generating pleasing dividend income, our Dividend Income Portfolio remains cash rich (in fact we are almost 62% in cash) awaiting the next crash.

While I would have preferred to have more high quality dividend paying shares owned in the Portfolio, generating an increasing income, we remain steadfast in our investment strategy to invest only in high quality dividend paying shares when they are (near enough being) historically undervalued, at the point of purchase.

Until then, I focus on the prospects of individual companies; looking at those prospects through the lens of their valuation, sustainability of their dividend and dividend growth, not through the lens of price changes. So whether one is ‘bullish’ or ‘bearish’ on share prices is pretty much irrelevant from my perspective.

2013 dividend prospects

The better question for me is whether I am bullish or bearish on the dividend streams from the best dividend growth stocks?

In general, our dividend predictions for 2013 at Dividend Income Investor.com of many companies is okay, though underlining earnings growth may well weaken during the year. However, I expect that those dividend growth stocks with good business models and strongly managed dividend policies will continue with those into 2013, and well beyond.

I also expect the average dividend increases for the best dividend growth stocks to be in the 5% to 10% range, with some lower and some higher. Across a portfolio of good dividend growth stocks, the overall income should increase faster than inflation. I expect that to happen again with our Portfolio in 2013.

What about valuation?

With the heightened interest in dividends over the past couple of years, not least due to our marketing initiatives, some pundits have declared that many FTSE100 dividend stocks are on their way to bubble territory, meaning that they are severely overbought and overvalued.

I concur to a point. Based on our investment methodology, we are indeed heading into that direction. Of course, there are always exceptions. However, for some time now, I have been unable to find a sufficient number of historically undervalued high quality dividend growth stocks to add to our Dividend Income Portfolio. In fact our last purchase was in March, 2012.

Whether or not the entire category is overvalued in some broad sense really doesn’t come into play when you think about stocks one at a time.

Which brings me neatly to Tesco . . .

Tesco’s Revival in the make – is Tesco a Buy?

Let’s be clear of this, Tesco's UK sales over the Christmas period were good, at least compared to last year’s.

As I reported earlier, here, Tesco’s admission that its “shopping experience” hadn’t been as good as it should have been embolded, Phil Clarke, Tesco’s chief executive, to embark on a £1bn turn around project aptly named “Building a Better Tesco”. I reported extensively on its initial progress, here.

Also of all the major UK retailers Tesco is the only one with the prospect of significant growth over the next decade(s) via several new areas of business in the UK e.g. Tesco bank services and emerging online sales, as well as in its international operations.

Lets not forget that Tesco’s Asian business activities are vast, spanning more than five emerging and rapidly growing developing countries such as South Korea, Thailand and China.

Asia will increasingly become key to Tesco’s growth over the next 10 to 20 years. In fact, based on current growth rates, the region is likely to surpass the UK before much too long. Unfortunately, the City’s short term view doesn’t recognise this yet. Steeped as they are in next quarter performance . . .

In the meantime Tesco UK is likely to be suffering low growth rates during the next few quarters. As per Tesco statement profit growth would be “minimal” in its next fiscal year.

Not surprising, as I mention here with consumers being unsure about job security and suffering an ongoing squeeze on their incomes it is clear that not only Tesco but also many other retailers are finding the going tough.

While Tesco’s turn-around is still at an early stage, its shares are still trading substantially below the levels they were before the profit warning last year, and even somewhat below Warren Buffett’s average purchase price of around £3.60 – unconfirmed reports suggest Buffett owns about a 5 percent stake in Tesco.

At this stage, investors should be looking at Tesco as a solid 4.4 percent dividend play with (perhaps) some near inflation protection.

However, unfortunately, Tesco is not historically undervalued at these price levels.

Make sure not to overpay when you buy dividend paying shares. Establish at what share price level we regard Tesco, and, many other well known dividend paying companies as historically undervalued: >Click Here for more information.

Many thanks

Steven Dotsch
Managing editor
EMAR Publishers
Dividend Income Investor.com
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