Adding Some Equities

Give me a chance
Give me a sign
I'll show her anytime
Su-Sussudio
--Phil Collins

While my macro outlook remains decidedly bearish, I have been buying some equities over the past months. Nothing crazy. Currently, my net stock exposure is about 4% of total liquid assets (19% long minus 15% index short). If we should happen to sell off hard over the next few months, I may take that exposure up to ~25%.

Various factors are making me more sanguine toward equities, including:

Financial repression. This is the label being assigned to global policies that are forcing interest rates toward zero for the foreseeable future. Suppressed interest rates discourage traditional forms of saving. As such, dividend paying stocks, particularly those of large cap low beta names such as Johnson & Johnson (JNJ) and Procter & Gamble (PG), look increasingly attractive. Many of these stocks yield 3% or more, which easily beats the payout on multi-year CDs. Moreover, they tend to hold their value pretty well in general stock downdrafts. Yes, principal is still at risk, but I'm increasingly comfortable holding a few of my favorite divendend payers here as income generators.

Inflation hedge. If you review this site's archives, you'll find many posts discussing inflation vs deflation. I've generally favored a 'deflation before big inflation' sequence. It is becoming increasingly apparent to me, however, that I might have it backwards. Tendency of central banks to print aggressively to avoid any economic pain suggests that Big Inflation may precede the ultimate deflationary bust. Think Weimar. While stocks may not keep up with real assets like gold in such a scenario, they will likely hold up better than cash.

Decent value. I'm actually seeing decent value in a few of my favorite names (i.e., well branded, cash rich, high margin, strong competitive position stalwarts). JNJ seems reasonably priced. In tech, Cisco (CSCO) and Applied Materials (AMAT) look interesting. After the recent downdraft in the miners, Pan American Silver (PAAS) popped up on my radar as well. I don't have to torture my discounted cash flow models to find value here. One limitation, however, is that the basis for my cash flow modeling is the last 3-4 years of financial performance--a period that has been generous to US corporations. As John Hussman has frequently stressed, using the past few years of historical performance to forecast future performance is likely to over-estimate future cash flow generating capacities. While I'm in full agreement, my valuation models are pretty conservative in their assumptions, making me comfortable with taking initial positions in some of my favorite names.

Yes, there is downside risk here, which is why I'm only 4% net long stock at present. Because lower prices reduce that risk, I'll likely use price weakness (if/when) to add to my fave names.

positions in AMAT, CSCO, JNJ, PAAS, PG, SPX, gold