As the third quarter came to a close, eyes were on Washington as the House of Representatives escalated what has been an annual brawl over the budget into a shutdown of mostly non-essential functions of the Federal Government. Congress has been rehearsing for this Kabuki dance since the last government shutdown in the mid ’90’s. They have made sure to insulate themselves from the most powerful constituencies by exempting Social Security, Medicare, Federal Aviation Administration and National Security related entities from the “shut down.” This keeps most voters from flooding Congress with hate mail for a while, unless they happen to have planned a national park vacation. If predictions that the stand off will continue for weeks is correct, then the buffalo in Yellowstone will be free to roam without those annoying cameras clicking, at least for a while.

Should you be worried? Bullish equity markets are said to “climb a wall of worry.”  The media can be reliably counted upon to magnify the crisis du jour, but economic fundamentals trumps temporary crisis in the long-term. I believe there is a good chance that the shutdown and the debt ceiling debate to come will cause a market sell-off. But we invest based on long term fundamentals. A healthy sell off will likely be a reason for adding some good merchandise to your portfolio’s shopping basket. Anyone who tries to time selling/buying/selling based on political machinations will, in my opinion, miss what continues to be an opportunity to participate in an expanding US and world economy.

The positive fundamentals driving the US equity market at this time are:

  • near record low borrowing costs for businesses
  • improved consumer confidence
  • falling jobless rates
  • Recovery in the housing and construction sector
  • an era of flat to lower energy costs

Now consider the things that are not so bad at this time:

  • we are not in a shooting war in the Middle East
  • we are not on the verge of a new higher tax rate (as during the last quarter of 2012)
  • we are not facing the uncertainty of an election
  • we are not facing a massive clean up bill from a major hurricane, earthquake or similar natural disaster.

…and for those over age 45, recall that we are not on the verge of a nuclear war, something that  frequently seemed imminent between 1949 when the Russians got the Bomb and about 1991 when the Soviet Union collapsed.

One of the most attractive aspects of investing in equities today is the relatively high rate of dividends and interest still available to savvy investors. Example: Kinder Morgan Inc. (KMI) has a current yield of 4.45%. Kinder Morgan LLC (KMR) yields 6.6%. Electric utility Southern Company is paying 4.6%. Simon Property group offers a 3.06% yield and McDonald’s restaurants have a payout  of 3.34%.  Don’t forget preferred stocks: most clients have a few of these in their portfolio mix, with yields between 5.5% and 7%.

These yields represent something like 3 to 5 times that available from certificates of deposit. Of course savvy investors also know that earning higher returns entails more risk than owning certificates of deposit. The past five months have adequately demonstrated this principal: When the Federal Reserve Chairman ruminated aloud about “tapering” the extraordinary bond buying program that has kept interest rates so low, back in May many high yielding holdings dropped sharply in market price. Quite a few investors it seems stampeded out of higher yielding stocks like utilities, MLP’s1 and REIT’s2. This irrational behavior has, admittedly, dampened client performance, but it has also made some quality issues bargain buying opportunities. Year- to- date client portfolio returns have varied widely, but if I had to name a median return it would be a positive 6% for most. This return is decidedly lower than the stock market averages so far in 2013, but we have always suggested that your portfolio would seem to “underperform” during bull markets. We earn client loyalty when we keep your money from falling off a cliff during stock market crashes.

Here is a list of some of the positions we added in the most recent quarter (please note not all client accounts received these investments):

  • American Tower Corporation, a real estate investment trust that owns thousands of cell phone towers throughout the world. 
  • Imperial Oil Limited (a major Canadian-based oil company with highly productive assets ramping up rapidly).
  • We also added Cummins, a manufacturer of commercial engines driven by cheap natural gas.

Existing holdings that were helpful to portfolio values in the quarter included Williams, Cummins, Dominion Resources and Public Storage,  a REIT whose 6% growth since mid-June, stood out since most of the REIT sector was beaten up in the quarter.

Positions that gave us indigestion during the quarter included any bond fund, bonds in general, preferred stocks and two long time favorites: Simon Property Group and Kinder Morgan. The softness in Simon is probably due to the fact that the company had become a bit rich on a valuation level. As I believe consumer sentiment will continue to improve, I believe this stock is due for a significant rebound.  I appreciate that the softness in Kinder Morgan may seem a bit discomforting to our newer clients. The reasons for this weakness are reviewed in the September update to this blog below. Since that was written, my confidence in both Kinder Morgan LLC and Kinder Morgan Inc. remains unshaken. Sometimes, the finest investments experience significant fluctuations in price. Between May 2003, when we first purchased Kinder Morgan LP for around $40 per share and December 31, 2003, the stock rose to about $49. But by the following May, a year after original purchase, the price had plunged back down to close to the $40 level, an overall fluctuation of 20% in each direction. But the skill of the management team, which continues to own a significant portion of the company as family holdings, has produced a total return of about 15% per year, despite these periodic sell offs. Is this stock screaming “buy me?” I suspect so.

Your quarter end reports should be out by end of of October. Please let us know if you have any questions when you receive yours!

An early invitation to all clients: our annual Client Appreciation Holiday luncheon is calendared for December 11 at Summit House restaurant. Mark you calendar!

1Master Limited Partnership (MLP) is a limited partnership that is publicly traded on a securities exchange. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities.
2 Under U.S. Federal income tax law, a real estate investment trust (REIT) is “any corporation, trust or association that acts as an investment agent specializing in real estate and real estate mortgages” under the Internal Revenue Code. Because a REIT is entitled to deduct dividends paid to its owners, a REIT may avoid incurring all or part of its liabilities for U.S. federal income tax. REITs can be classified as equity, mortgage or a hybrid.