Update on H&Q Life Sciences Investors (HQL)

In my original writeup on HQL on October 27 I noted that I was interested in this closed-end fund after reading about it on BioHealth Investor, but something was bothering my intuition and I was deferring purchase of shares.

My subconscious mind must have realized that Democrats would gain control of congress in the November 7 elections and that would be negative for health care stocks.

The health care sector did react negatively at first, but the market now seems to be getting used to the idea that Democrats will be running things, and life will go on.

After all, many of the Democrat congressional leaders are wealthy and they have a vested interest in the status quo. For example, Nancy Pelosi has a huge stock portfolio. (Clicking the link will open a .pdf file which is her financial disclosure statement.) Pelosi’s stocks include a large position in Johnson & Johnson. It’s not likely that she is totally anti-business, or that she has an agenda of sabotaging the health care industry.

I believe this little correction in health care stocks has created a buying opportunity and I plan to buy HQL as soon as I feel confident the bottom is in. The shares yield 8.3% and they were selling at a discount of 6.82% to the net asset value as of November 16.

The 50 and 200 Day Moving Average Trading System

I have always been interested in mechanical trading systems and I began to use different systems to trade the markets in the 70s and 80s. Later on, when I had access to a good computer, I back-tested the most promising systems against 50 years of price data for the Dow Jones Industrial Average. The Dow is ideal for back-testing because it does not trend as smoothly as many things you could trade. If a system works with the Dow, it has to be pretty good! Most of the trading systems I tested showed poor results against this data series. The short-term trading systems fared the worst.

The only system I tested which is good enough to actually use in the stock market is the 50 and 200 day moving average crossover system. The rules are simple: when the 50 day moving average of the DJIA crosses above the 200 day moving average, buy the DJIA at the open the next morning; stay long until the 50 day moving average crosses below the 200, then liquidate the position the following morning. This is a long-term trading system which gives infrequent signals. It keeps you in the market during protracted rallies but gets you out soon after a serious correction gets under way. And if the correction turns into a multi-year bear market, the system will keep you on the sidelines for the duration.

The 50 and 200 system does not do quite as well as a buy-and-hold strategy, but it does capture most of the upside with a lot less risk.

During the 50 year test period there were several lengthy whipsaw markets which resulted in 3 or 4 unprofitable trades in a row. It would have been hard to stick with the system during one of those difficult periods, but if you had, you would have done quite well in the end.

DIA is the ideal vehicle to use with the 50 and 200 system, but it works well with SPY, QQQQ, and other actively traded ETFs. I have also used it to good effect with mutual funds and even individual stocks.

I don’t give investment advice, and I am not recommending that anyone actually use this trading system; I’m just saying that it works for me.

Using the sell signals to sell short does not work at all! The long-term uptrend of the stock market is just too persistent.

I am more of a buy-and-hold investor than a stock trader now, and I generally use shorter-term technical signals to buy stocks, but the 50 and 200 day moving average system is still handy to provide a daily reality check. Right now, my intuition is telling me that we are on the brink of a bear market, but the 50 and 200 day moving averages are telling me to relax and enjoy the rally as long as it lasts.

Red Alert

Yesterday I walked through the living room while my wife was watching Oprah, and there was an “expert” on there saying that the market had nowhere to go but up. The viewers were advised to run out and buy stocks. I think the Oprah show may have become the prime contrarian indicator for the 21st century, replacing the cover of Time magazine.

I am enjoying this rally as much as anyone, but it is important to recognize that all the conditions for a major market top are in place and a severe selloff could start at any time.

The yield curve shows that the bond market has been forecasting a recession for months, and recent steepening of the curve suggests that the recession could become severe and prolonged.

But the stock market is rallying as if we were embarking on an economic boom.

When the stock market is having an argument with the bond market about the future, the bond market almost always wins.

The percentage of stocks rallying is very high. More than 400 of the S&P 500 stocks are trading above their 50 day moving averages.

Likewise, the NYSE Bullish Percent Index is over 70. This index level is associated with market tops. All market sectors except health care and information technology appear severely overbought.

Smugness and bullish sentiment are very high. The VIX has reached a level only seen at market tops.

The difference between new highs and new lows on the NYSE is in an area associated with short-term tops. There were only two new lows on the NYSE yesterday.

But today’s buyers will become tomorrow’s sellers when the tide turns. I think this is a good time to stick with low-volatility stocks paying good dividends and maintain a large cash reserve.

Update on Americanwest Bancorp (AWBC)

AWBC has shot up about 8% since it was mentioned here last Saturday. That is quite a move for a low beta bank stock! I can’t find any news to account for the price spike. The company did issue a revision to previously issued third quarter results, but that announcement came out last Thursday. I still haven’t bought AWBC. This surge was not accompanied by a rise in on-balance volume, and I think it was caused by short-sellers closing their positions. I expect AWBC to re-test the 52-week lows within coming weeks. If that test occurs and is successful, I will start to look for an entry point.

Free Correlation Tracker

I own stock in State Street Corp. (STT), sponsor of many popular ETFs including the select sector SPDRs, and I was pleased to discover that STT is making available a free correlation tracker at their SPDR website. The site says it is powered by SmartMoney.com and the tracker is very similar to the one offered by Smart Money which you have to pay to use. There is no way of assessing the validity of the data, but after playing with this tracker for a few days I have no complaints.

You can enter the ticker symbol for any security, and the screener will present lists of individual stocks which have the highest and lowest correlation. Naturally they also show how each of the select sector SPDRs correlates to that security. You can also directly compare any two stocks to determine their correlation. I find these correlation trackers very helpful and I have to admit that after using this one, I am more favorably disposed to using the select sector SPDRs.

One way I used the tracker was to see how I could use select sector SPDRs to diversify my portfolio. I entered the ticker symbols of each security which occupies a 5% or greater weight in my porftolio and noted the select sector SPDRs which have the lowest three year correlation. Like a broken record, the tracker kept saying: XLK (Technology), XLV (Health Care), and XLY (Consumer Discretionary).

I never buy stocks that don’t pay dividends, and that has kept me underweight in technology. One purchase of XLK would do the job, adding coverage of internet equipment, computers and peripherals, electronic equipment, office electronics and instruments, and semiconductor equipment and products; but it would also increase my existing exposure to telecom and wireless telecom services. One possible solution would be to use QQQQ to add technology exposure instead of XLK. QQQQ has a .91 correlation to XLK, but it does not include the NYSE-traded telecoms.

Health care exposure really does need to be increased in my portfolio. I own a few blue-chip pharmaceuticals but in terms of adding health care exposure, it would be safer and smarter to buy XLV, the health care ETF, and avoid any further single-stock risk in an area where I have no technical expertise. One investment would provide comprehensive coverage of health care equipment and supplies, health care providers and services, and biotechnology as well as pharmaceuticals.

As far as the consumer discretionary sector goes, industries such as automobiles, apparel, hotels, restaurants, leisure, media, and retailing, I think I might be able to do better by picking individual stocks on my own, but I will keep an open mind to using XLY. If the whole consumer discretionary sector tanks next year due to a recession, XLY shares may become cheap.

A series of equal weight sector funds sponsored by Rydex just started trading last week. They will directly compete with the capitalization-weighted select sector SPDRs, and might be an attractive alternative, if they end up having enough trading volume to be liquid. But we won’t know that for a long time. I am going to use the select sector SPDRs. They are very liquid and inexpensive (average expense ratio is 0.24%) and I might as well patronize the family business, so to speak.

A Fool and his Money are Soon Parted

There was an article in the WSJ last week entitled “Safe Stocks” which stirred up some controversy. I didn’t read the article itself, but I understand it used a Smart Money “Foxhole” stock screen to identify stocks with low volatility and high sales growth. Random Roger blogged about this article with a post called “Safe Stocks?” with a chart showing that two of the stocks recommended in the original article are actually quite volatile.

I don’t know where Smart Money gets the beta figures they use to estimate volatility, but different web sites can give widely varying beta figures for the same stock. Perhaps they are comparing the stock to different indexes, or using different time frames for the calculation? Some of them may be using obsolete information.

There may be a better beta reporting service, but the NYSE works for me. The NYSE’s beta figures are consistently realistic, always pass the common sense test, and I think they are updated daily based on incoming data. In addition the information is provided free of charge.

Here are the stocks which were recommended with the beta given in the original article, followed by beta provided by NYSE:

BFAM .60 1.00
CHD .20 .44
FDX .60 1.11
GEHL .70 1.23
OMM .50 1.35
SONC .10 .73
WLP .10 .73
ZMH 0 1.04

It is striking that there is no correlation at all. The discrepancy raises serious doubts in my mind as to whether information from Smart Money or the Wall Street Journal can be trusted. Several of these “safe stocks” are actually much more volatile than the market.

Low beta by itself is no measure of safety, either, but when a stock’s beta is considered along with its dividend yield, a better picture of relative safety can emerge. Secure dividends always enhance a stock’s safety. But if this list of “safe stocks” is screened for dividend yield, it will be seen that only one of them, Church & Dwight (CHD), pays any dividend at all. And CHD’s current yield is a pathetically low 0.67%.

There is no doubt that CHD is a profitable consumer products company – they have cornered the market for baking soda with their Arm & Hammer brand, and they sell other popular items such as Arid deodorant and Trojan condoms – but a quick review of the charts suggests to me that CHD is hardly safe to purchase at this time. RSI indicates the stock is overbought. It is already up 32% for the year too, and in the past there has been a tendency for CHD to crash in late fall or early winter. That pathetic 0.67% dividend yield isn’t going to do much to cushion any decline.

I guess the conclusion is that highly regarded information sources may not be reliable, even if they are charging you for advice. Look before you leap: a fool and his money are soon parted.

Americanwest Bancorp (AWBC)

For the time being, Americanwest Bancorp will be our final look at some lesser-known banking stocks which are falling into the pond at the end of the year. AWBC has a market capitalization of $228M, and it is the only small-cap bank stock I have found that looks liquid enough to trade and also worthy of further study.

AWBC offers retail banking and mortgage loan activity through 44 branches in Eastern Washington and Northern Idaho. The company was founded in 1974. As the long-term chart indicates, AWBC has enjoyed sustained growth greatly exceeding the S&P’s, but with less volatility (beta .85). The company is in the process of buying another small regional bank, Utah based Far West Bancorp., for $150M. This merger will accelerate AWBC’s planned expansion into Utah by adding a well-known brand with 16 branches and a strong customer base.

Americanwest makes no apologies for the fact that their third quarter and year-to-date earnings are down sharply, and they express strong confidence in the future, reiterating their intention to continue with their aggressive expansion plan. At its recent low of 19.98, AWBC was trading at a 25% discount to the all-time high price of 26.75 recorded last March.

The company’s website indicates that AWBC paid annual 10% stock dividends and steadily increasing cash dividends until 2004. Since then, there has been a .fixed 03 quarterly cash dividend and no stock dividends have been issued. The shares yield only 0.58%. Normally I would not consider a stock with such a small dividend unless it were increasing rapidly. AWBC is plowing as much money as they can into expansion.

But it caught my attention that on-balance volume has risen sharply this fall, even while the stock has been plummeting to new 52-week lows. AWBC is definitely under accumulation and a solid support level may have been reached.

Commerce Bancshares Inc. (CBSH)

Commerce Bancshares provides consumer and commercial banking through 191 branch offices in the states of Missouri, Kansas, and central Illinois. The company also underwrites and sells insurance, engages in securities brokerage, manages proprietary mutual funds, and provides trust and estate planning services. CBSH has outperformed the S&P 500 significantly since 1985, yet with much less volatility; the shares have a beta of .60.

CBSH has raised the dividend every year since 1986. The current yield is 1.95% and the payout ratio is less than 30%. Commerce has also issued at least a 5% stock dividend every year since 1993.

CBSH shares made an all-time high of 52.86 last December, but since then they have been drifting sideways to lower as earnings, while good, have not met expectations. CBSH made a 52-week low last month at 47.88 and they have rallied a bit since then. The stock tends to set cyclical lows about three months apart. I am planning to buy some at the cycle low next January, or sooner if it makes fresh 52-week lows before then.

A 9 or 10% discount from the all-time high price may not seem like much of a bargain, but CBSH has a low beta, and this is a company which has amply rewarded patient, long-term investors. They have weathered many an economic downturn with hardly a scratch.

Fulton Financial Corp. (FULT)

Fulton Financial Corp. offers consumer and commercial banking services through 254 branch offices in Pennsylvania, Maryland, New Jersey, Delaware, and Virginia. The company also engages in insurance sales, investment management, trust, brokerage, and investment advisory services. Fulton has a market capitalization of 2.8B. This company has a good growth record approximately equal to the S&P 500, but with less volatiliy; the beta of the shares is only .72.

FULT offers a generous dividend yield of 3.7%, although the current payout ratio is a bit high at 54%. The company’s website shows that the cash dividend has been increased every year for the last 20 years; in addition, the company has distributed an annual stock dividend every year since 1990, ranging from 5% stock dividends to 5-for-4 splits. Thus, FULT has been an excellent vehicle for long-term investors.

On a short-term basis, the weekly chart shows fairly well-defined cycles that have been recurring for more than two years – the peaks have been six to seven months apart, and so have the valleys. FULT peaked in July and is declining. The next cycle low would be expected any time between now and December, and I think that will be a great time to get on board. Fulton Financial looks like a nice component of a geographically diversified portfolio of mid-cap bank stocks.

Colonial Bancgroup Inc. (CNB)

CNB provides commercial banking services from 301 branch offices in Florida, Alabama, Georgia, Texas, and Nevada. In addition to the usual banking activities, CNB engages in full service and discount brokerage; holds interests in residential and commercial real estate developments located in Atlanta and San Antonio; sells insurance products and annuities; provides investment advisory services; and owns and manages certain real estate loans.

The long-term chart shows an excellent picture of long-term growth far surpassing the S&P500, but with less volatility – CNB’s beta is only .63. With a current market cap of 3.61B, the company still has plenty of room to grow too.

CNB shares reached an all-time high of 26.90 last June, but since then they have retreated 13%, despite rising earnings, and CNB stock just made a new 52-week low November 6. The shares are yielding 2.83% with a payout ratio of 40%. According to the company’s website, which is reminiscent of yahoo.com in its appearance and comprehensiveness of information, the dividend has been increased steadily over time, at a rate outpacing inflation; but the dividend has not been increased every year. There were 2-for-1 stock splits in 1997 and in 1998.

CNB is appealing as a core portfolio holding, especially if the price comes down a tad more in the next few weeks.