Progressive Investor Sample Article
News Highlights; Next Phase for Solar; Market Commentary; Analyst Conversation
Issue 66: October 2009
Analyst Conversation: Where We Go From Here
We interviewed financial advisor Patrick McVeigh of Reynders McVeigh on where he sees our economy and market going over the near term.
PI: What do you see until the end of the year in terms of the market?
Patrick McVeigh:
I think the fundamentals are in place for stocks to go higher for the balance of this year. The market's been rising since March - all the cash that's been on the sidelines should keep it moving up as they get back in. The psychology is still mostly negative - people are still scared of the market. That's a good thing - when they're feeling too good about the market we have to be scared.
Government has done its bit to make the markets go up - keeping interest rates low, putting a lot of money into the economy. We're still somewhere in the early to mid stages of the reversal of the fear.
A combination of the massive worldwide stimulus and the need to rebuild inventories, will lead to GDP growth for the next 6-12 months. The steps the Obama Administration took to resolve the crisis have been effective for the most part. We've spent about 35% of the stimulus - when all that's gone the private sector has to replace government spending, but that's 6-12 months down the road.
We're somewhat optimistic. I believe we'll return to investing in high quality companies that increase dividends. That's the core of peoples' investments and many people need it for income.
PI: How have your portfolios done this year?
Patrick McVeigh:
On average, our stocks are about 2% higher than the S&P, but because we avoided financial stocks for several years, we also didn't lose as much in the crash. High quality stocks haven't led the markets back, it's been the more riskier stocks that dropped the most during the downturn. Strong, stable companies like Johnson & Johnson (NYSE:JNJ) didn't go down as much and haven't come back as much.
PI: What are your thoughts on the economic recovery, pundits tells us we've entered?
Patrick McVeigh:
It will likely be modest and very uneven because some economic sectors will continue to face stiff headwinds. We believe one of the most important long-term trends facing our economy for the next decade. is consumer de-leveraging (i.e., paying off their debts), which will constrain growth.
Baby Boomers may have been about peace and love in the 1970s, but they opened their wallets to consumerism in the 1980s and 1990s. That's why consumers became an ever larger portion of our country's economy (and, not coincidentally, in lock-step with the expansion of credit in the system).
In the US, consumers have been contributing 60-70% of GDP. History repeats itself - in the 1920s, consumer spending rose to 70% of GDP after a similar, but smaller, credit splurge. By the end of the 1930s, consumer spending hovered just over 60% of GDP. We expect to see a similar adjustment over the next ten years.
People are under lots of pressure from unemployment, home prices being down, savings accounts down, people getting older, needing to save more. Baby Boomers are being forced to accept the reality of insufficient savings for pending retirements and younger people are digging out from debt. The consumption trend is over. The trend towards saving is just getting started and will impact our economy (in good ways and bad) for years to come.
PI: Even if consumption declines in the US, what about developing countries?
Patrick McVeigh:
They will experience the same natural progression. Many families have 2-3 cars in the US, that's excessive. People have been buying cars to fill their biggest need, not daily needs. That's why you see one person in most SUVs. The same thing happened with homes - everyone wanted a bigger house. As China and India advance, people will buy more cars there, but the pendulum will swing back.
Luckily, they'll be buying next generation efficient vehicles which will take over the market quickly, especially as energy prices rise. The world economy has been shaped by cheap energy for the past 50 years or more, and that's clearly hit a wall.
In a world of cheap energy, the cost of producing and moving goods around the world didn't matter. We saw what happened to food prices last year when energy prices spiked. It's time to re-think old patterns.
It will be interesting to see how the carbon cap or tax situation plays out. Priorities will shift to energy costs and environmental considerations. It could be more important to minimize energy costs than to have cheap labor. That would bring manufacturing home rather than shipping things around the world, which could become increasingly expensive.
PI: We may indeed transition to higher quality, greener products.
Patrick McVeigh:
Baby boomers may have turned into consumers, but they are also behind the push toward corporate responsibility. 10-15 years ago, there wasn't the same level of concern about designing and marketing green products, but now its clear that unless a product is fairly green it won't do well in the marketplace.
Our kids grew up recycling. My hope is the core green consumers, which have been about 10% of the population, grows to 15-20% in the next generation. I think that's a big driver that will re-shape the economy. There's also a sense of getting by with less which leads to concern about the quality of products.
We need new avenues of growth for the economy - sustainable growth, not just selling more stuff to people. We continue to see several major long term trends that investors should be cognizant of:
- The global middle class will grow by 600 million in the next 10 years
- Innovation in green technology is creating new industries
- Medical advances are opening broad new frontiers for discovery
PI: How are you following the major trends in your portfolios?
Patrick McVeigh:
For the past couple decades, if you just invested in what baby boomers were doing, you probably did OK.
It's not fun to think about, but many people invest in aging Baby Boomers through health care technologies like stem cells (Geron (Nasda: GERN), nursing homes and the like.
The stimulus package emphasizes health care information technologies: Cerner (Nasdaq: CERN); Computer Programs & Systems (Nasdaq: CPSI).
As people get older they buy more health care products and need to save money. Perrigo (PRGO), which holds a 70% market share in generic drugs, packages private label brands for CVS, Walgreens etc. Historically, about 1 in 4 people buy generics, which sell for as little as half the price of branded products. There's lots of growth potential.
PI: Another megatrend you're obviously following is that of green products, energy efficiency and green technology.
Patrick McVeigh:
Yes, one of our large holdings is in ABB (NYSE: ABB), which does about $30 billion a year in revenue building efficient transmission lines, and has a great balance sheet. It's a big industrial company that operates around the world, but we own it as an energy efficiency play related to the electric grid. The build out of renewable energy requires improving the grid and introducing a smart grid.
Another favorite of ours is John Deere (NYSE: DE). We're in a world where it's difficult to grow more food - modern farming is slowly destroying itself through too much fertilizer and pesticide use. We need to get smart. We wish there were ways to invest in truly sustainable agriculture, but among big companies, Deere is playing a role through drip irrigation, helping farmers site wind turbines on their land, and enabling farmers to reduce synthetic inputs. The tractors they sell have GPS units, for example, that focuses fertilizer applications only where it's needed. [Use the Progressive Investor search engine to read previous discussions about DE].
We like what IBM's doing, but the stock price is too high. In the technology space, we own EMC Corp (NYSE: EMC), which enables people to do more with less. Their virtualization software cuts down on electricity use and reduces the number of servers companies need. We also have large positions in Intel (Nasdaq: INTC), Apple (Nasdaq: AAPL) and Applied Materials (Nasdaq: AMAT).
Large companies like these should make up about half the equities in our portfolios. Then we layer in smaller green growth companies, but only for people that can handle volatility. Renewable energy sometimes leads and other times lag the market. It's an important and growing part of a portfolio, but we're also seeing many "conventional" companies viewing green opportunities as growth drivers.
PI: Many people see solar companies heading for a crash because of all the competition and over-supply.
Patrick McVeigh:
There are significant tax incentives to build solar plants in the US on both federal and state levels. If you were to build a plant in Oregon now, it's almost free. Many industries go through phases where there's too much capacity and demand has to catch up.
The cost for solar systems will decline significantly, and as conventional energy costs rise, the solar market will do fine. Solar stocks have had a hard time this year because people are so negative about those trends. I think it will turn around in the next 12 months - demand will increase, and costs will be low enough to spark another leg of growth.
Sure, poorly financed companies will go out of business and there will be new companies. Some of the big ones will get bigger. There aren't a lot of barriers to entry into the solar business - you can buy a turn-key plant. The solar business model may become more vertically integrated, where the manufacturers own the installers.
PI: Since it's hard to pick the solar winners, it is easiest to buy the Solar ETF (TAN)?
Patrick McVeigh:
We like to buy individual companies, those we think are the strongest names, but the ETF is fine for people who don't feel confident in making a choice. We've stuck with SunPower (Nasdaq: SPWRA), which has a strong market position and makes the highest efficiency PV, Applied Materials (Nasdaq: AMAT), which makes thin-film solar equipment, and Spire (Nasdaq: SPIR), which makes equipment for solar PV. We've been pleasantly surprised by how well First Solar (FSLR) has done, but the share price is expensive.
PI: Outside of solar, which green stocks do you find attractive?
Patrick McVeigh:
As a group, solar is more attractively priced than wind, but Vestas (VWS.CO; VWDRY.PK) is still a good long term name to own. Wind stocks prices may become more attactive soon - they're still experiencing difficulties in new order flow and project finance.
We've done very well with EnerNOC this year and we're interested in Itron (Nasdaq: ITRI). Itron's share price was over $100 a share a year ago, but it hasn't been keeping up with the market in the past six months. It looks like it's beginning to move now - it's a strong company in the smart grid space where there are many catalysts independent of what's happening in the general economy.
We'd love to recommend Green Mountain Coffee Roasters (Nasdaq: GMCR), but it's very expensive. Normally, if a stock gets this high, I'd say sell it or short it, but their business model justifies the high price. People are moving toward single serve coffee - it's still only 15% of the market so there's lots of room for growth. They sell the coffee maker to competitors at cost, who then to buy GMCR's little K-Cups to use it. Their organic/ fair trade coffee lines continue to grow.
PI: What do you that's defensive in your portfolios?
Patrick McVeigh:
Sometimes it's defensive to avoid certain sectors like finance. The US dollar could weaken in value - the government debt and risk in the financial sector are weakening our balance sheet. We diversify our risk by making sure all our assets aren't in dollar denominated stocks or bonds. We might own bonds from other governments like Canada; we also own company bonds that have strong balance sheets. We're holding bonds that have relatively short maturities because we could end up with inflation and higher interest rates down the road.
People who invest based on these megatrends and stay focused on high-quality companies with strong balance sheets have the opportunity to make significant progress through a difficult, slow recovery.
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Patrick McVeigh is President of Reynders, McVeigh Capital Management, a green/social portfolio management firm.
