Expert Q&A: Wealth Building Moves for 2021
The stock market’s relentless post-election rise is causing ripples of anxiety on Wall Street. As equities hover at record highs, many investors are waiting for the next shoe to drop.
Amid this atmosphere of optimism mixed with uncertainty, I sought insights from one of the shrewdest analysts on our team: Robert Rapier [pictured], chief investment strategist of Utility Forecaster.
A prolific writer, Robert’s articles have appeared in Forbes, The Wall Street Journal, The Washington Post and the Christian Science Monitor. He also has been a featured expert on 60 Minutes and The History Channel. Let’s see what he has to say about current conditions on Wall Street. My questions are in bold.
The post-election stock market rally has been powerful. Do you think stocks are substantially overvalued and if so, do we face an imminent sell off?
You just never know when a sell-off is imminent. In 2020, I was concerned about a sell off months before it happened. If someone tried to move money to the sidelines too quickly, they would have missed out on a lot of upside. Then, after the sell off the market staged a remarkable recovery. Many people missed out on that because they were expecting more carnage.
Here is my point. We should not be overly focused on short-term fluctuations. Historically, despite deep corrections at times, the stock market has a great long-term return. I once saw a study that said if you had missed out on the initial upturn at the end of each of the major bear markets, you would have substantially underperformed the long-term average of the market.
I don’t try to time the market. I advise others not to time the market. Invest steadily over time, and when it’s time to withdraw, remove money steadily over time.
But just to address your question directly, by most conventional measures, the stock market is overvalued. Almost every sector in the S&P 500 is trading well above historical norms.
The only S&P 500 sectors with a current P/E ratio that isn’t double-digit percentages above the 10-year average are consumer staples and energy. Some of that is because profits last year fell due to the pandemic, but stocks also advanced sharply despite the decline in profits. So there are some really inflated P/E ratios presently.
We’re in the midst of sector rotation, whereby economically sensitive stocks are well-positioned for gains as the economic recovery accelerates. Which cyclical sectors look best now?
The underperformers over the past few months have been utilities, health care, technology, and consumer staples. I think technology will take a breather for a bit after three tremendous years in a row, but I see more relative value in the other underperformers given my expectations for the rest of this year.
Utilities had a huge year in 2019, but then pulled back last year. They are still gaining their footing, but I believe that once interest rate fears settle down, they are poised to do well.
The energy sector has bounced back better than most analysts expected. Which subsectors of energy look particularly appealing?
Energy has been the top-performing sector two quarters in a row, after an abysmal first three quarters in 2020. As long as we continue to emerge from the pandemic, the energy sector will catch back up. But it’s still below where it was to start 2020.
The exploration and production (E&P) companies have really come on strong, as have the refiners. Some integrated supermajors like Chevron (NYSE: CVX) have had huge recoveries, and others, like Royal Dutch Shell (NYSE: RDSB) are still down from where they were to start 2020. I think you can find the most value, and certainly a good stream of income, in the pipeline companies like Enterprise Products Partners (NYSE: EPD).
How worried should investors be about inflation?
It’s always a consideration, but I don’t think it’s a worry yet. You just have to make sure your investments are keeping pace. Parking money in a low-interest account is a guaranteed way to lose purchasing power over time.
You often deploy an investing strategy called “covered calls.” Explain how they work.
This is one strategy that has been demonstrated to outperform the markets in the long term. You increase your income stream and buy some downside protection. The catch is that your gains may be capped.
Here’s how it works. Let’s say you own 100 shares of Hewlett Packard (NYSE: HPE), currently trading at $15.72. The company pays a quarterly dividend of $0.12, for an annual yield of 3.1%. I can enter a contract in which I sell an option that allows someone to purchase my shares of HPE by some future date and at a specific price.
Here is an actual example I looked up as I was answering this. Presently, there is a call option for Hewlett Packard with an expiration date of 9/17/21 and a strike price of $17.00. The premium on this call is $0.65/share, which is more than the total annual dividend of HPE. So, by selling the call, you have more than doubled your effective annual yield. Second, you reduce your cost basis by $0.65, or 4.1%.
If shares are at or above $17.00 at expiration, your shares will be called away. (They could be called earlier if the share price rises above $17.00 before the expiration date.) In other words, you will sell them for $17.00 regardless of the price at the time of expiration.
However, your reward here is the premium, plus two dividends that will be paid between now and then, and a price that is above the current price. The total return for this transaction, if shares are called away, is 14.4% for a holding period of 157 days. The annualized return is 33.5%.
If shares are below $17.00 at expiration, then you keep them and can enter another transaction. Your reward in this case is an annualized yield that was pushed all the way to 12.7%.
Some investors don’t like the idea of giving up potential upside, but in my experience, you will make more selling calls across your portfolio than you will lose out on in capped upside. And there are studies that back me up on this.
Some investors are turned off by options trading. Are covered calls suitable for risk-averse traders?
I tell people “Don’t trade options. Just sell them.” It has been said that most people lose money trading options. So don’t be a gambler. Be the casino. Let others gamble, while you bank the certain call premium.
In fact, selling calls on your positions is safer than simply owning the stocks, because the calls reduce your cost basis over time. So, for risk averse investors, this is a way to further lower your risks.
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