May 18, 2012
May’s Pullback and Your Portfolios Understated Returns


This month has not been friendly to stock investors. Regardless of which market index you look at, U.S. stocks have fallen since the start of May. The DI portfolio’s benchmark, the iShares DJ U.S. Index (IYY), is down 6.6% month to date, as the chart below shows.

Market pullbacks and corrections tend to happen to quickly, often without any notice from Mr. Market that his mood has shifted from chipper to glum. They are uncomfortable, as the current pullback is, and the magnitude of their decline is unpredictable. The good news, however, is that they are temporary. Bulls run for a far longer period of time than do bears on Wall Street.

Where investors often do the most harm to themselves is selling when prices are falling and then waiting too long to get back into stocks. This has the twofold affect of locking in losses and missing out on big gains, a lose-lose proposition. Selling during turbulent periods only works if you have the ability to predict when stocks will rebound. Soothsaying skills are not easy to come by…

Another mistake investors make is underestimating the actual return they are getting from their dividend-paying stocks. When a stock goes ex-dividend, you have accrued cash flow. This is money owed to you that has yet to be paid. For example, AFLAC Inc. (AFL) will pay a quarterly dividend of 33 cents per share on June 1. If you owned the stock on its May 14 ex-dividend date, you will pocket the income. But, since the dividend has yet to be paid, your brokerage account’s balance excludes it. Thus, the performance you see is understated. This is true of your accounts as well as the performance numbers we show for the DI portfolio.

Obviously, price performance matters too, and we are not immune to that fact. From a capital gain/loss standpoint, the DI portfolio has been performing in line with the benchmark. Though our utility stocks are up for the month, our cyclical and financial stocks are getting hit. Concerns about an economic slowdown in the U.S. and renewed worries about the sovereign debt crisis in Europe are causing babies to be thrown out with the bathwater. Mr. Market is far less picky about what he sells than what he buys.

We are getting a cushion from dividends, and this is helping our monthly performance, but we’d still rather have more favorable market conditions. The current pullback is not fun, but downside volatility is a part of investing in stocks.

News and Notes

During AFLAC Inc.’s (AFL) investor’s conference, held on Tuesday, the company reiterated its operating earnings growth forecast of 3% to 6%, excluding the impact of currency translations. For 2013, the company forecast growth of 4% to 7%, the CEO Dan Amos said he wouldn’t be happy with 2013 growth below 5%. The forecast assumes no change in the interest rate environment.

Amos thinks the company will repatriate more Japanese profits into U.S. dollars next year, assuming no big investment losses. He intends to use this money to help buyback shares in 2013. As far as the dividend, an increase has yet to be announced, but Amos said he was “confident” that the 30th consecutive annual increase will be approved by the board of directors.

AFLAC held a five-hour analyst meeting on Wednesday. During it, the company said that 27.2% of its portfolio is invested in Europe, down from 35.8% a year ago. Portugal, Ireland, Italy, Greece and Spain account for just 2.1% of AFLAC’s consolidated portfolio, down from 4.0% last year. Given that worries about the company’s exposure to Europe have impacted its stock price, these shifts should be welcome confirmation of comments about reduced exposure to Europe made during the first-quarter earnings conference call.

Regarding its forecast, AFLAC added details about Japan. Sales in Japan are expected to range between +5% and +10% this year, but range between -5% and 0% next year.

RBC Capital Markets downgraded AFLAC to “sector perform” on Thursday, citing the insurer’s exposure to Europe. Reuters quoted the research report as warning that ALFAC’s bond portfolio is still at risk for “major additional write-offs.” Based on the portfolio composition listed above, we don’t think the downgrade was warranted, but it takes differences of opinions to make a market.


As we said last week in regard to Chevron Corp.(CVX), Brazil is trying to find a balance between profiting from its oil reserves and contending with citizens who are worried about potential environmental damage. This week, Reuters reported that Petrobas, the Brazilian state-led oil company, said that Chevron is unlikely to shut its offshore Frade field in Brazil permanently and output may restart after the causes of a November spill are resolved. Chevron has been embroiled in a difficult, politically fueled court case led by Brazilian federal prosecutor Eduardo Santos de Oliveira since December of 2011. Oliveira was seeking $22 billion in damages from Chevron and charged several Chevron regional heads with crimes that included the possibility of extended jail time. Recently, Chevron has received favorable rulings, while prosecutor Oliveira was removed from handling the case. Bloomberg Businessweek reported that fines are now expected to be in the millions and no Chevron employee is expected to face jail time.


General Dynamics (GD) is expected to receive $755 million in orders this year from Saudi Arabia to convert old M1A1 (Abrams) tanks to a “like new” M1A2S tanks. This contract work would be performed at the U.S. Army owned factory in Lima, Ohio, that is operated by General Dynamics. The Lima Army Tank Plant is the sole domestic facility currently capable of manufacturing tanks and was slated to shut down, halting tank production in the U.S. for the first time since World War II. General Dynamics will also receive about $650 million for continued work on 125 kits to modernize M1A1 tanks for Egypt, according to Army officials. General Dynamics had warned that halting domestic tank production would endanger a total of 14,000 direct and indirect jobs. Army and Pentagon officials had planned to cut Abrams funding to help achieve $487 billion in required defense spending reductions over the next decade. Army officials first proposed halting Abrams production last year as part of its fiscal-2012 budget, but lawmakers blocked the move, adding $255 million to continue work converting old M1A1 tank hulls into new M1A2 tanks. No new tanks have been built since the 1990s, and about 75% of the old tanks are re-used in the conversion process.

The Senate approved legislation to extend the life of the Export-Import Bank by three years. The Export-Import Bank (Ex-Im Bank) is the official export credit agency of the U.S. government. It was established in 1934 for the purposes of financing and insuring foreign purchases of U.S. goods for customers unable or unwilling to gain loans. General Dynamics hopes to benefit from the sale of additional Gulfstream planes through the program. Ex-Im Bank Chairman Fred Hochberg plans to provide more financial aid to U.S. corporate jet manufacturers, branching out from a traditional support for Boeing to help an industry where demand has suffered. Competitors such as Brazil’s Embraer SA and Canada’s Bombardier Inc. benefit through subsidies from their home export credit agencies. The Ex-Im Bank supported $90 million of corporate jet deliveries last year to customers of General Dynamics’ Gulfstream unit as well as Textron’s Cessna Aircraft and Hawker Beechcraft Corp. Hochberg has indicted that he hopes to boost the aid to $1 billion by 2014.


On Wednesday, Medtronic, Inc. (MDT) announced that it had been notified by the Justice Department that federal prosecutors have closed their investigation related to INFUSE Bone Graft with no further findings. The investigation began in late 2008 into whether the company marketed the product, a bioengineered protein that spurs bone growth, for unapproved uses.

On Thursday, Medtronic announced results from a new CoreValve ADVANCE study that shows that women and men benefitted similarly from the Medtronic CoreValve System. The study, presented at EuroPCR 2012, evaluated patients who were at high risk for surgical aortic valve replacement. The Medtronic CoreValve System is currently limited to investigational use in the U.S. The gender analysis found that survival rates were nearly identical between genders, with no statistical differences in 30-day and six-month all-cause mortality, cardiovascular mortality or the 30-day MACCE endpoint (major adverse cardiac & cerebrovascular events). “The robust ADVANCE trial provides a compelling discovery that the CoreValve System is an excellent therapeutic option for both men and women, and it helps us begin to consider how men and women present differently prior to implant and might be managed accordingly,” said Axel Linke, M.D., professor of medicine at Universitat Leipzig Herzzentrum in Leipzig, Germany, and principal investigator of the ADVANCE clinical trial. “An important next step will be to further evaluate why stroke events were more common for women, including the possible role of medications that were prescribed less frequently for women in this study.”


The Wall Street Journal reported on Tuesday that activist shareholder Relational Investors LLC has acquired a roughly $600 million stake in PepsiCo, Inc. (PEP), in a move that many observers believe puts pressure on the chairman and chief executive, Indra Nooyi. According to the article, the investment firm has let it be known that it feels that PepsiCo’s slow-growing beverages business would be better off as a separate entity from the rest of the company. Such a move is not favored by PepsiCo management. The article goes on to say that the investment fund and PepsiCo have met and discussed the structure of the North American beverage business and both sides have come to an understanding. A PepsiCo spokesman said the company has had constructive discussions with Relational Investors.

For several months, frustrated investors have been calling for a possible split of PepsiCo’s beverage and better-performing snack businesses. To counteract this, Mrs. Nooyi has taken steps to improve company performance, including cutting nearly 9,000 jobs and boosting the marketing budget in 2012 by as much as $600 million. The company has been struggling to keep pace with its biggest rival, Coco-Cola Co. (KO), whose Diet Coke brand surpassed Pepsi-Cola in 2010 as the second-best-selling soft drink brand in the U.S. The article went on to say that Relational Investors has indicated that it feels PepsiCo and Mrs. Nooyi are moving in the right direction with a focus on improving margins and returns and a focus on the North American beverage business. How long Relational’s patience will last, however, remains to be seen.


On Thursday, Target Corp. (TGT) announced that its first-quarter earnings rose 1.2% as sales were stronger than anticipated. In addition, the company raised its fiscal-year 2012 earnings outlook to a range of $4.10 to $4.30 per share from previous guidance of $4.05 to $4.25 a share.

For the quarter ended April 28, Target reported a profit of $697 million, or $1.04 per share, compared with a year-earlier profit of $689 million, or $0.99 per share. Analysts polled by I/B/E/S had been expecting first-quarter earnings of $1.01 per share. Total revenues rose 5.9% to $16.87 billion, which also beat analyst estimates. The company’s Canadian segment lost $55 million for the quarter, due to start-up expenses related to Target’s expected market entry in 2013. This reduced total company earnings by $0.08 per share for the quarter.

The company forecast second-quarter earnings would be in the range of $1.04 to $1.14 per share, excluding expenses tied to entering the Canadian market. The I/B/E/S consensus earnings estimate for the second quarter currently stands at $0.99 per share. The company also said May sales so far are “on plan” for a low- to mid-single-digit increase. However, it also cautioned that consumer confidence may be waning. “Consumers were feeling a bit more confident in their financial situation, making them somewhat more comfortable spending across all categories,” said Kathee Tesija, Target’s merchandising chief, on a conference call. “However, the consumer optimism about the future reached a peak in February, and began to decline in March and April.”


European Union regulators extended the deadline for their review of United Technologies’ (UTX) $16.5 billion bid for Goodrich until Aug. 31, 2012. As we have reported previously, the EU Commission’s preliminary investigation indicated potential competition concerns regarding the markets for engine controls and AC power generators. The commission also has concerns about the removal of Goodrich as an independent supplier of fuel nozzles and engine controls, as well as in the area of aftermarket services. The commission now has until August 31, 2012, to make a final decision.


Vectren Corp. (VVC) held its annual shareholder’s meeting earlier this week. Much of the information shared was already known, such as the impact of the warm winter. CEO Carl Chapman noted that the warmer weather hurt the utility and coal divisions (customer coal inventories are high), but helped the infrastructure services unit. Utilities account for between 80% and 90% of core earnings.

There were a few things of note, however. First, Chapman reiterated his target for annual shareholder returns of 8% to 10%, a figure that includes earnings and dividends. Secondly, he described the current payout ratio (which is 58%) as being “a little higher than we’d like” and stated 55% as the target. Finally, Chapman talked about opportunities for Vectren’s infrastructure unit. He said the aging energy infrastructure and growth in North Dakota’s oil and gas production are a source of additional revenues. He also mentioned the possibility of making another acquisition in this area.



Portfolio Calendar for the Week of May 21, 2012

Stocks Trading Ex-Dividend

Company Ticker Quarterly Dividend Payment
Payment Ex-Dividend Payable
No stocks are scheduled to trade ex-dividend during the week.

Stocks Scheduled to Make Dividend Payment

Company Ticker Quarterly Dividend Payment
Payment Payable Ex-Dividend
Eaton Corporation ETN $0.3800 Fri May 25, 2012 Thu May 3, 2012

Stocks Scheduled to Announce Earnings

Company Ticker Date and Time EPS Estimate
Medtronic, Inc. MDT Tue May 22, 2012 BMO $0.98 ($0.97 - $1.00)
AMC = after market close; BMO = before market open

Recent Dividend Announcements

Company Ticker Quarterly Dividend Payment
Payment Ex-Dividend Payable
No stocks have scheduled dividend payments during the week.
Recent Portfolio Alerts

Portfolio Additions

Date Company Ticker
5/4/2012 Leggett & Platt, Inc. LEG

Portfolio Deletions

Date Company Ticker
5/4/2012 Wal-Mart Stores, Inc. WMT