Focus Your Portfolio On Big Cap Stocks and Sleep Well

This morning I took a moment out from writing some large articles which consumed all my time yesterday, to read an interesting article on loan to deposit ratios over at Soberlook. The author presents an overview of the USA Total loan balances relative to bank deposits and shows how this loan growth rate is continuing to deteriorate. In other words deposits are growing but loans from banks are declining. This is often looked upon as a problem for further economic expansion because the theory is that capital is not being loaned out fast enough or in sums big enough to grow businesses and the economy.

What I also found interesting was a chart showing that this pattern actually does not appear to lead to a recession. On one hand then analysts feel that a declining rate of loans is poor for business growth which would seem logical, but the pattern certainly points to recessions during periods when the rate of loans is higher. You can review the article through this link. Perhaps part of the reason is that these periods of declining loan rates leads to period of higher loan rates meaning that recessions are spawned during the loan rate periods but fail to show up until the high rate period sets in. In other words when loans are tighter the groundwork is being laid for a slowing economy. When this is spotted by the administration, loan rates increase but they are too late to reverse an economic slowdown. Just thinking out loud on that one.

I commented on the article but thought it would be worth a few more words on my site as it relates to investing.

USA Rate Of Loan Declines

From a purely economic point it does make sense to think that a declining rate of loans does lead to a slowing economy. However perhaps there is more to it than just freer capital being made available. When an economy also has stronger deposit trends it seems to help stabilize the nation as a whole. Everything from a more stable dollar to stable inflation outlook seems to be a result in part by the rate of loans and deposit rates. When the rate of loans is rising rapidly we also seem to see a rise in inflation and while the economy does bubble along, often a lot of the capital is not just being loaned to start-up and growing businesses but to individuals buying everything from cars to houses. The looser credit is the more buying individuals certainly seem to do. While the economy does seem to grow more rapidly, a lot of the growth appears to be more in a bubble environment such as we saw with housing.

Housing and Your Personal ATM

When housing became an individual’s personal ATM, as it did from about 2002 to 2007, the savings rates also plunges. With the Fed trying a balancing act between loans and deposits, perhaps the economy is entering a period of more stable and sustained growth. We do know from past history that lots of free cash seems to lead to economic crashes and tight credit seems to lead to recessions. But having a declining loan rate at the present interest rates may in fact be helping to sustain the present economic expansion and help the economy heal from the last financial crisis.

Crisis Averted?

When individuals have cash available, they do not need to borrow as heavily. In a crisis such as the past housing crisis, if more individuals actually were able to maintain their housing payments perhaps many more homes would not have been repossessed by banks and the huge influx of distressed houses may never have happened. While this in itself would not have stopped the financial crisis, it would possibly have made it less severe. The fact that the financial crisis was averted through a huge inflow of liquidity shows that despite high loan rates, there was actually little free capital available to assist in bailing out financial institutions from the over-leveraged mess they were in.

But this is only speculation on more part and certainly lots of economists and analysts would disagree and probably strongly.

Strength and Confidence From Big Cap Stocks

But I do think while a declining rate of loans can impact start-ups and small to medium businesses I think these statistics may also be telling us that loan demand is at present lower. Part of this has to come from the huge number of corporations that have refinanced through the last 5 years.

Historic low-Interest Rates

With interest rates at historic lows corporations in not just the USA but worldwide have issued corporate debt at historic lows. Many corporate preferred shares that were paying over 5% and 6% have been recalled by many corporations for obvious reasons and new preferred shares are often being issued at 3% and 4%.

Larger Corporates Are Self-Financing

So while the rate of loans is poor, many corporations are flush with cash. Overall I would have to believe that a declining rate of loans is not affecting too many larger corporations, but may indeed impact smaller ones. This is just another reason I prefer to stay with larger corporations for most of my stock and option investing. Larger corporations such as Coca Cola, PepsiCo, McDonalds and pretty much most of the corporations I trade within, have much easier access to cash. Not only can they borrow but they are also able to issue preferred stock and corporate bonds. In essence they can raise their own capital. This is exactly what these large corporations have done over the past 5 years and again this can only lead to a lower rate of loans overall. This is a smart move on the part of these corporations. They have financed themselves at interest rates that have actually never existed before.

No Problem Getting Financing

Since decades ago I found out that I was terrible at picking the next “great” stock to trade and instead had years of up and down returns, I turned to big cap stocks that are market leaders in the field. These are the types of stocks that are so big that they can get financing when they need it and issue preferred and common stock as well as corporate bonds that will be picked up. Many of them have balance sheets stronger than small countries.

Sleeping Nights

I found that while many of them did not have the big annual returns of the speculative stock or small to medium size stock, I did not have to worry about these stocks being wiped out. This meant that I did not need to worry about my capital being wiped out. It also meant that in a crisis period such as the financial crisis of 2008-2009 and the 2001 to 2003 bear market, I had confidence to trade within them even though they declined along with the market direction itself.

Decline In Value Was An Opportunity Not A Nightmare

In fact the decline in value was welcomed because it gave me the chance to buy my favorite big cap stocks at deep discount prices.

For example below are 6 stocks that I trade continuously in. I have traded these stocks for more than a decade. Each chart below shows that stock from their highest valuation in 2007 to October 2013.

Johnson and Johnson Stock

Johnson and Johnson Stock for example pulled back to below $50.00 in the last bear market but it has recovered well and now has doubled its value. The dividend has also been increased annually. This type of stock is ideal for my Put Selling strategies. A collapse in a stock like this during a recession or bear market is almost welcomed.

PepsiCo Stock

Another similar stock is PepsiCo Stock. While it does not command the market share of Coca Cola, PepsiCo is a giant in its industry. In 2007 it was trading almost where it is today. It then collapsed losing 50% if its value in the bear market of 2008. But again, this stock has recovered and my Put Selling has worked well for decades. When a stock like PepsiCo Stock collapsed like it did in the bear market of 08-09, I began to buy small quantities of the stock starting in October 2008 and continuing into April 2009. Without the confidence that the stock would recover, it is almost impossible to trade within small to mid cap stocks during a crisis or bear market because it is difficult to know which ones will survive. Even among the ones that do survive you have to wonder how long they may take to recover.

Coca Cola Stock

With a stock like Coca Cola Stock I never worry about how long it may take to a full recovery from a pull back or bear market. If this type of stock took years to recover, it would not matter to my Put Selling strategy or any of my stock and option strategies because I know that eventually this stock will recover. I cannot say the same of many small to mid cap stocks.

McDonalds Stock

Another corporate leader is McDonalds. McDonalds Stock weathered the financial crisis of 08-09 well without a cash flow problem despite the downturn in the economy. Again, this giant corporation has a steady cash flow and no problem issuing corporate debt and shares. This type of stock makes buying it during a steep recession such as we saw in 08 – 09 an easy decision.

Microsoft Stock

Even a stock like Microsoft Stock which has still not recovered to the highs of 2007 does not concern me and does not impact my stock and option strategies. This stock has a huge cash flow and no problem raising additional cash as we have seen in its past corporate bond offerings. I never worry that Microsoft Stock may end up at collapsing and disappearing, taking my capital with it.

Intel Stock

Another stock that has not done much since 2007 is Intel Stock. Yet the sideways pattern works incredibly well for my stock and option strategies and once again this mammoth of a company never has trouble raising cash.

Big Cap Stocks Focus Summary

So while the rate of loans may be declining to the most they have been in 30 years and the rate of deposit steadily climbing, I believe that any problems will first appear in the small-cap stocks and then spread to the mid-cap stocks. I trade within those companies that have balance sheets of tens of billions of dollars and assets worth even more. These companies give me the confidence to continuing to trade my strategies no matter what the economy may throw at. I do believe every investor looking for solid annual returns to compound their portfolios needs to consider the ramifications of trading within only small or mid cap stocks. For every homerun, there are lots of outs. With my big cap stock portfolio though any event that looks like an out instead is an opportunity to buy at discounted prices. That’s the type of confidence I enjoy and need for my portfolio to experience annual double-digit growth rates.