Sales of Emmental – the Swiss cheese with all the holes in it – are dropping. The chief reason is the rising value of the Swiss franc, up nearly 50% against the Euro in the past two years. Result: The Swiss are importing cheaper cheese from countries that use the Euro, and Emmental is losing out to Mozzarella.
There’s an important lesson here about the impact of hot money rushing into a small market. The Swiss franc is one of the few rock-solid currencies left, but the Swiss economy isn’t very big. So when global investors start moving money into the Swiss franc in search of safety, the impact is enormous. That’s what’s pushed up the price of Swiss cheese.
The reason I bring this up is that something similar is likely to happen to the highest-rated stocks – with happier results – as AAA-rated investments become scarcer. Hot money looking for the safest havens will head for the financially strongest companies. And since there aren’t very many such investments, their share prices are likely to soar. In my view, the scarcity of creditworthiness figures to be the most important investing theme of the next 20 years.
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Since this may all sound overly abstract, I’ll explain in more detail. There are three essential points:
1. Today’s important financial trends are really about demographics. It may seem as though the U.S. and Europe have suddenly become financially unmanageable. But there’s a simple explanation for the recent spate of problems in the industrial world. The Baby Boom generation – children born between 1946 and 1964 – began hitting age 65 this year. Up until recently, the Boomers have been in their most productive peak-earning years. Now they are retiring. For the next 18 years, the biggest bulge in the population will be leaving the tax-paying category and moving into the entitlement-receiving category.
2. Relentless increases in health-care costs will keep busting the budget. The news from Washington focuses on the never-ending struggle between budget-cutters and tax-hikers. But neither of those groups is addressing the most serious problem – soaring health-care costs due to expensive new medical technology and an aging population. The cost of Medicare and Medicaid as a percentage of GDP is projected to double to 13% by 2035, according to the Congressional Budget Office. That should more than wipe out whatever savings there are from non-entitlement budget cuts, as well as any politically feasible tax increases. Social Security, although financed with its own separate taxes, will get more expensive, too.
3. Investments with the highest creditworthiness will become rarer. Many institutional investors, such as life insurance companies, need to match their future liabilities with the safest investments available. There’s always been an almost infinite supply of the highest-quality credits because of the enormous U.S. Treasury bond market, as well as international bond markets. But as countries struggle with budgetary problems, there will be fewer and fewer top credits around. Some of the best will be a relatively small group of AAA-rated international corporations, as well as other select companies with no debt or plenty of cash on hand. This universe will be only a fraction of the size of the global bond markets that have traditionally been rated AAA.
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I’m not suggesting that the U.S. and other industrial countries are going to default. But over the long term, industrial countries will not easily be able to reverse the financial trends that have caused the recent debt-ceiling battle in the U.S. or the Euro crisis. And it is to be expected that institutional investors will want to move some money to the safest assets available.
The amounts of money are so large, and the pool of corporations that have the highest financial strength is so limited, that even the shift of a small percentage of global assets could drive the prices of the most elite stocks up to Swiss Emmental cheese-like heights.
Right now, the stock market is paying very little premium for creditworthiness. As a benchmark, just consider the P/E ratios, based on estimated calendar 2012 earnings, and the dividend yields of the four U.S. nonfinancial corporations that are still rated AAA: Automatic Data Processing (ADP, 16.3 P/E, 3% ), Exxon Mobil (XOM, 8, 2.6%), Johnson & Johnson (JNJ, 12, 3.6% ), and Microsoft (MSFT, 8.3, 2.5%).
There’s certainly not much premium in those valuations. And there are several dozen other U.S. companies of nearly equal quality trading at modest prices. Moreover, through mutual funds and ETFs you can have access to similar foreign blue chips.
Buying low, when premiums are washed out, is the best strategy for long-term investing success. From that perspective, today’s investors actually have a safe and very timely strategy available. Put together a portfolio of the most creditworthy stocks, including foreign blue chips if you like, that also offer above-average yields. Then whatever the bad financial news may be, you’ll know that your shares eventually stand to receive a premium valuation as hot money goes looking for the last safe havens.
