Sunday, February 27, 2005


I read a piece by Standard and Poors today that put in sophisticated terms part of what I have been saying for a few months; now is the time to invest in large cap value. Two or three months ago, I emailed several readers directly in regard to IRA and 401-K accounts. I suggested moving out of small cap growth funds and into the S&P 500 index. The move has paid off. The S&P 500 index has out-performed other markets and closed at its 2005 high Friday.

The fancy language used by Standard and Poors boils down to a call to avoid interest rate sensitive securities. Again, I have suggested that one should avoid bonds and I have even publicly announced my trade of DUK for NSC. The S&P article states that growth stocks are more sensitive to interest rate changes than are value stocks and the duration of the market is now 19 years; up from 15 in 2003 but down from 23 in 1999.

Duration is a measure of the time it takes to get your money back from a bond investment. A bond with a high coupon interest payment would be of shorter duration than a lower coupon bond on the same maturity. S&P has applied the concept to the stock market. Undoubtedly they will charge a stiff fee for lists of stocks by duration.

I don't see much value for such a service. It is easy to understand that NSC (Norfolk Southern Railroad) is economically sensitive relative to DUK (Duke Energy) which is more interest rate sensitive. Trying to determine the exact number implies a higher degree of accuracy than I think is reasonable to expect.

So far, I have been wrong about NSC and DUK by a tiny margin. I would still have made the trade knowing a duration number on these stocks. I would still be at a tiny loss and would be at the tax advantage of holding the gain un-realized on DUK. However, I still believe the US economy is moving into an expansion that will cause long-term bond rates to rise. I do not believe the rise will happen until after the trade deficit starts to turn or until after the dollar strengthens. Never-the-less, I want to be out of DUK and into NSC before these other events occur.

Note, I am not advocating trading out of growth stocks. It is the Standard and Poors article that talks about growth stocks having long duration. This is obviously true because growth stocks generally pay smaller dividends than value stocks pay. But, I don't buy growth stocks for the dividends and projecting capital gains far in the future is problematic at best. The point is that it would be a mistake to sell out of a superior growth stock only because its duration is lower than any number of value selections.