Archive for August, 2006

2006-08-29 :: Defensive Stocks

Tuesday, August 29th, 2006

There is a lot of interest in defensive stocks right now.  I have a problem getting excited about them as their earnings and valuations are so mismatched.  Their earnings just don’t support their valuations, which are in typically higher than average and their earnings are less than average.

The chart above shows you a 5-year comparison of Apache Oil and Johnson & Johnson.  Apache falls within the group of cyclical stocks closely tied to economic growth; Johnson & Johnson is a defensive stock that you are supposed to own to protect against an economic downturn.

The growth of Apache over five years exceeds 200%; the growth of Johnson & Johnson over the same five years is 25%.  When constructing a diversifed portfolio, including the defensive stocks can lead to significant underperformance of portfolio returns.  Every few years, the defensive stocks will outperform the cyclicals for a few months.  In anticipation of the last recession (5 years ago) they outperformed for a period of nine months, then languished for five years, barely keeping ahead of inflation.

We are adding some defensive names, with stop losses set, to get us to the next stage of the cyclical bull market.  The defensive names will be our source of funds to reposition client portfolios at that time.  The long-term name of the game is investing with the economy, and ultimately the cyclicals will be the winners.

More later!

mb

2006-08-26 :: Energy and Other Thoughts

Monday, August 28th, 2006

The Energy sector ended last week quite strong, with oil topping $72 and energy stocks up 2% on average for the week.  Oil was down in Europe overnight, so we’ll have to see what happens today.

We start this week off with news of a merger, with Western Refining buying Giant Industries.  As we’ve discussed several times in the past, companies in the Energy sector are making huge earnings and accumulating an unbelievable amount of cash.  If they don’t put that back into R&D to find new oil reserves, they have only a couple of other choices available:  increase dividends to shareholders, buy back their own stock, or buy another company.  All three are positive to stock prices in the Energy sector.

The broader market was down last week in spite of Energy being up.  Investors had fears that the economic slowdown would pick up steam and turn into a recession based upon economic reports showing housing sales were slowing further and the index of US manufacturing showing a significantly bigger contraction than forecast.

One sector that we are trying to increase exposure to is the large cap pharmaceutical companies.  I continue to wait for a pull back to the 21 or 50 day moving averages so we can get in.  The three companies that I want to add are Merck (at $38.50), Pfizer (at $26.35)  and Johnson & Johnson (at $63.75).    When we do buy in, we’ll set stop losses at the 50 or 200 day moving average level to protect the positions in case this sector is used as a source of capital when the market turns and money begins to flow back into the cyclicals.

More later!

Mark

2006-08-24 :: Tweaking Infrastructure

Thursday, August 24th, 2006

Infrastructure stocks are still one of my favorite asset classes, in spite of their dismal performance since May 12th’s stock market selloff began.  We have been using this time to tweak our holdings of infrastructure companies, and have sold off two:  Florida Rock and Headwaters.

Florida Rock has a great long term track record and will be a great company to own in the future.  Unfortunately, their fortunes are tied very closely to the housing market, which is in a consolidation mode for the forseeable future.  Florida Rock is benefiting from the rebuilding of the post-Katrina Gulf Coast, but not enough to convince the traders in New York that its not a housing stock.

Headwaters growing business segment is one that converts the byproducts of burning coal (the ash) into useable fuels.   Unfortunately for them, they also have a housing related business segment (manufactured stone and siding), which is causing them to be sold off with the housing market.  The coal-related business is the reason we purchased HW in the beginning, and it is seeing strong earnings growth as anticipated, given the move to add coal fired generators to electric plants to replace natural gas generators.  But, its tough to fight the trend when the traders get something in their heads.

We’ll likely buy these stocks back at some future point as their business fundamentals are too sound.  Right now, though, we will focus our infrastructure investing on non-residential housing related companies.

Below, I’ve cut/paste a story from BusinessWeek that details the success of the non-residential infrastructure business. 

More later!

Mark

Construction: A Tale of Two Sectors

Is there a building boom in the U.S.? It depends on which segment of the construction industry you’re looking at.

A surprising array of major U.S. macro indicators — consumer spending, factory activity, corporate profits, and trade — continues to defy expectations of an economic slowdown. And that strength is also fueling a hefty boom in the nonresidential construction market. But good news for the builders of office buildings and schools hasn’t filtered through to the economy’s one nagging weak spot: the housing market.

Flush times continue for the nonresidential construction industry. Nominal [i.e., unadjusted for inflation] growth in the sector has hovered in the 17% to 25% range since Hurricane Katrina, with little signs of a slowdown. The boom in the real [adjusted for inflation] spending figures has been nearly matched by an unprecedented explosion in construction materials prices.

What’s the implication here? Companies’ construction spending is in nominal dollars, so when price pressures finally subside in this booming market — as suppliers eventually deliver larger quantities to buyers — the dropback in prices will probably allow a sustained solid growth path for real spending. Companies should be able to accelerate building plans as acquisition of materials becomes more price-effective.

2006-08-21 :: Earnings Growth in the Second Quarter

Monday, August 21st, 2006

The chart below from Dirk Van Dijk shows earnings growth for the various industrial sectors.  Not surprising, Energy is at the top, with 65.62% earnings growth during the second quarter.  Others of my favorite sectors are also near the top, Industrials and Materials.

At the bottom, you’ll see Consumer Staples, the industry group that has been acquiring the most interest recently as the talking heads have been telling everyone to move into defensive stocks.

When you invest in a company, you are really purchasing a stream of future earnings.  A stream that is growing 65% is inherently more valuable (particularly when you pay 7, 8, or 9 times those earnings as measured by the P/E ratio) than a stream growing by 5% (and you are forced to pay 22 times those earnings as measured by the P/E ratio). 

The traditional rule is that during an economic slowdown, you move into defensive stocks.   I read those books, too, in my Masters classes, but come on…how about some independent thought and reasoning.  We are now living in a world economy, not in a compartmentalized US economy.  At the margin, world-wide liquidity is tightening, but not enough to throw us into a worldwide recession.  As proof of that, one of the most sensitive economic indicators, the Baltic Dry Index of shipping rates on the world’s busiest shipping routes, is booming; its up 60% over the last three months.  Oh, those three months also correspond to the period when the defensive stocks have been outperforming those stocks tied to economic activity.

The current lull in the economically sensitive stocks is only natural after a few years of outperformance.  But the earnings growth numbers will prove to be the deciding factor and all of the people that moved into defensive stocks will miss the turn in the market. 

Based upon recent reports they’ve published, Citigroup and Goldman Sachs are both clearly in the corner that says that the economically sensitive stocks are due to turn around soon.  Most of the rest of Wall Street is pushing for the defensive stocks.   When in doubt, follow the earnings; they generally lead to profits, particularly for investors.

More later!

Mark

Sector Q2 Median
Growth Rep.
Q3 Median
Growth Exp.
2006 Median
Growth (Exp)
Q2 Median
Surprise
% Reported Pos
Surprise
Neg
Surprise
Match
Energy 65.62% 25.00% 29.39% 4.82% 96.67% 21 8 0
Industrials 18.64% 17.48% 16.67% 3.22% 94.34% 38 7 5
Telecom 16.88% 19.26% 2.42% 6.90% 100.00% 8 1 0
Materials 14.82% 21.43% 23.93% 3.62% 100.00% 24 5 1
Utilities 13.33% 7.76% 3.25% 7.59% 100.00% 20 8 3
Cons. Disc. 11.11% 8.33% 10.93% 4.65% 91.86% 60 10 9
Health Care 10.61% 8.47% 10.64% 4.17% 94.64% 42 7 4
Financials 9.91% 8.51% 10.53% 3.13% 97.70% 61 17 7
Tech 8.58% 7.57% 10.18% 3.85% 81.01% 39 16 9
Cons. Staples 5.00% 3.39% 6.70% 3.39% 89.74% 26 6 3
S&P 500 13.21% 9.38% 11.48% 3.90% 93.00% 339 85 41

2006-08-20 :: The Week Ahead

Sunday, August 20th, 2006

This coming week is light on economic news, with housing sales stats (existing and new) due out Wednesday and Thursday.  Fed Chair Bernanke is also scheduled to speak on the economy at a meeting in Jackson, WY. 

However, the big news is that on Tuesday Iran is scheduled to announce whether they will accept the incentives that the US and Europe have offered it to end its nuclear program.  I doubt that anyone is expecting that they will give up their program; the best case scenario is that they will indicate they are more accomodative to inspections and monitoring.  Their response has the potential to rock the markets if they thumb their nose at the negotiators, but they are more likely to seem accomodative and act otherwise (that’s been their pattern so far when dealing with the European negotiators, according to the International Atomic Energy Agency).

The week ahead will continue to have its turbulence.  Last week was very friendly, with the broader markets up a couple of percent.  The positive sentiment came from the feeling that the economy could acheive a soft landing, that oil prices were headed below $70, and that peace in Lebanon would hold. 

Have a great week!

Mark

2006-08-15 :: Entry #2 – Oil Technical Analysis

Tuesday, August 15th, 2006

Here is a great article/analysis that I’ve cut/paste from RealMoney.  I thought you might like to see someone other than myself who believes that we are in a long-term bull market for Energy.  This article is long on technical analysis, which I’ve written in the past is a good partner to but not a substitute for fundamental analysis.   As the article progresses, there is some very logical fundamental analysis included that sounds an awful lot like stuff I’ve written here in past entries.  Hope you find this interesting….Mark

Trend Is Still Crude’s Friend
By Jim Wyckoff RealMoney.com contributor
8/15/2006 8:16 AM EDT

Image

Image Veteran traders know “smart money” follows market trends. Indeed, the market adage “the trend is your friend” has made many a trader wealthier over the years. In the crude oil market, the trend has been for fundamental events — both expected and unexpected — to support rising prices over the past seven years.

The latest unexpected fundamental event to support the crude oil market is the partial shutdown of a major BP (BP) oil pipeline in Alaska. While it has been reported that a total shutdown of the line is now unlikely, a partial shutdown will reduce output by about 50% — or around 200,000 barrels per day. Just before that, it was a marked escalation in fighting between Israel and Hezbollah. Before that it was Iran and its nuclear ambitions. Last year it was Hurricane Katrina.

Crude oil futures prices at the New York Mercantile Exchange are in a steady climb from the December 1998 low of $10.35 a barrel. Last month, the nearby NYMEX crude oil futures contract hit an all-time high of $78.40 a barrel. Deferred crude oil futures contracts have hit levels above that mark.

The monthly chart for NYMEX crude oil futures shows a steep price uptrend from the 1998 low is still firmly in place. There are no technical clues to suggest the steep and strong uptrend in crude oil prices will end anytime soon. Remember that the trend is your friend in trading markets.

To underscore the strength of the uptrend in crude oil futures prices, the Directional Movement Index (DMI) technical indicator overlaid on the monthly crude oil chart shows a present ADX line reading of 33.83. (The ADX line is a technical indicator that measures strength of directional movement of a market or stock. Any ADX line reading above 30.00 suggests a strong price trend is in place.)

Source: Jim Wyckoff

An important aside is the fact that the Continuous Commodity Index (CCI) recently hit a fresh 25-plus-year high, which also bolsters the notion that it’s unlikely crude oil futures prices will fall back significantly any time soon. The CCI is a basket of raw commodities prices rolled into one composite price index. The index is watched very closely by traders in all markets and is an excellent gauge of overall raw-commodity price inflation in world economies. In other words, raw-commodity price inflation is at a level not seen in over 25 years — led by the rise in crude oil prices.

With strong economic growth in China, India and other industrialized countries, it’s not likely that demand for raw commodities, including crude oil, will subside. Raw-commodities market bulls are presently basking in a worldwide tightening of supply-and-demand ratios for many raw commodities. In crude oil, from a geopolitical perspective, many industry veterans argue that there is anywhere from a $10.00- to $30.00-a-barrel “risk premium” built into the futures market at present. This means added value has been put into crude oil prices because of geopolitical uncertainty — be it Middle East, African or Venezuelan tensions, or the general threat of terrorist acts against energy infrastructure facilities around the globe. Don’t look for this added-risk premium to abate any time soon.

Interestingly, crude oil bears can correctly ascertain that any large terrorist attack against a major world economy could produce an immediate drop in crude oil prices. Reason: The possible sharp reduction in demand for jet fuel, gasoline and other energy due to consumers suddenly tightening their belts and staying home, for at least a short period of time, following any such terrorist act or threat thereof. Such was the case last Thursday, when oil prices fell amid revelations U.K. authorities had foiled a terrorist plot aimed at U.S.-bound airplanes.

Bottom Line: Bulls will continue to enjoy the solid advantage in the liquid energy futures markets. While corrective setbacks in prices, such as early this week, are a normal market occurrence, look for the nearby crude oil price — which at present is the September futures contract for the NYMEX — to trade in a range at higher levels — bound by overhead technical resistance at the contract high of $76.52 and by solid downside technical support at $70.00 a barrel. However, any escalation in the present Middle East crisis, or a terrorist attack on a major oil installation — such as has been attempted in Saudi Arabia — will most certainly spike crude oil futures above the $80.00-a-barrel price level — and possibly even close to $100 a barrel for at least a short period of time.

2006-08-15 :: Lower Than Expected Inflation Report

Tuesday, August 15th, 2006

There’s joy in the streets this morning as the Producer Price Index reported much lower than expected.  The PPi came in at a 0.1% increase, below the 0.4% concensus projection and teh core rate actually fell 0.3% compared to a projected 0.2% increase.

Traders are taking this as a sign that the Fed is closer than ever to being finished with higher interest rates.

We’ll likely see consumer and economically sensitive stocks rally this morning.  If we see follow through until the end of trading today, that will be a good sign for the struggling markets.  If, like yesterday, we have an early rally that fizzles out by the end of the day then the struggle will continue for the forseeable future.

The big test is tomorrow when the Consumer Price Index is released.  If we see a similarly friendly CPI number, the consumer and cyclical stocks should react positively.

What to watch for:  since the following news items that should have caused rallies fizzled – the Low Employment Number Rally, The Fed Pauses Rally, the  Israel-Hezbollah Cease Fire Rally – we need the Inflation Numbers Rally to take hold and sustain.

As an aside:  the defensive stocks are way overvalued at this point.  Proctor and Gamble is sporting a near 25 P/E with earnings growth projected in the low teens.  Why own this other than because its a rule of thumb to own it as we move out of a Fed tightening phase?  The last time the defensives out performed was in 2001, and it lasted for nine months.  Since then, the cyclicals tied to the US economy more than quadrupled the performance of the defensives.  Stick with earnings growth and low P/E’s for long-term outperformance; just ride out the current lemmings-following-the-rule-of-thumb market and all will be well.

More later!

Mark

2006-08-14 :: Macroeconomic News Takes Center Stage

Monday, August 14th, 2006

Now that we are past earnings season and found that the energy, metals, and infrastrucutre stocks are printing money (the infrastructure stocks were up 3% on the week compared to a market that was broadly lower), its time for the market to focus on the macroeconomic and geopolitical news that is going to impact the market.

Foremost, we have an inflation report coming at us that will likely show that inflation increased again last month.  This will add concern to the traders that the Fed’s pause will be short-lived.

Also, we had the Israeli-Hezbollah cease fire instituted over the weekend, but fighting resumed a few hours later.  This may be just a small skirmish or a full breach of the cease fire, its hard to know now.

Energy stocks, in spite of strong earnings, will likely move lower if the cease fire holds.

The graph above was borrowed from Mark Manning.  It shows the performance of the commodity index fund (a fund of energy and metals stocks).   You can see that these stocks – despite the recent pullback – remain in a long-term uptrend and have not breached the trendline.  I know its been a difficult market this year, but as you can see from the graph we remain in a long-term bull market for these stocks and we just have to wait out the current soft patch.  When they resume their upward move to the next high, the earnings growth and low P/E will propel these companies to the normal double digit returns.

More later!

Mark