Archive for September, 2006

2006-09-27 :: 11,709 Today?

Wednesday, September 27th, 2006

6:30 AM – It looks like we are set to break through the key 11,709 level on the Dow today as the futures point up.  As discussed in the post the other day, if we break through 11,709 we will have cleared the double top formation in the chart and should continue to head higher, barring any major problems in the approaching earnings release season.

8:30 AM – U.S. stock market futures turned lower, erasing earlier gains, after weak durable goods data and a rise in crude prices spooked investors who had been focusing on a run at all-time highs for the Dow Jones Industrial Average.

9:00 AM – We are at 11,706, the cash market is going up in spite of the futures!

If we break through the 11,709 level, we will be adding positions as described in the earlier post, repositioning portfolios to fit with the revised investment strategy.

More later!

Mark

2006-09-23 :: A Busy Week

Saturday, September 23rd, 2006

It was a busy week in my world.  As you read on Thursday, we have changed our investment strategy for the next several months, until the current correction in the cyclicals, energy and metals stocks abates. 

Toward that end, when the energy stocks rallied we sold 1/2 our positions in a number of names.  We will continue to pare back  energy positions on rallies with the full understanding that we will likely buy back some of those same names in 2007 when the energy bull resumes.

Thursday’s posting also told you how we were going to re-deploy those funds.  From a tactical standpoint, we need to wait to see if the broader market is going to go into a decline during October.  The chart of the Dow you see above (cut/paste from Dick Arms at Realmoney) shows that we are forming a classic “double top” in the market.  If  the index can break above the 11,709 level reached in May, we will put this cash to work in the areas discussed in that posting.  However, Wednesday’s peak at 11,680 and the subsequent fall to Friday’s close at 11,508 seems to indicate the market will follow the standard pattern of a double top and retreat to that 11,300-ish level at the peak of the inverted V in the middle of the W. 

Late September and early-mid October are seasonal downdrafts in the broader markets, before the traditional end of year rally.  Over the next couple of weeks, the most likely course for the market is that the Dow will retreat to the 11,300 level and then rally back to and potentially above the 11,709 level by year-end.  As the market corrects and we see price entry points for the stocks that fit into the revised strategy, we will be putting the available cash to work so that we can fully participate in the rally into the new year.  If we get a quick reversal of the current downward move to break above the 11,709 level, we will invest that cash immediately as the 11,709 level would provide the new “floor” for the market.

For those of you that watch your accounts online, you will see the energy sales settling early next week.  If you don’t access your account online and you’d like to, feel free to contact Andy and he can set you up ( thorman@bankchampaign.com or 217-351-2870 ).

Have a great weekend!

Mark

2006-09-21 :: Strategy Update

Thursday, September 21st, 2006

Sorry for not posting anything for the past week, but we’ve had bank examiners and I’ve been tied up with them and with re-assessing our investment strategy.  Below is the strategy that I began to implement over the past few days.   It is always a major undertaking to make a shift when there are changes in the macro-investment environment.  I have been hoping to reduce our energy exposure to the moderately overweight level discussed below, but with three energy hedge funds collapsing and dumping their stocks in recent weeks, it has severely hammered the energy sector.  As rallies ensue in the aftermath of the hedge fund disasters, we will use that as our selling points.

Anywany, here is the revised strategy:

·        The United States economy has entered a period of sustained economic growth, with fewer and milder economic recessions, which allows the companies that benefit from economic growth to flourish and their stockholders to enjoy above average investment returns.  Cyclical industrial companies, energy and mining stocks are the winners here.

·        The economies of China, India, Brazil and Russia, along with the smaller Far East economies, are the engines of growth in the world and will become increasingly important as their citizens move from third world living standards to western living standards.  Energy, mining, and heavy equipment stocks will benefit from this.

·        The deficits we are experiencing in the United States will ultimately lead to a devaluation in the dollar compared to other currencies against whom we compete.  Having an emphasis of Canadian, Japanese, Australian, and European stocks in portfolios will protect against adverse consequences of the devaluation and will provide additional returns as well.

·        The demographic trends in the developed world, whereby the baby boomers in the US and Western Europe are beginning to reach retirement age mean that an ever-growing amount of money will be spent on health care.  Drug stocks, generic drug stocks, medical device makers, and related companies will be the big winners in this trend.

·        In the long-term, the supply/demand imbalance in the energy market will continue to lead to ever-higher energy prices, and a move into coal and other alternative fuels. Energy stocks, coal producers, and alternative energy producers will benefit from this imbalance.

·        The geographical location of energy reserves will have a particularly important impact on investment returns.  Companies that have reserves of oil and natural gas in the United States and Canada will ultimately be valued higher than companies with supplies subject to political or philosophical events, in countries like Iran, Nigeria or Russia.

·        In the near-term, likely through much of 2007, energy companies will be in a flat trading range, with occasional bounces up.  The exception to this will likely be the deep-water drillers and their suppliers.  We will use rallies in these stocks to pare back our exposure to a moderately overweight position, and re-deploy those assets into large-cap growth stocks and financials.  We will also continue to re-allocate energy exposure to the deep-water drillers and their suppliers.

·        Near-term, through the end of the year, we will be concentrating on technology (non-semiconductor), financials, and building positions in large-cap growth stocks.

·        The economic conditions of 2007 will likely benefit large-cap growth stocks, given their relatively consistent (albeit it low) earnings growth.  Financials should also benefit from the anticipation and ultimate implementation of a Federal Reserve interest rate cut. 

·        It is currently not predicted that we will see a recession in 2007, but the only caveat to that is the fact that every time we have had a real estate bear market nationally (despite what might be happening at the local level of individual communities) the US has had a recession.  In a market that goes through a recession, bonds and bond-equivalents will also benefit from a lowering of interest rates that the Fed implements to combat the economic slowdown.

·        As the economy begins to strengthen in 2007, we will see a return to the energy bull market and the return of the cyclical stocks that provide the outsized returns stocks can provide.  We are simply in one of those transition markets that provide low returns because the types of stocks that lead the market do not have the earnings growth on average to support significant investment returns.  There are specific case where a particular company will rocket ahead higher, but that will be the exception and not the rule.

·        Our revised equity sector targets for client portfolios based upon this strategy revision:

Basic Materials – 7.5%

Consumer Discretionary – 2%

Consumer Staples – 5%

Energy – 15%

Financials – 17.5%

Health Care – 15%

Industrials – 15%

Information Technology – 15%

Telecommunications – 3%

                                                Utilities – 5%

2006-09-12 :: Energy Update from Morgan Stanley

Tuesday, September 12th, 2006

Below is a cut/paste from a report yesterday (in the midst of the Energy Sell-off) by Morgan Stanley on the Energy Sector.  They continue to view it as being able to outperform the overall market from an earnings standpoint. 

I agree with their analysis.  It is easy to second guess yourself and lose sight of your strategy during a sector correction/rotation, like we see right now.  In spite of Wall Street earnings estimate cuts for the defensive stocks, the momentum investors (who are currently ruling the roost in terms of active trades at the exchanges) are selling the oils and metals (again, in spite of earnings upgrades and affirmations by Wall Street) and putting money into the defensive stocks.  This sort of counter-intuitive momentum move usually lasts a quarter or two before things revert to the fundamentals.  Unfortunately, it can be rather painful to endure while its going on.

“There is currently high correlation between Return
on Sales and P/S and Return on Net Operating
Assets (NOA) and EV/NOA. With the rally becoming
more mature, expectations and relative valuation of the
service and equipment stocks in our coverage universe
have started to become uniform. On 2007
expectations, BJS and GRP are starting to price in
stalling growth while SLB and the subsea equipment
and engineering firms have the highest growth
expectations beyond 2007. We see the international
OCTG segment as the only area where we expect
strong growth beyond 2007, while the market appears
to price in more of a peak. We would therefore expect
the outperformance within this segment to continue.”

During a market like this, we take the opportunities that are given to us.  We sell off certain assets to generate tax losses for taxable accounts to offset future gains.  We reposition within sectors to take advantage of the companies with the best growth possibilities within the sector (like swapping BJS and GRP for SLB, as Morgan Stanley discusses above).  We generate cash from the stocks that perform best in the earliest part of the cycle and hold steady or increase positions within companies that perform best in the later parts of the cycle.

When you see a screen full of red, its easy to lose faith.  That’s not our job, though.  Its our job to provide the best long-term returns possible for out clients, and we have to capitalize upon the opportunities that are present.  That’s what we are currently doing.

More later!

Mark

2006-09-11 :: Energy Super Cycle Still Intact

Monday, September 11th, 2006

Below is an article from an energy analyst that outlines why the energy investment cycle is still in full swing.  I liked it so I thought I’d share it with you.

The Oil Cycle Is Intact
By Christopher Edmonds

9/8/2006 2:00 PM EDT Image

Image With crude oil trading around $67 a barrel, skeptics are arguing that the bullish part of the oil cycle is over. After all, prices are down nearly $8 from their highs and are near five-month lows. If you’re a worrier, it’s time for some perspective. So far in 2006, the average price for a barrel of crude is $59.44. In 2005, the average price of crude oil was $50.04. The last two bullish cycles for crude — 1999 and 2001 — occurred with oil prices at $16.56 and $23.00, respectively. As a result, it’s hard for me to characterize $67 oil as bearish. In fact, as I’ve argued on this site for more than a year, $60 crude is, in the long term, more bullish than $70 crude, because it lessens the impact of high crude prices on the consumer and the economy. The recent decline is the result of several issues:
  • Gasoline demand is seeing a seasonal slowdown as summer driving season comes to an end.

  • Heating oil (another refined crude product) faces a lack of demand before cold winter winds blow.

  • There’s been a lull in geopolitical events that have placed a supply risk premium on crude prices.

  • The 2006 hurricane season has, to date, been uneventful.

Each of these factors should contribute to a decline in the price of crude oil, but that shouldn’t suggest crude is headed straight back to $40 a barrel.

The Cold Shoulder

In the past decade, crude prices typically weaken in the shoulder months, which are the periods in the spring and fall during which demand slows. In the fall, consumer demand shifts from gasoline to heating oil. In spring, consumers start to demand gasoline instead of heating oil. Shoulder months are also a popular time of the year for maintenance. Many refiners perform routine, seasonal work on their plants to ensure they’re in peak operating condition and to prepare for the turn from gasoline to other distillate products. This year could see more refining downtime than normal. Many refineries that were online after hurricanes Katrina and Rita have been running full tilt since last fall to make up for plants that were damaged in the storms. As a result, the need for longer turn times and outages becomes more prevalent as they play catch-up. Valero (VLO) , the nation’s leading independent refiner, said this week that it was hoping to keep its maintenance schedule as light as possible. However, the company hinted that certain refineries — including its Houston, Memphis, Tenn., and Port Arthur, Texas, plants — would be down at times for equipment upgrades. Valero had a handful of unexpected second-quarter outages, which allowed it to complete a portion of its regular maintenance ahead of schedule. Other refiners, such as Tesoro (TSO) and Sunoco (SUN) — and integrated companies such as Exxon Mobil (XOM) — may all face similar maintenance schedules as the turnaround season begins.

The World as We Know It

The world stage will also continue to present challenges to crude supply. Although violence and instability remain, the bigger long-term issue is the ability of the world’s largest producers to sustain production. The need to maintain existing production levels should support oil prices at or above $60 a barrel, which is the average price for oil so far in 2006. Then, add the ebb and flow of geopolitical events that provide a boost to crude prices. While the urgency of the situations in Iran and Nigeria has dissipated for now, it is almost certain to reappear. The U.N. Security Council will consider sanction language in the ongoing Iran nuclear issue, which will draw traders’ attention back to the potential threat to oil supply. Moreover, the situation won’t be resolved anytime soon, so Iran will continue to play the West against China and Russia. That will affect oil prices for months to come. Nigeria also remains a concern, as rebels keep trying to undermine the oil trade in the Delta region. Headlines have slowed in recent days, but the autumn months are typically ripe for skirmishes that tend to affect production. Any event that disrupts supply — either through production or pipeline sabotage — will affect global crude prices. Oil prices are unquestionably due to moderate, as they nearly always do in the shoulder months. However, challenges to production, combined with the high probability of additional geopolitical headlines, should keep prices from slipping much below year-to-date averages. As winter spurs demand for heating oil and other distillates, prices will probably firm. That should signal to equity investors that the cycle is intact.

2006-09-08 :: Defensive Stocks Downgraded

Friday, September 8th, 2006

What a wierd world.  Nothing is making sense.

All along I’ve been writing that the earnings on the defensive stocks don’t justify their current P/E’s and valuations.  We are now seeing that these same defensive stocks are being downgraded by the Wall Street firms in favor of technology.  Campbells Soup, General Mills, Pepsi, Coke, Anheuser Busch – earnings estimates cut and stocks downgraded.  So, what are they doing up today?

Technology is a beginning of economic cycle investment.  Defensive stocks are an end of economic cycle investment.  Is Wall Street saying that we are looking at the beginning of the next cycle in spite of what Fed President Yellen stated yesterday?

Schlumberger, Devon Energy, Phelps Dodge, Freeport McMorhan – energy and metals companies upgraded.  So what are they doing down today?  Earnings be damned?  Never!

When my stomach grinds like it is now, I have to revert back to the basics:  In the end, earnings matter.  Wall Street has it right that the defensives don’t have the earnings to support their valuations and that energy and metals do have the earnings to support significantly higher prices. 

So, who’s buying and selling in this market?  Most likely its mutual funds and hedge funds that want to have the defensives in their portfolios at quarter-end.  That is a decidedly short-term impact, but it still makes for an ugly day if you own oils and metals.

More later!

Mark

2006-09-07 :: When (Fed) Doves Cry – Today's 2nd Entry

Thursday, September 7th, 2006

The President of the San Francisco Federal Reserve Bank, Janet Yellen, has been the most dovish member of the policy committee that sets  rates.   Prior to the August 8th meeting, she noted that the Fed didn’t want to tighten too much now has changed her tune a bit.  She now sounds like someone that isn’t in support of the Fed’s current pause and could support further rate hikes.

President Yellen said, “With inflation too high, policy must have a bias toward further firming.” She noted that the impact of the past increases were still working their way through the pipeline, but the clear implication of her remarks is that the Fed isn’t ready to cut rates anytime soon.

This had an important negative psychological impact today.  There was red across the board, with the defensive stocks heading down even more than the energy stocks.  Pepsi, Colgate Polmolive, Coke, Bud, Merck, Pfizer, Johnson & Johnson, Disney, Walgreens, all leaders of the defensive stock trend of the last several weeks were down today.

Oddly enough, the energy indices were down less than the defensive and broader indices.  Particularly troubling was the fact that bank stocks (generally the leaders in a market where the Fed eases) took in the chin today, down > 1%.

We are clearly in the seasonal doldrums for the equity markets that will last for a few more weeks.  The earnings strength is still with the energy, materials and infrastructure stocks.  The defensive stocks are having fairly flat earnings growth (or even earnings disappointments, in the case of Colgate).    The financials will begin to get upward earnings estimates revisions once the Fed signals a clear direction with their “bias.” We’ve started adding some bank stocks to portfolios, a bit at a time, so that we can build positions prior to an announced change in bias and so we can be in place for the big moves in bank stocks that come from lower interest rates.

Earnings always tell the tale in the long run, despite what happens in the short run.

More later!

Mark

2006-09-07 :: Back From Alaska

Thursday, September 7th, 2006

Hi all,

I returned from a week of fishing, boating, white water rafting and wolf watching in Alaska yesterday afternoon.  The blog entries will resume either later today or tomorrow.

In the news was a big announcement from Chevron and Devon Energy of a huge new oil field discovered in the deep waters of the Gulf of Mexico.  This sent Devon shares (which is one of the companies we added to various portfolios this summer) up significantly higher as their reserves increased significantly.  This is the sort of news that you can expect, and that we’ve discussed here in previous postings, with oil above $70.  Companies can afford to develope oil fields that were unprofitable at $30 oil.

Additionally, the cyclical stocks have outperformed the defensive stocks over the last week. 

More later!

Mark