Tuesday, March 3, 2009

On Bottom Fishing

Believe it or not, I'm no "perma bear." And from studying the history of markets and economies, it has become very clear that some of the best opportunities can be had during periods of falling prices. Ultimately, the best opportunity happens when prices stop falling. This is the one we all wish we caught and talk about for decades after. Buying stocks in '33, or '82. Commodities in '71 or '99. Real Estate in '42 or '91.

The one thing it seems is common to all those times is that nobody is talking about buying. It's not that there is a wave of negative sentiment. There is no sentiment, because nobody cares anymore.

That is not the case yet with stocks. When they finally hit bottom, CNBC will likely no longer have enough viewership to continue. The daily ups and downs will disappear from the newscast, or a least be relegated to the back end - after the weather and sports. The very mention of the stock market will bring forth the most foul-tongued responses from quaint old ladies and former stock jobbers alike.

But in the meantime, there will be opportunities to profit from either direction of the bear market. There are times to be short or fully in cash, and there are times to be partially long. We are shifting from the former to the latter (or at least I am). I'm still in the process of shedding my puts, ensuring that the transition is a smooth one, not sudden and kamikaze-like. But it is now time to start looking at potential vehicles to consider should we arrive at a "slap me silly" buying op.

So I will share my process with my readers in the hope that it is of some help. Back in the dog days of November, when it looked like the world was going to end, I wrote, "Looking for Relative Strength." At the time, I was looking for companies that were still rising, or at least holding above their October lows. Indeed, the group of stocks I indicated ended up massively outperforming the S&P over the following 2 month rally.

Again, I am looking for stocks that are in a technically solid position, have strong cash balances - exceeding their debt, decent business models and attractive earnings. Oh, and it would be nice if they were trading at a respectable multiple relative to those earnings.

I'm not going to lie to you folks. There isn't much that fits those criteria. Many of the companies that are trading at decent valuations (under 10x 1 year trailing earnings) and pay a dividend are saddled with incredible amounts of debt. Telecommunications, and utilities come to mind. The big pharma stocks are at risk of increasing competition from generic producers (not that I disagree with it), and also from government competition.

Many of the stocks with strong balance sheets and good business models/growing earnings are trading at absurd multiples of 30+ and paying no dividend.

There are a lot of small caps that look to be in a decent position, but they require constant financing via share dilution. Any share rallies will be met with such dilution, so it's something I want to avoid.

In looking for stocks that have been unmercifully punished, you run incredible risk of waking up one morning and learning that your trading vehicle announced XX Billion in losses and opens 30% lower.

So there is not a lot to offer from many of those sectors. I am avoiding utilities, telecom service providers, big pharma, financial services, retail, insurance, most commodity producers, and anything else that could conceivably be persecuted by a populist president looking for something to tax. The pickings are slim. Which may or may not be a sign that a near-term bottom is actually close.

The following is a list of companies that are in sectors I think are relatively safe from opportunistic politicians or debt problems, and/or have been displaying decent technicals that suggest some relative strength.

As you can see, there is nothing on this very incomplete list that screams "buy me". But they are in better positions than many of the other companies their size. Ultimately, at an earnings trough, I would want to see these companies trading at P/E values half their current levels.

Technically, many of these are looking very vulnerable, displaying the dreaded "rounded top." Consider cash-king Cisco:

Standing in front of a chart like this seems suicidal.

However, more expensively priced (relative to earnings) is a company like Google, which looks a little healthier:

But as I said, nothing here is screaming at me to buy it. It all looks like it wants to go much lower. Perhaps I'm being too picky. But I'd rather miss a multi-month rally than risk a significant portion of my capital by standing in front of freight trains.

If I do decide to get bullish it will likely be something from that list. Unless my readers have some other ideas? Thoughts?

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Anonymous said...

What are your thoughts on Med Tech as a sector? ABT and JNJ are pricey, but MDT looks like a screaming buy with PE <10.

RRB said...

I would think the biggest opportunity currently would be in bonds or preferred stock?

Matt Stiles said...

MDT and ABT have too much debt relative to their market caps for my liking. JNJ isn't bad, but I think their drug component could be vulnerable.

Certain corporate bonds look attractive. Convertibles as well. I'm staying away from most preferreds - we can see now that they are not treated well in the event of problems.

I don't particularly look at bonds as trading vehicles. They're more of an investment - something I'm not planning for a few years at least. That is, I'm pretty sure I can get Coca-Cola (for example) debt cheaper at a later time.

dacian said...

Hey Matt,

"So I will share my process with my readers in the hope that it is of some help."

Pls. do that, it will help for sure. I'm 90% in cash and waiting for some panic there to look for some picking and buy some stocks (I sold my short positions too early as usual :)).

Have a look at Akamai Technologies, it seems like the stock is in strong hands. I also bought recently Dragon Oil (they have some internal problems due to some improper behavior of some of their managers, so it might be a bit risky - look on their web site for a press release on the subject).

mike.montchalin said...

1973 Was also a good time to buy real estate.

But today, there are just too many houses. How far must prices fall to make it a good deal, in spite of the oversupply?

Says the median price of a house in Chicago is $7,500. I copied that price right, but did the paper get their story right?

Matt Stiles said...

I like Akamai. They're a little short on cash, but have no debt. Probably a takeout candidate.

mannfm11 said...

If I thought we were going to have a real recovery, I would probably buy energy stocks and MSFT and INTC. That group of stocks you posted with CSCO added in the duo I mentioned, you could probably do okay if you drew another 4 out of the hat and bought them all. But, you know INTC and MSFT didn't fare well this last bull. I have a hard time buying GOOG at its cap value because it bugs me that a search engine with a few other media nuances is one of the top 10 most valuable companies in the SPX. If they didn't run into anti trust problems, a company like MSFT could duplicate GOOG and maybe split market with them for a fraction of this amount.

mannfm11 said...

To be honest, I have been thinking about the same thing. I think we go below the 30% point from the top of the major indexes before this thing finds a real bottom. This market is starting to look like Japan or 1930-1932. I read an email in my mothers email about 12 acres of land and 12,000 foot steel building near tollway extention for $1 million. If you could get $30,000 a year out of the building, that would be near 3%. Unless DFW stops growing suddenly, that land will bring $10 million in 15 years.

Matt Stiles said...


I think you're on the right track. When the entire thing bottoms out, the best investment opportunities won't be in the stock market. They'll be in providing basic services in your own communities.

So many businesses will end up going bust - not because they can't make money - but because they can't pay their debts.

There is literally nothing left of the small shopkeeper. The big behemoths that came in and took them over did it with debt. When they close down, the gap between supply and demand will be huge. Food, clothing, hardware, etc.

But the stock market will likely bottom years before the real economy, so there will be a time to own both.

Matt Stiles said...

I should also add that when I am searching through companies that have little debt, my filters have no way of telling me if a certain company's debt matures soon or many years in the future. I don't doubt that there are many of the latter.

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