Running Out of Time

Well, so far the Federal Reserve is winning out over my timing models that continue to suggest caution should be the preferred strategy in the short-term; and last week that strategy was wrong footed as the D-J Industrial Average (INDU/16086.41) notched another new all-time high. Still, over the years I have learned to trust my indicators even if at times they have proven overly cautious. Indeed, better to lose face and save skin! Nevertheless, in my travels last week I continued to talk to various portfolio managers (PMs), and this week I am in New York City seeing more PMs and visiting with the media. Late last week I reconnected with David Ellison, portfolio manager of the Hennessey financial funds. In a recent missive David had this to say:

Conclusions from recent company visits:

  1. Credit conditions are continuing to improve.
  2. Loans going on the books the last 3-5 years are the best quality in 25-30 years.
  3. Loan demand is slowly picking up – starting to see competition.
  4. Cost cutting/efficiencies are a growing management focus. – 2-3 years to work through.
  5. Improving fee income another growing focus of management – loan demand will help this effort.
  6. Balance sheets are liquid with much improved liability structures – I see some of the best balance sheets of my 30-year career.
  7. M&A activity expected to increase as regulatory process clears up – everyone is looking.
  8. Dividends and buybacks are expected to increase.
  9. Valuations (P/E and PR/BK) are around the average historical ranges.

In general, companies will benefit from higher lending activity as liquidity (yielding 0.25% at the Fed) is deployed into loans at current rates in the 4% range. Companies will benefit as cost cutting and fee income enhancements work through the income statement. Companies will benefit as credit continues to improve and the cost associated with bad assets abates. I believe a rise in rates and/or increase in loan demand will benefit EPS growth more than the market believes. I believe the market is underestimating the benefit of cost cutting and fee enhancement. I believe M&A activity will be more than expected as recent deals have been accretive and stocks of both buyer and seller have risen. If you believe the economy is getting better, and this will show up in loan demand and modestly higher rates, then I think financials are an attractive investment. Financials are “economic growth stocks.”

And then there was this from another portfolio manager friend, namely Shad Rowe, founder of Dallas-based Greenbrier Partners, who had this to say in his recent letter to investors:

The questions I am most often asked, and the questions I ask myself are: “Is the bull market over?” “Is it too late to own stocks?” “Is it time to get defensive?” My answer to each question is a cautious “No.” A useful stock market adage is, “A bull market climbs a wall of worry.” Goodness knows our elected officials in Washington have given us plenty to worry about. As a result, distracted investors may be ignoring developments both in Washington, and in our economy, that may enable a more sustained bull market than most people can contemplate. We have been over these developments in previous letters so we will skip covering old ground. Meanwhile, our major themes appear to be intact and our companies’ businesses are performing as hoped. Our top 16 positions represent approximately 89% of our equity and are listed below in descending order of value. Included are our rationales for continuing to own these stocks.

Of those 16 stocks, six of them are followed by our fundamental analysts with favorable ratings. They are listed below with Shad’s reason for owning them:

Facebook (FB/$47.01/Outperform). Facebook is the backbone of the social media experience for more than one billion connected users around the world and provides the means for marketers to reach these potential customers with more efficiency and precision than has ever been possible.

Apple (AAPL/$556.07/Strong Buy). Apple represents the most desired digital ecosystem in the world and it trades at a discount in comparison to its peers, the market, and its intrinsic value on virtually every metric.

Google (GOOG/$1059.59/Outperform). Through organizing and providing access to the world’s information, GOOG has become the most powerful force in advertising and is navigating the transition to mobile and video beautifully.

eBay (EBAY/$50.52/Outperform). eBay has quietly put together a powerful combination of digital assets that position the company to thrive in the $10 trillion global commerce and payments markets.

Bank of America (BAC/$15.82/Outperform). Bank of America represents a proxy on an improving domestic economy and a company that still has vast room for operational improvement.

Qualcomm (QCOM/$73.58/Outperform). Qualcomm’s patented technology and innovative products are vital to the growing, global mobile device industry and management has a proven track record.

As for last week’s stock market action, despite signs of increased risk of another pullback the equity markets notched new highs with the NASDAQ Composite actually closing above 4000 for the first time since 9/7/00. The D-J Industrials have now made it eight weeks in a row on the upside, although Friday’s late sell-off was somewhat disappointing. The upside skein has left five of the 10 macro sectors pretty overbought with the remaining five being Consumer Staples, Energy, Materials, Telecom Services, and Utilities, which are not overbought. Interestingly, eight of the 10 S&P macro sectors closed lower for the week, a sign there is at least some kind of distribution going under the guise of higher major market indices. Moreover, the S&P 500 (SPX/1805.81) is trading at its highest price-to-earnings ratio in a year. In addition to my timing models continuing to counsel for caution, there are signs that the stock market is becoming more selective. For example, the percentage of stocks above their respective 30-day moving averages continue to trace out lower highs and lower lows, as can be seen in the chart on page 3 from the good folks at the Lowry’s organization. Further, one of my indicators is flashing a warning sign not seen since the tops in 2007 and 2000. Yet I have to admit, time is running out for the bears because I have learned the hard way it is tough to put stocks away to the downside in the ebullient month of December.

The call for this week : While time may be running out for the bears (this week should tell), time is not running out to start making your tax-loss bounce list. Remember, some stocks that have not performed this year will be sold for tax losses to offset gains taken in other positions during 2013. To that point, there was a story in the weekend Wall Street Journal titled “Coal Plants Shut By Marcellus Glut.” The gist of the story is that coal-fired utility plants are shutting down because natural gas is so cheap in certain areas of the country, and electric prices are so weak, that nobody can make a profit. The story reminded me of when “they” were closing copper mines like the Anaconda Copper Mine in Lyon, Nevada back in 1978, and all the copper stocks were screaming buys. Over the next few weeks I will be looking at the beaten up coal stocks, as well as other tax-loss bounce candidates.

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© Raymond James

© Raymond James

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