Posted on 11/25/2002 5:26:18 PM PST by rohry
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Managing OPM (Other People's Money) Where Have All The Value Stocks Gone? REITs, tobacco, and pipelines appear at the top of the list. The REITs pose a danger, if you believe the housing market is in a bubble and subject to declining rents as vacancies rise. Where I live, they are building another 200,000 sq. ft. office building across the street from a 150,000 sq. ft. building that is still unleased. Our office building is surrounded by what I call see-through buildings. They are see-through because they have no tenants. This hasnt stopped the construction of even more and bigger buildings around our office and home. The glut of new buildings has brought down rents and it is now possible to get free rent plus improvements added into a lease. Tobacco is coming under an assault as more states look to raise tobacco taxes on the poor as the least offensive route to raising taxes. The wealthy smoke cigars. Here in the People's Republic of California, they have nearly doubled the tax on cigars. Cigar smokers buy their cigars online to escape this punitive tax. This has caused the local merchants to suffer or go out of business. Cigarette smokers now make trips to Mexico to support their habit. The smuggling trade is now thriving. One can well imagine the day when the Peoples Republic looks for a modern day Elliott Ness to fight this new menace to our society. Pipeline companies have problems with accounting and greed in management fees. Several of the more prominent companies in this group not only have accounting issues, but also charge shareholders exorbitant fees. We have only been able to find two companies in this group worth buying. Stocks selling at below book value show the greatest promise, but the more obvious ones such as power producers, may take years to play out. This is an instant gratification society with few long-term players. The days of John Templetons "Buy undervalued stocks and wait 3-5 years for the markets to realize its value" went out with the 90s. Low P/E stocks remain suspect because of earnings. Many companies, such as Ford, may be far too risky given the uncertainty of this economy and Fords balance sheet issues. The promising area we have found lies in the area of dividends. Dividends provide an investor with cash flow that enables an investor to remain patient until value can be realized. Dividends also offer a better and safer way to evaluate earnings since you cant pay a dividend unless you have the actual earnings and cash to do so. In this area we have identified promising issues in the area of oil and gas, drug companies, consumer staples, defense, and gold. However, since we remain suspect of this rally, we have set potential target prices on these issues before we will buy them. The present rally lacks much to be desired, It remains helter skelter and more dangerous than previous rallies because it is all built on hot air and false premises. Looking for Value in Sectors We then looked at many of these stocks to find a compelling story that would have caused these stocks to rally as they have. For example, is business embarking on a new capital-spending boom that would drive profits in this sector? Are the business prospects improving, and has pricing power been restored within the industry? In each case we found the answer to be a resounding no. We then asked why should stocks be rallying to this degree. Is there something on the horizon that we have missed? Is there a new killer application that will drive earnings and revolutionize the industry? Have company CEOs been guiding earnings higher? In each case the answer was, "No." Pro forma profits were higher year-over-year, but comparisons were made all the more easier due to last falls tragedy. Those companies that did improve, did so mainly through cost cutting and will face a tough year next year. Next years earnings will be made against tougher comparisons. Next year will also be impacted by larger than normal pension contributions that will be necessary to make up for pension losses. Even those companies who did report improvements have failed to account for all expenses. Cisco, by its own admission, said its profits would be 60% lower in its most recent quarter had the company had to account for expensing stock options. In the case of GE, the company will report lower earnings growth this year and next. For the first time in almost a decade, the company will experience back-to-back single digit growth. On the day the cGE reported this dismal news, they announced an increase of the dividend by one penny. On that bit of news, the stock rallied 10%. What, if anything, has accounted for this rallys extension? The answer to that is a momentum rally that followed intervention into the markets to prevent a further decline. Stocks gapped up on three days in what appeared to be intervention by a large unnamed buyer in the futures market, buying futures at any price. From that point momentum took over and helped the markets to climb further. Money then shifted out of bonds, which is one reason bonds have tanked and rates are rising. Fund mangers sold most of their defensive stocks and then piled into the same select group of tech stocks, Internet stocks, and beaten down financials. They moved in a herd-like mentality, chasing the same group of stocks, bidding them up in spectacular fashion. A graph of the SOX and Amazon.com are illustrative of this trend. In what has appeared to be a collective leave of their senses, the fund industry embarked on a large speculative gamble. Their own buying in mass, along with momentum players, drove these issues up in a maniacal fashion similar to Internet IPOs in the late 90s.
Looking For John Q and Herbie Homeowner Once again we find ourselves in the minority in failing to believe the spin. The fact that GEs earnings are trending down is a more telling story than a penny increase in their dividend. In the case of GE, which gets the majority of its revenues from its finance unit, is even more telling. We dont doubt that Cisco will end up being a survivor and so will Dell. What we question is Ciscos accounting. The companys failure to account for stock options, which by its own admission would have lowered earnings by over 60%, and the fact that they chose to buy back their overvalued stock, says much more about their business prospects. You dont buy back your stock at inflated prices, if there are numerous business opportunities. Looks Like a Trend-Following Rally to Me This tendency of the industry to experiment with other peoples money might not be so reckless if it was their own money they were playing with instead of others. In fact, only the continuous stream of bullish pronouncements coming from analysts on ever-worsening news matches the frequency in which the herd takes collective leave of their senses. It seems that Wall Street is in the business of turning lemons into lemonade. It is symptomatic of a new disease that is spreading called pen-a-sideness. The symptoms of this new disease stem from the failure of money managers to distinguish EBITDA (earnings before interest, taxes, depreciation and adjustments) and EBIDTAS (earnings before investigation, deposition, trial and sentencing). It may behoove analysts and fund managers to take a closer look at least core earnings as defined by Standard & Poors which show that stocks, contrary to present hype, are still selling at multiples closer to 50 times earnings than the current estimate of the high teens or mid-20s. There are so many pro forma variations these days that it is very hard to know which multiple analysts are referring to other than to say it isnt GAAP earnings. In summary, we see nothing in this rally that would give us great confidence that it was anything other than a bear market rally. As the folks at Elliott Wave have pointed out recently, this rally has been weaker than previous rallies. It also falls within the parameters of most bear market counter rallies. Gains are limited to about 20-24%, and the days the market rallies are getting shorter in time span, averaging about 30-35 days. What should be a warning to the alert investor is the number of growing bullish pronouncements by the financial press. The increasing frequency of these new calls for a new bull market in stocks have a tendency of occurring just as the rally is about to fade. As this mornings Wall Street Journal points out, December could be a pivotal month for investors. Earnings warnings for this quarter should start appearing next month as big companies warn of disappointments this quarter. Already, profit projections are coming down quite rapidly. I have no doubt they will come down more rapidly as we get closer to the end of the quarter. It is with great assurance that I believe that they will get so low that companies will once again be able to beat them when actual earnings are reported. It is all part of the earnings game played each quarter. As the WSJ reports in E.S. Brownings column, earnings wont be the only worries. As listed below the market will have plenty to worry about:
Hopes for a rebound in profits are what have been driving this rally. It is another hope-driven rally interspersed with a lot of hype and hyperbole. A clue as to what is coming may be taken from the current rush to lower estimates. When estimates are lowered, it is a good sign that the trend is worse than forecasted. Why else would the forecasts be coming down if they were confident they were accurate?
Increased Taxes in the Cards? Today's Market Continue to pour into tech on the belief a recovery is right around the corner. Networking and chip stocks are at the top of the list with airlines, paper and chemical stocks followed by natural gas stocks. On the losing end were defensive issues such as gold, defense contractors, and oil. Gold got hit again after jumping Friday, despite a sharp run up in lease rates as shown in these charts. Seasonality factors are now coming into play. It is this season factor that has been behind the recent rallies upsurge. However, given the reality of this rally moving so quickly into a handful of sectors raises suspicions as to its durability. The markets have priced in no surprises. In the words of one veteran, The markets are priced for perfection. Caveat Emptor. |
Good question...
The SP-500 had a mediocre breadth reading of 275 to 218 while the Russell 3000 had a considerably more positive 1857 to 1042. The S & P Smallcap 600 had better than twice as many advances over declines, while the Russell 2000 (secondary stocks) had just a hair under 2 to 1.
The Leadership Index stocks with heavier than average volume had respectable breadth, while stocks of fast growing companies actually had more declines than advances. This tends to show a lack of confidence in fundamentals.
A very bright spot was found in a watchlist of select high-tech stocks: 27 gainers with 4 declining; The Nasdaq 100 in contrast had 70 gainers to 28 decliners.
Both CSCO and INTC were downgraded today. CSCP didn't decline and INTC advanced smartly. The ability to ignore bad news is always a good plus.
Call it a day for internal balancing and bookkeeping. It certainly wasn't a bad day, volume lightened and it could be expected that volume will continue to lighten right into Thanksgiving, despite the fact there will be some key economic stats coming out, with a lot of attention especially on Consumer Sentiment.
LOL....great line...wish I had written it.
as always, thanks Rhory and good luck to all!
Stonewalls
Good question...
Don't look at me; I finally got around to reading my Q3 401k (or is that 201b?). 12 out of 14 funds in the red (several in double-digits), both for the quarter and the year (a couple for the year approaching 33% loss). That doesn't even take into account Bloody October (of course, it also doesn't take into account Bounce-Back November).
Speculative madness. Don't try to make sense out of it.
Richard W.
It might require good news to finally pop the bubble. Perhaps consumers will finally have enough confidence in the economy to liquidate their funds and spend the money.
How have they overlooked a national lottery?
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