Sunday, October 12, 2008

Beyond the 2008 Stock Market Crash


I spent the weekend enjoying my new nephews, the beautiful fall weather in Montreal and listening to some excellent interviews like CharlieRose's discussion with Peter Thiel, Maria Bartiromo, Michael McKee, Steven Pearlstein and Fareed Zakaria's excellent interviews with George Soros and Jeffrey Sachs.

I also dusted off a copy of John Rothchild's, The Bear Book: Survive and Profit in Ferocious Bear Markets. I figured it doesn't get any more ferocious than this so why not read some words of wisdom?

By pure coincidence, I opened the book on page 52, right on the section of HITTING BEAR BOTTOM:

A bear market is a bull in gestation
- Anonymous

After the final plunge in stock prices that heralds the bear's demise, you're presented with a buying opportunity, perhaps the opportunity of a lifetime.

You need two things to take advantage: ready cash and a tin ear. The latter is necessary to drown out the drone of doomsaying that's sure to accompany stocks at the bottom of the Wall of Worry, where doubters are preeminent. Theyve been disappointed too often to believe the next turnaround is for real.

Capitalizing on these opportunities is easier said than done. those who sold already are sitting on a pile of cash, reminding themselves never to gamble in stocks again. When the new bull market begins, they don't benefit. Those who haven't sold already are obvious candidates to sell into the next rally.

An excellent example was the Great Depression bull market of 1932-1937, a happy interlude lost in the gloom of the day. People who bought stocks near the Dow's low of 41.22 in 1932 nearly quintupled their money as the Dow advanced to 194.40 in five years.

They got a quicker payout in the S&P 500 - up 154 percent in three years. Such gains are always uncommon, but in the 1930s, with one out of four adults lacking a paycheck, they were nothing short of fantastic.

How could you sense it was time to jump into stocks at their nadir in 1932? Not from the newspapers. They were spreading despair headline by headline: banks going bankrupt, companies closing their doors, one out of four workers out of work. None from expert commentators, none of whom was calling for a rally.

Not from your broker, if you still had a broker in 1932. Brokers with clients were more fearful of stocks than clients were. Groucho Marx's broker was gloomier than Groucho, as Groucho himself reported:

Groucho: Aren't you the fella that said nothing can go wrong...that we are in a world market?

Broker: I guess I made a mistake

Groucho: No, I am the one who made a mistake, I listened to you.

Broker: I lost all my money, too.

Groucho: Well, buck up. Don't let it get you down. Just remember - twenty years from now you'll be looking back on these as the good old days.

This, on the eve of the most profitable advance for stocks in any five-year period before or since! To take part in this bonanza, you had to ignore prevailing opinion and rely on the obvious fact: stocks were incredibly cheap.

By the end of 1931, Dow stocks were throwing off nearly 11 percent in annual dividends. No matter what happened to the market going forward, you could be reasonably confident of collecting that huge yield, made more attractive with inflation in remission and long-term bonds paying 5-6 percent.

I took the time to type the passage above not because I am confident we are at "THE" bottom ( I am still worried about capitulation crash), but because people need to step back and THINK a little before succumbing to the madness of the crowds.

Too many people, including yours truly, get swept up in the emotion of the day without stopping to think that the world still needs energy, health care, infrastructure, financial services, technology and whatever else so we can go on with out daily lives.

It is time people stopped asking whether this is "THE" bottom and start asking themselves what does the real economy need to go on functioning.

The question I get asked the most is what should I buy? I hate this question for the simple reason that your risk tolerance might not be anywhere close to my risk tolerance.

In industry parlance, I am a what you call a "punter," a trader who takes all or nothing risks. I am 100% cash one day, 100% in one stock the next day (or morning) and out again. I can go weeks without making one cent and then BOOM, I can make 100% in a couple of weeks (or even days) by getting into the right position at the right time.

Conversely, I can lose HUGE on a position because I got in too early, thinking it was the right level to enter. This happens to everyone who tries to time markets for a living. Moreover, because I do not like tight stop losses that whipsaw me in and out of positions, I often have to remain patient to see gains.

All this to say my gains (and losses) are lumpy and my style is not meant for 99% of the investors out there unless they have strong intestines and time to track the markets every single day (I do not advise it but it is an excellent experience).

But if I were advising you on your portfolios, I would tell you that there are very few times in the stock market where you can make an obscene amount of money and they typically follow massive selloffs like the one we are experiencing these days.

Even if it is a bear market rally, it could be a powerful one given that most hedge funds, mutual funds and pension funds are under-performing and they need to make up some of the losses going into the end of the month.

Apart from writing my blog, I spend my days building a collection of stocks which I track on my Yahoo portfolios and separate by industry.

I typically try looking at the following every day:

Yahoo most percentage change

Paul Kangas' Stocks in the news

WSJ: Market Data Center

StockScouter Ratings

I also try to keep an eye on what the top hedge funds and mutual funds are buying or selling:

Seeking Alpha's hedge fund section

and

MFFAIS - mutual fund facts about individual stocks

From MFFAIS website, I like to track the activity in the following hedge funds and mutual funds, focusing on what they recently added or sold in their portfolios (data is lagged but fairly recent):

AQR Capital Management

Atticus Capital

Bridgewater Associates


Caxton Associates

Citadel LP

Clarium Capital Management

Farallon Capital Management

Greenlight Capital Inc

Golden Tree Asset Management

Goldman Sachs Group

Hussman Strategic Growth Fund

Legg Mason

Letko Brosseau and Associates

Maverick Capital

Quantum Capital Management

Soros Fund Management

Spinnaker Capital LP

Sprott Asset Management


Tiger Global Management

Viking Global Investors LP


I then couple my bottom up research with my top down views and I also track changes in leveraged ETFs like Ultrashort and Ultra proshares.

I love the markets so for me spending ridiculous hours reading, researching and to a lesser extent trading is just fun. It's tiring as hell, especially in these crazy markets, but this is what I love doing.

My experience as a senior investment analyst at two of the largest Canadian public pension funds also allowed me to gain valuable knowledge of hedge funds, private equity funds, commodities and other asset classes.

This unique perspective allows me to assess how developments in one asset class will be felt in other ones. In fact, the biggest problem in public pension funds in Canada and the rest of the world is that each asset class works in silos without understanding how developments in one asset class will shape others.

Billions of dollars were funnelled into all sorts of risky assets and securities without a proper assessment of whether or not there was a massive bubble in alternative investments and securitized products like CDOs and CDS.

The end result? We are living it. The Great Deleveraging, which is why I believe we are going to have many bear market rallies during the next decade as we sort this mess out.

In these type of markets, you have to be nimble and take advantage of opportunities. Despair will only lead you to become demoralized and paralyzed. Retail investors need to take stock of their finances and pension funds need to start thinking about where the future opportunities lie and stop following the pension herd who rely on bad advice from "cover your ass" consultants.

Now, before I proceed, please read my disclaimer below. I can't guarantee anything. In fact, nobody can. The best hedge funds and mutual funds are down 30, 40 or 50 percent this year as the savage selloff has hit all sectors.

Moreover, neither the stock markets nor credit markets have stabilized. The latter are the key in all this and hopefully inter-bank lending will start again as governments start guaranteeing bank lending.

But when you consider the madness of the crowds and see good companies being punished along with bad companies, you have to ask yourself why are investors throwing the baby out with the bathwater?

Below I use various sources to discuss sectors that were punished during this last selloff. Again, do your own due diligence, follow the wise advice of people like Jack Bogle as well as other experts, and keep in mind when "animal spirits" rule, there may be no halting the market's avalanche.

***Discussion on Stocks To Watch***

(To be updated as I get more info)


Agribusiness

Given its recent selloff keep an eye on Potash (POT) because fertilizer is still in great demand. Other agribusiness stocks I track are Archer Daniels Midland (ADM), Agfeed industries (FEED), Agrium (AGU) and Monsato (MON).

Consumer Stocks

Let's begin with a Forbes article, Buying in the Bear Market and this Barron's October 6th article, What's The Best Way Out of Here?

You will notice that many fund managers took refuge in consumer staples like Campbell Soup (CPB), H.J. Heinz (HNZ), Kraft Foods (KFT), Johnson & Johnson (JNJ), McDonald's (MCD) and Coca-Cola (KO). You can add a food distribution company, Sysco Corp. (SYY), to this list.

A lot of this companies got whacked last week but people still need to eat, drink and brush their teeth.

I would add the following staples to the list: Kroger (KR), Colgate Palmolive (CL), Procter Gamble (PG) and Molson Coors Brewing Company (TAP).

By the way, beer companies and tobacco companies like Altria Group (MO) which pay high dividends are the best performers over the long-run (no surprise there but unlike a cool beer, I hate the tobacco products).

In a slowing economy, price focused retail giants like Wal Mart (WMT), Costco (COST) and Target (TGT) will do well. But there are other smaller discount retailers like Big Lots (BIG) and Dollar Tree (DLTR) that are worth keeping an eye on.

Energy

Oil stocks were crushed as oil prices fell below $78 on fears of a global recession. The energy rich Canadian benchmark index, the S&P/TSX took its worst beating in 70 years.

Given these developments, last week the UltraShort Oil & Gas Pro Shares (DUG) went from $50 to $74 - a 48% move in one week!

If confidence is restored, oil prices will jump back up in the near term and you might want to DIG in by buying a leveraged ETF or buy individual stocks like Exxon Mobil (XOM), Enbridge (ENB), Imperial Oil (IMO), Devon Energy (DVN), Conoco Philips (COP) , Canadian Natural Resources (CNQ), Trans Canada Corp (TRP) and a host of other beaten oil companies (check Letko Brosseau's activity on MFFAIS for more ideas).

The plunge in oil prices wreaked havoc in the solar sector. The two solar names that I love at these levels are Solarfun (SOLF) and Yingli Green Energy (YGE), but there are so many other good solar plays like Canadian Solar (CSIQ), JA Solar Holdings (JASO), LDK Solar (LDK), Renesola (SOL), Suntech (STP), Trina Solar (TSL) and in Canada, keep an eye on Timminco (TIM.TO) and 5N Plus (VNP.TO).

Bear in mind that solar companies got a generous eight year tax credit extension in the latest rescue package. Moreover, if Obama wins, which increasingly looks like the case, he will pump more than $150 billion into solar and other alternative energy sources.

This sector is super volatile but these companies are growing at unbelievable growth rates. Those low trailing P/Es are nothing compared to the even lower forward P/Es so keep an eye on this sector.

If you are skeptical, read this article from Solar Feeds: The Beginning of the U.S. Solar Boom?

Mining, Steel and Aluminum

Mining shares got slaughtered in the last selloff. I noticed the Soros Fund picked up Cameco (CCJ) and in steel and aluminium, keep an eye on AK Steel (AKS), Mittal (MT), US Steel (X), and Alcoa (AA).

Healthcare


The healthcare sector is another one I like long-term based on demographics. Names like Abbott Labs (ABT), Amgen (AMGN), Novartis (NVS), Bristol Myers (BMY), GlaxoSmithKline (GSK) and Pfizer (PFE) are well known but keep other smaller ones like Forest Labs (FRX) on your radar screen.

Among healthcare plan companies, I like Cigna (CI), Humana (HUM) and WellPoint (WLP) but also lesser known healthcare plan companies like Psychiatric Solutions (PSYS), a company that provides inpatient behavioral health care services in the United States.

Biotech ETFs are worth investing in but institutional investors should also look at top performing healthcare funds like Montreal's Sectoral Asset Management. Among biotechs, I like Affymax (AFFY), Genentech (DNA) and Vertex (VRTX), but given the volatility in the sector, ETFs are better for most investors.

Another healthcare sector I like is medical devices where I am tracking companies like Align Technology (ALGN), China Medical Technologies (CMED), Hologic (HOLX), and Syneron Medical (ELOS).

Infrastructure

Infrastructure stocks are also an excellent long-term play because decaying infrastructure needs to be replaced. Infrastructure ETFs already exist (IGF), but there are good companies like KBR (KBR), URS (URS), Tetra Tech (TTEK) and Canada's SNC-Lavalin (SNC.TO) that are worth tracking. Also, on water treatment, keep an eye on Watts Water Technology (WTS).

Keep an eye on utilities like Duke Energy (DUK), FPL Group (FPL), and SouthWestern Energy (SWN).

Among the big conglomerates, I was told by someone I trust that 3M Co. (MMM) is a well run company. I am also keeping my eye on Dupont (DD) and Dow Chemical (DOW).

Small Cap Stocks

Small cap stocks got creamed in the last selloff. I am looking at the Ultra Russell 2000 (UWM), but there are plenty of names to picks from including tech stocks that are worth their weight in cash.

Business Services

One business service stock I like is Paychex (PAYX) which Quantum Capital Management bought in their fund.

Technology

The technology sector was crushed last week but the tech heavy Nasdaq will snap back strongly if confidence is restored.

If you want to take a sector bet, buy the Ultra Pro Shares QQQ (QLD) or focus on individual names that were slammed like Apple (AAPL), Research in Motion (RIMM), Intel (INTC), Cisco Systems (CSCO), EMC (EMC), Qualcomm (QCOM) and Yahoo (YHOO). I also like Jabil Circuits (JBL).

In the sofware space, I like Microsoft (MSFT), Oracle (ORCL), Symantec (SYMC) and Citrix Systems (CTXS).

On the global level, I like Taiwan Semiconductor (TSM), China Mobile (CHL) and Nokia (NOK).

Finally, in a slowing economy, I really like Priceline (PCLN).

Financials

I hate this sector the most because I simply do not trust bankers. If I were to buy a bank, I'd stick with Warren Buffett and buy Wells Fargo (WFC) and Goldman Sachs (GS). I am also keeping an eye on Bank of America (BAC) and HSBC (HBC), arguably one of the best banks in the world.

If you want to take a leveraged long position in the financial sector but do not want to pick specific companies, you can buy the Ultra Financials (UYG) Proshares ETF.

Insurance stocks like Allstate (ALL), AXA (AXA) and Canada's Manulife (MFC.TO) and Great West Life (GWO.TO) caught my eye. Of course, you might just want to buy Power Corp (POW.TO) and stick with the Desmarais family, the Buffetts of Canada.

On a global level, I would go Greek for value and buy the National Bank of Greece (NBG):

NBG is Greece's largest lender, with total assets of $132 billion, 579 branches and some 32% of the country's mutual fund business. While mortgages and consumer loans account for 56% of the bank's domestic lending portfolio, both continue to experience healthy growth rates. In fact, NBG profits are growing at a 30% clip and its return on equity is a healthy 28%.

What really excites Christy, however, is not NBG's healthy share in Greece, but rather its position as the junction between Europe, Africa and Asia and its growth outside the relatively tiny nation.

In 2006, NBG bought Turkey's Finansbank and, more recently, NBG has been gaining share in Romania, Bulgaria and Serbia. Business is booming in southeastern Europe and already accounts for 12% of NBG's earnings.

Investors are worried Europe will follow the U.S. into a recession, but Christy is confident that bargain-priced NBG, bolstered by its growth in emerging Europe, will continue to prosper.

I have to agree that NBG is one of the best run banks in Europe and with a 11% dividend yield, the stock is cheap after being crushed last week. (Another Greek stock worth looking at is DryShips (DRYS), a shipping company which also got crushed during this last selloff and it carries a 5% dividend yield).

As I end my biased commentary, I see that Asian stocks and U.S. futures advanced as governments back banks.

It looks like the worst stock selloff in history is behind us (for now), but I need to see at least two consecutive up days in the markets before I can breath easier.

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