Thursday, October 22, 2009

Stocks for the Long Run

The financial markets had an interesting day yesterday that were consistent with the hypothesis that a correction is underway. The late-day sinking spell in stocks was unexpected and had no real obvious cause, though a report from the "why does any care what he thinks" personality and "analyst" Richard Bove is said to have sparked selling in the financials. EBR however has been noting early signs of weakness in the financials and has been more than hinting about a change of leadership. The late-day price drops are just the opposite of what started happening in the winter when stocks were ready to be taken upward.

It is routine to have a correction in a strong end-of-recession (depression) rally. The deeper the recession low from the high, the more likely the post-rally recession is to undergo a more severe drop. 1975 saw such a downturn, and adjusted for the inflation of the time, the rally to the 1975 high was about as good as it got until the markets blasted off in 1982 when Mr. Volcker eased up on Mr. Reagan, having achieved both the crushing of inflation expectations and the securing of a strong midterm election for the Democrats less than three months later.

Nonetheless, there are always investment opportunities on the long side in today's markets, where one can go long a "short" fund or short a "long" fund. Within stocks, here are three that were mentioned months ago as having strong fundamentals, recession-resistant qualities, and, importantly, strong long-term charts.

One way to look at these charts is to open a second window and click for the charts in that window, keeping this one open throughout.

Click for the 2-year and max charts for Ross Stores (ROST; discount clothing), with the 2-year showing the 50 and 200 day moving averages. The long-term chart hardly shows the depression. The stock went to an all-time high this year. It is now correcting. Fundamentally, it may have problems getting enough cheap inventory, as general clothing stores are ordering very conservatively. This is one that I would not buy yet unless it were for a multi-year period.

The 2-year and max charts on Teva (TEVA; generic drugs) are similar but the stock looks different than ROST to me. The brand drug-makers have been regaining pricing power, which helps Teva. Teva had much less of a run off the bottom than Ross, which more than doubled. Teva is almost immune to the inventory cycle. If it meets consensus 2010 estimates, it is trading at about 10.5 X earnings. This stock could easily trade at 16-18 X earnings. I own Teva but not Ross.

Finally, I admire the business discipline of the little-known stock National Presto (NPK; diversified), and mentioned it this spring. Click for the 2-year and max charts. The max chart is difficult to interpret casually because the company is cash-rich in an old-fashioned way and pays huge dividends once a year. Thus, the total return is far greater than the chart suggests. The stock simply looks ahead of itself, but it has strong support at 80. Not shown is NPK's fundamental problem, which is that traditionally it sells down every now and then to book value, which is far below the current price. I am out of NPK for now.

The working hypothesis here is that the well-publicized penalizing of Citi and BofA is not quite a death sentence but could easily put the kibosh on their over-hyped, over-traded, over-priced stocks. Every bubble ends up frustrating the bulls in the field of the prior bubble. This cycle and these stocks are expected to follow the script.

Junk may well have had its day for a while. The stocks highlighted above, and the pharmaceutical sector in particular, may be relatively immune if all we are facing is a correction within a cyclical bull move; granted that in the style of Churchill's comment about Russia, this is probably all happening within a secular bear market that may be just passing the halfway mark.

Copyright (C) Long Lake LLC 2009

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