Chicken

Conspiratorially, all this relentless rise in the price of the average stock is designed to suck John Q. Public in at prices which soon enough will crash--thing subprime housing and the like. Sluggish real economic activity representing leads to a longer and longer period of Fed ease, with more and more leverage being used. Thus the real economy's weakness in a period of alleged recovery paradoxically leads to higher stock prices, as future earnings don't change much but the short-to-mid term discounting rate stays low.

In August 2007, I said to an investing friend that I believed that the domestic, non-export-oriented part of the economy was in a recession. After all, housing was already in a depression and autos were in a severe recession. The Fed had undertaken emergency action following several months of bad news out of Bear Stearns, housing securitized stuff, and early credit crunch action.

What is amazing is watching Gallup's polling almost daily. Real people still are near cycle lows in observing companies not hiring and in spending on discretionary goods.

When you read about Best Buy's results signaling strength, remember how much competition no longer exists to siphon large amounts of sales away. Nothing at all against this company or stock-- I have traded it successfully a number of times the past year, all from the long side. And one can praise the chart here as setting up for a saucer-shaped breakout.

But BBY sells for 7 times tangible book value and has a dividend yield of about 1.3%.

So it's at 12X current year estimated earnings, but if it were truly cheap, it would have been LBO'ed or acquired by some giant company.

So this is one of many high quality companies that could take a much higher stock price, and the set-up (conspiratorially again) just might be that the public finally gets interested in stocks at $50. Who knows, this could be an $80 stock in a year or two. Or margins could get crunched, earnings estimates could decline, and the stock could easily head to 2X book, which would be an utter disaster.

When stocks were valued based on tangible assets, there was a large margin of safety that does not exist now. One to look at is Everest Re ("Re") and other insurers/reinsurers. The stock has been weak on the heels of a projected Q1 loss due primarily to the Chilean earthquake. But it trades well below current tangible book and could lose money this year and the stock could rise a great deal. Plus you are paid over 2% to wait. To me this beats a 5-year Treasury. No retail clamor exists for RE.

With the absence of public participation, the institutions and Big Finance are playing the high school game of chicken with each other, this time with other people's money instead of real lives and cars. If the public doesn't get suckered in, then they to eat the overpriced sardines they bought to trade.

Ordinarily one would think that these guys are too smart to get stuck holding the bag.

Not so. Think the recent CDO mess etc.

All the incentives continue to favor gambling. Traders are getting it while they can.

There will be more growth this spring. And it will continue. What someone else's company is worth after the orgy of money-printing is the stock buyer's/stock owner's question. Stocks are so far above their historical replacement ratio and so far above their normal cyclically-adjusted price-earnings ratio that fund managers etc. rationalize these valuations by using circular reasoning that the weak economy has caused low interest rates and therefore high valuations are OK.

Yours truly has taken some quick 15-20% profits in DLTR, TJX and ROST and added RE and Chubb (CB) late last week. Too many stocks have gone up too far, too fast. Very few have strong asset-based underpinnings. The market has to discover these relative gems one day. If not, the worst is that one is trapped in value stocks as occurred from 1998-2000-- one was early, but they led the up-move and in fact many bottomed at the overall NASDAQ peak in March 2000. Money just decided to sell the momentum stuff and buy the value stuff. It just sort of happened.

Playing chicken is for kids.

Copyright (C) Long Lake LLC 2010

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