- So what lies around the corner, now?
Early this week, the rapid advance meant that the market was in “overbought” territory. A sell-off didn’t come as a surprise. Technically, on Tuesday, literally thousands of stocks had advanced so far, so fast, that they were considered statistically “overbought.” Unfortunately, with volatility still incredibly high, what would normally have been a 1% or 2% decline was magnified into a pair of -5% days and the worst two-day sell-off since 1987. What’s around the corner? Continued volatility, but hopefully the degree of volatility will gradually decline.
In the grand scheme of things, this week’s sell-off in the market doesn’t concern me, much.
What does concern me is the sell-off in crude oil. I know, I know. Gasoline falling from $4 per gallon down to $2 per gallon is one of the few bright spots for U.S. consumers. Furthermore, I think that lower gasoline prices will meaningfully reduce the impact of today’s awful consumer sentiment numbers. Psychology stinks, but with more money left in our wallet after leaving the gas pump, maybe we’ll go ahead and order out for pizza.
However, crude oil finished the week at about $61, which is too low. I’m hearing about drillers pulling rigs out of the Piceance Basin and shipping them up to the Dakotas. That’s not good for Western Colorado, and it’s not a good sign for the economy. It’s an indication to me that the U.S. recession has spread to the rest of the globe and it’s very serious.
Another possible explanation for $61 oil is that hedge funds have been dumping commodity assets as a result of capital calls and liquidation requests. If plunging commodity prices are a result from too many sellers rather than a global bust, then it should be a reasonably short-lived phenomenon. Particularly given the inflationary activities being promoted by Central Bankers around the world, it seems to me that crude oil ought to be closer to $90. $61 crude oil, if it persists, suggests to me that we’ve entered a long-lived Global Recession. Or worse. That is a very unfriendly scenario, and one which I hope is not around the corner. I believe, instead, that global economic activity will respond to lower interest rates and easy money, but I’ll probably wait for confirmation from crude oil before committing capital to that asset class.
Finally, around the corner I see U.S. companies having to pay a price for the financial panic we just experienced. The current recession will last longer and unemployment will go higher than I was expecting over the Summer. Financial stocks, which are trying to go higher, will have to overcome several obstacles. Financial companies, almost by definition, are heavily leveraged. They own lots of assets, have lots of debt, and are seeing more of those assets decline in value while their borrowing costs have skyrocketed. Their profits get squeezed. These companies are also having to raise capital at distress sale prices, which means what profits that remain are having to be shared among a greater number of stockholders. Earnings per share have to decline. To top things off, in order to preserve cash, dividends have been cut, and may be cut again. Common stock shareholders, I fear, will continue to experience tough times ahead.
So what’s around the corner? Fortunately, fewer companies are at risk of going bankrupt. Most of the problem banks have been merged out of existence. This means that bondholders are probably safe. Note that most savvy financial company investors, and the government, aren’t investing in common stock. They are buying preferred stock. Preferred stock dividends are rarely cut except in dire circumstances. As a result of the bailouts, common stock owners may or may not do well, but it looks like most preferred stock dividends are now secure. Because preferred stock prices have fallen dramatically, many of these investments now yield more than 10%, and chances are that the preferred stock prices have room to appreciate as well. Preferred stock issues that used to trade around $25 have fallen to below $15. If they increase in price to $16.50 in the next 12 months, investors would enjoy a total return of over 20%.
Our fund strategies recently purchased a mutual fund which owns these preferred stocks, and the individual stock strategy is selling some of our insurance company holdings and switching over to preferred stock issues in those same companies.
The end of the financial panic most likely means that bondholders and preferred stock owners will be able to enjoy their steady payments for the foreseeable future. Common stock holders, however, may find earnings depressed for many months to come. While we wait for signs that the global economy is also stabilizing, we’ll take advantage of opportunities for high yields at less risk through the debt and preferred stock portions of companies’ capital structure.
Three weeks ago we could see the precipice from where we stood, and it was truly, madly, deeply frightening. Today, thank God, I can see “normal” from where we’re at. We’re not back to normal, yet, but I think we’re headed in the right direction. A normal market, even in the midst of a deeper recession than we’d planned, is probably a market that trades above current levels.
This week we had an historic election with the winner promising to raise taxes and willing to redistribute wealth. Capitalists are scared. We saw concrete signs that the economy has slowed considerably as a result of the financial panic. And we were “overbought.” This week’s sell-off was “normal,” albeit a bit exaggerated by the abnormally high volatility.
Next week’s march back to “normal” should be a lot more enjoyable. I’m hopeful that the rest of the world will soon begin to share in this recovery.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
Posts
No comments:
Post a Comment