If you want to know what the stock market looks like when it starts to price in a more than a slowdown and more of a chance of an economic recession, just look at the tape last week and today.
The old mantra is that the stock market cannot achieve a sustainable rally without the financial stocks participating in a bullish run. It’s no secret that financials continue to be sold on any strength. The real truth is that nobody believes these write-downs are the total end of "new charges" nor are the bad headlines over. Topping that is the point that balance sheets are irrelevant and no one can use any real ratios to determine the true value of the stocks. That may change later in the year as the values reach a point that even in a worst case ballpark "guestimate" make these just too attractive to pass up. Foreign sovereign funds have already started stepping up to the plate.
M&A in 2008 is looking like more of a much smaller deal-size for private equity firms, but they will continue to do deals. Just forget about the mega-LBO’s. M&A for the most part will be strategic M&A between public companies or public companies acquiring private companies and operations. If you worry that an overseas future employer may be in the hand at your office, it is our belief and the belief of others that more deals in non-core infrastructure (so no CIFIUS risks) but still in stable businesses will come from overseas buyers who feel they are getting a 20% to 25% discount because the greenback is now essentially the US Peso.
Retail and consumer discretionary spending slows drastically, and if you have tracked our daily 52-week lows you will see that retail spending in furnishings, apparel and accessories, and even in all high and mid-priced restaurant chains have been just ugly as hell. It seems to be mostly the same names and same sectors hitting new yearly lows each day. When you see Bed Bath & Beyond warning of much lower earnings the hope that this is just a slow down becomes too optimistic.
Using the dividend or stock buyback candidates isn’t a sure bet either. The highest yielding stocks are frequently that of REIT shares and the market is throwing these out like they are all plagued and as though they will all have to access capital at ridiculous terms.
We won’t even mention the terms auto stocks, housing stocks, and the like. Even if energy prices back off, they are still astronomical. To make things worse, even a slowdown in domestic energy demand came into play might not assure that prices come down drastically.
But now technology upgrades with new more robust computers and mobile devices are starting to show severe cracks in the stock prices. Even if the slowdown here doesn’t end up as bad as fears are becoming to show, the multiples that investors are willing to pay is coming down. The same is starting to hold true on high-growth non-tech companies.
So investors flock to defensive stocks, and we compiled an ‘early 2008 defensive list’ that combines value stock methods with defensive strategies in companies that investors eat, drink, or smoke the products. So far these are up today but we want to caution that if the market takes a broad-based serious turn south that these will fall too (just in theory not as much). We’d also warn of near-bubble valuations starting to appear compared to earnings growth and to the market overall.
Have you noticed the appreciation in commodity stocks lately?
Technical averages become important and major support violations take away many hopes of a recovery in any rapid time frame. When you see the market and stocks trade on a "Gap and Crap" basis where the stocks open higher and sell-off immediately, that takes away most enthusiasm too. This leads to periods of mere trading rallies or "oversold bounces" that are short-term blips rather than the start of anything major.
Despite the fact that things have been ugly, the trick is to take a contrarian approach and look for situations where even under realistic bad-case scenarios the selling has been too much. That doesn’t mean you’ll catch the bottom and that doesn’t mean you are entitled to gains just because you do your homework.
A recession is a slowdown that went into negative growth. The employment situation is almost never as good as say a year before when you go into a recession. An absence of credit or an absence of consumers being able to stomach taking on more credit is also a pre-recession trend. Declining home prices help this along faster. Inflation acts as a tax hike. When big financials start to lose money, this helps bring a recession too. All of these are present today. The greater and greater chance for a recession is being priced into the markets at the start of 2008.
If the markets begin to reflect a recession in reality, we think it will be pricing in only a brief recession of say two quarters or maybe three. Its just hard to convince those in economic pain of the current situation being temporary. We may be another two to four weeks before "relative book value" and "dirt cheap earnings valuation" arguments can really hold much water because we haven’t seen the initial 2008 earnings guidance from most, and forecasts from even a month ago may not hold any water this week.
Oh yeah, and the belief that the global emerging markets have entirely decoupled AND will remain entirely decoupled from the U.S. will prove to be a farce. They can still grow, but taking on added risks to chase 3% or 4% economic growth is much different than if you think you are buying 10% growth. As long as you see stocks still rallying individually when there is good news, then things haven’t truly gone to hell in a hand basket. When you see stocks still being sold on good news then the safe havens disappear.
If the economic numbers mysteriously get better or if the bottom fishing stock buyers can overtake the influence of mutual fund withdrawals, then there may still be some hope. Hope is getting harder and harder to find.
Jon C. Ogg
January 7, 2008
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