Active Trader Update
A Christmas-Comes-Early Portfolio
Jon Markman
07/27/06 - 07:30 AM EDT
The market may seem pretty confusing right now, but trust me, by the time Christmas rolls around, it will all become crystal clear. When you've got a fire warming the hearth and Andy Williams ballads rocking your iPod, you're going to think back on missed opportunities this summer, slap yourself on the forehead and let out a big "D'oh!"
So what is it that will be obvious in hindsight? It's probably a devilish blend of three positive and two negative events. Take your pick, and combine as appropriate:
- Unexpected armed conflict in Lebanon and Israel pushed U.S. stock prices down to levels that discounted way too much pessimism over the potential impact of higher crude oil prices. Shares of American capital goods and industrial manufacturers got too cheap. Should have scaled into them over the summer.
- Seventeen straight interest rate hikes by the Federal Reserve led wary investors to become overly pessimistic on monetary policy. Rising rates have smashed shares of U.S. homebuilding companies to levels previously seen only during recessions. Should have scaled into homebuilders that were priced around book value.
- Reports of rising semiconductor inventories, sinking prices and a lack of buzz on hot new electronic gizmos led investors to punish technology stocks to low valuations. But then it turned out that a hot new Sony(SNE Quote) PlayStation 3, flashy new video iPods and a surprisingly cool, small wireless media player from Microsoft(MSFT Quote) emerged in the fall and sold millions of units. Should have scaled into battered or bruised tech stocks with solid growth prospects and undernourished expectations.
- Three years of a low-volatility bull market lulled investors into a false sense of security. They whistled past all the classic warning signs of a bear market akin to those of 2000 and 1974, expecting the decline that began in May 2006 to reverse by the fall. Yet geopolitical tensions, monetary-policy overkill and a collapse of business and political confidence undercut virtually all sectors of the market except the most "defensive." Should have sold everything but bonds, utilities, drugs and consumer staples over the summer at the start of their multiyear rebound.
- The political collapse of the Bush administration after years of political, military and fiscal missteps led to a sweep by Democrats in the midterm congressional elections. New House committee leaders appear ready to follow through on their threat to launch impeachment hearings against the president. Foreign investors flee U.S. equities over the governmental turmoil, and stocks of all stripes sink to three-year lows.
Crisis Consulting
Of all the viewpoints, it seems to me that the first is the most likely to turn out to be accurate. Ned Davis Research published a report late last week that reviewed the performance of the market in the one-month to one-year spans following major financial or military crises. On average, the decline of stocks concurrent with the crisis flash point is 5.7%.Fed Relief
As for the possibility that it will turn out that Federal Reserve fears are overdone, the stocks with the best potential are ones that are, naturally, the most interest rate sensitive. Most prominent among these are banks and homebuilders. Since we've got a couple of banks already in the Dow group, for your Christmas Gift Portfolio, I suggest you turn your attention to the ravaged builders. I know all about the many reasons you would want to run in the opposite direction of this most-hated group, but historically, the best time to buy these companies is when they're trading at book value.A Pessimist's Portfolio
Now, if you're of a more pessimistic bent, then the fourth and fifth "future in review" scenarios are probably the most appealing. In that event, just in case some stocks survive the brush fire, you'll want to add some utilities and health care shares to your Christmas Portfolio. The top-rated Dow Jones Utilities Index companies are TXU(TXU Quote), AES(AES Quote) and Duke Energy(DUK Quote), so these are a great place to start. Others include New Jersey Resources(NJR Quote), Pepco Holdings(POM Quote), OGE Energy(OGE Quote) and Avista(AVA Quote).| Stocking-Stuffer Stocks |
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| Name | 7/24 Close | Mkt Cap | % Chg YTD | Price/Book | PE | Industry |
| CSX (CSX) | $63.53 | $13.7 B | 22 | 1.6 | 13.8 | Railroads |
| Norfolk Southern (NSC) | $46.95 | $19 B | 3.4 | 1.98 | 13.8 | Railroads |
| Mentor Graphics (MENT) | $12.93 | $1 B | 20.8 | 2.2 | 1.4 | Technical Software |
| Avatar Holdings (AVTR) | $54.50 | $431 M | -4 | 1.27 | 7.3 | Residential Construction |
| JPMorgan Chase (JPM) | $44.20 | $149 B | 8.7 | 1.38 | 16.5 | Money Center Banks |
| Citigroup (C) | $47.46 | $233 B | -3.3 | 2.06 | 9.5 | Money Center Banks |
| Walt Disney (DIS) | $29.37 | $62 B | 18.8 | 2.41 | 21.1 | Entertainment |
| ExxonMobil (XOM) | $65.36 | $386 B | 13.8 | 3.44 | 10.9 | Integrated Oil & Gas |
| Merck (MRK) | $38.95 | $81 B | 17.4 | 4.32 | 17.1 | Drug Manufacturers |
| Altria (MO) | $79.49 | $166 B | 6.6 | 4.36 | 14.8 | Cigarettes |
| Johnson & Johnson (JNJ) | $61.98 | $182 B | 2.7 | 4.44 | 16.9 | Drug Manufacturers |
| United Parcel Service (UPS) | $80.00 | $51 B | 4.8 | 5.11 | 22 | Air Delivery |
| Caterpillar (CAT) | $70.52 | $45 B | 18.3 | 5.11 | 15.5 | Construction Machinery |
| Tarragon (TARR) | $13.03 | $367 M | -37.1 | 1.02 | 2.8 | Residential Construction |
| Meritage Homes (MTH) | $36.82 | $941 M | -43.8 | 1.06 | 3.3 | Residential Construction |
| KB Home (KBH) | $40.31 | $3.5 B | -46.2 | 1.19 | 3.7 | Residential Construction |
| The Ryland Group (RYL) | $37.99 | $1.7 B | -49.4 | 1.2 | 3.8 | Residential Construction |
| Xyratex (XRTX) | $23.11 | $634 M | 25.3 | 3.69 | 0.9 | Data Storage Devices |
| Orleans Homebuilders (OHB) | $14.27 | $244 M | -27.5 | 0.92 | 3.9 | Residential Construction |
| Source: MSN | ||||||