Readers are well aware that I have been cautious on stocks for most of this year. High valuations, deteriorating
fundamentals and a hostile
supported such a position. In fact, I wrote that the "average" stock was probably a better short than long at the beginning of 2007.
I am now changing my tune -- it's time to add equities and risk to one's portfolio.
Clearly there's a cascade of bad news surrounding the housing market correction and the collapse of the structured finance business. That stupidity should not return for quite some time.
There's also a mid-cycle economic slowdown in full bloom. Many sectors of the economy will face slowing demand, and the global economic system might just implode. If that occurs, this trading call is premature.
But just in case the world continues to spin and life as we know it continues, many individual stocks are simply too cheap not to own. At the end of this column, I'll discuss the cases for
( TWB) and
. If we narrowly miss a recession, or even experience a shallow one, many economically sensitive sectors of the market will be attractive long-term investment opportunities.
The Macro View
After the recent correction, many stocks are now cheap or fairly priced. Although the major cap-weighted indices are down around 10% from their high levels, the mean and median stock in the S&P 1500 has plunged almost 30% from its high. Clearly, this has been a nasty stealth bear market disguised as a moderate correction.
With this decline, valuations have improved immensely. The average stock trades for around 15 times estimated 2008 profits, down from a peak of 20 times earlier this year. Many stocks trade for 10 times next year's estimates or less. My entire portfolio sports a single-digit
price-to-earnings ratio. It's hard to not like high-quality companies at nine times earnings.
Fundamental conditions, while deteriorating, are still decent. Clearly the morons who run most financial institutions have gotten the banking system into a bit of a pickle with their structured finance fiasco. And the Fed will respond to this crisis appropriately with further, more aggressive easing.
I loathe admitting this, but we need a period of easy money to help mitigate the problems from the last period of monetary promiscuity, Easy Al's 1% deflation hoax stupidity.
Although we do need more recession insurance, just in case the credit contagion spreads, the real economy is still growing slowly. Domestically, consumer durables are soft. However, many sectors in this economy are still living off strong global demand, including technology, energy, infrastructure, transportation, agriculture, aerospace and consumer staples.
Because global demand for these products is strong and lead times are long, these businesses should continue to thrive.
But we do need the Fed to acknowledge the negative impact that the credit crisis could have on the real economy, should it spin more out of control. That's why a few more aggressive rate cuts are required now. If the Fed waits to move until we enter a recession, it will be much too late.
I believe that a 3% to 3.5% fed funds rate would appropriately balance the need for credit-crunch-inspired interest-rate relief with inflation concerns.
So with all these concerns, what could turn investor psychology more positive?
A friendlier Fed, for starters. Some soft, yet not imploding financial data would help. And investors need to get over the daily panic of subprime/structured finance writedown announcements. We know that $200 billion to $300 billion of losses may exist, and that only about $60 billion has been disclosed. Get over it already. This issue will be around for years to come, and it shouldn't precipitate the end of the global economy.
Should the economy not collapse, here are some of my thoughts on sector exposures. I have liked the global infrastructure/commodity/energy theme all year. I continue to buy the dips in these industries: technology, machinery, integrated oils, materials and commodities. The global capital investment story has at least a few more years to run. The CEO of
recently said that it was only in the first or second inning; I believe it's the fourth. Either way, much of the game lies ahead.
I have avoided most of the names in the domestic consumer and finance spaces this year as well -- I am still cautious on many of these sectors. However, I do like some companies that provide small-ticket consumer goods such as toys, footwear and specialty retail. I believe retail can hold in well enough to give companies with specific growth engines an excellent trading opportunity. I even emphasized a few of them in
my last column.
The New Longs
: At $62, this global niche manufacturer of aerial work platforms, cranes, mining and construction equipment trades for nine times earnings with 15% revenue and 20% earnings growth. Terex will continue to benefit from the global infrastructure boom for the next few years. Last quarter, Terex's backlog grew 70%. I expect a positive earnings surprise this December quarter as deliveries catch up to orders.
Also, a new story is emerging domestically, a "rebuild America" theme. The slowdown in residential construction will give the politicians opportunity to focus those freed-up resources on rebuilding America's highways, roads and bridges.
leading beneficiary of that activity with its construction, aerial and crane divisions. The last time I highlighted Terex, it tripled. This time, my target is only a double, or 13.8 times my 2009 forecast.
: At $77, Conoco is trading for seven times my 2008 estimate, with prices for oil and natural gas rising. By far the cheapest of the major integrated companies, Conoco has two very underappreciated features: its lack of production-sharing contract (PSC) exposure and its natural gas position. I believe natural gas will benefit from a global BTU arbitrage situation in 2008. Natural gas is simply way too cheap vs. oil as a fuel.
I believe domestic fuel switching, new natural gas-fired electricity capacity and foreign demand bidding away liquid natural gas (LNG) shipments will all conspire to keep natural gas prices higher than expectations. We might even get a real winter this year as well.
Also, Conoco has very few production-sharing agreements with foreign state oil companies, so it doesn't have to forfeit barrels in lieu of high prices. This will be a not insignificant issue for most majors.
After a fourth-quarter earnings number that prints closer to $3 than $2, investors should develop a better appreciation of Conoco's charms. My target remains par ($100) on a $10+ estimate.
: It's now trading around $24. I highlighted this tween (9-14 year-olds) retailer a couple of years ago and it doubled afterward. Despite being a much stronger company and better story today, the stock has returned to my original feature price in the low $20s.
This company has one of the most powerful growth stories of any retailer in the domestic market, with 15% to 20% square footage growth and strong comp-store sales.
Their Limited Too brand is a mature cash machine feeding the growth engine that is Justice. That 200-store division, which sells lower-cost tween products to a much broader universe via strip center stores, could grow to 800-1000 stores. Stunning square footage growth as well as mid-teen comps should drive powerful growth for Tween Brands for the next five years.
You get all this revenue growth, margin expansion potential and a 20% recent accelerated share repurchase program for only 10 times my consensus calendar 2008 estimate of $2.40 a share. How's that for a PEG ratio? On my earnings estimates, a proper valuation would be a stock in the mid-$40s, another double.
: Currently trades around $12. This represents the only time I have highlighted the same stock in two consecutive columns.
I am doing this for a reason: After the last column, Flextronics' management confirmed the stunning accretion from the Solectron deal I had forecast. At 10 times 2008 calendar profits and growing 25% for the next two years, the stock is a compelling growth company disguised as a value stock.
The Solectron deal represents a major inflection point for the entire EMS business. The industry should still generate strong, double-digit revenue growth, but now better competitive dynamics will improve pricing, profitability and free cash flow characteristics. One leading Wall Street firm forecasts a 20% free cash flow yield for Flextronics on calendar 2009 profits.
Be inflexible; I'd buy and hold those shares for the next two years to capture this sea change. If management's financial targets are achieved in a decent economy, the company could make $1.60 and trade into the mid-$20s.
Cramer: These Oil Stocks Will Keep Rising
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As you can see, the latest correction has clipped many stocks so badly and to such low valuations that big upside trades may result from the right fundamental outcome. My earnings and valuation target for all stocks mentioned are hardly aggressive. Yet these, and many other stocks I own, have 50% to 100% upside potential.
That's what I mean when I write, "too cheap not to own." That's why the "anti-implosion" rally makes so much sense in here. It is not a risk-free trade, and it requires some news around a stabilizing economy and credit environment.
But should conditions there steady a bit, that trade -- the anti-consensus, anti-sanity one -- might be the most profitable investment decision you can make right here.
At the time of publication, Marcin was long Terex, ConocoPhillips, Tween Brands and Flextronics, although positions may change at any time.
Robert Marcin is the founder of Defiance Asset Management, a private investment management firm. Client accounts managed by Defiance Asset Management often buy and sell securities that are the subject of commentary by Marcin, both before and after it is posted. Under no circumstances does this column represent a recommendation to buy or sell stocks. This column is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither Marcin nor Defiance Asset Management can provide investment advice or respond to individual requests for recommendations. However, Marcin appreciates your feedback;
to send him an email. Marcin is not required to update or held responsible for updating any portion of this column in response to events that may transpire subsequent to its original publication date.