Richard Moore, CFA, writes about strategies for asset allocation in IRAs.
Last week's stock trading was typical of a market looking for a bottom.
The major stock market averages were all lower for the week. Beneath the surface, however, many stocks were doing just fine. There were more stocks up than down last week, and the average stock showed a small gain.
Here's a chart of the Value Line Geometric Average compared with the
This is a five-year chart of the S&P 500 in black and the Value Line Geometric Average (measuring the movement of the average stock on the
) in red. The scales are comparable for each average. Starting in July 2007, the average stock began to perform much worse than the S&P 500, forecasting the eventual top for the S&P in October.
The underperformance has pretty much continued until January. Since then, the Value Line Average has been flat while the S&P 500 has gone lower. Last week continued the recent divergence with the Value Line Average increasing slightly while the S&P 500 declined. It is too early to tell if this positive divergence will mark the bottom of this correction but the signs look good.
My indicators were unchanged last week. The equity put/call ratio remains near record levels and is extremely bullish. Similarly, the confidence level of smart investors is far above that of dumb investors and is also extremely bullish. Short-selling by odd lot investors compared to their level of purchases remains in bullish territory.
Neutral readings are being given by the level of money flows into Rydex bearish funds compared to flows into bullish funds and by the volume of selling by odd lot investors compared to their purchases.
The lone indicator that remains bearish is the volume of shares traded on the Nasdaq compared with volume on the NYSE. Two weeks ago there were some signs that speculation was finally coming down to more normal levels. However, the volume ratio rebounded last week and the 10-week moving average is still stuck in bearish territory.
This set of indicators leads me to maintain my recently reduced cash target at 6%. I am slowly reducing the cash position in my IRA and it stood at 14% at the end of last week.
Looking for Good Buys
Finding new stock ideas to buy is still problematic. I am continuing to purchase
S&P Depository Receipts
as a way to reduce my cash position but new individual stocks are hard to find. The leadership of the market continues to be centered in commodity-oriented companies and it is possible that these companies will continue to lead the market higher in the near term.
My screening system continues to highlight many companies in the energy sector of the economy and I took a new position last week in one of these companies.
Complete Production Services
is an oil and gas service and equipment company that works predominately with natural gas exploration and production companies. Natural gas has increased in price catching up with the explosion in oil prices and exploration activity seems to be increasing. Growth has been near industry averages but margins and return on assets have been sub-par.
The company's challenge is to increase these returns and last year was a good start. Revenue was up 37% and EBITDA was up 39%. Valuation for Complete Production is extremely low relative to the industry. The company's P/E ratio is 10.2 compared with 18 for the oil and gas service and equipment industry. Price/cash flow is only 5.6 compared to 12.5 and the company sells at a 30% discount to the industry median when measuring Enterprise value/EBITDA.
I had several nice winners last week. The best performer was my recent acquisition,
Life Sciences Research
, which was up 13.5%. Even at current price levels the stock seems attractive, selling at a 20% discount to the median company in the research services industry.
Cal Maine Foods
continued its winning ways and was up 9.4%. The company still seems cheap but it is hard to value the company on earnings that are probably not sustainable over the longer term. One more problem for the large number of short sellers in this stock: the company has established a dividend policy of paying out 1/3 of current earnings as dividends -- this amount will have to be paid by investors who are short this stock.
Rofin Sinar Technologies
was up 7.9% last week and now looks close to fairly valued. I will probably reduce my position in the stock this week.
The following table shows all the current holdings in my IRA as of March 28, 2008:
Richard Moore, CFA, has 40 years of experience in various facets of the investment business. He has been employed by banks, mutual funds and investment advisory organizations during his career and has also owned retail and service businesses. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Moore appreciates your feedback;
to send him an email.