Rough Weeks Ahead: Have Cash To Re-Deploy On Some Of These Plays

by: Emmet Kodesh

The reaction of the indices September 18 to the Fed's announcement of continuing QE made a big point plainly: the markets are not rising because of economic strength but on a tide of liquidity, that is, debt. "Easing" sounds so nice, like a lubricant, but what is greased is not the gears of the economy, jobs with benefits, industrial expansion, and so on but a bull market sliding higher on leveraged bets punctuated by sudden HFT downdrafts of profit-taking. Continuance of QE indeed was needed to save the housing and bond markets but it is a confession of failure. The comments by "doves" among the Regional Reserve Bank Presidents like William Dudley confirm this however bland the language may be.

The economy is weak and vulnerable as sovereign and private debt levels, often under-reported, rise. Treasury Secretary Lew has stated that tax receipts will not fund the government beyond mid-October. This is part of the push to raise the debt ceiling by October 17 so deficit-spending can continue. Everyone knows the ceiling will not be raised temporarily so DC can square things away and live by balanced budgets: those days and even rhetoric about that way of conducting the nation's business are gone. The government runs by a series of "continuing budget resolutions" the current one needing to be renewed September 30 and its renewal now is enmeshed in the debate over the Affordable Care Act. Expect four more weeks of markets like we have had since reality re-appeared four minutes after the opening bell on Thursday, September 19. There have been five consecutive red days for the DJIA and S&P since. I hope you have heeded suggestions these past several weeks to increase cash positions and not to sell out bonds whose asset values have risen significantly as yields fall by QE.

The premise and context of this study is that these uneasy conditions of wavering and dangerous fiscal policy, weak fundamentals and a pending huge increase in business costs that will hit jobs (the ostensible beneficiaries of QE) constitute a stress test on the markets. Only the most profitable companies will weather the storms of the next month and the upheavals in governance and society in the next few years. Thus the merits of overweighting cash to be mostly re-deployed as things settle, probably by late October seem clear.

That is the defensive posture. Because QE is likely to continue at or near current levels through the November 2014 elections, good buying opportunities should emerge as late October approaches. Action in the queasy aftermath of last week's Fed statement reveals some of the better plays I began to identify and examine here and here. This article presents some low debt, very profitable companies in sweet spots in the socio-economic structure you should watch, research and be prepared to buy when four weeks of malaise start to lift. On the fifth day of declines and unease, PMs (precious metals) recovered and the best companies showed the strongest gains as noted below.

After the plunge on Thursday, 9/19 and the two days of shallower but widespread declines that followed, a few companies stood out in all sectors. In energy, British Petroleum (NYSE:BP), Chevron (NYSE:CVX), Tesoro (NYSE:TSO) and Total S.A. (NYSE:TOT) are notable. All have very high revenues and cash flow / debt ratios and BP at 6.6% and TOT at 7.1% respectively have the best growth. BP and CVX at 20.3% and 17% have the strongest ROE and CVX the best EPS at $12.34. Given its overall metrics and return to the oil fields at Kirkuk in the semi-autonomous Kurdish region of northern Iraq, BP looks like the first choice in this group.

Industrials that have stood up relatively well and have excellent metrics include Boeing (NYSE:BA), Caterpillar (NYSE:CAT), Deere (NYSE:DE) and 3M (NYSE:MMM). In addition to excellent revenues and cash flow / debt ratios, BA at 55.9%, DE at 39.8% and CAT at 24% provide great ROE and DE at 7.6% and BA at 3.4% show good growth in a period when global economies are struggling to grow rather than contract. Mixed commodity miner Rio Tinto (NYSE:RIO) that I have praised many times this year for its diversification and astute board of directors has been rising steadily for months and has stood out in this recent rough patch. However, Monsanto (NYSE:MON) and Northrop Grumman (NYSE:NOC) are superior in profitability with revenues / debt of 6:1 and 5:1 respectively. NOC has 20.6% ROE and MON 18.4% while MMM at 25.4% and $6.38 EPS.

In consumer discretionary, giant McDonald's (NYSE:MCD) and mid cap Whole Food Markets (NASDAQ:WFM) have bucked the recent sea of red and should steadily outperform. MCD is relentless in innovating to meet diverse tastes and styles. It has 2.2 revenues / debt, $5.45 EPS and is growing its dividend to $.81/share starting in December. WFM is debt free and has 13.1% revenue growth. They belong on a short list of holdings as does Disney (NYSE:DIS) in the media-entertainment sub-sector. Its revenues are 3 x debts with 6.3% growth and enduring appeal which glows brighter as times grow dim.

Apple (NASDAQ:AAPL) has been uneven (which is better than most equities) in recent days but it is recovering from its late 2012 decline and is one of the most profitable companies in the markets with revenues 10 x debts, cash flow 2.6 x debt and 10.7% revenue growth helping to produce $40 EPS. If your holdings are in diversified funds and ETFs you have APPL but it is worth adding as an additional overweight holding. It now yields 2.5% on a sustainable 27% payout and the buzz about its "gold phone" should not be overlooked.

On September 25, PMs revived from their latest descent to the underworld. As noted above, the best companies showed some of the strongest gains in the market: First Majestic (NYSE:AG) +2.34%, Yamana Gold (NYSE:AUY) and junior McEwen (NYSE:MUX) both + 2.90%, Silver Wheaton (NYSE:SLW) +2.94%, and silver miners Fortuna (NYSE:FSM) 3.69% and Endeavour (NYSE:EXK) +6.81. MUX and FSM are debt free juniors and the former has steady growth and diminishing costs. AG and EXK have boards experienced in all aspects of mining, great on-site management and multiple sites, five for AG and 3 for EXK as well as numerous E&D properties prepared to proceed as increasing demand hits supply shrinking from reduced capex and production in the last two years of depressed prices. Silver remains a vital industrial commodity. Those new Phones, appliances and high tech engines all need silver.

These are great companies to own as political and fiscal issues get clarified in the next 4-5 weeks. Remember that PMs are very volatile and it is unwise to chase them on a rise. Familiarize yourself with their long term and recent price action and use limit orders and discipline to catch them on frequently recurring down days or weeks. With the DXY USD index dropping this month into the lower part of its 52-week range and yields coming down quickly by QE, PMs should move higher but one still needs to know the price action even for the best companies.

For those who follow the sector, top producer Barrick (NYSE:ABX) is continuing to sell its higher cost sites and mid-tier IamGold (NYSE:IAG) maintains its cost control and decent 2.2 x 1 revenues/ debt while re-positioning its assets toward an even balance between North and South America and West Africa. Taking into account all factors, the best companies are AG, EXK, MUX and AUY in that order. The strong companies covered above should help you ride out rough seas.

Disclosure: I am long BP, DIS, SLW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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