Five weeks into the year, I am sticking to my guns: The economy isn't good, but stocks aren't so bad. For those of you pressed for time, let me summarize concisely what follows: Turn off CNBC and read some SEC filings and listen to conference calls.
OK. For the rest of you have some time to follow my thought process, I always think that the market is ripe for picking stocks. I admit my bias! With that said, though, 2008 and 2009 were years to avoid or seek Beta rather than to chase Alpha. 2010 will most likely not see the directional moves we have experienced over the past two years. The action just this past few weeks could serve as a model for what might ensue over the balance of the year.
So far, while the market is indeed down, it's important to keep things in perspective: The Bear Rally lives, at least to this point. We have seen ferocious rotation out of sectors and asset classes that performed exceptionally well last year, but, from my perspective, it's just profit-taking. The S&P 500 in aggregate is down 4.25% YTD after rallying 6% last quarter. The two best areas last year, Tech and Materials, are clearly pulling the market down. Emerging markets soared last year as did commodities, but now they are back into the ranges from the summer. These things get lots of attention in the media, but do they really signal anything at this point?
I think that there are a lot of very interesting things going on that don't seem to get media attention: M&A is back (OK that gets some attention, but not as much as what's going on in Greece!), dividend hikes and share repurchases are cranking up, investors seem to snap up large-cap names that gap down on earnings misses (now that's a good sign). Yes, they are also selling overextended names that report good numbers, but they aren't pulling out of the market, just redeploying.
So, rather than assume that this rotation is indicative of a return to the days of early 09 or late 08, I suggest that investors keep in tune with the bigger picture. The key risk factor isn't the dollar, it's our interest rates. If we see rates rise despite the economy being weak, it's probably game over. That will be the sign that the deleveraging is kicking in again. For now, though, the game goes on (and it's definitely a game). I suggest spending time focused on special situations or turnarounds or seeking exceptional management (last year all companies needed was someone who could hand out pink slips). Valuation matters. The tide isn't rising, nor is it receding yet. Take a look at this chart - is this scary?
Will the market go up or down this year? Yes, but not much, at least not initially. Perhaps Beta begins to trump Alpha later this year, but I suspect a narrow range ahead. My Top 20 Model Portfolio is all about Alpha, as it is by design always fully invested. The model performed exceptionally well last year, and it is doing well so far this year. While it was up in January, it pulled back last week to about unchanged, which is well ahead of the market. I have recently described rather extensively the strategies I am pursuing there, though I would note that we have already sold two names and replaced them with a technology company and another industrial.
I think that this market will reward hard work in the trenches. It's probably best to focus in areas where others don't, so that probably means smaller names and more of a value orientation or GARP rather than aggressive growth. As the global economy remains challenged, we should continue to focus on companies with better balance sheets. My guess is that the kind of market I envision will require us to be more opportunistic than normal, taking profits when they arise and jumping into herd selling situations. I certainly don't have a crystal ball about whether or not the market rally from the lows last March continues all year, but I am confident that there are plenty of opportunities for those willing to do the work.
Disclosure: No stocks mentioned
