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Summary

  • The recent sell-off in the market accelerated in Thursday's trading, with indices posting major declines.
  • This market pullback could continue for awhile as valuations got overextended and as the Federal Reserve slowly curtails QE3.
  • Investors should have a game plan to deploy new capital into the market at lower entry points.

Financial pundits are not having a good year so far in 2014. Most predicted both interest rates and equities would continue to rise in the New Year; albeit at a slower pace than in 2013. They have been wrong on both counts up to this point. Four of the last six trading days have seen deep declines in equities. This accelerated Thursday, as the S&P 500 lost over 2% and Nasdaq posted a decline north of 3%. It seems the adage "Sell in May and go away" has arrived some 4-6 weeks early this year.

The market posted declines of 17% and 13% respectively after the conclusion of QE1 and QE2, before another easing program was announced by the Federal Reserve. Investors believing the reaction to the slow curtailing of QE3 would be different this time, even with equities at much higher valuation levels, were placing bets that seem to ignore recent market history. This wager is looking more and more like the wrong one, and just maybe it is not "different" this time around.

In addition, valuations in the market were deeply overextended to begin the year, after 2013's huge rally that saw equities return over 30% including dividends. This was the best year in the market since the late 90s. It was also accomplished in what continues to be the weakest post-war recovery on record. Hardly the 4% to 5% GDP growth we saw in the rip-roaring 80s and 90s.

More importantly, earnings only increased roughly 5% in 2013; hardly the robust fuel that should have been required for such a huge advance. Furthermore, profits in the first quarter of this year are expected to be approximately flat year-over-year with the same period in 2013.

Over the last month, investors that were in the momentum names that did so well in 2013 like Tesla Motors (NASDAQ:TSLA) have been taken out to the woodshed and beaten like a rented mule. Small caps have also significantly underperformed the market over the past month, as the Russell 2000 (NYSEARCA:IWM) is now down more than 6% from its highs in March.

Investors who heeded my call (I,II) to build positions in blue chips and high-yield sectors like real estate investment trusts (REITs) have done well this year. My own portfolio is down ~2% from its highs this year, but still up ~3% YTD.

I believe it is too early to go whole hog "buying the dip", but prudent investors that have "dry powder" should be looking to add allocations slowly to beaten-down stocks and sectors. I have quit allocating new funds to the value & income stocks and sectors that have served my portfolio so well in 2014.

Instead, I am looking at some special situations, as well as long-term growth plays that have come down a significant amount over the past month. We will cover these growth plays in part II and III of this piece in order to keep this article concise.

However, one special situation I am looking to add shares to is General Motors (NYSE:GM). Its recent recall scandal has knocked ~20% off its stock price. This had cut the company's market capitalization by some $12B. The automaker just almost doubled its estimated cost of this recall to $1.3B.

Let's say this doubles or triples again as it pays off liabilities that technically it rid itself of through its bankruptcy in 2009. This would amount to a total cost of ~$2.5B to ~$4B. A $12B loss of market capitalization seems excessive in light of this.

Earnings should rise ~15% this year to just under $3.60 a share, before jumping to over $4.80 a share in FY2015, according to the current consensus. Stock is cheap at 7x FY2015's projected EPS, and also yields 3.4%. For long-term value investors, this seems like a no-brainer.

On Saturday and Sunday, I will discuss some of the growth plays I plan to pick up on sale, should the market downturn continue, which seems likely. Investors should make similar game plans and enjoy the opportunity to add funds at lower entry points. In addition, they should not have to be subjected to all the usual "Sell in May and go away" articles that usually come out at this time of the year.

Source: 'Sell In May And Go Away' Arrives Early In 2014