June '08: A Stock Picker's Environment

What are the conditions of a stock picker's environment?

• Condition #1-Fear of economic calamity has been taken off the table.
• Condition #2-Positive catalysts for recovery are identifiable but will take time to develop.

In such an environment, investors are anxious to put their money to work but are leery of further weakness spreading from the damaged sectors. Welcome to June 08. In case you've forgotten, the Fed will rescue any large financial institution whose collapse poses a risk to the economy (I had to throw that in there for all of you who started to panic over the Lehman (LEH) news from Tuesday).

In my last article, I compiled various quotes from big-time market participants who suggest that we are in the final stages of the credit crisis, the oil spike and the bottomed-out dollar, representing three major components of market weakness whose recovery would provide positive catalysts to the upside. However, I don't think anybody expects these three issues to rapidly improve in the short term. It is going to take some time as they work out the remaining obstacles.

Let's look at financials as an example: further declines in real estate valuations will put continued pressure on the financials (XLF). Standard & Poor's agrees. On Monday they lowered their ratings on Lehman Brothers, Merrill Lynch (MER) and Morgan Stanley (MS) on concerns about further write-downs in their holdings of U.S. mortgage and residential construction loans. Who wants to invest in a balance sheet with sinking collateral?

The mark-to-market disclosure requirements of Sarbanes Oxley have fundamentally changed the way financials do business. As they adapt their business models to deal with the new transparency, a long term recovery in the sector cannot happen until real estate finds its bottom. It seems logical that a bottom won't happen until prices give back 50% of the 2003-2006 'easy lending' gains. Data from a typical California neighborhood like Thousand Oaks show us that median home prices jumped from $425,000 in 2003 to $770,000 in 2006/2007. Current prices are $669,000. That leaves us with another 12% to drop before we start to bottom out. We're headed in the right direction but we're not through all of the pain yet.

With an ultra-sensitive, election-year government working to avoid a widespread calamity we find ourselves in the midst of a perfect setup for robust stock picker returns. Anxious money will pour into the best-of-breed growers over the next few months. Back in January, when hedge fund manager Doug Kass correctly forecast the current market climate, #11 on his list of predictions was "investors pay up -real up -for growth. The three horsemen -- Research In Motion (RIMM), Apple Computer (AAPL), and Google (GOOG) move into bubble status. Their shares double in 2008 even as most equities decline." (thestreet.com)

Picking the obvious growth stories is the best way to play the beginning of the 2nd half recovery that Ben Bernanke spoke of on Tuesday. Low domestic interest rates, emerging market weakness, a low US dollar and declining real estate all lead us to the same conclusion-there aren't any investment alternatives. People have to put their money somewhere. I recommend staying away from the indexes as they sort out the final stages of weakness. Instead, focus on those companies who have a story to tell, a catalyst that will fundamentally carry them through the remaining rough period.

Our firm, Lone Peak Asset Management, is increasingly shifting client funds away from general sector funds and into unit trust portfolios that can more efficiently capitalize in a stock picker's environment. Such portfolio's are built around specific growth catalysts like the China Rebuild Portfolio, the Apple iPhone Portfolio, the Hybrid Automotive Portfolio and the McCain/Obama Portfolios. Cherry pick the high growth companies when the broad market takes them down. Respect the phase. The overall market is setting up to run again, but now is the time to be invested in the proven winners.

Disclosure: Long AAPL

Comments

[fxtrader07:]

Sorry, but imho you are wrong in two ways and very late to the game.
The premier mistake is to think that investors are desperate(anxious) to put their money to work, now that "fear of economic calamity has been taken off the table." First of all, the fallouts from the financial crisis of the past 12 months are only starting to show up now. second half recovery dreams, "the worst is over!-fairytales and the like represent the mainstream consensus right now and are almost certain to be proven wrong. Second, what "investors" are you talking about? retail guys have long ceased to be an important buyer of equities. households have been net-sellers of equities (stocks and stock mutual funds) for the past years. institutional money? the banks scramble for cash and will liquidate positions into any rally. certainly, they have no ammunition to buy anything in substantial amounts. pension funds? well, some, of course, but many are under pressure from the credit market fallouts don't expect them to jump right back into equities. hedge funds? very unlikely. they have been the first to feel the pain of tighter credit and higher margin requirements. if at all, they will do long/short setups. they will not be substantial fresh buyers because they do not have the credit available tro do so. so what investors are you seeing whio are so anxious (and acapable) to buy and bid prices up? Don't forget, a guy like doug kass is not there to hold your hand and make you money. he is talking his book as most everybody else.
Second, you are late to the game. very late. What do you think was the reason that the Nasdaq and stocks like aapl have held up much better than the broad market so far? And what do you think, how much positive earnings and growth momentum can they sustain once the u.ds. economy really slows down and shows no sign of recovery? the consumer is stretched out to the hilt and even another round of "tax rebates" won't change that. Europe is starting to slow down and Emerging Asia will follow. The u.s. exporters who wstill make good money are not able to pull the entire economy out of the misery.
so, i agree that the only strategy is stock picking here. but even more important is to build cash and preserve capital. there will be really nasty stock market declines over the coming 2-4 years when those with patience and cash will be richly rewarded. Chasing faltering growth that more often than not is based on overly optimistic assumptions will be a receipe for disaster, thoguh.

2008 Jun 04 05:38 AM

[secmaven:]

What number of trillion dollars is invested in money market funds? Isn't this money looking for higher return? Preserving capital by earning 3% interest in a 6% actual inflationary environment is not exactly the best strategy. Buying a little POT seems to be a far better alternative use of the money.

2008 Jun 04 11:25 AM

[ed auerbach:]

Secmaven: $3.5 trillion. Thata a lot of zeros.

2008 Jun 04 02:55 PM

[dsrtwriter:]

the market is usually right. When you have that much money parked at three percent, the concern is not the 6 percent inflation but the potential of a 10-20 percent drop in the price of equities.Sure,POT and other favorites which are now totally discovered are buys at some price, but at what price? That is the question so difficult to assess.

The market is parking money for a reason; it is telling us that the future may not be so rosy for some time, and ready cash for purchasing discounted equities beats riding the hot names downward.

2008 Jun 05 07:16 PM