Hunting Season in Blue Chip Territory

In my first article published on Seeking Alpha, I made my case for the bear market.

Well, we're here. Now what?

If you are a trader, it's a disaster. Traders in markets need buyers and sellers, and there has been a glut of sellers in the last few days. Buyers are taking a prolonged holiday.

If you need price spikes, waves, momentum trading, charts, whatever, the absence of buyers wrecks your trading models. We're talking about your trading program going Microsoft (MSFT) blue screen. How many financial institutions - hedge funds, mutual funds, index funds, long/short funds - can you think of which require horizontal price movements?

If you are an institutional investor who has money through a variety of advisors (hedge funds, trading companies, investment banks) and you see your paper gains quickly erase, your trading programs initiate redemption requests from those firms to protect your principal.We're talking about college endowments, pension funds, charitable endowments and other institutions who have a fiduciary duty to preseve these investments.

If you are near or at retirement age and you took on equity risk forgoing bond income, you are pushing back your retirement date.

Meanwhile, in the real world, employees are getting up and going to work and bosses are paying them. Money is exchanged in supermarkets for goods like bread and meat, which appeared to be in plentiful supply. Yet the P/E Ratio of the DJI is reaching "normal levels" or, what people held hostage to overpriced equities call "bargains".

In an overleveraged society where the consumer makes up 70 percent of the economy, an increase of the savings rate will lead to the contraction of the economy until a proper balance is struck between savings, debt and consumption. This correction could take a few years.

But photosynthesis goes on unabated. Life continues on the farm. Coffee will continue to brew and there will always be snow to shovel. Most Americans will engage in activities which touch and concern most if not all of the components of the Dow 30. That's why it is considered a barometer of American life.

The Dow 30 barometer reads that the contraction has already occured or that the market has priced in a future contraction. Some people have felt that contraction but not on the level that it suggests. Forget for a moment about what it is supposed to say and how macroeconomic data interplays with supply, demand, commodity and currency pricing within each Dow component. Just focus on the forced selling and absence of buyers.

The increase in housing prices caused the stock market to similarly inflate through cheap credit and mispricing of risk. Now this illiquidity has forced margin call selling of equities distorting the true value of each company. The price-to-earnings ratio of ConocoPhillips (COP) is absurd. It just reflects the inexorable flood of forced selling into the market.

Traders with short and intermediate term outlook are understandably miserable with volatility levels and the constant rule changing by various governmental agencies. But if you are a long term investor and you do not have someone poking you in the ribs for their money back, we are experiencing a tremendous opportunity. The market needs long term investors to take their shares off of their hands. The selling will continue until sufficient capital is reached to meet redemption calls. Some institutions will fail. But out of that misery and failure, investors in low price high dividend yield Dow 30 components will come out ahead with a long term perspective.

Do not get confused by the panic of the traders infecting media with whom they have forged close relationships. The economy is forecast to get worse in the future, and yes, there will be plenty of bad news. But long term investors need to focus on the fact that the decline will not stop until the selling stops. The selling will stop. But until someone knows how many redemption orders are out there, or the total amount of margin calls, it is officially a buyer's market. In a buyer's market, buyers take their time to buy. It is a buyer's market when the charts are useless when supports are smashed through to the basement. It is a buyer's market when there is a government intervention every other day. It is a buyer's market when world leaders converge. It is a buyer's market when sellers work over the weekend. I watch football over the weekend. Who's better off?

October is only halfway over, and Thanksgiving isn't that far away. If you were thinking about buying, why bother? You can wait for a sustained rally and take a chance that it is just a bear rally and see more forced selling later. You can buy a dividend fund like the Dow 30 Enhanced Premium & Income Fund (DPO), which is yielding 23 percent to diversify the sector. You can buy individual stocks like General Electric (GE), Pfizer (PFE) or ExxonMobil (XOM) if you are leery of a sector or enamored with a particular management team at a company.

As long as you understand that there will be no short term recovery, it is hunting season in blue chip territory, and you can wait as long as you observe the forced selling.

If you think there will be a quick rebound, you'll hock the gold and put the cash into your equities immediately. Just be prepared to shut down the terminal for six months or a year. Or, if you want to be prudent, you could time out purchases between now and years end without feeling like you missed out on anything. It would be a fair bet to assume that having our fair share of "silver bullets" fail, the hammer is clicking on empty cylinders. This is a good thing for a buyer.

Happy Hunting.

Disclosure: Author recently purchased shares of COP, DPO, GE and PFE

Comments

[Smarty_Pants:]

Some good advice. No need to be in a rush trying to pick the bottom. There is plenty of time to wait and search for bargains. Search now, buy later. You won't miss out on much.

Also, be aware of how the Dow 30 Enhanced Premium & Income Fund (DPO) operates before you buy it. It isn't as straightforward as you might imagine.

To quote from the initial offering prospectus:

" Under normal circumstances, the Fund will purchase all of the thirty
common stocks included in the Dow Jones Industrial AverageSM
(“DJIASM Index”), weighted in approximately the same proportions as
in the DJIASM Index (the “Dow Stocks”). The Fund will also purchase
other securities or financial instruments,

primarily SWAP CONTRACTS,

designed to provide additional investment exposure (i.e., leverage) to
the return of the Dow Stocks (the “Additional Dow Exposure”). The
Dow Stocks and the Additional Dow Exposure collectively are referred
to herein as the “Total Dow Exposure.” The Fund also will engage in
certain option strategies, primarily consisting of writing (selling)
covered call options on some or all of the Dow Stocks (the “Options”)."


So a quick summary: the fund buys stocks and SWAP CONTRACTS (purchased OTC like the ones currently sinking the big banks) and then write call options against these positions for income.

Bottom line: DPO will have huge exposure to counterparty risk on the other side of those SWAP CONTRACTS. Keep that in mind. Doesn't mean it won't work just fine, but then again it may have problems.

Let the Buyer beware.

2008 Oct 12 06:51 PM

[JayC:]

If selling slows down, why does that assure the market that equities will go up? If this is the case, shouldn't volume of quality large caps traded plummet to almost zero? For example, if 100 shareholders of BlueChipCompany exist, and 99 of them want to hold onto their shares, but the 1 who is desparate to sell then sells to a buyer who only wants to buy at a price 25% lower than previous day, won't the price go down anyway for BlueChipCompany on that day?

2008 Oct 12 10:20 PM

[longandshort:]

Altria (MO) - Classic stock that nobody wants to sell. P/E = 4.8, EPS = 3.8, dividend yield = 7%..stock at $18!. With the future aquisition of UST, expect the dividend to rise...

2008 Oct 13 12:20 PM

[Butch Weber:]

I look at DPO as a good thing! I have pulled out from last year's 401K slump with this great high yield monthly income dividend stock. It is currently at 16.49 % yield and has been paying .17 per stock montly for over two years now. It has a solid performance record. I agree that we have to watch all stocks carefully and the minute it changes, I change as well.

Aug 20 09:19 AM

[Clifford:]

DPO yield is mostly just giving money right back (Return of Capital). The only reason it shows a high total return is that it is trading at an unsustainable +25% premium to NAV.

From CEF Connect:
"[DPO] Estimated Components of Distributions
These percentages are as of the last calendar year. Early in the year, until the prior year's audited breakdowns are available, these will be estimated values.
Ordinary Income: 18.10%
Long term Capital Gain:
Short term Capital Gain:
Return of Capital: 81.90%"

Nov 05 09:12 AM