Buy, sell or hold? I think it is too late to sell. The question in my mind is whether to “catch a falling knife” or wait until there is some confirmation of a bottom in technical or fundamental terms. Countless pundits have warned against ever trying to call a bottom in a real bear market, which this clearly is. But the other mandate is to “buy when there is blood in the street” - buy when fear grips the market, sell when greed is peaking.
To decide which philosophy to follow I am looking at both the technical condition of the market and a gut feeling on fundamentals. I think the financial crisis may be peaking although the real economy has only just started to drop, and I think stocks look about as cheap as they are likely to get from an historical viewpoint.
Below is a Goldman Sachs chart comparing current values with those at past market bottoms. Note that the current data is through 10/7. Prices are nearly 10% lower now. Seems like today’s market looks like ‘73 and ‘00 in terms of the drop - beating all drops except ‘29 - and compares favorably (lower) in terms of P/E with all but ‘29, ‘73, and ‘80. But in regard to the latter two remember that current interest rates are a lot lower, so a higher P/E seems to be justified now.
On the basis of this technical analysis it seems like a bottom may be fairly nearby.
Looking at fundamentals, the financial crisis may be peaking, although it is impossible to say for sure, but the main thing that makes me question that the market has bottomed is the fact that the debacle in the real economy has not had time to catch up with the damage to the financial markets. We still have a lot of trouble ahead. I expect bankruptcies for Ford (F) and GM before this is over. While that might be good for both companies and for the economy by eliminating some untenable legacy contracts, it would probably spook the market further. There are also more challenges to the banking system coming from credit card and car loan defaults. A fair amount of unemployment is coming. And for energy investors in particular, oil prices have further to fall I believe.
As I mentioned in my recent newsletter, a viable strategy may be to start buying in fairly small quantities now and “dollar cost average” in over the next few months back to what you consider a full investment position. I am planning to follow that sort of a plan although I will certainly feel my way as events unfold.
Among the first stocks I will buy is TBS International (TBSI). This shipping company has staked out a unique territory as a sort of “Federal Express of shipping.” Instead of being a bulk shipper of commodities like most shipping companies, TBSI concentrates on serving particular clients, often with fixed price contracts that are booked well in advance. The clients are often entities constructing enormous projects, like building a new refinery, for which they need very large items shipped in. TBSI has a significant service component to their product adding substantial value over the bulk shipping rate and drastically reducing the level of competition they face. Thus their earnings are not completely tied to the Baltic Dry Index that has been dropping like an anchor recently. In fact during the most recent BDI drop before this one TBSI’s earnings kept growing. I doubt they will be completely immune to this current downturn and I expect analysts to begin dropping their earning expectations that are currently running north of $6 per share for both ‘08 and ‘09. EBITDA is substantially greater than earnings. The stock meanwhile at $8.50 is more than 80% below its $71 12 month high.
I also like the midsteam natural gas players about which I recently posted. They provide a stable business model and attractive dividend to support their stocks. Moreover, I expect the use of natural gas to be expanding in the U.S., even as the price of the commodity continues to languish due to over-production. Many of the midstream players are compensated on a volume basis, not on the basis of the price of gas.
Some of the financial plays may bounce back rapidly. While I am not by any means an experienced analyst of finance stocks it seems to me that Goldman Sachs (GS) and Blackstone (BX) have business models that are well positioned to profit in coming years from the problems that other firms are experiencing in the lending area. They can be bought for 1/3 to 1/4 of prices they commanded earlier this year. While they may experience a year or two of poor earnings, I think they will remain category champions and it’s hard for me to imagine a purchase at this point not being very profitable within two years.
In summary, I come out somewhere between “don’t try to catch a falling knife” and “buy when fear dominates”. My sense is to begin buying on a phased in basis. I don’t want to get caught up in the mania if we see a huge up day, and it would not surprise me to see a day when the Dow gains over 1,000 points. And I don’t want to despair if we continue to see red all over the screen. I’d like to just buy in slowly, particularly after market declines, to the extent that I have investable cash. One other thing: you may have noticed that oil and gas producing stocks are not the first ones that I am buying.
Please note: everyone needs to make her own investment decisions in consultation with her professional advisors, of which I am not one.