Investment Strategy: Try to Catch a Falling Knife?

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. 

Comments

[PeteK:]

Mr. Kingsdale,
This is really making sense.
Very good analysis. Thanks.

2008 Oct 13 09:10 AM

[George Gorski:]

As I see it there are 3 steps to avoid a world depression. Retailers sell at 4 times the wholesale purchase price; 1/4 for the cost of the commodity, 1/4 for expense, 1/4 for profit, 1/4 for growth. The stock market is comprised of stock retailers, since quality stock prices are now between 1/4 to 1/3 of their 52 week highs, there is buying activity as of Friday Oct. 10, 2008. The financial sector bailouts will not turn this market around because the fundamental problem has not been fixed. Nor will devaluating all commodities help. The world will expect a lower price for US manufactured goods, if the price of their own commodities are lower. The main problem is the US trade deficit. Before the US dollar drops from the sky in the coming months, the US should be going back to the G7 or G20 conference table now and negotiating Balanced Trade Agreements with nations, for example, an equivalent value of GE goods traded for an equivalent value of crude oil. No surplus or deficit allowed. This would restrict the amount of trade to China, since they are reluctant to spend their surplus on US goods. The US should shop around for these Agreements to get the best bang for their products. I am suggesting world trade without the use of currencies, since the currency of many nations are suspect. This action may spur shortages and most definitely force domestic production and growth. That is why Pickens and Buffit are investing so heavily in the US energy and manufacturing sectors, they know where we are headed and they are going to profit from it. OPEC may finally get broken. The second step is the financal system getting back to basics, All new or renegotiated domestic individual loans should be based on the traditional 0.34 debt/total family income ratio. This should be enforced, any abuse higher should result in an immediate surrender of all family assets or fining the offending Financial Institution.
The third step involves new rules for stock market trading. No more than one stock trade flip per time frame, say per week. All stock trades to be taxed at 1/4% of the trade value without an allowable tax deduction. Also the allowance for 24-7 hour stock trading, 365 days per year. We are a global economy.

2008 Oct 13 10:17 AM

[Texan Tycoon:]

The current soar stomach of economy was raised on weak non-operational management. General Motors is nearing the last days as Ford will likely be following in the very near future. The interesting thing about the rally on Wall Street is when investors see a soar in numbers they breathe easy. That is the first mistake in the world of investing especially when we are trying to recover. Being comfortably deceived is part of the plan that Wall Street plants in your minds as to keep you biting for more. They don't care about your loss or how you invest!!!

What the real meaning of a plus 345 to 400 points is that investors with money raised the bar on certain comodities and this keeps sucker investors coming back to lose more. Our country needs to take this loss and move on in our future trading. So, in part I do not favor investing right now especially when in a few days we will see a catastrophic loss in stock!! I hope you are all listening since I predicted the stock hitting a low of 8,000 and on its way to 3,000. Yes I mention 3,000 and a real possibility of even more than that of a loss.

Because I know this from experience, I am passing this on so Americans do not take anymore losses... We cannot afford to play stock speculation when we are ailing in world financial loss. A smart move would be to protect what you have and keep on introducing new businesses. Oil will have to drop to less than 40 dollars pb when they have no buyers. This in turn will start the wind and alternative storm of energy. This is what we need and not more drilling. More drilling will lead to oil in containers with no place to refine and a cost of billions to Americans to just get these rigs online. Imagine when big oil has no other place to go but out of business and we get to stay in business.

Smartly, pressure on auto makers and big oil mean freedom from monopoly! The lower class will not be the ones buying any oil or cars and since this makes up over 2/3 of the United States then that must mean that many less buyers. It's simple to understand supply and demand as just another term used by these corporations. Middle class will stay afloat by also conserving energy and money as their companies demand that they stay free from mass spending. In conclusion, America is imploding and we need to bail our selves out by not buying into oil plans and not spending on current vehicles that would put you in the poor house. Buying stock is not a good idea right now. You may say buy low and sell high, and that was the old thinking regime. We now live in an organic world that has more issues facing loss than gaining in a rich man's game.
Well this is my message to all who want to come out of this smiling in the end because it will take your patience and understanding to make this move in our economy work! We need a bowel cleanser to clean us of the greed that is the current cancer in our world! This is the bottom line.

2008 Oct 13 10:26 AM

[henarl:]

Excellent article and a well thought out investment plan.

2008 Oct 13 01:52 PM

[Steve Selengut:]

Investment Management - Put More Smart Cash In Your Future

The stock market is a dynamic place where investors can consistently make reasonable returns on their capital if they comply with the basic principles of the endeavor and if they don't measure their progress too frequently against irrelevant indices.

The income securities market is most often a less dynamic place where investors can consistently make reasonable returns on their capital if they understand the basic principles of the endeavor and if they focus steadfastly on the income produced by their holdings.

Securities markets are truly fascinating--- replete with promise, mystery, and unscripted daily drama. But individual investors are even more interesting. We've become media driven creatures that must have reasons, predictability, blame, scapegoats, instant gratification, and an imaginary sprite called certainty.

We are becoming a culture of hindsightful speculators, attempting to replace the raw beauty of unpredictable market and economic cycles with an upward only mythology superimposed on a vast casino-like landscape. Most would-be investors are simply keyboard-skilled gamblers, impatient, lazy, and unfamiliar with the nature of the securities they bet upon--- in either direction.

Wall Street provides chips, tables, odds, croupiers, and atmosphere. There are no controls on speculation, and (obviously) no oversight to prevent product creativity from undermining the very foundations of capitalism. Big brother picks up the pieces and imposes more controls and safeguards on the innocent--- while we re-elect the guilty.

Yet the beacons of simplicity burn brightly at the end of the always-under-construct... tunnel between The Battery and Capital Hill. If investors could focus on them (unemotionally) through a cycle or two, the sanctity of stocks and bonds would be re-affirmed and the rationale for derivative drug abuse all but eliminated.

The classic investment strategy that worked so well prior to the development of the multi-level derivatives is so simple, and so trite, that it just begs to be ignored. B-o-r-i-n-g! Surely, the investment Holy Grail will never be found by individual issue buyers and coupon clippers.

Investors willing to identify the realities of our wonderful marketplaces, to recognize and embrace the opportunities with an understanding that goes beyond media hype and blog threads, will survive and prosper. They just need to look back, to rediscover the principles of investment success that can shelter their futures--- but without futures.

The Investor's Creed is a pillar of the Working Capital Model, an investment management methodology developed over three decades ago. It synthesizes basic asset allocation principles, an IGVSI trading strategy, and market psychology into five principles of portfolio operation that transcend market cycles, administrations, and global temperature changes.

Remember, this is a summary and it should raise questions--- limited explanation is provided:

One: "My intention is to be fully invested in accordance with my planned equity/fixed income asset allocation." There must always be a "planned asset allocation" using cost basis instead of market value for calculations. Always be looking for buying opportunities that meet your quality, diversification, and income (QDI) standards.

Two: "Every security I own is for sale, and every security I own generates some form of cash flow that cannot be reinvested immediately." It is important that a profit-taking target is assigned to every security; it is essential that you pull the trigger when or before the target is achieved. The words "I do not need the income" cannot be thought, much less uttered.

Three: "I am happy when my smart-cash position is nearly 0% because all of my money is then working as hard as it possibly can to meet my objectives." Smart Cash is compounding capital, created by portfolio dividends, interest, and profits. If it remains uninvested while new investment opportunities exist, it loses IQ points rapidly. Long corrections can make you too happy.

Four: "I am ecstatic when my smart cash position approaches 100% because that means I've sold everything at a profit, and---" This condition should occur whenever there is a serious rally going on in IGVSI equities and you have no income asset allocation in the portfolio. In that case, it's a good time to re-assess your asset allocation plan.

Five: "--- that I am in a position to take advantage of any new investment opportunities (that fit my guidelines) as soon as I become aware of them." Unless the equity market is at an all time high level, it is likely that there are new buying opportunities out there. But never relax your QDI standards, or rush into overpriced securities.

Simply put, The Investor's Creed portfolio management plan keeps you buying investment grade securities when prices are low, and selling them at a relatively easy to achieve profit-taking target. Investment grade companies are most likely to survive major financial havoc, are generally in the forefront of cyclical advances, and are always kind enough to provide regular cash flow for portfolio building or grocery shopping.

If you've ever turned an unrealized gain into a realized loss, if you've ever sold mutual fund shares to deal with monthly expenses, if you've ever been unable to take advantage of low prices for lack of income, this is an approach you need to consider. It won't work without well thought out QDI rules and a disciplined mouse.

Can anyone tell me why this approach is difficult with conventional mutual funds?


Steve Selengut
www.sancoservices.com/
www.kiawahgolfinvestme...
Professional Investment Management from 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

2008 Dec 09 08:36 AM