Who Will Blink First?

Includes: AMWD, ATW, HCI, RGA
by: David Brown

Yesterday was not pretty. Stemming from a sign of opposition to more stimulus from the Chinese government, shares in the Shanghai Composite dropped 5.3% overnight, its largest one-day fall in four years. The Industrial & Commercial Bank of China went limit-down at 10%. Given the signs of disagreement among our domestic Fed members, that was enough to send our markets reeling at the open.

By noon EDT, the Dow Jones Industrial Average had fallen well over 200 points, and the S&P 500 and Nasdaq were both off more than 2%, with decliners beating advancing issues on the NYSE by more than 20 to 1.

More rational trading took hold in the afternoon, with the Dow Jones closing down 1%, the S&P 500 losing well over 1%, and the Nasdaq losing over 1%. The NYSE decline/advance ratio "improved" to a little worse than 1 to 6.

No, not a pretty day!

Interest rates continued to climb yesterday, with the 10-year U.S. bond yield reaching a high of 2.66%, up a startling 50 basis points from just last Tuesday. Fortunately, afternoon trading sent the 10-year yield lower to close at 2.53% because traders showed little enthusiasm for buying the 10-year bond at 2.66%. his was likely due to the rapid rise and the unwillingness to risk overnight losses in U.S. treasury bonds.

Clearly, the rapid exit of dollars from the fixed income market has not yet translated into a rapid flow of dollars into the equity markets, but equities is where much of those funds will likely end up, given the rising risk of bonds. It is really a case of "who blinks first." Assuming the stock market holds near the current support levels, it is our opinion that the bond contingent who have sold or will sell their bonds will blink first by purchasing equities.

There were few pockets of safety yesterday. Gold, silver, and most currencies also fell, although silver rallied to close up a bit. Crude oil had a decent day, gaining 1.4%.

All domestic stock sectors fell sharply yesterday. Financials were down the worst (-1.87%) with Industrials (-1.53%) and Technology (-1.39%) close behind. Utilities were down the least at -0.08%.

The remainder of the week will challenge both equity investors and fixed income investors, due to the plethora of economic releases scheduled this week. Although there were no significant releases yesterday, that will change, beginning tomorrow. That's when we get the important durable goods number for May and, perhaps more importantly, a preliminary consumer confidence report for June. In both cases, analysts expect slightly worse numbers than the previous month, but they expect slightly better than previous numbers from new home sales and the Case Schiller report, both due tomorrow.

Today we get the third GDP estimate for Q1 (expected to be unchanged); on Thursday, initial jobless claims and personal income (both expected to be a bit better than previous); and on Friday we'll have the Chicago PMI (expected to be a little worse) and the final June consumer sentiment number from the University of Michigan, expected to be unchanged.

We continue to seek out undervalued equities (see below) and recommend hedging with the VXX, which shielded us well last week.

4 Stock Ideas for this Market

I selected the following stocks from a MyStockFinder search, concentrating on undervalued small-cap and mid-cap stocks.

Atwood Oceanics, Inc. (NYSE:ATW) - Energy - Mid-cap

  • International offshore drilling contractor
  • Expected earnings growth for current quarter is +69.6%, with a steady +20% per year expected over next 5 years
  • Forward P/E of 8.34
  • Price on 6/24/2013: $52.05

Reinsurance Group of America, Inc. (NYSE:RGA) - Finance - Mid-cap

  • Insurance holding company
  • Expected growth rate is 10.9% for the current quarter and 40.7% for next quarter
  • Forward P/E of 8.21
  • Dividend yield: 1.4%
  • Price on 6/24/2013: $66.03

HCI Group, Inc. (NYSE:HCI) - Finance - Small-cap

  • Holding company; engaged in property and casualty insurance business
  • Earnings growth expected to be 64.9% this quarter, 118.5% next quarter, and 46.4% this year
  • Forward P/E of 7.44
  • Dividend yield: 2.7%
  • Price on 6/24/2013: $29.10

American Woodmark Corp. (NASDAQ:AMWD) - Consumer Cyclicals - Small-cap

  • Manufactures and distributes kitchen cabinets and vanities for the remodeling and new home construction markets.
  • Earnings growth expected to be 371.4% this quarter, 164.3% next quarter, and 108.3% this year
  • Forward P/E of 16.00
  • Dividend yield: N/A
  • Price on 6/24/2013: $32.48

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.