Twilight Zone Stats: 2 Sectors To Play

by: Emmet Kodesh

Reviewing government numbers on the economy is like being in the twilight zone. There is no inflation, too little inflation Mr. Bernanke said July 31, although oil is up, health insurance and College are up and housing prices supposedly have risen 12-13%. Food gets steadily more costly but there is 1% inflation, officially. "Unemployment" is not too bad so everyone should forget that the U-6, almost never noted much less discussed, was the original measure. John Williams' home page gives you the U-6 front and center: it has been 14-16.5% since the crash of '08. Williams sees inflation measured by 1990 standards at about 5.2%. If one uses the CPI-U methodology of 1980 and earlier, inflation is nearly 10%. In his July 17 note (#544), Williams writes that 2Q housing starts were -31% annualized. Taper talk late in May and June hurt bonds and housing badly.

Fudged numbers, elaborate and labyrinthine metrics plus government spinning combine to keep economics "the gloomy science." Food and energy costs were purged from inflation stats 23 years ago to suppress COLA increases in Social Security. Main Street Truth and mainstream narratives increasingly part ways. DC is going to revise all GDP #s since 1929 to "prove" how much better things are now, and so it goes. Constant revision of stats (like 1Q 2013 growth revised down from 1.8 to 1.1%) creates a fog of confusion and forgetting. This makes it easier to sell the next official story, policy or appointment.

More QE is dangerous but clearly is needed: when it is tapered, we will reap the whirlwind. Mortgage applications and re-financing YTD are down 57%. The burial, for now, of tapering helped the market's August 1 sigh of relief, +120 DJIA and a lovely +25 on the S&P. Let's look at two very different sectors, media-entertainment and PMs (precious metals and miners) that for different reasons are compelling buys.

Media helps government get bigger (so it can help us more) and entertainment distracts people from the ugly truth of socio-economic decline. Several of the major media-communications conglomerates align with cultural trends. They are good investment plays.

Before examining specific companies, consider that strategy depends on one's read of global and domestic economies and cultural trends. Here is a useful datum: on July 30 a top market analyst at Citi Bank, Tobias Levkovich insisted to several doubting questioners that "consumer confidence and consumer stocks do not correlate" and tapering will drive the S&P down to 1615 by year's end. He noted that "people are chasing the tape" and that Citi was sticking by the 18 month outlook they reiterated last December. "I'm very bullish for the next year," he said, stating that Citi's earnings-yield analysis shows the S&P at 1850 by June-July 2014. I hope he's right. He believes that valuations are excessively high at this point, especially in consumer discretionary stocks. This analysis suggests investors should bank gains and watch how Fed policy develops. August 1, however was happy hour.

Investment & Allocation Strategy:

I believe that increasing cash positions makes sense for many macro reasons, socio-economic, geopolitical-financial and fiscal. Many crises already grip or are ready to clutch world economies and markets. There is so much uncertainty and "interventionism" (a term of von Mises) in the system that it is difficult to find clarity about much except growing government interventions in fiscal policies, families, schools, overseas and in various sectors of the economy.

As things shape up, I would not advise having more than 12-15% of assets in PM bullion and miners combined. Yes, many fundamentals have strengthened: I have reviewed them often in my archive. But fiscal policies and government talking points have made the economy like a game show. The audience is cued to laugh or smile and nod their heads but it isn't funny or safe and many of us don't get the joke. I will discuss PMs in closing after reviewing a more promising sector.

As the gap between harsh reality and virtual optimism widens, the media-entertainment space is primed for strength. I noted Penn National Gaming (NASDAQ:PENN) in my previous piece. PENN is down from its April high but has been strong for three years, has an improving quick ratio, now at .98, and overweight ratings.

Even better are major culturetainment vendors like Disney (NYSE:DIS), Time Warner (NYSE:TWX), Viacom (NYSE:VIA) and Comcast (NASDAQ:CMCSA). CMCSA owns NBC Universal, NBC and its affiliated networks and Universal Pictures as well as its internet, cable and phone networks and them parks. Its quick ratio is a strong 1.2; it has $2.41 EPS and yields 1.73% on a mega cap of $112 billion. In my view the best in this sector is TWX. It has a good quick ratio of 1.14, $3.35 EPS, yields 1.85% and has risen 50% since August 2012. Its culture-shaping power is in holdings like CNN, the Turner networks, HBO and Time.

Do not immerse yourself in the products of this sector but own and overweight it. DIS is another mega-cap growing mightily: 22% YTD and 42% since the post-election plunge last November. Its $3.33 EPS yields 1.15% and an okay quick ratio, .90 is sustained by its huge cash flow and market share. Its holdings include ESPN, ABC and its affiliated networks, Epcot, Magic Kingdom, Miramar, Resorts and more in its $116 billion cap. DIS is as strong a play as TWX.

Two other mega-caps to overweight are aerospace-defense giant United Tech (NYSE:UTX) with an $8.45 billion cash flow and $62 billion revenues, and electronics, transport, health care and energy behemoth General Electric (NYSE:GE) with its quick ratio 2.85 and $147 billion revenues: these companies suit the times and make the world. Even more than Energy giants like Exxon (NYSE:XOM) or Shell (NYSE:RDS.B), media and major aerospace companies are the sweet spot of contemporary socio-economics.

Continue to underweight bonds. To get an idea of entry points, look at their n.a.v. levels the last week of June and June 21-7, 2012: seasonal patterns pertain. Maneuvering toward a new Fed Chair also will increase volatility unless Dr. Bernanke assures us every month that QE will continue. Bond asset prices have been inflated for many years: when yields rise from tapering or even creep up despite continuing QE, volatility will be significant and new buying levels will emerge. Until then most bond classes except perhaps short term corporate (NASDAQ:VCSH) exemplify Jim Grant's famous epigram, "return-free risk."

The PM sector is a play on the fundamentals of technology (silver) and all but inevitable monetary and reserve currency changes (gold and silver). The best companies in the sector are Silver Wheaton (SLW), one of the most profitable issues in the markets because of its streaming model and First Majestic Silver (NYSE:AG) for its low debt, increasing output and revenues and multiple sites. Given the volatile nature of the fiscal-economic situation, I would not add to AG above $12.50 or SLW above $22 though both should far exceed these levels, especially SLW, in the next year. SLW and AG continue to be rated "Strong Buy" with respective 12-month price targets of $33.50 and $20 respectively. SLW's target has been revised down while that of AG has held steady at $20/share.

Among major producers, Goldcorp (NYSE:GG) is good for its $4.9 billion revenue, low debt/equity and good quick ratio. Mid-tier IamGold (NYSE:IAG) is a value with $1.57 billion revenues, 3 quick ratio, geographically diverse sites and 4.9% dividend. You may be able to enter at $4.75 which would be great. Today's flight to equities hurt PM miners so don't get pre-occupied with day-day action. Also note Kinross Gold (NYSE:KGC). I often mention this depressed major producer ($4.7 billion revenues) which has just beat on 2Q revenue and earnings/share. By cutting its dividend it will increase profitability and share price. In the small cap space, McEwen Mining (NYSE:MUX) and Silver Standard Resources (NASDAQ:SSRI) have zero to minimal debt. SSRI has a great quick ratio and cash and cash and equivalents 3x its liabilities. These two companies as yet have few sites though MUX's El Gallo I & II sites in Mexico are being expanded at minimal cost. SSRI's consensus price target, $10.79 is 48% above its August 1 close, $7.29. MUX is rated "Strong Buy" with a $3.34 price target, 70% above the August 1 close after six trading days of declining bullion and PM miner prices.

Remember that the PM sector is very volatile. As the source of values competing with fiat culture, they attract particular Sovereign interest as the global monetary system changes.

I would not now add to Health Care (NYSEARCA:VHT) positions. The sector will be strong going forward but is at very high multi-year levels. You might add to Utilities (NYSEARCA:VPU) since it is volatile, pays good dividends and likely will soon present lower levels to buy. It won't hurt to defer significant purchases till a 5% or more dip in the sector you prefer. Such drops are likely to occur as Citi suggests. Be cautious on Financials (NYSEARCA:VFH): they have had a strong year but look at the 5-year chart. If you think the banks are sound, buy but it is more prudent to own financials in a diversified fund or ETF especially after a strong YTD. Do not rely on their ability to shape government policies: this may come back to bite nearly everyone.

The larger problems, a soap opera culture befogged by a growing haze of strange and frequently re-defined stats and increasing cynicism make a case for increasing cash and real assets, perhaps a few more silver coins or bit of land. Perhaps Citi's macro analysis is correct and 1-2Q 2014 will see soaring indices. The administration wants control of both houses of Congress and happy markets would help this occur. In the long term no mono-culture, whether of crops or thought is viable but long-term thinking is not in fashion these days. So stay nimble and buy the media-entertainment majors and select PM companies.

Disclosure: I am long SLW, IAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.