Monday, March 30, 2009

The persistent rally of stock market

The stock market
enjoyed an unusually strong week with the BSE Sensitive Index finishing 12.06% or 1,081.81 points higher, and the Nifty ending
10.74% up. The CNX Midcap Index underperformed the main indices with a relatively modest gain of 5.77%.

Tata Steel was the biggest winner among the index stocks with a 26.9% gain. The other index stocks to go up included ICICI Bank, HDFC Bank, Sterlite Industries and State Bank with gains falling between 19.3% and 18.0%. None of the index stocks declined last week.

Unitech was the biggest winner among the more heavily traded non-index stocks with a 33.2% gain. The other non-index stocks to go up included PNB, Aban Offshore, Lanco Infratech, Axis Bank, Sesa Goa, JSW Steel and Yes Bank with gains falling between 32.4% and 23.6%.

Akruti City was the biggest loser among the more heavily traded non-index stocks with a 51.6% loss. The other non-index stocks to go down included Edserv Softsystems, MindTree, Crompton Greaves, Tulip Telecom, Everonn Systems , Firstsource Solutions and Gujarat NRE Coke with losses falling between 22.1% and 2.9%.

Intermediate Trend

The market remains in the intermediate uptrend which started on March 6 when the Sensitive Index made a bottom at 8,047. The levels below which the uptrend would end are now a considerable distance down at 8,867 for the Sensitive Index, 2,739 for the Nifty and 3,190 for the CNX Midcap Index.

These would be revised upwards to the level where the next minor decline bottoms out. Most global markets are in fairly strong intermediate uptrends, and are typically somewhere between their one-month and three-month highs.

Long-Term Trend

The market's long-term trend is down. The index has been in a 3,300-point range between 7,700 and 11,000 since the end of October, without any clear sequence of rising or falling tops and bottoms. It would therefore be best to take 11,000 as the level to cross for the Sensitive Index for a bull market confirmation. The corresponding level for the Nifty is 3,250, and that for the CNX Midcap Index is 4,000. (Figures have been rounded upwards).

Almost 25% of the market's heavily traded stocks are now at two-month highs or better, and over 15% are above their 200-day moving averages. These could be the first signs that the bear phase may have already ended. In any event, quite a few stocks may have already left the worst behind them.

Trading & Investing Strategies

The market is currently in an intermediate uptrend, and long-term investing should be put on hold until the next intermediate downtrend develops and has run for a week or two. It will be a good idea to hold on to past and recent investments, and not get out of them as this rally progresses. This portfolio building exercise suggested over the last few months is simply to buy stocks at low levels, and not in anticipation of an early end to the bear market - even though this now looks like a distinct possibility.

Global Perspective

The major trends of all global markets remain down, but the intermediate trends of almost all the markets are up. The Dow would enter a bull market (major uptrend) if it were to climb above 9,500. The Shanghai Index has crossed its 200-day moving average, and a global bull phase will become a real possibility if other indices follow suit.

The BSE Sensitive Index had lost 37.5% in the twelve months that ended on Thursday, keeping it at the 21st place among 35 wellknown global indices considered for the study. Chile continues to head the list, but with a 11.6% loss. New Zealand, South Korea, Israel and Spain follow. The Dow Jones Industrial Average has lost 35.6% and the NASDAQ Composite has lost 30.4% over the same period. (These rankings do not take exchange rate effects into consideration).

(The author is an independent technicals analyst)

Monday, March 23, 2009

Sifting for Gold Among High-Profit Stocks

It's time to draw up a shopping list in preparation for the market's recovery. Here are 56 solid stocks that offer compelling value, relative to bonds, based on earnings yield. Topping the list: WellPoint.

THE DAY WILL COME when you will want to own stocks again. Really, truly, it will. After last week's strong showing, maybe you are already feeling a little left out. Bear-market rallies will eventually give way to a full-blown bull market. And when that time comes, you don't want to miss it. For that to happen, it is vital to prepare a blueprint to help guide your investment choices.

Jeremy Grantham, market seer and chief investment strategist of Boston money-management firm GMO, stressed the importance of being ready for the inflection point in a recent piece titled "Reinvesting When Terrified." He concluded that "you absolutely must have a battle plan for reinvestment and stick to it," all the more so when prospects appear their darkest. GMO now forecasts healthy long-term returns of 10% to 13% for equities.

There is no question that in an environment in which assets are still being repriced and balance sheets restructured, caution is wise. No one is suggesting investors should double down on the market -- but it is probably time to start averaging down.

DRAWING UP A PLAN OF ACTION and setting certain investment parameters before heading into what is arguably still a war zone should offer investors some protection against losses while positioning portfolios to capture potentially powerful returns. If you are skeptical of the ability of stocks to outperform ever again, as a case in point Grantham recalls the 105% return in the Standard & Poor's 500 for a six-month period beginning in June 1933, long before unemployment peaked and bank failures ran their course.

In a five-month period during the 1974 bear market, he points to the 148% advance in equities in the U.K. Moreover, during the Great Depression, there were six advances of 20% or more before full recovery took hold.

To help you with your blueprint, we created a screen based on the earnings yield of a stock -- the earnings per share for the most recent 12-month period, divided by the current stock price. This percentage, which is the inverse of the price/earnings ratio, provides a way to compare stocks with bonds or money-market instruments. The higher the yield relative to fixed-income securities, the better the value of the stock. Ray Dalio of Bridgewater Associates has said the key piece of advice he would offer to investors would be to consider the earnings yield of a stock before making an investment.

Understanding that the earnings outlook for a company isn't etched in stone, most of the stocks in our screen, with just a few exceptions, are expected to produce decent -- if not exceptional -- long-term earnings growth, a factor that will only enhance the rate of return compared with bonds. Last week's huge Treasury-market rally made these stocks look more attractive.

WE HAVE SCREENED FOR COMPANIES whose earnings yield is at least twice that of the 10-year Treasury's recent 2.8% level (it was trading at 2.61% on Friday). We chose that multiple to take into consideration the extra risk associated with stocks. Right now, the stock market as a whole, as measured by the S&P 500 and its earnings yield of 9%, appears to be undervalued in relation to bonds as measured by that 2.8% Treasury-yield yardstick.
Table: Better Than Bonds

We wanted to isolate those companies on the best financial footing, so we weeded out those with debt-to-total-capitalizations higher than 40% and debt-to-equity ratios greater than 60%. To underscore our emphasis on stability, only companies with market values higher than $15 billion made the final cut.

You might wonder why we didn't just screen for dividend yields -- which investors typically use when making a decision on buying a stock. Our thinking is that with companies increasingly slashing or suspending dividend payouts to conserve cash flow and bolster liquidity in these troubled times, this is fast becoming an unreliable indicator of a stock's potential investment return.

Not surprisingly in the current environment, only two financial companies made it to our final screen. They are property-casualty company Traveler s (ticker: TRV), with an earnings yield of 15% and mean long-term earnings-per-share growth estimated at 8.5%, and Warren Buffett's financial conglomerate Berkshire Hathaway (BRKA), with interests in insurance as well as manufacturing, media, consumer-discretionary and retail sectors and an earnings yield of 7.5%.

Travelers' conservative management of its investment portfolio, stable personal-lines business, manageable debt load, and strong balance sheet has helped it weather the current downturn well, and should give it an edge in a recovery.

Berkshire Hathaway is, well, Berkshire Hathaway (see Barron's, "Don't Count Out Berkshire Hathaway," March 2). Despite pressure on its investment portfolio from an ill-timed foray into the oil patch through a ConocoPhillips (COP) stake -- Conoco also makes it onto our long-term list -- and Buffett's staunch support of some beleaguered banks, plus some derivative bets that so far appear to have backfired, Berkshire ended 2008 with $24 billion in cash. And it continues to be well-positioned to take advantage of others' travails. One area Buffett now finds attractive is high-yielding investment-grade corporate bonds.

Only one utility makes our list: Duke Energy (DUK), a pure-play electric utility sporting a 9.9% earnings yield and estimated mean long-term earnings growth of about 4%. Duke has ample liquidity to support growth and see it through this economic crisis. Investors will likely be drawn to its solid balance sheet and geographic diversity, as well as its 7% dividend yield -- which in this case appears to be sustainable.

Most heavily represented on our list are companies in the health-care and information-technology sectors. Indeed, Nos. 1 and 2 on the list of 56 companies are managed-health-care companies WellPoint (WLP), with an earnings yield of 17.2%, and UnitedHealth (UNH), boasting an earnings yield of 16.8%.

After a difficult couple of years, WellPoint is on track to improve its shareholder returns. New management is in place, claims inventories are down, and reserves have been strengthened. The company is expected to generate free cash flow of $3 billion in 2009, and to repurchase up to $2 billion of its shares this year.

Topping the list of info-tech stocks is Hewlett-Packard (HP), whose earnings yield is 12.9%. Hit hard by the global downturn and frozen IT budgets, the computer-printer giant posted lower-than-expected revenue in its fiscal first quarter, and reduced its earnings outlook. But synergies from its acquisition of EDS as well as share gains should provide meaningful earnings support. When spending does tick up, Hewlett-Packard is well-positioned to benefit (see the Dec. 29, 2008 Barron's "How HP Prints Profits"). Meantime, it ended the first quarter with $11.3 billion in cash; operating cash flow was $1.1 billion. Also, the company has $7.9 billion remaining in a share-repurchase program, after buying back $1.2 billion of its shares in the prior quarter. Needham & Co. has called Hewlett-Packard "a must-own name in large-cap tech."

There are few media companies that make the grade, but one that does is News Corp . (NWS, Class B), owner of Dow Jones, which publishes Barron's. News Corp. shares have been battered by the deep advertising recession affecting the entire newspaper industry. Also, when Peter Chernin, Rupert Murdoch's longtime second-in-command, announced recently he would leave the company, concerns were raised about succession plans.

Still, the company's balance sheet is in fine shape, with a manageable debt load and cash available to cover its obligations through 2015. News Corp. is expected to generate $2.2 billion in free cash flow this year. At 8.1%, its earnings yield is about 2.9 times the yield of the 10-year Treasury. The stock could benefit if management chose to buy back shares, a signal that the worst for the media industry and economy might be over. At least one analyst has a price target of $14 on the shares, which would indicate a roughly 100% move from current levels.

Our screen, while not foolproof, is compelling for the values it has turned up among companies representing a wide range of sectors. The size and standing of the companies as well as their sound balance sheets and potential for growth should result in meaningful returns for those investors with an action plan in their pockets.

E-mail comments to mail@barrons.com

Monday, March 16, 2009

Making Sense of the Stock Market's Wild Ride

Fortunes are won and lost from day to day in a volatile market that shows no signs of settling down soon

By Ben Steverman

Once again, the wild stock market has made fools of those who would try to predict its direction.

Amid buckets of bad news and a gloomy mood on Wall Street, stocks took a violent swing to the upside. In just three days, the broad Standard & Poor's 500-stock index advanced 10.7%, which is more than what stocks rose in four of the last five years.

That followed a scary descent for the S&P 500 to the lowest levels in more than 12 years. From Jan. 6 to a low on Mar. 6, the S&P 500 dropped 29%.

All this volatility makes stock market investors look like they can't make up their minds. If stocks prices change so much from Monday to Thursday, investors apparently don't know what U.S. companies are really worth.There are two common ways of explaining the market's recent rally, and both underscore investors' extreme uncertainty and skittishness.
Citigroup Memo

The first explanation is based on theories about how markets work. For one thing, stocks rarely fall day after day without a break. Stocks "were more oversold than [they've] been in my 13 years on Wall Street," says Dave Rovelli, managing director of equity trading at Canaccord Adams. "We were due for a rally."

Stocks seemed to react to a Mar. 9 letter from Citigroup (C) Chief Executive Vikram Pandit, touting his troubled bank's performance in the first couple months of 2009. But to Rovelli, that was just a trigger to a rally that would have started eventually anyway. The S&P 500 had declined in 13 of 16 trading sessions from Feb. 13 to Mar. 9.

Richard Sparks of Schaeffer's Investment Research agrees. "The market was ripe for a rally," he says.
Shift in Market Psychology?

The rebound was driven not by long-term investors but by traders with a very short attention spans. "It's driven by big money, momentum players," Sparks says. "It's such a tough market to trade," that these market participants focus on "very short-term time periods." Traders jump on market trends, but those moves don't last long and can turn on a dime.

The volatility is most striking in the financial sector. From Mar. 10 to 12, one measure of the financial sector, Financial Select Sector SPDR (XLF) rocketed 30% higher. The same index had lost half its value from the beginning of the year to Mar. 9. Professional traders are no doubt making—and also losing—a lot of money on these rapid moves. Successful traders must be "nimble enough and right enough," Sparks says.

Some wonder, though, if the past week marked a significant shift in market psychology. Dan Genter, president of RNC Capital Management, says the recent rally doesn't just reflect the moves by short-term traders but also by long-term investors who are beginning to put money into the market.
Pricing In Worst-Case Scenarios

Stocks—particularly bank stocks—were trading at absurd prices. "All these companies are not going out of business," he says. By falling to 1996 levels, stocks priced in a worst-case scenario for both the economy and for earnings prospects. At those levels, "unless you think the world is coming to an end, it's difficult not to be bullish long-term," says Uri Landesman of ING Investment Management (ING).

Few in the market believe the world has solved its economic and financial problems—quite the opposite. But, Genter says, "it's not just in freefall anymore." He hopes that, by dropping to an extreme low this month, stocks now have a new low below which they're unlikely to fall again.

Landesman says the market needs to see a strong rally from these levels. Or, he worries, stocks will lose their momentum and fall back again. Rovelli also warns of more volatility ahead, particularly in the next couple weeks as bullish and bearish traders battle over the direction of the market.
Long-Term Volatility?

The wild ride could last much longer than that. Scott Jacobson, an expert on volatility and chief investment strategist at Capstone Sales Advisors, says high volatility in the stock market tends to last for two to four years during and after a recession. "I'm sure we have two years of volatility at least," he says.

The problem with a volatile stock market is that it doesn't just reflect investor uncertainty. Wild swings also cause uncertainty and confusion among the investing public, who see their retirement nest eggs grow or shrink erratically from day to day.

Market observers often say the stock market is supposed to move higher six months before the economy does. But, from this standpoint, it's impossible to know whether the market's newfound optimism is a harbinger of things to come, or simply a temporary rest stop on the market's trip ever lower.

Steverman is a reporter for BusinessWeek's Investing channel.

Friday, March 06, 2009

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