Author: CJ Brott, Capital Ideas
Disclosure: Long BHI, CAT
Last month we wrote about a potential end to investor gloom and the possibility of making money in shorter term momentum stocks. That is happening.
The market indices are rising and that is stirring animal spirits. Trading opportunities are opening up for some of the beaten up stocks. And we are excited because these stocks are far safer than the high relative strength stocks normally associated with momentum investing.
In this atmosphere we have continued putting money back to work. Recently we bought two cyclical stocks. Both companies’ stock prices have been depressed by worries about the economy and yet each reported earnings that exceeded expectations.
One is Baker Hughes (BHI) and the other Caterpillar (CAT). Both stocks have declined substantially from their highs and formed reasonable bases from which to launch a rally. We think these companies should benefit short term and could continue higher if the market does.
Baker Hughes fell from $64 to $38 before stabilizing. It fell with the collapse of oil and gas prices and production problems in the Bakken shale. But with earnings of about $4 per share it was too cheap. Now with oil, gas, and the stock market rising, it is a very interesting play.
Caterpillar has fallen on China worries and a current belief that the economy worldwide is collapsing. But with earnings of $10 per share and a favorable outlook for the future, it is hard to justify the fall from $116 to $80 per share.
With the market rallying and investors looking for familiar companies which pay dividends CAT may rally back towards its old high.
Last month we stated that bear markets end with a whimper not a bang. It would be easy to believe that we have heard that whimper and become euphoric as the market indices approach their old highs. Rather than blindly following the crowd we believe now is the time to analyze the underpinnings of the current market rally.
From a technical perspective, the current rally is based on a narrowing group of stocks. This is not a formula for long term success. So we will be watching to see if participation broadens and the market demonstrates staying power. If so we would expect to see a continuation of the current move with the potential for multi-year highs.
From the fundamental perspective we still face the November elections and the worry of Congressional inaction resulting in the so called “fiscal cliff.” This uncertainty is causing investment by business into their companies to grind to a halt.
Their current outlook remains gloomy. But while businessmen look at current conditions and cannot invest, a market professionals’ business is to look to the future and determine if stock prices have already discounted the worst possible outcome.
As professionals we cannot know the future so we will be guided not by today’s news but by market conditions. In the short term if the market falls, we will look for opportunities to become more fully invested. If the markets continue to rise as they become more fully priced, we will most likely reduce exposure. For now we will try to sit back and enjoy the ride.
We are a registered investment adviser firm based in Texas. CJ Brott founded our firm in 1984. Since 1980 he has been lecturing regularly on financial topics at Southern Methodist University. He is a sought-after public speaker and has been interviewed by various national and local financial publications. We benefit from CJ’s many industry contacts when making investment decisions.