What to Short
Obviously the market is in a negative mood. This will translate into lower P/Es:
* Return to fundamentals - PEG must be ~1. That is, stock prices will return to a point where future growth is greater than or equal to P/E.
* Prices to drop - Whether because P/Es exceed growth expectations or because of lowered growth expectations, stock prices will continue to drift down
So I am looking for stocks where PEG >1 and/or where growth rates are under threat. There are 3 major trends that will lower growth rates:
1. Consumer spending reductions
2. Housing related
3. Corporate IT related
Before I go to the list, lets talk tactics.
I am assuming that the pattern will resemble the last bubble recession. So where are we?
In the last recession
* Year 1 (2000) a transition period with the market barely moving
* Year 2 (2001) recession begins and Dow has sizeable swings, falling as much as 20% before rising. But each drop was lower and lower.
* Year 3 (2002) Dow collapsed 30%
I would argue that we won't see a 2 year transition this time (i year flat and 1 year down). With the internet driving information faster, coupled with a much more significant bubble, I think the fall will be faster. A 1 year transition marked by a 15% drop. If we are now in month 3 of this year 1 and if we can expect a 15% total drop, then we should expect a further 10% drop over the next 9 months.
But the transition year is marked by large up and down swings. To avoid getting caught buying a put during an upswing, my approach is to buy puts that expire 5+ months out. I am trading off risk for reward. Now, this next point may seem contradictory, but I also don't necessarily want to hold to expiration. The extra time I am buying is insurance, that is all. The market could find some strength for a month, and we need to be able to outlast that.
Overall, I think a lot of opportunity remains to buy puts and to do well. I think the mood will get uglier in 2 quarters as exconomic growth stagnates further.
One final point. I looked at strike prices that were close to or just out of the money. With some little variation, the June puts require a 16% drop in stock price to reach breakeven. That would be within the range of expectations: although 2001 ended with a 10% drop, there were deeper drops throughout the year. Obviously, an even lower strike price is cheaper. My thinking is that we just had a major drop and there may be a dead cat bounce, so anything far out of the money is actually too risky.
THE BLUE COLLAR RECESSION
I have been dead-on correct that we are in a blue collar recession. I predicted the increase in unemployment, and that's what chilled the market this week. So let's be clear about what is coming down th epipe: belt tightening.
RETAILERS
All retailers will be challenged to make their sales numbers, and all will do so only by sacrificing margins. They are already hit hard, but the damage has yet to start because they have relatively high PEs. Assume flat income growth at best. In which case any retailer with a PE > 10 will get chopped down to size.
But be careful - many will protect income by layoffs and store closings. That helps a bit (look at Radioshack or Pier 1) but it doesn't grow sales. They will squeeze suppliers next, so that's a logical place to look as well.
Saks (SAKS)
Macys (M) - $10B debt on top of retailer troubles
Sears (SHLD) - The June $100s are $12.80
Zales (ZLC)
Radioshack (RSH) - The first retailer to try to tighten operations. The effects are already done - so they have no more upside.
Home Depot (HD)
Pier 1 (PIR) Still room to drop
AUTO
Honda (HMC) - They make off road vehicles, motorcycles and cars and trucks. That plus a strengthening yen.
HOG - Harley is toast
TRW - They are slowing down
Auto Nation (AN) - Car sales will be drying up
Carmax (KMX) - Large used car dealership
RECREATION
I've been saying for months: boats, jet skis, and so forth are play toys that will be suffering.
west marine (WMAR) - Boats
winnebago (WGO) - RVs are already hit but there's still room to drop
thor (THO) - RVs are already hit but there's still room to drop
arctic cat (ACAT) - Gone, baby, gone
carnival cruise (CCL) - Business in the Spring will be bad
Lifetime fitness (LTM) - Will folks be cutting back on gym dues? At the very least, fee hikes will be hard to charge
MGM Casinos (MGM) - I see a slowdown in Vegas excurions and conventions. Plus MGM hasn't yet been hit by a downturn in stock price.
INSURANCE
Fewer houses being covered. Reductions in insurance coverage on autos, property and health.
American (AIG)
Prudential (PRU)
RESTAURANTS
A lot less dining out
Middleby (MIDD) - This is a Motley Fool darling, and rightly so. Except that I think restaurants will start pushing out orders for new equipment. This is one of the few stocks I've considered that has not been hit yet. Which makes it a good target.
EMPLOYMENT
Monster (MNST) - Companies will start cutting back hiring plans.
HOUSING
Masco (MAS) - Cabinets? Home furnishings? Not likely
IT CUTBACKS
Hewlett Packard (HPQ) - Much of the business is locked in (leases) but growth is nowhere. And some companies will simply be going out of business
Palm (PALM) - Dead man walking
OTHER
Gannet (GNI) - Lower advertising revenue for newspapers
Select Comfort (SCSS) - A $2000 bed? Pass.
* Return to fundamentals - PEG must be ~1. That is, stock prices will return to a point where future growth is greater than or equal to P/E.
* Prices to drop - Whether because P/Es exceed growth expectations or because of lowered growth expectations, stock prices will continue to drift down
So I am looking for stocks where PEG >1 and/or where growth rates are under threat. There are 3 major trends that will lower growth rates:
1. Consumer spending reductions
2. Housing related
3. Corporate IT related
Before I go to the list, lets talk tactics.
I am assuming that the pattern will resemble the last bubble recession. So where are we?
In the last recession
* Year 1 (2000) a transition period with the market barely moving
* Year 2 (2001) recession begins and Dow has sizeable swings, falling as much as 20% before rising. But each drop was lower and lower.
* Year 3 (2002) Dow collapsed 30%
I would argue that we won't see a 2 year transition this time (i year flat and 1 year down). With the internet driving information faster, coupled with a much more significant bubble, I think the fall will be faster. A 1 year transition marked by a 15% drop. If we are now in month 3 of this year 1 and if we can expect a 15% total drop, then we should expect a further 10% drop over the next 9 months.
But the transition year is marked by large up and down swings. To avoid getting caught buying a put during an upswing, my approach is to buy puts that expire 5+ months out. I am trading off risk for reward. Now, this next point may seem contradictory, but I also don't necessarily want to hold to expiration. The extra time I am buying is insurance, that is all. The market could find some strength for a month, and we need to be able to outlast that.
Overall, I think a lot of opportunity remains to buy puts and to do well. I think the mood will get uglier in 2 quarters as exconomic growth stagnates further.
One final point. I looked at strike prices that were close to or just out of the money. With some little variation, the June puts require a 16% drop in stock price to reach breakeven. That would be within the range of expectations: although 2001 ended with a 10% drop, there were deeper drops throughout the year. Obviously, an even lower strike price is cheaper. My thinking is that we just had a major drop and there may be a dead cat bounce, so anything far out of the money is actually too risky.
THE BLUE COLLAR RECESSION
I have been dead-on correct that we are in a blue collar recession. I predicted the increase in unemployment, and that's what chilled the market this week. So let's be clear about what is coming down th epipe: belt tightening.
RETAILERS
All retailers will be challenged to make their sales numbers, and all will do so only by sacrificing margins. They are already hit hard, but the damage has yet to start because they have relatively high PEs. Assume flat income growth at best. In which case any retailer with a PE > 10 will get chopped down to size.
But be careful - many will protect income by layoffs and store closings. That helps a bit (look at Radioshack or Pier 1) but it doesn't grow sales. They will squeeze suppliers next, so that's a logical place to look as well.
Saks (SAKS)
Macys (M) - $10B debt on top of retailer troubles
Sears (SHLD) - The June $100s are $12.80
Zales (ZLC)
Radioshack (RSH) - The first retailer to try to tighten operations. The effects are already done - so they have no more upside.
Home Depot (HD)
Pier 1 (PIR) Still room to drop
AUTO
Honda (HMC) - They make off road vehicles, motorcycles and cars and trucks. That plus a strengthening yen.
HOG - Harley is toast
TRW - They are slowing down
Auto Nation (AN) - Car sales will be drying up
Carmax (KMX) - Large used car dealership
RECREATION
I've been saying for months: boats, jet skis, and so forth are play toys that will be suffering.
west marine (WMAR) - Boats
winnebago (WGO) - RVs are already hit but there's still room to drop
thor (THO) - RVs are already hit but there's still room to drop
arctic cat (ACAT) - Gone, baby, gone
carnival cruise (CCL) - Business in the Spring will be bad
Lifetime fitness (LTM) - Will folks be cutting back on gym dues? At the very least, fee hikes will be hard to charge
MGM Casinos (MGM) - I see a slowdown in Vegas excurions and conventions. Plus MGM hasn't yet been hit by a downturn in stock price.
INSURANCE
Fewer houses being covered. Reductions in insurance coverage on autos, property and health.
American (AIG)
Prudential (PRU)
RESTAURANTS
A lot less dining out
Middleby (MIDD) - This is a Motley Fool darling, and rightly so. Except that I think restaurants will start pushing out orders for new equipment. This is one of the few stocks I've considered that has not been hit yet. Which makes it a good target.
EMPLOYMENT
Monster (MNST) - Companies will start cutting back hiring plans.
HOUSING
Masco (MAS) - Cabinets? Home furnishings? Not likely
IT CUTBACKS
Hewlett Packard (HPQ) - Much of the business is locked in (leases) but growth is nowhere. And some companies will simply be going out of business
Palm (PALM) - Dead man walking
OTHER
Gannet (GNI) - Lower advertising revenue for newspapers
Select Comfort (SCSS) - A $2000 bed? Pass.
posted by Andrew at
12:10 PM
2 Comments:
Good insights, quality information. One point to add...
As these Specialty Retail stocks continue to sag they may become takeover targets by larger, more diversified companies.
One example - West Marine (WMAR) is currently selling at ~8/shr with a P/E of 110. While the high P/E suggests a significant continued downside on the stock price it's notable that the book value of WMAR assets is about $12.6./shr. A company like that which has done poorly for shareholders in the past few years, but has a strong hold on a dedicated market seems to be a good takeover play.
Hmmmm. What exactly is making up that Book Value? It isn't cash. What are the assets that folks own?
I notice the following:
$2 per share Goodwill
$12 per share inventory
$1.50 per share debt
Goodwill - worthless
Inventory - A depreciating asset with eroding value.
Debt - Very real
They are carrying $250M of boats and supplies while selling only $40M per year. That's a problem. And sales are going to drop.
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