"Don't try to buy at the bottom and sell at the top. It can't be done except by liars." These are the wise words of Bernard Baruch, American economist and advisor to U.S. presidents during both world wars. However, we all still ask, are we likely near a top? I don't think so, but let's examine the evidence.
Are we close to a top?
David Rosenberg of the investment firm Gluskin Scheff recently mentioned the following data from one year ago, compiled by his firm. (I am grateful that David has put me on his distribution list for research; I read a lot of his insights.)
- The VIX was 50, not 17.
- The yield on the 10-year Treasury note was 2.9%, not 3.7%.
- The budget deficit was $900 billion, not $1.5 trillion.
- Baa spreads were 540bps and tightening, not 260bps and widening.
- The market was 20% "cheap" as per Shiller P/E ratio, not 25% overvalued.
- The DXY was at 90 and depreciating, not 80 and appreciating.
- Oil was at $47/bbl, not $82/bbl (we can see $80+ crude being good for the Saudi market; we're not sure how it fits in bullishly to the S&P call).
- Equity PM cash ratios were at 5.5%, not 3.6%.
- Market Vane bullish sentiment was at 32%, not 53%.
- Real GDP was -6.4%, not +5.9%; and the ISM was 36, not 57 (we were in the basement looking up, not on the rooftop looking down).
Take the above data for what it is (i.e., we've come a long way). It is unlikely that the market will see the same type of appreciation as it did in 2009. If you are looking for parallels from the recent past, the sharp rally in 2009 is similar to the rally in 2003, while for most of 2004, we had a trading range market. In my opinion, 2010 is likely to look more like 2004.
Growth at a reasonable price is the way
The best strategy is to focus on stocks with reasonable valuations that can withstand the trading range environment. Much has been said of Warren Buffett's successful bet (via Berkshire Hathaway (NYSE: BRK-A)) on Goldman Sachs (NYSE: GS), but he caught some flack on his General Electric (NYSE: GE) warrants that, as of this writing, remain out of the money. As I opined last year, if we were anywhere near the bottom of this recession, GE would make a fine investment. The S&P AAA credit-ratings cut in March 2009 was a great buy signal.
General Electric cut its dividend to $0.40 from $1.24 in February 2009, its first such move since 1938. Since GE derives 30% to 40% of earnings from its finance unit, the financial crisis affected the company more than other industrial companies. Still, with the sale of its majority stake in NBC Universal and its refocusing on its industrial and medical business, GE becomes an even more leveraged play on a continued economic recovery. Warren Buffett's 22.50 warrants won't expire out of the money with GE trading at less than 15 times earnings, 1.6 times book, and 1.2 times sales.
More big, cheap stocks
Philip Morris International (NYSE: PM) is the international business of the old Altria Group. The new Altria (NYSE: MO) is the U.S.-based business, which has lower growth prospects, but a higher dividend at 6.9%. Both stocks have done well, and both will do much better if the economic recovery continues. No dividend cuts are expected of either of them. Typically, any hikes in cigarette prices are followed by a small volume drop, but rising revenue on a net basis. The international business does not have as hostile of a regulatory environment as the U.S. business. If you are looking for growth at a reasonable price, consider that Philip Morris International trades at 12 times forward earnings and yields 4.5%. If you are looking for yield, Altria is your best bet.
If you are betting on economic growth, you are betting on rising oil prices. In such an environment, I prefer ConocoPhillips (NYSE: COP) for its direct association of profit growth to the price of oil. The stock trades at a forward P/E of 7, a PEG ratio of 0.6, and 1.25 times book value. This is a very attractive valuation for a major oil company, and particularly for investors that are likely to buy and hold for the next three to five years.
To recap, the wild part of the rally -- where junk stocks outperformed -- is likely over. Focus on quality stocks for the rest of 2010.
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