Bat Like The Babe, Swing For The Fences

Zing, zing, zing went my heartstrings as I watched U.S. Steel bound up 10% intraday – without me involved. So another $5 number burst into double digits, following General Electric GE , Macy’s M and Alcoa AA . Plenty of $10 stocks pushing into the twenties. Underline American Airlines AAL , Halliburton HAL , Occidental Petroleum OXY and Enterprise Products Partners EPD .

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General Electric at its low showed a market capitalization in the $50 billion range. Now it’s pushing $100 billion, but still pretty much ignored. Not again a “polite” institutional piece of paper. Freeport-McMoRan FCX takes the cake with a range this year from under five bucks now in mid-twenties. Demand for copper in China is on the rise, a leading indicator for this pretty’s earnings power. Perhaps, in the range of $2 a share.

A fair question is where are the fundamentals propelling major recoveries in stock prices? Here goes:  For recovery in oil-based properties like Halliburton and Occidental Petroleum – project the low in oil futures is no less than $40 a barrel and that OPEC won’t react foolishly with big increases in production quotes. I regard this as an even-money bet.

My oil service play, Halliburton, is ahead of itself. To justify the $20 stock price, it’s anticipating $2 a share in earnings power by 2222. This is a stretch but I’m hanging in because the directional recovery is soundly based but as yet difficult to sharp pencil.

Bulls in General Electric, now ticking over $10, are extrapolating big recovery in Boeing’s BA aircraft shipments next couple of years and much improvement over all in its industrial business. Because GE, of all $10 paper extant, is most likely to regain an institutional following, I’m hanging in but the easy money starting at five bucks, now10 bucks, is history.

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Freeport-McMoRan bottomed in March at five bucks, too. Its 12-month chart tracks one of the steepest-upward trajectories I’ve witnessed. Five years ago, it also traded at five bucks. The stock today at $25 is in new high ground. What is it saying? Well, at the least, $2 a pound copper is history and $4 a pound lies ahead of us, propelled by incremental demand for copper in China on recovery in commercial and industrial construction. Rest of world takes longer. No major increases coming in copper production next couple of years. So, supply and demand should remain near equilibrium, a bullish construct for copper pricing. You gotta dream a little.

If worldwide GDP surprises and shows strong recovery next couple of years, copper prices could spike to $4 a pound. This scenario is more plausible today but still far-fetched. I’ve sold 3-month options against my position, but Freeport is a buoyant piece of paper that attracts every speculator in the world. It could get overplayed, but still a strong hold.

American Airlines with an income statement gushing blood is a pure case of raw speculation. Does business travel ever come back big time? I dunno. Their recently issued convertible is how to play any recovery. With a 6.5% coupon, the bond never sank below $90 and now trades at $129, yielding 5%.

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I couldn’t sleep with the common stock after doubling from its $10 low. Briefly, the stock flirted with a bankruptcy scenario to a pure-recovery play, all in a matter of weeks.

Underlying all this speculative fluff is a seldom spoken word:  COURAGE. If you can’t withstand super-volatility, possible bankruptcies or daily price fluctuations, up or down of 10%, buy more utilities or whatever is non-volatile. Then, go back to sleep for a couple of years.

How be exploitive with minimal risk? Only buy specs which retain some measure of balance sheet strength. My rule of thumb is the ragamuffin in question must carry at least two years of business sustainability. Before I plunge into a $5 piece of paper, the balance sheet first gets a looksee, not the income statement.

This analysis is expressed in the MAD ratio. The market value of the equity needs to equal the market value of the company’s debt. Underlying all this is the concept of the capacity to raise capital to stay alive. American Airlines is a good example. Underwriters were able to raise billions in convertibles and straight debentures with paper yielding 6.2%.

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At the height of LBO activity in 1987, I had to pay over 8% for a traunch of preferred stock which then enabled me to sell a straight debenture issue with banks as standby underwriters. Lest we forget, we’re in unpredictable and unsustainable low ground with interest rates near zero in the money market while AAA credit-worthy corporations can float debentures yielding 2%.

Lest we forget, interest rates do get reflected in the price-earnings ratio of the S&P 500 Index. This ratio now stands at 19 times projected 2021 earnings, a very-high number speaking historically. Normally, rank speculations and low-priced stocks sell no more than 10 times earnings with the market at 15 times earnings. To some extent, speculators have wind at their back in terms of projected price-earnings ratios for comeback paper. We’ll see how extended this can get during 2021.

Ironically, you can’t hide in fixed income markets. Even going out 10 years in Treasuries, yields rest under 1%. Preferred stocks all trade at call prices around $25. They do yield 5%, but there’s no upside herein. Unless you go below BB in quality it’s hard to find debentures that aren’t callable yielding 5%. Consider, U.S. Steel’s debentures, a single-B credit with a 6.65% coupon trade at $85. This is ultimate risk paper only attracting crazies like me.

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The solitary investor always needs to keep in his head the pie chart construct of market sector weightings. Technology’s the ascending sector these past five years. Ignore it at your own peril to performance. Gains in big capitalization issues like Amazon AMZN , Facebook, Alibaba BABA , Alphabet and Apple AAPL range up to 500%. Tech comprises over 20% of the S&P 500 Index.

While valuation for these pretties stays elevated, I can’t find any serious fundamental issues that could force me to throw tech paper out the window. The FTC’s case against Facebook seems ludicrous because they approved years ago the acquisitions of Instagram and WhatsApp. At the time, both looked risky, but today are worth 100 times what Mark Zuckerberg shelled out for them. For Facebook a billion today is petty cash. Their R&D spend runs near 20% of revenues, approaching $20 billion, a Big-League number.

Another prospectively mispriced market sector is financials, around 10% of the S&P 500 Index. Return of the economy to normalcy is the ideal setting for bank earnings, for Goldman Sachs GS and others. I’d be double-weighted herein. If you’re overweighted in tech and financials, you’ve invested over half your assets. Consider the remaining half available for high-yield bonds and sundry-rank speculation in the woulda, coulda, shoulda ragamuffin world.

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A sidenote on clients’ investment results. Major banks like JPMorgan Chase JPM have underperformed benchmarks this year and past several years. Too much money was held in Treasuries and AAA corporates. Much equity capital was earmarked for the S&P 500 and for index funds. Technology was an underinvested sector. Traditional wealth managers are clearly underserving their clientele who remain too passive and unquestioning. Over time, this adds up to serious money.

Speculation should not be considered a dirty word.

Sosnoff and/or his managed accounts own U.S. Steel debentures, General Electric, Macy’s, American Airlines convertibles, Halliburton, Enterprise Products Partners, Freeport-McMoRan, Amazon, Facebook, Alibaba and Goldman Sachs.

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msosnoff@gmail.com

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