Raise High The Roof Beams, Ragamuffins
In roiling markets nobody ever catches absolute bottoms or tops for stocks. Range of amplitude for a diverse bunch of unwanted goods this year is breathtaking. From its March low, the S&P 500 Index rose 65%, but cyclicals like Halliburton HAL and Freeport-McMoRan FCX soared 300% and 400%, respectively. Waz you there, Charlie?
When I looked at Macy’s M five-year chart, I was surprised it ranged above $50 before commencing a declining head and shoulders formation. This once-proud merchant, anchor tenant at many first-class regional shopping centers is struggling for air.
As for General Electric GE , it was numero uno in the S&P 500 Index with a market capitalization of $415 billion in 2001. But, by 2014 it dropped to second place, market cap pared to $262 billion. Presently, we’re around $60 billion. Jack Welch, its long-revered headman, leveraged and then nearly destroyed his company with foolish acquisitions.
Let’s hope Macy’s joyous parade on Thanksgiving Day stays perpetual. Santa Claus in his reindeer driven chariot waves up to me in my apartment windows facing Central Park. It’s my leading indicator for a buoyant stock market. I wave back at Santa, reassured.
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When stocks sink to five bucks and below, they are shunned by the Street’s houses, their analysts and most traders. Nobody dares recommend a piece of paper that can wallow into bankruptcy. After all, the Street’s memory is indelible.
Everyone remembers the once-proud Lehman Brothers blow up in 2009 while Merrill Lynch needed to be merged out at $4 a share. What about the demise of Sears, Roebuck and high flyers like Polaroid and Xerox XRX ? Bankruptcies in leveraged businesses like banks and retailers are recurrent phenomena cycle-after-cycle. General Motors GM needed serious bail-out capital along with American International Group AIG in 2009.
When a stock ebbs into single digits, only courageous players who don’t report to committees deal in such junk. Balance sheet analysis rather than income statement perusal takes over. My analysis of Halliburton suggested the balance sheet was strong enough to withstand the cyclicality of the oil service business for couple of years.
The ratio of the market value of the stock relative to the market value of its debt approximated one to one. Halliburton wasn’t about to succumb. This is Mike Milken’s MAD ratio which he explained to me when we bought Chrysler after Lee Iacocca took over as headman. Management counts. Years later Iacocca even demanded that the government sell back warrants it held at book value rather than market value. Lee was told to take a walk.
Warren Buffett’s original investment in Geico was imperiled by management’s overly aggressive rate cutting, going for market share. I remember buying a block of $4 Geico from Goldman Sachs GS after Pennsylvania’s insurance commissioner had decided he wouldn’t preside on Geico’s demise.
If companies like Geico, Sears, Roebuck, General Motors and AIG do encounter gut-wrenching financial pressures, a fair question is what valuation yardsticks are appropriate? Should airlines ever sell at more than 10 times earnings? For me, not by much more. I’d use average earnings power over a full cycle for industrials and oil sector paper. Same goes for materials plays like copper, steel and aluminum. As I write this piece, U.S Steel and Alcoa AA , intraday bounced nearly 10% (without me).
Halliburton and Freeport-McMoRan carried potential to earn maybe $2 a share, in a good cycle, even more. So, these babies currently ticking near $20 are reflecting average earnings power multipliers. Unless you believe they’re headed for at least a couple of good years, you’re too late to the game.
Macy’s, General Electric and American Airlines AAL are more blatant specs where it’s difficult to construe an earnings model going out a couple of years. All you can say is there’s latent earnings power of a couple of bucks a share based on the history and configuration of their businesses. My assumption is the country approaches normalcy in the industrial, energy and consumer sectors by mid-2021. The market already has discounted that much resiliency.
Other side of the coin, is internet and e-commerce houses wallowing in free cash flow, spending enormous sums on R&D and allocating as much as 20% of operating earnings on stock awards to key employees. Everyone, starting with Microsoft MSFT and Facebook, carries excess balance sheet liquidity. Nobody, excepting Apple AAPL , adopted aggressive stock buyback programs.
Apple sells under 20 times earnings, while big tech operators tick at 30 times operating earnings and above. Facebook sells at seven times book value. Why buy back your stock at such a premium? Why not boost spend for R&D, hopefully to build out your operating footprint?
Trillion-dollar market capitalizations barely held their own during this market rally in unwanted sectors like financials, materials and energy that were so badly wounded earlier on. I’m in my barbell construct with tech at one end and financials, oil services, copper, aerospace and retailing on the other end. So far, I can’t find fundamental reasons to sell down internet and e-commerce paper, but valuation is pricey. Let it stay so pricey.
Back of mind, I hear a voice disclaiming on GDP recovery to normalcy by mid-year, 2021. The market already has discounted as much, selling at 19 times what it thinks is next year’s earnings power for the S&P 500 Index. This pricey number’s solely explainable by near zero interest rates and minimal inflation. Let’s hope the next chairman of the FRB has very little to do but pray for some inflation.
Why not sell your AT&T and get your hands dirty? Ragamuffins stand for a newly emerging algorithm on leveraged speculation. Where’s your moxie? Think of George Soros shorting the pound with serious money decades ago. All this in the face of Bank of England avowing it would never, ever devalue the pound.
Our FRB chairman just proclaimed he’ll keep interest rates near zero next three years. Don’t count on such nonsense, either.
Sosnoff and/or his managed accounts own Halliburton, Freeport-McMoRan, Macy’s, Citigroup C , Enterprise Products Partners EPD , Goldman Sachs, General Electric, American Airlines convertibles, Microsoft and Facebook.