Fundamental Trading Diary

Fundamental analysis of the capital markets

End of Year Strategy

We’re coming up to the traditional Santa Claus rally, and to quantify this, I’ve used Seasonalysis to examine the patterns.  Here are some interesting patterns about the S&P 500:

  • Nov 25 through Dec 5, SPY has gained an average of 1.7%, going up 88.9% of the time
  • Nov 21 through Dec 9, SPY has gained an average of 2.4%, going up 88.9% of the time
  • Dec 4 through Jan 4, the S&P 500 has gained an average of 1.7%, going up 77.6% of the time – going back to 1960!

The bias towards the upside is clear, but the question that remains is whether the depression the United States is facing will provide the exceptional case.

What is the market telling us?  Let’s look at the big retailers. Confidence in holiday earnings looks very high.

Retailer P/E Ratio
Wal-Mart 15.69
Amazon 76
Target 16.56
Costco 24.34
JC Penny 25.46

Those are strong multiples that imply strong growth.  For some time now, multiples have been growing, and earnings surprises have been consistent.  Forward multiples look to have a lot of value.  The question remains:  how realistic is forward earnings growth?

S&P 500 Forward P/E For Nov 20, 2009

Who wouldn’t want to buy IBM at 11.66, GS at 8.88, or MB at 1.66?  Quite clearly, the market doesn’t really have that much confidence in future earnings, and the good run-up we’ve had supported by a steady stream of earnings surprises has not really convinced buyers of a sustained recovery.

Let’s look at some key companies & sectors.


Technology is now the single largest sector in the United States.  The landscape is dominated by a small handful of hardware and software makers:  Microsoft, IBM, Apple, Google & Cisco.  Telecommunication giants AT&T and Verizon are generally included in this sector, but they have as much to do with technology as Circuit City;  they are utility companies with retail outlets.

Let’s compare their sales from the peak on October 2007 to now:

Symbol October 2007 Price/Sales Ratio October 2007 Total Trailing 12m Sales November 2009 Price/Sales Ratio November 2009 Total Trailing 12m Sales
IBM 1.7 $94.68B 1.746 $95.53B
MSFT 5.523 $51.12B 4.683 $56.3B
INTC 4.184 $35.97B 3.24 $32.78B
GOOG 14.257 $13.43B 7.966 $22.68B
AAPL 6.448 $22.63B 4.923 $36.54B
HPQ 1.355 $100.55B 1.012 $117.21

At present, these companies add up to $1.015 trillion dollars in market capitalisation, sitting on a foundation of $361.04 billion dollars in sales — a market cap to sales ratio of 2.81.

In 2007, these companies had a combined market capitalisation of $1.067 trillion dollars after $318.38 billion in sales — a market cap to sales ratio of 3.35.

The take-away is that these companies are collectively worth what they were at the peak in October of 2007, and have better sales by $42.66B.  Individually, the picture is interesting.  Google and Apple matured into earnings , and the modest commodity PC & office equipment maker Hewlett Packard has actually increased sales by close to 17%!

These companies have an ability to survive and thrive because they service the consumer, government, business, and export to foreign economies.  Apple does have more consumer exposure than the others, and they are now selling into the Chinese market, but piracy remains a real concern.  My take on the top six is that they remain a good hold as long as USD denominated asset inflation continues.

HPQ makes a case against bottom-up investing:  you could have predicted a $16.66B increase in sales & $0.52B increase in earnings, but you would have lost money buying it.


Without mark-to-market, the largest institutions in the world are a black box.  We can only imagine that reflation is good for these institutions.  The smaller banks are dropping like flies as Main Street fails to recover with Wall Street.  Forecasting these companies in aggregate boil down to liquidity flow & momentum with particular attention to detail to the debt markets.  Forecasting the largest banks obviously have the most importance due to market cap weighting in the indices.

The closed-end debt funds have had momentum slowing for longer than the equity markets.  Prior to the great collapse starting in July of 2007, closed-end debt funds had already began to sink, and I would expect the high-yield funds to drop first when the rug of reality is swiped from underneath the feet of equity pricing.  Total return (equity value adjusted for dividends from interest) of these funds have slowed, but it hasn’t (yet) experienced the kind of drop I’d expect before a roll-over of USD denominated asset inflation momentum.

I am watching the debt markets, as they likely will be the first to fall.  Their fortunes are pinned recursively with that of all USD denominated assets, and as reflation continues, the big boys will continue to do well.

Basic Materials

The major integrated oil companies like Exxon Mobil are disappointing based on weak demand.  As storage and hoarding become more difficult, oil prices are going to be under pressure for at least the rest of the year, and perhaps into the first quarter of 2010.  Buyers are betting on recovery and hoarding.  There are full tankers who will not sell at current prices because they’ve taken a bath.  The price of oil will be under significant supply pressure with little real demand for the conceivable future.  I am selling all of my American centric integrated oil & gas as a consequence.  They originally looked like deals, but the market was pricing in this pressure.


Based on the persistence of global returns (momentum), USD denominated asset inflation remains quite strong.  19 of 22 global equity indices are at or near their rally highs.  Out of the US sectors, only the utility group is lagging.  Gold is at all-time highs.  Silver is +117% since its Octobter 2008 lows.

The juxtaposition of real economic activity being at a crisis low and assets being at a crisis high isn’t lost on many people.  Corporate profits are coming from growth-less USD denominated asset inflation, cost-cutting, job-shedding and government bail-outs.  The steady stream of “surprises” has guided multiples higher, and a failure to meet expectations would likely to trigger a dramatic sell-off.  Some sectors, like energy, may already be there.

For now, I am modestly long.  Prices with the same denominator trade in sympathy, but debt, money & commodities will probably signal that it’s time for the exits before equities roll over.


November 23, 2009 Posted by | Uncategorized | Leave a comment