What do new believers buy?

S

Missed the train

When I look back at my writing, my estimation of the recession, recovery was flawed in two major ways:

1. I underestimated the amount & duration the market would move against the Fed & the government during the panic phase
2. I underestimated the amount & duration the market would move, responding to stimulus & recovery

Ultimately, of course, the stimulus & emergency measures taken by the Federal Reserve & government didn’t halt the decline;  it was the removal of mark-to-market accounting.  So:  the market knows what’s important…

The prevailing question to those like myself who are underweight equities:  the S&P 500 is up 75% from its cycle lows.  Have we missed the boat?

Has the pilot executed a perfect landing?

Nassim Taleb equated correctly tuning the economy for recovery to landing a 747 between the mountain & sea on a very short run-way.

Let’s consider our current economic context:

Jobs

Non-farm Payroll Change m/m

Job losses have peaked, and we are once again heading into positive territory.  The rate of NFP change has been been historically very sticky to the prevailing trend.  Although I would not rule out a negative NFP in this cycle, I suspect that some very strong positive releases are coming in the next 6 months.  I even expect it to be strong enough to take the unemployment rate down – perhaps to 9% by the end of the year.

Corporate Earnings

2009 was still brutal for corporate earnings.  S&P 500 earnings require a +47% move to match their 2006 peak.  Consider a selection of multiples:

MSFT: 16.08
T: 12.41
AAPL: 23.27
JPM: 20.24
GS: 7.95
MRK: 6.96
JNJ: 14.86

Also, consider the companies still in the red:  BAC, C, BK, PNC, MET…

Valuations and earnings are all over the place.  As a whole, the largest stocks are positioned aggressively for growth, but many stocks could see a sharp earnings recovery & subsequent share price lift.  I would look for 2010 EPS for 70 or better – giving a forward P/E of 17.

This is already priced into many stocks, but probably not into many financial stocks in particular.

Working Thesis

So:  the great battle between inflationary and deflationary forces seems to have tipped over to the side of growth & risk.  Massive co-ordinated efforts globally by both government and central banks have saved the capital markets from a 1929-1933 style cliff-dive.

This isn’t sustainable.  A Keynesian response is leading to awful mal-investment from every sector:  governments (particularly the American government, pissing their productivity away with health-care, taxes & inflation, and spending their stimulus dollars on stemming the tide, maintaining the energy dependent status quo, and not building out new infrastructure for the future), central banks (liabilities taken on during the waterfall decline), people (buying new cars & houses they can barely afford) & investors (buying stocks & bonds at prices that ultimately will fall prey to deflation).

Generally, I think we can expect longer busts, and shorter booms.  We’re in a boom, until the awful foundation of mal-investment & energy structure pulls us back into the flames.

What’s left to buy?

I am overweight institutions that stand to gain the most from a recovery that haven’t quite seen the effects on their balance sheet yet.  Apart from the usual things I like, I think a possible list of candidates are:

• Financial institutions in the red:  BAC, C, BK, PNC, MET
• Natural gas
• Short long treasury yields

I just want to make sure that I’m ready to jump off the train…