Uncle Ben's B-52's and Outlook 2009
By Frank Barbera CMT. December 16, 2008
So the Fed went “all in” throwing its full weight behind the fight against deflation. By slashing short-term rates once again and targeting mortgage and agency bonds, the Fed is announcing to the world that monetary inflation is now the weapon being brought to bear. For stocks, monetary inflation will serve to arrest the decline and bear market, which has had the equity markets in a stranglehold all year. With a more passive Fed, and a lot less intervention, we would probably find ourselves in the Deflation, DJIA 3,000 camp. Yet, those arguing deflation must see they are fighting the combined forces of the known universe and while it may take time, and likely will take time, ultimately, they are likely to find themselves on the wrong side of a rising equity market. To this end, today’s Fed announcement should serve as notice to investors to perk up and begin contemplating what sectors and individual companies might make good 3 to 4 year investments. Since doing the best homework always takes time, this is probably not a bad time to start. While traders will find no dearth of opportunities in the market's wild swings, for longer range investors the next six months will probably afford a number of low risk entry points to buy quality businesses on sale.
In today’s update, we take a look at a variety of different industry groups to take note of current events and how the slow down in the global economy has impacted different sectors. Among the most hard hit sectors in recent months has been the natural resource space where ‘demand destruction’ was the perceived downside catalyst, the idea being that a slow down in major economies would cripple forward demand for raw materials. As a result, everything from copper miners to iron ore producers, coal suppliers to platinum producers have been devastated.
Just yesterday, Anglo American, the world's largest platinum producers, announced plans to cut spending by more then 40% in the year ahead while delaying important iron-ore projects until the values for metals firm. “Anglo is now in cash conservation more given what we perceive as a big pull back in demand.” Last week, Rio Tinto Zinc (RTP), the world's third largest mining company, also announced that it would pare expenditures slashing spending by $5 billion and cutting jobs by 14,000. For RTZ, the weakness in the price of copper, zinc and nickel are forcing the company to reign in spending. And, majors such as Lonmin PLC, Xstrata and Impala Platinum have all warned of agony unless output is curtailed. Lonmin PLC will be cutting as many as 6,000 workers.
Elsewhere, leading Brazilian Iron Ore producer Rio de Vale (RIO) has already announced laying off 1,300 workers and putting more then 5,500 on paid leave. More cut backs are anticipated joining companies such as France’s Arcelor Mittal (MT) and Russia’s Severstal which have already announced drastic cuts in both workers and production. Here in the US, majors such as Nucor and US Steel face nearly 50% capacity utilization rates with US Steel recently announcing the closure of a major mill.
As a result, one theme which is likely to emerge as 2009 unfolds is the concept of ‘supply destruction’, namely that the plunge into economic contraction has been so rapid, with so many companies cutting back sharply right off the bat that as 2009 unfolds, the perceived excess demand will be counteracted by a sharp reduction in available supply. In my view, one has only to ponder the prospect of China's huge new $582 billion dollar infrastructure spending program to understand that in the next recovery cycle, core basic materials will live to fight another day. For China, $582 billion dollars buys a lot of infrastructure, with the equivalent spending power in excess of 3 trillion US. Add to this the fact that the prior cycle was very atypical where basic material inventories are concerned. While Nickel and Aluminum currently have hefty supplies, supplies which are likely take a year or more to chew threw, other metals did not see inventories bulge to the high end of the historical range and thus may be in a position to normalize more quickly than most would believe. For Copper, Lead, and Zinc, aggregate inventories are presently not historically at high levels with Copper the 800 pound gorilla for most mining operations.
In the case of the large cap basic material miners, the odds are high that the 85% decline seen from the absolute peak in October 2007 to the recent lows is now fully discounting in a sluggish ‘pricing period’ for the year ahead. This decline has also retraced 86% of the preceding bull market which began at the bottom in September 2001. Over the last few weeks, these stocks have established a small double bottom formation and are just perceptively attempting to break out above a declining trend line which has been in effect for many weeks. While the first rally off the lows in these stocks will probably stall out in the weeks ahead, the odds are high that an extended basing pattern will follow with the stocks setting up a wide-swinging trading range. As key moving averages decelerate during the first six months of 2009, the prospect of a second half recover for basic materials could take shape. In many cases, these miners now sell at some of the lowest price-to-sales, and price-to-book value ratio’s on record.
Nevertheless, for basic materials the industry is likely to remain largely depressed for most of 2008 as a surge in layoffs suggest that we are still months away from the end of the economic recession. In fact, since November 1st, 2008, announced US layoffs have exploded and now total 178,561 jobs with layoffs in just the first half of December including these announcements for high quality blue chip companies: Bank America (35,000 over 3 years), Whirlpool (150 jobs), Procter and Gamble (320 jobs), MMM (2,300 jobs), Freeport McMoran (600 jobs), Praxair (1,600 jobs), GM (another 2,000), Dupont (2,500 jobs), AT&T (12,000 jobs or 4% of workforce), International Paper (1,500 jobs), US Steel (3,500 jobs), JP Morgan Chase (9,200 jobs or 21% of WAMU Staff), Las Vegas Sands (216 jobs), and Masco (500 jobs), United Technologies (350 jobs), Adobe Systems (600 jobs), Dow Chemical (11% workforce – 5,000 jobs), and Wyndham Worldwide handing out 4,000 pink slips.
So what industries could be a bit more recession proof? Well, the answer to that is that no industry is fully insulated to a contraction of this scope and size. In reality, the question becomes which industries are recession resistant rather then recession proof. To that end, we note that the consumer non-durable goods producers have also been quite severely affected during the recent bear market. Many of these companies remain very close to their lows with a sampling included in the table below. In the table, we show the 52 week highs for each issue, the 52 week low, the recent close, and the differential between the recent close and the 52 week high.
|Consumer Goods||52 Week||52 Week||Recent||% from|
|Procter and Gamble||PG||$73.25||$56.02||$59.89||-18.22%|
|Fomento Mexicano SAB||FMX||$48.89||$18.80||$29.40||-39.86%|
In the case of the many US centric producers of consumer staples, one important factor that will aid their outlook in the year ahead is a trend reversal in the US Dollar. For many of these companies, such as Pepsi, Coke and Colgate, a lower Dollar will help earnings as these companies have products that are exported throughout the world. For large US multi-nationals with substantial business overseas, the weaker dollar could be a recession fighter. As we have noted consistently in the pages of this column, for weeks the US Dollar has been in a topping mode. Over the last few days, that topping formation broke sharply to the downside with the Dollar Index now breaking below its rising trendline and below its 50 day moving average. While there are those who continue to forecast a stronger greenback, we believe that the huge supply of new dollars being printed up by the Federal Reserve will trigger a new phase of consistent dollar depreciation, something that should be a blessing to US exporters.
Above: the Dollar Index breaking down
On the next chart shown below, we see a long-term view of the US Consumer goods producers, many of which are severely depressed at the current time. Over the last 10 years, the growth rate for these issues has been at a much slower pace than was seen in the 1980’s and early 1990’s.
Nevertheless, the bear market of the last 12 months appears to have knocked many of these issues down to the low end of a rising channel, with the daily Advance-Decline line also moving down to retest long term support. In our work, we also plot a 200 day moving average on the A/D line and then create an oscillator by plotting the distance above and below the 200 day average. As can be seen on the second chart, this oscillator is now once again historically oversold hinting that a low-risk entry point may be at hand for some of these blue chip quality names.
Above: Consumer Goods producers with long term A/D Line and 200 day moving average
Above: Detrend Oscillator of A/D Line and 200 day moving average – deeply oversold.
Above: GST Healthcare Index (40 stocks – top) with Relative Strength Ratio versus S&P 500 (lower)
Another sector which looks to have reasonable appreciation potential ahead of it could well be the healthcare segment. While Big Pharma and the HMO universe may find difficulties ahead, the rest of the healthcare universe may offer much better returns. In the chart above we show the Healthcare Index and on the bottom clip, the relative strength ratio of Healthcare versus the S&P. While the healthcare index positively plummeted during the most recent decline, it did manage to decline by a smaller quantity then was seen in the overall broad market. As a result, the R/S Ratio managed to carve out a higher, less negative low, and this often be a good leading indication of a forthcoming rotational shift. In a slow economy, healthcare tends to be among the least negatively affected segments as ‘people are always getting sick’. Given the truly sharp declines that have rumbled through this sector, we now find a number of issues that are trading near historic lows. In the table below, I show a sampling of high quality health-care names which are now trading with Forward Price Earnings ratios below 12 and with PEG Ratios (price-earnings to growth) well below 1.00. In all cases, the 5 year growth estimates exceed 10% which I believe is conservative given the aging demographics of the US Baby Boom.
|Value in Healthcare||Forward||PE/G||5 Year|
|Growth on Sale?||P/E||Est Growth|
|St. Jude Medical||STJ||11.99||0.90||15.21|
|Varian Medical Systems||VAR||11.96||0.83||18.00|
Above: GST Healthcare Index with McClellan Summation Index for Healthcare stocks
In looking at the charts for the Healthcare providers and medical equipment stocks, we find that in all likelihood, a more extended base will develop. In the near term, it is likely that these stocks will rally in tandem with the stock market if the stock market is able to extend its gains into the New Year. However as things stand, I believe the stock market rally will run its course within the next few weeks and then begin another substantial retest of the lows phase. This will be another painful decline and will probably force most stocks back down to the lows. In the case of the healthcare stocks, I will be watching to see if a retest of the lows several months from now sets up a positive divergence on the McClellan Summation Index. As can be seen in the chart above, during the most recent panic decline, the Summation Index reached its most oversold values ever seen. Normally, these kinds of readings are NOT associated with final bear market lows. Instead, they are normally followed by (a) a sizeable bounce phase (which we are in right now) and then (b) a retest phase, which sets up a positive divergence as the Summation Index holds at much higher, less negative values even as prices retest former lows. If the stock market is able to put in a final bear market low in the first six months of 2009, there is a good chance that healthcare could be a good hunting ground for longer range investors looking for good returns and predicable growth at a reasonable price. In the weeks ahead, I will continue to comb through the various sectors for potential ideas as I do expect more good buying opportunities to take shape during the first few months of the New Year when it is likely the S&P will retest its lows.
That’s all for now,
© 2008 Frank Barbera