Sunday, January 4, 2009

Not Another Year Ahead Piece!

I want to publish my thoughts about 2009- not because I think I can see the future, or because I want to give advice. Rather, I want to have something in print so I can refer to it in coming months and see a snapshot of where I was at the start of the year. That might help me to understand where I made mistakes, and what unanticipated developments caused me to change my thinking.

I think that the stock market made an important bottom on November 20, 2008 at around S&P 750. I allow for an undercut of that bottom. Although every bear market is different, I wouldn't be surprised if we see something like the 2002-03 experience, when the market made its primary low in October (at about 800), rallied to 927 on Jan 10, then fell back to a classic double bottom around 828 on Feb 7 and March 7.

But I do think that the market is presenting us with an extraordinary opportunity over the next 2 or 3 years. I believe that there are many very high quality blue-chip stocks with bulletproof balance sheets and franchise businesses selling at once-in-a-decade valuations. Many offer substantial dividends. I think that these companies could rise 50 to 100% or more in value over the next 2 or 3 years. I'm currently invested in ABB, BA, CSCO, DD, GOOG, INTC, SLB, SYY

If I'm right, I'll almost certainly underperform "the market". In the next bull market, some of the best performers will be high beta names: maybe airlines, or miners, or E&Ps, or beaten-down retailers. But I think that I've found the easy money trade, with very good upside and less risk. If I'm wrong and the market continues down, I'll definitely perform better with these more stable names.

I'm currently about 33% invested in my high-quality portfolio, with the balance in cash. I've been looking for a chance to add to those positions and start a few others, but the market's runup in the past two weeks has taken most of them beyond my target buy points. If the market goes straight up from here, I'll miss an opportunity (although I do have more equity exposure in my retirement accounts). If a new bull market has already begun, I'm willing to take the chance that I'm underinvested. I could easily see more downside, and real losses are more painful than missed gains.

My best guess is that the market trades in a range for at least the next few months. Maybe 750 to 1000 or so, but that range is just a guess. I'll look for a chance to add at the lower end of the range. If it gets up near 1000, I'll consider selling calls on existing positions.

I'm thinking hard about energy stocks. I've only got one (SLB) in the portfolio now. Although I wouldn't expect oil to make a V bottom and charge straight back above 100, I was interested in some recent investor surveys which showed a distinct lack of appetite for energy. The most bullish forecast for oil in 2009 was about $75/barrel , and most expected something around 40 or 50. I'm no expert, but I know that oil is an essential commodity, and recent prices of 40 or lower lots of supply became uneconomical to produce. It wouldn't take much in my opinion to see a slight pickup in demand push prices well above most expectations. It's probably a good "fat tail" trade, buying far out of the money calls. I'll try to play it by adding to SLB and finding one or two more high-quality energy companies that are down 50% or so from recent highs and have great balance sheets.

I'm avoiding beta names. I don't want anything in the portfolio that could get slammed if we find that the drug didn't work, or the hole was dry, or they couldn't roll over their revolving line of credit. No triple short ETFs-- which are really just coinflip bets anyway. No emerging markets, although I wouldn't be surprised if China turns out to put up some great performance in 2009. No small caps, although some very smart smallcap managers with great research will probably have a career year. I don't have great research, so I don't want to own stocks where the smart money sells well before the dumb money (me) discovers a problem. Smart analysts and hedgies can get a great informational edge with many small stocks, but much less so with BA or DD.

I expect that the recession will continue through 2009, and that it will be one of the most severe on record. I think we'll be able to see light at the end of the tunnel by year-end or maybe earlier. I do allow for the possibility--say 10%-- that the current economic malaise extends for much longer than I expect, perhaps 5 years or so. I'll keep some cash around to avoid blowing up, but I certainly will suffer if that happens.

Interest rates and gold should both go up. It's a consensus viewpoint, but I just can't see how all of the government stimulus won't eventually induce significant inflation (although much more dangerous is the possibility that they can't inflate). I don't like bonds. Even with historically wide spreads, higher interest rates will hurt bond prices, and I can get bondlike yields from the dividends on some of my stocks. Munis scare me. I think that many state and local governments are underfunded or worse, and the recession will exacerbate their problems. I don't think that the state of California will default on its debt, but its 6% 30 year paper doesn't interest me.

Finally, a few other names on my stock watch list: CAT, WAG, UNH, PFE, COST, GE, COP, and IBM. I've got some levels in mind if they sell off. No financials. Although I'm certain that the financials will have an absolutely rip-roaring rally at some point, I don't know when. I suspect that they're pretty well washed out, but they don't fit my criteria for bulletproof balance sheet.

So, in summary, there's plenty of money to be made from here in relatively safe stocks. Don't get greedy, and look to add on dips.

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