by Jamie Dlugosch | November 24, 2008 4:11 am
With the first quarter of 2009 behind us, we can now draw some reasonable conclusions about the current bear market and where we are heading for the remainder of the year.
If we simply look at the snapshot of market valuations on March 31 and project those results for the remainder of the year, investors might think that the markets are headed for another disastrous year. Such an assumption, though, would be misguided and misses the subtle cues of the market’s moves throughout the quarter.
At the start of the year, investors were hopeful for a January effect of higher prices, but never came. Instead, we were all treated to more losses and wild swings in prices that suggested a high degree of uncertainty. At the nadir, the S&P 500 was down more than 26% for the year. At that time, panic was at a peak and professionals and amateurs alike acted defeated, and more importantly, disinterested.
That attitude set the stage for a powerful rally whereby the S&P 500 finished the quarter down a mere 11.7%. On the surface that may seem harsh, but considering where we were during the quarter investors should be encouraged by the result.
While the markets may not see the 20% annual gains that some were predicting at the beginning of the year, a single-digit positive return for 2009 is not out of the question. We have moved smartly off the bear market lows, and more importantly the economy has had time to heal. If we do indeed finish the year with single-digit gains, such a return would correspond to the health of an economy that is wounded, not broken.
At the start of the year, I provided my Top 10 Stocks for 2009. The first quarter, performance of the stocks on the list is quite impressive. An equal investment in each would have resulted in a portfolio that is outperforming the market by nearly 500 basis points.
That is a huge result considering the negative bias in the market. The question is where do those stocks go from here?
Here then is an update on each of the Top 10 Stocks for 2009.
If you had asked me at the beginning of the year to select the one stock on this list that would perform the best, I would have told you Jacobs Engineering (JEC).
At the time I made this list in late November of 2008, we had elected a new President that had indicated a willingness to invest heavily in infrastructure spending as a way to stimulate the economy and promote jobs. Instead, we got a mere pittance when the actual Stimulus bill was passed in February. That disappointment translated into a big loss in valuation for JEC. The stock was down more than 19% in the first quarter of this year underperforming the market.
I remain optimistic on JEC as infrastructure needs greatly exceed current spending allocations. A stronger economy should help JEC recover during the remainder of the year.
At the epicenter of the financial crisis and economic collapse, the homebuilding sector made for a great contrarian play for 2009. With so many failed calls for a bottom, I expected positive things for the company this year. I have not been disappointed.
Shares of Pulte Homes (PHM) finished the quarter exactly where the year started making the homebuilding sector one of the strongest groups in the market. This week, PHM announced a premium acquisition of fellow builder, Centex (CTX). As a result of the deal, shares of PHM fell by more than 10%. I would use this opportunity to buy. Inventories of homes for sale are dropping, prices are stabilizing and demand for new construction is only growing. These ingredients bode well for PHM for the rest of 2009.
Like Jacobs Engineering, the expected boom in infrastructure spending was supposed to provide a boost to shares of Chicago Bridge and Iron (CBI). In addition, the potential in the energy markets, including nuclear facilities, was to provide ample sources of revenue growth for the company. None of this is materializing as of yet. This, in combination with the weak economy, has negatively impacted operating performance.
In February, CBI announced earnings that beat expectations, but its forecast was well below analyst estimates at the time. The forecast reflected the reduction in Stimulus spending expectations and the weak economy. Shares collapsed on the news only recovering slightly by the end of the quarter. The stock is down more than 37% this year.
It would be easy to give up on CBI as a result, but I view the reaction to the weak forecast as being way overdone. Infrastructure spending is likely to increase as the economy strengthens. I expect CBI to recover in its entirety before the year is out.
Although the 10 stocks for 2009 are greatly exceeding expectations, not all is perfect. If there is one mistake on the list of stocks it would be General Electric (GE). I vastly underestimated the risk posed to the company by its finance arm. Even though the company appears to have the resources to withstand massive write-downs of poor performing loans, investors care little. Shares of GE are down more than 37% making it one of the poorest performers on this list. I would have been much better served selecting Honeywell (HON) in looking for a beat-up industrial concern for the list.
But I’m reluctant to jettison GE despite the disappointment. Locking in a loss is never a good idea. In addition, the worst of the financial crisis looks to be behind us. The government and the Federal Reserve are proving to be a solid backstop for struggling financial companies, including GE. I don’t expect a homerun here for the rest of the year, but one just never knows.
At the start of the year, the one sure thing that I felt strongly about was the oil sector. Having crashed from the peak of $150 per barrel, crude prices had fallen significantly below the stated goal price of OPEC. That fact alone triggered production cuts that have helped support oil prices. Speculation regarding the recovery of the global economy is also helping push oil prices higher.
When I put together the list of Top 10 Stocks for 2009, I wanted to weight the portfolio to this critical commodity. Sure enough, oil prices have indeed recovered to above $50 per barrel. As a result, oil stocks, including natural gas company Chesapeake Energy (CHK), are performing very well this year. CHK is up over 5% in the first quarter. For the remainder of the year, I expect oil prices to slowly rise to $70 per barrel. As such, CHK should continue to outperform the rest of the market and lead the Top 10 Stocks for 2009 higher.
Another winner on the list is Tesoro Petroleum (TSO). Its shares finished the first quarter in positive territory. With refiners, the most important aspect regarding the pricing of crude is stability. The good news in 2009 is that the crazy price volatility of 2008 is behind us. Gone are the speculators and excessive use of leverage that resulted in buyers hoarding crude in a market with shrinking demand. TSO can now process that crude with a better idea of front-end and back-end costs. That stable environment is necessary to make profits in a very difficult business.
Given the huge cut in TSO’s stock value, making money on the rebound makes sense to me. That rebound has yet to conclude and should be in play for the remainder of 2009. But if oil prices become more volatile, all bets are off.
You never know where success in a portfolio will come from. During the first quarter, one of the big winners in the market was offshore driller Transocean (RIG). The company has benefited from the increase in oil prices more than most. Its shares are up more than 24% in just the first quarter alone. It would be tempting to take money off the table, but if oil prices are heading higher, there should be more gains for RIG.
Investors often sell their winners too early preventing huge gains that can crush the market. I say let it ride on RIG. If there is a stock that can double in value from the start of the year, it is this company. And $70 oil will go a long way in getting us there. Based on first-quarter performance, we are right on track for that double.
As a rational investor, I like to take advantage of inefficiency in the market. During a highly volatile bear market, there are more examples of mispricing than at any other time. In 2008, hedge funds bid up shares of companies tied to the agriculture space. Fertilizer companies, in particular, became very hot stocks with lots of momentum. That momentum came crashing down as the market collapsed. Though operating performance and growth prospects were hardly diminished, big hedge funds were forced to sell shares for reasons other than valuation. Their loss is your gain.
If you bought Mosaic (MOS) at the beginning of the year, you would be sitting on a gain of more than 21%. The inefficient pricing still exists in my opinion. Demand for food is only increasing, and MOS is positioned to benefit from growth in demand for products that improve farming yields. Doing more with less, especially in a recession, is what the world is about, and Mosaic will play a big role in that.
I expect MOS to be another stock with double potential for the rest of 2009.
My third bet on the infrastructure play is the last disappointment on the list. Fluor Corporation (FLR) is down 23% in the first quarter of 2009. If you have yet to buy any of the stocks on this list, I would take a hard look at these infrastructure plays. Indeed, the Stimulus package disappointed, but the reaction to the news has more to do with aggressive shorting in order to profit on that news than any other factor.
Valuations in the group, including FLR, are cheap in my opinion. If there is any positive news on infrastructure, those that sold aggressively will be forced to cover their shorts. In other words, the potential gains here are higher than the rest of the market.
If you believe that the economy will recover, these stocks are the place to buy. I would expect FLR to recover these losses before the end of the year.
I put Archer Daniels Midland (ADM) on the list for the same reasons I selected Mosaic. Not wanting to put all my eggs in the fertilizer basket, ADM provided exposure to agriculture without the volatility. Given that I was correct on my analysis of the fertilizer group, I certainly could have selected another stock from this segment, but I took the conservative route instead. I shouldn’t complain. ADM is outperforming the greater market with a loss of only 3.6%.
But don’t expect too much from ADM going forward. ADM is more of a defensive stock that will do well in a recession. I viewed the stock as a growth opportunity from the prism of the end of last year. Looking forward, those growth aspects are slipping by the wayside. I’ll stick with ADM for the rest of the year, but if the economy does recover, ADM will be on this list for this year and this year alone.
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