Some reading on market fundamentals

Readers here know that I like articles by Bennet Sedacca and Jeff Saut on market fundamentals, posted from time to time at Minyanville (listed in "other sites of interest" at the right side of this page). Here are some quotes from recent articles by both of these fine minds posted there:

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Will Darwinism Return to the Markets?
Bennet Sedacca - Dec 30, 2008 12:30 pm

“It is not the strongest of the species that survives, or the most intelligent that survives. It is the one that is the most adaptable to change.” —Charles Darwin

2008 in Review: Has the Easy Market Call Come and Gone?
As regular readers know, I've had a cautious, even bearish view, towards equities and credit over the past couple of years. The handwriting was on the wall and both seemed woefully overvalued. That being said, my long-standing target for the S&P 500 of 750-800 was reached this autumn, a level that has held, even in the face of awful economic news. I do believe an ultimate low of 500-600 is possible, but most of the pain (in terms of price, not time) has been faced.

Some people will tell you that the bad news is now ‘priced in’ for the S&P 500, but I strongly disagree. According to S&P, its ‘top down/macro’ earnings estimate for 2009 has fallen all the way to $42 per share. This is in direct contrast to the cumulative ‘bottom up/stock-by-stock’ estimate of $70 or so from Wall Street analysts. The Wall Street folks have been overly optimistic for 20 years or more while S&P has a habit of being on the mark since they don’t have an axe to grind.

My point is that while the S&P 500 has moved from nearly 1,600 to a recent 860 (a 45%+ decline), it remains at a healthy 22 times S&P’s earnings estimate for 2009. Bulls will tell you that the market is cheap because even if the $42 earnings number is correct, these are ‘trough’ earnings - or the low point for the cycle. I'll concede that even if the $42 is a trough number, the market is not cheap on any other metric, price to book, dividend yields, etc. In addition, P/E ratios based on trough estimates assume that earnings will rebound sharply once the bear market is over, but this is certainly not our outlook.

I must concede that the easy call being out of stocks or underweight stocks in general has been made, and is now probably past for the most part. For 2009 and forward, a general call on the overall market won't be as easy, but good money can be made in company selection and sector rotation.

While equities in the US suffered 40% losses for 2008, corporate bonds and other credit-sensitive securities got killed (some ‘core’ fixed income managers were down as much as 25% for the year). The pity about 2008 for most investors is that they were let down by what was supposed to save them: diversification. 2008 will be remembered as the year of the ‘1 beta event,' a year where there was nowhere to hide, except in Treasury notes and bonds.

My firm fully expected the ‘1 beta event,’ which explains why we were nearly void of equities (for clients that allow us to go to a 0% weighting) from April until our buy in the 750-775 area in the S&P in November. While my firm isn't close to being bullish about stocks in general -- or even credit in general -- I believe that pockets of value are beginning to develop in some risky asset classes. I also believe that we'll enter a period of Darwinism where the best managed companies pick up the pieces of poorly managed companies that will likely fail. I believe that Darwinism will occur at the national, corporate, municipal and individual level.

... Losses stemming from the Credit Crisis have now crossed the trillion-dollar threshold as you can see in the table below (tables are in the article posted at Minyanville). Worse yet, 242,273 job cuts have been announced in just the public world of financial companies since the Crisis began. If that weren’t bad enough, Bloomberg now actually has a ‘Bailouts’ tab on this part of their analytics. Truthfully, had I not witnessed all of this first hand, I wouldn't have believed it to be possible.

This may be the list of companies that doesn’t emerge from this period of Darwinism. And if any do, it will do so only as a shadow of its prior self - run by the government or broken into pieces, rendering it unrecognizable. Companies that won't survive are likely those that aren't able to finance themselves in a profitable manner. Let’s face it: If your name is on these lists, it's because you needed the money - plain and simple.There are actually others like American Express and General Electric Credit Corporation that are indirectly on this list, as they've used the Fed’s Commercial Paper lifeline to finance themselves. They're not directly on this list - yet. But look for others, including other insurance companies, real estate investment trusts, and other finance companies like GMAC, CIT Group, and Capital One among others. When we're all said and done with this bailout process, many trillions of dollars of taxpayer money will be thrown at the mess that the Fed helped start in the first place.

What kind of company will survive the test of Darwinism? Those that can finance themselves, have pristine balance sheets, and have management teams that saw the economic mess coming, tightened their belt and rode out the storm. These might include companies like Johnson & Johnson (JNJ), Exxon Mobil (XOM), Pfizer (PFE) and Proctor & Gamble (PG). These companies don't need to come to the debt market to finance themselves all the time. What was more pitiful than the auto industry hearings in Washington where a bunch of grown men sat there and said "we recklessly managed our companies, we are almost bankrupt, please bail me out." Darwinism suggests that these companies should fail. In fact, they should fail to make way for better run companies with stronger balance sheets and more-adaptable management, even if they're from another country.
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Who will be the Losers and Winners in a World of Darwinism?
The short and simple answer to the question of survival is that those companies -- who were prudent with their finances and took the time to understand the impact of a global unwinding of the largest credit bubble in history -- will be around to operate in the next phase. Whether you're running a Fortune 100 company, a hedge fund, a small business, or simply an investment portfolio, those that were prudent with their capital and weren't greedy will likely survive.

And whether we're talking about running a brokerage firm into the ground due to excessive leverage and greed or an investment portfolio with excessive leverage, the sad truth is that you won’t be around to take advantage of the wonderful opportunities that exist after an asset class gets carved in half. ...

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I don't want to copy in his whole article, so check it out at Minyanville if you want to see what he's recommending for, as he puts it, "what to own during 2009, not for all of 2009" - themes he thinks will work during 2009 and perhaps into 2010. Personally, I especially appreciate his comments on the fundamental outlook, confirming what technical traders already suspect: that the fundamentals don't signal the all-clear for a bullish market outlook, either.

And now, below are quotes from the recent article by Jeff Saut:

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Jeff Saut: Expect Further Embezzlement
MV Respect - Dec 29, 2008 11:43 am

Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

Mark Twain once opined, "History doesn’t repeat itself, but it often rhymes." Nowhere is this truer than in the stock market because it is mainly a combination of fear, hope, and greed only loosely connected to the business cycle. ...
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Manifestly, only when the tide goes out does one discover who’s been swimming naked. Unfortunately, if past is prelude, like in the 1930s there will be more "Mr. Madoffs" in the coming months, which should lead to increased negative investor psychology combined with massive Congressional hearings resulting in more wrong-footed regulations like the Sarbanes-Oxley Act. While this is likely the course we are steering over the coming quarters, the real question becomes, "Have the equity markets already discounted such events?"

In past missives we have suggested that the equity markets have been in a bottoming process since the October 10th capitulation “low.” We have given numerous metrics for that view, but in this week’s Barron’s the always insightful Stephanie Pomboy makes our prose pale in comparison when she states:
"In the very near-term, there are a variety of reasons to anticipate a rally in risk. ... Most notably, yields on corporate credits have climbed to multidecade (and in the case of junk, record) extremes. At the same time, cash [must be] burning a hole in investors’ pockets with 0% yields before inflation and dollar debasement."

Obviously I agree with my friend Stephanie, which is why my firm has been recommending the scale buying of distressed debt situations like BlackRock MuniHoldings Insured (MUE) and Nuveen Insured Dividend Advantage (NVG), both of which sell at discounts to their net asset value and have over 6% tax free yields. We also have been recommending Lord Abbett Bond Debenture Fund (LBNDX) with a near 9% yield. Moreover, even though we have avoided the financial complex for years, for those wanting exposure to said complex our vehicle of choice remains the iShares S&P U.S. Preferred Shares (PFF), which is yielding over 10% and has a 78% exposure to the financial complex’s preferred shares (see the attendant chart). Additionally, during the past few weeks we have added the iShares MSCI Japan (EWJ) and iShares FTSE China (FXI) to the ETF portfolio.

... [A]s MaroStrategy’s Bob Parenteau notes, "The prime monetary policy operation becomes the Fed’s ability to use its infinitely expandable balance sheet to purchase longer maturity Treasuries, GSE debt, mortgage backed securities, and in the extreme, even equities and corporate bonds with the objective of getting private market interest rates down and asset prices up." My firm continues to think the Fed will be successful. Happy New Year everybody.

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Well folks, these quotes from two articles written last week by two analysts I respect, although not obviously in full agreement. Maybe this also fits with the comments from the technical analysis side - from here, it's possible to project either a good rally, or a significant correction in equities indices (the S&P500, Dow Jones Industrial Average and Nasdaq generally) - so whichever side you choose to play from, be careful out there!