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Going into the FOMC meeting, from a tactical point of view I was looking for an opportunity to take some profits and increase cash, hopefully by taking advantage of short-covering I expected on MBI. This occurred and I sold all but 200 MBI and more or less half of my remaining TESS, both written up and posted earlier this week. This leaves me with about 250,000 in cash and a smug feeling because MBI is now trading well below where I sold it.
With earnings season around the corner, I will be operating on the basis of the following scenario: 1) choppy, sideways trading. 2) Greater variability of earnings, with a corresponding increase in the intensity of investor reactions. 3) Lower interest rates, combined with uncertainty about earnings, will make dividend payers with consistent earnings more attractive. 4) The dollar's weakness against other currencies will a) make US industry more competitive and b) make profits earned in other currencies more attractive. 5) Recovery in housing and related industries has been made possible, but will develop slowly until the securitization process begins to function smoothly, with some industries recovering sooner than others.
My strategy is to buy stocks when they are trading low in their historical range according to various metrics, typically price/5 year average earnings, and sell them as they hit the midpoint. I find myself selling somewhat lower than the midpoint in the interest of avoiding round trips and having cash on hand for opportunistic buying. Most of my remaining portfolio holdings fit into the scenario outlined above and I have cash, so my main focus will be shopping for beaten down stocks.
Partly that will come down to what's on sale. A value strategy frequently winds up in sectors that are out of favor, for good reason, and relies on waiting for conditions to improve. In an effort to reduce this slow timing difficulty, I have been trying to develop some ideas as to the probable sequence of recovery: that is, what sort of sector rotation to expect.
One factor I would consider is how much bad news is still out there waiting to be revealed in the financial statements. Homebuilders have mostly disposed of non-core businesses and negotiated sizable lines of credit during happier times. While they will show reduced profits and may write off more land or options, I think most of the bad news is behind them. They have a relatively clean track to run on once qualified buyers begin to appear. Mortgage finance companies, banks, and financial guaranty insurers still have losses that have not yet occurred, or of which they are not yet aware. P&C Insurance has its own cycle, but should recover quickly to the extent depressed valuations reflect fear of the unknown in their bond portfolios.
Basic materials and building supplies should recover ahead of the homebuilders, on the theory that the materials have to be bought and put into the houses before they are sold. Because they will have cut expenses during the downturn, they should show good profits as soon as revenues increase.
Business services and office furniture and supplies should recover gradually along with those they serve. I have value candidates among electronics manufacturing services, semiconductor equipment, and semiconductors, all of which are not directly linked to housing. Both MSFT and IBM look relatively inexpensive to me.
After all of this, I get back to the fact that I am a bottom up investor. I start with the individual company, examine it in its industry setting and relative to its peers, and try to select value companies with strong management and well-defined strategies. A strong competitor in a difficult industry can often be a good buy as it takes share from weaker competitors or participates in the consolidation process. Sometimes sufficient homework gives me an opinion that is based on factors others may not have considered or fully appreciated, or I have a different perception of risk and will be rewarded if correct. By sticking with my natural style, I do better in the long run and don't have to worry about second guessing myself in areas where I am not fully informed.
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