Will Q4 Be Strong Yet Again?

Fourth quarters in recent years have been strong periods for the equity market, but I wanted to put some hard numbers behind my recollections. I went back all the way to 1990 and calculated the S&P 500’s performance for each of the last sixteen fourth quarters. The results, shown below, were even stronger than I had remembered.

As you can see, fourteen of the last sixteen years have produced positive S&P 500 returns in Q4. The mean return for the period since 1990 has been 6.5%. The average gain in the positive years is 8.0%, while the average loss in the negative years is only 4.5%.

Does this mean investors should be 100% equities going into October? Surely some will do just that based on these statistics, but I am being more cautious. The market has had a very, very strong third quarter and I want to protect some of those gains.

Stocks simply feel overbought currently. With the average fourth quarter producing a 6.5% gain since 1990, I am going to have to take “the under” and say this year will be less impressive than average. On the bright side, I’ll be thrilled if I’m wrong!

Has the Housing Bubble Burst?

All I’ve heard recently in the financial media is that the housing bubble has finally burst. It’s really quite comical. First of all, there was never a housing bubble. Everyone just threw around the bubble term because we had experienced one in Internet stocks a few years back and it was easy to categorize a very strong housing market as a bubble.

It’s true that the housing market of the last five or six years was one of the strongest we have had in this country. The same can be said of the broad stock market from 1982 to 2000. We had the biggest equity bull market ever. However, it was not a bubble for all stocks, only one sector of the economy. Technology and telecom names fell by 90, 95, even 100 percent.

Outside of tech though, there was no bubble in stocks. The S&P 500 fell 50% when the “bubble burst” but the Nasdaq fell 80% and tech made up 30% of the index. As a result, half the S&P 500 loss was from tech stocks. Without the bubble, the market would have been down 25%. That classifies as a bear market, not a bubble.

Markets don’t experience bubbles every five or ten years. It’s a much rarer phenomenon than that. People are also calling the bull market in commodities as a bubble. It’s not. It’s a bull market. Markets are cyclical and when they rise they do so very quickly, but bull markets and bubbles are not synonymous terms.

So, yes, the housing market is very weak, but let’s stop saying how the bubble is bursting. The mean home price in the U.S. remaining flat or only rising 1 or 2 percent does not classify as a bubble bursting. Not even a 20% drop in housing prices on the coasts qualifies. That’s just a bear market, which is what typically follows a bull market. When housing prices in certain markets fall by 90% or more, then we can start calling it a bubble. Not going to happen.


Analyzing Yahoo!’s Profit Warning

Two months ago I outlined a long Google/short Yahoo! paired trade as a way to play the possible p/e multiple convergence of the two leading Internet advertising companies. This week’s third quarter warning from Yahoo prompted an ugly sell-off in the name. Google shares were down for the day as well in sympathy, but it dropped far less than Yahoo!, which is exactly what the paired trade is supposed to capitalize on.

The question we have to answer now is, “What do we make of the Yahoo! shortfall?” There are two ways we can go here. One, the Yahoo! warning signals that the economy is slowing significantly and advertising clients are pulling back their ad budgets. This would hurt Google in the same way as Yahoo!. On the other hand, it could simply be that Yahoo! is becoming less and less relevant in the advertising space, and Google continues to steal market share.

Back in July when I first wrote about this trade I was in the latter camp. I remain there today. I think Yahoo! is getting beaten at the same game they once dominated. Google is dominant enough in domestic search that most of the market share gains have been made, but they still are doing better than Yahoo! on a relative basis.

This is not to say that a slowing economy would not hurt Google as well. When the day comes where we see dramatic ad budget cutbacks, it will be time to exit both stocks. I just don’t think we are seeing that yet. Last quarter we saw a bad quarter from Yahoo!, followed by a strong report from Google. That supported my thesis. This week we found out that Yahoo! again is having trouble. I think Google will post a solid third quarter, and as a result, I am keeping the paired trade on for now. When the online advertising market starts to suffer due to the business cycle beginning to turn over, then I’ll take the profit from the trade and move on to something else.

Full Disclosure: I have a position in the paired trade mentioned above, long shares of Google (GOOG) and short shares of Yahoo! (YHOO).


Overvalued Stock Screen

Every once in a while I will run a screen to find stocks that might be overvalued. This can serve to identify candidates for short sales. After a nice upward move in the market, coupled with increased bullishness among market pundits, searching for some shorts to hedge seems reasonable.

I screened for U.S. companies with market caps of at least $2 billion that sport price-to-sales and price-to-book ratios of at least 10. The screen yielded 10 stocks, which are listed below in alphabetical order.

Akamai Tech (AKAM)
Amylin Pharma (AMLN)
CBOT Holdings (BOT)
Celgene (CELG)
Chicago Mercantile Exchange (CME)
Genentech (DNA)
Intercontinental Exchange (ICE)
Las Vegas Sands (LVS)
Ultra Petroleum (UPL)
Vertex Pharma (VRTX)

Full Disclosure: I am short shares of Celgene (CELG) at the time of publication.

Commerce Bancorp Sale Unlikely

Shares of New Jersey based Commerce Bancorp (CBH) soared 6% Friday and are continuing to hit multi-month highs today, jumping as much as 2% in early trading. The jump is being attributed to continued speculation that CBH will be one of the next regional bank takeover targets. I think the odds of Commerce agreeing to a sale are extremely unlikely.

Close followers of CBH are aware that the company has been growing very rapidly in recent years and their expansion plans continue. Management has been able to maintain impressive levels of organic growth and even after years of expanding their banking branch footprint in the U.S., they remain only visible in a few main states. Commerce has a large presence in New Jersey, New York, and Pennsylvania, along with a recent move into Florida. Baltimore and Washington DC are also in CBH’s sights in coming years.

Given the success of the Commerce growth strategy, and the many areas that remain untouched, selling the company to a larger, more national bank makes little sense for the company at this time. While buyout rumors have been swirling for years now, and evidently continue to do so, investors should be wary of the stock’s recent run-up and that such talk will become reality. Commerce Bancorp has years of internal growth ahead of it, which will prove profitable for shareholders even without a buyout offer.

Full Disclosure: I own shares of Commerce Bancorp (CBH) personally as well as for clients.

Taking Some Profits in Coach, Among Others

With the recent market rally we find ourselves within 1% of the previous highs on the S&P 500 index. I am beginning to trim positions a bit here into the strength. I am fully aware that this move could backfire given that we are heading into a seasonally strong period for equities, but as we once again near the top of the trading range, I feel it is prudent to tread more carefully.

What have I been trimming exactly? A couple of areas. First, asset managers. These stocks have been strong with the market doing well. Since they track the overall direction of the indexes over the short term, they seem to be ripe for selling if I’m right and the market is closer to the end of the rally than the beginning of it.

I have also been selling much of the Coach (COH) stock that I alerted readers to in the $25 area. The stock has soared, along with other consumer discretionary names. At more than $33 per share, we’ve seen a 30% jump in a very short amount of time. The stock now trades at 20 times forward earnings, about in line with their projected 15-20 percent growth rate. While the stock is not overly expensive here, the value proposition that got my attention has largely been corrected with the recent rally.

All in all, I urge investors to tread carefully now that we have gained much of the losses back from July and August. I have a tough time justifying a 2007 target on the S&P 500 of more than 1,400 at this time. This leaves us with about 6% upside in that scenario. If that is the most I could miss by raising some cash here, I don’t think I’ll be doing anyone any great harm by shifting some funds away from equities and into more income-related securities.

Attractive Entry Point for Chesapeake Energy

The recent energy pullback (correctly predicted on this blog a few weeks ago on 8/24) provides some interesting entry points for long-term energy bulls. Crude oil has dropped from the high 70’s to $65 per barrel and natural gas has dropped from $8 to $5 and change.

As I have mentioned previously, for the short to intermediate term, I believe natural gas is a better bet than crude oil. I don’t think we are heading back to $50 crude anytime soon, and most of the correction is likely behind us. However, future catalysts bode well for natural gas prices, as well as leading producers such as Chesapeake (CHK) and Anadarko (APC). After recent corrections, those two names trade at less than 9 and 7 times 2007 estimates, respectively.

Why is natural gas attractive down here at around $5.50 per unit? Two reasons that I can see. One, with no major hurricanes yet this season, investors are beginning to price in the best case scenario for natural gas bears, namely that we will have no damaging storms this year. The investing game is all about comparing current expectations with future probabilities. If we do get a big storm or two, natural gas will zoom right back to $8 or $9. Without a storm, the current expectations prove accurate, and prices likely stay the same. All in all, not a lot of downside from current levels in either scenario.

Let’s look past hurricane season to factor number two; the winter. Last year we had a very warm winter, which served to limit natural gas heating demand, and quickly brought prices down from elevated levels reached after Hurricane Katrina. Now I’m not a weather forecaster, and even if I was the odds I’d be correct wouldn’t be very high, but chances are good that we could have a colder winter this year. Again, it’s all about expectations. Current natural gas prices are pricing in moderation with respect to both the remaining hurricane season and winter temperatures. If we get a surprise on either front, or both, there is nice upside to natural gas prices and the leading domestic producers.

Full disclosure: I own Chesapeake personally and Anadarko would be my second choice if I needed to pick another name in the group.

Apple Shares are Pricing In Positive Catalysts

In recent months I recommended investors take a close look at shares of Apple (AAPL) after they concluded a long descent from a high of $86 per share all the way down to the mid 50’s. While the P/E multiple on the stock has never been low, even after a 35% haircut in the shares, the company does have more than $10 in net cash on its balance sheet, as well as something that fewer and fewer companies have going for them at this stage in the business cycle; excellent growth.

In anticipation of new product announcements, shares of Apple have rallied lately and are surging nearly $3 today to more than $72 each. For those of you who did some bottom-fishing in the 50’s, I think it may be wise to take a few chips off the table. The company’s outlook remains very bright, and growth managers will want to own the stock, but I think a lot of good news is being priced into the shares. Any disappointments regarding the specifics of the company’s new products, and we could see some of the recent gains given back.

Apple remains one of the most attractive growth opportunities in the technology space. I just think after a 30% rebound from the lows, slight profit-taking might be in order as investor demand right now is quite elevated.