Market Caught in Nasty Feedback Loop
Fear makes opportunities for those with cash, patience, and fortitude.
Ouch! As of Thursday's close, the S&P 500 total return is a jaw-dropping negative 37% year to date and down 25% just since Sept. 26 (the Friday before the House initially rejected the rescue plan). The only investors who have to be happy about this are those who entered the mess with mounds of cash sitting on the sideline.
It appears we are in several nasty feedback loops. At least anecdotally, there is evidence of many forced sellers in the market. Not just Lehman Brothers, but hedge funds and even individual investors who use leverage, as well as fund managers dealing with massive redemptions. The further down stocks go, the greater the forced selling, and so on. As just one example, take Boston Scientific (BSX). This week, some of the company's founders "involuntarily sold" more than 13 million shares, and more such sales at Boston are likely. In this market, liquidity is king.
Even those not being forced to sell are in what might be called a fear-feedback loop. The lower stocks go, the more fearful investors become that the world as we know it is ending, and the more they sell.
Another problem, this one more threatening to the businesses we own, is that the very sour mood in the stock market is going to spill over to the Main Street economy. The "wealth effect" is running in full reverse at the moment, and the reduction in consumer spending will cause earnings at many of our companies to fall, banks to in turn be even more cautious, and round and round we go. I have no doubt we are in a recession right now, and I am adjusting my economic expectations even lower than they already were.
So should we run for the exits, yelling in hysterics? Make no mistake, though the economy looks like it is going to contract, it is not the end of the world. Businesses still have intrinsic value, albeit moderately less than before this economic storm hit. For those with the cash and patience, there are very many ridiculously priced bargains right now among exceptionally high-quality companies. Below are some of my current favorites among the firms that should make it through this just fine because their cash flow is intact.
Berkshire Hathaway (BRK.B)
Between GE (GE), Goldman Sachs (GS), and Constellation (CEG), Warren Buffett has spent perhaps half of the $30 billion in cash that was sitting on the balance sheet on June 30. Yet the company still has a copious amount of liquidity in an illiquid world. Our fair value estimate remains $5,700.
Magellan Midstream Holdings (MGG)
This pipeline company is relatively immune to the economic issues plaguing our economy. In fact, the company came out and said Thursday that, as we expected, its business is holding up just fine. Magellan said it expected to raise its quarterly distribution to a $0.354-per-unit rate, up 4.7% sequentially and 22% higher from this time last year. Despite the healthy distribution growth, the indicated yield on the shares now approaches 11%.
Kinder Morgan Management (KMR)
Much like Magellan, Kinder also came out this week and said it was raising its distribution payment to $1.02 quarterly, representing 16% year-over-year growth. Kinder now yields in excess of 10%. With these master limited partnerships, I have never seen such high-quality and relatively low-risk companies trade anywhere close to these valuations.
I liked the company a month ago when it traded at a 7% free cash yield and had 10% the stock price in cash, and I like it even better with a cash yield approaching 9%. I thought I'd be much older and grayer before seeing Microsoft trade at less than 12 times trailing earnings.
This health-care giant has seen its stock take it on the chin in recent days. Part of this is because Europe is showing some economic troubles of its own, and the dollar has soared relative to many currencies. But 11 times forward estimates for this solid, diversified company providing the most nondiscretionary items around? Like a lot of things in the market, it just does not make much sense.
I don't think you have to have a huge appetite for risk to make very handsome returns in this market, just the fortitude to own stocks at all. I'm just sad I don't have more cash lying around.
Hang in there...
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Paul Larson has a position in the following securities mentioned above: BRK.B, CMP, KMR, MSFT, NVS. Find out about Morningstar’s editorial policies.