Opportunity: Buying or Selling

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The market sold off sharply on Friday, to say the least, on a payroll number that was far lower than expectations. Is this the beginning of a series of awful numbers, an opportunity to sell, or are we just seeing another weak start to the summer—perhaps another opportunity to buy?

That is a tough question to answer at this point. We have seen a great start to the year for the market the last three years. Those great starts have been met with heavy selling in May and then the bulls come in and roar to the tape to finish the year.

I don’t think we should jump to any conclusions at this point. Let’s try to take an objective look at things and try to make some sense of what is going on out there. The payroll number was obviously weaker than anyone expected. The ISM was also released Friday. The New Orders number in the ISM was better than expected. The number was actually at a cycle high. This number is highly correlated with future ISM numbers and the future direction of the stock market. So, that is one positive we can draw from the data released. Clearly, the headline employment number in conjunction with all the chaos in Europe will lead to a sell-first, ask questions later day in the markets, like we saw last Friday.

The weak data released last Friday led to a massive surge in metals prices. The buying in the metals complex came on increased hope of further quantitative easing by our Fed. In many ways we have already received a very large order of stimulus.  Commodity prices have dipped considerably. There are huge headlines in every paper when gas prices spike. The deep analysis from the papers always talks about the increased “tax” we all pay at the pump in the form of higher gas prices. Well, we have all received a bump in pay over the last several weeks in the form of lower gas prices. As we enter the summer prices are actually considerably lower than a few months ago and down year over year. We have also received a bump in cash flow through lower interest rates. Those in good standing have been able to lock in the lowest interest rates on record. The headlines never seem to capture the downward move in gas prices. Certainly, there are many in the US that have had to deal with mortgage woes over the last several years. It is equally true that there are millions of small businesses and individual borrowers that have been able to reduce the cost of borrowing significantly over the past year.

Lower commodity costs proved to be very beneficial to companies in the second half of 2011. Lower input costs had a positive impact on profit margins for businesses and lead to positive earnings surprises in the second half of last year. The cost side of the equation is setting up to be positive for corporate America again this year. Questions remain on the demand side however.

All of the information I have mentioned above has taken a back seat to what is going on in Europe. As long as peripheral Europe is garnering headlines the market will stink. How is that for sophisticated analysis? You can talk all you want about the size of Greek's economy or the fact the Europe has been in one state of turmoil or another since the Renaissance. As long as there is no way to quantify the issues with banks in Europe and who is ultimately going to foot the bill to sort things out buyers will be scarce. 

However, remember the ultimate leading economic indicator is the stock market itself. The market is saying right now that the knuckle heads in Europe don’t have a clue right now; but, soon as a plan is announced the market often spikes aggressively. The ability of the market to look ahead often leads to sustained rallies when they look the least likely. That is because while we all try to put on our junior economist hats and analyze the pros and cons of the latest plan the smart money is buying because the event (whether it be QE 1 or the first bombs of the Gulf War or any other gaming changer) triggers the end of the latest market negative and the time to be bullish. 

So, let’s just sit on the cash we have raised over the last several weeks and remain cautious. Do not become obsessed with the level of the market. Follow the drill, remain married to just your spouse, not any particular stock.  If a stock doesn’t perform move it out and add some cash. There will be opportunities to both buy and sell in this current environment just like any other environment. Buy the names that continue to report good numbers and remain well positioned relative to their competitors. Sell the names that role over. This culling of the portfolio will give us the chance to see things more clearly and take advantage of opportunities as they present themselves as the year unfolds.

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About Thomas J Smith CFA

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