Picking Up Stocks Amidst The Carnage?

You’ve all seen the headlines. Yes, it’s brutal out there. The Dow (^DJI) continues to plunge and has lost over 2300 points in just the last 7 sessions. As this Bear roars (and he is pissed!) there is nowhere to hide in stocks.

But you know that already as you watch your portfolios - most likely in shock.

Don’t panic.

Gold, while volatile, has at least not seen as bad of a sell-off unless you own the gold mining stocks, which are at the mercy of selling hedge and mutual funds. The Gold ETF, SPDR Gold Trust (GLD), which owns the physical metal and not the mining companies, has been holdings its own. Gold has been up three out of the last four sessions. It is also one of the few asset classes up on the year.

It was a miracle the markets were holding up under the incredible circumstances gripping the financial industry and now we are seeing that the stubbornness was an illusion. Traders and investors are facing the reality of the seriousness of this situation and it isn’t pretty. It’s pretty much mass fear.

If you’re in cash, that’s great. If you’re in gold, hooray. I hope you’re in some dividend paying stocks, as you’ll reap some income during the downturn.

But be ready. Amidst the carnage that is occurring there will be a silver lining. There will be stock deals like we haven’t seen in decades. Maybe ever. How strong is your stomach?

Taking the Pain Quickly

The Super Bear Market of 2001-2003 was a slow bleed. It was a thousand cuts that eventually exhausted the markets and then the upturn began.

The 2008 Bear is stabbing vital arteries and going in for the kill. In some ways that is preferable to the Super Bear earlier in this decade. Harsh- but more efficient. It’ll wipe out the excesses quicker.

But make no mistake. The markets will rally off their lows eventually. Will it be a fake-out?

Common investor sentiment is that the Crash of 1929 began the Great Depression on that fateful Black Monday and also Black Tuesday. But that’s not completely correct.

The markets took a crushing blow in October 1929 but bottom feeders came in to buy and eventually the markets rose 50% of their lows by April of 1930. Happy times were here again! Only they weren’t.

That April, the markets began to slide and the bleeding didn’t stop until three years and an 89% decline later.

Absorb that for a moment. A loss of 89%.

History never exactly repeats, but it pays to heed the lessons.

John Templeton, a young investor just having graduated from college in 1939, borrowed $10,000 from friends and relatives in the beaten down market that year to buy up every share he could that was trading under $1. They thought he was crazy. Out of the 104 companies he bought, 34 were in bankruptcy at the time.

Out of the 104, many of them ultimately went on to make huge profits. Only 4 became worthless. That risk, and those companies, made him rich. Mr. Templeton went on to found the Templeton mutual funds. He died this year at the age of 95.

Finding a Bottom

Lots of analysts have been saying this week that we’re at a “bottom” in this market (for the near term). But we are dealing with unprecedented times with a financial situation not found in a normal bear market (like we saw, for instance, earlier this decade). Therefore, I don’t believe we can look to “normal” indicators.

Instead, let us again consult history. At market tops, the dividend yield of either the Dow Jones or the S&P will be at a low level. We saw this in recent years as the Dow was topping 14,000 and the Nasdaq over 5000 and neither was paying much of a dividend.

Conversely, when markets are at a bottom, record dividends get paid (basically because companies become cheap but still have cash flow.)

What was the dividend yield of the Dow in 1932 at the height of that Super Bear Market? Almost 16%. Conversely, in 1929, during the boom and the market peak, it stood at only about 3%.

The dividend yield of the S&P 500 is currently just over 3%, the highest since the early 1990s. Does that mean this is the bottom? I have no crystal ball, but it’s doubtful.

Historically, 3.0% is not altogether high. I don’t have the S&P numbers to compare, but in 1980, before the last great bull market began and when Business Week was touting the “death of equities” on its cover, the Dow Jones was averaging about a 7% yield.

Defeat Fear

How strong is your stomach? This Bear will separate the men from the boys. Fortunes will be made. Will you be among those who make one?

Just ask Warren Buffett. During the Super Bear of 1972-1974 he stepped in with his waiting cash to buy a host of companies. Many companies traded at 2 or 3 times earnings. It was a no-brainer, yet very few people followed Buffett’s path to riches. They were too afraid.

He told Forbes Magazine at the end of 1974, “All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”

That time is coming soon. Not quite yet, but soon. Be ready.

Dollar Cost Averaging is Your Friend

You don’t have to “know” when the bottom is to take advantage. Hardly anyone ever times it right. That’s why dollar cost averaging is your friend. Continue to put money into your 401k and your favorite stocks.

If you like Potash (POT) at $220 a share, what’s there not to like at $85?

Buy companies with solid business models when they go on sale. Because businesses aren’t shut down, despite what you’re hearing. Many are thriving. They have customers and they’re making money. Buy them cheap now.

Yes, some stocks may fall some more. But you’ll buy more again next month and the month after that.

Don’t let fear paralyze you.

Bargains Already Abound

Some sectors are looking incredibly cheap.

The Shippers:

The shipping sector has been crushed by falling commodities prices and fear that suddenly no one will be shipping crude around the world and that countries don’t need grain. The Baltic Dry Index, which determines prices for shipping dry bulk goods, has fallen through the floor.

Overseas Shipholding Group (OSG): a Zacks #1 Rank stock has a forward P/E of 4.58 and a dividend of 3.90%.
Frontline (FRO): a Zacks #2 Rank (buy) stock has a forward P/E of 5.43 and a dividend of 33%.
TBSI International (TBSI): a Zacks #3 Rank stock has a forward P/E of 1.1.

Keep in mind the dividends may not hold on the shippers due to falling shipping rates. But even if the dividends get cut, these stocks are attractive.

Steel:

ArcelorMittal (MT): a Zacks #2 Rank (buy) stock has a forward P/E of 2.47 and a dividend of 3.90%.
AK Steel (AKS): a Zacks #3 Rank stock has a forward P/E of 2.12 and a dividend of 1.40%.

ArcelorMittal, the largest steel company in the world, reaffirmed third-quarter guidance yesterday and said that its profit for the second half of 2008 would exceed the record $13 billion profit in the first half of the year, though the company also said it would be cutting production in some markets. That’s welcome news in the steel sector, which has been badly battered in this market.

Fertilizers:

Bunge (BG): a Zacks #2 Rank (buy) stock has a forward P/E of 3.80 and a dividend of 1.80%.
CF Industries Holdings (CF): a Zacks #3 rank stock has a forward P/E of 2.71 and a dividend of 0.70%.

Energy:

ExxonMobil (XOM): a Zacks #3 Rank stock has a forward P/E of 7.04 and dividend of 2.20%.
Apache (APA): a Zacks #3 Rank stock has a forward P/E of 4.55 and a dividend of 0.70%.

The forward P/Es are based on future earnings. Many of these companies will see lower earnings going forward due to the commodities downturn. But that doesn’t mean these sectors aren’t still cheap. Exxon, remember, was making lots of cash with crude at $70 a barrel just last year.

Earnings Season Blues

This earnings season will reveal a lot about what has been going on inside companies during the crisis. This week, Illinois Tool Works (ITW) warned on third quarter and full year earnings. It lowered third quarter to the range of 82 to 86 cents from 93 to 99 cents due to a September slowdown in industrial production. The full year was lowered similarly.

ITW’s warning will be just the start. Alcoa (AA) led off earnings season this with horrible numbers. EPS wasn’t even close to analysts’ estimates, who had already been cutting estimates into the number due to the fall in aluminum prices.

Brace yourselves.

But, again, there will be opportunities created here. With the Dow now down 40% in the last year, the most since the 1930s, things are looking mighty attractive.

We may never see a sell-off like this again in our lifetimes.

Be ready to seize the day. Have a strong stomach.

And have patience.

Disclosure: The author of the article owns shares of GLD, POT, FRO, APA and XOM.

Posted in Categories: Contributor, External Research, Stocks, USA.

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