enterprise

What Would You Do If You Weren’t Afraid? – Forbes


I’m afraid to leave my desk as I’d miss the next 5% blip up in the market. This makes sense only if you think energy futures won’t sink further and the peak in coronavirus numbers are near at hand.

Consider: Energy paper like Schlumberger
SLB
, Exxon Mobil
XOM
and Halliburton
HAL
do swing 10% or more intra-day. Same goes for banks like Citigroup
C
, even JPMorgan Chase
JPM
. For gaming casinos like Wynn Resorts
WYNN
it’s repeatedly a 10% variance along with aerospace names like Boeing and Spirit AeroSystems Holdings
SPR
.

By comparison, tech and e-trade paper like Amazon
AMZN
, Alibab
BABA
a, Microsof
MSFT
t, even Apple
AAPL
seem like polite paper, half as volatile as the market or less. There’s a rationale for such variance. Major tech houses carry ample balance-sheet strength, sizable free-cash flow and don’t pay dividends.

No other sector of the market sports unassailable balance-sheet strength. Pharmaceuticals come close, but dividends across the industrial sector are suspect. Same goes for energy. Autos and aerospace will need sizable infusions of federal capital while a default crisis in the bond sector already needs FRB attention.

In technology, I’m willing to look across the valley. My assumptions aren’t particularly rosy, expecting it takes all of 2020 for the country to stamp-out coronavirus cases. The fourth quarter could mark the nadir in earnings losses for large and small businesses. Consumer spending and single-family housing bottoms out, and auto sales recover at a moderate pace.

The country may not return to normal until yearend, but the discount function in the stock market sets in earlier, maybe, by mid-year. Before you discount recovery, an historical review of past decades’ bear markets is a sobering exercise for showing restraint.

Tackle first the valuation structure of the just ended bull run had us at 18 times optimistic earnings for 2020, approximately $170 on the S&P 500 Index. Historically speaking, markets rarely sell at 18 times earnings for very long. Wars, recessions, inflationary spirals and uncomfortably-high interest rates, say 7% to 8%, do intervene.

Previous bear markets ended after the market succumbed to 10 times earnings, yielding 5% and selling at book value. Our bull run at its peak at yearend sold at two times book value, yielded 2% and ticked at 18 times forward 12 months earnings projections.

None of the Street’s pundits called attention to such extremely dicey metrics. Analysts today still issue buy recommendations on their stocks even after 50% shrinkage and tentative earnings recovery still not in sight. Never forget, analysts are paid to be bullish, reluctant to make sobering earnings calls, lest managements complain to their bosses.

Reality today, even after all the market’s retracement, it sells at a huge premium over book value. Call it 1.5 times its net assets, while yielding 3%. You could say that if the coronavirus isn’t contained next couple of months, look out below, another leg down rests in the cards.

A market at book value, 10 times apparent earnings and yielding 5% would take us back to around 1,000 on the S&P 500. Before dismissing this scenario consider it took place in the financial meltdown of 2008–2009. Same goes for 1982 when Paul Volcker took Treasury rates up to 15% to rid the country of its inflationary expectations at 7% to 8% per annum.

Go back much further – to the Cuban missile crisis and President Kennedy’s face-off with Roger Blough, headman at U.S. Steel
X
, who raised steel quotes. Today, U.S. Steel is a near-basket case ticking at six bucks.

Present money managers, maybe those in their late forties, did experience the tech bubble of 2000-2001, but on Black Monday, October of 1987, they were just learning long-division in grade school. How many of us experienced the horrendous real-estate recession of 1973-1974? Prime co-ops went for under $100,000 and builders watched equity in Fifth Avenue office space dwindle to petty cash, billions below book value.

In 1974, I remember buying American Express
AXP
for a song. Held it a couple of years while Warren Buffett hangs onto his position, now a serious percentage of Berkshire Hathaway
BRK.B
’s asset value. My long-term chart on interest rates and price-earnings ratios reveals that valuation dwells in the high-teens when interest rates at 2% to 4% hold sway. Who dares build an earnings model today unless using normalized numbers? At least, current corporate liquid assets to short term liabilities range higher than 30 years ago. But recession sops up liquidity before you know it.

Look at price-earnings ratios of large-cap tech houses to the S&P 500. I’d draw a trendline through 1.5 times the market. Microsoft ticks close here with an impeccable-balance sheet and much free-cash flow. My biggest position, a look-over-the-valley kind of stock. Same goes for Alibaba, but I can’t justify owning Amazon based on a statistical exhibit. I’m entitled to one or two exceptions, no more.

My chart on long-term oil futures, a 2015 construct, put them at a $72 peak in 2020 from $52 in 2015. So much for long-term charting. Everyone missed how geopolitics leads economics. With play money, I just bought a couple of MLPs, Enterprise Products Partners and Williams Companies
WSM
. I have a small loss, day one.

The sole time oil futures traded under $20 a barrel was 2002. Two years later, futures ticked at $40, then peaked at over $140 in 2009. Don’t ask me why. Six years ago, Microsoft sold at a 10% discount to the S&P 500. God knows why! Yearend 1972 the market traded at 18 times earnings, where we were three months ago.

Even then, heady valuations failed to hold up. Decades later, Polaroid, Xerox
XRX
, Avon Product
AVP
s and Eastman Kodak
KODK
turned into goat meat. Schlumberger sold at 57 times earnings then and Sears, Roebuck at a 29 multiplier. These were once proud managements, now humbled, scrambling to endure vicious changes in their businesses from upstart competitors like Walmart
WMT
.

Net, net, I’m not ready to jump back in. The world harshly endured a flu pandemic in 1918. Who is to say the worst is over or even that we’ve got our hands around our problem?

Let’s hope I’m wrong on coronavirus longevity. Buying into a strong market is safer than being premature. First, let the sun come up like a red-rubber ball. My shopping list covers Walt Disney, Apple, Citigroup, Wynn Resorts, but no ragamuffins excepting Freeport-McMoRan
FCX
and Halliburton. Looking over the valley, all I can see is mist.

Sosnoff and / or his managed accounts own: Citigroup bonds, Spirit AeroSystems Holdings bonds, Alibaba, Microsoft, Enterprise Products Partners, Williams Companies and Freeport-McMoRan bonds.

msosnoff@gmail.com



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