The Worst of Times to Buy Stocks?

By RANDALL W. FORSYTH | MORE ARTICLES BY AUTHOR

A leading fund manager sees conditions in today's market that presaged past plunges. A "perfect storm" lies ahead, adds a technical guru.

When practitioners who take distinctly different approaches to analyzing financial markets come to similar conclusions, it behooves investors to pay attention, even if those conclusions clash with yours.

John P. Hussman, who puts his Ph.D. in economics to work by heading the eponymously named Hussman Funds, thinks that the present ranks among what he calls "A Who's Who of Awful Times to Invest," along with such unpropitious periods as 1973-74, 1987, 2000-02 and 2007-09.

Walter J. Zimmermann Jr., who heads technical analysis for United-ICAP, a technical advisory firm, puts it more succinctly: "A perfect financial storm is looming."

Those dire forecasts contrast with the overwhelming bullish sentiment in the stock market. Indeed, that's part of the problem indicated by Hussman's criteria for a "Who's Who," which describes "the basic 'overvalued, overbought, overbullish, rising-yields' syndrome." The criteria are:

• the Standard & Poor's 500 trading at more than 8% above its 52-week exponential moving average

• the S&P 500 up more than 50% from its four-year low

• the "Shiller P/E," based on the cyclically adjusted trailing 10-year earnings, developed by Yale economist Robert Shiller, greater than 18; it's currently 22

• the 10-year Treasury yield higher than six months earlier

• the Investors Intelligence's bullish advisory sentiment over 47%, and bearishness under 25%; in the latest data, the numbers were 47.9% bulls and 26.6% bears

WHEN ALL THOSE CONDITIONS OBTAIN, as they very nearly do now, look out below. In 1973, a 48% collapse ensued over 21 months, and in August 1987, there was a 34% plunge over the following three months. Since that ancient history, losses of 10% to 18% ensued in the 1998-2000 period, followed ultimately by a plunge of more than 50% in the dot-com bust of 2000-02. And in 2007, a correction of 10% culminated in the 50%-plus plunge of 2007-09 (see chart).

Proceed With Caution

Fund manager John Hussman warns that his five indicators of an "overvalued, overbought and overbullish" market (shaded areas) are again in place.

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The Hussman Strategic Growth Fund (ticker: HSGFX), it's worth noting, sidestepped the bursting of the dot-com bubble by actively hedging the fund's equity positions. Its total return fell by just 21% from peak to trough in 2008, compared with a 35% decline for the S&P. However, it missed out on the subsequent rally, owing to a "defensive investment posture," Hussman wrote in the fund's annual report. Since the fund's inception in July 2000 through the end of February, it had returned 94%, five times better than the 19%, including reinvested dividends, for the Standard & Poor's 500 stock index over that doleful market span.

More recent selloffs also ensued in 2010 and 2011, although the latter decline was deferred by the Federal Reserve's QE2 [quantitative easing, part two] securities purchases, Hussman writes. "Aggressive monetary policy did not prevent the ultimate declines, though massive central-bank interventions have undoubtedly helped to short-circuit the more violent follow-through that occurred in 1973-74, 1987, 2000-02 and 2007-09, at least to date," he adds pointedly.

Hussman cautions that, while stocks sometimes immediately succumbed to the deadly combination of criteria, more often, they can hold up for weeks or even months, which frustrates those who stand aside or hedge while the averages make new highs.

"Even so, my greatest concern as an investment manager is the possibility that some number of our shareholders will grow so exasperated with remaining defensive during these periods that they capitulate and take a significant position in the market at the worst possible time," he wrote.

"The completion of the present bull-bear market cycle (and it will be completed) will undoubtedly present strong opportunities to play offense," Hussman concludes, "but today stands among a Who's Who of the worst historical times to do so. Particularly for investors who do not have a large number of future cycles between now and the point they will need to draw significantly on their assets, a defensive stance is crucial here."

That may not take much persuading if Zimmermann's "perfect storm" blows through the stock market, which could happen imminently, he reckons.

The New York Stock Exchange Composite Index "looks poised to peak and reverse lower this week," he warned in his weekly client letter on March 4. "All the essential ingredients for a major break lower are now in place."

On the technical side, Zimmermann also cites the high level of bullish sentiment, plus waning relative strength and a negative formation on the charts called a "rising wedge."

In an interview with Barron's, Zimmermann adds that he watches the NYSE Composite as a gauge of American business, rather than measures such as the Dow Jones Industrials or the S&P 500, which are dominated by multinational giants, which, he quips are "countries with their own armies―of lawyers."

THERE ARE AMPLE FUNDAMENTALS to knock the market down, including the well-advertised surge in gasoline prices, which Zimmermann calculates absorbed the discretionary spending power for half of America. And the escalating tensions over Iran's nuclear program "is the gift that keeps on giving…if you like fear-inflated energy prices," he wrote in the client letter.

At the same time, "the euro-zone response to their deflationary debt trap continues to be further loans to the hopelessly indebted, in return for crushing austerity programs.

So, evidently, not content with another mere recession, euro-zone leaders are inadvertently shooting for another depression. They may well succeed."

The euro zone is (or was, he stresses) the world's largest economy, and a buyer of 22% of U.S. exports, which puts the domestic economy at risk, he adds.

Of course, this time may be different.

The Bottom Line

While many market watchers, includingBarron's, think that the recent rally still has legs, a confluence of signals suggests that we could see a sharp pullback in the next few weeks or months.

Monetary policies from nearly every major central bank around the globe are either already aggressively easy, like the Fed, the European Central Bank, the Bank of England and the Bank of Japan, or are in the process of easing, as is the People's Bank of China.

So excess liquidity may continue to boost risk assets.

What's less often mentioned is the likely severe fiscal tightening at the beginning of 2013, unless there is legislation to stave off big tax increases that kick in before the end of this election year.

Dividends, which have come back into fashion, would get taxed at ordinary-income rates as high as 39.6% next year, up from 15% currently. Capital-gains rates also are due to go up, to 20%, from 15%.

What usually roils markets is uncertainty. Absent legislative action, it's certain that investors will be paying higher taxes. That would be enough to put the market at risk, even if it didn't meet Hussman's overbought, overvalued and overly bullish conditions, and even if the negatives cited by Zimmermann didn't exist.

With the Standard & Poor's 500 up 24% from the October lows, it may be a good time to take some chips off the table. 

A version of this story appeared on Barrons.com on March 6.

 

Finding Cheap Stocks Around the Globe

Finding Cheap Stocks Around the Globe

By NEIL A. MARTIN | MORE ARTICLES BY AUTHOR

Veteran stockpicker W. George Greig sees opportunities in Europe and Asia because the market isn't differentiating between average and superior companies.

 

When Barron's first interviewed portfolio manager W. George Greig in August 2000, he was running William Blair & Co.'s William Blair International Growth fund, a $350 million diversified global-equity product that invests in companies outside the U.S. That strategy clearly paid off: The fund's assets have mushroomed since then, to $3.6 billion.

Over the past three years to Jan 31, the fund (ticker: WBGIX) has generated a 19.13% annualized return, beating the 17.53% posted by its benchmark, the MSCI AC World ex-US Index. That performance put it in the 26th percentile in Morningstar's foreign large-growth fund ranking for that period.

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Bob Stefko for Barron's

"The market isn't paying much for either past success or future potential right now." -- W. George Greig

Greig, a 59-year-old MIT and Wharton School graduate, is now also Blair's global strategist. That makes him a key player in overseeing the roughly $48 billion in assets that the Chicago firm manages. "It's a team effort," he modestly says, referring to Blair's group of sector analysts.

We interviewed the 30-year industry veteran (who has spent half of those years with Blair) on his recent visit to New York. He gave us his views on global markets and why he thinks developed Europe is cheap and emerging markets are promising. For the details, keep reading.

Barron's: The year 2011 was a tough one for the global economy, given the multiple financial and economic crises around the world. What does 2012 look like?

Greig: We're basically optimistic. The damage done to developed and emerging economies and the global financial system by the 2008 financial crisis has receded and left comparatively little after-effects economically. But it did leave its mark, more psychological than real. Economists believe that the global economy will expand by 2% in 2012.

Most economists would characterize 2012 as a subpar year for growth. I wouldn't disagree, but even so, the world economy should show nominal growth of $2 trillion to $3 trillion this year, which is approximately the same as the size of the U.K . economy. That will generate a lot of dynamism, a lot of creative destruction, and a lot of value creation for companies that can take advantage of it. Corporate performance, measured by return on capital, has continued to be strong over the last couple of years, but the market isn't paying much for either past success or future potential right now.

Wall Street has rallied a lot since January. What's the implication for non-U.S. markets?

It is positive. During 2011, both developed and emerging economies experienced bear markets. The misery was spread around pretty evenly. But the rally in U.S. stocks has helped everyone. Foreign markets have responded very well and some have outperformed their U.S. counterparts. Investors can find something to like in many parts of the world, especially developed Europe, emerging Asia―most notably China―and changing Japan.

What's the biggest risk facing investors?

Probably this global experiment in monetary stimulus that G-4 central banks have embarked on. Nobody really knows whether it's inflationary, deflationary or anti-deflationary. The old rules about the relationships between monetary authorities, the financial sector and the real economy become invalid if interest rates are zero. It's a new ball game.

Asset prices are sending mixed messages about the inflation outlook. Commodities are voting for a little inflation, but the output gap [the difference between the actual and potential output of an economy] is still saying deflation.

What's the key to making money now?

It's finding companies that are producing strong corporate performance and strong returns like SAP [SAP], Diageo [DEO], Samsung Electronics [005930.Korea], andRolls-Royce Holdings [RR.U.K.]. Even when we were in a highly inflationary environment 30 years ago, that was the key to making money. It still is today.

Strategically, our approach is very consistent. It is a bottom-up-driven strategy. We look for value-creating companies that earn above-average returns, and we also focus on valuation.

A lot of our country positioning is really the aggregation of the companies we're interested in. For example, the U.K. is a market where we've tended to have a big commitment, but that's largely because of global leaders like Burberry Group[RBY.U.K.] and Rolls-Royce―the heritage is British, but the growth is global.

Are global valuations attractive now?

Yes, very attractive. Valuations have been so compressed that there's not a lot of difference between each sector's valuation and the market's. To me, that means that opportunities to get strong returns out of the best-performing companies are now better than they have been for a long time because the market isn't differentiating between the average company and the superior company.

Where are the better valuations?

In our view, Europe, including the U.K., stands out. Europe is trading at 9.7 times expected fiscal 2013 earnings, which are expected to be up 11%, on average.

This has made some pretty big, well-known names like Royal Dutch Shell[RDSB.U.K.], Sanofi [SNY], BNP Paribas [BNP.France], and BMW [BMW.Germany] very attractive. They trade on single-digit 2013 P/Es of 7.6, 9.4, 6.2 and 8.9, respectively.

What about emerging markets?

There are trade-offs between emerging and developed markets, in terms of growth and stability. Emerging economies obviously provide the growth impetus, but in many cases developed markets provide the products, technologies and brands that enable a lot of that growth. In terms of stock-market valuation, it's a close call―emerging markets are still significantly below their peak valuation levels after the 20% or so correction they had last year.One-and-a-half years ago we were talking about concerns about valuation in a rising-interest-rate environment in emerging markets. But now valuations are much more attractive, and rates are going down, not up.

But Europe is a cheaper and better bet?

We believe that European equities offer the greatest potential and stability. The prices of European equities declined sharply last year but are rebounding this year.

All right, let's talk specifics. What companies do you like in Britain?

Abcam, a British company [ABC.U.K.] is a leading provider of antibodies to research scientists. The firm has a market value of approximately $1 billion and annual sales of £83 million [$132 million]. Abcam has created a successful strategy of using third-party antibody suppliers and creating a massive, interactive catalog of over 50,000 products that incorporates customer feedback into its product descriptions, enhancing the value of each product. This, in turn has the potential to drive future sales growth. It is the second-largest global provider of antibodies, with an estimated 10% share of a fragmented market that is growing in the high single digits.

George Greig's Picks

		Recent
Company	Ticker	Price
Abcam	ABC.UK	341 pence
BMW	BMW.Germany	�9.20
Fast Retailing	9983.Japan	¥17,400
Getinge	GETIB.Sweden	190 kronor
Samsung Elec	005930.Korea	1,180,000 won
Source: Bloomberg

Abcam's stock has recently come under pressure on concerns of research funding cuts as a result of academic and governmental budget pressures. While Abcam has cautioned on these macro-oriented issues, its business―and stock―have been more resilient than [related firms'] because Abcam sells less-expensive consumable products that are used in everyday research, rather than more-expensive equipment that could easily be deferred. In addition, the company continues to increase its catalog product offering at an impressive clip and is expanding beyond its core research-antibody product offering.

Who else do you like in Europe?

We're big fans of luxury German auto maker BMW, which is growing at about double the pace of the auto industry. Its strong-selling products include the BMW 3, 5 and 7 series, as well as the X3 and X5 SUVs. BMW also manufactures the Mini and Rolls-Royce. With estimated global sales of �0 billion [$93.2 billion], this manufacturer has strong operating momentum, supported by a recovery in its traditional markets of Germany and the U.S., as well as continuing and highly profitable growth in China, which is the largest market in the world for the 7 series and X6 crossover vehicle, and the second-largest market for the X3 and X5 models.

BMW's most recent sales reports show robust sales across geography and models with a positive mix effect. Mini sales were at record levels in 2011, and Rolls-Royce sales were up 30%. The European launch of the new 3 series in March, along with continuing trends globally should underpin unit growth nearly twice that of the automobile market as a whole. At a recent price of �9.20 [$91.78], BMW's stock was trading below its July 2011 high. But earnings growth and demand remain strong. At 8.9 times 2013 earnings, the stock's valuation is attractive.

Anyone else in Europe you want to mention?

We hold a Swedish medical-equipment and device manufacturer and supplier by the name of Getinge [GETIB.Sweden], because we look for companies with leadership positions in their industry. Getinge is No. 1 or 2 in 17 of the 19 medical specialties in which it competes. It recently acquired Atrium Medical, a U.S.-based cardiovascular device maker that has grown at a 17% compound annual growth rate over the past eight years. This has helped Getinge improve its business mix by selling more surgical products backed by more intensive research and development. This should help insulate it from potential pricing pressures. The stock is trading near its 52-week high of 193 Swedish kronor [$28.80], but we think there is still room for more growth over the next 12 months.

Do you find China attractive on a valuation basis?

Yes, although historically single-digit P/Es tend to be rare and unusual in a market like China.

Still, you have some concerns, right?

The key concern for the global economy is China's growth prospects, because China has become the single largest source of global growth. If expectations for China are unsustainable, negative consequences for growth in the rest of the world are likely to be more severe and more enduring than those caused by, say, a recession in Europe or the U.S.

The anxiety over China relates to perceptions of overinvestment in general and in real estate in particular. Of further concern is that much of this excessive investment has been fueled by credit―corporate, household and government. On the other hand, we think that China's political leadership values economic stability and has enough means at hand to ensure such an outcome.

About 2.7% of our assets are in Chinese names, with our single largest holding there being the Industrial & Commercial Bank of China [1398.Hong Kong]. That's a small position, compared with our commitment to other areas of the world like the U.K., which accounts for about 23% of our total portfolio assets, or Germany, which represents 8%, or Switzerland, 5%, or France, 6%. But China has been a higher weighting in the past and will likely be a higher weighting again at some point.

Japan's market has been good this year.

Yes, it has. Cost management has gotten a lot better, but financial productivity is not very good at all. Companies are earning better margins than they used to, and more consistently, but the balance sheets of Corporate Japan have gone to being too weak to being too strong, and inefficient.

Who has attracted your attention there?

Fast Retailing [9983.Japan], which operates chain stores in Japan specializing in in-house-brands casual wear that are marketed under the brand name of Uniqlo. We purchased the stock, which has a market capitalization of $22.6 billion, on weakness following the March 2011 earthquake. Management has been successful in controlling costs and supporting the operating margin. Its share price benefited from a rally following the lows after the earthquake, on stronger-than-expected sales, higher 2012 guidance and increased new-store-opening targets in Asia ex-Japan. We believe that growth will continue to be supported by international expansion in the next 12 months. The stock trades at 21 times next year's earnings.

Samsung Electronics is one of your larger South Korean holdings. Why?

Samsung is one of the world's largest technology-hardware companies. More important, it continues to be one of the most impressive execution stories in the tech sector. It's benefiting from multiple trends that have created a tail wind for its telecom, semiconductor and memory businesses. While it is important to be mindful of the cyclical nature of the firm's largest earnings drivers, momentum is strongly in their corner.

Thanks, George

Speed Trap Ahead for U.S. Telcos

Speed Trap Ahead for U.S. Telcos

By TIERNAN RAY | MORE ARTICLES BY AUTHOR

LTE promises both payoff and peril for the wireless industry.

 

The New, New Thing for the wireless industry―much faster wireless connections called "long term evolution," or LTE―promises just as many headaches as breakthroughs.

Apple's (ticker: AAPL) unveiling last week of a new iPad with LTE cements its importance. LTE is branded as a kind of 4G service.

Verizon Communications' (VZ) wireless unit has been the leading proponent in the U.S., but one day it is expected to be deployed by just about every phone company around the globe.

For consumers, it's fast, really fast.

LTE's "theoretical maximum" speed, as nerds put it, is 300 million bits per second. That's as fast as the fastest WiFi networks in homes and offices.

The telephone companies are happy because LTE not only moves units of phones, but also lets carriers squeeze more bits out of each hertz, the fundamental unit of measurement of wireless spectrum.

"It's the closest thing we've seen to a win-win in telecom," says Craig Mathias, principal with wireless consultancy Farpoint Group; what benefits the phone company has sometimes come at the expense of what consumers want.

LTE already has deepened the disparity among U.S. carriers.

Verizon and AT&T (T) are far ahead of others. Verizon has the ability to serve 200 million U.S. citizens in various markets across the country with LTE, versus 75 million for AT&T. Sprint-Nextel (S) is just getting started.

"To the extent people realize LTE is a faster download, it will be a competitive advantage," says Piper Jaffray's Chris Larsen, as will the breadth of the LTE coverage.

LTE "should help Verizon continue to capture the lion's share of new smartphone subscribers, and potentially a much higher share of tablet subscribers," says Davenport & Co.'s Drake Johnstone.

For Verizon and AT&T, the benefits nevertheless are not clear cut.

For one thing, LTE is just at the beginning of the road.

"It's a big, shiny, empty network at this point," says Jennifer Fritzsche, who follows Verizon for Wells Fargo.

As that service fills up, it will require increasing capital investments.

A recent report by Cisco Systems (CSCO) said that while LTE and other 4G connections are only 0.2% of all mobile connections, they generate 6% of the traffic.

Moreover, the true payoff only comes if customers are satisfied, not disappointed. And that will depend on how expectations are managed.

Times have changed since the very first iPhone was introduced in 2007, when Apple reportedly demanded that any carrier selling the phone provide unlimited monthly data subscriptions. Both AT&T and Verizon now cap how much you can use.

The problem is that with fancy gadgets such as the new iPad and, presumably, the next iPhone, users will bump up against the reality that faster speeds just let them blow through their contracts quicker.

"Any customer who succumbs to the temptation to download a movie on their iPad via LTE will soon learn the error of their ways," with a fat phone bill, says Craig Moffett, who follows the phone companies for Bernstein Research.

As a result, Farpoint's Mathias expects more interest in what's called "WiFi offloading," where customers are bumped from LTE onto the nearest WiFi network.

That could mean opportunity for WiFi network operators such as Boingo Wireless (WIFI) and iPass (IPAS). Ditto for WiFi equipment vendors likeAruba Networks (ARUN) and Meru Networks (MERU). Chip vendorsBroadcom (BRCM) and Qualcomm (QCOM) are already touting their parts for higher-speed versions of WiFi, called 802.11ac. 

Rally On

The Nasdaq Composite rose 0.4% on the week, to 2988.34. It was the tech-heavy index's fourth consecutive weekly advance.

Tiernan Ray can be reached at tiernan.ray@barrons.com or atblogs.barrons.com/techtraderdaily orwww.twitter.com/barronstechblog