Volatile enough for ya? What to buy and sell as the market vibrates between fear and hope

11/16/2012 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

So many moving parts for the end of 2012. China’s economic acceleration (maybe.) Europe’s economic deceleration and continued debt crisis (certainly.) The fiscal cliff in the United States, a stubbornly slow economic recovery, and the potential for recession.

Each by itself has the power to change the direction of the financial markets.

In combination they could cancel each other out or multiply their individual power.

I think we’re likely to see lots of volatility—much of it to the downside. Days that have the smell of investor panic—like Wednesday November 14 when nine stocks fell to everyone that rose on the New York Stock Exchange. Swings from endless worry (like now) to unjustified optimism (give it two weeks.)

Is there a strategy for navigating a way through this maelstrom?

The strategy (or maybe strategies) that I’m trying to follow in this period is one that I’ve advocated before as a way to deal with the extraordinary volatility that comes with the market these days. It builds on the idea of opportunity costs. It involves selling stocks that look like they’re going to need more than six months to see their upside. I may like these stocks for the long run but the opportunity cost of sitting in dead money is too high because…during this period, I’d like to have some cash so that if a great stock that I’ve had my eye on for months (or years) suddenly gets cheap, I’ll have the resources to buy it. During this period, I’d like to raise my cash for those opportunities not by selling my strongest stocks—that’s always a temptation during periods of volatility when the strongest stocks are the only ones you can sell without a big loss—but by selling those where the potential pay off is farthest away.

What stocks do I want to buy? Those few that seem never to go down except when the market is really, really in a downtrend. (Take a look at a chart of Middleby (MIDD) since August to see what I mean.) Stocks that have been knocked down so far in a selling swing that they’re now bargains on even near term prospects. Stocks that could break big to the upside in early 2013 if—as I think likely—growth in China and in the United States turns out to be not strong exactly, but at least stronger than expected.

Yes, those are ideas that I’ve recommended before. (Along with the idea of buying dividend stocks if volatility knocks down the price enough to produce a 5% yield.) But they’ve worked in other periods of volatility in 2012. Wash, rinse, spin, repeat.

In this post I’m going to lay out my best guess at timetables for the three big macro movers—and suggest how they might fit together. The goal is to give you a roadmap to the news that will drive market emotions. And then I’ll offer specific examples to give you an idea of what to pursue and what to shed during this end of the year mayhem.

Let’s begin with what I call my “Timeline to Disaster.”

 

You can really start with any event you chose. Me? I like to start with Europe and Greece

The European muddle

At the November 12 meeting of European finance ministers Greece didn’t get the 31.5 billion euros it needs to keep the lights on and the banks open after the first week in December. The finance ministers will meet to try again on November 20.

What’s likely? Greece will muddle through until the November 20 meeting. At that meeting Greece will get its funding but the International Monetary Fund on the one side and the European Central Bank and the European Commission on the other will not bridge their differences about extending the deadline for Greece to reduce its debt to GDP ratio to a sustainable level. That will get put off until the December meeting.

I don’t have much hope for a December agreement. There’s just too much baggage here—to get to a sustainable level of debt the European Central Bank would have to agree to write down the value of the Greek bonds it now holds. To put any formal extension into place—to agree on what happens after Greece gets its 31.5 billion euros—EuroZone governments would have to go back to their electorate and explain why they need another 30 billion euros to fund Greece with no prospect for this marking the end of the crisis.

I think what we’re looking at is the end game in the Greek crisis—but one that no one wants to admit that they’re playing. The result will be one more payment to Greece—another kick of the can down the road—in December and then sometime in 2013 the beginning of serious talks about letting Greece exit the euro while keeping it in the European economic community.

The euro-muddle timeline.

Here’s my call on a euro debt crisis timeline: Worries that Greece will have to shut its doors and that Europe won’t act will keep the market on edge through a deal (totally inadequate as it might be) at the end of November. Then elation at a deal (any deal) in December and then in the early part of 2013 fears return as the deal is seen as inadequate again.

Now let’s move to the United States and its fiscal cliff.

I can quickly recap the worry here. The expiration of the Bush administration tax cuts (and some stimulus package tax cuts) plus the automatic spending cuts set to go into effect in 2013 (as a result of the deal to lift the debt ceiling) would be enough, most economists fear, to send the country back into a recession. Some grand bargain involving tax increases, reforms to the tax code, and spending cuts is needed to head off this disaster scheduled for early 2013.

The fiscal cliff timeline.

First up, worry, worry, and more worry that the two parties will take us over the cliff. I think that’s what you’re seeing now. Second, a shift to a totally deceptive picture of the two parties acting like responsible adults and working on some kind of consensus solution. The President convenes meetings with business leaders and holds conferences that bring together the leaders of both parties. I think that even takes us as far as a draft proposal for avoiding the fiscal cliff sometime during the post-election, pre-inauguration lame duck session of Congress. I think this stage could well begin with the scheduled Friday, November 16, meeting of the President with Congressional leaders.

Third step, that optimism gets trashed when House Speaker John Boehner confronts his own Republican Party caucus and then announces that he doesn’t have the votes to pass anything like that consensus solution.

Step four, I think the market swings to an extreme of pessimism as investors listen to politicians in Washington talking about the impossibility of a solution or the need to take the country off a fiscal cliff in January in order to force a deal. The bottom in this swing comes as some politicians start to say they don’t think the crisis is nearly as bad as everyone says and that going off the fiscal cliff is no big deal.

The question in this time line is how long the first wave of optimism lasts. I think it’s got a good shot to run through most of second half of November as President Obama barnstorms around the country and Republican leaders in Washington try to sound like the reach-across-the-aisle compromisers that many people think the election demonstrated that voters want.

But as we approach December with no deal, I think journalists will start to remind us that Congress doesn’t work very far into December in most years. In 2011 the House recess was scheduled to begin on December 9. And the swing from optimism to pessimism will be heightened by any talk that going off a fiscal cliff would be a good thing or at least not so bad. The only thing the markets will have going for them during this period is that pretty much everyone who wanted to sell to avoid potentially higher tax rates in 2013 will have sold.

China, the joy of a successful transition.

It’s all over and there was never any shouting. On November 15 China announced the seven leaders that will make up the Standing Committee of the Politburo—the highest level of the collective leadership of China. All the suspense is gone—although overseas experts will spend months trying to figure out which leaders are pulling the strings from “retirement.”

But now China can go back to business as usual. The immediate tasks are implementing policies that will accelerate China’s economic growth from the 7.4% rate in the third quarter and finding a balance between policies that address real desires for a more balanced legal system and for access to clean air and water, to name just two demands that have fueled demonstrations recently, with the Communists Party’s insistence that it remain the sole source of all power in China.

China’s timeline.

It looks like the new leaders are inheriting an accelerating economy, just as the outgoing government hoped. Growth started to pick up in September and recent statistics are compatible with an increase in growth to 8% in the fourth quarter and to an even faster rate at the beginning of 2013.

The big question in constructing a timeline for China is figuring out when investors will believe that growth has reliably picked up. Right now investors outside China seem inclined at this point to ignore the signs. I think it will take the January release of actual fourth GDP growth numbers showing the acceleration to create a significant number of new believers.

Enough volatility in that for you? It’s going to be a bumpy ride, no doubt about it.

The only good news I can offer is that if the United States can avoid the fiscal cliff—and I think we will even if not until January—then we’re looking at a first quarter of 2013 that builds on accelerating growth in China and a huge sigh of relief (and some positive growth as well) in the United States. If that projection is reasonably accurate, I’d sure like to have picked up bargains on volatility in the fourth quarter.

What, looking backward from the first quarter of 2013, would I like to have purchased during the big volatility of the fourth quarter of 2012?

Stocks that almost never go down—if they crack under the pressure of end of the year volatility. I’ve already mentioned Middleby. Other stocks that fit this category include Precision Castparts (PCP), Nestle (NSRGY), and Yamana Gold (AUY), all three members of my Jubak’s Picks portfolio http://jubakpicks.com/ ); ASML Holding (ASML); Svenska Handelsbanken (SHBA.SS in Stockholm); Paddy Power (PAP.LN in London); and Kroton Educacional (KROT11.BZ in Sao Paulo.)

Stocks that crashed by 20% or more on the volatility—the crash has to be unjustified by individual company fundamentals, of course. Some candidates here (already down 20% or potentially headed in that direction) are Apple (AAPL), Latam Airlines Group—until recently Lan Airlines--(LFL), Yara International (YAR.NO in Oslo or YARIY in New York), Randgold (GOLD), Broadcom (BRCM), and Cheniere Energy (LNG).

Stocks that will outperform in 2013, even if they don’t drop 20% in the fourth quarter of 2012. My candidates here include stocks among U.S. homebuilders such as Lennar (LEN) and Pulte Group (PHM); Chinese consumer stocks such as Home Inns and Hotels Management (HMIN) or Café de Coral (341.HK in Hong Kong), energy infrastructure stocks such as Schlumberger (SLB), Jubak’s Picks member SeaDrill (SDRL), Keppel (KEP.SP in Singapore), and Ensco (ESV); and emerging market stocks such as CorpBanca (BCA), Industrias Bachoco (BACHOCOB.MM in Mexico City) and Arcos Dorados (ARCO.)

And, looking backwards, what would I have sold? Stocks in sectors where supply is just too great and demand is recovering just too slowly for gains in the first half of 2013. Examples would include Corning (GLW), EMC (EMC), Potash of Saskatchewan (POT) and current Jubak’s Picks member Polypore International (PPO.) Or stocks that had a good run in 2012 but now don’t have a catalyst for moving markedly higher in 2013. Examples would include Novozymes (NZYMB.DC in Copenhagen) and Baidu (BIDU.)

These lists will all change with the volatility I expect through the end of the year. They’re not meant as definitive but rather as examples of where to look for buys and sells. I’m not sure that the end of the year period is going to produce a big net move one way or the other. But I am convinced that volatility will make it very interesting.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund owned shares of Apple, Arcos Dorados, Broadcom, Corpbanca, Corning, EMC, Ensco, Home Inns and Hotels Management, Industrias Bachoco, Keppel, Kroton Educacional, Latam Airlines, Lennar, Paddy Power, Precision Castparts, PulteGroup,  Randgold, SeaDrill, Svenska Handelsbanken, and Yamana Gold at the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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