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Jubak's Journal
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| | Jubak's Journal
Revisiting my 10 picks for a dangerous year
It's just three months into the year, but already it's clear that the volatile market is creating new opportunities. Im adjusting my picks.
By Jim Jubak
Almost three months ago, which can be a lifetime in a volatile stock market, I wrote "10 ways to profit from a dangerous year." My thesis then was that 2004 would be an extraordinarily volatile year for the financial markets. As a result, investors needed to develop a strategy to profit from that volatility.
Im calling 2004 the Year of Investing Dangerously, I wrote. Investors who separate short-term mini-panics from the long-term trend should be able to beat the market indexes. For investors in the right place at the right time, uncertainty and volatility can spell opportunity rather than losses.
"The financial markets will climb the traditional wall of worry next year to produce a gain, when everything is netted out, of somewhere less than 10% for the major indexes. But that 10% net gain will come with more than the usual degree of volatility.
And with that theme, I offered five trends that could upset the markets and 10 stocks that I thought had the potential to turn turmoil into opportunity.
The markets have hit their first major volatile patch of the year, so its a good time to revisit those trends. In general, they stand up well but could use a bit of tweaking. At the end of this column, Ill also take a look at those 10 picks now that were a quarter into 2004.
Worry No. 1: Interest rates spike
What I wrote then: Why interest rates didnt move permanently and significantly higher last year is the great puzzle of 2003. Everything from a weaker dollar to rising deficits to a strong economy argues for higher rates. Even with the U.S. Federal Reserve holding the line on short-term rates to give the recovery time to build momentum, long-term rates should have moved higher.
But after a brief spike upward this summer, long rates have spent months going nowhere. In recent weeks, they have actually declined. At the end of October, the yield on the 10-year U.S. Treasury note was 4.3%. On Dec. 24, it stood at just 4.15%. Thats just about the same as the 4.14% yield the 10-year notes paid in October 2002, when we were all still asking when the recovery would arrive.
Whats the investment opportunity here? I think investors will spend the year anticipating a rate increase from the Fed. The anticipation, in turn, will keep a lid on gains in the rate-sensitive financial sectors. But I dont see the Fed moving on rates until late in the year. That delay should give the best financial stocks a couple of quarters to score huge earnings gains from the spread between 1% short-term rates and what these companies charge borrowers on their loans.
How Id change that now: Not much. The Federal Reserves interest-rate hikes still look inevitable, but they may have receded even further, maybe all the way into 2005. That means even bigger potential upside surprises from stocks and sectors that investors were writing off because rates were about to move against them. (I should note that the 10-year note was yielding 3.78% on Friday.)
Worry No. 2: The dollar's stumble turns into a tumble
What I wrote then: The U.S. dollar is down nearly 20% against the euro this year and more than 10% against the Japanese yen. The euro is the currency used by most members of the European Union. The dollar has been declining since July 2001. Then, you could have bought a euro for 84 cents. But, on Dec. 19, it took $1.23 in U.S. currency to buy that same euro.
Theres little reason to believe that this trend doesnt have further to run. Merrill Lynch projects that, on the fundamentals, the dollar will fall for the next 18 months, or well into 2005.
Adding to the apprehension is the knowledge that currency moves almost always overshoot both on the upside and the downside because, at some point in their development, they are influenced as much by emotions as fundamentals. Investors dont want to hold dollars simply because no one wants to hold dollars, and that fuels a drop below fundamental value. That last stage, when the dollar falls further than it should before reversing, can lead to a period of intense volatility in the financial markets.
So wheres the opportunity in this somewhat scary scenario? Two places:
- Gold and gold stocks, which have been the major beneficiaries of the dollars fall so far, have a lot further to run.
- Companies that will see revenue soar with a cheaper dollar. The falling dollar will further stoke the boom thats sweeping U.S. farming right now. Usually that leads to rising prices that put an end to the cycle, but, this time, the falling dollar should keep the boom rolling. Id look to the railroads that haul bulk products such as corn, wheat and soybeans as a way to take advantage of this trend.
How Id change that now: Not much, although I would emphasize that investors should expect rallies in the dollar and corrections to the price of gold and gold stocks as the longer-term trend unwinds. I think were in the middle of such a correction to the gold rally now, which marks a chance for late comers to get in. And I dont expect the strength that the dollar has intermittently shown against the euro in recent weeks to derail the long-term trend toward a weaker dollar.
Worry No. 3: Inflation will come roaring back
What I wrote then: I know the arguments for higher overall inflation, and I just dont buy them.
Is inflation likely to be higher in 2004 than in 2003? Yep.
But the world remains awash in excess capacity that this recovery looks unlikely to dent. Because capital is cheap, the world continues to add car and chip and consumer electronics factories even though theres a vast current oversupply of those kinds of plants. The globalization of labor, not just for low-wage jobs but for higher paying white collar knowledge work, guarantees that labor demands arent likely to push inflation strongly upward
But since the potential for inflation remains real, this worry will be with investors for 2004. When the very volatile short-term economic numbers suggest that inflation may be on the rise, the markets will hammer bonds and push up the price of gold.
How does an investor profit from this? By recognizing that while general inflation is likely to remain low, commodity inflation is real. Driven by the huge demand in China, India and other labor-rich but resource poor developing nations, the prices of everything from coal to nickel have been on the march.
How Id change that now: Again, I would have emphasized that no rally goes uphill without a correction. The correction, though, is close to running its course, and Im thinking about buying into stocks in the sector that Ive sold and adding new positions.
Worry No. 4: Energy prices cant stay inexplicably high, can they?
What I wrote then: Youll understand this worry better if you remember that Wall Street has spent all of 2003 projecting that oil prices would fall to $25 per 42-gallon barrel or even as low as $18. And it hasnt happened. On Dec. 22, benchmark West Texas crude was selling for $31.98 a barrel on the spot market. Thats exactly the same price that West Texas crude sold for on Dec. 22, 2002.
Since no one on Wall Street has a convincing explanation for why oil prices remained so high in 2003, theres very little conviction behind projections that call for lower oil prices in 2004. The consensus on Wall Street is that oil prices will come down in 2004 and the shares of oil stocks are priced for that inevitable fall in the price of a barrel of oil. Still, no one will be very surprised if oil prices behave irrationally for another year.
I think thats indeed extremely likely. The stubbornly high level of oil -- and natural gas -- prices is a result not of the global supply and demand picture that shows an excess supply of oil. Instead, they result from localized supply and demand imbalances -- labor strife in Venezuela and Nigeria, for example.
Here, I recommend going with the cash flow and buying shares of companies that sell products and services to oil producers. Oil producers are currently awash in cash, so theyve got plenty of money for drilling and exploration. Expanding drilling makes sense even if prices fall from current levels to as low as $22 a barrel -- quite a cushion. And oil producers know that theyve got to increase proven reserves and supply after years when low prices led to underinvestment in exploration and production.
How Id change that now: Even Im surprised that oil prices have not only remained high but have actually moved well above the $32 level of the end of 2003. (Crude in New York topped $38 a barrel last week.) In retrospect, I misjudged the effect of the weak dollar on OPEC discipline. The members of the Organization of Petroleum Exporting Countries are showing unprecedented backbone because they know only climbing oil prices can make up for the effects of the tumbling dollar on their countries real purchasing power.
Worry No. 5: This overvalued market is headed for a big fall
What I wrote then: I dont disagree that the some sectors of the stock market, especially technology stocks, are overvalued right now. And Id certainly agree that its normal for a correction to follow a rally of the dimensions that started last March.
But a big drop that leads to a resumption of the full horrors of the bear market? I dont see it. Certainly not in the first three quarters of 2004 while the economy is growing and interest rates remain low.
What is likely is an absolutely normal correction that feels like the beginnings of a big drop to some investors. If enough of the folks who have been calling for a market collapse convince themselves that this is the beginning of exactly what theyve been looking for, then the correction could be sharp and vicious.
But short. Theres a tremendous amount of money on the sidelines still hoping to get in. Even many bullish investment advisors and portfolio managers arent fully invested. And its clear that some investors have been taking profits in technology stocks as the year comes to an end.
The odds for a correction go up in January as we come off the traditional Santa Claus rally and enter a period of seasonal weakness. January could be even weaker than usual this year if investors who wanted to take profits in 2003 but who didnt want to pay taxes put off some of their selling into the new year.
How do you play this worry? By keeping some cash handy and a buy list of stocks that you were itching to own but were too expensive to buy in 2003.
How I would change that now: Were in the midst of just such a normal correction, so the basic thrust of my argument holds. But the economy is even harder to read than I thought it would be when I wrote this column in late December. Volatility this year is likely to be even greater than I expected then. The basic underpinning of the stock market remains low interest rates, and stocks arent likely to get into real trouble until rates clearly head back up.
The revised list
How do these tweaks, additions and caveats change the stocks I mentioned in that column as the best way to play these worries? I think the thrust of those choices was about right. With three months more under my belt, however, Id now give the edge to different stocks in the sectors I highlighted in a few cases.
My list then:
| Jubaks 10 stocks for a year of investing dangerously | | Company | Chng. since Jan. 2 | Industry | Company | Chng. since Jan. 2 | Industry | | Canadian National Railways (CNI, news, msgs) | 8.40% | Railroads | Freeport-McMoRan Copper & Gold (FCX, news, msgs) | -0.40% | Copper and gold mining | | Capital One (COF, news, msgs) | 18.10% | Consumer lending | MBNA (KRB, news, msgs) | 9.05% | Commercial banking | | Carbo Ceramics (CRR, news, msgs) | 19.10% | Ceramic materials for oil and gas drilling | Noranda (NRD, news, msgs) | 8.70% | Mining and metals | | Cognizant Technology Solutions (CTSH, news, msgs) | -5.90% | Business software | Patterson-UTI Energy (PTEN, news, msgs) | 8.60% | Oil & gas drilling and exploration | | Expeditors International (EXPD, news, msgs) | -3.72% | Air delivery and freight services | Southern Peru Copper (PCU, news, msgs) | -18.70% | Copper |
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My list now:
| Jubaks revised 10 stocks for a year of living dangerously | | Company | March 19 close | Industry | Company | March 19 close | Industry | | Canadian National Railways (CNI, news, msgs) | $23.65 | Railroads | Companhia Vale do Rio Doce (RIO, news, msgs) | $53.72 | Iron and copper mining | | Capital One (COF, news, msgs) | $72.40 | Consumer lending | Mohawk Industries (MHK, news, msgs) | $82.34 | Carpeting and floor covering | | Carbo Ceramics (CRR, news, msgs) | $61.46 | Ceramic materials for oil and gas drilling | Noranda (NRD, news, msgs) | $17.24 | Mining and metals | | Bunge (BG, news, msgs) | $39.45 | Agricultural chemicals | BP (BP, news, msgs) | $50.08 | Oil & gas production | | Analog Devices (ADI, news, msgs) | $45.11 | Analog and DSP chips | GrafTech International (GTI, news, msgs) | $14.22 | Graphite for the steel industry |
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Despite the substitution of specific names in individual sectors, I think the second list represents the same themes. I urge readers, as usual, to follow their own due diligence in turning my themes for 2004 into individual stock picks.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: BP, Bunge, Freeport-McMoran Copper and Gold and Noranda. He does not own short positions in any stock mentioned in this column.
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