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Long-term investing in a shortsighted market
If you know it often makes sense to buy stocks that are temporarily out of favor, there are some nice opportunities in today's market. Some savvy buyers are already proving this.
By Jim Jubak
Great news for long-term investors: Long-term investing is dead.
The style is out of favor, in the doghouse, snubbed and dissed. The current market is all about cutting and running at the first sign of trouble, riding momentum, switching sectors to follow the hot hand and speculating on the direction of the next inflation, GDP or oil number. And big-time volatility is just hanging around to slap any investor who even thinks about riding out a rough patch. Ready to ride out a 10% drop, are you? Well, how about 20%? In a week?
But as any good contrarian knows, the biggest profits come from buying stocks that are temporarily out of favor and holding them until the herd falls in love with them again. Just as 1999 and 2000 were the wrong time to blindly invest for the long term, now is the time to build portfolios for the long term. Sure, its lonely out there as a long-term investor. But if it sometimes seems that no one else is doing it, you might just be on to something good.
Ill start by looking at the evidence that long-term investing is dead (or, more exactly, that the ranks of long-term investors are seriously diminished) and some reasons why the strategy is so out of favor. In my Aug. 20 column, I gave you my picks for profiting from volatility in the next six months or so. Today, Ill follow up with some promising stocks for the long-term investor.
Not the usual summer slump
I know its August and long-term investors may just be on vacation and ready to come back in force in September, but I dont think so.
Of course, August is never an especially busy month in the markets and volume this month isn't outside recent norms. If anything, volume has been heavier than in some recent summers. On Aug. 18, for example, New York Stock Exchange volume hit 1.3 billion shares, which would've been a better-than-average day in August 2001, 2002 or 2003. Volume this year also has been a marked improvement from 2001 and 2002, when nobody wanted to trade equities.
But the nature of the volume has been unusual this summer.
Compared to historical norms, volume has been dominated by program trades, those computer-generated buys and sells of baskets of stocks. Institutions use them to try to make a profit on small discrepancies in price between indexes and individual stocks, or to make a bet for or against a market sector. (The NYSE defines a program trade as one that involves a basket of at least 15 stocks with a value of $1 million or more.)
In the June 21-25 week, program trading made up a record 71% of all NYSE trades. Granted, that figure was inflated by end-of-quarter trades as several indexes changed their components, but the percentage is still far ahead of the 52% peak for the same index-update period in 2003. And the average week this summer has been dominated by the big boys and their computers to an extraordinary degree, as well. For July 6-9, program trading made up 55% of volume, while the figure reached 49% July 12-16. Comparable figures for similar weeks in 2003 are around 40%.
A recipe for volatility
When individuals venture into the market these days, theyre more likely than usual to be selling short. (Short-sellers borrow stock and then sell it, hoping to replace the borrowed shares with stock purchased at a lower price.)
Technicians looking to find turning points in the market often look at the ratio of short sales by individual investors to those by specialists who make markets in individual stocks and have their fingers on the pulse of the daily ebb and flow of demand. Historically, rising short sales by individuals has been a good contrary indicator of market tops and bottoms. For example, when the number of short sales by individuals rises to overwhelm the number of short sales by specialists, meaning that individual investors are more bearish than the specialists, the market has often been close to a bottom. Recently, the individual/specialist short-sale ratio has climbed to near 2.5, the highest level of public shorting since the weeks following the Sept. 11, 2001, terrorist attacks.
I find that number intriguing for two reasons: 1) It might indeed be signaling a (likely temporary) bottom, and 2) individuals are engaging in a high number of short sales, which are in nature short-term trades, at a time when market volume and investor interest in equities is generally low.
Add low trading volume, high program-trade volume and individual short-selling together and you get a recipe for volatility. These days, volatility feeds on volatility because so many investors, especially at institutions and hedge funds, want to protect themselves against or profit from volatility. This results in huge moves in volatility like the recent 15% decline in the Chicago Board Options Exchange Volatility Index ($VIX.X), in just the four trading days ending with Aug. 18.
Oil and the markets
The huge increase in the price of oil adds one last element of volatility to the market. The oil markets have become the casinos of choice at the moment with traders and hedge-fund managers placing their long and short bets. Its hard to tell how much of the rise from $40 a barrel to the recent price of about $49 is a result of a huge short squeeze as traders who bet that oil would fall have had to buy to cover their losing bets before they lose even more. Id expect that another huge wave of short sales has been placed at current levels by traders who believe the price again is too high. And short-covering on these trades, if oil looks like it will move higher, could propel oil above $50.
All this adds to the volatility of the oil market, as well as putting in place a mechanism that almost guarantees that prices will top $50. Thats of critical interest to equity investors because now the stock markets moves are closely linked to the price of oil. If oil prices are volatile, then stock prices will be volatile.
Its no wonder that, in these conditions, there are so few long-term investors. The volatility makes it hard to hang on to long positions by increasing the speed of ups and downs and by increasing the dimension of up and down moves.
The volatility almost immediately revives memories of the 2000 crash in technology and some other growth sectors. Committed long-term investors who were burned in that market understandably have trouble dividing legitimate fears from knee-jerk panic in a market like the current one.
And it doesnt help the psychology of those still committed to investing for the long term that some of the most visible leaders of the long-term approach havent been particularly enthusiastic about the current market. Sort of makes you think twice about buying anything when Warren Buffett says he cant find any stocks to buy and is instead betting in the currency markets against the U.S. dollar.
But take heart. Some pretty smart investors havent given up on the strategy, and they're finding stuff to buy. Joseph Steinberg and Ian Cumming, who run Leucadia National (LUK, news, msgs), have been buying long-distance phone assets, first WilTel Communications, part of the wreckage from the crash in optical communications companies in 2000, and now 5% of MCI (MCIP, news, msgs) for $246 million. Their track record suggests Steinberg and Cumming might know what theyre doing: For the last five years, Leucadia National shares have returned an average of nearly 20% annually and the 10-year annual return is 13.5%.
4 long-term strategies
So lets say that you want to be a long-term contrarian in this market, what options do you have? I can think of four different long-term strategies that you can mix and match to fit your profile as an investor.- Buy deeply distressed stocks. This approach requires strong analytical skills that can separate stocks that will rise again from the depths and those that are never going to move off the bottom. Oh, and it doesnt hurt to have lots and lots of patience. (You cant simply piggyback on the choices of players like Leucadia National since they can wring value out of things like tax-loss carry-forwards that dont do much for the average individual investor.) Here are four names to check out: JDS Uniphase (JDSU, news, msgs), Nortel Networks (NT, news, msgs), Calpine (CPN, news, msgs) and Level 3 Communications (LVLT, news, msgs).
- Buy the buyers of distressed stocks. Why not put the folks at Leucadia National and other deep-value investors to work for you by buying their shares? There arent a lot of publicly traded companies that follow this strategy, but then again, how many do you need to own? Besides Leucadia National, check out Wesco Financial (WSC, news, msgs) and Cincinnati Financial (CINF, news, msgs). These companies all have different strategies and define value in different ways, but they're all definitely long-term investors.
- Buy temporarily cheap stocks. This is less risky and requires less original work to figure out the true value of assets than buying deeply distressed stocks. Stocks like these have simply been hit hard by the volatility of this short-term-oriented market. But traditional fundamental analysis will still work pretty well with stocks like these. I gave a list of 10 that fit this category in my last column. The examples in that article are well worth holding beyond the end of the year.
- Buy temporarily cheaper blue chips. Some great growth stocks never get cheap. But they do get cheaper, and long-term investors can do extremely well by adding to positions when that happens. (This is obviously the least risky of these four strategies.) Here are three stocks that belong to this group: Amgen (AMGN, news, msgs), PepsiCo (PEP, news, msgs) and Sysco (SYY, news, msgs).
Speaking of Amgen (nifty transition, no?), I havent written anything about the biotech sector in a while. But August and September are seasonally strong months for the sector, so Ill give it a whirl in my next column. That column will run on Aug. 31 because Jubaks Journal switches to once-a-week publishing while Im on vacation for the next two weeks.
New developments on past columns
10 best stocks for the rest of 2004
Certainly its too early to say that last weeks move up in stocks is anything more than a bounce, but some technical signs did turn positive. While trading volume remained light (not a good sign because strong rallies are built on strong volume), the pattern of changes in volume improved. Last week, volume increased on days when stocks moved higher. Thats a sign that rising prices made more people want to buy, which is exactly what you need to sustain a rally. Prior to last week, volume was higher on days when the market was falling, a sign of selling pressure.
Editor's Note: Jim will be on vacation for the next two weeks. While hes out, a new Jubaks Journal will be posted every Tuesday. Come September, Jubaks Journal will resume its regular Tuesday and Friday schedule.
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: JDS Uniphase, Leucadia National and PepsiCo. He does not own short positions in any stock mentioned in this column.
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