Cyclical Stocks Appear to be Cheap

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Cyclical Stocks Appear to be Cheap

Cyclical Stocks Appear to be Cheap

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My main industry model is illustrated in the graphic.  Green industries are cold.  Red industries are hot.  If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?”  Price momentum tends to persist, but look for areas where it might be even better in the near term.

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If you are a value player, look at the green zone, and ask where trends are over-discounted.  Yes, things are bad, but are they all that bad?  Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled “Dig through.”

If you use any of this, choose what you use off of your own trading style.  If you trade frequently, stay in the red zone.  Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?  Why change if things are working well?  I’m not saying to change if things are working well.  I’m saying don’t change if things are working badly.  Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.  Maximum pain drives changes for most people, which is why average investors don’t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then.  This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.  It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and Reinsurance, particularly those that are strongly capitalized.  I’m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle — I am not interested there even at present levels.  The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their “regulators.”

I’m looking for undervalued and stable industries.  I’m not saying that there is always a bull market out there, and I will find it for you.  But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.  I don’t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.  The red zone is pretty cyclical at present.  I will be very happy hanging out in dull stocks for a while.

That said, dull is hard to find these days.  Where will demand remain strong, or where will demand rebound are tough questions.

The Red Zone has a Lot of Cyclicals

What I find fascinating about the red momentum zone now, is that it is laden with cyclical companies.  That does not make sense in a confused market environment where the market has no been making any progress.

So, as I considered the green and red zones, I chose areas that I thought would be interesting.  In the red zone, I picked transportation names, and reinsurers, which have run, but could run a lot more.

I have move than enough energy producers, so I am not fishing for those industries here.

Much as cyclicals are displayed in the red zone, it does not mean the red zone or cyclicals are a good place to be.  The is a lot of weakness not just in the US, but globally.  I am left hard: where is the economy growing where the culture is honest enough that I trust the statistics?

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you.  I looked for companies in the  industries listed, but in the top 4 of 9 financial strength categories, an with returns estimated over 15%/year over the next 3-5 years.  The latter category does the value/growth tradeoff automatically.  I don’t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen.  Remember, this is a launching pad for due diligence.

Company Ticker Industry Name Financial Strength Proj 3-5 Yr % Annual Total Return
FedEx Corp. FDX Air Transport A

21

United Parcel Serv. UPS Air Transport A

18

Autoliv, Inc. ALV Auto Parts B++

26

BorgWarner BWA Auto Parts A

20

Eaton Corp. ETN Auto Parts A+

29

Gentex Corp. GNTX Auto Parts B++

21

Genuine Parts GPC Auto Parts A+

15

Johnson Controls JCI Auto Parts A

25

Magna Int’l ‘A’ MGA Auto Parts A

29

Honda Motor ADR HMC Automotive B++

19

Coca-Cola KO Beverage A++

15

Molson Coors Brewing TAP Beverage B++

21

PepsiCo, Inc. PEP Beverage A++

15

Amgen AMGN Biotechnology A++

17

Questcor Pharmac. QCOR Biotechnology B++

22

United Therapeutics UTHR Biotechnology A

35

Adobe Systems ADBE Computer Software A

24

Autodesk, Inc. ADSK Computer Software A

22

CA, Inc. CA Computer Software B++

23

Intuit Inc. INTU Computer Software A

15

Microsoft Corp. MSFT Computer Software A++

20

Oracle Corp. ORCL Computer Software A++

18

SAP AG SAP Computer Software A

21

Symantec Corp. SYMC Computer Software B++

22

Apple Inc. AAPL Computers/Peripherals A++

24

Dell Inc. DELL Computers/Peripherals A

28

Hewlett-Packard HPQ Computers/Peripherals A+

33

Ingram Micro ‘A’ IM Computers/Peripherals B++

21

NetApp, Inc. NTAP Computers/Peripherals A

22

Synaptics SYNA Computers/Peripherals B++

22

Tech Data TECD Computers/Peripherals B++

20

Akamai Technologies AKAM E-Commerce A

29

Digital River DRIV E-Commerce B++

21

Archer Daniels Midl’d ADM Food Processing A+

17

Fresh Del Monte Prod. FDP Food Processing B++

15

Heinz (H.J.) HNZ Food Processing A+

15

Herbalife, Ltd. HLF Food Processing B++

15

Kellogg K Food Processing A

17

Kraft Foods KFT Food Processing A+

15

Peet’s Coffee & Tea PEET Food Processing B++

19

Tootsie Roll Ind. TR Food Processing A+

15

Canon Inc. ADR CAJ Foreign Electronics A

22

FUJIFILM Hldgs. ADR FUJIY Foreign Electronics A+

37

Kyocera Corp. ADR KYO Foreign Electronics A+

16

Sony Corp. ADR SNE Foreign Electronics A

42

Quality Systems QSII Healthcare Information A

32

AGCO Corp. AGCO Heavy Truck & Equip A

22

Caterpillar Inc. CAT Heavy Truck & Equip A+

22

Cummins Inc. CMI Heavy Truck & Equip A

25

Deere & Co. DE Heavy Truck & Equip A++

20

Gardner Denver GDI Heavy Truck & Equip A

18

PACCAR Inc. PCAR Heavy Truck & Equip A

25

Equifax, Inc. EFX Information Services B++

18

Thomson Reuters TRI.TO Information Services B++

24

Hanover Insurance THG Insurance (Prop/Cas.) B++

23

Baidu, Inc. BIDU Internet A

33

Ctrip.com Int’l ADR CTRP Internet A

36

eBay Inc. EBAY Internet A+

20

Google, Inc. GOOG Internet A++

23

IAC/InterActiveCorp IACI Internet B++

19

Netflix, Inc. NFLX Internet A

32

priceline.com PCLN Internet A

21

Sohu.com Inc. SOHU Internet B++

28

First Solar, Inc. FSLR Power A

37

Badger Meter BMI Precision Instrument B++

17

KLA-Tencor KLAC Precision Instrument B++

21

Landauer, Inc. LDR Precision Instrument B++

15

National Instruments NATI Precision Instrument B++

17

Rofin-Sinar Techn. RSTI Precision Instrument B++

22

Thermo Fisher Sci. TMO Precision Instrument A

17

Waters Corp. WAT Precision Instrument A

16

CSX Corp. CSX Railroad B++

22

Norfolk Southern NSC Railroad A

22

CME Group CME Securities Brokerage A

18

Goldman Sachs GS Securities Brokerage A

24

IntercontinentalExch. ICE Securities Brokerage A

20

Investment Techn. ITG Securities Brokerage B++

31

NYSE Euronext NYX Securities Brokerage A

26

Schwab (Charles) SCHW Securities Brokerage A

21

Altera Corp. ALTR Semiconductor A

19

Analog Devices ADI Semiconductor A+

15

Intel Corp. INTC Semiconductor A++

21

Linear Technology LLTC Semiconductor B++

20

Microchip Technology MCHP Semiconductor B++

25

NVIDIA Corp. NVDA Semiconductor A

26

QLogic Corp. QLGC Semiconductor B++

35

Semtech Corp. SMTC Semiconductor B++

17

Silicon Labs. SLAB Semiconductor B++

16

Skyworks Solutions SWKS Semiconductor B++

15

Taiwan Semic. ADR TSM Semiconductor B++

26

Tessera Technologies TSRA Semiconductor B++

37

Texas Instruments TXN Semiconductor A++

21

Xilinx Inc. XLNX Semiconductor A

18

ADTRAN, Inc. ADTN Telecom. Equipment B++

25

Broadcom Corp. ‘A’ BRCM Telecom. Equipment B++

19

Cisco Systems CSCO Telecom. Equipment A++

21

F5 Networks FFIV Telecom. Equipment B++

20

Juniper Networks JNPR Telecom. Equipment B++

31

NETGEAR NTGR Telecom. Equipment B++

22

NeuStar Inc. NSR Telecom. Equipment B++

16

Polycom, Inc. PLCM Telecom. Equipment B++

33

Qualcomm Inc. QCOM Telecom. Equipment A+

16

Forward Air FWRD Trucking B++

20

Knight Transportation KNX Trucking B++

23

Werner Enterprises WERN Trucking B++

15

Research in Motion RIMM Wireless Networking B++

21

Zebra Techn. ‘A’ ZBRA Wireless Networking B++

20

Use these ideas as you see best.  I am not reinvesting at present, and so I am not actively looking at these names. That said, a number of them are in my portfolio, namely: INTC. THG, HPQ, ORCL, AMGN, HMC

Full disclosure: long INTC. THG, HPQ, ORCL, AMGN, HMC

By: alephblog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.
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