Economic Recovery? Yes!
Off-the-Bottom is a Tricky Game
Still the Biggest Growth Story out There
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I am far from an economist, thank goodness, but with all the worry during the past week about the economic recovery coming unglued, I wanted to inject some facts (gasp!) into the conversation. Twice before in Cabot Wealth Advisory I’ve touched on the lone economic indicator I follow regularly--the Economic Cycle Research Institute’s (ECRI) Weekly Leading Index.
In brief, ECRI has a good track record of economic forecasting, and I like the group because they approach their task much as I approach mine--by using tools that have actually worked in the past. In ECRI’s case, they looked at decades of past recessions and recoveries, found the handful of economic data points that lead the cycle (i.e., they turn up or turn down months before the economy does, with few false signals), and combined them into one index ... the Weekly Leading Index.
Anyhow, they offer a press release every Friday that states the Index’s movement and, more important, its growth rate. When the growth rate runs above zero, it’s a sign of expansion; below zero, contraction. And anything over, say, +10% signifies a very strong economic advance upcoming.
When I first wrote about the Index near the end of last year, it was forecasting the worst recession since the 1930s ... pretty good call. And even as late as this March, it really hadn’t turned up in any major way. During the worst of the recession, the Index’s growth rate nearly fell to a stunning minus 30%; compare that to a worst-case minus 20% during the awful 1974 recession! And you know the result--600,000 job losses a month and two quarters in a row of GDP shrinkage of more than 6%. Yuck.
But all that is in the past. As of last Friday, the Weekly Leading Index itself had risen sharply in recent months (including a streak of nine up weeks in a row, the first time that’s happened in 20 years!) and its growth rate now stands at plus 4%, the first positive reading in two years.
To quote Lakshman Achuthan, ECRI’s managing director, “We’ll definitely see the end of this recession this summer. As unique and unprecedented as this recession has been, the transition to recovery is showing up in a textbook way in the leading indicator charts.” My interpretation: The odds are very much in favor of a recovery--possibly a powerful one--starting in the weeks ahead.
In the real world, then, you should keep your head up. I’ve talked to many of my friends who are understandably worried about their jobs and their companies; many have recently gone through another round of layoffs. But it’s very likely that worry is unfounded, and that the next big move by most employers will be to hire (even if that takes a few months, which is possible).
Now, don’t misunderstand me--I’m not saying you should use the Weekly Leading Index to make judgments about the stock market; the stock market and the economy are two separate animals. I just wanted to pull out the factuallybased ECRI Index to debunk all the talk that’s popped up in recent days that our economic recovery is toast. It’s not! No one’s saying it’s going to be 1999 all over again, but better times are almost certainly on the way.
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Now, with all that said, the recent worries about the economy have led to some weakness in the overall market, especially the commodity stocks. As of mid-day today, the Oil Services Holders (symbol: OIH) is down 21% from its June peak, the Energy Select SPDR (symbol: XLE) is off 22%, and the Market Vectors Agribusiness (MOO) is off 15%. And many individual coal and shipping stocks have been pummeled.
To me, though, these stocks aren’t down because of economic fears. Instead, I believe it’s just the “off-the-bottom” phenomenon--that is, when stocks that have fallen 80% or 90% during the past year begin to rally, it can be exciting and fun for a while ... but it rarely persists for longer than a couple of months before things peter out.
Why? Overhead! In plain English, overhead is potential selling pressure from investors who own the shares at higher prices. You see, if a stock is at multi-year price highs, everybody has a profit, so every investor is happy. But when a ton of investors (and I’m talking about institutions here, not your average Joe or Sally with 100 shares) own shares at higher prices, they tend to sell during rallies, hoping to get out even, or at least, recouping much of their loss.
Thus, while it’s always tempting (and occasionally profitable) to jump on the off-the-bottom bandwagon, it’s a tough game to play. I received plenty of calls and emails asking about this, that and the other off-the-bottom stocks during April and May, but most of those are currently sitting at two- or three-month lows.
But what about ever-declining oil production and China’s endless building efforts that are sucking up the supply of copper, steel, coal and the like? Well, all that might be true, and who knows, maybe in the long-term these commodity stocks and sectors will build solid launching pads and make another sustainable advance, a la 2006 or 2008. But, really, all those facts I just listed are already known by everybody--and in the stock market, the obvious and well known rarely works.
So let this be a lesson to you: Off-the-bottom situations, no matter how good the story, will always have to battle with overhead resistance, making any advance choppier and unlikely to last. That doesn’t mean it’s impossible to make money off these stocks, but your margin for error will be small, and you have to be quick on your feet. Over the longer run, you’re better off focusing your attention on the leaders--those near their 52-week price highs, not near their 52-week lows.
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Now to the question that’s surely on everyone’s mind: What do I think of the market here? My answer: Shorter-term, I’m cautious. Longer-term, I’m optimistic.
While I’m certainly not buying with both hands right now, I am viewing this period of time as the market’s first consolidation/pullback/whatever-you-want-to-call-it since the bottom was put in back in March. It’s been going on for about one month now, allowing many stocks to build fresh launching pads. So in that sense, it’s relatively normal.
Is there a chance this could turn into another market rout? Anything is possible in the stock market--you’re not going to hear me say that the market will “never” do something. But right here, I am very much leaning toward the view that this sloppy action in the market is going to lead to further upside ... eventually.
I could offer all sorts of predictions, but what’s the point? The market is going to do what it’s going to do, so your best moves are two-fold. First, trimming your sails a bit right here; selling your worst performers and your losers, and holding some cash, is prudent.
Second, however, is to NOT stick your head in the sand. Right now is when you should redouble your research efforts, building your Watch List with stocks that are resisting the market’s downward pull. When the market gets going again, these will likely be the stocks that bring the best profits, especially if they react well to their upcoming earnings releases.
One such stock I’m following closely is the #1 glamour stock in the entire market--Green Mountain Coffee Roasters (GMCR), which we’ve written about a few times in recent months. For most investors, GMCR only came on their radar in late April, when the stock gapped up 37% on its first quarter earnings report. Yet the stock is actually up since that huge move, and it’s still holding up well despite the market’s weakness, consolidating the past five weeks.
And why not? The company has one of the most attractive razor/razor-blade business models we’ve ever seen, addressing a mass market as big as there is. (Coffee, tea and cocoa drinkers.) The company already owns about 6% or more of the total coffee brewer market thanks to its Keurig single-cup brewers (it varies a bit by the quarter), and I see no reason it can’t get to 10%, 15%, 20% or more in the years ahead. And each brewer sold leads to an immense amount of recurring income from the K-Cups used.
One of the biggest positives in my mind is that the top two brands of at-home coffee makers (Mr. Coffee and Cuisinart) have thrown in the towel and decided to team up with Keurig to launch co-branded, K-Cup based single-cup brewers in the months. That tells me that Green Mountain’s 80% share of the single-cup market is likely to last for years.
Of course, earnings are coming up around the end of the month, and if for some reason they disappoint the lofty expectations, I know GMCR can get hit. But I think, if you didn’t buy any after the earnings gap because you thought it was overheated, that you can buy a little (i.e., maybe one-third or one-half of what you’d normally buy, dollar-wise) around here and see how the stock does in the weeks to come. It’s still as big a story as there is.
All the best,
Mike Cintolo
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