March 7, 2003
Waiting on Iraq -- Debating what may become valuable
Most of the economic news over the last month has been horrible, and there was no reason to believe that this morning’s jobs report was going to buck the trend. However, given that economists were calling for a slight increase in payrolls, the 308,000 decline is somewhat shocking. This ugly number, when combined with the hefty jump in weekly jobless claims over each of the last two weeks, tells us that not only is corporate America scared to hire workers but they are still scared that their current employment base will be constrictive to profits going forward. ‘Don’t worry: Things will get better in the second half of 2003’, or so we are told…
As for the 5.8% unemployment figure – a number an encouraged Kudlow said was still ‘historically low’ following its release – this number is pure myth. Not only does the ‘not in labor force’ numbers continue to rise (these are unemployed or ‘discouraged’ workers not included in the 5.8% number), but thanks to a myriad of recent methodology changes the data is suspect. Much like the 2001 recession, which we found out about in BLS revisions in June 2002, we will not know the extent of unemployment in the US until the longer term revisions arrive. In the meantime, and not unlike O’Neill arguing ‘there was no recession’, we have to put up with people like Kudlow; people that think bombing Iraq will cure all that ails the US economy, and that a terrible jobs report is really not that bad.
As expected, the markets slumped following the jobs report. However, thanks to the capture of two of Bin Laden’s sons stocks began to rebound before noon. I am not going to try to explain the rest of the day’s movements and/or the movements that happened as the UN meeting progressed. Quite frankly, if you try to comment on what this market is doing one minute the next minute you can look like a fool. Nevertheless, what we do know is that the US economy suffered through recessions before Bin Laden or Saddam arrived, and that the threat of recession is growing.
* How do the optimists keep their eyes shut to the growing possibility of recession? Well, they call on the Fed to cut interest rates. Fed futures are now pricing in a 1% Federal funds by May.
Fed May Cut, Blaming War
Another Fed cut may be able to improve things (stock market sentiment) on a psychological level. However, can anyone really ignore what has happened during the last three years? Can anyone flat out lie and say that another Fed cut will surely be the one that turns the economy around?
That the economy is showing no signs of a rebound and the Federal funds rate is headed to 1% (or lower) is proof positive that cutting rates is not working. Quite frankly, if anyone with an ounce of common sense (Kudlow included) was told that the Federal Funds rate was heading to 1% three years ago they would have predicted an awful recession (s). As it stands now, consumers cheered the mildest recession on record (2001) by accumulating more debt and leveraging their homes.
In short, it would be baffling if anyone still argues that Fed rate cuts -- geared towards stimulating near term demand -- can be used as a magic wand to solve the longer term nightmare of excessive debt. However, given that there is few things to cheer about and Wall Street has to remain bullish (to sell their financial products), prepare to be baffled in the coming days.
Iraq Buoying stocks?
It is possible that Iraq has become a stock market positive. After all, short sellers are on their hands for fear of being trounced once, and if, the US attacks.
Although this is not the type of warped speculation anyone makes, if the Iraq situation didn’t exist and the economic numbers were this awful the markets would already be testing their October lows. The question no one can answer is if the Iraq situation didn’t exist would the economic numbers be this bad? After all, while the logical answer is no (the numbers would be better without Iraq), the case can be made that stock prices have been ignoring the bad news in recent weeks because everyone is expecting a huge post-attack rally. To reiterate, Iraq could be one of the few stock market positives.
Gold Stocks Shaken
Following the Bin Laden news gold completely collapsed by more than $10 an ounce. By days end gold had rebounded, ending at roughly $350 spot.
For those of you wondering if this is a preview of things to come when, and if the Iraqi war progresses smoothly – yes it is. However, who knows if the next time gold is whacked if it will be falling from $355 an ounce or $455 an ounce? I sure don’t. Rather, Iraq could linger for weeks/month or the US could strike within a couple days. Minute by minute things seem to change.
Gold stocks were trounced as the POG gold collapsed and, for the first since last years retest, Meridian gold closed well below our Wish List selling price.
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The speculative orgy that was in many mining stocks is showing signs of abating, and this could open up buying opportunities in the days ahead. Although I could certainly be wrong, I do not believe hedging against Iraq uncertainties with gold stocks is a good idea. Rather, cash and hard gold are my preference.
Be Ready For Iraq
The markets are within striking distance of their October lows and the Iraq situation could bring about another wave of selling. What these two events mean, and if recent history is any guide, is that the markets could sell off sharply but rally sharply soon afterwards. Call it a bear bounce or dead cat bounce, but this could represent a good buying opportunity in specific companies.
To note: It is impossible to claim when a ‘bottom’ in the markets may hit and/or whether or not prices will for sure rebound when, and if, the U.S. attacks. However, what you do know is that when other investors are heading to the exits that this can be a good time to enter the room. More investors could head to the exits in the coming sessions.
-- These speculations do not necessarily pertain to the major ‘averages’, which all appear extremely overvalued.
Watch List Watch
After scouring the Watch List not many companies jump out as immediate buys. However, one group to consider is Tobacco (UST and MO). Regardless of what happens in Iraq the Tobacco group is likely to be volatile next week, or when many expect developments on Altria’s Miles case (Illinois). Uncertainty surrounding this case – which ‘alleges cigarette names (“Marlboro Lights") misled smokers into believing that they were less dangerous than full flavor cigarettes’ – helped send most Tobacco stocks lower today. Quite frankly, both MO and UST are one sell off away from reaching levels that may be considered undervalued to long term investors. This isn’t necessarily an investment opinion based on a market bounce, but on yield and corporate longevity. Both UST and MO’s yields are roughly 7%.
Beyond Tobacco companies, another stock worth considering is NorthWest Natural Gas. NWN’s yield is now hovering above 5% and its stock price ($24.60) is close to our target area. If Iraq developments prompt a widespread sell off companies like NWN may decline, but are unlikely to crash and burn. NWN is unlikely to cuts its payouts unless something terrific happens (severe economic contraction).
Lastly, one company not already on the Watch List that we took a look at this week was Innovative Solutions & Support Inc. While our research is far from over, ISSC is an intriguing story that could buck the near term trend of economy.
Innovative Solutions & Support Inc.
ISSC deals with cockpit information systems (Flat panel display, monitoring systems). The company’s near term focus is on the Reduced Vertical Separation Minimum (RVSM) retrofit market, but longer term the company is planning to market total cockpit solutions (Flatpanel display systems). The company’s revenues have been sliding due to the completion of its KC-135 retrofit (a government contract that accounted for more than 40% of revenues (average) over the last three years).
ISSC trades at $6.00 a share, has more than $4 a share in cash ($61 million), and less than $8 million in total debt. The company posts consistently attractive margins, generates free cash flow and is using cash to buy back shares (this could be good or bad). The reason why ISSC is attractive is because the RVSM retrofit market is expected to grow before the FAA imposed deadline (January 2005). Essentially RVSM
allows airplanes to fly at higher levels and closer together -- this helps retrofitted aircraft (older aircrafts) save on fuel, and helps more planes fly within busy areas at once. The company has a strong current backlog and a healthy unreleased backlog (primarily delayed government contacts).
The Bad News
ISSC’s growth potential has been impacted by government delays. Moreover, after the retro fit mania ends (the company is unusually bullish about how massive demand will be in the coming months) the company could enter a challenging period if newer products do not gain marketshare and/or if the economy/airline industry does not rebound strongly. Lastly, there remains the question of why insiders are not pouncing on the stock given the company’s enthusiasm. The stock is extremely illiquid.
Stock Pickers Grow Impatient
Warren Buffett does not believe that stocks are attractive at current levels. However, Warren Buffett is a billionaire that usually buys entire companies -- there are thousands of companies whose market caps are too small for him to even consider.
Point being, while there is few stellar value investments to be found, there is always the possibility that many solid smaller companies will reach attractive prices all at once (a huge sell off). As such -- given that stock prices in this environment can swing 5-10% in a matter of sessions -- the stock picker has to be prepared.
If Iraq uncertainties send stock prices lower companies like ISSC could reach extremely attractive levels. In fact, it is a good idea to find these types of companies – profitable, clean balance sheet, low stock premiums to equity – even if Iraq uncertainties didn’t exist.
While we are not selecting ISSC we are going to investigate it, and many other companies further. Undervaluation is out there! There are companies that will perform well even if, and when, the Dow succumbs to 5,000, 4,000, or worse.
These are not the ramblings of an equity optimist, but the confessions of an impatient stock picker. Such is why Buffett’s words are helpful: the greatest investor ever is also stumped by current valuation conditions.
No one at or associated with FallStreet.com has an investment position in any of the companies mentioned above.
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