Fiscal Cliff Giddiness: Hang Onto Your Shorts (Literally)
An investor colleague of ours whose portfolio we assist in managing recently sent me an interesting email. Although the topic of conversation was primarily concerning Markel (MKL) and the merits of owning the stock, he provided some insight into the fiscal cliff fears and how he saw opportunity.
"As for Markel, it doesn’t make sense to jump in after a 300 point gain. The time to have bought was w/in the past few weeks when the market was declining on “cliff” fear. I would have thought that you might have suspected a last minute deal and the resulting jump in the markets. I did and did a little buying last week".
My response:
"The proposed merger of Alterra involves a cash and stock transaction, which presents merger arbitrage potential for some investors. I believe this is one of the reasons that MKL stock got so hammered when the deal was announced in December. Regarding your comment that it would not make sense to jump in after a 300 pt. gain, it is the unique arbitrage "angle" which suggests little or no correlation to the overall market advance. That said, the link below offers the best explanation of the merger/arb considerations".
However, it was the expectation that he thought I should have anticipated a "last minute deal" as the catalyst for a rally. And why the hell wasn't I jumping in? He was certainly correct in his assumption that a "Fiscal Cliff" faux-resolution would spell relief, but a 300+ point rally in a few days is over-the-top. On this issue I replied:
"As for me expecting some sort of last minute fiscal cliff deal, all I can tell you is that the only expectations I had of a deal were the possibility of an up-or-down vote which is what ultimately occurred. All this does is delay "sequestering" for two months and is on top of a brewing fight on the debt ceiling. Hardly a cause for celebration in my view as a flawed and fragile partisan "peace" is going to erupt into a three-stage budget fight in the coming months".
It took me a while to articulate this sentiment, but I'm sticking to the story! In retrospect, his logic was legitimate (in the context of being in front of the rally) but the outcome was for the wrong reasons in my view. Nobody ever went broke underestimating the dysfunction of Washington politicians, but apparently it does not take much to push a market up 300 points these days. Yet, we're not total pussies, and we did add to natural gas positions and generic drugs.
However, postponing, deferring or whatever the hell you want to call it (fiscal cliff, budget, debt ceiling) only means that the fireworks show has been delayed, not cancelled. The fiscal problems are still problems and the rancor in Washington is likely to be blared at higher decibels in the coming months.
The bigger issue (and concern) to me are when Q4 earnings reports start rolling out next week. I will bet a paddle or two that "macroeconomic" concerns are going to be cited as a reason for those companies who do warn on their earnings. It's not that I think the number of things that could go wrong is high, but the magnitude of how wrong they could go is what's worrisome.
The VIX traded near $14 last Friday (mid-day) posting one of its biggest weekly loss in more than 26 years. Option Monster's Pete Najarian who knows a thing or two about options put it this way on CNBC's Fast Money broadcast Friday:
"Because of what I think will be coming in March, I think it's time to buy – if you're in the market - buy protection now at these levels," he said.
Najarian was referring to downside protection, via puts or VIX contracts.
As for potential investment opportunities, there are several stocks we think would be attractive going into earnings season. Perhaps if the markets give back some of the 300 point yee-haw of last week, we might be able to buy these on the cheap:
Balchem Corp. (BCPC) is a small-cap diversified chemical / basic materials play which we find intriguing. Also, pseudo Berkshire Hathaway look-alike Markel (MKL) discussed earlier is interesting. Absent significant upside revenue surprises, quality-of-earnings and quality of cash-flows will be our focus. Declining profit margins are one thing but lousy liquidity and "managed" earnings are worse. Companies and industries with pricing power will likely post decent results, but we expect top-line growth to be a mixed bag overall.
For those of you who missed out on last week's equity party, don't wash your hands quite yet. Things are apt to get messy and soon. It is in uncertain times such as these where doing your homework will likely be beneficial to your pocketbook. Pay attention to the financial statements and be careful...it's a jungle out there.
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