The Day Ahead: The Hunger for Risk Remains

 | Feb 14, 2013 | 8:15 AM EST  | Comments
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Let's say, at the start of the year, I had abducted an investor with so-so knowledge on the markets; say I was really mean to this person, depriving them of all access to things business and finance. If I had just released this person back into the iPad-toting world, here is what they would see:

● The fourth-quarter earnings season trounced bottom-line analyst forecasts. (Yes, estimates were slashed going in -- but who cares gives a darn about earnings quality, right?)

● Investors haven't a care in the world, as reflected by the CBOE Volatility Index (VIX). Guess there is something valid to the flow of money into riskier assets -- that is, stocks.

● There's tepid concern on bond-yield creep from both Spain and Italy, as opposed to the rampant fear of an entire financial system implosion that we saw circa 2011 to 2012.

● Most key leading indices -- for example, the S&P Railroad Index -- continue to perform quite convincingly relative to the S&P 500. The advance in the Utilities Sector SPDR (XLU) and degradation in the iShares Emerging Market Index (EEM) could therefore be shoved to the back burner for a later debate -- when stocks are heading down the drain.

● The relative strength reading on the S&P 500 seems to be comfy chilling above 60, and there is no outward indication that this number -- as it has in past periods -- is making folks hesitant to push the market higher. Investors are holding on to stock gains, scouring mutual fund holdings for new grand-slam ideas and looking to move money from lower-yielding assets into the seemingly fertile land of equities. I love that tame risk-free-rate assumption! (You would be surprised by the change in output for free cash flow and fair value with the even the tiniest of a riskier outlook.)

The lesson here is that there is nothing glaringly wrong with the market on this Valentine's Day. It's operating under the assumption that the ultimate future will be brighter than the first half, which promises to be dominated by fiscal drag. This is known as "price discovery," and it's precisely what a market is supposed to do. As a result, I have been hesitant to jump on the fee-collector bandwagon – the idea that it's wise to do something rash right now, even ahead of an impending correction that has yet to fully show its ugly head.

That said, I maintain the opinion that you should be more cautious at the moment. But, rather than a get-the-heck-out, smash-the-sell-button outburst, I suggest a moderately bearish stance: a short-term buying reprieve, and portfolio reevaluation. A number of developing factors call for such a measured approach, including a growing number of earnings warnings from consumer-cyclical names; a leveling in the upward march of leading stock indices; and valuations that are too sanguine on macroeconomic risk factors.

The way I see it right now, we stand to hit a hiccup in the February economic data that will unwind a bit of the enthusiasm for risk. Note that the January retail sales report was a minor bump worth remembering. The next area I plan to focus is on the Empire State survey.

Listen, Find a Better Company Than J.C. Penney

Am I potentially becoming interested in J.C. Penney (JCP) as a long recommendation? Perhaps. But hold your horses on executing a trade here. Ahead of the company's earnings report, due Feb. 27, you need to be aware of these thoughts following the recent news on an expanded credit agreement.

First, J.C. Penney's holiday quarter likely ended worse than what the already-dire market predictions foretell. The chief concern here is the cash-burn rate.

Second, the market will cast serious doubt on the six-month outlook for J.C. Penney, basically ignoring the recent glowing comments on the 2013 turnaround offered by CEO Ron Johnson.

Third, the company will likely need to tap incrementally more expensive credit in order to finish adding new shop-in-shops. That, in essence, reduces the long-term returns on these, especially if consumers continue to cast a "no" vote on the new pricing model. J.C. Penney needs traffic.

Finally, yes -- you should still be concerned about the company's credit ratings following the release of the holiday-quarter numbers.

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