No Knives to Catch

 | May 29, 2012 | 3:00 PM EDT
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After a long weekend of graduations, backyard feasts and amusement parks, I returned to the market this morning to find it heading higher as China's lending activity picked up, Ireland cooperated with the European Union, and Greece did not disappear. This is a very headline-driven market, and gains can slip away as quickly as they materialize. Most of the conversations I am hearing are still decidedly negative, or involve speculation on where to buy into the recent decline. Talking to investors in the past month makes me wonder what alternative world I live in. You would think we had seen some massive selloff in the equity markets, but that is not the case. The markets are down a little more than 5% in the past month and that is not unusual for the stock market.

I have been routinely running screens the past couple of weeks to see if the market is undergoing a significant inventory-creating event. The truth is, so far, it isn't even close to a real bargain-hunting opportunity. This morning I ran a screen looking for stocks that fit into the definition of falling knives, as developed by Charles Brandes in his study of buying stocks after steep selloffs. Buying stocks -- especially large-cap stocks that have fallen 60% or more in the past 52 weeks -- has been a wildly successful investment strategy.

In a market that has really fallen to the inventory-creation level, this screen will produce a plethora of potential bargains worth further investigation. That is simply not the case this time. When I look at my list of stocks, one of the larger companies that has declined substantially in the past year is YPF SA (YPF). The Argentinian oil-and-gas giant was recently nationalized by the Argentinian government to gain more control of the country's energy and economic outlook. Although there is still some stock left in the hands of the public, I have no interest whatsoever in the stock. Neither the company nor the government has the money to fund the long-term costs needed to meet their needs and I question who would want to partner with a government that has no qualms taking what it needs from private investors.

Coal stocks are well represented on the list (I covered those in detail over the weekend, so I will not revisit them here). Natural gas is not as well represented as you might expect, but that is coming later this year. Not only are earnings going to be weak, but we could see some substantial asset write-downs by the gas producers before this cycle is over. For now, I have exposure to the sector through EXCO Resources (XCO) and Penn Virginia (PVA), but I will hold off further commitments until there are more declines in the sector.

First Solar (FSLR) makes the list as well, as the stock is down a disturbing 87% over the past 52 weeks. First Solar is so heavily dependent on subsidies that until we see a very strong global recovery, the industry will struggle. I cannot justify an investment in these stocks unless they trade with a heavy discount to liquidation value. In the case of First Solar, my back-of-the-envelope calculation is approximately $7 a share. I will not predict that they fall another 60% to hit that level, but until they do, the stock does not fit my definition of safe and cheap.

I am not seeing a selloff worthy of dragging out the canes in the style of Henry Clews and Victor Niederhoffer just yet. We may get there, but for now, doing nothing is still the best course for the long-term, safe and cheap investor.

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I reached out last week to my close friend Ken Shreve, who is a prominent writer for the IBD.  I asked Ke...
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