The Day Ahead: Ignore These Themes at Your Own Peril

 | Dec 06, 2012 | 8:30 AM EST
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Welcome to #ThinkingThursday, when we momentarily unlock ourselves from the chains of the daily grind and ponder larger investment themes. The market is on the cusp of showing us its true feelings on fiscal cliff's impact on the real global economy, and I happen to believe Mr. Market is poised to dish a helping hand of humble pie. But, regardless of whether you are bear or bull, there are a couple of aspects likely going overlooked here.

1. Misguided Focus on the Topic of Special Dividends

I am not exactly a fan of the 2012 special-dividend mania. In the very short-term, I believe special dividends are bringing unwarranted stabilization to stock prices overall, thanks to companies announcing the handouts to sympathy names. Investors will stick around to pocket the dividend and then, quite possibly, split later this month to lock in a strong total return as debt-ceiling negotiations join forces with final-minute cliff tomfoolery.

Assuming we do see the selloff I anticipate, it's the group of special-dividend payers that will warrant fundamental inspection in January. You see, these companies will have set market expectations that 2013 earnings will be robust enough to support a higher payout ratio, which will compensate for meatier tax rates to weigh on shareholders. The class of companies will probably focus intensely on leveraging their existing asset bases through detailed execution of business models in order to make payout ratio hikes a near-certainty.

Long-term, there is a risk of underinvestment in fixed assets, but the market is trying to tell us that this special group is worthy of consideration in a suppressed growth -- or, dare I say, recessionary environment. Baseline examples: Costco (COST) keeps on climbing, whereas Gap (GPS) was sold due to no special dividend in the cards.

2. What Do the Whales Buy with Year-End Dividend Checks?

The whales -- i.e., fund managers and so on -- are sitting on stocks whose planned special dividends will likely be rendered too pricey, valuation-wise, for investors with long-term horizons. It's hard to imagine a whale staying with a company such as Costco -- which is reinvesting the dividend -- after one has secure an early, and juicy, dividend check in the area of 20x forward earnings. After all, there are other opportunities expressing a favorable risk-to-reward ratio.

As I hinted at in my 2013 predictions note, industrials are where the new money could land early on in 2013. There remains a requirement not to pile on this thesis just yet, given the level of uncertainty that easily stands to wipe off 5% from the top of a fresh position in a day. However, China is turning the corner, and many industrials are deeply restructuring operations, so scaling into a longer-term position is looking appropriate. Think along the lines of a name such as Caterpillar (CAT), which has begun to receive slightly better sell-side commentary.

This deep-thinking session has now concluded -- and now let's move on to the ridiculousness. In tracking the market like a freak, on Wednesday I sensed that a few market players badly wanted to call an end to the selling and to begin a seasonality rally. Come on, folks, let's get real.

First, a more humble-sounding President Obama means close to zilch if the parties aren't advancing a dialogue behind the scenes, which is what reports suggest. If we see limited progression, headlines will swing to and fro -- and, with them, stock prices. Second, I'm not seeing a proper understanding of data.
There is more to interpreting complicated numbers than checking to see if a headline figure has improved from one month to another (which will spur "trend reversal" outcries). On the contrary, it's about trend-spotting in items underneath the neatly packaged headline, and then comparing these with a multitude of other reports and micro reads. For example:

● We saw an entire November of encouraging housing reports, including a gross-domestic-product figure that demonstrated housing as a contributor. This came ahead of a release from the S&P Homebuilding Index that's acting as if it caught a recent cold -- and ditto on housing derivative plays. This, moreover, is occurring in front of a Federal Reserve meeting that will probably result in action to aggressively drive interest rates further down. Pretty odd "tells", no?

● If it was rally-on and mad love for the consumer, would United States Gasoline Fund (UGA) be weakening?

● We're seeing bids under consumer staples and U.S. Treasuries, while SPDR Gold Trust (GLD) and iShares Silver Trust (SLV) continue to sink. Are you worrying about fourth-quarter earnings? If not, why? The services index from the Institute for Supply Management showed a 330-basis-point month-to-month improvement in new orders, but employment fell 460 bps. #QualityOfSales must be top of mind here.

Don't believe me? Chew on this: If we strip out the construction sector, since August average workweeks and average hourly earnings have remained stable or declined across goods producing and servicing producing sectors. There's been no pricing power, no raises and overtime.

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