There is a war raging on right in front of us, friends. Do you see it? Well, it's no Death Wish 3, that 1980s classic wherein Charles Bronson roams the thug-infested streets of New York rocking an abnormally large piece. Instead, stare into the colorful eyes of the trading screen and glean the not-so-hidden messages emanating from earnings of the day, comments by various market folk and news unrelated to the U.S.
These mini-paintball wars must be thoroughly digested before you understand this: It's not a "risk-off" market (I cringe when I hear risk on or risk off). It's a "valuation-off" environment. That means those seemingly über-attractive five-to-10-year-out opportunities become even more attractive today. This is also known as "cheap is not cheap enough." Companies that will eventually record earnings stability in Europe are viewed with skepticism -- because the future is, well, in the future, and we are dealing with quickly-developing events in the here and now.
Check it. I would love nothing better than to unleash every darn analytical nugget I've learned through the years and be that fit superhero who scores 50% upside on a stock call as others are playing the fear card. Heck, doing this before the holiday season would be extra special, as it would pay for family gifts. But heroics are on the back burner for me until the market hints that the bulls are winning the war once again. Pick a stock, sure, but remember: It better have everything going in its favor -- in the same vein as, say, GNC (GNC) or Monster (MNST). Stocks believed to be cheap -- those with single-digit price-to-earnings multiples -- are to be tossed aside, and only bought when sentiment truly stabilizes.
War No. 1: "Attractive" Valuations vs. Mr. Market
Add Cisco (CSCO) to the list of soldiers that have succumbed to Mr. Market's bayonet. Cisco traded around 9.8x forward earnings and boasted a reasonable 2% dividend yield before it announced its fresh quarterlies. That was in addition to improvement, in my view, of the earnings story in the past two quarters.
That valuation will be cheaper today, and the dividend yield higher. Why? The negatives to the international component on Cisco, consistent with what has transpired during first-quarter reporting season, were magnified to the Nth degree. The market computed the entire shebang and arrived at this conclusion: Contagion is real in Europe, and it's downright scary.
First, Cisco said the information-technology spending environment is cautious. I say that is quite telling, seeing as corporates are sitting on mounds of cash, even if you were to exclude cash stored overseas.
Second, said Cisco, demand is expected to reaccelerate in the second half of the year. Ah, yes, an old analytical jargon tool I personally once used -- sorry former clients and average Joes -- called the "back-end-loaded quarter." Dropping that nonsense line into this market is akin to strapping on a steak belt and jumping into an alligator infested African river. This market will penalize anything, commentary or guidance, perceived as carrying greater downside risk than upside potential.
To sum up, I say Cisco generated approximately 20% of its prior fiscal year sales from its European segment, with service providers and enterprise being the drivers. Commercial was flat. The market says commercial is dropping from that cliff and spreading its unfriendly downward velocity to the formerly healthy product areas. CEO John Chambers won't necessarily express it as I have done, but this is the market's time in the spotlight, and it will read things as it wishes.
Winner: Mr. Market. The cheap-valuation argument is overcome by energized selling on both good and bad firm-specific developments.
War No. 2: Commodities vs. Mr. Market
Oil prices are being attacked by growth concerns, and conventional wisdom says this is a positive setup for most businesses, especially consumer discretionary and transports. Gas is retreating, so let's visit an IHOP that is seven miles in the other direction for a stack of whole-wheat pancakes. Gas is retreating, so it will be cheaper to ship products for businesses, since the likes of FedEx (FDX) and UPS (UPS) must give back some of that fuel surcharge revenue.
Although my interest was piqued by the relative action in select restaurant stocks Wednesday vs. other names in the consumer-discretionary complex, the market is not yet handing us this trade -- that is, commodity prices off, consumer discretionary on.
Can you fault the market for its behavior, given that it's had to digest clear signs of European Union contagion, a double-dip in the U.K. and dead zones in Southern Europe? All the market has to go on is what it hears from McDonald's (MCD), a dour U.K. retail sales report and a Fossil (FOSL) two-part disaster -- both the quarter and the guidance. Dare I lump Cisco in there as well? Well, it does sell products that consumer-discretionary companies put through their capital expenditure budgets. The market, meanwhile, is projecting these factors to become worse in the second half of 2012.
Winner: Mr. Market.
On a cheerier note, natural gas futures closed at a two-month high, and there was life to be found in steel stocks AK Steel (AKS) and ArcelorMittal (MT). The rationale there has been that natural gas prices could reignite interest in natural gas drilling, and consequently demand for steel, given the tools involved here.
I myself remain cautious on steel. I wasn't thrilled with the sector's latest round of earnings and the discussion circulating on industry supply -- there's too much of the stuff, thanks to a combination of domestic plants continuing to churn out product and China really continuing to churn out product as demand has cooled.