The weekend was filled with discussions of how low we would go on the open this morning, which made sense given the news out of Europe on the heels of a simply ugly jobs report. Instead, though, we are right back into a market dead zone, in which there is a lot of headline risk and the majority of stocks are not cheap enough to buy.
I spent some time talking with Fred Crossman, my curmudgeonly options trader friend out in Chicago. Although we both have a value bent, Fred is more of a trader than I am and is much better at structuring and implementing trades than I will ever be. We share a view that the market is in a very frustrating place right now -- it is hard to buy outright, as the risks of current global financial and political situations are just untenable. We are both old guys who have been around a long time, and neither of us can recall a time when there was this much financial uncertainty in the markets.
Unlike me, Fred has an idea of how to deal with these markets. He pointed out that a lot of stocks, particularly some of the more economically sensitive issues, are at 52-week lows -- some are even pulling back toward the 2009 lows. He thinks that some of these names, including Cliffs Natural Resources (CLF) and Hess (HES), reflect most of what can go wrong in the world. He also thinks that, unless the world stops eating, fertilizers such as Potash (POT) and Mosaic (MOS) are pretty cheap at current levels.
The basic idea is simple. Take some of these stocks that are priced for the end of the world, and go long; at the same time, short the S&P 500 in equal amounts against them. If the world does end, all of these stocks are already beaten up, and it is likely that the broad market will fall farther than our cheap stocks. If the world does not end and begins to recover, these economically sensitive stocks should rise farther and faster than the market. If we are dead wrong, we will have what amounts to a scratch trade -- or at least a smaller loss than being outright long or short at this point in the market cycle.
When I look at the S&P 500, I see some great companies trading at multiyear lows. Dell (DELL) has struggled in recent weeks, but I have seen this movie before. The stock is down more than 25% in the past month and is close to its lows of the past five years. Energy-related companies such as Nabors (NBR) and Baker Hughes (BHI) are trading at multiyear lows, as weak natural gas and falling oil prices have weighed on their share prices. Most of the coal stocks are at multiyear lows, and including them in this trade would seem to make sense, even though I would not be would be outright long in the sector just yet.
This trade could allow us to put some money to work in spite of the uncertainty surrounding the markets. If we structure our trade so that we select stocks at multiyear lows with dividend yields higher than the market and solid fundamentals, it can be put on so that it's cash flow positive and has a strong chance of solid gains over the next year or two.