August has been a rough month for the stock market. Traders are not used to this kind of volatility and I have heard of more than one intrepid soul, armed with insufficient knowledge and experience combined with excess leverage, who blew out their account this month.
Most of the walking dead were options folks who woke up each morning sure that they could outperform the math geeks with supercomputers by drawing lines on charts during lunch hour. These "Don Quixotes" of the market are always the first to leave the arena and we are starting to see that once again.
The burning question on everyone's mind seems to be if this is a buying opportunity. Frankly, this question stuns me. To think that this a huge buying opportunity implies a total lack of knowledge of market history.
Back before the Federal Reserve created free money addicts, we would see 5% declines a few times a year and a 10% pullback once a year or so. Such a move was just business as usual. It was a buying opportunity if it occurred when the market was at low levels and the price action created absolute bargains, but that's not the case now. At the open this morning, the market was just 7.1% below all-time highs.
Looking at the S&P 500, my copy of Barron's tells me that we are trading at 20x trailing earnings right now. Just 28 of the 500 stocks trade at price-to-earnings multiples of 10x or less. By comparison, 145 stocks, or 29% of the index, have P/E multiples of 25x or more. Only 40 stocks currently trade below book value and almost all of those are banks or energy-related companies.
As I have said repeatedly of late, we can argue all day about how overvalued the market is at current levels, but we cannot even begin to discuss the market being cheap.
There are some individual exceptions, of course. I have discussed some of the major oil stocks. Chevron (CVX) is trading below book value for the first time in more than a decade. Even at the depths of the 2009 lows, the stock traded at a healthy premium to book value. While I am aware that prices can go lower in the oil markets, I also believe they will eventually improve and that Chevron will survive until that happens. Until that happens you enjoy a healthy dividend yield.
You can also start buying Adams Natural Resources Fund (PEO), a closed end fund that owns energy blue chips and trades at a discount to net asset value. As I said last week, this is a solid long-term pick but be aware that prices may well go lower and you should have at least a five-year timeframe when buying into energy now.
Most of my focus right now, however, is on the community banks. They do not seem to care what the broader market is doing and my little portfolio of small banks was basically flat last week and is higher for the month. Many of these stocks are still cheap and the activists have been active. Just last week, Rick Maples of Keefe Bruyette & Woods told American Banker magazine, "It is a ripe time for activist investors to be pushing some of these companies that are underperforming to sell."
I am fortunate enough to have been around the sector long enough to know who the community bank activists are and which banks they are likely to target. Given the regulatory compliance and technology costs driving smaller banks to merge this is almost an arbitrage trade between the banks' current price-to-book value and the takeover multiple that is 1.35x. Limiting your buy list to those stocks below 90% of book with at least one activist investor takes most of the market risk out of the equation.
There is a little bit to do here, but it is not a huge buying opportunity. I hope it becomes one. I have practiced what I preached and have cash levels in the portfolio that would make Hetty Green crack a smile. A decline of 20% or so from current levels would make me happy as I could buy regional banks at 85% of book again, infrastructure stocks would trade where I could comfortably buy in front of all the spending that has to happen over the next decade, and I would happily buy all the stocks the hedge funds were dumping to meet margin calls.
We are not there yet.