Here Comes Santa Claus
It’s the fourth quarter stupid!
While I believe a good deal of the blame for the recent market mayhem goes to the Fed for shifting to neutral, let’s not forget that it’s the fourth quarter. It’s not so much that time of year for roasting chestnuts, as it is for writing off the kitchen sink at ailing homebuilders, lenders, investment banks, automakers and other impaled companies whose shares drive the major indices. This quarter’s parade of write-offs seems to have blindsided the market, but it should not have. Every Benjamin Graham and his mother knows America’s sick and wounded will take the opportunity to wipe the slate clean now, and hope to start ’08 anew.
At some point, hopefully soon, charge-off warnings should peter out. However, we will still have to contend with another phenomenon indigenous to Q4, tax loss selling. I’m sure it’s already played a role, but it could continue as investors trade losses in companies like Beazer Homes (NYSE: BZH) for new interests in shares like Toll Brothers (NYSE: TOL). Despite my example, a good deal of tax loss selling is not replaced with new holdings in the same specific industry; this is probably much more common within institutional portfolios. Nevertheless, when we run the final lap of a losing year, you can expect stocks to generally sell off further. However, the trend also provides greater likelihood for a strong “January Effect.” The important point is that at some point before the end of the year, tax loss selling and fourth quarter warnings should run out of fuel, leaving scavenger value investors ample pickings for the winter.
So then Greek, how do we play this hand?
To best advantage I would seek the top ideas in weak industries where I believe valuation may be unjustly penalized most due to the circumstances outlined above. These names will have been sold off alongside their more troubled peers, but they will also likely be added into many portfolios whose charters or strategies call for diversification and industry exposure. In home building for instance, I view Toll Brothers (NYSE: TOL) as the crème de la crème. TOL, which caters to a higher-end home buyer, has seen its shares tank 44% this year through November 26. Still, that compares to a decline of near 85% for BZH. While the entire group could find shareholder support starting in December or January, I would not venture any new capital into any participant but the industry leader since housing is expected to remain troubled well into ’08 and the Fed is set to sit on the sidelines until the fire rages.
Another clear area to look for beneficiaries of seasonal portfolio adjustment is within the financial sector. If you lost money in Citigroup (NYSE: C), you’ll want to take the tax loss, and then you might also buy into one of its beaten silly peers. These days, most of the capital flow has been out of these shares for the previously discussed tax reasoning, but soon flow should shift as value seekers close in. In the search for buy ideas, I prefer a name like Merrill Lynch (NYSE: MER), down 45% year-to-date, because of its diverse product offerings. Morgan Stanley (NYSE: MS), which has lost 28% year-to-date after netting dividends, also offers opportunity for the same reason in my view.
I think you get the idea, and you should already be aware of plenty of opportunities of your own that you can apply the strategy too. My risk caveat here is that I would look to about a week after the December 11th FOMC announcement for an upward move to start in earnest, since I expect market surprising Fed inaction to drive further downside. Before today's Kohn comment, and given recent equity direction, there’s a decent chance that this possibility could become fully priced in ahead of the meeting. In that case, you have load up sooner. Good luck applying the strategy, and oh, don’t forget to leave the milk and cookies out for Santa!