Rally On Fumes

I believe that the current rally is running on fumes. Before I get to the bearish side of the ledger I want to acknowledge the positives. The large float shrink (ie. share repurchases & cash M&A) is an undeniable positive. As long as the share repurchases and cash M&A continue at the current pace it is difficult to imagine much more than a correction. The second positive is seasonality. April is one of the stronger months of the year for stocks. Extended markets often become more extended during seasonally positive periods. The negative side of this is that in another month we enter the weaker part of the year where we have seen market corrections in each of the past 3 years.

Investor sentiment is troubling as the vast majority of the sentiment indicators I follow are showing excessive optimism. Whether it be hedge fund managers, investment advisers or newsletter writers the consensus in unanimously bullish. Former "Chicken Littles" suddenly have  a greater appetite for beta. The following excerpt from an article in the WSJ captures the current mood:
The market's record-breaking spree has raised a new fear in many American households—dread that they are missing out on big gains.

When stock prices collapsed in 2008, the bear market wiped out half of the savings of Lucie White and her husband, both doctors in Houston. Feeling "sucker punched," she says, they swore off stocks and put their remaining money in a bank.

This week, as the Dow Jones Industrial Average and Standard & Poor's 500-stock index pushed to record highs, Ms. White and her husband hired a financial adviser and took the plunge back into the market.

The economy is stumbling along and profit growth has slowed to crawl. The full effects of the tax hikes and the sequester have yet to be felt as spending habits do not change on a dime. A slowing economy with more headwinds ahead is not the ideal environment for profit growth. Valuations are full even with profit margins at record levels. It is difficult to see where further profit growth will come from.

Up until now the large float shrink has kept me from getting too bearish. But as we approach the seasonally weaker part of the year with the market even more stretched I am more likely to act on my bearish inclinations. The bears, if there are any left, may be coming out of hibernation soon.

A Tidbit From The Oracle Conference Call

Amdocs (DOX) and Comverse (CNSI) both provide billing software and services for telcos. As a shareholder of both I found a portion of the Oracle Q&A very interesting. The following is a portion of the Oracle conference call on Wednesday from Seeking Alpha (my emphasis added):
Larry Ellison

We have a very, very significant presence in billing systems, in provisioning systems, in the telco space. And what we’d like to become is one of the most strategic suppliers to telcos overall, which involves broadening our footprint of what we supply them.

So you’re going to see us, through our own engineering, through innovation and acquisitions, greatly broaden our footprint as our ambition is to be the primary technology provider to the telecommunications industry. So that’s an area where we’ve been very successful, in certain parts of it, and we think we can expand that business by adding to the footprint.

Crimson Wine Group: Bull Case on a Unique Spin-off Opportunity

My write-up on Crimson Wine Group (CWGL) is up at Market Folly. I explain why the stock may have 70% upside.

Doing Less

As the market has risen it has become increasingly difficult for me to find stocks that meet my value criteria. I look for companies with predictable free cash flows at a low price. These companies suddenly seem few and far between. I tend to stay away from companies that are highly levered, capital intensive or cyclical.

During 2010, 2011 & 2012 there were periods when the market got ahead of itself but I was still able to find bargains. During that period healthcare, select consumer staples and enterprise software companies were trading cheap even when the market became expensive. Even though there were periods when the market as a whole became unattractive I did not have  a hard time finding individual securities. Currently, I can hardly find any new stocks to buy that meet my criteria.

The reason I believe this has occurred is that the market has rightfully put a premium on companies with more predictable free cash flows. But I cannot help but wonder if I am becoming more complacent and not looking hard enough. This weekend I came across  a chart that argues for the former. Defensive stocks are more expensive than they have been to cyclicals in forty years.

I have made some adjustments to my strategy by buying select cheap, cyclical stocks but carefully hedging out the cyclical risk by shorting similar companies. However, for the most part I have been selling off positions as they reach my targets without being able to replace them.  The past few years have been ideal for my strategy but the current environment argues for doing less and that is precisely what I am doing.