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October 27, 2005

What's Next?

As if on cue, the Nasdaq tapped on the underside of resistance and promptly shed 1.5%. The sell-off was a slow, steady grind that began at 9:30a and ended at 4:00p. The Dow and SPX were each off about a percent, so the selling was ubiquitous today. I have a strong feeling that today could be the beginning of a cascading slide, but then I thought the same in mid-September. My September prognostication was not totally inaccurate.. we're about 4% lower since thenÂ… it just hasn't been as sharp a decline as I've been expecting.

One stock that stood out today was XM Satellite, which disappointed fans with its subscription forecast. Back in the spring I outlined how this company is boxed into diluting its equity. The cash flow numbers don't seem to add up to more than zero, so they are destined to issue more debt or more equity or both, probably next year.

Part of the spook in today's market were rumors that GM may file bankruptcy. While they are not likely to do so soon, I wouldn't rule out the possibility down the road. GM's mountain of debt and pension obligations add up to major trouble unless they can get their house in order quickly. GM is perceived as a bellwether of our entire economy, particularly since we are consumer-driven, and their troubles spill over, psychologically if not fundamentally, into the entire market. On the flipside, shrewd investor Kirk Kerkorian has recently taken on another 2 million shares of GM. It would be hard to imagine him doing such a thing unless he had a plan to save the company from bankruptcy. Therefore, I am reticent to short or buy puts on GM shares. Perhaps a viable play would be to straddle GM with long-dated puts and calls. I haven't thought this one completely through, but will note future thoughts about it here.

Particularly hard hit were the home builders. On the heels of report that Centex is getting desperate to sell some of its inventory in Georgia (which may or may not have instigated today's decline), the homeys shed 3-5% across the board. Many of the issues, such as Toll Brothers, Hovnanian, and Meritage, hit new lows since the August peak. People are starting to get the idea, mentioned many times on this Web site, that the unraveling of the housing picture will affect consumer spending in a big way. In commiseration with this concept, star retailers such as Best Buy, CDW, Target, and Urban Outfitters have been shedding share price rapidly this week.

To combat the coming consumer weakness, the soon-to-be Fed Chairman, Ben Bernanke, will almost certainly push toward easy money early in his tenure. With this likelihood in mind, precious metals have been behaving well, showing enough technical strength to threaten a serious rally in the near future. What I find interesting is the relative weakness of the mining stocks. Looking over a longer period than just a few weeks (short-term relative strength reveals very little useful information), we see that the mining stocks are well off their peaks of a year ago, while gold is 6% higher and silver is about even to year-ago prices. To illustrate, note the prices of Newmont Mining ($44 now vs. $51 a year ago) and Pan American Silver ($15.90 vs. $18.80).

What appears to have happened is two-fold: 1) a speculative premium has been deflated, and 2) a risk premium for energy costs has been added. If I am correct about oil staying tame for the intermediate-term, and the metals make a big move, both these premiums could conceivably be pumped back into mining stock prices, making them excellent trades. Due to my direct silver exposure, I do not own either of these stocks, although I do have some long-dated calls. If and how you play this scenario is totally up to you and your portfolio needs.

Disclosure: Long BBY, CDWC, XMSR Puts; Long NEM, PAAS Calls


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