When The Water Reaches Your Ankles Fall Off The Dance Floor

I’ve learned to stand alone as a player, but now I feel as if I’m dancing in water climbing above my ankles. Tired of splish-splashing, it’s time to leave the sunken floor boards to the rising tide.

My sound picks over a year ago, after appreciating 200% or more, are coming in. I’m talking about Macy’s, Alcoa, Halliburton, United States Steel and Freeport-McMoRan. Why is Microsoft’s headman cutting his position in half? After a great 5-year run is Microsoft suddenly overpriced on fundamentals? If we can learn anything from Warren Buffett it’s don’t disturb winners if you believe their franchise is intact. Go, Microsoft!

Don’t rate stocks trading at double or triple par like Microsoft as polite investments. After all, Boeing and Alibaba got schmeissed in half once cracks developed in their franchises.

Faced with a market shaking like a wet dog, I’ve shuffled more funds into high-yield bonds. There’s mounting anxiety herein, but my thesis is simplistic. The new variant of Covid-19, Omicron, takes down the world's economic growth to near zero. Interest coverage wanes on companies operating in cyclical sectors like energy, raw materials, even retailing, but nothing fatal

I’m a player in the spread game. When spreads between BB bonds and 10-year Treasuries widen above 300 basis points, I’m a buyer of BBs unless I sense deep recession facing the western world. Spreads have just widened on BB bonds to 3.03%, so my knee jerk is add to long standing positions in industrials like Ford Motor and Freeport-McMoRan as well as Cleveland Cliffs, United States Steel, Murphy Oil, Spirit AeroSystems Holdings, Macy’s, DISH Network and Teva Pharmaceutical Industries.

Penalty costs for being wrong on high-yield paper can be brutal. Dealer bids evaporate or gap down several points. A forced seller turns himself into minced meat. Forced selling does appear when institutional holders can’t retain paper that has lost a credit rating. I like to step in then but my guideline is the market value of the stock must at least equal the market value of its bonds.

This is Mike Milken’s MAD ratio. When it’s 1 to 1 you are effectively buying a bond that is the equivalent of its common stock. Unless the company falls into bankruptcy, you are bound to make serious money herein because the property in question can raise capital and thereby survive. Just so long as I like the company in question, whether Chrysler or Bank of America under stress, I’d cross my fingers then step in.

If our market falls into a Covid-19 funk on rising new cases, the first stepdown would be to wipe out overvaluation in the S&P 500 Index. I put this number minimally at 10%. The market shouldn’t sell above 18 times optimistic earnings projections for 2022.

As yet, nobody’s penciling in a recession. If such unfolds take at least an additional 10% off the averages. The market would sell then at 1.5 times book value and 15 times muted earnings power. Assume the FRB is tone deaf to mild recession tendencies, more focused on inflation in labor and energy quotes.

I assume 10-year Treasuries move up from under 1.4% yield to 2%. The historic spread between 10-year Treasuries and BB bond paper then holds above 300 basis points. If recession is in the air, spreads do widen, but it prompts me to add to holdings.

My equity portfolio construct already is migrating away from cyclicals like Alcon and United States Steel, into non-cyclical healthcare names like UnitedHealth Group and Zoetis. I remain overweighted in financials, carrying Citigroup, Bank of America and Goldman Sachs because I don’t see recession around the corner. There’s still pent-up demand for retailers like Home Depot and consumer durables like Ford Motor. My energy play in MLPs so far is a loser, but I did add yield paper like Exxon Mobil.

Prime tech houses like Alphabet and Facebook still trade too rich for me, except for Amazon, where its cloud footprint now is wagging the e-commerce dog. Same goes for Microsoft, a major player in cloud services.

How does market frothiness dissipate? The business cycle just works down to a harsher reality. Corporate earnings come in. Omicron’s spread could be the little cloud in the sky that waxes bigger and bigger, putting markets in the shade.

In the investment world, you are what you do not what you say. My biggest positions remain in place: Microsoft, Zoetis, Home Depot, Goldman Sachs, Amazon, Bank of America, Alcoa and Ford.

I’m betting the little cloud doesn’t get too big.