Thursday, August 19, 2010

Jobless Claims Crush Stocks; Mergers Push Valuations

There's no escaping the obvious. Initial unemployment claims for the most recent week registered at a 10-month high, with half a million Americans filing for unemployment compensation.

That news, coupled with some hard-to-believe figures from the Philadelphia Fed, wiped out all of the week's prior gains and sent stocks reeling to their lowest close in a month. The major averages have been trading below their 200-week moving averages, and cannot seem to gather enough momentum to break out of the current trading range.

Significantly, trading volume reached its highest level in a week, also marking the fourth consecutive Thursday in which stocks have traded to the downside. Despite heavy play in stock options - which expire tomorrow - and some fairly significant attempts at late-day tape-painting (or, banging the close), current momentum in strictly on the side of the bears.

A couple of merger announcements caught the market's attention, specifically, Intel's (INTC) offer of $7.7 billion in cash for internet security firm, McAfee (MFE), which boosted shares of the company to be acquired by 17 points, a 57% gain.

Also on the merger block was First Niagara's (FNFG) offer to buy all of New Alliance Bankshares (NAL), a Connecticut-based regional bank, in an all-stock deal.

Both deals pushed valuations of the acquired companies to ratios of roughly 18-20 times earnings, which, by most standards might seem reasonable, though in today's liquidity-squeezed environment seem a bit on the overpriced side of the equation.

Valuation, more than ever, is going to have meaning once again for publicly-traded firms, though it's doubtful that the rich P-E ratios of the Fortune 500 companies and Dow 30 can remain in place for long, many of them trading at 20 times current earnings or higher. In a fast-paced environment, those valuations may be appropriate, but today, when all indications are for modest growth, if any at all, valuations would be more prudently placed in the 8-12 times earnings range. Should the economy continue to worsen, even those figures would seem rich.

Valuation and price discovery, the tools of any astute investor, have been shunned for years, with Wall Street assuming that 12 to 15 times earnings is the benchmark for a stable company. In the current environment, both investors and companies seeking to purchase rivals or valued additions, had better sharpen their pencils.

One other potential acquisition, that of Potash (POT), the Canadian-based fertilizer manufacturer, by Aussie giant BHP Billiton (BHP) for $130 per share - all cash - was rejected by the company to be acquired, calling the bid "woefully inadequate," though shares of Potash have zoomed up 36 points, or about 30% since the hostile offer was tendered on Tuesday.

The whole deal sounds cockeyed on the surface, and even if BHP is desperate, should not produce any tangible combination. with earnings in the previous four quarters of $4.64, even trading at $112 per share (prior to the offer), Potash was sporting a PE of 24, well into nose-bleed territory. With the stock up to 148 at last look, valuation has to just under 32 times earnings, meaning BHP will invest enough to generate a total return of capital by the year 2042, if Potash continues to perform as it has the past year.

Considering the global footprint of both companies, the deal would make sense, though Potash may have missed the boat ad says it is seeking other suitors. Obviously, some investors believe the company is worth much more than the $130 per share, though a value investor would normally walk away shaking his or her head. In this case, the value investor is running from the mob of momentum junkies crowding the trade. The valuations are ludicrous, even if they were put up in better times.

Outside the merger mania, most stocks were sinking slowly. Not a single stock on the Dow 30 showed a gain, as investors took cash out of just about every equity investment.

Dow 10,271.21, -144.33 (1.39%)
NASDAQ 2,178.95, -36.75 (1.66%)
S&P 500 1,075.63, -18.53 (1.69%)
NYSE Composite 6,855.14, -112.94 (1.62%)

Declining issues pounded advancers by an enormous margin, 5147-1322, though it could have been worse, and likely will be within days or weeks. New highs managed to stay ahead of new lows, but just barely, 275-220. It is worth noting that there was a tremendous run-up in stocks from mid-July through December of last year, so routinely making new 52-week highs is going to be a more difficult task in weeks and months ahead.

NASDAQ Volume 2,104,113,000
NYSE Volume 4,935,496,000

Crude futures continued to slide from their ridiculous levels of earlier in the month, losing 99 cents to close at $74.43, an odd occurrence for mid-summer driving season, though inventory levels continue to indicate slack demand. Gold caught another reasonable bid, up $4.10, to $1,233.80, with $1300 now the preferred price target. Silver slipped seven cents to $18.32. One wonders how long the gold boom - now in its tenth year - can last and whether these current levels indicate a topping pattern. Quadrupling your money by simply holding onto coins or bars over the past decade seems to have been the best of all trades, even though one would not have to as much as lift a finger.

Such is the condition of markets today. Idleness may be the best recipe for preservation of capital as deflation holds prices down and punishes speculation.

No comments: