Profit Hunters Club

ProfitHuntersClub · Site Admin Joined: 31 Mar 2006 Posts: 25

These likely losers come from sectors that are likely to sink some more before they hit bottom -- but when that happens, these names may be good investments again.

By Jon Markman
November 01, 2007
If the U.S. stock market were a Western, right about now an Army scout named Clem would look up from the campfire to remark that something didn't seem right. And the camera would pan back to show a line of Sioux just about to swoop down from a hill in full war dress -- bows cocked, arrows nocked.

November is typically one of the best months for investors, and right now there is a lot of cash in money-market funds just yearning to be put to work in cheap stocks. Yet among many professional investors, including longtime bulls, there's a gnawing unease with the market that doesn't seem to fit with the fact that most major indexes are trading near highs. Three pros with strong long-term records told me that in recent rallies they had unloaded most of the stocks they'd bought over the past five years.

Now you don't want to be jumping at ghosts, especially around Halloween, and these investors could easily change their minds on a dime, or in a quarter, and be back in the market in a heartbeat. But you might as well at least have a good idea about the types of stocks that they are shunning. Because your success over the next 12 months might be better characterized by the companies you managed to avoid than the ones that you held on to.

In the 2000-2002 bear market, after all, you would have been smart to own small-cap real-estate investment trusts, regional banks, and breweries, which defied the broad trend by going up, but you would have been just as successful by simply steering clear of Internet, software and semiconductor stocks.

So today I will take a break from chronicling the misdeeds of banks, home builders and derivatives junkies and consider instead a list of seven sectors and stocks to avoid for the next six to 12 months.

Banks and brokers
Sorry, I just couldn't stay away from dumping on these miscreants, so after a nanosecond's break, let's get right back on their tail. You may recall that over the summer, Merrill Lynch (MER.N) told us its exposure to subprime-loan failures was minimal; then in September it said maybe its exposure was around $4 billion, and a few weeks later it said, "Um, make that $9 billion."

Well, folks, they ain't done yet. Because Merrill got into the mortgage-securitization game late and accelerated its business of underwriting collateralized debt obligations, or CDOs, into the bitter end -- like a driver who lead-foots his car over a cliff -- the broker simply cannot know the extent of its losses yet.

A peculiar characteristic of these highly leveraged instruments is that the more losses they incur, the more losses they incur. This vicious cycle occurs because CDOs were used as collateral for more loans when placed in so-called structured investment vehicles off the banks' balance sheets. So the more that the value of this collateral deteriorates, the more that banks must put up in real money to keep the rest of the structure from eroding and collapsing. To do that, they must sell other stuff they own -- stocks, bonds, business units, etc. -- at a time when buyers know that banks are under stress and will exploit their weakness to get rock-bottom prices.

This cannot be complete, as supposedly high-quality CDOs that were rated AAA by debt-rating agencies are still being downgraded by those same agencies to below investment grade, further eroding not just their value but also the value of anything for which they served as collateral. To use a more timely metaphor, they're like brush fires that spawn more brush fires. On Monday, for instance, Fitch Ratings announced that another $36.8 billion in CDOs face downgrades, which means that banks will have to announce more write-downs in coming weeks.

Another huge problem: CDO underwriting and structured investment vehicles generated massive profits for the banks and brokers over the past few years. Now there's a big, smokin' hole where those revenues used to be, and no replacement in sight. Until this fire runs out of fuel, you must continue to avoid major bank and brokerage stocks like Merrill, Lehman Bros. (LEH.N), Bear Stearns (BSC.N), Bank of America (BAC.N), Citigroup (C.N), Washington Mutual (WM.N), KeyCorp (KEY.N) and Wachovia (WB.N). Also avoid debt-ratings agency Moody's (MCO.N) and McGraw-Hill (MHP.N), parent of rating agency Standard & Poor's, as the agencies were dupes in the financing wars.

These companies will shrink as they jettison damaged divisions and fight off lawsuits, and investors will be confused as to the companies' true worth. Eventually these proud institutions with long histories at the center of modern capitalism will find a bottom and trade sideways for half a year -- and they will make great bargains. But for now, mark them A for Avoid.

Transportation
It's hard not to admire the big-rig drivers who roar down the highways every night as we sleep, delivering vegetables, newspapers, cars, steel, computers and shampoo to distributors and stores. Our just-in-time inventory systems demand their constant availability. Yet this is an industry in decline, as revenues, earnings and margins are plunging amid a retail slowdown. YRC Worldwide (YRCW.O), parent of truck lines Yellow and Roadway, reported this week that volumes are back to 2001 levels and decelerating.

Higher costs are eating the company alive, and profit margins are plunging. YRC management told investors that the "unpredictability of the economy" made it impossible to provide any forecast for 2008. Avoid YRC along with JB Hunt Transport Services (JBHT.O), Con-Way (CNW.N), Knight Transportation (KNX.N) and Old Dominion Freight Line (ODFL.O).

Publishing
It's almost too easy to pick on newspapers and magazines, but they are unfortunately at the vortex of three pernicious trends: Slumping U.S. real-estate sales are killing what remains of their classified business, waning retail sales and mergers among big retailers are damaging their display-ad business, and the Internet is stealing major-consumer-brand advertisers left and right. Ad revenue is on track to fall an additional 7% this year, and after years of cost-cutting and outsourcing there are just not many more efficiencies to be found except for head count.

Although reporters and editors are an easy target, they also happen to be the key reason that anyone still reads local news in the paper. Just to pick on one company that operates in real-estate war zones Florida and California, McClatchy (MNI.N) last week reported that in the latest quarter real-estate ads were down 26%, auto ads were down 14.9% and employment ads were down 15.3% -- and next quarter looks like more of the same.

While many analysts believe publishers are trading at 30% to 50% discounts to "fair value" during a cyclical low, there are no clear catalysts on the horizon to bring that value into focus.

News Corp. (NWS.N) may have bailed out Dow Jones investors, but don't expect its generosity to extend further. Avoid The New York Times (NYT.N), Gannett (GCI.N) and McClatchy.

Recreation and furnishings
I hate to be a spoilsport, but when Americans are losing their homes, U.S. job growth is stagnant, wages are stifled, home-equity loans are out of the question and energy is expensive, they don't tend to vacation much, or buy many recreational vehicles or furniture. Starwood Hotels & Resorts Worldwide (HOT.N), rightly celebrated for its excellent Sheraton and W hotel chains, among others, is suffering from its exposure to the deathly pace of the time-share market.

Meanwhile, sales at snowmobile maker Arctic Cat (ACAT.O) are hitting a wall, and home-furnishings manufacturers and retailers such as Bed Bath and Beyond (BBBY.O), Williams-Sonoma (WSM.N), La-Z-Boy (LZB.N), Stanley Furniture (STLY.O) and Bassett Furniture Industries (BSET.O) have no cushion to speak of. Avoid them all.

That's not all for this rogues' gallery, but I've run out of room.

Fine print
Now come down off that ledge. It's not so bad everywhere. In my Sept. 28 column, "Recession or not, here's a game plan," I recommended some possible plays for year-end strength, and fortunately they've done well so far. During a span when the broad market is up 1%, my picks are performing like this: MarketVectors-Agribusiness (MOO.N) is up 7%, ProFunds Government Bond (GVPIX.O) is up 3%, iShares Latin America is up 10%, and EMC Corp. (EMC.N) is up 22%. I still like them all.

At the time of publication, Jon Markman did not own or control shares of companies mentioned in this column.

Source: http://finance.sympatico.msn.ca/investing/stocks/article.aspx?cp-documentid=5658174