I Could Not Have Said It Any Better Myself
Editor's Note: The following process is shared in the vein of education and is not intended as advice.
The agricultural and heavy machinery companies have been hit hard recently together with the drop in the commodity names. Given my favoritism for mining stocks, I decided to look for opportunities - be it "pairs trades" or hedges - within that group.
The list of companies I considered comes from TC2000 "Manufacturing - Farm & Construction Machinery" group. I started looking for "pairs" with high correlation and where the historical spread between the stocks had gotten out of whack. Once I narrowed down my selections, I then quickly looked at the fundamentals of the companies to avoid stepping on any obvious landmines. From a matrix of nine stocks, I kept only the combinations with a 1-year correlation of at least .75, and with the current spread greater than 1-standard deviation off the 1yr. average spread. The results were:
Looking at the fundamentals I found that Terex (TEX) is having accounting "issues," and has been in the crosshair of our friend Herb Greenberg. Therefore the latter "pairs" was eliminated from consideration.
Coincidentally, in checking out the fundies I ran across a recent industry note by Barry Bannister of Legg Mason which echoes many of the themes often expressed in the 'Ville. Here is what he says:
Perhaps broad stock market weakness may be telling us that the Fed's nostalgia for cooking up a stale brew of yield curve manipulation in support of attempts to remedy debt-supported growth with the application of more debt, as well as withdrawal symptoms from no longer being able to feed at the trough of disinflation, may end with a (calamitous) 2006 recession in autos/ housing and low-end consumers slowing their purchases at Wal-Mart (WMT).
So, we speculate that the Fed may be forced by circumstances to ease by next year, changing its bias against inflation at the expense of growth to the exact opposite view. In addition to a hard landing scare in 2006, we see commodities resurging from the expected 2005/2006 pullback, and commencing a new 5-year re-inflation wave that may require (and feed off) fiscal and monetary accommodation.
Our relative strength models incorporate a view that the S&P 500 has a good chance of falling to $900 in the next two to six quarters, down 30% from the recent high of just over $1,200.
I could not have said it any better myself.
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