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Opportunity, Bubble, Or Both?


Four companies to investigate more closely.

When the 30-year US Treasury yield crawled below 4% this week, I looked through the entire S&P 1500 for stocks with yields above 4%. Stretching for higher yields is exactly what got Wall Street and its clients into this mess so, to be clear, I'm not interested in that too-often misleading number alone. I added the additional requirement of companies which raised their dividend payment each of the past five years, and that growth rate must have been more than 10% per year. Finally, I scraped the list for only the stocks whose long- term debt to capital was below 10%.

4 of 1500 made the cut:

Paychex (PAYX)
Pfizer (PFE)
Watsco (WSO)
Footlocker (FL)

Only two show both top and bottom line growth over the past four quarters: Pfizer and Paychex. Only one showed acceleration, albeit very slightly, in sales: Pfizer.

I couldn't be less impressed with a company's recent past and near term future fundamentally (despite the fact that Health Care is my favorite sector from the long side) than Pfizer's. However, I run these traps precisely for this reason – to examine stocks that I would not otherwise be attracted to in any way. In Pfizer's case, I am long a few of the names I think they might end up using some of their war chest of cash to buy out. But, being paid more than a 7% yield on shares purchased at these levels is also intriguing. Some stocks had their own bear markets already, and may be much closer to the end. Some stocks may have already run out of sellers.

Click to enlarge.

Watsco (WSO) was interesting to me because it lives in a sector – Industrials – that is among the most vulnerable in my view because of the unwinding funds levered to anything based on any infrastructure anywhere. After 7 or 8 years of the world's capital being allocated almost everywhere but the US, I believe that trade is in the painful process of reversing. As I highlighted recently, the most conspicuous quote on my screens all summer and my favorite long was the US Dollar. Watsco sells its AC, heating and refrigeration equipment in the US, not overseas.

Click to enlarge.

As I Buzzed yesterday, we were working all morning trying to unravel rumors and liquidity concerns among Master Limited Partnerships in the Energy space. These often overlooked, and for most of their histories boring old yield plays, were thrust into a violent selling spree that took prices down so low that implied yields on some of them which might typically be 4-6% for most of my career were at 10-12%. There are plenty of problems if short-term liquidity is simply shut off in 2009 for these guys, but with real assets to lean against, I think measured risk even from private capital would be interested. So, how do you know the difference between forced and natural sellers? Take a look at the almost 30% top to bottom move on Natural Resource Partners (NRP) which leases coal mines.

Click to enlarge.

Crazy summer, huh? That was the past eight trading hours alone for one of many MLP's that might be among the most defensive groups out there. Natural sellers? Me thinks not. As I was checking on another, Kinder Morgan (KMP), I did find one announcement yesterday after all. They were raising their distribution.

One of the few things I am convinced of is that while all eyes are focused on cleaning up the mess of blown up bubbles, the solutions always inflate new ones. Investors have gone from climbing over each other to expensively borrow money as fast as they could to now running even faster into each other trying to lend money awfully cheaply by buying Treasuries. We hear a lot about redemptions but not as often about smart long-term allocators of capital hired to steer a pension or endowment, for example, through a massive addition. At their next meetings they will be staring at, among many complex choices, a rather simple one: Do we want more of a 30-Year Treasury at 4% and instruments tied to it, or some stocks yielding 4% and some much more?

Keep an eye peeled on the TBT which is an ETF measuring twice the inverse of the Lehman 20+ Year Treasury.

Click to enlarge.

Our problems are clear. But the solutions are likely already working on creating the next one, and might be setting up a pretty good trade, from bonds to stocks.
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Positions in NRP, WSO, 30-yr TSY.
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