Capital Ideas & Analysis

Taking IPO’s to the bank? Ever since July there has been a strong divergence away from the S&P500 and new issues. In a credit crunch, should IPO’s be bought and not avoided? I think after one of the largest waves of M&A activity creating such a short supply of good ideas, mixed with the idea that most companies that IPO have the next quarter in the bank, this makes sense right here. With everyone wondering what the older companies will do, it is taken at face value that these were/are immune to the credit and housing problems. Certainly something to look out for. Here is a list of recent IPO’s for those willing to play this game. Click on the list to enlarge.

Source: Investors Business Daily

Wow, “the Dow Jones Industrial Average has climbed in the fourth quarter for nine consecutive years, and in 24 of the past 27 years. The Standard & Poor’s 500 has produced fourth-quarter rallies in 13 of the past 15 years and racked up an average 6.3% haul, according to researchers at Bespoke Investment Group.” (Barron’s)

Maybe even in bear markets we should be more long than short in the fourth quarter. Playing the odds will seem to work more often than not.

Ken Fisher did some great work on sector bubbles in his book, “The Only Three Questions That Count”. He showed how Energy in ‘79 was 22.34% of the S&P, ‘80 was 27.93%, ‘81 was 22.8%. In a similar event, the Tech bubble being 18.54% in ‘98, 30.02% in ‘99, 21.85% in 2000. We currently have Financials at; 21.3% in ‘05, 22.3% in ‘06, and as of today in ‘07, 20.77%.

In the past 17 years the financials average around 16% of the S&P 500 market cap and is currently 20.77%. Tech averaged around 14% and peaked at 30%. So if in fact there is a top in the financial sector it is clearly not as large as the Tech bubble. A 5% of market cap drop vs a 16% drop. I don’t have information on what energy averaged in the 1980’s. In the bubble year, 1980 had a total return of 32.5% on the S&P 500, 1999 21%, and if this connection is right the 2006 returns were 12.94%. What happened in the following years? In 1981 the S&P lost 4.9% and in 2000 lost 9.1%. Currently we are up roughly 7.6%. The years these negative years were up 21.6% in ‘82, down 22.1% in 2002 (with 2008 obviously unknown).

 Moreover, we may very well have a top in financials in terms of market cap. I don’t actually know if the S&P involves real estate in their financial equation, but if they do, this makes a lot of sense. How ever much sense it does make, or how ever real it is, it’s clearly not as large of a bubble in comparison to energy and certainly to Tech. So if Tech losing 16% market cap value takes the market down 50%, then Financials losing 5% could, using “perfect” math pull us down 16.6%. So let us take the current peak of 1555 on the S&P and multiply it by .834 (or -16.6%) and it gets us to 1296.87. By looking at the chart we see a lot of support around this level in 2006, 2001, and 1999. This would pull back the wealth created from the last two years created in real estate, that being the truly booming part. Comparing to Tech once again we look at the chart of the NASDAQ we see that the bottom in 2002 wiped out the booming era of Tech in 1998-2000. 

So bearish call would be to say we end down roughly 9.6% in 2007 if in fact we get a wave of selling. However, I wouldn’t expect this to happen all in 2007, which means perhaps we are down 4-5% in 2007 in this bearish call. That of which is not all that bad. And as it was smart to get into the NASDAQ around 1300 or lower in early 2001, 2002, or 2003, I believe it will be smart to get back into the S&P around 1300 if we see the market turn bearish.

How do we trade this if in fact it happens? If the market turns bearish and breaks through levels like 1490, 1460 then I believe we go short on the S&P 500 with going long the SH, double short financials with the SKF, and going long the QQQQ. I say this because as we can see here;

when it comes to market cap percentage the financials bottomed as tech peaked, and when tech bottomed financials peaked. We also know that tech is seasonally right, the NASDAQ is still down 45% from its high, and large cap growth often outperforms after value outperforms the way it has in the past few years. I think going long bio-tech works with this as well.

Game Plan: From all of this I’m currently setting up long names like AMZN, MSFT, CELG, as well as long WB because of the dividend though very ready to flip the position (for only a few points though) given what I have outlined. Financial names that will get hit the least in this situation will be the 5% dividend group; BAC, WB and definitely C because it has done nothing in the past five years. If one chooses to go short financials with the SKF I would pair it with one of these dividend payers. I also think some commodity exposure is right in this situation as this scenario would create a weak(er) dollar, so gold and oil seem right (currently long GLD and SLB) and seem so with or without any bearishness, these areas should be owned.

Sources: Bespoke Investment Group, Standard & Poor’s, Yahoo Finance, Ken Fisher’s “The Only Three Questions That Count”