Looking For The Light



Investors can be excused for worrying.

The economy is contracting, stocks are slumping, and consumers are running scared. We’d love to tell you people are overreacting. But the landscape is undeniably bleak, and we won’t blow smoke at you.

What we will do, however, is point out a few slivers of light piercing the dark clouds by looking at two key components of sentiment. While today’s headlines may be grim, the news does not need to be good for stocks to go up; it only needs to be less bad than what’s expected.

Holding a sizable cash position remains appropriate, but periods of widespread gloom have often been good times to buy high-quality stocks, like the two profiled below.

Newsletter bears roar
Investment newsletters are unusually pessimistic. As of March 3, 29.7% of newsletters were bullish, while 44.0% were bearish. Bulls have outnumbered bears throughout most of the last 19 years.

However, bearishness has risen in six of the last eight weeks.

Glimmer of light: Periods when bears outnumber bulls have historically been good times to buy stocks, and sometimes you can find bargains when investors sell en masse.

In the last three months, newsletters have downgraded Transocean ($56; RIG) more often any other stock. The contract driller has seen its shares fall 60% in the last year, hurt by worries that lower oil prices will slow drilling activity. While the shallow-water drilling market has weakened, Transocean’s strength lies in deepwater projects plumbing depths greater than 4,500 feet. The global market for deepwater rigs has not slowed much, and rig-rental rates rose slightly in February. Transocean requires its clients, mostly large and financially strong firms, to sign contracts difficult to break, resulting in a low cancellation rate.

The consensus calls for 2009 per-share profits to slip 4% to $13.74. The company boasts a sturdy balance sheet and earns outstanding Quadrix® scores for Value (92), Quality (94), and Overall (96). Transocean, trading at just four times expected 2009 earnings, is a Focus List Buy and a Long-Term Buy.

Consumer action
Declines in personal consumption in the last two quarters suggest that consumers — who account for about two-thirds of U.S. economic activity — have pulled in their horns. January retail sales came in stronger than the market expected — which translated to a year-over-year decline of “only” 9.7%.

Weak sales should not surprise us, as rising unemployment and huge losses in retirement accounts have U.S. consumers spooked. In February, the University of Michigan Consumer Sentiment Index fell within a point of the November 2008 low, which itself represented the lowest reading since early 1980.

Glimmer of light: January retail sales topped December sales, and early numbers from February point to another increase. Excluding automobiles and gas, January sales fell just 2% from year-ago levels, not exactly a nosedive. If retail sales are leveling off, it could indicate the worst of the consumer panic has passed.

Even if consumers continue to cut back, they seem loathe to give up their satellite television. DirecTV ($20; DTV) is delivering solid operating results despite a rough environment for companies dependent on consumers. Per-share profits climbed 13% in 2008 on 14% higher sales, and consensus estimates project 19% profit growth this year. DirecTV grew at a brisk clip in the December quarter, topping consensus projections by adding 301,000 net new U.S. subscribers.

DirecTV targets wealthier (read: less risky) clients. Despite economic weakness, the average collection period dropped 10% in 2008. While not immune to the downturn, America’s largest satellite TV provider expects to deliver solid growth this year, boosting the U.S. subscriber count by 5%. DirecTV is a Focus List Buy and a Long-Term Buy.

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