Focus on Individual Companies in this Pullback

Saturday, November 13, 2010

The S&P 500 dropped 2.2% for the week after rallying for nine straight weeks. Bull markets, especially new ones, are difficult to get involved in because with everyone wanting in, the perfect entries are snatched up very quickly. As is often stated, stocks rise on an escalator and fall on an elevator. The pullbacks are always the clear buy areas in hindsight but fear always accompanies buying into a declining market especially when CNBC carts out all the permabears to scare us all.

The macro versus micro battle rages on

It is amazing to see how persistent the battle between the micro and the macro has been over the last year. Whenever macro worries have hit headlines the market has declined with high correlation between stocks and assets. Once we solve/delay/forget the problem stocks are freed up to continue their rally on the steadily improving micro picture.

As Zacks Investment Research laid out this week, third quarter earnings have been great on the whole. With 7/8ths of the companies in the S&P 500 having reported, we've seen 72.7% of all reporting firms do better than expected, 79.4% report positive year-over-year growth and total net income reported up 27.4% year-over-year. Full-year total earnings for the S&P 500 expected to jump 42.0% in 2010, 14.3% further in 2011. Bottom up valuation puts P/E at 14.9x for 2010, and 13.1x for 2011.

With tailwinds from round two of quantitative easing and greater clarity on the political front with the midterms out of the way, the market may be primed for greater upside. China may tighten which could impact global growth but it's not some out-of-the-ordinary possibility as they have been slowly curbing inflation for the last couple years already. And imagine that, Europe's debt woes were not perfectly and entirely fixed with the ECB's debt package; but coordinated action from officials should be able to prevent any renewed panic.

Ignore the market, find good companies

The initial move off the March 2009 bottom was fast and furious as the S&P catapulted 80% higher in little over a year. This summer's correction represented the first significant worries of a double dip and we were reminded that the developed world is still dealing with too much debt. Yet, the last two months showed the strong resilience of our markets and in short order we rallied right back to April 2010 highs.

I will be the first to say that I don't know if there's more downside in the market up here. I am very optimistic over the next year but I just couldn't tell you whether the market will go down or up next week. But, quite frankly, I don't think it matters all that much. For most of the last three years, ignoring the market's moves was nearly impossible and possibly deadly. Heightened correlation made it imperative to watch the general market closely and many chose to just trade it directly as a basket.

As we rally further though, the market is somewhat less relevant. The S&P is up 7.5% year-to-date but what has that really mattered for the likes of Apple (AAPL) up 46% YTD, Baidu (BIDU) up 169%, Netflix (NFLX) up 214%, (CRM) up 56%. There are extremely impressive, innovative companies out there doing great things. These companies are rapidly growing their earnings and will perform well in any moderate market. Barring a complete collapse which I believe is highly unlikely, a company like Apple will keep making more iPads and iPhones and we'll all keep on buying them.

I think the key to not being the guy in hindsight who says that was the pullback to buy (but didn't actually buy) is focusing on individual companies and stocks that provide compelling setups. My focus is on some of the companies I've been writing about like Google (GOOG), EMC Corporation (EMC) and Potash Corporation (POT). I don't find predicting whether the market will be up or down 2-3% this week as a worthwhile endeavor but I do think EMC around $21 or POT around $130 could create very attractive entry points. Finding good stocks trading around solid levels will be my focus in the coming days.

Brandon R. Rowley
"Chance favors the prepared mind."

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