Market momentum is Red. The markets closed the week in positive territory after a late-Friday rally helped push stocks higher. Heading into next week, investors should look to deep value to start building positions for the long term. While we may experience valuation compression on earnings, there are some stocks that are getting too cheap.
It was another tough week in the markets. Investors continue to dump stocks, and institutions aren’t flowing capital back into stocks. The Federal Reserve technically began tightening its balance sheet Wednesday. However, the central bank only cut $19.5 billion in assets, and all of the sales were linked to mortgage-backed securities.
It’s clear that the Fed is worried about a liquidity crisis. Otherwise, it would have sold some of the bonds on its near $9 trillion balance sheet. It’s also a sign ahead that these central banks are ill-prepared to engage in tightening. The U.S. central bank, Bank of Japan, Bank of England, and European Central Bank are – combined – supposed to cut $4 trillion from their balance sheets by the end of 2023.
But doing so could create serious problems for their currencies. The liquidity challenges and forward earnings adjustments that I see in the next two months are why we likely haven’t hit a bottom in the equity markets. But at some point, I have to hold my nose and start deploying some capital. Here’s my current watchlist of CHEAP stocks.
Higher Risk, Medium Reward Cheap Stocks
Balance sheets have improved among global steel manufacturers such as U.S. Steel (X), ArcerlorMittal (MT), and Ternium (TX). Each of these stocks has a Piotrotski F-Score over 8. Of course, recessionary pressures will weigh on them in the near term.
Of any category, these stocks could continue to see earnings expectations continue. Still, the global commodity will be central to any recovery – and these stocks have gotten incredibly cheap over the last few months. These are the types of stocks that investors should consider deep, out-of-the-money credit spreads as a way to enter positions.
Lower Risk, Higher Reward Cheap Stocks
Housing stocks have taken a serious hit over the last few months. Recessionary concerns remain a strike against the sector, as do rising interest rates. However, stocks like Tri Pointe Holdings (TPH) – F-Score over 8 and PE of 4 – will still capitalize on a U.S. housing market with a four million home supply deficit. I’ve noted other stocks like Beazer Homes (BZH) and Taylor Morrison (TMSC) are trading under book value and stand to benefit from consolidation and lower costs (especially lumber) in the future.
Medium Risk, High Reward Cheap Stocks
Finally, there are a number of oil exploration and production companies that have pulled back after the June 8 momentum switch. They are looking like solid longer-term investments based on their strong cash flow. Devon Energy (DVN) is trading at $55 per share with a dividend north of 9%.
However, investors who sell puts at the $50 level would lock in a stock with a 10% dividend. It’s rare that you see energy producers paying dividends higher than most midstream pipeline operators. But the lack of coherent energy policy has oil producers now kicking back cash flow to investors at a staggering level.
On Tap for Next Week
Next week is a slow week for financial news and economic data. We will see the June unemployment number arrive next week, and markets anticipate a little more softness as layoffs start to arrive. I fully anticipate that the unemployment rate will remain under 4%. But don’t be surprised to see that number tick higher until the Fed gets inflation back under control. The Fed needs to raise interest rates above inflation – the so-called Taylor Rule – to efficiently drive prices lower. However, the central bank can’t just spike rates to 5% tomorrow.
There remains a lot of pressure in this market that still needs to be released. Remember that cash is your friend.
