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Stocks' 1% drop last Wednesday provides at least two tests. The first, naturally, is a test of the unrelenting and metronomic uptrend in the market that has prevailed since about Labor Day, with only the briefest backslide in November. The demand-versus-supply breakdown has clearly been in favor of higher stock prices; investors have been under-exposed to equities, and sellers largely remained at bay.
Then last week, with the hottest stocks—small-caps, momentum-driven tech and commodity shares—taking a stiffer hit than the big-cap indexes, there were hints the hot money might be taking a breather. How like this market to hit a new post-crisis high, and then shake out the excessive optimism among Wall Street pros right when Apple (ticker: AAPL) reports a stupendous profit performance. When the U.S. stock-market's capitalization doubles in 22 months. When retail investors invest more cash in U.S. equity mutual funds than foreign funds for the first time in recent memory, according to Lipper. When the economic data generally are upbeat. And, not least, when President Obama begins snuggling up to business.
Even a further probe of a few percentage points to the downside likely wouldn't augur anything too serious. During this nearly two-year bull run, earnings-reporting seasons have often served as times for consolidations and pullbacks. It would be helpful to the bulls' cause if this little setback were met with a sudden cooling of expert and trader sentiment and a demand spike in hedging instruments. In the words of Robert W. Baird strategist Bruce Bittles, "Before the current slide runs its course, we should see a resurfacing of caution and skepticism among investors."
The other test is being administered to the growing and increasingly vocal crowd insisting that the low-volume, low-volatility sleepwalk to new bull-market highs is evidence of a market rigged by the Federal Reserve and not allowed to decline meaningfully, with every intra-day dip rescued by what even a technical analyst quoted by The Wall Street Journal Tuesday called a "mysterious force."
Well, sure, the Fed wants to see equity markets move higher. All post-recession, ultra-easy Fed regimes in history have desired, if not engineered, rising stock prices. The main difference with the Bernanke Fed is that the chairman is honest about it, having cited higher stock prices both in an op-ed article and this month in a talk at the FDIC as one barometer of the success of its "quantitative easing" campaign. The phrase "Don't fight the Fed" is decades old, let's recall, which doesn't mean it has always been a great investing guide.
The more interesting question is whether the investment community came into this year so convinced that the Fed and assorted other actors somehow wouldn't let stocks drop meaningfully that the market's knack for confounding group expectations means just that might happen.
AN OLD WALL STREET SAW HOLDS THAT sometimes it's cheaper to buy oil and gas reserves on the New York Stock Exchange than in the ground. Or, in the case of ATP Oil and Gas (ATPG), on the Nasdaq.
ATP is a driller with a concentration in the kinds of deepwater Gulf of Mexico fields where drilling permits were curtailed after the BP (BP) disaster last year. It acquires proven but undeveloped reserves and exploits them.
The stock is volatile enough that some investors might wish for a rodeo clown to protect them from its bucking aggression. It was over 50 in the oil boom year of 2007, crashed to below 10 in the aftermath of the BP explosion and has since rebounded to 15.64. At today's price, its equity-market value is $800 million. Adding debt and other liabilities, and subtracting $200 million in cash, brings the enterprise value to $3 billion.
The value of its proven and probable reserves, discounted at a 10% annual rate (a measure known as PV-10), is $6.6 billion, pretax. Should the disparity between market prices and value be narrowed, the stock would more than double from current prices.
David Steinberg of DLS Capital, a $300 million deep-value firm and ATP shareholder, notes that the company's rigs alone are worth close to $1 billion.
The government has been moving to issue permits again for new deepwater projects, and ATP has said it expects four new approvals in 2011.
ATP is a leveraged company. Any project delays mean a higher cash-burn rate, and there have been concerns in the past that a dilutive equity sale might hit the market. Yet the present valuation seems to more than build in these risks, leaving significant upside should they fail to become manifest.
E-mail: michael.santoli@barrons.com
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