Does anyone ever pay full price for a product at Jos. A. Bank?  I don't know why anyone ever would when that specialty retailer of men's clothing has made it clear with its advertising that you will ultimately get what you want on sale if you wait long enough.

The waiting part is of course the hardest thing for some shoppers who just have to have that pair of VIP Take It Easy Plain Front Pants now -- the $89.50 price tag be damned! 

I think paying $89.50 for what is basically a pair of khakis is a bit steep, but that's just me.  For the record, I recently bought that same pair of pants from Jos. A. Bank on clearance for $18.99.

It is not my intention this week to analyze Jos. A. Bank's (JOSB) approach to doing business.  Frankly, their perennial sales suit me just fine (no pun intended). 

My reason for sharing this personal anecdote is that it speaks to a peculiar stance in the stock market where there often seems to be an eagerness to pay a higher price for stocks in fashion and less of a desire to buy stocks out of fashion at clearance prices.

In Retrospect

Pricing in the stock market of course isn't the same as pricing in the retail arena.  In the latter, a low price is a low price.  In the former, a stock could be trading at a low price, yet still be considered expensive based on the company's earnings and/or earnings prospects.

Still, we can't help but think how unloved the housing stocks were less than five years ago when their earnings were collapsing and they were thought to be expensive even at clearance prices.  Today, they are now among the most loved stocks because their earnings have rebounded, never mind that they are believed by many to be expensive again on a valuation basis.

In retrospect, the collapse seen in the stock prices of homebuilders in 2007 and 2008 afforded investors, who thought they were too expensive in 2005 and 2006, an opportunity to establish longer-term investment positions at a much lower cost basis.

Been There, Done That.... and Doing It Again

What is important to remember about cyclical issues is that their fortunes rise and fall with the business cycle.  There are some periods when those fortunes are very good and everyone clamors to buy the stocks.  And there are some periods when those fortunes aren't so great and the stocks get dumped.

The latter appears to be the state of things for many of the basic materials stocks, which were all the rage during the commodity supercycle.  Now, they simply produce rage for investors who have held the stocks on the way down as the supercycle has become less super thanks to the slowdown in global economic growth.

You might have been kicking yourself in 2007 and 2008 for not buying the basic material stocks when they were on fire, but telling yourself that you would be sure to buy them when the inevitable correction came.

Well, that correction came and went... and now it has come back again for several stocks, as seen in the charts below for the likes of Freeport McMoRan (FC) and Cliffs Natural Resources (CLF).  

With many of the basic materials stocks trading at noticeably reduced prices, the perspective is such that they are on the cusp of a commodity superbust and are not good investments.  If one believes these companies are just going to keep adding capacity in the face of falling prices and lessening demand, that is a defensible assumption.

However, it doesn't stand to reason that they would follow such a path of self destruction.  These producers will ultimately cut back on production if prices remain depressed. 

Homebuilders, you may recall, cut back sharply on housing starts because that was the rational thing to do in the face of falling prices and lessening demand.   That depressed their earnings prospects greatly for a period of time, but it ultimately set the stage for the profit and growth revival most public homebuilders are now experiencing.

For what it's worth, the SPDR S&P Homebuilders ETF (XHB) is up nearly 300% from its 2009 low, with a significant portion of that ramp coming in the last two years.  The inference here is that it took a while to capitalize on an investment in these stocks, but, boy, when the tide turned, it made up for the opportunity cost incurred during the forlorn holding period. 

What It All Means

The near-term road ahead may not be easy for the basic materials stocks with the eurozone in recession, the US struggling to achieve escape velocity, and China's growth slowing.  Those known issues though are a large part of the reason why many basic materials stocks have already come down sharply in price.

Should economic activity accelerate, the fortunes of the basic materials stocks are apt to follow, as is customary when the business cycle turns.

It could admittedly be awhile for that to happen, but with the haircut many of these stocks have already taken, there is an opportunity today for long-term investors to start building a position at a much lower cost basis.  Some of the potential opportunity cost in holding these stocks will be mitigated by the fact that many of these companies pay a dividend.

Aiming to identify some possible candidates for clearance-price shopping, we screened the S&P 500 Basic Materials sector, which is comprised of 30 companies, using just two parameters: (1) stocks that are down at least 20% from their 5-year high and (2) stocks that have a dividend yield greater than zero.

The first parameter is the more relevant one for today's discussion.  The screen produced 11 basic materials stocks that are technically in a bear market relative to their 5-year high while the S&P 500 itself has risen to an all-time high over the last five years. 

This is not to say that there isn't still price risk for the basic materials stocks.  There is, only it's not as great as it used to be when they were very much in fashion.

--Patrick J. O'Hare, Briefing.com