How to Play the "Fiscal Cliff"

Jamie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The market continues to be obsessed with the fiscal cliff. Stocks are drifting lower as the ramifications of the recent election set in.

I’ve got news for you. There is more going on here than just the fiscal cliff. The market is adjusting to a new world of austerity and higher taxes.

We are entering uncharted territory. History will tell you that nothing good can come from higher taxes so the reticence of buyers is completely understandable. Cliff or no cliff the future looks a bit sketchier than it did before the election.

The funny thing is that all of this was entirely predictable. The world today looks just like it did before the President was reelected. In other words, no matter who won the White House, taxes will be going up in the future.

Nothing good can come of this, or can it?

That is the debate that is raging now in the market and the outcome is very difficult to predict. We just don’t know how things will turn out given all the changes taking place. Sure, many are venturing a guess as to the outcome, but keep in mind a guess is still just a guess.

Instead of getting lost in the debate, investors can and should simply focus on the daily inefficiencies in the market. There are opportunities to exploit each and every day as individual stocks trade with historic amounts of volatility.

Here are a few observations that you might be able to take advantage of today:

Homebuilder earnings provide valuable clues

On Monday, before the market opened, two key homebuilder companies released earnings results. First up was Beazer Homes (NYSE: BZH), who reported a loss of $2.82 per share for the quarter ending September 30. Analysts were looking for a loss of $1.82 per share.

The big miss resulted in shares collapsing. Beazer shares dropped a whopping 17% on Monday. Considering Beazer shares have essentially doubled in value since last October, perhaps we should interpret the loss as simply a bout of profit taking.

Another homebuilder reporting results on Monday was DR Horton (NYSE: DHI) who reported a profit of 30 cents per share for the quarter ending September 30. Analysts were expecting a profit of 28 cents per share. Revenues missed expectations coming in at $1.3 billion versus an estimate of $1.35 billion.

Shares of DR Horton also fell on Monday with shares down 6% on the day. Again, was the action more about profit taking or worries about the actual numbers?

The rational investor looks at the action without emotion. The bottom line is that while the housing market has stabilized in 2012, gains in homebuilding stocks during the last year have already reflected such a fact and perhaps a bit more.

It will take huge numbers to justify current valuations. As we are seeing, the numbers might not be supportive of the huge run-up in share values. I don’t think the selling stops here.

On the flip side, stocks associated with housing might offer representative value in the space. Home Depot (NYSE: HD) shares rocketed higher on Tuesday after the company hit the trifecta with its earnings report.

The big box retailer reported results that beat expectations on both revenues and profits. They also raised guidance. As a result, shares gained an impressive 5% in early trading on Tuesday before relinquishing a portion of the gains when the market collapsed at the end of the session.

The strength in the industry and a strong consumer are all good reasons to own this stock going forward. It makes for a better option than owning overpriced homebuilding shares at the moment.

Retail has an early Christmas

Home Depot was not the only retailer reporting results this week. Shares of Abercrombie and Fitch (NYSE: ANF) were on fire Wednesday. Before the market opened the teen retailer impressed investors with a quarterly profit that exceeded analyst estimates.

The company made 87 cents per share for the quarter ending September 30. Analysts expected a profit of 59 cents per share. More impressively Abercrombie increased guidance for the year to a range of $2.85 to $3.00 per share. The current estimate for the year was for a profit of $2.48 cents per share.

The news sent the formerly struggling retailer to a near 30% gain on Wednesday. It was not the only winner on what is shaping up to be another losing day for the overall market. Shares of office retailer Staples gained 2% on its own robust profit report.

The cat might be out of the bag in the retail space.  The rest of the market might be twisting in the wind, but the consumer is strong and spending. That spending is likely to result in strong profit reports for other retailers.

But not every retailer is a buy. JC Penney (NYSE: JCP) is dying a slow death. The company has embarked upon a new pricing strategy that is simply not working. Until the company proves it can grow its business I would stay away from this company. Perhaps more striking is that shares still trade for 36 times Fiscal Year 2013 earnings estimates. You simply don't pay that price when company is losing money and continually missing estimates.

Same goes for Sears. The department store is a microcosm of the games that get played on Wall Street. There is no real business model here, only financial shenanigans. It's not working, obviously, thus you should avoid this company like the plague. Like JC Penney, Sears is expensive. Analysts expect the company to lose $1.53 in the current fiscal year ending January 31, 2013. Those losses are expected to jump to $2.50 in the following fiscal year. This company is so obviously going in the wrong direction not much more needs to be said.

What investors should consider for the long term with apparel retailers and others are improving margins. With consumers spending, prices are firming, if not going up in the space. Those higher prices, in my opinion, have yet to be reflected in current analyst estimates.

And of course, there is QE Infinity in place to keep spending alive and well. Retailers might be the best investment game in town while we the fiscal cliff drama plays on.

Be not afraid

I almost have to laugh at the panic emanating from Wall Street and beyond with respect to the budget debate. Investors are selling stocks first and asking questions later. Within the chaos there are nuggets of opportunity.

The time to buy is whenever there is blood in the streets. We may have more losses as the drama plays out, but there are some selective buys as well. Get rational before the market, and your portfolio will likely benefit.

jamdlu has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend The Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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