The Sky Isn't Falling (Again)

Contrary to popular belief, the US economy is not failing. Nor is the world economy.

Therefore when the market is more than 4 standard deviations below its 2 year moving average [go to Yahoo! finance and graph an index, add Bollinger Bands for the 499 day period with 4 standard deviations, and you'll see that we're below the bottom line) it may be a GOOD TIME TO BUY [my guess, and it's just a guess, is that the S&P 500 sees an intraday low of 768 to 825 which implies downside of 8 to 15% from here -- however during bottoming periods like this the "bottom" can be very short -- sometimes less than an hour -- so hitting "the bottom" is unachievable].

PS: High yield bond spreads to treasuries are at an all time high. Unless defaults are far worse (or recoveries far less, or both) than at any time since the market was created in the mid 1970's then now is probably a terrific time to buy junk bonds.

Many happy returns.

Thoughts

We live in the most interesting time for finance since the Great Depression – that much is sure. We’ve seen the worst one year return for the S&P 500 and Dow since the Depression – same with the worst 30 day return. This crash should be known as the “Panic of ‘08”.

Because this is the worst panic since the 30’s, the temptation is to compare this crisis to ones from before the end of the depression. This is a bad comparison – and would be akin to seeing the roaring twenties bubble bursting, and making predictions using the dark ages in Europe as a template for what happens when an unprecedented expansion crashes.

Institutions were created as an effect of the depression, such as the FDIC, unemployment insurance, the SEC, and many others. These have changed the world for the better, and our downside economic risk is much less now.

Similarly, economic data and news are much more available, and current. Many believe that the Depression was caused by central bankers tilting at inflation windmills that had been extinguished years before – in the United States Andrew Mellon was raising rates until 1932 – 3 years into the Great Depression. We should note that today the Fed Funds interest rate was first cut over a year ago – and we’re seeing governments around the world that had been fighting the inflation windmill too long, like the EU and China, now cutting rates.

So we should not be surprised when this panic is over much faster than the doomsayers expect.



Finally, Rebecca asked me to comment on Credit Default Swaps – why they are unregulated, what part was played in the downfall of AIG, Lehman, or the freezing of the credit markets:

CDS are unregulated because of the way they came into existence – they started as agreements between financial firms to insure debts. If Bear Stearns owned debt from Russia, and wanted to buy insurance, they could agree with AIG and a contract be entered into. Insurance is a legitimate and needed product that should exist.
Problems began when it was realized that Credit Default Swaps could be used to speculate on a default without having owned the debt. To use an example: I might say “I’ll bet you $100 that the Steelers will win the Super Bowl next year” – and you might have to pay me $10,000 if I’m right because it’s such low odds today. Credit Default Swaps are almost exactly the same thing – a hedge fund would say to AIG “I’ll give you $17,000 per year for the next 5 years for you to guarantee $10 million in Fannie Mae senior debt for those 5 years”, they agree and write up a contract.

This led to failures for a simple reason – our financial institutions are based on trust and faith. Just watch “It’s a Wonderful Life” and you’ll see that a bank doesn’t have a vault where they make a neat stack of the money each account deposits with them waiting for the day it is withdrawn – they keep some liquidity but invest the vast majority of their deposits. When everyone asks for their money back at once (because they don’t trust the bank) it causes a run on the bank, leading to failure. This is what happened to Bear Stearns and many other institutions this year. Credit Default Swaps led to these runs on the banks because when people began betting on a failure – by buying the CDS of Bear Stearns – it drove up the price of that protection – and people notice that. So when the CDS of Bear Stearns began trading at such high prices that was implied there was over a 50% chance of a failure – everyone who had money there started pulling it, because it was obvious trust had been lost.

So regulating Credit Default Swaps will help many things, but unless regulation requires that you actually own the bonds being insured through a CDS it will not stop this phenomenon whereby we see speculative buying of CDS which ends up bringing down the institution [people blame the shorting of the common stock, but it is more the speculative buying of CDS that casuses these runs on banks].

CDS led in part to our credit freeze for a different simple reason – there is too much of them and no one knows how much exposure firms have. Buffett called derivatives (talking about CDS presumably) “weapons of mass financial destruction” years ago – and he was right. AIG “failed” because they had been writing an extreme amount of these contracts – and when things got worse than anyone had predicted – it put all of AIG’s AAA balance sheet at extreme risk. Now credit between financial institutions has been frozen because each firm wants to hoard cash and doesn’t trust their neighbors.

Another problem with CDS is counterparty risk – they’re agreements between two parties – so your counterparty better be sound. The way firms account for these is they offset their exposure – i.e. if AIG has written trillions of dollars of CDS – but some benefit AIG if Lehman fails, and some hurt AIG if Lehman fails, they net these positions. The problem is that those agreements are with different parties, and if one side fails the result won’t look like they netted. So how does one firm trust another when you can’t tell what their risk is?

So we need regulation of Credit Default Swaps where the amount is limited – just like a bank cannot lever up infinitely, neither should AIG have had so much discretion as to the amount of CDS they would write. We also need a universal counterparty, so that the risk that the other side fails goes away. I believe that universal counterparty is in the works currently. However, I don’t think that changes to restrict the amount of CDS you can write is in the works [but will happen eventually because it’s so obvious], nor do I think anyone in power wants to make CDS into an insurance policy rather than speculative bet.

This last factor is important – if you had to own the debt being insured in order to buy a CDS (and had to sell them together as well), then they wouldn’t be nearly so speculative (and CDS prices would reflect the actual perceived risks of institutions from the parties doing business with them, rather than the perceived risks of speculative gamblers). I believe it is highly unlikely this change will be made, which is unfortunate. There’s a huge difference between someone that I owe money to being able to insure that debt, and someone being able to take my bet that the Steelers will win the Super Bowl next year – one is a legitimate financial activity that is needed and desired, while the other is enabling speculation.

Market Bottom?

I see reason to believe that the market bottom was this morning. We won't know for sure until this is confirmed by declining volatility levels (^VIX and ^VXO). The market has fallen over 40% in the past year and over 30% in the past 30 days making this the worst crash since the depression.

Some pundits are saying "you still have time to sell now" - I don't believe this. Market crashes happen near the top - that's why this big decline has come as a day after day grinding rather than a single (or double) day event.

I'm a big believer that "the pendulum swings both ways, and it swings too far". There is good reason to believe it has now swung too far:

1) Historic speed of decline
2) Extreme fear levels (^VIX)
3) Favorable valuation levels (trailing 10 year P/E is now down to 13.6, price to book, dividend yield etc are all at long term lows)
4) Forced selling brings price too low
5) No one wants to own stocks
6) Front page of newspapers and magazines (not financial magazines) is the stock market

I read somewhere today an interesting statement - when markets are going up we all forget what can surprisingly go wrong - now we're all forgetting what can surprisingly go right. I believe there's a lot that may go right that will shock investors (or former investors who have bailed) -- most notably the shocking amounts of liquidity being pumped into markets which could create a major boom.

Will I be right? Not based on my recent predictions.

While I'm not going to update the recommendations (lack of time) I will add MER - Merrill Lynch to the list as of today's close.

The Market is Cheap

Well, in case it wasn’t terribly obvious, I was very wrong in my last posting. I called it “time to buy” – it wasn’t (at least in the short term). I said I thought WaMu would be fine – they weren’t [I will say that looking back on 2008, we will know that Jamie Dimon got the best deal of the year in purchasing WaMu for only $1.9 billion, without assuming any debt].

So I was wrong. However, I believe that the market is a “screaming buy”. We have fallen too fast (fallen faster than in 1987, looking at it month by month, based on percentage below 100 and 200 day moving average). We have cheap valuations. There is an insane amount of stimulus being applied – which lags by 6 to 12 months, but will eventually cause an improvement in the markets. If housing bottoms in the first half of 2009 [as I’ve long predicted], then this will look like a tremendous buying opportunity – and I think it is.

So how did my last recommendations fare? [MMM (-9.92%), UNH (-25.70%), PETS (-9.33%), APA (-20.69%), DPS (-3.00%), ADSK (-17.07%), AIB (-22.70%), PBR (-18.92%), TEX (-37.04%), WM-PK (-100% )] averaging a loss of 26.44%, underperforming the S&P 500 [-15.78%] by a whopping 10.66%. Since inception on 7/31/2007 the recommendations have lost 11.82%, outperforming the S&P 500 [-25.97%] by 14.15%.

I recommend buying stocks at this juncture. Ones I prefer: SSO, QLD, DDM, DIG, UNH, COP, ADSK, AIB, PBR, TEX, ASF, MT, BBY, L, MDR, PCZ, BID, SVU, TXT.

Here are some stocks that hit 52 week lows today that I think are cheap:

TKR – Name P/E P/Book Enterprise Value/Revenue
ASF – Administaff 11.6 3.1 0.3
AET – Aetna 9.3 1.8 0.7
AA – Alcoa 7.5 0.9 0.8
MO – Altria 10.3 10.1 1.2
AXP – American Express 10.4 2.9 2.7
APA – Apache 7.0 1.8 2.7
MT – Arcelor Mittal 4.3 1.0 0.8
ADM – Archer-Daniels-Midland 6.9 0.9 0.3
BJS – BJ Services 7.3 1.5 1.0
BP – BP 5.7 1.4 0.5
BHI – Baker Hughes 9.1 2.3 1.4
BBY – Best Buy 10.3 2.9 0.4
BA – Boeing 9.2 4.7 0.6
BYD – Boyd Gaming 12.2 0.5 1.6
CBS – CBS Corp 7.0 0.4 1.1
CI – Cigna 8.9 1.9 0.6
CVS – CVS 15.0 1.4 0.7
DVR – Cal Dive 10.6 1.7 2.1
CAJ – Canon 10.3 1.6 0.9
KMX – CarMax 25.4 1.7 0.4
CAT – Caterpillar 8.1 3.3 1.3
CX – Cemex 5.1 0.7 1.2
CRL – Charles River Labs 21.1 1.9 3.0
CVX – Chevron 8.2 2.0 0.7
CHS – Chico’s 34.5 0.9 0.4
CBK – Christopher & Banks 18.0 1.1 0.3
XEC – Cimarex Energy 6.0 1.0 2.0
COH – Coach 9.4 4.8 2.1
COP – ConocoPhillips 5.9 1.1 0.6
GLW – Corning 7.8 1.7 3.3
DE – Deere & Co 7.7 2.2 1.4
DVN – Devon Energy 8.5 1.6 2.8
DFS – Discover Financial Services 11.8 0.9 NM
EMC – EMC Corp 13.9 1.9 1.5
FIS – Fidelity Info Services 9.3 0.9 1.4
FRX – Forest Labs 8.0 2.1 1.6
FDP – Fresh Del Monte Produce 7.0 0.9 0.5
FTO – Frontier Oil 4.9 1.4 0.3
GD – General Dynamics 11.4 2.2 0.9
GE – General Electric 10.9 1.8 4.2
GNA – Gerdau AmeriSteel 4.4 0.9 0.8
GSK – Glaxosmithkline 12.7 8.3 3.1
HAL – Halliburton 9.0 3.1 1.5
HES – Hess Corp 9.1 2.1 0.7
HPQ – Hewlett-Packard 12.7 2.7 0.9
IR – Ingersoll-Rand 6.3 0.8 1.4
IBM – IBM 12.4 5.0 1.6
IFF – International Flavor & Frag 14.1 4.6 1.7
KG – King Pharmaceuticals 15.4 0.8 0.7
L – Loews Corp 6.6 0.9 0.6
MAN – Manpower 7.5 1.0 0.2
MRO – Marathon Oil 7.4 1.3 0.5
MDR – McDermott International 7.3 3.1 0.6
MCK – McKesson 13.1 2.2 0.1
MRK – Merck 13.2 3.4 2.6
MCO – Moody’s 14.0 NM 4.2
MOT – Motorola 16.2 1.0 0.4
MUR – Murphy Oil 7.2 1.7 0.4
NYX – NYSE Euronext 10.0 0.9 2.1
NBR – Nabors Industries 6.5 1.2 1.8
NOV – National Oilwell Varco 8.7 1.5 1.5
NWS.A – News Corp 7.4 1.0 1.1
NE – Noble Corp 6.3 2.1 3.2
NUE – Nucor 5.7 1.4 0.6
OXY – Occidental Petroleum 7.1 2.0 2.2
PBY – Pep Boys 19.8 0.7 0.3
PCZ – Petro-Canada 3.8 1.0 0.7
PBR – Petrobras 14.7 2.6 1.9
PLA – Playboy NM 0.6 0.6
PKX – POSCO NM NM 1.0
PCP – Precision Castparts 9.0 2.3 1.4
PRU – Prudential Financial 10.0 1.1 0.9
RTN – Raytheon 13.0 1.8 1.0
RSC – REX Stores 5.1 0.4 0.4
COL – Rockwell Collins 10.6 4.4 1.6
RDC – Rowan Companies 5.2 1.1 1.4
SWY – Safeway 10.5 1.4 0.4
BID – Sothebys 5.9 1.6 1.6
SUN – Sunoco 14.2 1.5 0.1
SVU – SUPERVALU 7.3 0.7 0.3
TGT – Target 12.6 2.5 0.8
TTM – Tata Motors 6.0 1.5 0.6
TEX – Terex Corp 3.7 0.9 0.3
TXT – Textron 6.1 1.7 1.1
MMM – 3M 12.1 3.6 1.9
TWX – Time Warner 11.1 0.7 1.7
TSN – Tyson Foods 60.0 0.9 0.3
USG – USG Corp NM 1.0 0.7
UL – Unilever 14.5 1.2 0.6
VIA.B – Viacom 8.1 2.1 1.6
WAG – Walgreen 12.7 2.2 0.5
WLP – WellPoint 7.7 1.1 0.4
WSM – Williams-Sonoma 13.5 1.3 0.4
WYE – Wyeth 11.1 2.6 2.1
YUM – Yum! Brands 15.0 25.1 1.6
ZMH – Zimmer Holdings 17.1 2.4 3.3
ACMR – AC Moore 14.8 0.6 0.2
AAPL – Apple 19.2 4.4 2.1
BAMM – Books-A-Million 5.4 0.8 0.2
CAKE – Cheesecake Factory 12.9 1.6 0.7
CTXS – Citrix Systems 20.1 2.1 2.3
DELL – Dell 11.1 10.6 0.4
EBAY – eBay 47.0 2.2 2.4
ERTS – Electronic Arts 13.6 2.4 1.9
EXPE – Expedia 13.2 0.8 1.3
FWLT – Foster Wheeler 8.3 5.1 0.6
LOJN – LoJack 8.4 0.8 0.3
MNST – Monster Worldwide 14.1 1.5 0.9
FLWS – 1-800-Flowers.com 15.2 1.4 0.4
OXPS – optionsXpress 10.2 4.3 1.5
RICK – Rick’s Cabaret 7.5 1.2 1.9
RMCF – Rocky Mountain Chocolate 10.3 4.3 1.6
SIGM – Sigma Designs 6.4 1.1 0.8
SPLS – Staples 14.3 2.4 0.9
SBUX – Starbucks 20.7 4.0 1.0
WFMI – Whole Foods 17.1 1.7 0.4

Obviously this is not an exhaustive list of all cheap stocks – these are just the ones that hit new 52 week lows today that I noticed.

Where's the Bear?

The market continued down until it bottomed on 7/15/2008 at 1,200.44. In my prior estimations, this could be the top of the range for the “bottom”. In other words, there’s a risk we may see a new low sometime over the next several months. However, I expect that the market is in a rally, and will continue for some time (how long or how high I do not know).

Specifically I want to comment on Fannie Mae and Freddie Mac. I’ve posted about this before so I won’t rehash, but suffice it to say I expect that the preferred securities are “money good”, and so I will recommend them here. In order to not skew my recommendations I will only recommend one, and I choose Fannie over Freddie. Why? Because Fannie is in a better capital position than Freddie and if things get really bad for one and not the other, Freddie will be the worse. The ticker on Yahoo for the liquid issue of preferreds from Fannie is FNM-PS, but it is known on some sites as FNMpS and others still as FNMPRS. Most of the other preferred issues from the agencies have essentially no liquidity and offer huge bid/ask spreads, so I would avoid them.

I expect that FNM-PS will be volatile, and it will not surprise me to see continued double digit percentage increases and drops on single days. It would also not phase me at this price if Fannie did not declare the dividend on their preferred – the only concern I have is nationalization wherein the preferred is wiped out, which I don’t expect, and have posted reasons why here prior.

Since the last update the recommended stocks [MMM (-0.66%), UNH (-0.49%), JNJ (+1.18%), PEP (+1.27%), BBY (+7.65%), BDK (-1.34%), PETS (-6.85%), JOSB (+13.11%), and WNR (+20.15%)] averaged a gain of 3.78%, outperforming the S&P 500 [+0.34%] by 3.44%.

I recommend at this time MMM, UNH, PETS, APA, OXY, SNY, DPS, AEO, ADSK, AIB, and FNM-PS.

How's the Water?

Well I’ve been on a roll. I guess that means it’s time for a miss. I’m going to predict that the market heads lower until we bottom in September/October/November (sound familiar?).

“This sure feels like a recession” – even though the numbers haven’t borne witness to it. Economists in one recent poll (http://online.wsj.com/article/SB121660918668269545.html) seemed to see positive GDP growth in the second half of 2008 – with only 10% forecasting a contraction (recession). Stock prices have gotten interesting and eventually it pays to bite the bullet and buy in spite of bad news and a gloomy outlook. It’s time to dip your toes in the water, but not yet dive in. Generally when a recession is confirmed (headlines etc) then it is time to buy. This will likely not happen until October/November at the soonest.

In case it’s gone unnoticed, I prefer to buy what no one else likes – the stocks that are cheap and don’t have to produce huge growth and beat estimates in order to be a profitable investment. Chasing ever higher estimates is difficult – not going out of business is easy. While tech stocks have not gotten to the “no brainer” price yet, they’re heading that way fast.

This market is perfect for loading up on your favorites. To beat a dead horse again, think of this as a sale – 20% off – but there’s a lot of rubbish in this rummage sale. If you buy great businesses then you can get a terrific bargain; if you purchase something that wears out or has problems with its design – then the bargain you thought you were getting wasn’t one at all.

I am a believer that quality is the way to go when it comes to buying companies – and this is a good time to reiterate this – if the business isn’t the highest quality then this is probably not the right time, or price, to buy.

My prior recommendations [EWBC (+47.57%), MMM (-1.12%), UNH (-8.38%), JNJ (+5.57%), UYG (-1.21%), XHB (-1.97%), DNA (+29.10%)] averaged a gain of 9.94%, which outperformed the S&P 500 (-1.44%) by a whopping 11.38%. I recommend at this time EWBC, MMM, UNH, JNJ, PEP, BBY, BDK, PETS.

Overall record since I began posting recommendations on this blog on 7/31/07 has been +8.92%, compared to the S&P 500's -13.44%. My goal continues to be outperforming the market by 1.5% per quarter, so don’t expect that the next year will look as good.


Some other businesses that you might consider putting on your shopping list:

PG – Proctor & Gamble
CSCO – Cisco
KO – Coca Cola
AMGN – Amgen
LLY – Eli Lilly
BAC – Bank of America
JPM – JP Morgan
TGT – Target
FDX – FedEx
ODP – Office Depot
SPLS – Staples
SBUX – Starbucks
ADSK – Autodesk
CVH – Coventry
FIS – Fidelity Information Systems
JOSB – Jos A. Bank
LOJN – LoJack
RMCF – Rocky Mountain Chocolate Factory

Crunch Time

Thus far into the credit crunch, we have generally been able to cope with each crisis through a combination of two methods: existing plans [IndyMac and Subprime Lenders] and negotiated solutions [Bear Stearns and Countrywide]. We have now come to the climax of the story – Fannie and Freddie.

The world is scared of Fannie Mae and Freddie Mac – and for good reason. These Government Sponsored Enterprises (GSEs) have significant problems. They are financial guarantee companies, and like the other financial guarantee companies [the monolines ABK, MBI and the mortgage insurers MTG, PMI, RDN, TGIC], they are being thought of as likely to default. The GSEs have negative book value if their portfolios were marked to market – in other words in a timely liquidation scenario there would currently be a loss for debtholders. This is significant in that FNM and FRE have been considered “backed” by the federal government, which is why they have been assigned AAA credit ratings, even though they would not be worthy of such ratings on their own.

It is common thought that Fannie and Freddie really are “too big to fail” – and not just for the United States. Many foreign central banks hold much of their dollar denominated reserves in Fannie and Freddie paper. Unfortunately neither existing plans [bankruptcy] nor a negotiated solution [sale of the companies] would be a viable solution, as the GSEs are too large for a sale and too important for bankruptcy.

There are really only two options if we recognize them as being too big to fail (and therefore rule out bankruptcy) and also assume that they will need assistance:

1) The US government explicitly backs the GSEs debt
2) The US government injects additional capital into FNM and FRE

The first option cannot happen because this would likely cause the national debt to double, and the country would probably lose its AAA credit rating [per Moody’s early 2008]. Therefore the second option is the only logical outcome [also Secretary Paulson has in the past indicated that the government will not back Fannie or Freddie debt].

The capital injection could be completed in a number of different manners – junior (subordinated) debt, preferred stock, or common stock. The public feeling amongst our financial system big wigs is that, to avoid moral hazard, the common shareholders of Fannie and Freddie should pay the consequences of having invested in a GSE and lose the majority of their investment. A common stock capital injection would put the government’s claim at the same level as existing shareholders – moral hazard. Subordinated debt probably would have the effect of propping up the stock price. On the other hand a convertible preferred issue with highly dilutive terms would punish the common shareholders and provide the capital that FNM and FRE are thought to so desperately need.

There are models in past governmental bailouts of what works, and what doesn’t:

Penn Central Railroad 1970 – Penn Central was a failing conglomerate making ill-advised purchases of money losing non-railroad companies in a scheme to borrow ever more money for real estate investments. Eventually the corporation approached the government for $300 million in aid. Nixon approved the package ($750 million for railroads, of which $300 was for Penn Central) but congress did not approve the aid. Penn Central declared bankruptcy in June of 1970 leading to the creation of Conrail and Amtrak.

Lockheed 1971 - $250 million in federal loan guarantees.

New York City 1975 – Billions lent by federal government to the city at a rate of the one year treasury plus 1% on a term of 1 year with annual renewals.

Chrysler 1979 – 1.5 billion in federal loan guarantees, and creditors forced to renegotiate debt at 30 cents on the dollar. Deal allowed Treasury to participate in upside in the stock, and eventually the government made money. Recommended reading: http://www.time.com/time/magazine/article/0,9171,947356,00.html
http://www.heritage.org/research/EnergyandEnvironment/bg276.cfm
http://www.cato.org/pubs/pas/PA00Aes.html

Savings and Loan Intuitions 1980 to 1989 – The rules were changed for Savings and Loans such that insolvent institutions were not identified and shut down quickly by regulators, but rather hidden and allowed to remain open. Capital requirements were lowered, and fake capital (called “capital certificates”) were issued to troubled savings and loans.
http://en.wikipedia.org/wiki/Savings_and_Loan_crisis
http://www.fdic.gov/bank/historical/s&l/

Airline bailout 2001 – Playing the “terrorism killed our industry” card, the airlines received $10 billion in loan guarantees and $5 billion in cash from Congress.

I expect that the final solution to the bailout of Fannie and Freddie will have multiple prongs: 1) The US Government will inject over half of the needed capital through the use of convertible preferreds 2) The US Government will lean on other central banks to inject most of the remaining needed capital, probably through the use of subordinated debt 3) The Fed will ensure liquidity for the GSEs in the event they cannot roll their debt by providing access to the discount window [already known to be the case] 4) Fannie and Freddie will raise additional capital through the issuance of debt and preferred stock in the public markets. Through the provision of additional capital and liquidity Fannie and Freddie will be allowed to remain open for quite some time, and if the housing market turns in 2009, as I expect, the government will again ultimately make money on their bailout.

The Bear Takes Hold

Sometimes it's not fun to be right. The market has been terrible. Unfortunately two of my picks in my last update has also done terrible [PG should do well in the long run, but WNR was a mistake - only buy it if you think oil has peaked which is difficult to predict]. The good news is that financials are near the bottom [SKF, the double short Financial ETF did terrific since my last post, and should do terrible as Financials recover some of the ground they lost]. My view is that house prices probably will bottom around the end of Q1 2009. Traditionally this would mean that the bottom for banks and builders would be around the end of Q3 2008, or September/October/November. However banks have fallen so far (as have homebuilders, just not as recently) that it's likely that the bad news is priced in at this point.

Overall the market [S&P 500] has fallen 6.64% since my prior post, but had rallied in the period in between. I still believe that the S&P will probably fall about 15% from the level of my prior post which would be 1,164 [8.9% from here]. Overall the odds are that the S&P 500 should fall somewhere in the 5% to 15% range from here.

What has happened since Q3 of 2007 is that corporate earnings have been dropping, and financials have been pulling down the market. If history rhymes then what should happen next is that financials will bottom out, yet the S&P will continue to fall, accelerating and eventually dragging financials back towards their lows again.

There are a good number of regional banks today that are very cheap on a price to book basis. If their problems don't multiply and accelerate, long term investors will do very well to buy them here.

Overall the economy is either in a recession or on the brink of one. I'm a believer that looking back we'll say that Q2 2008 was the start of the recession and that it ended in Q1 2009 [plus or minus a quarter]. Typically the market bottoms 6 months before the recession ends which should put the bottom sometime in August to November, probably around September.

When we do have a bottom in the S&P it should be a terrific buying opportunity as the problems that are here are not going to be here forever.


My prior recommendations [SKF (+49.27%), JNJ (-1.91%), PG (-13.67%), BUD (+29.41%), FMX (+3.94%), WNR (-14.44%), DNA (-8.44%)] averaged a gain of 6.31%, which outperformed the S&P 500 by a whopping 12.95%. I recommend at this time EWBC, MMM, UNH, JNJ, UYG, XHB, DNA.

Overall record since I began posting recommendations on this blog on 7/31/07 has been -0.93%, compared to the S&P 500's -12.18%.

Recession On

While stocks are currently cheap, the unfortunate fact is that housing is going to get much worse, and the effects are going to be felt over a long period of time. I believe the stock market will fall for the next 4 to 12 months (let’s call it 6 months) and that we are in a bear market. If that’s all true the market should fall about 15% more from here. Stay away from financials/mortgages/real estate.

My prior recommendations [BAC (+1.18%), C (-6.52%), WB (-18.12%), BBY (-9.22%), JOSB (-6.95%), BWLD (+15.47%)] averaged a loss of 4.03%, which underperformed the S&P 500 by a whopping 6.32%. I recommend at this time SKF, JNJ, PG, BUD, FMX, WNR, DNA.

Overall record since I began posting recommendations on this blog on 7/31/07 has been -6.81%, compared to the S&P 500's -5.93%.

Recession Called Off?

Since my last update the S&P 500 is down 8.92%. As of yesterday (1/22/2008), the S&P 500 was at its lowest P/E ratio in 10 years, lowest P/Book ratio in 10 years, and highest dividend yield in 10 years. Clearly if we aren’t headed for economic disaster this is a time to increase your equity allocations. Also, as a side note, with the 2 year treasury yielding 2.09%, 5 year at 2.64% and 10 year at 3.51% you probably want to be getting out of bonds (put the “non-stock” portion of your portfolio into a money market, the yield of which will go down along with these Fed rate cuts, but you won’t risk losing money if inflation takes off and interest rates rise). In general I expect companies with (long-term) growing earnings that are trading at a discount to the market should be the best companies to invest in, although this is the style I prefer in all markets.

Unfortunately for my returns several of the last recommendations made here turned out very badly (Alcoa and Boeing particularly), and my methodology for tracking returns in this blog do not take into account any sort of equity weighting (in other words I’m assuming that stocks are always 100% of this portfolio).

At this juncture, I expect the dollar to remain volatile but not continue the drop it experienced over the past several years, meaning that international should be trimmed back to 10% of your portfolio or so. Also, I believe that the selloff in financials and consumer discretionary companies have been overdone, and they seem to be regaining their footing since the Fed’s surprise ¾% Tuesday morning. The true value today lies in these unloved companies that cater to the American consumer (plus if everyone gets an $800 tax rebate check, and low interest rates combined with the thawing of credit markets allows prime credit borrowers to refinance their home, some of that money should flow to these sectors).

My prior recommendations [WMT (+6.0%), JNJ (-6.1%), BCS (-15.4%), BA (-17.9%), DIS (-12.1%), AA (-20.1%), AIB (+1.5%)] averaged a loss of 9.16%, which underperformed the S&P 500 by 0.24%. I recommend at this time BAC, C, WB, BBY, JOSB, BWLD. Note that this portfolio is only financials and consumer discretionary companies which may be too concentrated or risky for many investors.

Many Happy Returns, Mark Hanna.

Recession Looming?

We've got cratering consumer confidence, slowing corporate earnings growth, a huge rally in bonds, banks disinclined to lend, and a generally bad set of circumstances for financials and retailers. The dollar has hit new lows against most major currencies (causing possible commodities increases and therefore inflation). Many of these issues are already priced in to stocks. The biggest risk could be investors seeing that their balances dropped more than 5% and selling, which would continue the drop in the market that started a month ago (although we are well off our lows).

I recommend stock investors consider sticking with 20-30% international and the remainder in large cap US multinationals. My prior recommendations [WMT (+9.5%), JNJ (+12.4%), BUD (+8.2%), AIG (-11.8%), PEP (+14.0%)] averaged a return of 6.46%, which outperformed the S&P 500 (2.61%) by 3.85%. I recommend at this time WMT, JNJ, BCS, BA, DIS, AA, AIB.

Overall record since I began posting recommendations on this blog on 7/31/07 has been +6.89%, compared to the S&P 500's +0.97%. For long positions in stocks I try to average outperformance of 1.5% per quarter, so I am happy with this return over 4 months.

Send me an email if you’d like at Mark.Hanna79@gmail.com. Many happy returns.

Bear's Woods

Per my previous post (a month ago) we have been in a bear market. As an interesting note on consumer confidence, it came in today at 105 (down from 111.9), and anything over 100 is positive (not to mention that the street's expectation was 104, which was exceeded). I believe that we are not out of the bear's woods yet, however I will be bold and call the bottom (in hindsight) as the intraday low on August 16th of (S&P 500) 1,370.60. At that point the market had sold off a little more than 10% from its high on July 16th. Overall I recommend the philosophy at this point of "when everyone is fearful, it is time to be greedy".

My prior recommendations [WMT (-5%), JNJ (+1.9%), BAC (+4.3%)] averaged a return of plus 0.4%, which beat the S&P 500 (-1.6%) by about 2%. So what? Well if the market averages [insert whatever long run average market return you believe in, most people use 10% to 12%], that average includes these types of markets. Beating by 2% in a month is a huge advantage for low-risk investors.

OK SO WHAT DO YOU LIKE NOW? REITERATE: WMT and JNJ. BAC will do great over the next 60 months, but I am not confident they will outperform over the next month. I still like the same play book 1) Growth at a reasonable price 2) Large Cap 3) With a dividend (or at least some indication management is allocating capital wisely). Think WMT, JNJ, BUD, AIG, PEP.

8 Months

Well it has been 8 months since my last post (math check: 7+12-11=8 whee). The stock market has rallied 4.6% over those 8 months. Doesn't sound like much. In actuality it is not that much, as earnings have increased well over this 5% gain, so stocks are cheaper.

That said, we are now in a bear market. We've just finished two down months for the indices (June and July) and are seeing chicken littleitis regarding financials (who doesn't like BAC - Bank of America at 9.5 times earnings and a 5.4% dividend yield???). I watched a little CNBC (dangerous) tonight and EVERY show featured EVERY person stating to stay away from financials and "don't bottom fish here".

I've been occupying some of my time (outside of moving from West TN to Knoxville, the family, the job, and everything else I do) looking at stocks and, more recently, stock options. To back up my case on a bear market we see 1) Elevated Volatility 2) Huge run up in short sales of stocks on the NYSE and 3) very cheap call options with expensive put options (IE the volatility index's run up has to do with puts becoming more expensive as everyone is buying downside protection). "Sell in May and walk away" is it?

OK SO WHAT DO YOU LIKE? I like 1) Growth at a reasonable price (some call this value some call this growth some blend, bottom line is earnings growth at a good discount to underlying value) 2) Large Caps 3) Those that fit #1 and #2 and pay a nice growing dividend. Think WMT, JNJ, BAC as the most obvious names.

Take care. Drop me a line if you'd like at Mark.Hanna79@gmail.com