Some Thoughts

While I have been wrong a lot over the past few months, I would point out a few important factors that we should keep in mind. 1) The time to buy is when recession is confirmed [I've been beating the Sep/Oct/Nov drum for this to occur for a long time] 2) The recession is not just starting as most believe - it's in the 6th or 7th inning [I finally found an article that shares my viewpoint that the recession started in Q4 2007: http://news.morningstar.com/articlenet/article.aspx?id=262592&pgid=hparticle] 3) Once the economy turns around [which requires two things to happen a) credit crunch to end which it mostly has and b) a restoration in trust in the economy which could happen at any time] it will likely be "too late" to buy (it won't be, but it will feel too late as we'll be far from our lows).

We may or may not revisit the 10/10/2008 lows, but I believe the 2002 lows will hold in any case -- because I believe the economic outlook is a lot better than most expect.

Also, Jeremy Siegel posted a good article on Yahoo that you may wish to review [http://finance.yahoo.com/expert/article/futureinvest/118916] in which he argues for a 20% return over the next year. One of his big points is also one of mine - that it's unreasonable to use trough earnings as the denominator in a P/E and compare to "normal". He claims that Ford, GM, and Sprint are less than 0.2% of the S&P 500 yet reduced the S&P's earnings by over 20% due to massive losses.

Look for high volatility to continue, but subside over the next 3 to 9 months. Conservative investors should strongly consider intermediate term investment grade corporate bonds.

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.

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.

It Was Time for a Miss

In case you miss the rest of what I say below, I want to point out that I am calling this "time to buy".

No one is always right. I was very wrong on the Fannie preferred. I thought it was “money good” and it looks like it may well not be. As you are certainly aware the government socialized Fannie and Freddie over the past weekend and eliminated future dividends on the preferred stock. There may be some value in the securities at these prices [assuming 1) housing recovers 2) the government doesn’t run these into the ground and 3) congress doesn’t eliminate the outstanding equity in the future], however the risk is great enough that I would not recommend the preferred stock (and if you own Fannie or Freddie common and want to hold on for the potential gain if the above 3 points are true you should sell, take the tax loss and buy the preferred in the same sized investment rather than holding the common – there’s a far higher chance of the preferred being worth something than the common). At least the government gave us the Q3 dividend on the preferred.

Also I recommended two oil companies which did poorly as oil fell and hedge funds that owned the oil producers have been forced to sell.

My outlook is this: I think this is time to buy. I expect that the July lows will in fact hold for the market and with Fannie/Freddie resolved (and I expect Lehman will be resolved similarly by Monday) there should be a lot less uncertainty. Furthermore I believe that the government took over Fannie and Freddie for the purpose of lowering mortgage rates, which has in fact happened significantly this week. If financing rates are cheaper home prices don’t seem as high and I think this will aid the housing recovery which I see occurring sometime in late Q1 or Q2 of next year (as mentioned here previously). If housing can stabilize this is very good for the stock market. Generally I do not see a global recession in the offing, which most market participants are betting on. If I’m right performance should be good relative to the market for a while, while if I’m wrong it will be poor. Generally I like financials, industrials, and energy companies currently.

Since I now have so much credibility in recommending beaten down financial preferred shares, I am going to recommend WM-PK. This is a preferred stock issued by Washington Mutual. I believe that the rumors of WaMu’s demise have been greatly exaggerated. The stock is somewhat cheap, but I don’t think after the massively diluted capital raise earlier this year that there will be a terrific return for common shareholders anytime soon. However with capital levels that are some of the highest in the industry and fairly solid reserves against losses their current condition is not bad. The concern is that their holdings of option adjustable rate mortgages will sour in the future when those negative amortization minimum payments turn into fully amortizing regular payments (i.e. when people stop being allowed to make a token payment and have to pay their full mortgage principal and interest installments). However, as mentioned above the government is lowering interest rates for mortgages – this has the distinct possibility of causing a turning point in the housing market. And those option ARMs don’t convert to amortizing payments soon for the most part – so there’s plenty of time for recovery in housing. Finally WaMu could always renegotiate the loans and allow for smaller payments from the borrowers which could reduce defaults if markets remain bad.

Energy: OPEC seems to be saying that they will defend $100/barrel oil prices which should be good for oil companies as their shares seem to have priced in much lower levels. Also global demand for commodities has dried up in the recent past as China had loaded up prior to the Olympics and then stopped buying, but I see this reversing as the Chinese pollution controls are returned to normal and the Olympics inventory is burned through. Probably positive for coal, copper, and oil, but I’m not very good at predicting commodity price moves.

Since the last update the recommended stocks [MMM (-1.37%), UNH (-1.12%), PETS (13.62%), APA (-5.94%), OXY (-16.28%), SNY (0.60%), DPS (5.87%), AEO (19.64%), ADSK (-6.28%), AIB (-5.55%), and FNM-PS (-71.02%)] averaged a loss of 6.17%, underperforming the S&P 500 [-2.09%] by 4.07%. Since inception on 7/31/2007 the recommendations have gained 19.87%, outperforming the S&P 500 [-12.10%] by 31.97%.

I recommend at this time: MMM, UNH, PETS, APA, DPS, ADSK, AIB, PBR, TEX, and WM-PK.

Many happy returns.

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.

Changes

So only a few days into year 2 and I am already making changes. Most notably I am dropping EWBC from my recommendations as it has reached 80% of what I believe it is worth and has risen too fast. Since June 27th when I first recommended EWBC here it has risen 104% - which given that this increase has occurred in a little over a month makes me comfortable with selling – for now.

I’m also going to again recommend WNR – an oil refiner. This was disastrous last year and probably will be again, however with oil having already fallen precipitously (however I do not believe oil will continue to fall forever) and gasoline remaining relatively stable the refiners should at least have a shot at earning a profit. WNR is risky in that they may decide to dilute shareholders by raising additional capital, which is how this investment may not work.

Also I’m adding JOSB – Jos A Banks which is an extremely well managed and cheap retailer of men’s dress clothes.

Since the last update the recommended stocks [EWBC (+23.62%), MMM (+2.12%), UNH (+8.44%), JNJ (+2.89%), PEP (+2.94%), BBY (+3.70%), BDK (+3.40%), PETS (+2.76%)] averaged a gain of 6.23%, outperforming the S&P 500 [+1.39%] by 4.84%.

I recommend at this time MMM, UNH, JNJ, PEP, BBY, BDK, PETS, JOSB, and WNR.

First Year

I can promise one thing – there will never be another year that I will achieve as much positive relative performance to the S&P 500 as this first year. So the best is now safely behind us.

I am not changing the current recommendations, but did want to provide an update so that there will be a record of the annual return. Over the period since the last update the recommended stocks [EWBC (+11.94%), MMM (+2.42%), UNH (+17.83%), JNJ (+2.03%), PEP (+3.27%), BBY (+3.55%), BDK (+5.91%), PETS (+4.17%)] averaged a gain of 6.39%, outperforming the S&P 500 [+0.59%] by 5.80%.

Over the first year my recommendations returned +15.88%, compared to the S&P 500’s -11.11% for total outperformance of 26.99%. My goal continues to be outperforming the market by 1.5% per quarter, and these extreme results likely will never be repeated.

I also would like to point out that these recommendations are only for your thoughtful consideration and that it would be imprudent for any person to blindly copy my recommendations – read at your own risk.

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

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

Economic Indicators

The Wall Street Journal today reported that the number of existing homes sold in October increased 0.5% month over month (+6.4% in West, UNCH in Midwest, -1.2% South, and -2.9% Northeast). These results were higher than the market expected. The median price of an existing home showed no change month over month, at $221,000 but was down $8,000 (-3.5%) year over year, the largest ever annual drop and record third monthly consecutive decrease.

Consumer confidence was expected to slightly rise to 105.8 from October's 105.1 but instead it has dropped to 102.9. A number over 100 is considered good.

I expect that my prediction on 11/11 ("Money has been flowing in the market in anticipation of a Q4 rally, which has driven the market up double digits. I think that if this rally does not materialize we could easily see a disappointing reaction") is beginning to pan out. I'd predict at this point Q4 will be fairly close to unchanged overall (if that is correct, we have about 4% to give back from large caps and 7% from small caps), and Q1 07 will be a downer. As pretty much always, I am bullish on the long-term outlook for the market, but today I am fairly bearish on the near-term.

To those who don't know my feelings on it - stay invested. It never really works to try to jump in and out of the market. Just consider these things and think about positioning your portfolio in a more conservative manner -- Focus more on mega cap companies with strong fundamentals. Make sure you have some (but not too much) foreign exposure for diversification.

Nine Ways to Manage Money Effectively

I will post my comments on this article soon.


GETTING GOING By JONATHAN CLEMENTS
Nine Ways to Manage Money Effectively November 19, 2006
You get the idea.
As a columnist, my goal isn't to report the news or to offer up an ever-changing list of experts' investment recommendations. Rather, there are some key financial insights that, I believe, should guide everyone's investing, and I pound away at them week after week.
I have been talking about some of these ideas for years, while others have only recently captured my imagination. Want to manage your money better? Here, I would argue, are nine of the most important financial ideas.
1) Just Say No
To save and invest successfully, nothing is more critical than self-discipline.
That means settling on a mix of stock, bond and money-market funds and then sticking with that mix, no matter how unnerving you find the market's daily turmoil and no matter how tempted you are to buy the latest hot stock.
More important, you also need the ability to delay gratification, so you save a healthy sum on a regular basis.
2) Get Off the Treadmill
You can't spend your way to happiness. But lots of folks try, setting themselves up for a lifetime of hefty credit-card bills and emotional disappointment.
You know the cycle: You see something in the store, you decide you just have to have it, you pony up the bucks and, a few weeks or months later, the purchase is all but forgotten -- and you're hankering after something else.
Academics refer to this as the hedonic treadmill. The lesson? If you want happiness, you won't find it at the shopping mall.
3) We Are the Market
Despite all the talk of beating the market, there's a devastating piece of logic that stands stubbornly in our path.
We can't all beat the market, because collectively we are the market. If somebody beats the market, somebody else must lag behind.
In fact, once investment costs are figured in, there are very few winners and most of us trail the market averages.
4) Their Gain, Your Pain
All this should be a reminder that, like it or not, you have two investment partners: Wall Street and the taxman. The three of you divvy up your investment spoils.
Want to keep more for yourself and pay less to the Street and to the taxman? Your best bet is to clamp down on investment costs and make the most of tax-sheltered retirement accounts.
5) Help Wanted
A decade ago, I would have argued that most investors were capable of investing on their own. I no longer believe that's the case.
It seems most folks don't have the time, interest and emotional fortitude to invest successfully on their own.
But unfortunately, you may not fare much better if you hire a broker or financial planner. Many advisers charge too much and have had scant formal financial education, so you really need to pick your adviser with extraordinary care.
6) Don't Be Left Behind
When experts argue the case for diversification, they will point out that buying a wide variety of investments can lower risk, because some of these investments will post gains when others are suffering.
The problem: Whenever we get a major financial crisis, diversification -- especially global stock-market diversification -- often proves pretty much useless, because everything plummets at the same time.
Yet I think this misses a key point. Even if, say, U.S. and foreign stocks tend to rise and fall in tandem, there are often startling differences in their annual return. Those who own just one market can end up suffering long periods of lackluster performance.
Moreover, diversification isn't just about tempering short-term swings in your portfolio's value.
You also want to limit the damage done by financial calamities, whether it's political upheaval that shutters a country's financial markets or the sort of devastating market collapse we saw in Japan in the 1990s.
7) Family Matters
Your children are your legacy. They will inherit your money and they will likely adopt your financial values.
Your family is also your greatest asset and your greatest liability. If your children or your parents get into financial trouble, you would likely help out -- and they would likely help you, should you get into difficulty.
It's worth keeping all this in mind. Talk to your elderly parents about their finances. Endeavor to teach your kids about money.
Think about how you manage your own money -- and what the consequences would be for your family, should something go badly wrong.
8) Invest for the Long Term
If you die young, it could be financially devastating for your spouse and children. But don't ignore the other risk: What if you live far longer than you ever imagined?
Many retirees are so concerned about dying young that they rush to claim Social Security early and they refuse to buy lifetime-income annuities. And this is indeed the right strategy if you're convinced that you and your spouse have a short life expectancy, and you want to die a little richer.
But what if you take Social Security early, don't buy the annuity and then live a surprisingly long time? Instead of dying young and rich, you could be very much alive -- and pinching pennies.
9) Last Resort
On days when the financial markets are open, I check the yield on inflation-indexed Treasury bonds every few hours.
As of Friday, for instance, 10-year inflation-indexed Treasurys were yielding 2.3 percentage points above inflation.
To me, inflation-indexed Treasurys are the investment against which all others should be measured. If I buy 10-year inflation-indexed Treasurys, I am guaranteed to beat inflation by 2.3 percentage points a year over the next decade.
Unless I am confident that another investment will outperform this benchmark, I stick with inflation bonds. They are, to me, the investment of last resort.
Jonathan Clements also writes the "Getting Going" column that appears Wednesdays in The Wall Street Journal. Write to him at: jonathan.clements@wsj.com1.

URL for this article:http://online.wsj.com/article/SB116388187938827618.html

Investing for 20-Somethings

There was a good article in the Wall Street Journal yesterday about retirement planning for 20-somethings. Here's a link to the full article. The article makes a few basic points:

• A Fidelity Investments study shows 16% of 20-somethings have no stock exposure
• Many 20's workers have all of their money in "stable-value" funds, which are glorified money-market funds
• You should always max out your employer's matching contribution
• Young people should have the majority of their money in stocks
• Vanguard's Target Retirement 2050 Fund is invested 90% in stocks
• The majority of your money should be in large-cap stocks like the S&P 500 Index
• Consider 10% in small and 10% mid-cap stocks
• Younger people are underserved by investment advisors because of their few assets

My recommendations to you, is that no one should have any retirement savings money in stable-value or money market funds unless you are within 10 years of retirement - and even then the percentage should be small. If you are more conservative, and you are in your 20's then you can consider investing up to 20% of your savings in bond funds - but don't expect to have as much money when you retire if you do.

Keep your eye on your goal - to have enough to retire on when you reach your target age. People who invest their money too conservatively will not have enough to reach that goal.

The Stock Market

The US stock market has been on a roll lately, with the S&P 500 index up 2.2% over the past month, and 12.5% since the low on July 17th. The only problem is there doesn't seem to me to be a legitimate reason for a 12% gain in 4 months. Consumer confidence has risen, and oil prices have dropped - so the US consumer is looking strong, but corporate earnings growth is slowing and there is a great deal of talk about the Fed cutting interest rates in 2007. Here are some excerpts from the Wall Street Journal about the market this past week:

WSJ.com: Wall Street Focus Shifts From Elections to Fed November 10, 2006.

Wall Street shifted its gaze from the fleeting turbulence of the midterm elections to more-familiar fare Friday: earnings, oil prices and the Federal Reserve.
...
"The topic de jour for the next few weeks will be the Fed" and its policy meeting in early December, said Ned Riley of Riley Asset Management.
Investors will also focus on consumer spending as the holiday season ramps up. A new survey by the International Council of Shopping Centers shows consumers may cooperate. On average, consumers plan to spend $676 on holiday purchases this year, up 9% from last year, according to the survey, helped by declining gasoline prices.
Wall Street will get an important batch of economic data next week, when the government releases its monthly inflation statistics. Any hint that inflation is creeping higher will likely trigger a selloff on Wall Street, said Mr. Malone, since many investors are banking on a Fed rate cut in early 2007 to cushion the softening economy's downward slide.
Until then, stocks are likely to languish, as they did throughout Friday, though they finished the day with a push into the black. The Dow Jones Industrial Average gained 5.13 points to 12108.43, gaining 122.39 for the week.
...
The Standard & Poor's 500-stock index gained 2.57 to 1380.90, and the Nasdaq Composite Index rose by 13.71 to 2389.72, its highest close since February 2001.
Oil prices fell $1.58 to $59.58 a barrel after the International Energy Agency lowered its global oil demand forecast for 2006 and 2007, citing weakening demand from China. Gold prices fell $7.50 to $629.30 an ounce after surging more than $18 Thursday after an official with the People's Bank of China said the country may diversify away from U.S. assets such as the dollar and bonds.
Treasury securities rallied after a Thursday auction of $13 billion worth of 10-year bonds showed strong demand from overseas buyers, including foreign central banks.
Though stocks have meandered in the past few days, some investors expect the uptrend that recently lifted the Dow industrials to a record high to resume. The period from November through January is traditionally the strongest of the year for stocks, and many analysts think this year will be no different.
...
The reason for Mr. Pavlik's bullish stance: expectations that the economy is on solid footing and that a rate cut by the Federal Reserve in the first half of 2007 will help growth continue.
While market analysts aren't in complete agreement about why stocks tend to rally at the end of the year, one factor is the wave of spending generated by the holidays, which tends to lend a bullish tone to Wall Street. This year, investors also hope a sharp drop in energy prices will lead to a happy holidays, the most critical time of the year for the nation's retailers.

Link to the full article.

You'll notice that there was quite a bit of mention of the expected rate cuts by the Federal Reserve in 2007 in that article. That theory is part of what is driving the market higher. The problem is, if the Federal Reserve cuts interest rates there will be a reason why. The Fed does not cut rates to drive the market higher; they cut rates to spur on a slow economy or to raise prices in the face of deflation. I think at this point we can rule out the idea that we may be facing deflation as an impetus for the Fed to cut, so it would have to be because the economy is slow. If the Fed sees that the economy is slow, and reacts, generally that means it is too late and a recession is in the offing.

So to bring all these predictions back together and spell them out in simple language, the Market assumes that the economy will be slowing in 2007, probably leading to a recession, and so stocks have been rallying higher. That is not a good reason for a rally.

Now, I do also feel that there is a likely chance of a relatively strong market through mid-December based on current bullishness and the general lack of bears recently. Also, the fact that for the past several years there has been a strong rally in Q4 is good reason (in investor's minds) for there to likely be one this year.

And I think that, ladies and gentlemen, is the reason for the recent rally. Money has been flowing into the market in anticipation of a Q4 rally, which has driven the market up double digits. I think that if this rally does not materialize we could easily see a disappointing reaction. Also, I wonder how much of the money is planning on leaving the market early in Q1 2007, as they expect a slowing economy and Q2 of each of the past several years has not been a tremendous time to be invested. I think we stand to see a peak in late November or early December followed by several months of market drops, which should be a good time to be buying, particularly mega cap companies with strong fundamentals.