Week of 09/11/2008

In This Issue:

Feds Ease The Mortgage Threat, But Create New Problems
Housing Is Now More Political Than Ever
Top-Yielding CDs Blast Treasury Returns
India's Outsourcing Stocks Are Again Attractive
The Bottom Line This Week

Two weeks ago, investors were inclined to ignore moderately bad news because they were focused on what looked like a coming economic recovery. Last Thursday, however, the optimism evaporated when the unemployment rate jumped unexpectedly. Rumors of additional problems with insolvent hedge funds added to the angst, as did growing worries about the king-sized problems at Fannie Mae and Freddie Mac.

Investors put it all together and decided the outlook wasn't as encouraging as they first thought. In fact, it was starting to look as if a further economic slowdown could be in the works.

When the new forecast made the rounds, the market dropped 345 points. We had a tepid 33 point rebound on Friday, but it fell into the faint praise category which actually deepened the gloom. When the final bell rang for the week, the Dow and the Nasdaq were down 2.8% and 4.7% respectively.

Over the weekend, however, the outlook went from dead black to positively upbeat when Treasury Secretary Paulson announced his benevolent agency would rescue Fannie and Freddie. On Monday, jubilant investors pushed the market back up 290 points.

Alas, the joy didn't have much staying power. On Tuesday the market dropped back 280 points when it appeared Lehman Brothers might follow Bear Stearns into the history books. The next day, the company announced a recovery plan and the market rallied 38 points. All in all, the five day trading period was another classic case of Wall Street whiplash.

Feds Ease The Mortgage Threat, But Create New Problems

The suspense about Fannie Mae and Freddie Mac is over, at least for a while. As with Bear Stearns, Indymac and other bailouts we've seen this year, Uncle Sam could not let the two financial service giants default on their obligations. That might have triggered a chain reaction meltdown that would have done great damage to the economy. The only surprise about the Fannie and Freddie bailout is that it took so long for the Treasury to act.

Although a sigh of relief surged through Wall Street when the mortgage leaders were rescued, there were also a few moans. That's largely because most of the agency's shareholders were wiped out when the government stepped in and took control.

But there was an even larger issue that the bailout created: it put a huge new burden on the national debt which set the stage for a future dollar decline, and possibly higher interest rates. In addition, another round of big-ticket costs are undoubtedly on the way as more of the America's home buyers default on their mortgages.

The mega-bailout also sent another message to America's financial service moguls that they can do pretty much as they please and get away with it. If one of their schemes works, they can make a lot of money. If it fails, America's taxpayers will be handed the bill.

Housing Is Now More Political Than Ever

Another problem is the U.S. Treasury is now in direct control of over 50% of America's mortgages (and 70% of new mortgages). That makes the agencies much more susceptible to political influence. Everyone from giant homebuilders to individual consumers will put pressure on the government to favor their interests. When politics trumps sound financial decisions –-not that there were a lot of them to start with-- the result can only be greater economic distortions down the road.

One financial practice that is likely to be changed right away is foreclosure rules. For months the government has been pressuring the financial service industry to lighten the burden on overstretched homeowners. Renegotiated mortgages, reappraised home values, and the like have all been on the government's agenda. Now that Uncle Sugar has a much more direct role in the mortgage industry, many non-performing loans will undoubtedly be extended. Of course, the public will be stuck with these losses as well.

Lastly, we think the bailouts will lead to a tug of war within the government over interest rates. If inflation picks up, the Fed will probably want to raise rates. However, the Treasury Department's newly-acquired mortgage agencies will want interest rates to remain unchanged, or even to be lowered. Although interest rate conflicts have always existed, they now seem likely to intensify.

We think the bottom line with the Fannie and Freddie takeovers is they solve the immediate crisis, but they will create even more difficult problems longer term.

Top-Yielding CDs Blast Treasury Returns

With all the turmoil in the financial markets there has been a flight to Treasury bonds. That's somewhat ironic since the Freddie and Fannie bailouts paint Uncle Sam's already-abysmal balance sheet an even brighter shade of red.

However, the Treasury can simply create whatever money it needs to pay its debts, so U.S. bonds are seen as ultra-secure. For that reason, the bonds only carry paltry interest rates.

Although Treasury bonds are in the limelight, CDs issued by highly-rated banks pay higher returns, and yet they are very safe. That's especially true since the FDIC stands behind CDs from accredited banks, provided the individual certificates are worth no more than $100,000. If the CDs are in an approved retirement plan, they are insured up to $250,000.

If you have more than the FDIC's maximum insured amounts to invest, you can get around the limits by setting up multiple accounts in different banks. But that's a lot of trouble. A better plan is to do business with a bank that will do the legwork for you by setting up insured accounts in several places. The individual accounts are then packaged into jumbo CDs that are sold to the bank's preferred clients. Because no account exceeds the $100,000 maximum, the new CDs are FDIC insured even if they may be worth several million dollars.

If your bank doesn't offer combined account CDs you might wish to contact EverBank and ask about their Insured Advantage Certificates of Deposit. The bank constructs its insured CDs in amounts up to $50 million. Terms run from three months to five years, and returns are usually above market rates.

For conventional CDs, we consulted Bankrate.com http://www.bankrate.com/ to see what returns are available from banks with secure 4-Star ratings. The table shows the best 1-year and 2-year rates in the U.S. as of September 11, 2008.

The Best CD Rates In The U.S. From Secure Banks
Bank 1-Yr APY 2-Yr APY Address Min Deposit
Zions Bank 4.16% 4.31% https://www2.zionsbank.com/ $1,000
GMAC Bank 4.15% 4.30% http://www.gmacbank.com/ $500
Capital One 4.00% 4.15% http://www.capitalone.com $5,000
Centennial Bk 4.18% 4.44% http://www.centennialbank.com $10,000
Nationwide Bk 4.05% 4.25% http://nationwidebank.com $500

India's Outsourcing Stocks Are Again Attractive

At the same time China was becoming a manufacturing titan, India stressed information processing services, which its companies market to the world. Thanks to the still-expanding global economy, India's IT services remain in demand. Nevertheless, the slowdown in growth pushed India's stocks down to levels we feel are once again attractive for long-term accounts.

Infosys Technologies (INFY, Nasdaq) is doing particularly well. http://finance.yahoo.com/q/bc?s=INFY We first recommended the company on May 12, 2005 when it was selling for $28.74 (split adjusted). The stock subsequently soared to $59.84. It is now $38.45, which gives us a 33.8% gain. That return compares very favorably with the performance of its U.S. competitors over the same period. It's no wonder that the stock scores high on Value Line's rating system for timeliness.

We think Infosys will continue to perform well in the global IT market. The company is expanding its operations again with the purchase of the Axon Group in the U.K., which will give it better access to the European market. Infosys is also expanding its influence in the U.S. by offering new services and better connections to its customers.

Another top Indian IT company we like is Satyam Computer Services (SAY, NYSE) http://finance.yahoo.com/q/pr?s=SAY We first recommended the stock in our October 20, 2005 issue when it was selling for $15.43. The price soon rose to $29.84, but it has since fallen to $21.25, giving us a 37.7% gain. Since Satyam's primary customers are in the troubled financial services industry, we think the company's ability to grow at all is remarkable. When the financial service industry begins to turn around, we think Satyam will move up even faster.

The Bottom Line This Week

High volatility has returned to the stock market as investors react to a succession of good and bad news. It doesn't help that we are in uncharted waters with the Fannie Mae and Freddie Mac bailouts.

With so much uncertainty, top-yielding CDs look very attractive. Some foreign blue chips also look quite good. Among the latter, Infosys and Satyam Computer stand out. Infosys may be the best medium-term performer. However, Satyam has the potential to do better longer term as the financial service industry digs its way out of the hole it dug for itself over the past seven years.

Until Next Week

The AIA "Advocate For Absolute Returns", a weekly publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next Thursday...


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Posted 09-11-2008 12:27 PM by Research & Editorial Staff