In This Issue:

Banks And Auto Stocks Led The Way Down, And Now Up
Yes, The Rebound Could Be Another Bear Trap
If There Ever Was A Time To Use Stops, It’s Now!
In Many Cities, Real Estate May Be Set To Rise
The Bottom Line

Over the past month, the stock market staged a strong reversal as the Dow and the Nasdaq rose 6.9% and 9.1% respectively. As often happens when investment optimism begins to replace a long period of pessimism, small stocks did better than their larger cousins.

However, many blue chips also performed very well. For example, our first three picks from last month, JP Morgan Chase (JPM), Archer Daniels Midland (ADM), and Ford (F) jumped 21.5%, 5.3%, and 42.3% respectively. Our fourth pick, SPDR Gold Trust (GLD), dropped 2.4%.

Banks And Auto Stocks Led The Way Down, And Now Up

The sharp jump made by JP Morgan Chase was not an isolated event in the battered banking sector. Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) saw equally impressive gains of 19.4%, 40.2%, and 15.3%.

The best return of all was made by American International Group (AIG), a company we didn’t recommend because it carries too much risk. Over the past 30 days, however, many big investors unexpectedly reversed their outlooks for AIG and the stock jumped from $0.46 to $1.22 - a 165.2% leap.

We think the banks are still greatly undervalued and are likely to rebound more from their horrific plunges. The road back will be volatile because progress will depend largely on the success of the government’s bailout programs.

Nevertheless, at today’s ultra-low stock prices the risk/reward ratio appears to justify taking small positions in Citigroup, Bank of America and Wells Fargo. Fortunately, a small investment is all anyone needs to get positions in what could be the biggest rebound story of our time.

Of the three additional banks that could become top performers, Citigroup is in the worst shape. http://finance.yahoo.com/q/bc?s=C Bank of America is in somewhat better condition. http://finance.yahoo.com/q/bc?s=BAC One or both of them may fail. However, there are strong political as well as economic reasons for the government not to let that happen. But, if the bailouts don’t work and Washington ends up nationalizing the banks, the shareholders will be wiped out.

Wells Fargo is a better prospect. The bank will benefit from the possible demise of Citigroup and/or Bank of America because it would pick up much of their business. http://finance.yahoo.com/q/bc?s=WFC Even without that boost, Wells Fargo should survive the recession and the housing plunge, and begin to recover once conditions improve.

AIG must be considered a rank speculation, which we would normally never mention. http://finance.yahoo.com/q/bc?s=AIG But at $1.20 or so, we believe AIG’s potential to jump on good news is very good. If you want to add a little spice to your life, 100 shares of AIG should do the trick.

In the automotive industry, we continue to think that Ford has the best chance for a profitable recovery. As with the banks, a small position appears to make sense at today’s low price.

SPDR Gold Trust (GLD) continues to look good because it is a hedge against rising inflation and a declining dollar. Both conditions seem more likely to occur than they did last month because the Fed just decided to create $300 billion out of thin air to buy Treasury bonds. We think the make believe money will come back to haunt us within a few months.

Yes, The Rebound Could Be Another Bear Trap

Over the past year we warned that the many rebounds that came along looked like bear traps. In every case we were right. After a few days or weeks of moving up, the market suddenly reversed direction and tumbled to new lows. The same thing could happen again this time.

But even if this rally isn’t the lasting rebound we have all been hoping for, there are some solid reasons to think it could last longer than its predecessors. If so, the rally could be profitable even if it ultimately falls apart.

The first reason for optimism is the market had already fallen 54% when the current upturn began. That’s about as bad as bear markets get. Even if the bear returns for one more raid on stocks, he probably won’t have much further to go.

Secondly, fundamentals are also beginning to reach bear market lows. Many top-quality blue chip stocks now have P/E ratios under 10, which has often been a turning point in the past. Since interest rates are on the floor, low P/E stocks that pay good dividends are especially attractive this time around.

If There Ever Was A Time To Use Stops, It’s Now!

Because there is no way to know if the current stock market rebound is another bear trap or the beginning of a new bull cycle, you may be tempted to stay on the sidelines until the matter is settled.

But if you take the safest position and this rally turns out to be the real deal, you will miss out on its biggest gains. That’s because anywhere from 30% to 50% of a bull market’s returns often occur before most investors realize the turn has finally come.

Fortunately, you can buy stocks with reasonable safety if you place stop loss orders on everything you pick. If the stocks go up as expected, you can raise your stops as you go along. That way if the bear comes back, you will be taken out before much damage can be done.

Remember, stops are very easy to place. To use TD Ameritrade as an example, right after you buy a stock you would enter a sell order at the price you would want to be taken out. When you see “Order Type”, simply click “Stop Market” and enter the appropriate number. Since stops cost nothing until they are executed (which might never happen), they are the cheapest insurance you can buy.

There are only two downsides with stop loss orders that you should know about. First, if the market makes a big down move and then bounces back, you may be sold out when you would have been better off hanging on. Secondly, if the market drops very rapidly and hits your stop, by the time the order is executed the price may have dropped below your sell point. Alas, not much on Wall Street carries a 100% guarantee.

In Many Cities, Real Estate May Be Set To Rise

All the activity in the stock market of late is masking some improving numbers in the housing market. Although the real estate outlook overall is still poor, in some areas prices for rental residential properties have fallen so far that for the first time in nearly 20 years they can “pencil out.” That is to say, the rents they generate can cover the mortgage payments, taxes and maintenance costs – plus provide a positive cash flow to the buyer.

The tax breaks that go with real estate investments —and the potential for long-term appreciation from today’s depressed levels— make real estate even more attractive. In addition, the collapse of the late great housing boom is pushing many new people into the rental market.

As with the stock market, it may be a decade or more before residential real estate gets back to where it was during the boom. But you won’t need a full recovery to make excellent profits. Thanks to the leverage in most real estate investments, only a partial rebound could still double your money.

For example, if you buy a $300,000 duplex with a 20% down payment, the deal will cost you $60,000. Your duplex would only need to appreciate to $360,000 for you to double your money. Meanwhile, the renters will pay the bills.

One way to enter the rental residential real estate market is with experienced partners. In most communities there are groups of people who have been buying properties together for many years. With more attractive deals becoming available, and with credit now very tight, many partnerships should be happy to accept new members. Your attorney, or a seasoned real estate broker, should be able to make the necessary introductions.

The Bottom Line

Investors have been through the mill during the past year. However, we think the disheartening losses paved the way for a dramatic rebound. The upturn may be starting now, or it may not come until later – but it’s on the way. To make the most of it, you will need to put money in the market while most investors are too nervous to leave the sidelines.

Your safest bets are the blue chip stocks we have been recommending for months. More aggressive investors should also consider some of the oversold banking stocks that have been performing well of late. Although the risks are high with the banks, we think the potential rewards are even higher. You can stack the odds further in your favor by using stop loss orders religiously.

Residential rental real estate is also starting to look good in many markets. Ignore the naysayers who suggest that there is no money to be made because it may be ten or fifteen years before prices return to their 2006/2007 highs. As we explained in our discussion, you don’t need a big rebound to make a good real estate investment pay off handsomely.