Association for Investor Awareness - Week of 02/26/2009

Research & Editorial Staff — Thu, 26 Feb 2009 14:43:00 GMT

In This Issue:

The Federal Bailout Is A Mixed Bag
Capitulation May Have Been Reached
Some Blue Chip Stocks Will Win Blue Ribbons
A Speculation Is Also Attractive
Gold Regains Its Appeal, But There Are Problems
An Economic Indicator That We Can Love
The Bottom Line This Week

Since our last newsletter on January 29, the stock market took a sharp turn for the worse. In fact, calling it a "turn" is an understatement. "Plunge" would better describe the 9.6% and 4.4% declines in the Dow and the Nasdaq. The slide left the market at a 12 year low.

Curiously, the plunge isn't due to another panic. At this point in the long bear market, most investors are too tired to sprint for the exits. Instead, many of them are dropping their gear and are simply walking off the field.

The Federal Bailout Is A Mixed Bag

Although we wish it were otherwise, we think the market will continue to drop until values become so attractive that they can no longer be ignored. Last month we thought that point had been reached, but the combination of poor economic news and a poorly executed federal bank rescue program sent another wave of discouraged investors to the sidelines. Most people now think the feds are "just winging it" and they won't be able to save the banks or the economy after all.

Overlooked during all the worries about the bank bailouts are other parts of the $787 billion federal package. Many of the individual programs have proven to be effective economic boosters during past downturns. About $315 billion will go towards education and job training. Nearly $190 billion will be spent on direct aid to states. Another $236 billion will go to tax breaks for families, renewable energy credits, and a temporary fix for the dreaded AMT. Most of that money will flow into the economy within a year.

Nevertheless, it now looks as if the economy may not begin to dig itself out of its hole until early 2010. That's not a huge setback from the late 2009 prediction that was becoming common. However, there is a big psychological difference between 2009 and 2010 that is having an outsized impact on investors. As we said earlier, many people don't want to stick around the stock market much longer.

Capitulation May Have Been Reached

The dark mood that is rapidly spreading on Wall Street may have a positive ending. As we said in a previous newsletter, bear markets rarely end until most investors are thoroughly discouraged, and they pull out of the market. Once the capitulation stage is reached, stocks typically start to move up again. Moreover, the final recovery doesn't turn into another bear trap. Instead, it just keeps going.

No one can know if the latest stock plunge marks the bottom of the severe bear market. However, with stocks down nearly 50% from their highs, we are almost certainly closer to the bottom than we are to the top.

Some Blue Chip Stocks Will Win Blue Ribbons

As a result, we continue to urge investors to use this opportunity to buy the bluest of the world's blue chip stocks for prices we have not seen in nearly two decades. Dozens of top-quality companies with very bright futures are in the bargain basement. If you don't make use of this unprecedented Wall Street sale, we think you will kick yourself within a few years.

JP Morgan Chase (JPM) is a case in point. http://finance.yahoo.com/q/bc?s=JPM Unlike most of its rivals, the company is solidly profitable. Not only did the bank stay in the black last year, it is making money now in the toughest economy we've had in recent memory. That's an enormous achievement that shows the underlying strength of this multinational powerhouse.

Nevertheless, JPM is down 54% from the high it reached during the boom. Investors are so afraid of the banking industry, they don't even want to own the best of the group. That shortsightedness is creating an opportunity for more reasoned investors to pad their long term portfolios with this world-class bank at a very low price.

Archer Daniels Midland (ADM) is another multinational blue chip that is ridiculously cheap. http://finance.yahoo.com/q/bc?s=ADM The company is in Wall Street's dog house for two reasons, neither of which will last more than a year or so. First, the slow economy is starting to hit food sales. Secondly, the company's ethanol business has been put in mothballs because oil prices collapsed from $149 a barrel to just $39.

However, food sales are projected to increase worldwide as governments make giant-sized purchases later this year to satisfy their hungry populations. Moreover, most of the money will go for bulk foods, which is the core of ADM's business.

Energy prices will also rebound once the global economy begins to recover. Because oil reserves were drawn down quite a bit during the recent economic boom, when demand picks up again prices should rise even faster, and probably go higher, than they did last time. When it happens, Archer Daniels Midland will be able to put its ethanol business back on line.

A Speculation Is Also Attractive

Even some stocks that are under a cloud are worth your consideration. It's all a matter of the risk/reward balance they offer. If prices are so low that the downside is very small, and the upside could be huge, it can make sense to make small purchases.

Ford (F) is one such stock. http://finance.yahoo.com/q/bc?s=F Unlike Chrysler and General Motors, Ford has not asked for a handout. In addition, critics are all agog about the new 2010 Ford Fusion hybrid family sedan. USA Today called it "the best gasoline-electric hybrid yet." And it has "the industry's smoothest, best-integrated gas-electric power system." Car and Driver put the Fusion up against the Camry Hybrid, the Chevy Malibu Hybrid, and the Altima Hybrid and said "it topped the others…."

Lastly, Ford would obviously be helped if its rivals need to pare back production to stay afloat. GM already plans to dump its Saturn, Saab, and Hummer brands, and Chrysler may not survive at all.

Gold Regains Its Appeal, But There Are Problems

The sinking stock market, poor fixed income returns, possible bank failures, and weak currencies, are prompting countless investors to buy gold as a last refuge. On February 20, the price of the metal came within $25 of reaching its all time high of $1,030 set in March 2008.

Many bulls are convinced that gold will continue to rise in the coming months. They correctly point out that in inflation adjusted dollars, the metal would need to reach $2,200 just to match the price it briefly hit in 1980. Of course, just because gold soared 28 years ago is no guarantee that it will do so again.

In fact, many gold critics say if the metal isn't blasting through the ceiling now, it probably never will. They argue that the economy is in much worse shape than it was in 1980, and so is the outlook for many financial institutions. So they ask, what is gold waiting for? One of our group quipped that if conditions must get twice as bad as they are now to make gold twice as expensive, we will all be back in the stoneage.

Gold's biggest liability is it doesn't do anything. It doesn't make products, grow crops, or otherwise add to the world's real wealth. That's why it almost always sinks when the economy is strong enough to support productive activities.

We think gold makes sense for part of an investor's portfolio, but don't plan on a long hold. For most people, the best way to buy the metal is with the SPDR Gold Trust (GLD) that holds over 1,000 tons of the stuff. http://finance.yahoo.com/q/bc?s=GLD The ETF is easy to buy and sell, there are no storage or theft issues to deal with, and it mirrors the price of gold almost to the penny.

An Economic Indicator That We Can Love

According to the Bespoke Investment Group, http://bespokeinvest.typepad.com/bespoke/ one of the most accurate of the non-traditional stock market indicators is the annual Sports Illustrated Swimsuit Issue. Over the past 30 years, an American has been on the cover of the issue 16 times. In 13 of those years the gain in the S&P 500 was a whopping 81.3%. Overall, the average was a still-healthy 10.6%.

We've decided that the indicator's sterling track record shows that we should pay more attention to the Swimsuit Issue. Accordingly, we have ordered several copies for our analysts that we will examine closely for clues to the economy. We never tire of working for your welfare.

The Bottom Line This Week

The stock market declined sharply last month when investors lost faith in the government's ability to save the banks and turn the economy around. The sour mood feels very much like a classic bear market washout that is typically followed by a rebound.

Although there is no guarantee that the same happy event will happen this time, we think many stock values have become too attractive to ignore. Looking particularly good to us are JP Morgan Chase and Archer Daniels Midland. More aggressive investors should consider Ford, a stock that might deliver extraordinary gains as America's only surviving automaker.

AIA Advocate for Absolute Returns : Bailout, Blue Chips, Capitulation