AIA Advocate for Absolute Returns : Ben Bernanke

Week of 10/09/2008

Research & Editorial Staff — Thu, 09 Oct 2008 14:47:00 GMT

Bargains Are Starting To Appear
A Bottom Fishing Check List
The Bear Isn't Finished Yet
Big Drops Lead To Big Rebounds
Financial Stocks Attract More Attention
There Is One More Shoe To Fall
The Biggest Question: Will The Bailout Work?
The Bottom Line This Week

Wall Street's thrill ride continued over the past week as investors made king-sized moves after every drop in the economic outlook. By the time the closing bell rang on Friday, the Dow and the Nasdaq were down 7.3% and 10.8% respectively. A good time was definitely not enjoyed by all.

Once again, investors saved their biggest gyrations for the following Monday when the market plunged some 800 points. Fortunately, the market regained 430 points before the end of the day. Stocks resumed their slide on Tuesday and Wednesday when they fell a total of 689 points.

Bargains Are Starting To Appear

It is encouraging to see that most of the big market drops are starting to attract bargain hunters, including big hitters such as Warren Buffett. That's not surprising since many stocks are clearly oversold when measured against their long-term potential.

We were delighted to see that one of the stocks Mr. Buffett picked for a multi-billion dollar investment was General Electric, a company we started to accumulate in February. Other stocks the value investors are buying include Burlington Northern, Cisco Systems, Coca-Cola, IBM, Kraft Foods, Hewlett-Packard, Intel, Procter & Gamble, and Pfizer – all of which have been recommended in The AIA Advocate.

A Bottom Fishing Check List

In times like these when the bear is still raging, successful bargain hunters don't take undue risks. Although they venture into the storm, they only buy stocks when the odds of winning appear to be solidly in their favor.

The first thing the bottom fishers look for is lots of cash and very little debt. With a strong balance sheet, a company can make it through a tough period even if it lasts quite a bit longer than expected.

The odds of success rise higher if the companies provide products and services that people need even when times are bad. Food, drug, and basic retailers are favorite choices.

Of course, stock fundamentals must also be right. A good rule of thumb is to find companies with price to earnings ratios that are close to their historic lows. For example, the P/E for SuperValu (SVU) is currently an attractive 7.3. By contrast, the P/E for Amazon.com (AMZN) is a stratospheric 42.6.

It's also highly desirable to get some income while waiting for the big payoff. Comparing SuperValu and Amazon again we find a 3.3% dividend and none at all, respectively.

The Bear Isn't Finished Yet

With all the fear we see in the market today, we doubt that stocks will turn around any time soon. First there needs to be a stomach churning washout, an ugly process Wall Street calls capitulation. It occurs when investors become so discouraged they keep selling stocks no matter how cheap they are becoming. When the last of the stragglers are out of the market, stocks will finally stop sinking.

Once a floor has been reached, smart money will begin to come in from the sidelines where it was waiting patiently for months. The influx of cash will solidify the market bottom and lay the groundwork for a recovery.

Currently, the market's partial rebounds after every drop indicate that the capitulation phase of the downturn is still to come. When it finally arrives, we hope you look beyond the carnage and remember the event marks the end of the bear market.

Big Drops Lead To Big Rebounds

Although the final stock market shakeout is still on the way, we continue to think you should begin to do some cautious value buying. Dr. Steve Sjuggerud of DailyWealth (www.dailywealth.com) looked at 150 years of stock data and found that over the past 70 years, there was only one time that the market turned in a worse 12-month performance than the period that's currently ending. (Assuming that stocks finish October about where they are now.)

Dr. Sjuggerud also found that when stocks had a terrible 12 months, they usually followed up by having 12 very good months. The only exceptions were after the dot-com bust and the Great Depression. However, stocks were at record highs during those two times, which is certainly not the case today.

There is one caveat: the relationship between year-long declines and recoveries only applies for the worst 12 months in a bear market. We may not be there yet.

Financial Stocks Attract More Attention

We were pleased to see the article, Financial Stocks, Yes Financial Stocks, To Consider in Barron's this week. As you undoubtedly recall, we have been recommending the group since the meltdown slashed their prices over the summer.

The only place we would differ with the Barron's article is with the stocks that were mentioned. Since many additional banks and S&L's are likely to fail before the blood bath is over --and it is impossible to know with certainty which ones they will be-- we think picking individual issues is not the best way to proceed.

Instead, we continue to recommend the Fidelity Select Financial Services Fund (FIDSX). http://finance.yahoo.com/q/bc?s=FIDSX When the sector rebounds, so will the fund, no matter how many firms don't make it through the shakeout.

There Is One More Shoe To Fall

Right now, the world is understandably focused on the financial service industry. In its shadow, however, another giant sector is starting to look weak: consumer spending. Because consumers account for about 2/3 of our economic growth, if they curtail their spending significantly the downturn will intensify.

Unfortunately, Joe and Sally MidAmerica are starting to grip their pocketbooks more tightly. The big three automakers saw their sales decline about 30% last month. Most shopping malls are also seeing sharp reductions. If the trend continues through the winter holidays, we could see the first quarterly drop in consumer spending in nearly two decades.

The bright spot in the consumer picture is most Americans are being frugal because they are scared, not because they don't have the means to buy what they want. If the federal rescue program appears to be working, millions of Americans will breathe a sigh of relief and go shopping again.

The Biggest Question: Will The Bailout Work?

We believe the government's efforts to turn the credit crisis around can work, but only if it is greatly expanded. Here's what most economists think should be done:

First, the big banks aren't the only financial service firms that are in trouble. Many regional banks, credit unions, savings & loans, and hedge funds are also on shaky ground. Collectively, they are worth more than the giant firms that are in the news every day, and they also need a lifeline.

In addition, the collapse of subprime, no-document, and ninja (no income, no job, no assets) mortgages started the credit crisis, but they aren't its only problem. Also at risk are countless short term loans that individuals and businesses make to each other. Bank to bank loans are also drying up. All these sources of capital are essential to the smooth functioning of our economy, and must resume.

It appears the government is starting to include additional financial service firms and types of loans in its rescue program. On Tuesday, Fed Chairman Bernanke announced a plan to buy large amounts of short-term debt in an effort to get lenders to make credit available again. On Wednesday, the Fed also lowered interest rates ½ point. Other measures are undoubtedly on the way.

The final bailout cost, of course, will be well above the initial $700 billion allocated for the rescue effort. In fact, the language in the law clearly states that $700 billion is the limit that can be spent "at any one time." Some economists think the total bill could be three times the initial figure. By this time next year we should know what the final tally is likely to be, and whether the massive spending is having the desired effect. Keep your fingers crossed.

The Bottom Line This Week

The financial service crisis appears to be moving faster than the government can keep up. One analyst referred to the rescue program as a "whack a mole" strategy. However, the money that Washington is spending should begin to take effect within a few weeks.

Meanwhile, some stock bargains are appearing. We think investors should start to make some cautious purchases over the next several months. Financial, food, drug, and basic retailers look the most attractive now.

Week of 10/02/2008

Research & Editorial Staff — Thu, 02 Oct 2008 16:38:00 GMT

A Nasty, But Not A Calamitous, Stock Plunge
Our Contrary Opinion
A Cure For The Crisis Is Already Being Applied
It's Time To Do Some Cautious Buying
Stock Buyers Should Sip, Not Gulp
The Bottom Line This Week

People who enjoy excitement must envy investors right now. Not even thrill seekers who travel to New Zealand for the world's highest bungee jump have anything on us. When it comes to big bounces, Wall Street is the place to be.

On Monday of this week, we completed the jumping part of the stock market's bungee experience. The rebound on Tuesday was nearly as exhilarating. Wednesday, thank goodness, was a quiet day of recuperation.

Of course the rubber cord could break at any time, in which case the game will be over. However, that seems very unlikely. If a crash was in the works, we think it would have happened on Monday when deep pessimism was rampant.

The market action we are having now is all the more exciting because there was no hint of it last week. The Dow dropped a tepid 2.2% while the Nasdaq just about doubled it with a 4.0% decline. It was barely enough to be a good warm-up for this week's main event.

A Nasty, But Not A Calamitous, Stock Plunge

On Monday, as everyone must know by now, the Dow and the Nasdaq plummeted 778 points and 200 points respectively. Pundits, of course, were quick to point out that the Dow's move was the "biggest stock plunge in history!"

That's true, but as Paul Harvey liked to say, "Heeeeere's the rest of the story:"

In percentage terms the Dow's plunge represented just under a 7% drop. By contrast, the Dow fell 23% on October 19, 1987, which was over three times the size of the hiccup we had this week.

Pundits also gleefully point out that the drop erased all the gains stocks made in the past eight years. Well, that's also true. However, eight years ago was the top of the tech and dot-com bubbles, which was hardly a proper place to begin a measurement. If we start from the market's bottom after the bubbles burst, stocks are up nearly 40%, plunge and all.

Our Contrary Opinion

Many articles about the financial crisis predict it will lead to a near-total meltdown of the U.S. economy. Credit will be unavailable, business will grind to a halt, consumers will stop spending money, and civilization as we know it will end. It's about the darkest outlook possible.

For such a scenario, the Monday-Tuesday stock decline seems mild. If the world is really in as much trouble as so many dire projections suggest, a much larger drop would have been likely. Either the outlook for the economy isn't anywhere near as bad as many writers believe, or investors don't understand the gravity of the problem.

We doubt the latter is the case. On the contrary, history shows that investors have a much better grasp of the future than professionals. That's not surprising because investors put money on their predictions, which tends to focus the mind.

Lastly, if we look at the market action on Monday and Tuesday together, we have another reason not to take poison. Our arithmetic shows the 778 point drop and the 485 point rebound left us with a 293 point decline, which was far from a disaster.

A Cure For The Crisis Is Already Being Applied

We are not in any way suggesting that the financial turmoil isn't serious. It is the most threatening event we have seen in many years. But we think Congress and market forces will restructure our financial system without killing the American dream.

In fact, the process has already started. In January, the Fed arranged for Bank of America to acquire Countrywide. Six months later BOA took over Merrill Lynch. In March, JP Morgan Chase was persuaded to rescue Bear Stearns.

Earlier this month, Uncle Ben Bernanke also paired JP Morgan Chase with Washington Mutual. On Monday of this week, Citigroup took over Wachovia. More "strategic alliances" are undoubtedly on the way, particularly with regional banks that are also having liquidity problems.

Even before the financial crisis hit, banking insiders predicted that a wave of consolidation was on the way. Guess who was expected to lead the charge? The list was headed by none other than Bank of America, JP Morgan Chase, and Citigroup. Recent events simply appear to have accelerated the buyout cycle. It also gave the buyers much better prices.

It's Time To Do Some Cautious Buying

Speaking of better prices, the best time to buy stocks is when everybody else wants to sell them. As uber-investor Warren Buffett once said, "We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful." He went on to say, "You must have a willingness to do something when everyone else is petrified. You must learn the lesson of following logic over emotion."

With the advice of "The Sage Of Omaha" in mind, we suggest that you consider the following blood-in-the-streets investments:

Financial Services

The low prices the large financial service firms paid for their acquisitions should lead to king-sized profits once the current troubles are over. But, with the financial crisis dominating the headlines, the leading bank companies are currently dirt cheap.

As a result, we are even more bullish on the long-term outlook for the Fidelity Select Financial Services Fund (FIDSX). http://finance.yahoo.com/q/bc?s=FIDSX Remember, this is a managed fund, which means its portfolio will hone in on the winners as they emerge. The fund already holds substantial positions in Morgan Stanley, JP Morgan Chase, Bank of America, and Citigroup. All of them are in the Wall Street doghouse because they also purchased many bad mortgages and ran into trouble. But the surviving banks are now starting to make up for their mistakes.

The Fidelity fund is down 46.5% from its October 2007 high, and it is off 26.2% this year. We think the steep discount makes the fund attractive for long-term portfolios. It should be a particularly good performer in retirement accounts.

Bond Funds

Bond funds also look good. On Monday, market psychologist Brett Steenbarger of TraderFeed (www.traderfeed.blogspot.com) pointed out that the iShares Investment Grade Corporate Bond Fund (LQD) lost 20% of its value over the past three weeks. http://finance.yahoo.com/q/bc?s=LQD Investors are worried that the companies whose bonds are in the fund will not be able to make their interest payments. We think that threat is greatly overstated for investment grade bonds.

To see how irrational bond fears have become, the iShares High Yield Corporate Bond Fund (HYG) is also down 20%. It's ridiculous to price the two very different classes of bonds the same way. It's all the more reason to think the investment grade fund is a classic case of the baby being thrown out with the bathwater.

Multinational Blue Chips

We will also repeat our recommendation of the iShares Dow Jones Select Dividend Index (DVY) that tracks the 100 highest-yielding stocks in the Dow Jones Total Market Index. http://finance.yahoo.com/q/bc?s=DVY&t=1y

When investors start to tiptoe back into the market following a scare, the first place they go is to high-yielding blue chip stocks. As a result, big stocks should be especially good performers at the same time they offer investors a high degree of safety.

Stock Buyers Should Sip, Not Gulp

If you decide to do some cautious bottom fishing, please proceed slowly. The financial crisis is far from over. We may see several more scares in the coming weeks. If you hold some cash back from your first venture into the market, you may see even better prices later on.

In any event, the best investment strategy during times of great turmoil is to buy a little bit after every significant market decline. That will leave your ultimate returns far higher than will be true for people who chase the rallies.

The Bottom Line This Week

The past three weeks have not been much fun. However, Mother Market has a way of rewarding investors who stick with her system over the long term. The greatest returns go to people who find the courage to buy stocks when they are out of favor and they are the least expensive, as is the case today.

Three investments that currently look very attractive are the Fidelity Select Financial Services Fund, the iShares Investment Grade Corporate Bond Fund, and the iShares Dow Jones Select Dividend Index. All of them have been top performers in the past, and they will almost certainly be top performers in the future.

AIA Advocate for Absolute Returns : Ben Bernanke

Week of 10/09/2008

Bargains Are Starting To AppearA Bottom Fishing Check ListThe Bear Isn't Finished YetBig Drops Lead To Big ReboundsFinancial Stocks Attract More AttentionThere Is One More Shoe To FallThe Biggest Question: Will The Bailout Work?The Bottom Line This Week

Bargains Are Starting To Appear

A Bottom Fishing Check List

The Bear Isn't Finished Yet

Big Drops Lead To Big Rebounds

Financial Stocks Attract More Attention

There Is One More Shoe To Fall

The Biggest Question: Will The Bailout Work?

The Bottom Line This Week

Week of 10/02/2008

A Nasty, But Not A Calamitous, Stock PlungeOur Contrary OpinionA Cure For The Crisis Is Already Being AppliedIt's Time To Do Some Cautious BuyingStock Buyers Should Sip, Not GulpThe Bottom Line This Week

A Nasty, But Not A Calamitous, Stock Plunge

Our Contrary Opinion

A Cure For The Crisis Is Already Being Applied

It's Time To Do Some Cautious Buying

Stock Buyers Should Sip, Not Gulp

The Bottom Line This Week

Bargains Are Starting To Appear
A Bottom Fishing Check List
The Bear Isn't Finished Yet
Big Drops Lead To Big Rebounds
Financial Stocks Attract More Attention
There Is One More Shoe To Fall
The Biggest Question: Will The Bailout Work?
The Bottom Line This Week

A Nasty, But Not A Calamitous, Stock Plunge
Our Contrary Opinion
A Cure For The Crisis Is Already Being Applied
It's Time To Do Some Cautious Buying
Stock Buyers Should Sip, Not Gulp
The Bottom Line This Week