AIA Advocate for Absolute Returns : Financial Stocks

Association of Investor Awareness - Week of 10/16/2008

Research & Editorial Staff — Thu, 16 Oct 2008 17:12:00 GMT

The Biggest Danger Now Is A Series Of Bear Traps
The Financial Crisis Has Further To Run
Some Bear Market Investments Have Promise
How Long The Bear Might Stick Around
A Contrary Economic Outlook
Another Shameless Plug For Blue Chip Stocks
The Bottom Line This Week

Stock volatility has become so extreme, we had to redraw the charts. Although there have been up and down days as large as those we have seen recently, never before have they come in such quick succession.

Last week, as everyone from New Guinea to New York must know by now, the Dow and the Nasdaq fell 18.2% and 15.3% respectively. That would have been tough enough by itself, but what made the week even more hectic is it contained a 679 point jump that many investors believed was the start of a reversal.

The market leaped forward again this Monday with a breath taking 936 point surge when U.S and European leaders decided on a coordinated financial rescue plan. Stocks took a breather on Tuesday. Then it plunged 733 points the next day on poor consumer spending data. We must expect more whiplash days as the credit crisis continues to unfold.

The Biggest Danger Now Is A Series Of Bear Traps

Although big market swings aren't much fun, they do show that investors are reluctant to quit the game. As we mentioned last week, however, bear markets rarely hit bottom until investors become so discouraged that they want nothing more to do with stocks. Until then, rebounds are likely to be traps for the unwary. Only when rallies become rare, can we begin to feel confident that the bear market has run its course.

The Financial Crisis Has Further To Run

The biggest reason we are not expecting a sustained stock market recovery any time soon is the credit crisis is far from over. Even with the billions (and possibly trillions) of dollars the government plans to inject into the financial service system, a turnaround will take months. In the meantime, more banks, S&L's, and hedge funds are likely to fail. The losses will almost certainly kill any stock rebounds that may get started.

The best strategy to use in a bear market is to buy high value stocks when the market is falling, and sell any lower value stocks when it is rallying. That way, when the bear cycle finally comes to an end, your portfolio will be heavily weighted with stocks that are likely to perform well during the next expansion.

Some Bear Market Investments Have Promise

More aggressive investors can also find profits while the market is dropping. Selling stocks or ETF's short is one way to go, but the strategy is risky. If the market goes up rather than down --and it gets away from you-- losses can be very high. If you do make short sales, you must be certain to protect your positions with stop-loss orders.

For most investors, the safest way to dance with the bear is with a fund that is structured to move contrary to the S&P 500 index. We think the most attractive is the Rydex Inverse S&P 500 Strategy Fund (RYURX) http://finance.yahoo.com/q/pr?s=RYURX . When Wall Street sinks, the Inverse S&P Fund will make you smile.

The ProFunds UltraBear Fund (URPIX) is equally broad in scope as the Inverse S&P Fund, but it is much more aggressive. http://finance.yahoo.com/q/pr?s=URPIX UltraBear also acts contrary to the S&P 500 - but it seeks to double the size of the moves. The fund uses the same investment vehicles as its more conservative cousin, but it purchases more of everything to gain extra leverage. Of course, the lever swings both ways: The UltraBear fund will decline quickly if the S&P 500 index rises. Neither of the Rydex funds charge a load.

The best strategy to use with a bear market fund is to buy it during the first big rally and hold it for the duration of the downturn. Trying to jump in and out of the fund with each market change is rarely successful. Staying with the dominant trend almost always pays the greatest rewards.

How Long The Bear Might Stick Around

As we said earlier, we doubt that the bear market will be going away anytime soon. But just how long might it be before the bull returns? More importantly, how long is it likely to take before the bull replaces the bear's losses?

In an attempt to shed some light on the subject, value investor Ali Khan took a look at the four biggest bear markets we had over the past 30 years. www.investmentplayground.net We put his research into a table that shows what we might expect from the current tug of war between the bear and the bull.

Bear Market	Duration	Percent Decline	Time To A Full Recovery
Jan 1973 - Oct 1974	21 months	57%	3.5 years
Aug 1987 - Dec 1987	105 days	35%	21 months
9/11 Terror Attack	28 days	21%	105 days
Mar 2002 - Sep 2002	173 days	29%	15 months
Average of first 4	234 days	35.5%	20 months
Oct 2007 - ?	264 days so far	40% so far	?

As you can see, the current bear market has already lasted 30 days longer and has fallen 4.5% deeper than the average. However, the crisis that triggered the current downturn was far greater in monetary terms than the previous four. It is most comparable to the severe bear market of 1973-74 when the market dropped 57%. If we see a repeat of that tough downturn, stocks will drop another 17%.

Of course, history rarely repeats itself. However, as Mark Twain observed, it often rhymes.

A Contrary Economic Outlook

You may recall that on several occasions during the past year we remarked that the economy was doing better than analysts expected. Even during the third quarter, when a recession was a forgone conclusion by nearly everyone, we noted that mainstream America was actually doing fairly well.

A few days ago, Casey B. Mulligan, a professor of economics at the University of Chicago, made a similar observation when he said, "...the economy doesn't really need saving. It's stronger than we think."

Prof. Mulligan made the case that "The non-financial sectors of our economy won't suffer much from even a prolonged banking crisis, because the general economic importance of banks has been highly exaggerated." He pointed out that pension funds, university endowments, venture capitalists, and corporations also provide large sums of money to businesses.

In addition, the average corporation gets about 25% of the funds it needs from its own cash reserves. If necessary, companies could get as much as three times that amount by cutting their dividends.

The professor also pointed out that banking services aren't about to vanish. To be sure, some banks are failing - but others are taking their places. If the survivors don't loan money, they won't last very long themselves. In any event, most businesses won't be hurt if the credit freeze lasts for a few quarters.

We think Dr. Mulligan is correct about the economy. His outlook certainly fits the pattern we have been seeing ourselves. If his prediction is correct, the stock market rebound could come a lot sooner than almost anyone expects.

Another Shameless Plug For Blue Chip Stocks

Whenever good times return, we are confident that the blue chips we have been recommending will be at the head of the Wall Street parade. As we have been reporting throughout this difficult period, many of our leading stocks are already doing better than expected.

Three of our companies that surprised investors over the past few days were General Electric (GE), Intel (INTC) and IBM. GE's profits fell 22% but they were above expectations. Intel turned in a 12% profit jump. IBM also said it will soon report an earnings increase.

But, as we mentioned earlier, wait to buy until rallies collapse and prices drop from the bargain basement to the liquidation table.

The Bottom Line This Week

Although the economy appears to be doing better than is generally believed, a recession seems likely that may last into the first quarter of 2009, and possibly further.

Rather than grumble about the slowdown, we think investors should use it to their advantage. Bear market funds such as the Rydex Inverse S&P 500 Strategy Fund look good for the near and medium terms. When their time at bat ends, many multinational blue chips are likely to score home runs.

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.

AIA Advocate for Absolute Returns : Financial Stocks

Association of Investor Awareness - Week of 10/16/2008

The Biggest Danger Now Is A Series Of Bear TrapsThe Financial Crisis Has Further To RunSome Bear Market Investments Have PromiseHow Long The Bear Might Stick AroundA Contrary Economic OutlookAnother Shameless Plug For Blue Chip StocksThe Bottom Line This Week

The Biggest Danger Now Is A Series Of Bear Traps

The Financial Crisis Has Further To Run

Some Bear Market Investments Have Promise

How Long The Bear Might Stick Around

A Contrary Economic Outlook

Another Shameless Plug For Blue Chip Stocks

The Bottom Line This Week

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

The Biggest Danger Now Is A Series Of Bear Traps
The Financial Crisis Has Further To Run
Some Bear Market Investments Have Promise
How Long The Bear Might Stick Around
A Contrary Economic Outlook
Another Shameless Plug For Blue Chip Stocks
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