Association for Investor Awareness - Week of 10/23/2008

Research & Editorial Staff — Thu, 23 Oct 2008 17:11:00 GMT

In This Issue:

It's Too Early For A Sustained Rebound
But, There Are Finally Some Signs Of Relief
What Everybody Knows Is Often Wrong
Another Contrary Economic Outlook
Cheaper Energy: The World's Biggest "Tax" Cut
This High Yield Investment Looks Good
The Bottom Line This Week

Mother Market took pity on investors last week when she tossed a few points our way. Actually, it was more than just a few. The total for Monday and Thursday came to a whopping 1338. Since she took back "only" 937 points, the Dow and the Nasdaq ended the period up a welcome 4.8% and 3.8% respectively.

When the closing bell finally rang on Friday and the week's gains were locked safely away, some of us let out a happy little "hurray." However, our killjoy number cruncher pointed out that with so many wild swings happening every week it was inevitable that the market would occasionally end on a high point. In other words, the bounce could have just been a random event. Rats!

On Monday of this week the market jumped another 413 points, but it gave back 746 points on the following two days. Oh well, the mini-rally was fun while it lasted.

It's Too Early For A Sustained Rebound

Although we were disappointed, we were not surprised that the bounce didn't last very long. There are still too many buyers around to think the bear market has run its course. As we said two weeks ago, the real recovery is unlikely to arrive until the last of the bulls have been chased away. That day is probably still several months ahead of us.

History also suggests that valuations need to rise before a sustained rebound will occur. To be sure, there are now some very attractive stocks on the bargain table. Chubb (CB) has a P/E of 7.2 and a 3.0% dividend yield. Pfizer's (PFE) numbers are 13 and 7.6%. For Merck (MRK) the teasers are 12.3 and 4.9%. It's becoming a long list.

However, most stocks have merely gone from sky high to fairly priced, which suggests they have further to fall. In most bear markets, the P/E ratios for the Dow blue chip stocks usually drop to 10 or less before they make a major rebound. At the present time, the Dow's P/E is 15.7.

But, There Are Finally Some Signs Of Relief

Nevertheless, some encouraging developments are starting to appear. An increasing number of banks are beginning to loan money to their most credit-worthy customers. Banks are also beginning to loan money to each other which helps make credit available where it is needed most.

In addition, many pension funds, insurance companies, universities, and corporations are starting to provide funds to businesses. Interest rates are also coming down a bit. It all points to a slow restoration of the credit system upon which our economy depends.

However, there is another problem with the credit crisis that is rarely discussed. In today's slow economy, many companies are putting their expansion plans on hold. As a result, the demand for credit is falling. If that trend continues, it won't make much difference if more money becomes available.

What Everybody Knows Is Often Wrong

When it comes to economics and investing, what "everybody knows" is often wrong. In fact, the greater the consensus about a particular outlook, the more likely it is that just the opposite will occur.

Oil prices are a recent case in point. Only three months ago, everyone from Nobel economists to Joe and Sally MidAmerica was certain that high priced oil was here to stay. Many of the most experienced people on Wall Street were equally certain that oil would reach $200 a barrel by the end of the year. Those outlooks seemed completely reasonable at the time.

Nevertheless, oil prices soon collapsed. Today oil is selling for only $70 a barrel, a 53% decline from its peak.

Another Contrary Economic Outlook

A small but growing number of economists are now beginning to think the widespread doomsday outlook for the credit crunch and the economy is also dead wrong. We spotlighted the idea last week when we wrote about Casey B. Mulligan, a professor of economics at the University of Chicago who said, "...the economy doesn't really need saving. It's stronger than we think." And, "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."

This week, Gene Epstein at Barron's wrote a two page article titled "Sorry, Chicken Little" that also cast doubt on the growing belief that the economy is doomed. He acknowledged that a recession seems inevitable due to the credit crisis and lower home values. But Mr. Epstein also said, "...it's possible that the downturn could prove to be one of the briefest and mildest on record." Talk about a contrary opinion!

Cheaper Energy: The World's Biggest "Tax" Cut

Mr. Epstein's main argument is the huge plunge in oil prices represents a massive booster shot for the economy that will soon begin to take effect. Not only is cheaper energy a benefit by itself, it should also bring down many other prices.

The first recipient of energy relief will be the American consumer who now has more money to spend than was true a few weeks ago. In many households, the savings totals several hundred dollars a month. As people begin to spend some of the money, inventories will be reduced, manufacturers will need to ramp up again, wages and employment will benefit, and so on.

To that happy outlook we will add that a reduction in scary news about bailouts and rescue packages should also help increase consumer spending. As we mentioned in a previous issue, Joe and Sally are mostly staying away from the mall because they are scared, not because they have no money.

The Fed is also trying to get Congress to play Santa Claus by sending another round of checks to individual Americans. The stimulus package we had earlier this year had a measurable impact even though most people put most of it into savings. With the holiday season right around the corner, the better part of a second helping of federal money will probably be spent.

Lastly, the economy will also receive a modest boost if the Fed lowers interest rates another half percent, as is widely expected. Such a reduction would leave the rate at 1%, a level that proved to be a magic charm when Alan Greenspan used it in 2003. This time around, the impact of cheaper money may be less because lending is slow for reasons other than interest rates. Still, a reduction would be an added stimulus to growth.

We are not trying to be Pollyanna. Huge economic problems remain, and they will take a toll. However, the end of the world may need to be postponed. If so, a stock market recovery may be closer than most analysts expect.

This High Yield Investment Looks Good

One investment that won't be helped by ultra-low interest rates is fixed income returns. Consequently, if your bonds and CD's will soon come due, they should be rolled over to longer term securities to lock in today's higher returns.

Alternately, readers might consider putting some of their money in high quality investments that have good dividend yields. We think one of the most attractive is Kinder Morgan Energy Partners LP (KMP). http://finance.yahoo.com/q/bc?s=KMP

Kinder Morgan is a master limited partnership that owns and operates over 25,000 miles of oil, natural gas, and fuel pipelines in the U.S. The company also has 150 terminals that store and transport petroleum, petrochemicals, coal and other bulk items by rail and truck.

Although energy prices are off sharply, KMP owns very little of what it pumps. As a result, KMP's price held up well while energy was dropping from $149 to $70. The price did drop sharply when the stock market fell out of bed recently, but it is now rebounding strongly.

Kinder Morgan is attractive because it currently yields 7.9%. Moreover, dividends have been increased for 12 years in a row and have been paid since KMP was formed in 1992. That's an excellent track record.

The kicker is that Kinder Morgan should also appreciate in price in the coming years. All in all, KMP appears to be ideally suited for the current conditions in the stock and fixed income markets.

The Bottom Line This Week

The dark cloud that hangs over the economy and the stock market opened up a bit over the past week. Although many serious problems remain, there are reasons to be optimistic that they are slowly being resolved. Some analysts think the process will take less time than is generally believed.

Meanwhile, several investments offer dividend yields that will keep investors warm while they wait for brighter days to come. Kinder Morgan Energy Partners LP looks especially attractive.

AIA Advocate for Absolute Returns : Recession, Oil Prices, High Yield