AIA Advocate for Absolute Returns : Stock Values

Association for Investor Awareness - Week of 04/29/2010

Research & Editorial Staff — Thu, 29 Apr 2010 20:11:00 GMT

Special Report

Protect Your Stocks From A Correction

In This Issue:

A Stock Market Downturn Is Overdue
Stop-Loss Orders Can Save A Portfolio
Safeguard Your Blue Chips With LEAPS
Some Funds Go Up During Downturns
We Don't Recommend Short Sales
An All-Weather Fund For Cautious Investors
The Bottom Line This Week

Since the bull market started last March 9, the stock market has been on a tear. For the 13 month period, the Dow rose 68.7% and the Nasdaq shot ahead 94.8%. After the unpleasant losses investors endured from late 2007 to early 2009, the rebound was especially sweet.

Although we think the bull market has further to go, we also think the near-term downside risks are becoming significant. Consequently, we are devoting this issue of the AIA Advocate to strategies that you can use to protect your portfolio while remaining invested for whatever additional profits are on the way.

A Stock Market Downturn Is Overdue

With the Dow now over the long-awaited 11,000 mark, nearly everyone on Wall Street is singing "Happy Days Are Here Again." One aggressive broker we heard about has the tune run softly in the background when he talks with his clients "to create the proper atmosphere."

Wall Street's army of cheerleaders aside, after its year-long run, a stock correction appears to be overdue, and it may be quite sharp.

However, there is so much money chasing stocks the run could also continue for quite awhile. If you cash out prematurely, you will miss out on any future gains – and they could be substantial. So what is a prudent investor to do?

Stop-Loss Orders Can Save A Portfolio

Fortunately there are several ways to stay in the stock market with reasonable safety. One of the best methods to protect your portfolio is to put stop-loss orders on everything.

Stops, as they are often called, are sell orders you place with your broker to be used only if your stock should decline to whatever safety level you chose. The orders cost nothing unless they are needed. They remain quietly in the background ready to pounce if your stocks start to slide.

To place a stop-loss order, simply pick a price you would like to get for your stock if it starts to move down. If the stock reaches your level, you will either get your price, or come close to it. Just be careful to pick a price that is outside the stock's normal trading range so it won't be sold prematurely.

There are three forms of stop-loss orders. A "stop market" order will be executed at the best price your broker's automated system can get if a stock falls to the point you specify. However, if the market declines quickly, your order might not be executed until the stock is below the level you picked. Nevertheless, you will be taken out long before most investors even know there is a problem.

A "stop limit" order works the same way, except your stock can only be sold at the exact price you specify. In most cases, stop limit orders work just fine. However, if it is not possible to get your price you won't be protected.

We think the finest protection of all are "trailing stops" that automatically move up as a stock rises. You can specify a percentage of the stock's price you wish to maintain, or you can choose a specific number of points. Either way, if the stock falls to your trailing stop, it will be sold automatically at the best available price.

Stop-loss orders have another big advantage investors don't usually notice until they start using them. Stops eliminate the need to make sell decisions when prices are falling, a task most investors don't do very well. Stop-loss orders make selling automatic, and painless.

Safeguard Your Blue Chips With LEAPS

LEAPS options can also be used to protect stocks that you think will go up in value, but could drop sharply if market conditions deteriorate. For such a stock, you could buy one downside LEAP option (called a LEAP Put) for every 100 shares you own.

If the stock falls to your strike price, or below, the profits you will make from the LEAP can offset your loss in the stock. If the stock rises instead, your LEAP will expire worthless. However, the loss from the LEAP won't prevent you from ending up with a nice profit if the stock goes up significantly.

LEAPS offer a simple and economical way to protect profits in a late bull market without selling the stock before the rally is over. We think LEAPS are very attractive right now and should be more widely used. They are available for nearly all blue chips traded in the U.S.

Some Funds Go Up During Downturns

There is another way to get some downside insurance at the same time you remain invested in the stock market for possible longer term growth. Two bear market mutual funds are designed to go up if the market sinks.

The Rydex Inverse S&P Strategy Fund (RYURX) offers broad protection against a stock market decline. http://finance.yahoo.com/q/pr?s=RYURX The fund is structured to move inversely with the S&P 500 index. The counter-cyclical action is achieved through the use of put options, short-sales, stock index futures and related strategies.

The ProFunds UltraBear Inverse Fund (URPIX) works the same way, but it is much more aggressive. http://finance.yahoo.com/q/pr?s=URPIX UltraBear also acts inversely to the S&P 500 - but it seeks to double the size of the moves. The fund uses the same investment vehicles as Rydex, but its managers purchase more of everything to gain the extra leverage.

Of course, the lever swings both ways: The bear market funds will decline quickly if the S&P 500 index rises. As a result, they are best used during uncertain times when the market could go either way, which seems to be the situation now. Once the break occurs, investors close out the losing position and let the winner run.

We Don't Recommend Short Sales

Some investors may wonder why we don't just sell weak stocks short, a strategy in which shares are borrowed from a broker and sold. The goal is to someday replace the borrowed stock at a lower price and pocket the difference.

The reason we don't make short sales, is very simple: the payoffs they offer rarely justify the risks they carry. Here's why:

When you buy a stock it can go up 100%, 200%, or more. There is no limit. In fact, investors who purchase high quality stocks, and hold them for many years, will often see breathtaking gains. Due to the power of compounding, many investors who appeared to be making only modest gains from their 30s to their 50s can suddenly find they are very wealthy by the time they reach 65.

With a short sale, however, the most a stock can do is drop to zero. That limits the potential return to a puny 100%. There aren't any three and four baggers, or more, with short sales.

On the other hand, there is no limit to the amount of money you can lose in a short sale if the stock turns around and goes up. Since you must eventually buy the stock to replace the shares you sold short, the pain could be extreme.

An All-Weather Fund For Cautious Investors

If you are tired of worrying about market reversals and how to deal with them, you may wish to consider putting some money into a good all-weather fund. We think the best of the lot is the Permanent Portfolio Fund (PRPFX). http://finance.yahoo.com/q/pr?s=PRPFX

As can be seen in its price chart, the fund rarely does as well as the stock market during booms, but it almost never does as badly during downturns. Instead, the fund seeks a happy medium and generates attractive long-term gains without taking undue risks.

The Permanent Portfolio Fund achieves its goals by investing primarily in precious metals, hard currencies, Swiss Confederation bonds, high grade corporate bonds, and stocks of leading energy and industrial material suppliers.

Although the fund sticks to a limited range of assets, the balance between them changes to suit the economic and investment outlook. The fund is currently configured to profit from rising inflation and a declining dollar. We think that strategy will pay off handsomely over the next few years.

The Bottom Line

After over a year of nearly unbroken gains, the stock market seems overdue for a correction. Since it has been awhile since the last one occurred, when the drop comes it may be larger than we usually see.

Investors who don't want to run the stock market rapids, but don't want to sell prematurely, can have their cake and eat it too with stop loss orders, LEAPS, and bear market funds. Among the latter we like the Rydex Inverse S&P Strategy Fund that performs well when the market drops. More aggressive investors should consider ProFunds UltraBear Inverse Fund.

Alternately, investors can put their money into an all-weather fund such as Permanent Portfolio Fund. It has an excellent long-term track record for delivering gains without pains.

Until Next Time

The AIA "Advocate For Absolute Returns", a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time...

Association for Investor Awareness - Week of 11/20/2008

Research & Editorial Staff — Thu, 20 Nov 2008 15:31:00 GMT

In This Issue:

Stocks Search For A Bottom
High Energy Prices Will Return
Commodities Will Also Rebound
Infrastructure Spending Is Likely To Soar
The Bottom Line This Week

Stocks stumbled badly again last week as deteriorating economic news caused another round of investors to throw in the towel. By Friday afternoon, the Dow and the Nasdaq were down an additional 5.0% and 7.9%. The declines left the two indices down 35.9% and 42.8% for the year. Ouch!

This week got off to an equally bad start. Although we had a 151 point gain on Tuesday, it was overshadowed by a 651 point slide on Monday and Wednesday.

Stocks Search For A Bottom

As we discussed in our October 16 issue, each additional market plunge marks another step in the capitulation process that must run its course before stocks can begin to recover. How long the selling will last, and how far the market will fall before the carnage stops, is anybody's guess. For the present, sentiment is overwhelming fundamentals.

What we do know, however, is most stocks are more attractively priced than they have been in over 20 years. We can also say that over a century of stock market history shows that investors will eventually price stocks at their proper values. That means we can start to purchase today's high quality bargains with a lot of confidence that they will pay off at some point in the future.

Three important developments look especially attractive now. We think each of them has the potential to significantly increase the value of your long term portfolio.

High Energy Prices Will Return

Contrary to what Joe and Sally MidAmerica may believe, the energy crisis is not over - it has merely been suspended due to the global economic slowdown. When demand picks up again, the world will go back to the tight supply/demand situation that pushed prices into the stratosphere earlier this year.

The numbers tell the story. Before the economy started to cool off, oil producers pumped 86 million barrels a day. At the same time, the world consumed 85 million barrels a day. The million barrel difference was the tightest supply/demand balance we've ever seen in a major commodity.

According to an article in Forbes, world oil demand has since fallen by 1.1 million barrels of oil a day. That small decline still leaves the supply/demand balance on a knife edge. It would not take a very big uptick in the economy, or a problem with supply, to push the world back into an energy deficit. Every expert we consulted expects to see it happen within a few years. Several analysts think that shortages may reappear by late 2009.

Astute readers might look at the data and wonder how such a small decrease in demand could create such a big plunge in prices. The answer is it couldn't do so by itself. However, during the first half of 2008 suppliers were so worried about a possible delivery interruption that they built up their inventories to record levels. The Saudi's even used retired oil tankers as depots.

As a result, when demand slacked off a few months ago the world suddenly found itself awash in oil, and prices plunged. Once the extra oil is gone, prices will start to move back up again.

Attractive Energy Investments:

We think the tight oil supply/demand situation is a great opportunity for long-term investors. One way to play the rebound is to invest in ExxonMobil (XOM), the world's largest energy supplier. http://finance.yahoo.com/q/bc?s=XOM

ExxonMobil is a highly diversified company that produces both oil and natural gas, much of which it turns into petrochemicals, fertilizers, plastics, and other products. The company also has interests in electrical plants that are fueled with XOM's energy.

Despite ExxonMobil's leading position in its industry, the stock now carries a low P/E of 8.2 and a forward dividend yield of 2.2%. All in all, we think XOM is greatly oversold.

Another company that should do exceptionally well over the next few years is Transocean (RIG), a stock we have recommended in the past. http://finance.yahoo.com/q/bc?s=RIG All the major oil producers report that they need to find additional supplies, and they are willing to spend many billions of dollars to get them. As one of the world's leading exploration and development companies, Transocean should capture a great deal of the new business.

Commodities Will Also Rebound

The outlook for raw materials and commodities is nearly identical to that for energy, and for the same reasons. Particularly with agricultural commodities and some industrial metals, the surpluses are not very large. The supplies will disappear quickly when growth starts to rebound.

Attractive Commodity Investments:

One company that is already bouncing back is Archer Daniels Midland (ADM), an old favorite of ours. http://finance.yahoo.com/q/bc?s=ADM From its 2008 low of $13.53, the stock is back to the mid $20 area - a move that occurred while the economy and stock market were dropping.

The ADM rebound should not be a surprise because many foreign economies are still growing, and so are their populations. Since ADM deals in inexpensive basic foods, including grains and oils, the company should remain on a growth track for as far ahead as we can see.

Yet to recover is another top-performing AIA Advocate pick, BHP Billiton (BHP). http://finance.yahoo.com/q/bc?s=BHP This leading supplier of industrial metals is more sensitive to the economy than ADM, but that means it should rise even more strongly when growth begins to pick up. Meanwhile, BHP has an incredibly low P/E of 5.7 and an eye-popping 5% yield.

Alas, the yield may decline later this year if lower earnings force the company to reduce its dividend. Nevertheless, we believe BHP is an excellent value that will be very rewarding in long-term accounts.

Infrastructure Spending Is Likely To Soar

Last week we discussed how President-elect Obama is likely to affect the U.S. economy. He has since announced that one of his first moves will be to boost spending to upgrade and expand America's woefully out-of-date infrastructure. Besides fixing serious problems, the projects will create countless jobs and pump badly needed cash into the economy.

One of the first projects will be to upgrade and expand our antiquated electrical grid. As many readers may have experienced first hand, the system is so strained that large regions of the country have been plunged into darkness due to relatively minor equipment failures.

Another reason the grid must be upgraded is much of it is unable to handle the additional power that will be produced by the new electrical plants that are scheduled to be constructed. Two solar and wind power projects have already been cancelled because the local grids could not handle the extra loads. This bottleneck must be removed before America can solve its energy problems.

Attractive Infrastructure Investments:

One company that is in the catbird's seat to profit from efforts to improve our electrical grid is General Cable (BGC). http://finance.yahoo.com/q/bc?s=BGC As its name suggests, the company is a major producer of high-capacity electrical wires that are used in power transmission systems worldwide. In addition, the company produces wires and cables that are used within electrical plants. Products are also supplied for many industrial applications.

General Cable looks especially attractive because it has been hammered by the slow economy and the stock market plunge. Its price is down 86% from its January high, which is out of proportion to its earnings decline from $1.11 to $1.07. Such an extreme sell-off can only happen during a market panic. When the sell-off ends, General Cable should move back up.

We also like the outlook for Quanta Services (PWR), a company that installs and maintains electric power transmission lines and power distribution networks. http://finance.yahoo.com/q/bc?s=PWR In addition, the company provides many services to the natural gas, telecom, and cable TV industries.

Quanta is also down sharply from the high it reached when the economy was booming. Although the outlook for continued profit growth this year has dimmed considerably, the stock appears to be greatly oversold for its longer term potential.

The Bottom Line This Week

In the current race for the exits, investors are tossing many high quality stocks aside no matter how good their long term prospects may be. Leading companies in the energy, commodity, and infrastructure sectors are especially attractive. However, we continue to urge everyone to buy stocks a little at a time because prices may go lower before they begin to turn around.

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.

Association for 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 : Stock Values

Association for Investor Awareness - Week of 04/29/2010

Special Report

Association for Investor Awareness - Week of 11/20/2008

Stocks Search For A BottomHigh Energy Prices Will ReturnCommodities Will Also ReboundInfrastructure Spending Is Likely To SoarThe Bottom Line This Week

Stocks Search For A Bottom

High Energy Prices Will Return

Commodities Will Also Rebound

Infrastructure Spending Is Likely To Soar

The Bottom Line This Week

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

It's Too Early For A Sustained ReboundBut, There Are Finally Some Signs Of ReliefWhat Everybody Knows Is Often WrongAnother Contrary Economic OutlookCheaper Energy: The World's Biggest "Tax" CutThis High Yield Investment Looks GoodThe Bottom Line This Week

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

Association for 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

Stocks Search For A Bottom
High Energy Prices Will Return
Commodities Will Also Rebound
Infrastructure Spending Is Likely To Soar
The Bottom Line This Week

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

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