Your Daily Profit

April 2, 2009

*****Recovery Hopes Spring Eternal

*****Public Private Investment Program 

*****Recovery Stocks

Fellow investor,

Unemployment numbers continue to rise, but investors are more focused on the hope that the economy has bottomed and may be positioning for recovery. At least for now.

Please note that I said “positioning for recovery.” Mortgage rates are down and that seems to be helping the housing market a little. Credit afforded by the Treasury aimed at removing toxic assets from banks is resulting in higher valuations for those banks.

But all of the steps that have been taken are in their infancy. How long will it take to work off the available inventory in the housing market? Will banks and private investors come to an agreement on acceptable prices for toxic assets?

These questions will be answered over time. And it should go without saying that there’s plenty of room for disappointment down the road.

*****The Public-Private Investment Program could create some very low risk profits for its participants. That’s because the Treasury and the Fed are shouldering most of the risk.

The first steps to enacting this program are being taken, as mark-to-market accounting rules are being eased. As it currently stands, balance sheet assets must be valued at a current market price.

But when it comes to mortgage-related assets, the current market is virtually non-existent. That’s true for two reasons. Obviously, with the housing market in the tank and foreclosures on the rise, there are legitimate questions as to the value of these assets. But value is also a question of leverage.

If you know someone must sell something, you have an advantage. You can offer a lower price because you know the seller is desperate; banks are obviously desperate. And there’s no doubt that current bids for toxic assets are low-ball offers.

Allowing the banks to value these assets at higher prices removes some of the desperation because that puts them in better position capitalization-wise. That, in turn, means there will be less low-balling going on.

We’ve seen a few entities agree to join Geithner’s Public-Private Investment Program, most notably Bill Gross’ PIMCO. That suggests there is value in these assets. But we’re going to need to see these assets change hands to really gauge whether the program is a success. And if there are delays and quibbling over price, the stock market could head sharply lower.

*****Even at current levels, there are attractive investments in the stock market. The sense is that even if the stock market moves lower, current valuations are attractive on a long-term basis. And if you believe the stock market has seen its lows, the downside is limited.

I’ve recommended a couple stocks in Daily Profit that should benefit from recovery expectations. They are Graham Corp (AMEX:GHM) and Hovnanian Enterpises (NYSE:HOV), oil services and a homebuilder.

Clearly there’s more risk with the homebuilder. But there’s also more reward, at least short term. We’ve seen that Hovnanian can make 15% to 20% moves in one day. In fact, it’s making one of those moves today. There is stiff resistance at $2 a share for Hovnanian.

*****Graham and other oil stocks are more directly tied to economic recovery. As the economy expands, oil prices will rise. But unlike the homebuilders, the oil stocks aren’t solely dependent on U.S. recovery. Emerging markets such as China and India also figure into the equation, and that’s why I say they are lower risk.

Even if the U.S. economy is slow to recover (which necessarily means homebuilders will be slow to move higher), the potential for oil demand to rise higher in China and India should make oil stocks more resilient.

Plus, there’s potential for a supply shortage in the next few years. Low oil prices have made many oil companies scale back their investments. That means new production isn’t coming on line as fast as it should.

nanian For now, that’s not a problem as demand numbers are depressed. But it’s easy to imagine demand rebounding quickly. That would expose any supply shortages and send oil prices and oil stocks much higher.

My advisory letter SmallCapInvestor PRO just dedicated a full issue to this potentially profitable situation. Plus, we recommended three small oil exploration stocks that could explode higher. They are currently priced between $0.80 and $2.60 a share. If you’d like more information on these stocks, please click HERE. 

That’s it for today. I’ll talk to you tomorrow.

Ian Wyatt

Editor

Daily Profit