3/14 Kelly Letter Topics
Weekly market review
Fed oversees banks
EU bails out Greece
China likes Treasurys
Consumers still down
CT suing Moody's, S&P
US AAA rating at risk
Strong retail sales
Topping oil prices
Index chart patterns
Households suffering
Market at 1150
What range top means
FMD shooting higher
Bluefin tuna ban
2010 EDITION
Much has changed; good investing has not
The Neatest Little Guide to Stock Market Investing, 2010 Edition
The market is still basing, although rising a little on end-of-quarter window-dressing moves. For newcomers, that means professional investment managers are selling losers and buying winners that have gone up in the last few months so their quarterly reports show them owning successful names, even though they didn't actually benefit from the good performances. The window-dressing buys are easier to detect than the sells. Why? Because everybody has different losers, but everybody chases the same winners.
It happens at the end of every quarter. Notice in your mutual fund reports that you don't see when purchases took place. That way when you see Google among the holdings you'll think to yourself, "Great! I've read a lot about Google's success and its stock has been on a tear. I'm glad to be in a fund that's smart enough to own it." Thus you stay put. Window-dressing purchases tend to drive high-performing stocks a tad higher at the end of every quarter, and that's what we're seeing now.
I'm still holding out for cheaper prices in telecom, alternative energy, and semiconductors. I doubt that I'm going to get the cheaper prices I wanted in the hot-and-getting-hotter Japanese stock market. I may send a Friday morning note to subscribers telling them to buy on Friday. It depends on what happens today in Tokyo. (It's noon on Friday here as I write.) Either way, I plan to issue a special report on Japan over the weekend explaining why I'm finally bullish on the recovery after years of false starts.
Onto kibasen.
Your votes have been counted and the results are in. I asked in my Sept. 24 article (see below) whether readers think boys or girls are more aggressive in the samurai cavalry game of kibasen. Amazingly, exactly half of all respondents thought boys and half thought girls. More women thought boys were aggressive and more men thought girls were aggressive. Tells us something about the state of relationships.
In fact, girls are far more aggressive at kibasen than boys. When the starting pistol is shot, the boys walk leisurely forward on the battlefield, clash with little noise, and simply achieve the objective of getting the opponent's hat and occasionally pushing somebody to the ground in good-natured fun.
The girls charge forward screaming at the sound of the pistol. They slam into the opposing team as if it were a true battle. I saw a girl start crying from the initial blow. Her adversary showed no mercy, choked the crying girl, and pulled her hair backwards until the girl's head craned over and she fell to the ground. Another team stomped on their fallen opponents until people's legs bled. A third clashing group looked friendlier with the two girls on top grasping fingers and laughing at first. Then one of them disentangled a hand, smacked her friend in the temple with the heel, and watched the girl topple to the sand. The fallen friend got to her feet holding her head and blinking her eyes rapidly. She made her way off the field in a drunken stagger.
So, if you ever face a group of Japanese people stacked on top of each other and charging at you, better hope they're men.
Three of my limit buy orders executed and we picked up excellent bargains in electronics retail and computer storage, and doubled down on our pharmaceutical holding. Here are the buy prices:
Electronics Retail: $25.00 on 9/19 Computer Storage: $4.25 on 9/23 Pharmaceutical: $26.50 on 9/23
I first bought the Pharmaceutical company on Feb. 25, 2003 at $28. Doubling down at $25 gives me an average buy price of $26.50. You can see all of these results on my Strategies page.
Specific company names and symbols are shown only to Kelly Letter subscribers, who receive email alerts from me. If you're curious to know more about The Kelly Letter, now would be a great time to take a look. Glance left to see how many open positions are slightly in the red. The market has been getting cheaper and subscribers are now smack in the middle of a great portfolio-building process. The market will rise over the fall and winter. Where will your money be when those red arrows turn green? Join now and get positioned for profits early next year. The letter is free for a month, so there's no risk. To read more about it, click here.
It's natural during a portfolio-building time like now to see recent buys drop a bit below our buy price. I'm not at all worried about our recent purchases and, in fact, if you haven't bought yet you can still do so and get even cheaper prices on several stocks than I got. Good for you!
Hurricane Katrina was devastating, of course, and Hurricane Rita is set to hit land over the weekend and cause even further damage. This is hurting insurance companies, as everyone around here knows from my ill-timed foray into PXRE Group, and also hurting the larger economy and market. Oil prices are still high and threatening to go higher. The Fed raised interest rates again, indicating that it's worried about inflation from higher gasoline prices. Although, not raising interest rates would have been a signal that the economy is in worse shape than people thought and needed the looser money to stay afloat. Talk about a tough position to be in. In the end, though, rates were raised and the market doesn't like that.
So there are several reasons for prices to be headed lower these days. Looking farther out, there's every reason to believe that the market will be fine and that our carefully-chosen investments picked up at bargain prices will do better than the general market.
We are still not as low as I think we might go. Notice the "think" and "might" in that sentence. There's not much certainty in this business. That's why you have to pluck the cheap prices when they come and not be terribly surprised when you could have gotten them a tad cheaper if you'd just waited a week. On the other hand, if you try to wait two weeks, you might miss the initial rebound of 5% or 10%.
The wise investor, facing those ever-present tradeoffs, chooses to buy some stocks a bit early just in case the rally comes later than expected, and some stocks a little later just in case the market drops lower than expected. That way, if the rally's early you still participate somewhat and if the rally's later you had a chance to buy deeper into the low prices.
That's what I've always done and it has always served me well in the final analysis. I have every expectation of it serving me well this time around, too. Your job, if you haven't already done so, is to decide what you want to own and at what prices, then set those limit orders and hope that they hit. More often than you think, they will. If you get good at knowing the right prices -- not perfect, but good -- the market will take care of the rest.
On that note, we're waiting for lower prices to buy into telecom, alternative energy industries, semiconductors, and Japan. The buy prices are set, and now we're just waiting.
And now for something completely different.
It's Saturday evening here in Sano where I spent the day watching elementary school children compete in their undokai, or sports day. It's like a track meet in that it has relay races, but it also has dancing and unusual group events like seeing which team can roll a five-foot-tall medicine ball around the track fastest.
In the kibasen, the remnant of a samurai cavalry game, three team members form a base, called the horse, and the fourth rides on top. The rider is supposed to steal the hats of riders on opposing teams, but it always becomes more than that as the kids pull each other's hair and punch their way to victory, sometimes by toppling the entire opposing team to the dirt. There are injuries and tears and sometimes blood. Now, here's the human nature question of the day:
Do you think the boys or the girls are more aggressive?
Please email your answer to me with "kibasen" in the subject. I'll tally the results over the weekend and post them along with the real answer.
Then we'll get back to portfolio-building next week.
My stop order to sell PXRE Group (PXT) at $16.91 executed quickly this morning. I am now completely out of the position at an 11% loss.
This is not something that happens very often around here and not something that I enjoy seeing. I usually buy investments on the cheap when I feel confident that even if they go a little lower, we're safe. I didn't feel that way this time.
The reinsurance business should have been fine taking care of Katrina. That's what I was looking at when I analyzed the stock and decided that the market had overreacted in its selling. Then Tropical Storm Rita turned into Hurricane Rita and started heading toward the same already-devastated areas. This sent the street into a whirlwind of selling around reinsurance stocks. Then the Fed raised rates for the eleventh time when many were hoping that it would give the economy a break in the aftermath of Katrina. Then the oil refineries shut down again and oil prices rose again. Then Rita strengthened and is now heading straight for the much-headlined coast covered by PXRE Group, among other insurers.
In other words, the storm became a perfect storm for this stock and too dangerous for my tastes. I took the quick 11% loss and will find somewhere else to make that loss back for you.
Where the market taketh away, it also giveth. To that end, we can derive some comfort in watching several positions on my buy list coming closer to our targets. I hope that we have a chance to pick up some cheap stocks that will rebound nicely over the fall and winter months.
Too, we have already picked up good stocks on the cheap and I'm not worried about them. For instance, is down to $44.50 from The Kelly Letter's buy price of $45. I'm not the slightest bit worried about that position. Same with , down to $24.25 from our buy price of $25. These are healthy companies temporarily depressed in a falling market. When things turn around, so will they.
I am keenly aware of the trust you have placed in me to find profitable places for your money. This small setback does not change the way I find investments nor the way I manage trades. It's a consequence of seeking profits in a volatile market, but one that I will nonetheless examine to find lessons for the future. In this case, I think that I would have done well to let the dust settle a little more after the hurricane before looking for places to invest. I was eager to get cheap prices quickly and in this case moved too quickly. While moving quickly has served me well occasionally in the past, this was not one of those times.
Moreover, PXRE Group was so affected by external events that my ability to gauge the stock's prospects was largely happening in the dark. I could analyze valuation ratios and business strength, but I could not analyze the weather. That was a factor beyond my control, but it clearly affected the stock far more than its earnings outlook. Unlike Bob Dylan, I do need a weatherman to know which way the wind blows. Unfortunately, the weathermen didn't know either. Hoping that the wind blows a certain direction is not an investment strategy. It's a coin toss, a pure speculation. I did not intend for PXRE to be a speculative play, but in retrospect that's what it became.
Those of you who have read The Neatest Little Guide to Stock Market Investing will recognize this discussion as coming directly from my Reasons And Limits Worksheet. A main reason for buying PXRE was that I thought the street greatly overestimated the costs of Hurricane Katrina and that reinsurers would emerge far healthier than investors expected. When Rita entered the scene, that reason dissipated as an unexpected layer of costs became possible. Add to that the fact that my Stocks To Watch list is filled with good companies getting cheap and NOT facing external circumstances, and all the factors were in place to cut losses on PXRE.
Now, keep in mind that PXRE is a solid company. There's a chance that it'll keep falling right down into a ridiculously cheap price range. If so, I'll consider buying again. On the flip side, if it rebounds strongly in the short term after we locked in an unnecessary loss, there will be no need to feel bad. The prudent move here was to stop the losses.
That was our own form of insurance. Sometimes, though we're hard pressed to remember it now, insurance is not claimed.
While I still think is a good buy and was a good way to react to Katrina, the market is disagreeing with me and a little too strongly for comfort. I'm placing a stop order at -11%, which is $16.91. With the price moving as quickly as it has been, that might hit very quickly.
As much as it hurts to see something like this, investors must always be prepared to admit a mistake when it happens. We can recover from an 11% loss fairly quickly. We cannot recover from a 50% loss too quickly.
The limit order to buy that I moved up to $25 over the weekend executed. The Kelly Letter bought at $25 and the stock closed at $24.50.
dropped 10% to close at $17.80. That puts us down some 6% from our buy at $19. People have asked me about stop losses on this stock. I generally use -9%, but I haven't placed it as a stop order yet on this stock. It's just a mental stop because I feel that this is a special circumstance where an entire industry is being unfairly punished. The reason for today's big drop is two-fold:
1) The company released its initial liability estimates for Katrina and projected a loss this year of $85 to $165 million, assuming no more major catastrophes this year.
2) That assumption of no more major catastrophes became suspect when Tropical Storm Rita began accelerating into a hurricane and heading toward Florida and New Orleans.
This, of course, drove the price of oil up as the already-damaged oil refining region faces another threat. sold off because it may have even greater losses on top of Katrina if Rita hits with the same consequences.
A couple of ideas here.
First, there's probably not much left to damage in New Orleans at this point. People are already evacuated and the city is already flooded. There should be little additional damage if another hurricane slams the city before repairs have been made.
Second, Rita might not cause any damage, in which case we should see a relief rally after she dissipates.
Also, you may recall from the initial note I sent recommending that a big reason for buying is that the company will survive these losses and remain standing in an environment of higher insurance premiums. Those higher premiums will lead to more profit for the company in the future and, therefore, a higher stock price. That's the rationale for investing.
I want to draw your attention to a little-noticed line near the bottom of today's AP story about estimated losses:
Like other reinsurers after the storm, predicted a rise in reinsurance rates.
The rationale has not disappeared. Let's hope that Rita does, and that we can get this investment and the Gulf region back on track. I know that the market can remain irrational longer than we can remain solvent, so I'm watching this carefully and will exit if it looks like too much downside ahead. As I did with UTStarcom, we may take a short-term loss and look to re-enter at lower prices for another try. I hope not, though.
The good news for you if you have not yet bought is that you now have an even better opportunity than I. The company is the same. The stock is cheaper.
Last week The Kelly Letter bought three new positions: . You could have picked up shares at lower price at several points during the week and you still can in one case. They closed the week at $45.20, $19.83, and $5.90 respectively, putting me up 0.5%, up 4.4% and down 1.7%.
I sent a note to subscribers suggesting that for a conservative way to get into the market you could do worse than to buy at $45. I picked it up at $45 on Friday. It's the world's largest brewer and a superb company that just keeps growing. While you should not expect Sun Microsystems-size gains, you could very well get 20% within a year. If you haven't bought yet, there's still time. It should touch $45 again in the near future.
Meanwhile, patience is still in order to buy the other positions listed in the Sept. issue.
had a wild week, hitting $26.60 on Thursday and then falling 4% to close at $25.50 on Friday. I'm adjusting my limit order buy price from $24 shown in the Sept. issue to $25.
fell 3.7% from Monday to Tuesday and I sent a note telling subscribers to move the limit buy price from $7.75 to $7.50. The stock got down to $7.70 and bounced along that level for two days before rising slightly to close the week at $7.78. I don't want to miss this one, so let's get those limit orders back up to $7.75 where I should have just kept them all along. We'll open this position yet.
fell to $3.90 on Thursday before closing the week out at $4.02. I'm keeping my limit order in place to buy at $3.60. The king of volatility may just get down there again before running higher over the winter.
hit $4.21 on Tuesday but closed the week at $4.47. I'm moving my limit order to buy at $4 to $4.25.
As much as I hate to chase momentum -- I'm much better at grabbing stocks near the cheap end before they recover than I am at grabbing them at the high end on the way higher -- we might have no choice with Japan. The decisive victory last week of Mr. Koizumi has greatly energized the country and all newspapers can write about is "mandate, mandate, mandate" for change. Without a doubt the Japan Post reform measures will finally pass, thereby injecting trillions of dollars into the economy. That should reinvigorate business activity and by extension the stock market. I've been trying to get into below $40, but last week the lowest we got was $40.95 on Wednesday before closing at $43.04 to finish the week 4% higher.
The fund has gained more than 40% in three months and has all the appearance of needing a rest and perhaps a little settling back. Surely the reforms cannot be enacted quickly enough to make a difference this year. Surely there will be some kind of disappointment with expectations so unrealistically high. That's what my gut tells me. Then again, my calculator tells me that Japanese stocks are still 75% cheaper than American stocks by almost any valuation measure. That's a lot of powder waiting to explode when Japan becomes the new hot international money target for the first time in 15 years. It's a classic case of being torn and in such situations I've been well-served by waiting. So we will. Let's watch what happens next week.
Now, a word about two of my investments that have some of you scratching your heads. are, indeed, not great companies. They don't fit the profile of great companies that I write about in The Neatest Little Guide to Stock Market Investing. What they are, however, are smart trades exactly the way Sun Microsystems has been a smart trade over the past few years.
has wisely diversified its offerings beyond China and remains a real bargain compared to its $35 price of two years ago. The steady implosion of its shares has brought the P/E down to 22 and the P/S down to a miniscule 0.30. The book value per share is $11.51. If we just get back to book, it'll be a 48.5% gain from $7.75.
is a key behind-the-scenes e-commerce company that's seen its business grow steadily despite bad profit margins. Having dropped some 60% so far this year, the stock has a P/E of 23 and a P/S of 1.2. Those are not bad figures for a high-tech leader. Such stocks are usually more expensive.
Value Line lists these two as its number 2 and number 4 highest estimated total annual return picks, projecting a 59% gain for the former and a 50% gain for the latter in the next 3-5 years. I expect those returns to happen much sooner than that.
As usual, there's a lot going on and we're slowly building a strong portfolio to benefit from a fall to winter rally. At the same time, the real world is reminding us that fall is not far away.
Here in Sano, we have beautiful weather making the transition from summer to autumn. The farmers are harvesting the rice that they planted last spring. Mornings and evenings bring the smell of smoke in the air as they burn the plant stalks after taking the rice. Monday is Respect For The Elderly Day, a national holiday, and I'll drive with friends to the mountain resort of Nikko for a hike and a dip in a hotspring.
I hope you're enjoying the weekend in your part of the world.
I wrote about in The Neatest Little Guide to Stock Market investing as a great company. It's still great with a low valuation (P/E 16) and a high profit margin (14%).
Yet, the stock has been sitting on its hands for the past year. It hit a high of $51.51 a year ago, then hit a low of $43.58 on July 28. It closed today at $45.27.
It's no screamer, but picking up shares at $45 wouldn't be the worst move of your life. If you're looking for a conservative way to get into the market, set that limit order and have a beer. Even making the almost guaranteed journey back to $50 would be an 11% gain. If it gets to $55, that's 22%. Could it do that in a year? I think so.
The market seems to be going our way. Since the weekend's note suggesting and others, this has happened:
- The Kelly Letter bought key Hurricane Katrina reinsurance company at $19, probably more than you paid. It spent plenty of time below that price for you to get a better deal than I'm recording for my performance tracking. Good for you! The stock is already at $19.35, a 1.8% gain.
- Prime Minister Koizumi won Sunday's election in a landslide, and he brought a slew of key allies with him. Japan should see some excellent reforms coming along, including the Japan Post savings being liberated and put into the economy. That is very bullish for the world's second-largest economy. As noted in the Sept. issue, however, I'm waiting for a slight pullback to enter . We are getting it. The fund slid 1.4% today. I'll let subscribers know with plenty of time to act when I decide to buy.
- Beaten down E-commerce company hit my buy price of $6 today and The Kelly Letter bought. It closed at $6.02. If you did not buy yet, don't fret. You'll probably have a chance to, yet again, beat me with a cheaper buy price. I hope you do!
- The other buy positions in the September issue are coming into range. Just today, fell 2%, fell 3%, and fell 2%. Keep the buy prices the same, except for . Lower its buy price to $7.50 from the Sept. issue's buy price of $7.75. We may just be able to squeeze a little better bargain out of it.
These are momentous times. The big news in America, of course, is the devastation of Hurricane Katrina in New Orleans. Americans, true to form, are exceeding the call of duty in their donations and help. Even when the government drops the ball, the people don't. I love that about my country.
Meanwhile, halfway around the world in Japan, where I currently live, it's election day. And not just any election day, mind you. This is The Big One. Without a doubt the biggest in 50 years. It will determine the fate of Prime Minister Koizumi and could dramatically alter the political landscape and give electro-shock treatment to the world's second biggest economy.
In both cases, Katrina and Koizumi, we find ourselves staring at two wonderful investment ideas.
With Katrina, investing is a touchy subject. Even after donating toward relief and doing all that we can to help, is it ever in good taste to hunt for an investment idea? Is there an uneasy feeling in the stomach if we make money off an event that rained such misery on so many people? There certainly can be, which is why I'm particularly thrilled to have found a company that has good upside potential and yet will be instrumental in getting The Big Easy back on its feet. Interestingly, it's not a construction company.
It's an insurance company. How, you ask, can an insurance company be a good bet after a disaster for which they need to pay claims? It's an interesting situation.
As longtime readers know, I watch and admire Warren Buffett and his company, Berkshire Hathaway. In so doing, I also monitor Berkshire's competitors in the insurance business. Now, mind you, no company is in better financial condition than Berkshire. However, others are pretty darned good and can sometimes be had far, far cheaper than their famous peer.
Now is just such a time. An event like Katrina is a megacatastrophe in the insurance business. Rare, thank goodness, but not so rare that we don't have some history. Katrina's infamous cousins on the megacatastrophe list include Hurricane Andrew and 9/11. In each case, insurance companies took a hit in the stock market because of the impending claims they'd have to pay. The claims were so big in the past that many companies went bankrupt. That's where your skepticism appears justified.
So far, pretty ominous. But think a little farther out. What happens to the companies strong enough to literally weather the storm? They are left with fewer competitors and the ability to charge higher premiums on the next renewal cycle. It turns out that the best place to find that situation is not the frontline insurance companies visiting homes and assessing damage, it's in the reinsurance companies that provide insurance to those frontline insurance companies.
Estimates for the financial damage from Katrina are still rolling in and are still wildly different from one another. The range is between $20 and $60 billion. No matter the final figure, it will be massive. But, and this is key so please don't miss it, it will not be as big as expected.
In every past megacatastrophe, the estimates have come in vastly inflated. That's good from the standpoint of getting the money in place that's needed. In the stock market, though, it unduly scares investors away from certain insurance companies that are seen as being dangerously exposed. Maybe even fatally exposed.
So, the prices drop. And drop. And drop. What the clear-eyed investor does is sort through the wreckage for the most deeply underpriced strong company. If it is indeed strong, it will survive, rebound, and flourish.
Guess what? There's just such a company at just such a deeply discounted price right now. And I do mean right now, because the price fell like a rock early last week, but already staged the first leg of a dramatic recovery last Friday. It's , and it closed last Friday at $18.87. It was fluctuating around $25 all summer then crumpled to less than $18 last Thursday. Hurry to buy under $19. Even if the stock simply gets back to its pre-Katrina $25, that will be a 31.6% gain. However, the stock has a year-over-year revenue growth of 20%, low debt, and a solid profit margin of 7%. It should go higher, perhaps above $30.
has survived every major catastrophe since its founding in 1982. I'm confident that it will survive Katrina, too, and be one of many helpful hands putting New Orleans back together again.
My Advice: Buy under $19.
Now, back to Mr. Koizumi and the reforming of Japan.
The Japanese market as measured by the Nikkei appears poised for a breakout. It's already above 12,000 and touching 4-year highs. It has done this before, though, and always disappointed to retreat back down to 10,000. That's why it's important to wait for a decisive breakout and compelling circumstances to believe that we may finally be at the trigger-pulling moment.
From Businessweek:
In S&P's view, the quantitative evidence seems to support that the economic recovery in Japan is well under way. In mid-August, the Nikkei-225 stock index and the Topix index both reached roughly four-year highs. Moreover, Japanese GDP grew for a third consecutive quarter and is expected to rise 2.5% for fiscal 2006. Employment is also better. In June, the jobless rate dropped to 4.2%, a seven-year low. And consumer confidence, though still sluggish, may improve as more people have money to spend.
Mark Headley, lead manager of the $185 million Matthews Japan fund, believes Japan's recovery has legs. He thinks the country's central bank is intensely focused on ending deflation, which has been "extremely brutal on consumer-spending habits, on corporate balance sheets, and has brought their entire banking system to the brink of bankruptcy."
Part of Japan's renewed vigor has more to do with politics than it does with banking.
Here's where we get our fireworks and why the world is suddenly unable to stop watching what is normally the most boring political arena on Earth. Prime Minister Junichiro Koizumi dissolved parliament last month and called for a snap election when members of his own party rejected his proposal to privatize the government postal service, called Yubin Kyoku. Japan Post holds 350 trillion yen in deposits and insurance assets. That's $3.3 trillion, making it the largest financial organization in the world. Mr. Koizumi's idea, if realized, would inject all of that capital into the economy. The resulting growth would really light a fire under the stock market.
I live in Sano, Japan and I'm typing this to you at 6:00 a.m. on September 11th. The snap election is today. It's a big deal, undoubtedly the most important election in the past 50 years here. Mr. Koizumi has appointed specific candidates of special appeal to take out opposing members of his party. These appointed candidates are called shikaku in Japanese, assassins. Many are women, several are TV personalities, one is a famous cookbook author, and one is Takafumi Horie, the internet entrepreneur.
When, as is expected, Mr. Koizumi and his assassins dethrone the fossils of the Liberal Democratic Party, the way will be clearer for reform. It won't be entirely clear, naturally, but much more open than it was in August.
Thus, it's a big deal. Trucks are driving around Sano blaring the names of candidates. Women are handing out fliers at the supermarket. Everybody's talking about it. The expected turnout is over 70%.
Clearly, something is happening in Japan. Can Mr. Koizumi and his band of reformers unlock the trillions needed to get this economy going again? I'm betting that they can, and my bet is on . Like other funds from the family, this one magnifies its returns, in this case twofold. When the Nikkei 225 rises 5%, this fund will rise 10%. It works the other way, too, but things look set to rise.
