This week, the pessimism of the prior two weeks gave way to a look at economic data that don't look unhealthy, and don't change the odds of another interest rate increase next month.
Monday and Tuesday brought no economic news and the market floundered in the vacuum, wringing its hands over the prior week's sea of red ink. The Nasdaq fell 1.6% to a six-month low. Technology bore the brunt of the selling. We took advantage of the weakness to pick up shares of eBay on Monday at $29.
On Wednesday, we finally got some fresh economic data. April durable goods new orders dropped 4.8%, more than expected. The slower pace got a few people thinking that the Fed might not raise rates in June.
Then, April new home sales came in at 1.2 million, a surprisingly strong 4.9% gain. That's the highest this year. A strong housing market over the past few years has boosted consumer spending with mortgage refinancing and home equity cash. Its inevitable slowdown has been expected to curtail consumer spending and, therefore, hobble the economy. So far, though, the housing market shows no weariness. Consumers can keep their shopping lists and gas tanks full, and that's good for the economy.
On Thursday morning, the mood got even better at 8:30 when first quarter GDP was revised upward from its initial 4.8% annual growth rate to an even stronger 5.3%.
"Now, wait a minute," you say. "I thought we wanted to see a slowing economy so the Fed can stop raising interest rates."
You're right. What's missing in the above facts is that economists had expected a revision up to 5.8%. Coming in at 5.3% was the economist's version of a bowl of porridge for Goldilocks: it wasn't too hot and it wasn't too cold, it was just right. It shows an economy that grew faster than we thought, but not so fast that extreme braking is required to keep it in control. Growth without inflation is about as good as it gets in economic circles, and Thursday morning delivered it.
The market rose, led by technology. A multi-year advertising and online payment partnership between eBay and Yahoo, and an agreement between the top computer maker and Google (GOOG) that will include Google search software on the maker's computers, brought more buyers onto the scene. Shares of eBay rose 12%. Among the big indices, the Nasdaq rose the most at 1.3% for the day.
Nothing follows good economic news like more good economic news, and we got it on Friday morning. The core-PCE deflator, an inflation gauge favored by the Fed, rose 0.2%. That's less than economists feared it would be, but actually not very low. The Fed wants a year-over-year increase between 1.75% and 2%, and this latest installment puts it at 2.1%, up from 2.0% in March. The market's positive reaction shows how much the mood changed in a week. Had the report happened a week earlier, the focus would have been on the "above 2%" angle rather than the "less than feared" angle.
This may be the first time you've seen the term "core-PCE deflator." PCE stands for personal consumption expenditures, and is the amount that people spend on goods and services. The Fed likes it more than the consumer price index (CPI) because it tracks a variable basket of goods while the CPI tracks a fixed basket. A deflator is a statistical tool that changes current dollars into inflation-adjusted dollars so we can easily compare prices over different time periods.
May has provided a textbook lesson in market moods. In the last four weeks, we went from ebullient to depressed to cheerful. On May 10, the Fed raised rates and said that it would watch incoming data before deciding its future actions. Because that language didn't say that the Fed was leaning toward ending rate increases, the market got worried...and started obsessing over incoming data.
But so far, those data have been mixed:
The U.S. trade deficit narrowed to $62 billion, lower than the expected $67 billion. (That was good for the economy, but meant that GDP would be higher, which could be inflationary.)
The University of Michigan consumer-sentiment fell to 79 in May from 87 in April, the lowest since October's score of 74. (People buying less is good for keeping inflation at bay, but bad for economic health.)
The core consumer price index (CPI) increase for April came in at +0.3%, 0.1% higher than expected. (That showed an inflation risk.)
First quarter GDP was revised upward from its initial 4.8% annual growth rate to 5.3%, lower than the 5.8% feared. (A higher GDP could be inflationary, but being lower than feared was a bright spot.)
The core-PCE deflator rose 0.2%. (That's less than economists feared, but puts the year-over-year increase at 2.1%, higher than the Fed's 1.75% to 2% comfort zone.)
After digesting that mixed bag, Fed funds rate futures hardly budged. They still expect another 0.25% rate increase.
What changed on Wall Street was the mood, not the facts. Remember this well, for it's the persistent theme of markets. Changing moods change prices, and provide intelligent investors with opportunities. I'm sticking with my forecast for strength in early summer, trouble in August/September, and a rally at the end of the year.
Let's take a closer look at the leading computer maker, eBay, the number-one semiconductor manufacturer, the Japanese stock market, and an online media giant.
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Leading Computer Maker (SYMBOL, $24.81)
Tue -1.2% | Fri +2.1%
The Kelly Letter bought on Nov. 9 at $29. So far, we're down 14%.
This week brought two pieces of news from this company. The first is that it's going to open full-size retail stores. The second is that it's going to bundle search software from Google on its computers and make Google its default online search page.
The company's store idea expands on its existing chain of 160 kiosks in airports and shopping centers that have been in place since 2002. Like the kiosks, the new stores won't carry inventory. Instead, they'll offer customers a chance to try out the company's array of products and then order them in the store, online, or by phone. Products will still be delivered to the customer.
The kiosks have done well and the larger store format is just an extension of that retail model. It comes at a good time in the company's product expansion. While people are familiar with buying PCs and printers online, they are not as comfortable with large-screen TVs and notebook computers. Consumers prefer seeing and touching those items before making a buying decision. The stores give them a chance to do so, while still keeping the company's direct-sales model intact.
Part of this decision had to come from the fact that arch-rival Hewlett-Packard (HPQ) is selling notebooks at a faster clip than this company, and it's doing so through retail channels. HP has said for a while that selling by retail as well as direct gives it an edge. It looks as if this company is conceding that point.
That makes perfect sense from a strategic view. After all, every PC maker has copied the company's direct model and inventory management techniques. That's why competing firms have lowered their costs and reduced the company's cost edge. Now, the company is simply copying an aspect of what has worked for its rivals.
Consumers provide just 15% of the company's earnings. However, they provided most of last year's growth in the PC market. With business purchases, buyers generally just look over a list of features and prices and do what's best for the business. With personal purchases, though, the buyer has a stronger interest in getting everything just right including color, style, and feel in addition to features and price. They can do so better in a store than online.
Now, this is not a RadioShack (RSH)-like rollout of thousands of stores across the land. Initially, the company will open just two 3,000-square-foot shops, one in Dallas between July and September and the other in West Nyack, New York between August and October. Dallas I get, but West Nyack? That seems an odd choice. It might be that Dallas is big and West Nyack is small, giving the company a complete picture of the American landscape. According to the 2000 census, only 3,300 people live in West Nyack and its land area is just 2.9 square miles. The median household income is nearly $100k, though. Perhaps that had something to do with the decision to open a computer store there.
The company's existing kiosks measure just 10 by 12 feet and are staffed by two or three people who provide information and help to place orders. The new stores will be 25 times that size, on a par with Apple's (AAPL) successful retail outlets. In addition to providing information and making sales, Apple also offers product support in its stores. The company isn't sure yet if it will follow that lead.
On Thursday, the company and Google announced their deal to put Google software on the company's computers. Google will also become the default online search for the company's computers. Each company will share in the revenue, but it won't amount to much.
The deal appears better for Google than for this company. It will make Google more visible in search, which is important in the firm's increasingly heated competition with Microsoft. Google is worried that Microsoft will use the new Windows Vista operating system to make using MSN Search easier than other search services. The Justice Department dismissed Google's concerns earlier this month. Now, it appears that Google has decided to beat Microsoft in the market rather than in the courts. Two weeks ago in Note 42, that's exactly what I argued Google should do.
The company also benefits from the deal in a small way. It gets a bit of extra profit on each computer shipped. In a nice turnaround, instead of Google receiving income on a pay-per-click ad basis, it will pay the company on a pay-per-ship order basis.
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eBay (EBAY, $34.20)
Thu +12.2%
The Kelly Letter bought eBay on Monday at $29. So far, we're up 18%.
This week confirmed precisely why we've been building a technology portfolio for the past eight months. Tech is beaten down, given up for lost in the shadows of rising commodity prices. In the past several years, however, technology has improved dramatically, markets have expanded, earnings have increased, and yet stock prices have either gone nowhere or gone down. That means the companies have become cheaper while getting better.
They've also become a bigger part of the economy and of our lives.
On Thursday, eBay and Yahoo (YHOO) formed a partnership to create mutual growth opportunities.
There are four areas of business covered by the multi-year agreement:
Search and graphical advertising
Online payments via PayPal
A co-branded web browser toolbar
Research around "click-to-call" capabilities
Yahoo will be eBay's exclusive provider of third-party graphical ads on eBay.com. eBay's PayPal will power Yahoo's online wallet service.
The latter part should provide a boost to PayPal's profits. Hundreds of thousands of Yahoo advertisers will now have the ability to pay via PayPal. Customers of Yahoo's other paid services including premium email, fantasy sports, DSL, and dating will also be able to pay with PayPal.
Parts of the agreement will be in place this year, with the remainder coming to fruition in 2007. There will not be much of an impact on this year's results.
While I find this to be a great development, I think eBay benefits more.
The extra profits to PayPal are obvious, but equally impressive is the whole new market being created in the form of graphical ads. eBay has a tremendous amount of traffic on its network of sites. Carefully placed ads will provide yet another way to monetize that traffic.
A dissenting opinion on the merger came from Henry Blodget, the former Merrill Lynch internet analyst famous in the late 1990s for his bold calls as dot coms rose, and then infamous for those same bold calls as dot coms collapsed. In 2003, he was charged with civil securities fraud by the SEC. He settled and is banned from the securities industry for life. Nonetheless, he remains an interesting voice in the internet investment discussion. His blog is at www.internetoutsider.com.
Blodget thinks that rather than working with Yahoo, eBay should just sell Skype to Yahoo because the VoIP company would fit a lot better with Yahoo's communication offerings than it does with eBay's store. With the proceeds, he suggests that eBay buy Amazon.com (AMZN). He argues that Amazon is going to have a heck of a time in the upcoming battle between eBay/Yahoo, Google, and Microsoft (MSFT). Both eBay and Amazon are stores, so together they'd be a more powerful store and would own that category. That, he thinks, is better than trying to be big in several categories.
There are two problems with that idea, though. First, Amazon might not want to sell. Second, eBay just bought Skype and purports to have high hopes for it. Yahoo's strength in communications via mail and messenger are, presumably, the reason the two companies are exploring click-to-call capabilities together. Maybe Yahoo brings the marketing muscle and user base while Skype brings the technology. Evidently, eBay thinks there's more long-term money in collaboration than in just selling the company.
I trust eBay's judgment over Blodget's.
Earlier in the week, Prudential Equity Group upgraded eBay from neutral to overweight, citing a compelling valuation after the steep price drop. The firm's price target for the shares is $40.
Getting there from our entry at $29 would give us a 38% gain. I'm more optimistic. I expect us to make at least 50%, which implies a share price target of at least $43.50.
We bought on Nov. 16 at $25, on Jan. 31 at $21.50, and on Mar. 3 at $20. Our average buy price is $22.17. So far, we're down 18%.
I've been looking to buy again at $18, but haven't placed an order yet. The stock moved around the $18 mark for most of this week, bouncing solidly off of $17.80 on Wednesday and Thursday. For now, I'm still watching.
We finally received acknowledgment of our investment thesis from an analyst. As you know, we own this company on the belief that it's coming back strong after losing ground to its smaller rival Advanced Micro Devices (AMD), which has steadily taken market share over the past year. I like this company's upcoming product line, and believe that the company will benefit from the broad computer buying that should come from the release of the new Windows Vista operating system in January.
On Monday, Rick Whittington of Caris & Company downgraded AMD from buy to above average, citing this company's improved line of chips on the way. He also noted that the company will probably get its 45-nanometer architecture out quickly.
What jumped out at me in Whittington's report was his conviction that the company won't make the same mistakes again. He said that the "organizational disconnect" between process and design, in addition to the company's underestimation of AMD's capabilities, led to poor execution. This is "not likely to be repeated in the period ahead."
He thinks, however, that AMD still has a window of opportunity to get a little more market share before this company ramps up volume on its new line in Q4.
When that volume comes, though, watch out. He says the Conroe chip will firmly place this company in the leading desktop role and that AMD won't have a strong response for some time.
Finally, somebody else on Wall Street recognizes that this company's mistakes are behind it and that it's working feverishly to right them. It is knuckle-cracking mad over the loss of share in the past year, capped by last week's announcement that Dell (DELL) would offer AMD chips in its servers. It'll be the first time in history that Dell has sold a machine without this company's chip inside. I guarantee that nobody is more keenly aware of the company's recent shortcomings than the company itself.
What a great time to own shares in the chip giant.
We bought into the Japanese stock market on Oct. 4 at $47.20. We sold one-half of our position on Feb. 17 at $64.55 for a 37% gain. The remaining half is now sitting at almost exactly that level of performance.
The rough seas of the past two weeks provided ample proof to us that we need to be out of this fund entirely before the real trouble hits in late summer. Three weeks ago on May 5, it closed at $74.75, representing a 58% gain for us. It then free-fell 19% to Tuesday's close at $60.77. That kind of plunge in 12 trading days was a valuable lesson. I'm happy that we didn't sell on Monday or Tuesday, but am still nervous about this fund and itching to find the right exit.
The problem is that Japan's economy is doing too well. Consumer prices just came in higher for the sixth month in a row. That means, in a familiar refrain, that Japan's central bank will probably raise interest rates for the first time since Aug. 2000. Some economists expect the first increase to come as soon as July.
I can tell you firsthand that prices are on the rise here. McDonald's (MCD) is charging more on certain set meals, and Tokyo Disney Resort (DIS) is planning to hike ticket prices by some 5%, its first such increase in almost six years. It looks like the deflating Japan story is finally over.
Even the International Monetary Fund thinks so. Daniel Citrin, deputy director of the fund's Asia and Pacific Department, said on Wednesday that "The risk of slipping back into deflation is pretty small, barring some unforeseen shock."
As investors in the Dow (of which McDonald's and Disney are members) and holders of Disney stock, this news is fine by us. As investors in the Japanese market ahead of interest rate increases and a tough summer, this news is worrisome.
We're probably fine until July, but keep an eye out for a sell email nonetheless. As the last three weeks made clear, things can change quickly.
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Online Media Giant (SYMBOL, $33.02)
Mon +3.2% | Tue +1.0% | Wed +3.4% | Thu +3.6%
We bought on Mar. 17 at $30. So far, we're up 10%.
It was a grand week to be a shareholder in this company. The stock went up every day. Whether you should thank last weekend's Barron's article or my constant raving about the company in The Kelly Letter is up to you.
This week, our investment thesis was confirmed.
Google stole the internet spotlight when it went public and became a verb. "Google it" morphed into the new way to tell somebody to check it for themselves. There's no doubt that Google's fast, simple searches and its well-placed text ads were the right way to rocket to the top.
What I've always questioned is whether that's enough. Our online media giant, I've pointed out, is concentrating its efforts on its many human-powered services. They are harder to beat with just improved technology, which is available to any of the leading net companies, and they're harder to duplicate because once a person is part of something with a log-in and password and custom settings that have become familiar, it's hard to get them to change allegiance. Let's call these reasons to stay "non-tech sticky points."
Because the company has already closed in on Google's search dominance, is almost set to close in on Google's text ad dominance, has steadily fortified its human-powered services, and is trading at a much cheaper level than Google, I've argued that it is the better net buy. Hence, we bought it.
This thesis received critical confirmation this week. On Monday, market research firm Hitwise reported that 80% of the traffic to Google's network of sites including search, news, maps, video, mail, and social networking, goes to the base Google.com page. Google's other efforts just haven't gained any traction. It's a one-trick pony.
What is constantly hammered on in the media is Google's growing market share. It's not a lie, it's just not the whole picture. Google seems to gain a larger piece of the search pie every quarter. It happened again last month for the ninth time in a row. Google handles 43% of all U.S. searches. This company is second at 28%, followed by MSN at less than 13%. There's no question that Google is the search leader.
That's where its story ends.
Remember the buzz around Gmail hitting the web with gigabytes of free storage that were sure to put others out of business? Before Gmail even got started, both primary competitors simply offered similarly huge amounts of free storage. Google's tech-delivered advantage was instantly nullified, and the above-mentioned non-tech sticky points kept people right where they'd been all along. Of the internet email market, this company commands 42%, Hotmail commands 23%, newcomer MySpace mail already commands nearly 20%, and Gmail claims just 2.5%.
It's the same story in news. The leader is, again, this company, followed by the Weather Channel, MSNBC, and CNN.
We've all seen the amazingness of Google Maps and Google Earth. I remember when I first heard about Google Earth from my uncle at Newport Beach during the annual Kelly Family Summer Vacation. He said I could see my own home via satellite right at Google Earth, for free! I looked, it was cool. Those satellite overlays were even included in Google's driving maps, making this company's look stale by comparison.
Here again, it didn't take the company long to buy some new computers, put some interns to work on the software, sign some data sharing contracts, and crank out its own upgraded satellite mapping service, also free.
My point is not that Google is not cutting edge and all that's cool. It is. It's just not unassailable and, in my opinion, is barking up the wrong tree with a focus only on what computers and software can do. The long-term winner online will be the company with the most people on the most services. It's not just about search. It's about human networks that have more than technology in their defense moats.
Back to maps. Who do you think is number one? The pacesetter, Google? Nope. It's third. Mapquest is first with a 56% share, then comes this company, then Google, and finally MSN.
This company's strategy is gradually winning the web. It ranks at or near the top of every major online destination category. Its graphical ad network is the strongest. Its pay-per-click text ad system is in beta now and coming along quickly. It should be in full force by year-end.
This company is the place to be online, and we own it.
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On Deck
Mon 5/29: U.S. markets will be closed for Memorial Day.
Tue 5/30: The Conference Board's consumer confidence report for May will be released.
Wed 5/31: Minutes from the May 10 FOMC meeting will be released. The Chicago purchasing managers index (PMI) will be released.
Thu 6/1: The Institute for Supply Management (ISM) reports its May index. It will probably drop from April's 57.3 to about 56, give or take 0.5. Construction spending numbers for April will also come out.
Fri 6/2: May's job statistics will be reported. They include the average workweek, hourly earnings, nonfarm payrolls, and the unemployment rate. April's factory orders will also be released.
That'll do it for this week.
It's the rainy season in Japan, and every trip out of the office requires an umbrella. Outside the window next to my desk sit four bonsai that I've received from friends. They've soaked up the rain and are a bright, pleasant green just waiting for the sun to break through. Everything goes in cycles.
More than 60 years ago, my grandfather fought against Japan in the biggest war the world has ever seen. Today, I live in a city that saw American bombers fly overhead to destroy nearby factories. America's former enemy is now its ally, and has been a delightful host to me for four years. The people of Japan built their economy with the help of America, and it is now number-two in the world, second only to the U.S. itself. A lot of good has come from America's military might. That good did not come cheap. The people who paid the ultimate price did so for generations of strangers to come. We are among those strangers.
Around the barbeque or in church or wherever you will celebrate this day of remembrance, do take a moment to actually remember. There's a reason for the day off. My grandfather lived. Many others did not. The only place for them to exist in this world now is in our thoughts. Let's make some space.
The recent ebullience was indeed suspect and mid-May brought a change in weather. The sunshine of two weeks ago turned to rain. The market is down and shrill calls of further losses ahead are ringing in the ears of investors.
Last week, investors focused on the Fed's policy statement, which did not indicate a pause for interest rate increases. The Fed said that it would be looking at incoming data to determine its future rate activity. It's most concerned about inflation. Investors joined the Fed in watching incoming data for clues to the future.
This week we got the first installment, and it wasn't good. On Wednesday, the core consumer price index (CPI) increase for April came in at +0.3%, a tiny 0.1% higher than expected. Because the core CPI measures consumer inflation for all goods except food and energy, the red flags flew high again.
By itself, maybe the April CPI wouldn't have been a big deal. However, it was the second month in a row that we've seen it increase by 0.3%. The Fed's forecast for this year is an increase of just 1.75% to 2%. That's a monthly equivalent of just 0.15%, or half of what we've gotten in the past two months. Remember:
Signs of inflation = More interest rate increases
Interest rate increases are not good for the stock market, so it fell. Rate increases put a damper on earnings. Currently, investors expect the second half of the year to see an earnings increase of about 10%. If rates go much higher, though, that might not be possible. Thus, stock prices go lower to account for the potential of lower earnings in the second half.
As ominous as the above reads, the situation is not much different than what we saw a couple of weeks back. What has changed is perception.
Before, the end of rate increases was seen as being just around the corner, so earnings were going to be fine and the market rose on those high hopes.
The only thing that flipped the coin was that the Fed said it wasn't sure when rates would stop rising because it hadn't seen all the data yet. That means we could get another increase in June to 5.25%.
Or not.
Don't dismiss that last possibility. The Fed's next meeting is a month away. If the world can change this much in two weeks, don't you think it can pull off another transformation in a whole month? You bet it can. It does it all the time.
All we're really quibbling over is whether there will be a June increase. There's always been a possibility of getting one. All the way back on April 10, I wrote:
The committee said it will continue watching economic data for direction. That means we could keep going beyond 5%. Will we get a 5.25% rate at the June 29 meeting? The futures market puts the odds at around 45%.
Even if we do get one but it comes with mollifying comments from the Fed, I think the market will see that as good news. If we don't get one and the statement is calming, I think we'll get a solid upswing in stocks. The only situation that would be harsh is another increase along with stern language indicating that there's no end in sight to the increases. Combined with what I see as a rough time in August/September, that could make for an unpleasant summer.
Truly awful? Not really. From the beginning of the year, I've been writing about the summer slump. We're in the weak half of the year already, and stocks are down. Not too shocking. We look ready for an oversold bounce during the remainder of May. If that gets followed by some positive inflation news, and that gets followed by a positive Fed meeting in June, we will see those higher prices I expect before the real sell-off begins.
That's the scenario I've been aiming at all year, and I still have my sights on it.
I found another fellow in my camp, somebody you may have heard of: Tom McClellan, of the McClellan Oscillator fame. The McClellan Oscillator is a measure of momentum applied to advance/decline readings. It generates buy and sell signals along with overbought and oversold readings. The technique was developed by Sherman and Marian McClellan. Tom is their son and works with his father in publishing The McClellan Market Report.
At the end of April, Tom forecast mid-May weakness. That was just as the market was scaling to old highs. It was a bold call, and accurate. He says now that the selling should end by May 23 and that the market should rise to new highs by the end of June. He then sees a choppy, sideways market into a weak spot in the fall, but not a dramatic crash. Beyond these mid-term predictions, Tom is calling for oil and energy stocks to bottom out in June, and then advance until year-end. He expects $100 oil and $4-a-gallon gasoline as well.
While I think we'll have more trouble at the end of summer than Tom thinks, he and I are in complete agreement for the next month or so.
Lest you feel panicked, recall that the price/earnings ratio for the S&P 500 is less than 16 on operating earnings and less than 18 on reported earnings. No signs of overheating there.
For now, though, the market psychology is dominated by inflation reports and Fed prognostication. Keep an eye on the data. So far, despite the action of the past two weeks, it ain't that bad.
On Tuesday, the Labor Dept. reported that the core producer price index (PPI) rose just 0.1% for a second straight month to leave the year-over-year increase at 1.5%. That's under control.
On the same day, we received reports that the housing sector is slowing down. April housing starts came in at their lowest level since Nov. 2004. Building permits also went down for the third month in a row. These data bolstered the view that the Fed should pause in June. Indeed, Fed funds futures still show just one more rate increase.
Sift through it all, and the only downer you're left with is that the core CPI was just 0.1% higher than expected. A reason to squint the eyes? Sure. A reason to buy emergency rations? No. Aside from sentiment taking a decided turn for the sour side of life, the fundamentals are not much different than they were when the Dow was approaching all-time highs at the beginning of the month.
Moreover, I've been pretty impressed with the Fed so far, and I'm not the only one. On Friday, Treasury Secretary John Snow spoke to the Bond Market Association. He said he's confident that the Fed will control inflation, and he seemed unconcerned about inflation: ""Overall growth is strong, and while it's true that headline inflation has picked up, core inflation remains in check," he said. He pointed out that the economy's expansion is still healthy thanks to low taxes and hefty business investment. Unlike the expansion of the late 1990s, this one does not smack of "irrational exuberance" and is durable.
Also on Friday, Kansas City Federal Reserve President Tom Hoenig spoke with Greg Ip of The Wall Street Journal. He said he thinks inflation and growth will slow, despite the recent data. He also said that the Fed is aware that the effect of rate hikes is delayed, so we're not yet seeing the benefits of past increases. "Let's maybe be a little bit patient here, and then decide what the right course is," he said. That's roughly the Fed's official stance: wait for the data.
This is an opportune time to point out something basic about the market. The only reason we can make money in it is that its prices change. They go up, they come down, and they do it again and again. While nobody can get the exact points right, we can get the trends basically right, and that's often good enough. The market is down now, but it won't stay down forever. When it rises again, it won't stay up forever. These movements are natural and should not be disconcerting.
What we should do is build a solid portfolio for the next up-swing. In that spirit, we're still trying to buy at $29. More on that below.
I have fresh reports on Applied Materials, Dell, Intel, RadioShack, Profunds Ultra Japan, and Yahoo. Every one of them is yours with a one-cent, one-month trial subscription to The Kelly Letter, which includes complete access to my archived research in the subscriber section of this site. It's hard to imagine a better place to get a full month of research time for a penny.
You would be forgiven for wondering if you'd fallen into a deep sleep after last week's article, only to wake up months later to find this one.
"Surely," you think, "things couldn't have changed this much in just a week." But they did, or at least people thought they did and reacted appropriately.
Last week, the Dow hit a six-year high and was within 150 points of its all-time closing high of 11,723 booked in Jan. 2000. People crowed about strong earnings and a weak employment report that was bound to make the Fed pause its rate-raising campaign after Wednesday's 0.25% hike. That's why everybody watched the Fed's statement closely on Wednesday; they wanted signs of a pause.
Then on Wednesday, we got the rate hike as expected, but we didn't get the signs of a pause. The rate went up 25 basis points to 5.00%. The statement read "some further policy firming may yet be needed to address inflation risks" and that "the extent and timing of any such firming will depend importantly on the evolution of the economic outlook."
That should sound familiar. It's roughly what the Fed has said at other recent meetings. It's waiting on the data. If economic growth keeps trucking along and signs of inflation appear, then we'll get more rate increases. If economic growth tapers and there's no evidence of inflation, then Wednesday's rate boost could be the last one for a while.
A glance back at this year's earlier articles will show that this wait-and-see stance has been the Fed's official word all year.
But the market seized on the lack of a definite statement ending rate hikes and it was enough to start the dominoes of negativity falling. Last week's happy talk of strong earnings and weak employment went out the window. In through a termite-chewed hole in the floor came talk of an impending interest-rate induced earnings slowdown (which we've seen coming all year) and a fatiguing consumer (old news).
There was the usual disagreement about what constitutes good and bad data. For instance, before the bell on Friday we received news that the March U.S. Trade Deficit narrowed for the second month in a row to $62 billion. Economists expected it to be around $67 billion. A lower trade deficit is great news, but, wait...no, it's not. It means we have to revise first quarter gross domestic product growth upward, and that could be a sign of inflation.
Right about the time that thought entered the collective conscience, somebody quipped that the price of imported goods bounced higher than it has since September. That smelled like inflation, too.
Then, the University of Michigan consumer-sentiment fell to 79 in May from 87 in April. We have to go all the way back to October's score of 74 to find a lower reading. That could have been taken as a good sign that inflation is not a threat because people are not buying much. Instead, it was taken as a thumbs-down for economic health.
Oh, and commodities are still skyrocketing. On Thursday, gold closed at a 26-year high, silver at a 25-year high, copper rose 9% in the morning and closed at a historic high, and oil gained 1.6% to $73.25 per barrel.
No two ways about it: last week's party is over.
Thursday was the worst market day for the big indexes since Jan. 20. The Dow ended the week down 0.5%. The S&P 500 lost 1.6%. The Nasdaq dropped 3.4%.
The main negative factor was interest rates. A bevy of analysts came out with either predictions of more increases ahead, or doubts about their previous convictions that we'll soon see an end to the increases. Here's a representative example. Speaking about his firm's position that the Fed will be able to hold at 5%, Deutsche Bank's top U.S. bond economist Joseph LaVorgna said that "given the FOMC's increased sensitivity to inflation risks, we admit to feeling less comfortable with that position."
The week's action was negative enough to make some subscribers wonder if the August/September market plunge I've warned about is already underway. Is it time to bail out? Should we be taking a position in a short fund immediately?
The answer to such critical questions is reserved for subscribers.
The good news is that you can become one for just a penny. That's right, I offer a full month of The Kelly Letter for just a penny. I'll send you the answer to the above bail-out question; weekend updates on Asset Acceptance Capital, Dell, Disney, and Microsoft; give you instant access to my report on the recovery of Japan; and provide you with a user name and password to access all archived Kelly Letter notes from the beginning of this year.
One other thing. Many times in the investment business, people join an advisory service when everything is going well and the positions in the portfolio are pushing all-time highs. That makes for a lot of excitement, but is actually bad for your returns. It's better to enter when prices are down and you can buy into positions at a price lower than the service paid.
Guess what? Now is a great time to join The Kelly Letter. While it's true that we just had a position hit a 100% gain last Wednesday and that several others are up substantially, we also have some key positions currently in the red. Over the summer, we'll be averaging down into those positions to lower our average buy price in anticipation of a strong fall/winter rally.
Why not come aboard for a penny and see what I've got planned? It's well worth your while just to review the portfolio and research notes, but I think you'll also discover that market-beating investment information can be a pleasure to read and affordable, too. Did you know that 86% of all Kelly Letter subscribers have stayed with the service? That's an industry-leading figure. Find out what makes me different, and how you can make money by taking advantage of the upcoming summer slump ahead of the powerful fall/winter rally.
It's almost 8:00 Sunday morning in Colorado as I write. That puts the time here in Japan at just before 11:00 Sunday night. In a few minutes I'll pick up the phone and call my mother at her home in the Rocky Mountains to wish her a happy Mother's Day.
I hope you have a happy one in your home, too. Whether it's wishing your wife or mom a happy Mother's Day, or whether it's being wished one yourself, may this day offer a celebration of your attachments to motherhood in whatever forms they take.
Ah, spring. Warming weather, blooming flowers, and rising markets. We've entered the seasonally slow part of the year for the stock market. Where did that "rising markets" part come in? From the partially open door labeled "End Of Interest Rate Increases," no doubt. They haven't ended yet, but anticipation of a pause or halt is in the air.
The averages are soaring into the air, too. Just last Friday, the Dow clamored up 1.2% to 11,577. That's a wee 146 points from its highest close ever: 11,723 hit on Jan. 14, 2000. Another 1.3% gain and we're officially in record territory for the Dow. The S&P MidCap 400 and the Russell 2000 Small Cap Index are also punching at the ceiling.
I continue to expect a major correction in August/September, but for now all is sunshine and pollination.
To wit, our permanent portfolios. So far this year, Double The Dow is up 15% and Maximum Midcap is up 20%. I've written that leadership is destined to switch from smaller to larger companies before long, and that seems to be happening. In the last month, Double The Dow rose 8% while Maximum Midcap rose just 6%.
Beer is back on the menu. We've spent most of our time in the red since buying our brewer last September. In the past month, though, it gained 9%, sufficient to bump us back into the black.
Our computer security firm also fared well in the past month: up 9%. It, too, is only a modest gainer for us, so far, but is moving aggressively and is well-positioned for dominance in the computer security industry. It's a little expensive for my taste, but that appears to be a minority view and may not matter if it can keep hitting growth targets.
On the economic and interest rate front, we had a jobs report last Friday that excited investors. According to the Labor Department, non-farm payrolls rose by only 138,000 in April. That's the smallest gain since last October. Maybe Q1's outsize gains were an aberration. Unemployment is still at 4.7%. The impact for us as investors is that there may be less inflationary pressure, so the Fed might be able to stop raising rates after next week.
There was a niggling point, though. Hourly earnings rose 0.5%, more than expected. Rising earnings could lead to businesses raising prices, but the increase wasn't enough to offset the generally good news that payrolls aren't growing too quickly.
Next week is rate-raising time. The FOMC meets on Wednesday and will raise the federal funds rate by 0.25% to 5%. It will be the 16th meeting in a row over the last two years that ended in a rate increase.
What's still up in the air is what will happen in June. Will there be a pause? Will there be a halt? Will there be another increase? Nobody knows. So, on Wednesday, people will pay more attention to what is said at the meeting than to the all-but-certain increase.
Either way, I think we'll see a significant rally as the market senses the end of tightening. Shortly after that, we should get a summer crunch as oil prices rise and the rate increases put a damper on earnings.
For now, though, we're creeping higher. The price of oil fell 6.3% in two days last week. The interest rate increases are fairly well priced into the market, as is high gasoline. There seems to be no need yet to rush for the exits ahead of a summer correction.
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E-Commerce Champion
In fact, one of my long-time buy targets is finally coming into range. After watching this e-commerce leader succeed for years at too high a price, I've been monitoring it carefully since its January share price peak above $45. Now, it's around $32 and heading to $30 fast. That's where I want to buy in.
This company handles more searches than Google and maintains more financial accounts than American Express, yet it's being overly penalized for a slowdown in its hyper growth. The slowdown is natural, however, because the company has made recent acquisitions and plans short-term investments to expand into new areas.
I've used this pattern time and again to make at least 50% profits. Just in January, the company's share price was above $45. There's almost no question that we'll see it recover to at least its previous high. If we can buy in at $30, then, we'll see at least a 50% gain. It's not a complicated formula.
I've already explained this investment to Kelly Letter subscribers, and they're poised to grab this stock when the time is right. The good news for you, however, is that the price target has not been reached yet. It's close, but not there.
If you'd like to join us in getting ready to buy this winner, please sign up for a one-cent, one-month trial of The Kelly Letter. You'll have instant access to my report on the recovery of Japan, and will receive the report on this exciting e-commerce leader once your email address is confirmed.
There's nothing to lose, and it takes just a moment to sign up. Why? Because all I need is your email address and name. No credit card number. No bank information. Really. See for yourself here.
It was a busy week in the market that ended net positive for us.
Tuesday provided the biggest stage show as Federal Reserve Chairman Ben Bernanke addressed the Joint Economic Committee of Congress. Worried that he'd signal an extended rate-raising campaign, the market dropped in advance of the testimony. Then, he seemed to say that the Fed might take a breather from its recent rate-raising habits.
That sounded good to all listeners and the market rose. Unfortunately, somebody mentioned that taking a breather is not the same as stopping altogether, and the market dropped on that collective epiphany. When the closing bell rang, the market was in the green by a slim 4 points.
Beyond the usual attention paid to the Fed, investors monitored earnings all week. In aggregate, the reports were encouraging. The first quarter ended well for most companies and guidance for 2Q was fairly upbeat.
For most companies, that is. The Big Kahuna, Microsoft, lauded in Barron's just three weeks ago and summarized for Kelly Letter subscribers in Note 36, missed earnings expectations and warned that future earnings wouldn't be as good as previously thought. That was Thursday night, and the stock dropped 11% on Friday. More below.
Yet, we had a great week in other areas. For the week, our student loan company gained 9%, our semiconductor maker gained 5%, our brewer gained 4%, our computer security firm gained 4%, and and our media company gained 3.5%. Last week's losers remained this week's losers; our computer maker lost 3% and our electronic retailer lost 4%.
Our permanent portfolios? Up again. So far this year, the Dow 1 is up 9% and Double The Dow is up 11%. Maximum Midcap dropped slightly, but is still up 16%. They remain the best-performing, simple long-term strategies. Kelly Letter subscribers invest more money each month after receiving reminder notes the day before it's time to buy. The latest reminder note was sent last Thursday and we bought more shares in the strategies last Friday. The long-term performance of each of these approaches is fantastic, but Maximum Midcap's recent strength becomes obvious in this table on my strategies page. I'm happy to continue showcasing this performer.
This week's economic events did not divert attention from Bernanke's testimony and earnings, but here's what they showed:
On Monday, the dollar reached a three-month low against the yen. This trend is one that I warned about as a potential reason to sell the remainder of our Japanese market position. I think we'll see another up-leg before getting to the seasonal troubles I've been warning about. I have a mental sight set on $77 as a sell price for the second half of our position. That would give us a +63% gain on the second half. Combined with our +37% gain on the first half, we'd net out at +50% on the entire position. The fund closed the week at $70.95, 9% shy of $77. Japanese markets are closed Wednesday, Thursday, and Friday next week for the Golden Week holiday.
On Tuesday, April Consumer Confidence hit 109.6, its peak since May 2002. March existing home sales hit 6.9 million, a 0.3% rise on the heels of February's 5% gain. These are both good figures, evidence of a healthy economy. That's what a lot of watchers don't want to see. They want to see signs of weakness so the Fed gets the go-ahead it needs to stop raising rates. Tuesday's numbers mean there's more tinder to fuel the fires of inflation.
On Wednesday, durable goods orders for March rose far more than expected to 6.1%. That indicates brisk business investment and hints at economic growth. Then, new home sales for March leapt up 13.8%, the most they've increased in the last 13 years. February's nearly 11% decrease was quickly forgotten among a chattering about reports of the death of housing being greatly exaggerated. Too, median home prices slipped 2%, the first time we've seen that in 27 months. Surely there's no need to raise interest rates in light of that?
On Thursday, China's central bank raised rates from 5.58% to 5.85%, its first increase since Oct. 2004. That came out of nowhere. Could global economic growth be on the down slope? The question alone gave some investors pause. The answer, per usual, stood us up.
Next week begins May. As the Stock Trader's Almanac has made famous, the May through October time frame is the weak half of the year. The so-called "worst six months" have produced no gains in the Dow in the past fifty years. If my forecast of an August or September drop prove true, then the worst six months will continue their tradition.
After that, I expect things to improve. According to the May 1 issue of Barron's, so do a lot of other investors. From the cover story:
In the latest Barron's Big Money poll of institutional investors, 57% of respondents say they're bullish or very bullish about the stock market's prospects through the end of this year, up from 47% who held such conviction last fall. Nearly a third expect the Dow Jones Industrial Average to finish the year at or above 12,000.
Like us, a good many of those managers are looking to technology as the place to beat the market in the next 6 to 12 months. In fact, almost 43% said so.
I have fresh updates on our brewer, our debt collector, our student loan company, our chipmaker, our computer security firm, and our software company. I also spent some time examining a report from JPMorgan Private Client Services Economist Anthony Chan addressing the earnings slowdown we've been expecting since December.
To see all of these updates, the earnings slowdown report, and the entire Kelly Letter portfolio along with all subscriber notes sent this year, please try my one-cent, one-month trial. If you have a penny and a month with which to do some investment reading, it could be the most profitable penny you'll ever spend.
