11/14 Kelly Letter Topics
Weekly market review
The bottom holds
Big bounce volume
Recession projections
The magic midpoint
LevMark Timer holds
Crocs is dying
Hope for Goldman
Importance of retest
I spent the early part of my investment career researching strategies to beat the Dow. I was intrigued by the book Beating The Dow by Michael O'Higgins and John Downes. Then, I relished further work by The Motley Fool to improve upon the strategies.
Each of the Dow strategies involves using dividend yield to select a portion of the 30 Dow stocks that have historically been most primed for recovery. All are large, market-leading stocks like Boeing, Coca-Cola, Intel, Microsoft, and Wal-Mart. That they will recover is almost never in question. What is in question is which ones are most undervalued at this moment and should, therefore, perform better in the short term than the whole Dow itself.
In my own further research, I discovered a strategy better than anything ever attempted before. It's more volatile than the Dow, but because the Dow generally rises over time, it comes out ahead of the Dow -- and all other strategies intended to beat the Dow -- over time. I call my strategy Double The Dow.
After putting it to work, I continued looking for better ways to beat the Dow and was pleased to discover that the best way is not with its own components, but with an entirely different index. We can still use the Dow as a benchmark, but if another index exists that loses less than the Dow in bad markets while gaining more in up markets, that index should be a better hunting ground for our investment dollars, right? Of course.
I found such an index: the S&P Midcap 400. Then I further researched how to beat it over time. That strategy is called Maximum Midcap, and like its predecessor, Double The Dow, it has done remarkably well in both backtesting (the way I researched both) and in real life since I began using it at the end of 2002.
From December 31, 2002 to last Friday, here's the growth of $10,000 in the Dow Jones Industrial Average (via the Diamonds Trust, symbol DIA) and in each of my permanent portfolios:
The Dow $14,828 Double The Dow $19,661 Maximum Midcap $27,886
Pretty exciting, wouldn't you say?
Best of all, these strategies are completely automated. Each month, I remind Kelly Letter subscribers the day before the last trading day of the month to make their monthly investment the next day. That's all there is to it. In each issue of The Kelly Letter, I show both the growth of the initial $10,000 in each strategy along with the growth of $100 invested on the last day of each trading month. It's right there in print (in pixel, actually) for subscribers to follow along and watch their own money grow with the letter's.
Double The Dow and Maximum Midcap are my permanent portfolios. They go down at times just like everything else, but they eventually come back up. Our $100 invested at the end of each month takes advantage of the down times to add more money at cheaper prices. Then, when the eventual recovery takes shape, we profit off of it instead of just getting back to even.
This is not revolutionary. It's called dollar-cost averaging and happens automatically by just sending more money every month. It's best suited to a volatile investment that eventually recovers, and both of my permanent portfolios are perfectly suited to this approach -- by design.
I tell you this today because tomorrow is the last trading day of January and I just reminded subscribers to get ready to send their monthly contribution tomorrow.
If you give The Kelly Letter a try for a month, you'll see exactly what the permanent portfolios buy. Do it now, and you'll be able to make your first investment along with us tomorrow.
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For just a penny, you'll receive every note I send until the end of February and have complete access to all of my research and portfolio positions on my subscriber-only website.
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To read more about The Kelly Letter, Double The Dow, and Maximum Midcap, and sign up for your one-cent trial in time to invest in the permanent portfolios with us tomorrow, please visit:
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Here at The Kelly Letter, we've had our eye on Advanced Micro Devices (AMD) since it was over $21 in November. Since then, it has fallen some 24%, a full 8.5% just this week. Our initial buy target was $20, from which it has steadily dropped as I've monitored the stock and felt that it had further to fall. Our current buy target is $15, which is 7.5% below Friday's close.
AMD's Q4 was tough. It's been fighting hard against a reinvigorated Intel (INTC) and it also acquired ATI, a manufacturer of graphics chips.
Together, those factors resulted in a $574 million loss. That's -$1.08 per share. In Q3, the firm made $134 million, or 27 cents per share. Its revenues rose 3%, but even that good news fades when considering that it's usually 10% during the holidays.
Last week, I provided subscribers with a look at Intel that showed the company's margins under pressure. It's not alone. AMD's gross margins fell from 52% in Q3 to 40% in Q4. Naturally, the cause is falling chip prices, particularly server chips.
In its conference call, AMD said that the pricing environment will continue to be "incredibly challenging" all year, and especially so in Q1. Despite that, it thinks it can get margins back up to 50% thanks to its "maniacal focus on costs". It has high hopes for its line of quad-core chips scheduled for a midyear release, and thinks Microsoft's (MSFT) new Vista operating system will drive unit volumes across the board.
Yet, AMD remains firmly in the crosshairs of a none-too-happy Intel which is going all-out against the upstart that dared to take away market share a year ago. Longtime Kelly Letter subscribers remember my articles from this time last year in which I predicted this very scenario of the pendulum swinging back the other way. We're seeing that now, and we've put money in place to benefit from it, but we must always look ahead to succeed in this business.
Looking ahead, I see AMD getting ATI fully integrated, continuing its proven ability to produce market-leading chips at a lower price than Intel, and faring well in the long-term margin war through tight cost controls.
This sharp, determined company will have its day again, but not soon. The near-term favors Intel, which is why we own it. The medium-term could see a reversion back to AMD, however, and for that potential we continue to watch for an attractive entry point.
Our thesis remains: own Intel while it prospers and raises its stock price while pushing AMD's lower. When AMD gets low enough, invest for its eventual recovery. Watch Intel, and when it looks to have done as well as it can on this up cycle, sell for a tidy profit.
Would you like to follow along with me as this saga unfolds? One month of The Kelly Letter is just a penny, and then just $5.48 per month if you want to continue, as 85% of all people who try it do. Come see what makes my letter different. If you're not happy, you can cancel at any time and the monthly payments stop immediately.
See what a personal, professional perspective can do for you. Wall Street doesn't have to be mysterious, cold, or complicated. Around here, it's explained in plain English, in a friendly manner, with clear targets and a common sense rationale.
Plus, my permanent portfolios are among the best anywhere, as my January 7 article showed. They just keep piling up profits year after year with almost no work, other than sending more money each month.
Why don't you join me for a month to see all of this for yourself? It takes just two minutes once you click here.
The price of oil is down 16% this year. West Texas Intermediate spot prices closed the week $1 lower than last at $51.99 per barrel.
I received a lot of email from subscribers who invested heavily in oil-related stocks. They're wondering if they blew it and should sell now to limit losses.
No.
One way to find comfort is by comparing the behavior of oil stocks with the price of the commodity itself. The Energy Select Sector SPDR (XLE) has the following top five holdings:
So far this year, while oil itself has dropped 16%, the Energy Select SPDR is down just 3.5%. That strong resilience is a positive sign, and probably means that crude doesn't have much farther to fall.
Grant Prideco (GRP), the only oil stock owned by The Kelly Letter, is down 7% so far this year. That's a reasonable slide against oil's greater losses. Overall, we're up 6% in Grant.
Now, think about who uses a lot of oil. Transportation stocks. There's a handy way to see how they're doing: monitor the Dow Jones Transportation Average, which consists of twenty stocks such as AMR Corp. (AMR), Continental Airlines (CAL), FedEx (FDX), J.B. Hunt (JBHT), JetBlue (JBLU), Ryder (R), Southwest Airlines (LUV), Union Pacific (UNP), and United Parcel Service (UPS).
If oil is truly down for the count, the Dow Transports should be on a steady run higher because their costs are coming down. Transportation investors are a smart bunch, and one of the factors they watch more closely than most people is the price of fuel, which is determined in part by the price of oil.
So, what are the transports doing? Not much. They're up 7% to right about where they were in mid-November, testament that oil has been declining but not enough of a tear to imply a longer-term trend.
Lest memory fail you, think back to 2003 when the U.S. first invaded Iraq and there was a not-surprising victory over the Iraqi army followed by President Bush's "Mission Accomplished" speech.
According to the Energy Information Administration, the spot price of Cushing, OK WTI dropped 22% from $35.83 in February to $28.11 in May. It averaged $30.66 in April, $30.75 in July, $31.57 in August, and touched its second bottom at $28.31 in September. From there, it embarked on its tremendous bull run to $74 last July. Even after the good news of a supposedly quick resolution to the Iraq war in 2003, oil wasted little time adjusting itself upward.
Ask yourself, "Have the geopolitical risks increased or decreased in the Middle East?" You know that higher risks in the Middle East contribute to higher oil prices. If we see rising risk in that region, it's safe to bet on higher oil.
The U.S. just committed even more troops to Iraq. The war is widening, not wrapping up. Iran is looking more hostile toward the U.S., not friendlier. China and Russia are cooperating to lock up more of the world's oil, not less. Those factors point to higher oil, not lower.
Banc of America investment strategist Joe Quinlan thinks that investors have "reached the point of maximum complacency" regarding the Middle East and oil prices.
Then, there are the alternative energy types who say that fossil fuels are on their way out. That's a beautiful picture of the world and one I'd like to see in my lifetime, but it ain't where the smart money sits.
According to the EIA's "Annual Energy Outlook 2007 with Projections to 2030 (Early Release)," oil, coal, and natural gas will constitute the same 86% share of the total U.S. primary energy supply in 2030 that they did in 2005. From the report:
The expected rapid growth in the use of biofuels and other nonhydropower renewable energy sources begins from a very low current share of total energy use; hydroelectric power production, which accounts for the bulk of current renewable electricity supply, is nearly stagnant; and the share of total electricity supplied from nuclear power falls despite the projected new plant builds, which more than offset retirements, because the overall market for electricity continues to expand rapidly in the projection.
You can be sure that if the outlook in the enlightened U.S. is all about fossil fuels, it's even more so in developing regions of the world.
Which brings us to an unavoidable fact. The oil story is simply this: demand is rising, supply is falling. That leads to higher prices over time.
T. Boone Pickens, one of the leading figures in the oil business, is calling for an average oil price of $70 per barrel this year.
Oil prices will rise. They might not next week, perhaps not even next month. However, the intermediate- and long-term trend is unmistakable.
Rather than selling out of fossil energy positions in this momentary downward blip, I suggest looking for places to buy in preparation for higher prices down the road.
Two that come to mind are Baker Hughes (BHI $67) for oil and BJ Services (BJS $26) for natural gas. Since last July, they're down about 20% and 24% respectively.
Natural gas is not the focus of this report, but stocks involved in it often move in sympathy with oil stocks because weather patterns affect both. For instance, we're seeing lower oil and natural gas prices now partly because of a warm winter. They rose on Friday, and the most commonly cited reason was that next week will be cold in Chicago and New York.
As is my way, I'd keep watching a while longer. Oil could get all the way down to $45 before real panic conditions begin peeking out. A downside risk is that energy companies will issue profit warnings and blame lower oil prices. That would send prices a leg lower and be a perfect time for bargain hunting.
Energy is not a fickle industry. It's one of the best developed and best managed on the planet. It's not going away. Your money invested in energy is safe. Do not sell because of currently low oil prices. They will eventually rise again.
If anything, watch the oil sector with an eye on buying.
We bought Microsoft in Aug. 2002 at $22.50. So far, we're up 39%. I was too early in buying, however. Just last June, we were at break-even. All of the gains have come since then, which lends credit to my thesis of the past year that the Vista and Office upgrades would drive the stock higher. Last summer is when the press began covering Vista in earnest.
Last week, I received a note from longtime Kelly Letter subscriber Chris pointing me to a Techworld article troubled by Vista's protection of premium content. The ultimate worry is that people will hold off on upgrading, which was Chris's primary concern. It's a widely held and valid one.
My reply to Chris was:
Yes, there's commonly a refrain to wait on an upgrade. Every major OS stage has faced the same warning to avoid being an early adopter. There are good reasons for it, but the upgrade cycle eventually covers everybody, even if not in the first month or so.
I, too, have a perfectly capable XP notebook and I won't rush to upgrade. However, already, we're seeing gaps that Vista will fill nicely. They'll add up, and one day the only option available to new computer buyers will be Vista.
Quick example: you can't burn files to a DVD by just dragging and dropping in XP's file explorer, the way you can with a CD. In Vista, you'll be able to. With much more capacity and data files growing all the time, DVDs are preferable to CDs. With XP, you need third party software to burn a DVD.
Then, MS Office won't be backwards compatible forever with XP files. As others upgrade, so shall ye. That's how it's always gone.
So, while I recognize that there's a lot to be said for waiting, not everybody will. No company has proven better at getting money on upgrades than Microsoft, and Vista and Office together are the biggest release in the firm's history.
The events of last week confirm those ideas. Microsoft is widely despised in the computing business and much of that disdain comes from its lack of innovation. Microsoft's business plan most often consists of taking ideas from others and then outmarketing those others.
I've mentioned this before, but to jog your memory: DOS was purchased, Word copied Wordperfect, Excel copied Lotus 123, Windows copied the Mac OS (which was based on an OS developed by Xerox at its famed Palo Alto Research Center), Money copied Quicken, the Xbox copied the Playstation, Internet Explorer copied Netscape Navigator, and even Microsoft's mouse was a knockoff of other designs.
Microsoft makes no bones about it. If you have a good idea, they'll gladly take it and destroy you in the marketplace with their fabulous sales team, bottomless bank account, and a few well-placed pieces of proprietary software that favor their own products. It's what they do. It's good for profits, but bad for accolades. It makes more enemies than friends in the computing industry, which craves innovation. It's the reason everybody loves the dazzlingly innovative Apple.
Imagine, then, what a breakthrough it was for Microsoft to win the "Best of CES" award at the Consumer Electronics Show, and for an operating system no less. The OS is not usually where the oohs and ahs come from on a computer. That gives an indication that what's on the way is a needle-mover. Vista will do things that we'll all want to be able to do. That will boost sales of new computers, sales of software, and reliance on the internet. We own investments in each area.
Even if the doubters are correct and there isn't a massive rush to upgrade at the end of this month, there will still be an upgrade cycle. It might span months or even years. That would be fine for long-term holders of companies on the gravy train, like us.
Will there be problems? Sure. There always have been, but Microsoft has always dealt with them and managed to still bank its billions. It'll happen again.
As readers know from my stock book, the Dow 1 strategy is automated. It chooses the second-lowest-priced of the ten highest-yield Dow stocks each year.
Last year, the stock was Pfizer (PFE). It returned 11%. This year, the stock is General Motors (GM).
While technically you should have already bought the stock if you're following this strategy, taxes make it wise to hold a little longer than a year to pay just the 15% capital gains tax on the sale of last year's stock (Pfizer). If you sell within one year, you pay your normal income tax rate, which is almost always higher, usually much higher.
So, if you're following this strategy, I suggest entering a limit order to buy GM at $30. It closed Friday at $30.24, so a slip of just 0.79% will bring it down to $30, which is sure to happen.
The bigger issue, however, is whether it's worth implementing the Dow 1 at all. It's the best of the old Dow strategies, but I show in my book that my doubling approach is superior to all of the old strategies, the Dow 1 included. In fact, it was specifically to beat the old Dow strategies that I spent considerable time researching a new one.
I follow the Dow 1 in The Kelly Letter and on this site mostly as a tracking mechanism, to show how excellent Double The Dow and Maximum Midcap are. Some people use it in their portfolio, but I don't recommend it. It's not that it's bad, it's that I've found something better. Compare the annual returns since I began tracking these strategies:
In view of the above, you'll probably agree with me that we've built better mousetraps. The Dow 1 is a great milestone on the timeline of investment progress, but we're past it now. As long-term, permanent strategies, Double The Dow and Maximum Midcap are better.
There may be a tactical reason you want a single Dow stock in your portfolio. If so, use The Dow 1 as a useful guide. If you're just looking for a permanent portfolio, however, don't bother with it.
This just in...
The end of this weekend's "The Trader" column in Barron's examined how various investment strategies fared in the past year. Merrill Lynch says that picking the 50 stocks in the S&P 500 with the least analyst coverage would have produced a 24.6% return. Evidently, that was the best strategy from 40 that Merrill's quantitative strategists compared.
Low ratio of price to cash flow generated a return of 23%. High dividend-paying stocks climbed 21.7%.
Birinyi Associates found that buying stocks with the lowest projected growth rate over the next five years earned an average return of 26.5%.
Notice anything interesting about all of those numbers? They're all lower than the performance of my simple Double The Dow strategy. It returned 29% last year, and didn't require anything as nutty as buying 50 different stocks.
Why hasn't anybody else picked up on these excellent doubling strategies? Beats me, but I'm glad they haven't.
