My Maximum Midcap strategy is down 20% since its October high. In the past five years, it has declined farther than that only one time before recovering, and that time was down just 25%.
The ensuing recoveries averaged +38% in an average period of seven months.
I wrote last summer that oil would rise higher before falling lower for a while, then continuing another leg higher. That forecast is unfolding.
Lower oil prices are probably not far away. There's no economic reason for oil prices to be this high. Peak oil theorists aside, we're nowhere near the end of oil. Production is actually increasing and is ahead of current demand and projected demand for at least another ten or 15 years.
Some economists say the main reason oil prices are high is that they're denominated in dollars, and the value of the dollar is sinking. Some economists say the opposite is true: the dollar is falling against the euro because oil prices are rising and Middle Eastern nations sell dollars they receive for oil as soon as they receive them.
Either way, there's more to rising oil prices than just a falling dollar. In the past five years, oil prices are up more than three-fold while the dollar has lost less than one-third of its value. Not exactly a hand-in-glove moment that would make O.J. proud.
As with the chicken and the egg, we're not sure whether high oil prices or high euro values come first, but we're sure they come together. What also looks increasingly likely is that both are getting set to reverse course.
As week after week goes by with no economic fallout from the weak dollar, the headline will lose impact. Even now, smart foreigners are taking advantage of lower real estate prices in some parts of the U.S. combined with stronger foreign currencies to buy property at 25% off. That could turn the low dollar into a real estate support asset, which would help the economy, which would help to boost the value of the dollar again.
Another factor shaping up to get the dollar standing tall is the unpegging of Asian currencies from it. India has been letting its rupee rise, South Korea has been letting the won rise, Singapore has hinted at a similar policy, and even China is grumbling about the high price of gas and food and thinking that maybe a rising renminbi would be a quick fix.
If the world goes closer to a free float, the higher return on capital in the U.S. economy should one day get the dollar back on top, or at least closer to the top than the bottom.
Currencies are very complicated, actually, and no matter how much we talk about what influences them, what might happen, what happened in the past, and so on, there may be a much simpler way to get a handle on the odds.
Here it is: think in cycles. Markets tend to move in cycles. The euro weakened against the dollar for the first two years of its existence. Then, for the last seven years it's strengthened. If you know nothing else about why or when, don't you think it looks about time for the worm to turn for a while?
Barron's reported over the weekend that GaveKal, a top research firm, thinks so. It expects that worm to turn down hard, in fact, to where the euro will fetch only $1.05 or $1.10 within two years, down from its current level of nearly $1.50.
So, let's say the dollar strengthens, the price of oil drops, and we get those Fed rate cuts everybody is sure are on the way.
Then, say the consumer keeps on shopping -- as happened over the weekend. That will bring retail profits in higher than expected, because nobody expects much of anything at the moment.
As the above come to pass, financial companies wind down their one-time loss announcements and will have successfully set the stage for rosy backward comparisons in future quarters. How hard is it to do better than losing $11 billion, after all? Not very.
Finally, to cap it all off, GDP keeps coming in positive and recession is officially avoided.
While that may not be a recipe for a rip-roaring stock market, it sure seems like a recipe for a higher one than we have today.
You know what all the analysts are predicting. You know how down in the dumps the stock market has been. You know how every year for the first three weeks of November economists say that the American consumer is dead.
Let's prove them all wrong, yet again. Today is Black Friday, the busiest shopping day of the year. Get out and do your part! Buy something, then buy something else, then something else, and just when you think you've bought enough, buy more!
If you're reading this at home now, you may already be too late for the early-bird specials, though. Despite the dour predictions, consumers have already headed to the malls to get ready for the big day.
Luigi sent this yesterday:
I have been notified by a friend that there are people camped in tents in the parking lot of a local BestBuy. Beats spending Thanksgiving at home, I suppose, and all those bargains tomorrow will make up for the mortgage they couldn't afford.
Right, and there's nothing like a good shopping spree to get over depression about the falling value of a home. In any event, with all the bankruptcies on the way, folks might as well use it before they lose it -- credit, that is.
Run the charges to the moon, send retail stocks climbing when they beat their low earnings estimates, sell shares in those stocks, hide the proceeds, and declare bankruptcy. If ever there was a recipe for a strong economy, surely that's it.
This just in: stores are open right now! Stop reading, put all your credit cards in your pocket, and head out the door.
Rather than a time to give thanks, this year's holiday may be more of a time to step back from the market, take a deep breath, and ask what smart moves can be made.
In that sense, there's plenty to be thankful for. Some wonderful businesses are on sale. If your time frame is longer than a week and you don't mind some volatility, then dark news and lower prices are good, not bad. If some of those businesses are ones you already happen to own, then remember the wise words of Bill Miller at Legg Mason: "Lowest average cost wins."
Or, forget about the market altogether and just have a warm, glowing, fulfilling time with your family, and be thankful to live in a great country, to be healthy, to have turkey to eat and people to love.
BusinessWeek's current cover story, The Consumer Crunch by Michael Mandel, struck a chord with many readers. Mr. Mandel contends that consumer spending is finally going to come down this time, to the tune of $200 to $300 billion, because the sub-prime crisis is ending the "borrow-and-buy boom" that people created with credit. In essence, now that it's harder to borrow money to buy a home, and it will soon be harder to get a credit card, shopping will slow way down.
There's a simple way to test this: apply for a new credit card. You'll have it almost immediately. Just look at what's available with a few clicks of your mouse. Credit Land is even offering "credit cards for fall shopping" to help the economy out.
Mr. Mandel says this free-for-all is over: "But executives from Capital One Financial (COF ), Bank of America (BAC ), Discover Card (DFS ), Washington Mutual (WM ), and others have told investors in recent conference calls that they are using more caution in extending credit."
Ha! There's a laugh. How could they use less? When you read that lenders are "tightening standards" and "using caution" just know that it means they now require both first and last names on the applications. New credit cards and higher credit limits are still about as easy to get as a drink of water.
I have mixed emotions about all this. In my personal finance book and countless articles, I advised readers to avoid credit card debt. I never carry a balance on credit cards, and neither should you. Smart readers of mine long ago learned to see through the shiny lures of cash back plans, mileage plans, point systems, and other goofiness to trick the unsophisticated into running up the balance and then paying usurious interest. So, in a way, I'm in favor of the great shopping spigot getting turned off.
I just don't believe it will happen. Frankly, people are too financially stupid to ever get it. They always have been, and that's why a multi-billion dollar economy based on credit rose up around us. What's more, it's not going to disappear because a small portion of banking business is encountering a small portion of customers who can't pay. That's all sub-prime is, folks. It doesn't affect all mortgages, much less all of finance, much less all of the economy.
Another thing to keep in mind is that people in debt, people with bad credit, are not new. They didn't just pop up last spring when the phrase "sub-prime" entered the popular lexicon. I've been lecturing to them for more than ten years -- to no avail. There are more than 34 million Americans with poor or "damaged" payment history, and banks do a brisk business figuring out how to make money off of them in second and third attempts, even being brash enough to define financial sophistication as the ability to go into debt in more ways than one! "Get the new Pyrillium card exclusively for the finer lifestyle that you deserve." Flexible payment plans, no interest for a year plans, swap land for credit plans, you name it and it's been tried.
In fact, the root of sub-prime trouble lies in the creativity and boldness of financial companies. Who else would have ever lit upon the idea of lending mortgage money to people who can't afford a house? More frightening, look at how many morons took it. So, now a portion of the morons are in trouble and the holders of the loans are in trouble, and for that we're to believe that decades of making people believe they're entitled to the good life is simply over?
I don't think so. I wish so, but I don't think so.
Even Mr. Mandel admits that his call for the end of the consumer is a cry of wolf we've heard for the past 25 years:
Truth is, economists have been complaining about excessive borrowing and spending since the early 1980s. Journalists began writing about consumers being "tapped out," "profligate," and "spendthrift." Magazines and newspapers regularly ran stories about debt-ridden Americans not being able to buy holiday presents for their kids.
Yet, the holiday presents were bought, new cards were issued, new homes were built, the internet happened, and somehow all those borrowing and buying morons were even convinced that they needed to drive SUVs getting 14 miles to the gallon, and not even $3 gasoline could convince them otherwise.
I'm afraid it's time we admit that nothing will ever stop the American consumer. We've demonstrated that we're willing to kill for what we want, literally. Look at headlines from the Middle East sometime. More apropos, people have been overpaying for coffee, cars, houses, clothes, jewelry, handbags, shoes, and cosmetics for longer than I've been alive. That's America. That's how people want to live and it will not stop.
I know Mr. Mandel thinks that it's different this time, but the numbers from stores don't support that so far this year, any more than they did in years past, as I wrote last Thursday. Wal-Mart says all's well. Last night, Nordstrom beat earnings estimates and issued a positive forecast. People are employed. Incomes are growing at 7% year-over-year. We might just have, yet again, a holiday season better than expected.
You want to know one reason why? Because all the credit cards that have already been issued carry untapped credit worth $4 trillion. Combine that with America's insatiable desire to buy and we might just get one heck of a shopping spree.
The market fell Monday when E*Trade Financial warned that it would take additional write-downs, and said its portfolios were being investigated by the SEC. Its stock collapsed 60% that day. IBM, meanwhile, happily announced that it would buy Cognos for $5 billion cash.
Tuesday sent the Dow up 320 points for its second-best day so far this year, thanks mostly to solid earnings from Wal-Mart and the company's belief that it will do well this Christmas season. Also, the financial sector looked ready to call an end to its sub-prime related write-downs.
When those same old sub-prime fears resurfaced, stocks fell on Wednesday and Thursday. Bear Stearns said it would take a $1.2 billion write-down. Oil prices rose again. Retail sales came in lower than hoped.
Friday looked to be another downer of a day, but stocks rallied in the final 30 minutes. That surprised many because industrial production fell, a Fed official sounded hawkish on rates, FedEx issued a profit warning, and Starbucks gave a dour forecast.
Oil prices eased last week, but are still near historical highs. West Texas Intermediate closed the week at $95.10, a drop of 1.3% from the prior week, but only $1.60 below the all-time high of $96.70 set on November 6.
Here's Econoday's summary of the week:
The bottom line is that there is slow growth ahead in the fourth quarter and possibly first quarter of next year with sluggishness in the consumer sector along with the assumed continuing downturn in housing. But Fed officials are counting on a rebound early next year. We will get to see more detail on the Fed's views this coming Tuesday with the release of their three-year economic forecast.
Much was made of the final half hours of several trading days last week. On Monday and Wednesday, stocks plunged in the final half hour. On Friday, they surged.
For some reason, people think the final half hour is more significant than other times in the market because it supposedly shows how people really feel. If they sell, they don't want to hold overnight. If they buy, they don't want to miss potential gains lurking in the nightly news.
Forget all of that. The direction of some final half-hours is followed through the next day, the direction of others is not. We saw that just last week. Monday's final half-hour plunge was utterly canceled by Tuesday's big rally. Wednesday's final half-hour plunge was followed through by Thursday's steady downward path. Friday's final half-hour surge has yet to be followed up.
There's no pattern to be found, thus no conclusion to be drawn. It's just a point of commentary with no meaning whatsoever. That's true even for short-term traders, but doubly so for medium- and long-term holders.
In this weekend's Kelly Letter, I look at how we're holding up, comments from the Fed, housing bargains, Boston Scientific, and Starbucks. If you'd like to read the letter, see my entire portfolio, browse through my complete archives, and receive all notes for a month for just a penny, please click here.
Don't you think people are too optimistic for a year-end rally to make it actually happen? You know what they say: when everybody's in agreement, everybody's wrong.
I'm not sure what optimism Greg's referring to in his note. I find an abundance of negativity around me.
The reason that recessions are so devastating is that few see them coming. We are still in a pre-election year which has historically been the best time to be in the market and, for this reason, many have remained steadfastly bullish. But this factor would be more than offset by the bursting of one or more of the bubbles that exist today so that when it comes, it will cause assets to get rapidly re-priced. Based on the data we are now seeing, if this time has not come, it looks like it's just around the corner.
With all the talk of recession, it's sometimes hard to remember that we're not in one, nor are incoming data showing one on the way. The latest was well presented yesterday morning by Dick Green at Briefing.com:
New claims for unemployment for the week ended November 10 rose to 339,000 from 319,000 the week before but remain at levels well below recessionary trends.
The NY Empire State index of manufacturing conditions for November was stronger than expected at 27.4, but down a bit from 28.8 in October. This is just a regional survey but is seen as an early read on November conditions. It is good news.
Then, there's Enzio von Pfeil who wrote on Monday:
We have just now asked the Bank to sell all individual stock positions, the view being that this is the beginning of the end. That is because markets not only swing from buy to sell, but they also start discounting news. So, as we put forth recently, we thought that that by selling in mid-December we would beat the rush to the door. Today, we have fast-forwarded this and sold out completely. . . . We have taken the sales proceeds and will be going into a "short" ETF on the S&P.
Regular readers will recall Mr. Von Pfeil from my disagreement with him about October. He went on "red alert" for October, saying that many of the market's crashes have happened in that month. I said that you should not fear. Indeed, the S&P 500 gained 1.4% in October while the Nasdaq gained 5.8%.
Other dire forecasts include Outstanding Investments editor Byron King calling for $150 oil by December, Bank of England Governor Mervyn King saying that stocks are headed for a severe fall, and the estimable Economist writing that "the United States may well be heading for recession" and expounding:
Dearer oil is set to squeeze households further (this week's drop in crude prices notwithstanding). Consumer confidence has already fallen sharply. It cannot be long before consumer spending stumbles, which in turn would hurt companies' profits and investment. The weak dollar will boost exports, but at only 12% of GDP, exports are too small to make up for a weakening of consumer spending, which accounts for 70%.
I'd say there's plenty of negativity to go around, and that the minority viewpoint would be one looking for higher share prices, not lower.
There are plenty of reasons to be nervous heading into this holiday shopping season if you're a retailer. Consumer confidence fell in October for the third month in a row. Income growth is sluggish. Energy prices are soaring. No surprise, then, that the winter gift-buying season, when retailers traditionally book most of their profit for the year, is looking less than jolly. Sales at stores open at least a year will increase a modest 3.5% in November and December, down from 4% last year and well below the 5%-plus growth rates of the late '90s, estimates the International Council of Shopping Centers.
Now, can you guess when Business Week reported that? You would be forgiven for mistaking it as current news, but the date was November 8, 2004.
I can't remember a holiday season that was rung in with good cheer in the financial media. It's always a story about America's strapped consumer finally reaching the end of his or her spending ability for the same list of reasons. Confidence is low. Inflation, often from energy, is high and that's mopping up discretionary dollars. Incomes are down.
What happened after that dismal prediction in November 2004? The Dow gained 4.9% and the Nasdaq gained 6.7% by year-end, and Business Week reported on January 10, 2005:
The momentum continued as 2004 ended. The Conference Board reported that its index of consumer confidence jumped almost 10 points in December to the highest level in five months. Monthly data through November and holiday sales reports suggest real consumer spending grew at an annual rate of 3% to 4% in the fourth quarter. Strong buying just before and right after Christmas also helped retailers' fortunes.
Here at The Kelly Letter, we are keenly aware of seasonal trends and market history. You should be, too. Don't let what others believe to be "new" headlines scare you away from profits.
Remember this simple fact: news is usually frightening, yet the market usually rises.
Every year at about this time, we hear that the American consumer is tapped out. This year the refrain came with gusto because of the sub-prime crisis. The ability to withdraw cash via home equity lines of credit is now gone, goes the argument, so Christmas shoppers will fail to show.
Funny thing is, we heard that last year. The year before that, it was credit card debt that was going to shut down the holiday season. The year before that, it was comments from T. Boone Pickens predicting that we'd seen $40 oil for the last time and that we'd one day get to $60. Such high oil prices were bound to eat up all the extra money in consumers' pockets, so they'd have less for shopping. Sound familiar?
In each case, consumers showed up beyond everybody's wildest expectations and all was well. That didn't necessarily spare individual companies. Last year, for instance, was Wal-Mart's worst holiday season on record, but that didn't kill the rest of consumer stocks nor the overall market.
Lo' and behold, Wal-Mart's looking a lot better this year. Yesterday, it posted third-quarter earnings of $2.86 billion, an 8 percent rise that beat Wall Street expectations. President and Chief Executive Officer Lee Scott said, "During the Christmas and holiday season, our price leadership position will benefit both our customers and the company. We have set the stage for a successful fourth quarter."
Expectations are so low for consumer turnout, and stock prices already so low in anticipation of it, that The Kelly Letter is finding bargains in the consumer sector. We bought a leading casual dining restaurant on the cheap, and are looking to buy the leading coffee seller at the right price.
Over the weekend, I added ProShares Ultra Financials (UYG) to The Kelly Letter's list of what I'd like to own. UYG is an exchange-traded fund that returns 200% of the performance of the Dow Jones U.S. Financials Index, which owns the likes of Citigroup, Bank of America, JPMorgan Chase, AIG, Wells Fargo, Wachovia, Goldman Sachs, and so on.
These are the stocks that have suffered the most in the sub-prime unwinding of late. UYG is down 39% since the end of February, and 28% just since Oct. 9.
There is little doubt that these high-powered names will weather the current storm individually, but when grouped together in an index there no question. Doubling the return of the rebound could be very profitable, to the tune of 100%.
I will keep an eye on it a little longer to be sure we've reached a good bottom, then put some money to work on the end of the sub-prime worries.
We're buying into one of the bargains created by yesterday's sell-off around sub-prime. The Kelly Letter watches and waits for sometimes months before a stock reaches its target price. Yesterday, we went well below our target price and are jumping on the chance.
Do not be afraid of this market. The experts called for an awful October. I responded that it would be fine, and it was. More on that soon.
