The Kelly Letter has been watching certain homebuilder stocks since last summer. With their recent recovery, some people have written wondering if we missed our chance to buy.
Well, we certainly missed a chance to buy, but I'm not sure it was the last chance. Homebuilders face big challenges, and they've been head-faking everybody for half a year now.
The one I'm watching most closely dropped to $13.50 in early October and then rose 29% by early November. "The train has left the station," went the refrain in notes I received back then, "and you missed it!"
The stock then dove 31% in the following three weeks, rose 48% in the next three weeks, dropped 60% in the next month, and is now up 105% in the last week. There were lots of trading opportunities to be sure, but I'm watching and waiting for the long haul gain and want more confidence before committing my subscribers to that.
Anecdotally, I've been waiting for a major bankruptcy in the group to signal that a bottom is near. We haven't had that yet. According to an article in yesterday's Financial Times, we may get it soon:
The risk of bankruptcies among the big U.S. homebuilders has risen sharply as the economy has weakened and an end to the housing slump remains distant.
Credit default swaps on homebuilders, which act as insurance on corporate debt, suggest some of the biggest are at risk of failing to keep up debt payments. According to Byron Douglass, an analysts at Credit Derivatives Research, the most exposed are Standard Pacific, Hovnanian, Beazer, and Meritage . All are among the top 15 publicly-listed U.S. homebuilders.
Mr Douglass said bankruptcies were "highly likely" among top homebuilders. Homebuilding is viewed as being the sector most threatened by the slowdown as housing has been the worst hit part of the economy.
Defaulting on debt is "in most cases coincident with bankruptcy," said Robert Curran, an analyst at Fitch Ratings.
The Kelly Letter has been buying aggressively during this downturn. We have active orders in place to average down on existing positions and to add new positions that we've been watching for months.
The Federal Reserve takes heat no matter what it does. Prior to the credit worries, critics referred to Fed Chairman Ben Bernanke as "Helicopter Ben" for his remark in 2002 that a government with a fiat money system can avoid deflation by just injecting more money into the economy at any time, and his citing Milton Friedman's quote about a helicopter drop of money to save the day. The idea was that, like Greenspan before him, Chairman Bernanke would let loose too much money into the economy and create bubbles.
Then, when sub-prime grew as a concern and that turned into the credit crisis in the fall, people cried that the Bernanke Fed was too slow to loosen the money spigot, even though the Fed began cutting interest rates all the way back in September. It didn't do enough, went the cry.
Then, last week, the Fed came out with an emergency rate cute of 0.75% and investors said that Bernanke was panicking.
Which was it? Was the Fed behind the ball and catching up, or on track and panicking? Either way, when the FOMC meets on Wednesday it is expected to cut an additional 0.25%. That will bring the Fed funds rate to 3.25%, which is a dramatic 2% lower than it was at the beginning of September. Naturally, the crowd is back to calling the chairman "Helicopter Ben" again for his efforts.
Don't bother participating in the easy game of blame the Fed. Instead, focus on what's happening in the economy and the market and see that time is finally on your side.
The market for mortgage-backed securities hasn't fallen for two months. Bank credit is looking healthier. Just about the time those are turning up, we now have both monetary stimulus coming in strong and even fiscal stimulus from Washington. Both of those have worked in the past. They'll work this time, too, regardless of how many people deride them.
Even if a recession squeaks onto the scene, it'll be pretty muted by the Fed's proactive efforts and Washington's helping hand.
Meanwhile, the bargain prices that the market has served up to start the new year are much appreciated. It's hard to go wrong buying stocks this cheap.
People looking to profit from a short-term bounce higher should consider a leveraged index ETF. The one I use in The Kelly Letter is looking especially ripe for more upside.
A good way to judge trading opportunities on indexes is by watching their MACD and RSI scores. Both together, along with the price chart, give good indications as to whether the odds favor rising or falling from here. The short-term read on nearly every major index right now is for more upside.
Browse over the leveraged index ETFs at ProShares for some ideas. If you run charts on any of them and examine the MACD and RSI, you'll see that about 15% to 20% short-term gains look likely from here.
I'll be discussing this in more detail in this weekend's Kelly Letter.
Capitulation is defined in the American Heritage Dictionary as the following:
ca-pit-u-la-tion (n)
1. The act of surrendering or giving up. Surrender. 2. A document containing the terms of surrender.
In Wall Street the term refers to the time when investors (all of them) sell all their stocks because they want out. The sole motivation for trading is to get out of the market and seek shelter in "safe" investments such as bonds or your mattress. The selling frenzy is painful, but relatively quick. Consequently, a sign of capitulation is mass selling that occurs over a brief time span.
As I write this on Monday night, the signals are not good. In London trading, future contracts on the Dow Jones Industrial Average were pointing to a more than 500 point drop. Trading in India was down more than 11% and halted. Hong Kong's Hang Seng index was down more than 8%; Japan's Nikkei index is down 5% and has suffered its biggest two-day drop in 17 years; Taiwan is off 6.6%. The major European bourses all suffered large declines on Monday, with losses of more than 7% in Germany and nearly 5.5% in the U.K.
Monday night here in California, I took a look at some of the major Asian and European tech shares, and the news is not good.
In Taiwan, shares of Taiwan Semiconductor (TSM) are down 7%.
In Tokyo, Yahoo Japan is down 7.4%.
Also in Tokyo, Sony (SNE) is down 5.3%, while Toshiba is down 5.1%.
In German trading, SAP on Monday was down 9.7%.
In Finland, Nokia (NOK) shares were off 6.3%.
In India, all of the leading outsourcing stocks were hard hit, with Wipro (WIT) down 7.9%, Satyam (SAY) down 4.5% and Tata Consultancy Services down 8.5%
In South Korea, Samsung shares are down 10.2%.
In Hong Kong, Alibaba.com shares have dropped 10%.
Also in Hong Kong, China Mobile (CHL) shares are are down 6.5%.
This all feels uncomfortable like October 1987. I would note that even before the infamous 22%-point drop on Black Monday, the Dow Jones Industrial Average had already fallen close to 20% from its peak. I wrote an opening market comment that day -- yeesh, I've become an old timer -- which noted that stocks had dropped dramatically in overseas trading heading into the opening in New York. I know that conditions are hardly identical in many ways, but this does not feel good to me. Not good at all.
From MarketWatch this morning: "Over two days, the Nikkei 225 dropped over 10% in Tokyo, and the DAX-30 fell about 10% in Germany."
From one of Dow Theory Letter editor Richard Russell's recent notes:
Now the foreign markets, Hong Kong, China, Europe, are starting to break down. Let me put it this way -- we're watching a deadly international bear market, one that is pressing down on every stock exchange on the planet. How it will all work out I honestly don't know. I've lived through a number of bear markets, but this one is shaping up as a "biggie," a real brute. That's my instinct, that's my intuition, that's my opinion after 63 years of studying and dealing with markets.
Global panic has hit the stock market. A plunge at the open is clearly indicated. . . . The market drop today is essentially on no news. That doesn't matter much, however. This is not like the sell-off in February 2007 in which a quick rebound occurred. These fears aren't going away overnight.
From the note I sent Sunday morning to Kelly Letter subscribers:
The latest selling looks to have spun out of control. I would not be surprised to see a final big spike down as everybody finally swears off stocks forever -- again.
Yet, interest rates will come down, earnings won't be so bad, oil prices will drop, food costs will drop, credit markets will crank up, political candidates will talk about America's strengths, and this downdraft, too, shall be lost in the long-term uptrend that is the stock market.
Stocks are cheap. The S&P 500 is down nearly 10% so far this year, and the year's not even three weeks old. The P/E ratio on the index is almost down to 13. Remember the great buying opportunity in 2002 following the bulk of the dot com bubble burst? Now that was a bear market, and yet the S&P 500's P/E was 15, not quite as cheap as it is now. So, even if earnings weaken from here, we have room for the P/E to rise and still find stocks cheap.
There's another measure showing stocks to be cheap. The forward earnings yield on the S&P 500 is over 7%, twice the 3.6% yield on the 10-year Treasury note. That kind of disparity has never lasted long.
Then the big news hit at 8:25 this morning: The Federal Reserve cut its overnight lending rate by 75 basis points to 3.50%.
Stock market bulls lost an important ally on Wednesday: Dan Sullivan is now convinced that we are in a major bear market.
Sullivan is editor of two newsletters, The Chartist and The Chartist Mutual Fund Letter. Sullivan has been publishing the first of these since the late 1960s, nearly 40 years ago. Very few others have been continuously editing an advisory newsletter for any where close to that long a period.
Sullivan, therefore, has seen lots of different kinds of market environments, which is why we should place more than the usual weight on what his intuition tells him. And right now, as he said in an interview Thursday afternoon, his "gut feeling" is that we're in a bear market that we will need to let "run its course."
As a result, Sullivan has liquidated his two model stock portfolios and gone completely to cash. The last time he was in an all-cash position was in early April 2003, nearly five years ago.
The Kelly Letter has been looking to buy financials at lows, but we have no active order in place yet. I'm waiting for a washout and a panic sell-off before buying. It's a great turnaround sector candidate, though.
Note the specific reference to sector, not individual company names. Such a massive rearrangement of fortunes makes it hard to see who's going to come out on top, or come out at all. Investing in the recovery of the whole group is a safer way to win.
We have placed active orders in other areas. So far, however, most of them have not filled. The market has not sold off to the next down leg that we've identified. Some look at that and say it's a sign of stabilizing, others say it means the worst is yet to come.
One thing about expectations being aligned in the downward direction is that it leaves a chance for positive surprises, as we got this morning from Advanced Micro Devices, a stock that The Kelly Letter has been acquiring:
Considering the devastating two years Advanced Micro Devices Inc. has endured, investors braced themselves for more bad news in the fourth quarter after rival Intel Corp. disappointed Wall Street with lackluster results.
The slowdown they feared didn't materialize.
Instead, Sunnyvale-based AMD managed to post a much narrower loss than analysts expected, jolting its stock on signs that AMD is driving down costs and protecting its share of the microprocessor market from an Intel onslaught.
"Obviously, they turned in a truly excellent quarter," said JoAnne Feeney, senior research analyst with FTN Midwest Securities Corp. "They've continued the progress they began making a couple of quarters ago. It should assuage the fears of a lot of investors about the company's ability to execute."
James Cramer wrote last night, "This is one of the worst markets I have ever seen." Ever?
We don't have to go back too far to see one much worse. From March 2000 to September 2002, the Nasdaq lost 78%. In this current market, from October 31 to yesterday, it's lost only 18%. The difference between the two is crystal clear on this chart.
Seems a little early for the "worst market ever" label.
I attended a meeting of financiers in Tokyo that invite me occasionally for commentary on the U.S. markets. Before lunch, we heard presentations about the Nikkei's prospects for the rest of this year. After lunch, we listened to projections for the S&P 500. All presenters were Japanese.
While they think the current storm is worse than anybody thought a month ago, they also think it's going to blow over. I'm in that camp as well, wishing I'd foreseen the market slide of the past month but not overly concerned about it lasting all that long.
My favorite observation on the Nikkei slide came from Shinnichi Ishinori of Imaichi Securities: "It won't go below 12,000 and if it does, it won't go below 10,000 and if it does that, it definitely won't go below 8,000."
Now there's a man who knows how to place his bets! Getting below 8,000 would take the Nikkei to the lowest range it's seen...ever. It hit 7,604 in April 2003. Mr. Ishinori's forecast is akin to me saying that the Dow "definitely won't go below 5,000." Of course not.
More interesting than any presentations, however, were the whispered conversations of our 90-minute lunch. There, I learned that all three of Japan's biggest banks are ready to pour money into America's troubled financial sector. That's just the latest evidence of smart money from around the world pouncing on the U.S.A. winter sale.
Mitsubishi UFJ, Mitsui Sumitomo Financial Group, and Mizuho Financial have pooled $10 billion that they want to put to work outside Japan's stagnancy. Just five years ago, the Japanese government had to bail out these same banks for problems that started in the early 1990s. Now, that bail-out money is fully repaid and investors here are riotous in their demands for the banks to find some decent places to put new cash to work. Enough with going nowhere, they've decided. Let's get where the action is.
The big three are serious enough in their intent to own part of America's dynamic financial system that they're prepared to go head-to-head with sovereign wealth funds in other parts of Asia that are aching to snatch a share of Wall Street.
For about the past six weeks, we've seen foreign money gushing into America to buy portions of semiconductor stocks and distressed banks. That the latest posse includes banks from Japan, a ground zero of financial disaster history, shows that those with experience in these matters sense more opportunity than danger.
The collective stance looks to be, "This too shall pass, and when it does I want to own as much of the recovery as possible."
Your Maximum Midcap strategy has made a lot of money for me in my retirement account. I follow the advice in your book and keep buying each month no matter what the news, and that's been a good way to cut down on stress and just wait for recoveries. So, thanks.
But I'd like to do better. Have you ever looked into timing strategies that use Maximum Midcap as the vehicle?
Yes, I have and with quite a bit of luck with one in particular.
Using standard deviations, moving averages, exponential moving averages, and other mainstays of technical analysis has not done much to improve the results of a simple dollar-cost averaging strategy, which is the one I suggest in the book and that Andrew mentioned. The improvements, when they happen at all, are not enough to to justify the extra hassle of needing to watch closely and take action at the ever elusive exact right moment.
What has shown some promise is using Gerald Appel's standard MACD. Since early 2000, whenever Maximum Midcap's standard MACD has dropped below -1.5, it has been a pretty good time to look for a bullish crossover divergence and invest in the strategy or increase the amount you invest.
Let's look back.
12/11/00 - 4/4/01 saw Max Midcap drop 39%. The standard MACD was -1.64 and made a bullish crossover within a few days. By the time the MACD reached +1.33 and showed a bearish crossover on May 25, Max Midcap had risen 47%.
5/21/01 - 9/21/01 saw Max Midcap drop 48%. This period included 9/11 and saw the worst MACD reading ever shown for the strategy. The standard MACD hit -2.47 on Sept. 26 and made a bullish crossover on Oct. 2. By the time the MACD had reached +0.59 and showed a bearish crossover on Dec. 3, Max Midcap had risen 23%.
Here, there was a problem. MACD gave unclear signals and by mid-April 2002 missed out on an additional 27% gain. That's a lot to miss. The good news is that it kept timers out of the plunge to come.
4/17/02 - 7/23/02 saw Max Midcap drop 47%. The standard MACD reached -2.16 on July 25 and made a bullish crossover on July 29. It was an unimpressive 8.8% run higher through Aug. 21, though, and the bearish crossover indicating time to sell didn't happen until Sept. 3, by which time Max Midcap had lost 5.7% from the July 29 buy.
However, that's a lot better than the 47% drop from the time period prior, and better than the drop to come.
9/3/02 - 10/9/02 saw Max Midcap drop 26%.
From here, I want to change the parameters of research to just pivotal moments because it's tedious for you to read through every little blip up and down.
The standard MACD did not deliver a strong buy signal at the single best buy moment of Max Midcap's history, which is disappointing. March 12, 2003 was the strategy's cheapest day ever and the MACD got down to only -0.52 with no bullish crossover. It did provide signals to help get timers in for a good portion of the +143% gain over the following 12 months, but not the full run.
Not until June 2006 did we see a deeply negative MACD, due mostly to the raging bull market and Max Midcap's riding it. On June 14, 2006 the standard MACD reached -1.92 and made a bullish crossover on June 22. In the next 12 months, Max Midcap gained 37%.
On Aug. 16, 2007 the standard MACD reached -2.36 and made a bullish crossover on Aug. 21. Max Midcap gained 12% by Oct. 16 when a bearish crossover happened.
On Nov. 27, 2007 the standard MACD reached -2.03 and made a bullish crossover on Nov. 29. It was a bad one, though. Since then, the strategy has been up, then down, then up, then down a lot to yesterday's close, 17% lower than on Nov. 29. The MACD did issue some sell signals along the way, but the bullish and bearish crossovers were too finely cut and too close together to form much conviction.
As of yesterday, the standard MACD is at -2.29 and has yet to make a bullish crossover. As you can see from this compressed history, however, an MACD that low usually signals a recovery on the way.
That's consistent with my market outlook based on where we are in the Fed's interest rate easing cycle and the valuation of the stock market versus bonds.
A lot of people wonder how I came up with the Maximum Midcap strategy featured in the 2008 edition of The Neatest Little Guide to Stock Market Investing. It's wildly popular with readers and onlookers because it has beaten more than 95% of all mutual funds in the past five years.
In the first edition of the book way back in 1998, I focused the permanent strategy portion of the book on traditional ways of beating the Dow Jones Industrial Average. Those usual ways are the Dow Dividend strategies, which seek to beat the overall Dow by buying the 10, 5, or fewer stocks that provide the highest dividends. It's a good approach, but not great.
In the second edition in 2004, I discovered that by just doubling the returns of the entire Dow I could beat all of the Divend Strategies over time.
In this third edition, I took that a step further by finding an entirely new index with which to beat the Dow. What I wanted was a group of stocks that rose higher in strong markets and fell lower in weak markets. "Could there be such an index?" I wondered.
Yes.
Most people think of the market as having two distinct categories: large companies and small companies. However, there's a third category: medium companies. Many people know that sometimes large companies do better in the market and sometimes small companies do better. What they miss is that medium companies tend to do pretty well all the time, and that gives them the best long-term performance of all the major groups of stocks.
Once I discovered that, I applied the doubling strategy that I used in the second edition of the book to come up with a way to double the midcap (medium-sized company) index. It's been leading the industry for the past five years, from the time I first began tracking it.
Just leaving a lump sum in the strategy has worked well over time -- better than 95% of mutual funds -- but a simple technique to make the system even better is to send more money each month or quarter. That's called dollar-cost averaging. Your regular money buys more shares when they're cheap than when they're expensive, automatically giving you an edge over longer time periods.
Maximum Midcap is ideal for that investment approach because it rises twice as much as the market and falls twice as much. The key to being confident is knowing that it always recovers. Combining extreme volatility with guaranteed recovery is a potent combination, and the new edition of my book shows you everything you need to know to put the strategy to work with your own money.
Don't take my word for it. Look at how the strategy has done over time. Imagine what that kind of performance could have done for your retirement account!
There's a lot of talk now about an impending recession. Some say we're already in a recession. The general conclusion is that if the economy is slowing down then stocks are doomed.
That isn't necessarily the case. We're trying to get through the sub-prime crisis, which affects a small part of the mortgage market, which represents about 5% of the economy. It has had bigger repercussions in the credit market, but so have other financial crises in the past and we've come through all of them.
In fact, during the savings and loan crisis of 1990, stocks began rising five months before the economy bottomed out. Stocks bottomed at about halfway through the Federal Reserve's interest rate cutting campaign. Interestingly, that's about where we are now by most forecasts.
Stocks will be fine once we get through this volatility. People taking advantage of current bargains will be rewarded before too long.
Wednesday, January 16 06:05 a.m. KYW-AM Philadelphia ("Newsradio 1060") 10:00 a.m. CJAD-AM Montreal ("Newstalk Radio 800") 11:00 a.m. Sound Investing Seattle with Paul Merriman 04:00 p.m. Investment Talk Radio online
I lived in Japan when I served in the military, and liked it a lot. I'm just curious, in your case does the pleasant culture make up for the high expenses?
While Japan is more expensive than other parts of Asia, it's not as expensive as most Americans think. The days of $20 hamburgers are long gone, down the same toilet that flushed away the stock market in 1989. Nobody bathes in golden tubs anymore, either.
In fact, once you take taxes, health care, and transportation into consideration, Japan is usually a cheaper place to live than the U.S.
Say you make a paltry $100,000 per year in America and are thus in the 33% tax bracket. After the U.S. federal income tax alone, you're taking home just $76,277. (The tax bracket percentage applies only to the last dollar you earn. You don't subtract 33% from $100,000 as you'd expect. That's way too simple. You have to deduct the rising percentages from the lower amounts earned until you arrive at your last dollar. Details here.)
State and local taxes vary, but lop off about another 20% for most folks in the fat part of the bell curve. That takes you down to $61,022. That would be fine if you received something useful for the taxes you paid, except that the only thing American taxes buy you is another war somewhere. Really. Glance back through recent history. The military industrial complex manages to arrange a war at all times to justify the exorbitant cost of a military that's so advanced it can wipe out any country on the planet. Too bad it was unable to protect the World Trade Center.
Let's look at that more closely, because I think it's important to understand why most people can't get ahead in America.
The Iraq War costs $378 million per day to operate. That's $138 billion for fiscal 2007. The war did not catch those responsible for 9/11, nor reduce the terrorist threat, nor secure access to plentiful oil fields. The only thing the war has done for you is jack up the price you pay for gasoline. Plus, bear in mind that the $138 billion per year is just for the operation of the war. It has nothing to do with the standard military budget, which continues uninterrupted at more than $600 billion per year, and growing. The U.S. military budget accounts for about 45% of global military spending, by far the highest percentage of any country. You're paying for that. The number two country, China, accounts for just 5% of global military spending. Just the operating budget of the Iraq War would have provided 39,000,000 Americans with health care last year. That's shown here. As is, though, your taxes pay only for the war that raises your gas prices. You get no health care, or much of anything else for that matter.
Overall, some 41% of your taxes pay for wars that do you personally no good. Not since World War II has it been possible to argue that a U.S. war has been for self defense. Every war in my lifetime has been either for defense contractor benefit or a nebulous and quickly forgotten goal.
So, your $100,000 per year loses 39% in basic taxes to become $61,000 due largely to the expensive burden of paying for America's never-ending wars. In Japan, that same $100,000 earned would lose only 19% in basic taxes to become $81,000. Keep in mind that Japan's tax system is among the most expensive in the world, yet it's still far less ravaging than America's. Plus, Japanese people actually derive some benefit from the taxes they pay.
Now, let's expand the rising price of gasoline thought for a moment. Why do you need to buy gasoline to begin with? Because America has no public transportation to speak of. If you want to go from point A to B, you're doing it in an expensive, inefficient car powered by ever more expensive gas. Almost like somebody's running this show deliberately, eh?
A typical car payment in America is around $500 per month. Gas runs another $100 to $400 per month depending on a number of factors, but let's go with $150 to be conservative. Then there's America's insurance racket. Unlike Japan, which has a national auto insurance plan that covers everybody buying a new car, America requires you to seek out your own insurance from the nearest rip-off artist with a new ad. Oh, and you have to pay registration tax every year or the cops will pull you over and charge you another transportation-related fee.
Add it up and you're paying $500 for the car, $150 for the gas, $100 for the insurance, and $50 for the registration for a grand total of $800 per month. In Japan, you would be able to reduce your monthly transportation budget to about $100 with convenient trains and buses that are clean and pleasant, unlike the dirty, dangerous buses that pass for public transportation in big American cities -- if they're available at all. In most places in America, a personal car is the only method of transportation.
Let's see how we're doing as Americans so far. Our $61,000 per year is $5,080 per month. We have to pay $800 for transportation, which brings us to $4,280. Then, because our runaway taxes pay for wars but not health care, we have to find a health insurance plan. That'll take another $500 per month at least, getting us down to $3,780. Housing expenses vary widely, but let's say that rent or a mortgage plus utilities and property taxes will be at least $1,500 per month, bringing us down to $2,280.
In Japan, the same $100,000 would be worth $81,000 after basic taxes, which is $6,750 per month. You'd lose only $100 to transportation, bringing you down to $6,650. Your health care is already covered by the taxes you pay, but there might be a small premium for special services, so let's deduct another $100 per month to get down to $6,550. Contrary to popular opinion, most housing in Japan outside of the most expensive parts of Tokyo and Osaka is cheaper than its American equivalent. A fine apartment can be had for $600 per month, and a typical home mortgage payment with all taxes included is just $800 per month. Even with utilities, we're looking at just $1,000 per month maximum housing expenses for most places in Japan, bringing our monthly income down to $5,550.
Now, a lot of Japanese people choose to buy their own cars. Here, too, Japan is better. A great car can be bought for $10,000 and few people pay more than $100 per month in gas. Almost nobody knows what a car payment is because they buy their cars with cash here.
Where would you rather earn your $100,000? An annual income that should make you rich leaves you decidedly middle class in the U.S. with a monthly net income of just $2,280. In Japan, you'd pocket $3,270 more. No wonder Japanese people pay for almost everything with cash. That reminds me -- I didn't even touch on the runaway credit card problems in America.
To sum up, it is decidedly not expensive to live in Japan. It could even be seen as a way of reducing the U.S. tax burden and fleeing to a place that has a social infrastructure. For me, though, it's not that. I still pay (a lot of) taxes in America after an excessive amount of time spent preparing and defending my income with the help of an accountant.
In Japan, I simply walk to City Hall, hand cash to the clerk, and watch as she checks my name off in a ledger book and tells me to have a good day. I'm not kidding. Life can be that simple, folks.
The following is based on my 2008 forecast sent to subscribers over the weekend. If you'd like to read the entire forecast, please sign up for the one-cent one-month trial of The Kelly Letter.
The market is in for more volatility until the Fed's rate cuts soak into the economy. The good news is that the Fed started cutting four months ago. The bad news is that it hasn't cut enough yet. It will catch up. I expect that we'll see some fine progress this first quarter.
Stocks are reasonably priced. The earnings yield of the S&P 500 is 40% higher than the yield on the 10-Year Treasury. In all six other periods when stocks were this cheap compared to bonds, the market was higher one year later.
I notice from your stock book that you advocate buying more shares of a good company when its stock price drops. I was wondering if you're doing any of that these days, and if you could explain a little more about the approach.
Yes, I'm doing a lot of it these days. I'm finding bargains in chip stocks, health care stocks, restaurant stocks, the financial sector, and home builders. I also think Japan is poised for a nice run, and am looking for both the right vehicle and right time to benefit from it.
Like Bill Miller at Legg Mason, I average down relentlessly. I rarely stop out of positions as they fall and, when I do, it's usually when they're looking likely to fall from a high point of gain. Rarely, such as when I took a flier on speculative stock Charles & Colvard in late 2006, I'll set protective stops to guard against catastrophic loss.
In general, though, I'm on the hunt for good businesses selling at a discount to their future potential. If I can increase that discount by lowering my average cost per share, I will. This requires faith in the company behind the stock, but I almost always have faith in the companies I own. I write "almost" because I have speculated occasionally on mere price movement alone, as mentioned above. That is the exception, however, not the rule.
If you believe in a company based on thorough research, and fresh data continue supporting that belief, then a price lower than what you initially paid for a stock is a chance to improve your ultimate performance.
Volatile times such as this one around the sub-prime credit crisis are ideal for doubling down, building positions, lowering average cost paid per share. I've been building positions in The Kelly Letter and I wrote to subscribers that I will continue doing so as long as the bargains persist. We are not alone. Smart money around the world is taking advantage of cheap share prices.
To wit: Abu Dhabi based Mubadala Development bought 49 million shares of Advanced Micro Devices at $12.70, the Abu Dhabi Investment authority bought 4.9% of Citigroup, China Investment Corp. bought 9.9% of Morgan Stanley, and Goldman Sachs bought 20% of First Marblehead. Bill Miller has been buying shares of beaten-down homebuilders Centex, Lennar, and Pulte Homes.
Kelly Letter subscribers and I have also been taking advantage of price weakness to buy shares of AMD and Marblehead. We're building positions in them to benefit even more when they eventually recover. We're also trying to get Starbucks on the cheap, as well as the entire financial sector and real-estate related bargains, as I mentioned above.
While this may make sense on screen in the calm of your home or office, it's harder to keep perspective when prices are falling. I inevitably receive harsh notes of criticism when a position I own falls below my initial buy price and I add more to it. I inevitably receive glowing notes of praise when that very same position rises later, and all memory of the process that led to the gain is forgotten.
I saw a small bit of that at work last month. I had saved a critical mass of angry notes regarding First Marblehead that I intended to address one weekend. Yet, the tide turned on the Friday before and the majority of those same angry note writers followed up with congratulatory notes when Marblehead rose 66% in a day on news that Goldman Sachs was investing in it and providing a cash infusion. I went from bonehead to brilliant overnight.
I'm neither. I did not invest in Marblehead with the knowledge that Goldman Sachs was also watching it. I invested in it with an understanding of its business model, the recognition that it would one day sell securitized student loans again, and an eye on its stock price history which showed recovery from just such depressed levels as we saw during those dark December days.
Funny thing is, that's the same thought process that led me to invest in IBM several times for an eventual multi-bagger profit during its long recovery in the 1990s, Decker's Outdoor for a 40% gain in two months, Intel for a 64% gain in 10 months a few years prior and again for the 32% gain that we were sitting on last month, and so on.
By the end when we sold, I was considered brilliant. During the process during which we bought at prices lower than my first purchase, I was considered a bonehead.
Knowing this, I encourage subscribers to see the negative performance of some of The Kelly Letter's positions from time to time as opportunities, not failures. If I'm not a seller of them as they fall, I'm a buyer. I'm building positions in the stocks.
An example from outside the letter's experience may help.
A good friend of mine loves Apple and he invested in the company during the end of the dot.com boom in 1999 and sold at around $30 in early 2000. The stock fell with all else tech and he waited for it to bottom out. He thought it had done so in December 2000 at $8. Then it rose.
That was the breakout, he decided. He knew the company had revolutionary products on the way. He bought at $12 the following April. The stock fell back below $8 again over the summer. On paper, he was down more than 33%. A bonehead, right?
Not exactly. He bought again and lowered his average cost per share to less than $10. It took months for the stock to get back up to $12 in January 2002 and then you know what happened? It fell for more than a year to less than $7 in April 2003.
After holding Apple for two years, he was down more than 35%. What did he do? He bought a third time, lowering his average cost per share to less than $9.
Was he early? Yes. Was he wrong? No.
Apple shares closed 2007 at $198. My friend's too-early, boneheaded investment gained more than 2,000% in seven years and eight months. He was thrilled that he bought three times, but wished he'd bought ten times.
My friend and I are not traders. If you subscribe to The Kelly Letter, neither are you. We are investors. We don't automatically stop out at -8% as some famous books suggest. We don't automatically sell at +20% as some other famous books suggest. We find good businesses coming back from the brink, and we build positions in them.
It requires minus signs along the way and can stretch emotions, but this approach works. It doesn't happen overnight, though, and to the instant gratification mindset of a trader, it's unacceptable. To the investor, it's great.
Recently, the internet has allowed short-term trading services to proliferate. Most of the "research" proffered online amounts to daily speculation, with the latest trend being the odds of certain stocks and indexes rising tomorrow. Those odds are often clustered around 50%, you'll note, rendering the data all but meaningless. It's still popular, I'm afraid, and sells well to the gullible.
Don't fall for it. The wealthiest investors are those with multi-year time frames. That's enough distance to provide the perspective needed to jump on short-term weakness for long-term gain. If you think you can buy today on hopes of what will rise tomorrow, and succeed at it consistently enough to overcome taxes, trading fees, and odds of failure at 50%, there's nothing I can do for you.
My friend acquired shares of Apple over a two-year, rocky period with all kinds of doubtful headlines. You should not underestimate the fortitude it took to keep buying when papers reported that the market might never recover from the dot.com bust. Remember, Apple is a technology company and was part of the out-of-favor crowd at that time, and the dot.com meltdown was one of the worst bear markets of all time. The Nasdaq plunged 78%, after all. It doesn't get much worse than that.
So, take heart when volatility sets in and weighs heavy on your portfolio. It's a tool to be used, not a risk to be feared. Understand that a buyer prefers low prices, not high, and that low prices don't come with happy headlines.
My 45 minutes on The Gabe Wisdom Radio Show last night created a flood of email asking about the investments I discussed.
I talked about the fire sale in the financial sector, why I think Starbucks is becoming a bargain that I expect to buy sometime this first quarter between $15 and $19, and how I created my permanent portfolios that have outpaced 99.998% of all mutual funds in the last five years.
If you sign up for the one-cent, one-month Kelly Letter trial before the weekend, you'll be sure to read more about the financial sector, Starbucks, the permanent portfolios, and my outlook for 2008.
I'll be talking with Gabriel Wisdom tonight at 7:00 pm Eastern on his radio show. Tune in to hear my thoughts on the market and what makes the 2008 edition of my Neatest Little Guide to Stock Market Investing an essential read.
May 2008 bring you closer to your dreams, within your target weight range, a larger nest egg, the president you want, and the ability to realize that most of what you're told never matters and what matters most is almost never discussed.
