Market Update

Consensus here is that the rally of late is not a bottom and to look for a pull back especially in financials near term. We're selling into these rallies or doing things like writing covered calls to protect against near term downside. We think the writedowns in the financials are not done, and I'm looking for weakness in Fannie & Freddie to drag that sector down until after they've figured out how much capital they will need.

That said, there are great buys in the financials right now, but don't buy the sector funds yet--I'd actually be a buyer of the short ETFs like DUG & SKF today if you're aggressive.

Oil's slide to below $115 is welcome news, and we do expect the downward trend to continue. We'll likely see about a 10 cent drop in gas prices and much lower heating oil costs over the next several months, which is good news for the consumer.

Commodities after their meteoric rise in 1H08 just finished their worst July in 35 years, and the news from the housing market is actually somewhat encouraging. But labor & inflation data and weakness in the financials will continue to hold the market back until credit fears abate and consumer confidence rebounds.

Bottom line:

We're still in a bear market, but there are great opportunities out there if you're able to be disciplined. It's bargain shopping out there right now.

Interesting fact:

We estimate that every 1 cent/gal increase in gasoline prices subtracts around $4 million per day from consumer spending. We would have to see an 80 cent/gal decline in the gasoline price to add the equivalent of the tax rebate checks that we were all so excited about.

Investment Ideas:

Preferreds: Right now, it's all about yield, and to that end we really like some of the preferreds. A handful of them got absolutely crushed last month, and there are several like BOA that are yielding 8% right now--that's a buying opportunity.

In equities: I do like a lot of the big banks just on valuation, but you have to be picky if you're gonna bottom fish. Resist the temptation to buy stocks like JPM or MER until more dust clears. If you're patient, you can start to look at some of the homebuilders like KBH. Right now, sector rotation is the name of the game--right now it's sectors like consumer cyclicals with a rising dollar, but you have buy the dips & sell the rallies until market sentiment improves.

In ETFs: With the global economy in such poor shape, I personally really love EFZ right now. It's a short emerging markets fund, meaning that when emerging market indexes go down, you make money. It's not for everybody, though.

Weep for Wachovia

Wow...

Wachovia is trading below $10 for the first time since May 1991. Is this just a temporary panic and a great buying opportunity, or is Wachovia's trip to the woodshed justified?

The last time that WB traded below $10:

Gas was $1.10. The Dow had just broken 3000. Americans were protesting Apartheid, watching the Soviet Union crumble, and searching desperately for Jeffrey Dahmer. Now, over 17 years later, it's Wachovia Investors that taste like chicken, and new CEO Robert K. Steel will do well just to avoid the death penalty for the venerable bank, which has lost over $100 BILLION in market capitalization since its March 2006 highs just over 2 years ago.

So, is it a buy?

Not until a few things happen. First, Chairman Lanty Smith must resign. His disastrous Golden West acquisition and failure to implement a CEO succession plan were avoidable disasters. Management has lost all credibility with the market. Second, fundamentals must play out. The continued credit woes, sluggish earnings growth, and further write-downs will keep Wachovia, and a lot of other banks, in the pen for quite some time. While I agree that a catastrophic failure of the bank ala Bear Sterns is not likely, having watched IndyMac & Fannie/Freddie, the prospect of a WB failure is regretfully a real one. If you own it, hold tight. But, as far as bottom fishing--I say don't jump back in just yet.

George Carlin 1937-2008

Carlin meant a lot to me.

He shaped my political philosophy more than anyone else outside of academia, and more than many within. I've always been a passionate civil libertarian, and I owe much of that to George Carlin.

And, people who care about freedom of expression like I do owe him big time. More than an entertainer, he was a reluctant player in the legal battle for freedom of expression--a fight which is still not over.

Everyone knows the 7 dirty words, but few know about the legal firestorm it caused.

F.C.C. v. Pacifica 438 U.S. 726 (1978)

We read this case in Constitutional Law during my first year of law school. It was the first time that I had ever felt truly passionate about something that I had learned in class. It's worth a read, even to the legally disinclined, because it shows how far public attitude toward expression has evolved since the 1960s, and due in no small part to George Carlin himself.

One bit that really hit home with me:

"The FCC, a non-elected body, appointed and answerable only to the President
of the United States, has taken it upon itself to decide that radio and
television in this country are the only aspects of American life not
protected by the first amendment of the Constitution.

You know why they did it? Because they got a letter from a Reverend in
Mississippi.

A Reverend Donald Wildman heard something on the radio
that he didn't like.

Well, Reverend, did you know there are two knobs
on the radio?

One of them turns the radio off and the other one changes the station!


Imagine that, you can actually change the station! It's called freedom
of choice, and it's one of basic ideals this country is founded on.
Look it up in the library, Reverend, if you have any of them left when
you get done burning all the books."


That neatly summed up my attitude toward these moral-crusading crypto-facist nutjobs. Seeing his HBO specials as a kid contributed to my awareness of type of intolerance, and to this day, I dedicate a great deal of time and effort toward fighting the same pin-headed thinking that he spoke of.


At times, however, I also share his conviction that such fighting is a waste of time. In evaluating the grim prospects of reason triumphing over ignorance, I'm reminded of another Carlin thought experiment:

"Think of how stupid the average person is. Then remember, half of us are stupider than that..."

The end of the dividend?

Our Chief Investment Strategist just did an interview in which he talked about one of his key themes in asset allocation--what he terms "dividend sanctity."

This is the idea that equity dividends are crucial, especially in periods like this one, where earnings growth is sluggish.

Free cash flow and balance sheet strength are of paramount importance, because they indicate a companies ability to weather a downturn without cutting their dividend.

Guess what? Weep for the dividend.

Barack Obama has repeatedly said that he will raise the tax on dividends and the capital gains rate. Like him or hate him, raising cap gain rates and div. rates will seriously hurt the market.

It will fundamentally alter asset allocation strategies as yield becomes less important. Investors need to be prepared.

Financials-Have we hit bottom (redux)?

Well, get ready for inflation, people, especially overseas. Tough talk from the Fed and the ECB this week are helping to fuel a dollar rally, but the Fed is not going to be able to raise rates this year without putting the kibosh on growth. Rock/Fed/Hard Place. So, get used to $4.00 gas and $12 corn flakes.

What does that mean for the markets?

It's not a pretty picture. High inflation and slowing relative earnings growth mean that equity markets in the U.S. are gonna suck for a while.

Picks of the week:

MON, BBT, AVX.

Sailing & Money

Sharemarket Theory for Sailors ©

My dear chap,

A lot of chaps are struggling ever since Upton-Smyth paid Lagonda's Child's fuel bill after the sojourn Med-side for the Thames 24 Europeans without first telling the World Bank. The Pimms account coming in the same week broke the camel's back and world equities have been in a tizz ever since.

Now given that owning a sailboat is about as financially reckless as one can get, it follows that sailors, though curiously wealthy are financial nincompoops under the surface. It is therefore in the interests of the sport's survival that I contribute some wisdom on the topic of portfolio theory in parlance easy for sailors to understand: -

So imagine, if you can, that a yacht race starts with all the yachts hitting the line right on the 'gun' close hauled on starboard. Gradually the yellow boat in the middle pulls ahead and you notice the crew have trimmed the sails better. That's an opportunity to back management - buy yellow! Shortly later, the whole fleet heads 5 degrees as the wind goes left. That's gives an advantage to the left hand boat, but it's too late to buy 'red' - the shift has already happened. And equally its to late to sell 'green', in the left, - they've already lost and all you are doing is locking in the loss. But if 'green' tacks while the rest of the fleet hold on in anticipation of the breeze backing left even more, then there is a chance that 'green' is now cheap if the wind reverts to its original direction.

Therein is the essential dilemma confronting both sailors and investors; - knowing whether a 'shift' is permanent or temporary.

You back green just as everyone else has given them up for dead. You are banking on the wind reverting right and green tacking back to port to cross ahead of the entire fleet.

But instead, the wind continues to go left? Green is hopelessly behind having sailed far away from a permanent header - go back to the marina, wait for next week? But in life the race never stops. Up at the front, 'red' is well into the progressive left shift and well ahead of yellow. You're chuffed at your star performer, (your had a secret 'flutter' on red), when suddenly yellow tacks and shiver your timbers (and margin lending account) they are on the lay line while 'red' is sailing ever onward greedily basking in being left hand boat in a permanent left shift (and forgetting to keep a watch on both the economy and the opposition - they are off buying a corporate jet!). Luckily you also had a little wager on yellow as a mid-fleet 'hedge' and suddenly its outperforming 'red', your best pick.

As the breeze starts to die across the course you pride yourself that notwithstanding your best pick is being upstaged by your hedge, you are first and second. But what's this? In the lighter winds the tidal flow is taking its toll and Roger you senseless if 'green' hasn't emerged ahead at the first mark having hugged the shallows near the headland - if only you hadn't sold!

On the run, one of the bigger boats has come from behind and casts a wind shadow that negates all the hard work of the 'small caps' trimming and picking the wind up the beat, and as it glides majestically through the fleet you abandon the 'colours' and opt instead for sheer size - always a fair bet - until, in the fallen tide, it runs aground on Arthur Andersen sandbank near the bottom mark.

Cutting your losses, but determined to eclipse the humiliation you launch yourself holus bolus onto 'green' whose sheer audacity has made a lasting impression on you.

You preen as green again heads far inshore to escape the tidal stream, but only to sweat in horror as the tide changes and in a dying breeze red and yellow's sails fall limp but are swept toward the mark in the now-favourable tidal stream.

By the rounding it is a two boat race, yellow, who has done nothing fancy, and red who has gone form hero to zero and back. With your now-diminished wager, you back red to 'pull it off' and are cautiously optimistic as they run a slightly 'hotter' angle toward a gently filling breeze while yellow hold deep waiting for the breeze to come to them.

Red are looking famous and you are basking in the admiration of Upton-Smyth's nieces when the unthinkable happens - red has put themselves dead upwind from the finish while yellow have held steadfastly on lay line to the pin. Yellow are going to cross ahead of red who is still two light air gibes from finishing!

So basically its all there; - wind shifts are no more predictable than price movements, the tide is central bank policy (never in equilibrium but always aiming for it), the bottom of the sea is errant auditors, the helmsman is the managing director, the trimmers are 'line' management while the bowman is chairman of the 'bored'. Yachts are companies (or the shares in them) as distinct to the buoys which, like cash deposits, never actually go anywhere). But most importantly, the finish line is your wife and Upton-Smyth's nieces are the stock brokers!

So there you have it, as much as everyone will mock you for having a 'yellow streak', your wife will adore you for it - and she will be there long after Upton-Smyth's nieces have abandoned you for the next crystal ball gazer.

Now on another matter - you'll be pleased to know the whole cunnalinghi affair has blown over so to speak. Of course I'd like to say it was down to my Shakespeareanesquue skills in the latest edition but truth be known a checkout filly put the whole thing to bed when she related to Upton-Smyth's good lady that cunnalinghi left a rather unpleasant taste. Thankfully the women's auxiliary went straight back to rewriting the Beijing welcome banquet menu on a Chinese theme. (They still believe cunnalinghi to be Spanish root vegetable - from down near the bottom). Committee most impressed though, with my grasp on meteorology and dynamic fluids and they've created a coaching/mentorship spot with the British Olympic squad. In my own interests actually as some I've selected put in an awfully poor showing at last week's selection regatta - young Upton-Smyth if I can be perfectly blunt!

I fear that in coaching like the sharemarket, history is doomed to repeat!

Truly truly,

Sir Walter Bard-Arse III
Magazine Editor
Chairman of House
Chairman of Rules
British Olympic Selector RYA
British Olympics Coach
Royal Mega Club and Sailing
Cowes, England. ©

04/02/08

Trading v. Financial Planning: Do you know the difference?

Let me preface the following by saying that I DON'T recommend the following strategy to the average long-term investor for various reasons that I'll get into later. But, just for a bit, I'm putting on my trader hat, and then I'll talk about planning.

Short the Financials: If you're really on board with me that the financials are headed down in the short term, and are able to be aggressive right now, there's a leveraged short ETF play that I like called the ProShares UltraShort Financials ETF (Symbol: SKF). I plan to talk more about ETFs in future posts. Basically, This is a short equities fund that trades like a stock which seeks to profit from downward movement of various issues within the financial sector. UNDERSTAND comma however: It's 3x leveraged short and thus very aggressive--you could lose most of your investment if finacials take off. Right now, I don't own it, and of course I'm obligated to disclose if and when I do, but I'm watching it.

And now that I'm officially fully off topic; speaking of aggressive ETFs, as I said yesterday, I'm also bearish commodities, specifically corn, gold, and oil. As such, I do actually own the ProShares UltraShort Oil & Gas ETF (Symbol: DUG), which is a mega short oil & gas play that moves 3x Oil, and is as such not for the faint of heart...

Back to the point: Being primarily concerned with financial planning, I can't overstate the distinction between strategic financial planning on the one hand and strategic or tactical trading on the other. They are related but distinct concepts, and many people don't quite get the difference, and their portfolios suffer because of it.

To illustrate the distinction: Tactical, Short-Term trading, such as the ETF trade discussion above, is almost NEVER part of an effective broad financial plan. In fact, very commonly the urge to trade is the number one portfolio-killer! For lots of reasons, but primarily due to costs and poor risk management, it would be maniacally negligent to recommend that my clients make trades like this with any sizeable portion of their portfolio.

But, if you've got some play money lying around, and the wife won't miss it, then who am I to tell you not to gamble a bit on some sector moves?

Financials Headed Back Down? 3/24/08

"Much like a kidney stone, This too shall pass..."

That the broader markets held up today is actually pretty encouraging given the shaken consumer number and the grim news from the housing front. But the report today further confirms the extent to which the turmoil in the housing market has infected the broader market.

I wrote about the rally in the financials yesterday. For the reasons I pointed out, I think it's likely the financials will go lower near term, and it looks like any recovery will be long (6-12 months) and bumpy. So, if you're long the financials, if you're in positions in like C, MER, JPM, GS, MS, and the like, you could consider writing some covered calls against these positions as a way to protect against the short term downside while retaining the long-term exposure.
Some of the financials, however, it's time to bag entirely IMHO. I'm especially bearish on C and WB. Wachovia's 9.5% dividend seems unsustainable, and a reduction in the dividend would be disastrous for the stock price. But, more importantly, the analysts say that it's likely that WB's true exposure to credit losses has not been fully elucidated due in part to its foreclosure accounting methods, even after they swore up and down that all the skeletons were out. Another write-down would be bad for investors. (I try to elegantly understate...)

Tack's Market Commentary 3/24/08

Market Commentary This Week:

Fully 40% of our nation's corporate profits come from the financial services industry, and the sector has been decimated following the credit crisis and fears that complex securitization has led to hidden risk on the big banks' balance sheets. But, after a recent rebound, many analysts are saying the worst could be over, and the big question in the markets this week seems to be: Have the Financials hit bottom?

Since hitting new lows on March 17 following the news about Bear Stearns, the index had seen a 34% decline since its June 2007 highs, and was down some 19% YTD on Monday. But, following the Fed's actions in the subsequent days and renewed optimism that the worst news has come and gone, the financial sector is in the midst of a huge upward surge. The NYK Index is up 12.3% from its intraday Monday lows.

Much of the carnage at some of the banks has been due to massive write-offs from bad investments in the market for CMOs (collateralized mortgage obligations). But, you can't simply blame the housing market. The creation and collateralization of complex securities has been both a boon and a problem for the industry. On the one hand, these new products have been a massive profit center to the banks, on another, the source of much of their ills, and, many argue, the source of the current credit crisis.

Many analysts believe we have seen the worst of the write-offs from the investment banks. The markets have yet to fully appreciate the positive impact of the moves to lower short-term interest rates, open liquidity loans up to investment banks and allow Fannie (FNM) and Freddie (FRE) to increase investments in U.S. mortgages by $200B.

Our guys say that the strongest players in the industry could see share price appreciation of 10-20% over the next year. Still, long term, uncertainty and questions about the sustainability of even current valuations still remain. And, many of the headlines in the near term will remain negative, e.g., CIT Group (CIT), Credit Suisse (CS), Goldman (GS) and Lehman (LEH) all with bad news this week. Some of the weaker banks could go bust or seek bailouts from larger firms, and analysts say that that much of the near-term performance depends on whether most of the risk is already priced into the share prices.

On a broader note, I talked last week about how a fall in commodity prices could be a precursor to a recovery in both the economy and equity prices. If this theory proves correct, then the news last week was encouraging. Gold fell sharply and the dollar gained ground.

Perhaps the most positive signal this week has come from the credit market, as this week, we've seen a pronounced steepening of the yield curve. The yield curve is the difference in interest rate on short term issues versus long term issues. In times of growth and relative stability, the yield curve is "sloping," with shorter maturities commanding lower yields and investors in long term maturites demanding a premium. In periods of economic uncertainty, the yield curve may "flatten," with investors demanding roughly equal premiums for both short-term and long-term debt. At Thursday's close, the spread between the 2 and 10 year note was 1.78 percentage points, double the 0.88-percentage-point long-term average. Last year, the difference was negative.

According to a Barron's article this weekend, Moody's economist John Lonski says the steep yield curve indicates that we are further along in a recession and that the situation will be better 6-12 months from now. And, a steep yield curve should help large commercial banks like JPMorgan Chase (JPM) and U.S. Bancorp (USB) over the brokerage houses, because a steep yield curve also allows financial institutions to borrow short-term money at low rates and lend it out for longer terms at higher rates.

The most recent developments all point to a possible bottom in the financials. But, the fundamentals are still pretty scary, and, as we saw with Bear Sterns, the current environment can change quickly, so tread carefully, especially if you are just entering now. It may very well be a dead cat bounce.

Weekly Recap as of close on 3/20:

Tack's Market Commentary 3/17/08

Here's my take on the markets this week.

There's a lot to be worried about, certainly. But, even with Bear, there has been some possible light at the end of the tunnel this week, to-wit:

1. Standard & Poor came out last week and said that It looks like (gulp) that the worst of the sub-prime crisis is behind us, $285 Billion Dollars later even before Bear Sterns.

2. Inflation seems to be relatively contained given the steep rise in commodity prices. Certainly, it's more expensive at the pump, and corn flakes cost more than cold beer, but core inflation remains largely benign.

3. The Fed finally seems to have gotten the message, especially after Bear Sterns, that a lack of liquidity is only part of the story--it's underlying asset quality and excessive leverage that took down BSC and threatens the financial system. What that means is that simply cutting the Fed Funds Rate won't do the trick, and the new unconventional approaches announced last week are welcome and needed. Rarely, if ever, has the fed made so much money available in so many different ways in such little time.

I'm not saying it's all roses and lollipops. There has been and will continue to be serious pain in the housing market. I feel terrible for people that have lost their homes and their life savings. But we came too far too fast, and we forgot to care about credit quality. Here's a telling fact. Of first time homebuyers, between mid-2005 and mid-2006, almost half put down nothing at all when they bought their homes, and the median down payment was just 2%. What the hell did we expect!?

There is still room to fall in the equity markets, certainly. The dollar's journey to the center of the earth hasn't helped, and isn't done. But, smarter people than I say that signs of a bottom are beginning to appear. We've tested & retested our January lows, which says to our pointy-headed technicians we're near a bottom. More fundamentally, a lot of these smart people say that a fall in the commodities markets will be our signal that we may have hit bottom. I think this is coming soon. Don't kid yourself--$110 oil will not be here for long. The strongest performing asset class year to date has been frickin' silver, with gold not far behind. Far from a flight to quality, I think it's speculation, and I really think it's close to time to get back in the equities ring.

Bottom line in my mind: the bears should get some perspective. Cycles happen. There is real pain out there, but the sky is not falling. It's interesting to me: everyone whines about underperforming managers, when the reality of the situation is that reason most funds do fine, but most people underperform the market. This is due largely to their curious tendency to exit the market when their portfolio is down, and to hang on to their best performing assets like grim death. Don't be like most people. Concept: Buy low. Sell high. Or, better yet, get yourself an appropriate & diversified asset allocation model and stick to it, and don't have to buy or sell much of anything except your sailboats.

We've been here before, and we'll be here again. 1998 was not that long ago--remember Long Term Capital Management? Remember the Russian debt default? Remember '87? This time around has been just as painful. But we'll be back, and soon enough we'll be whining about inflation & ready to inflate the next big bubble.

Can you say alternative energy?