Here’s why the only way to make money in this market is to turn conventional investing strategy on its head…

As cool weather descends upon the Northeast U.S., risk appetites start to wane. Last week, traders and investors finally sobered up. Are they second-guessing whether government spending can actually kick-start a sustainable recovery? Both stocks and corporate bonds sold off sharply.

The big questions of the moment: What kind of economic environment do we face? And more important, what’s already priced into the stock market? Here’s my view on these themes: As we see with “cash for clunkers,” government stimuli simply steal demand from the future.

But more importantly — because this is not yet a mainstream view — the real job creators in the U.S. economy, small businesses, will not expand hiring as expected. There are many reasons for subdued hiring plans; an emerging reason to avoid expansion and hiring will be heightened expectations that tax rates will soar in the future to pay for out-of-control government spending.

So I expect over the next several months, mainstream pundits and forecasters will start worrying about tepid hiring, even as the pace of job losses slows. As we “lap” the 2009 corporate cost cutting by early 2010, and top lines fail to rebound, earnings estimates will have to come back down. I’m amazed at how many sell-side analysts are modeling V-shaped recoveries in 2010 earnings. Most stock prices are disconnected from reality.

Another big question is how will policymakers respond to a sluggish-to-nonexistent rebound in hiring? The economically illiterate, and those with preconceived “big government” agendas, will use any crisis as an excuse to expand government. You’ll be ahead of the game if you realize — as many in the media and academia clearly do not — that the government has no resources. It’ll take money out of one of your pockets, skim some off for its cronies, and expect you to be grateful when they put some of it — debased by the Fed’s inflation, of course — back into your other pocket.

The labor market is dealing with a structural imbalance fueled by government-sponsored housing and credit bubbles. Many will call for the government to “solve” this labor market problem, which will cause a new type of market dislocation. By early 2010, some will push for the federal government to start hiring the chronically unemployed in “New Deal” type of programs.

Where you stand on this question will determine your expectations for the future performance of most stocks (ignoring special situations). I certainly don’t enjoy having such a bearish outlook on the economy, but it’s the conclusion I reach after weighing all the evidence about the real economy; the credit markets; and policymakers’ damaging, distorting influence.

Some pundits point to corporate mergers and acquisitions as reasons to be bullish, ignoring that fact that most deals occur closer to the peak of markets, and most deals destroy shareholder value, because the buyer overpays. The 2000 AOL-Time Warner merger is a case in point.

Recently announced deals in pursuit of tech service companies are not a sign of strength; they’re defensive moves to counteract declining hardware sales and profit margins. Cisco is constantly adding to its extensive list of acquired technology companies partly to divert the Street’s attention away from the poor growth prospects and rising competition in its core businesses. Dell’s and Xerox’s recently announced acquisitions are defensive because the computer hardware business stinks.

Corporate CFOs and Treasurers are happy about the recent bull market in risk. They know much more about their prospects than outside investors, so their balance sheet management is telling. In a word, the approach toward capital structure is “defensive.”

Heavily indebted companies are flooding the market with follow-on stock offerings to pay down debts. They’re also taking advantage of the Pollyannaish mood of the corporate bond market to issue risky bonds at attractive rates, as default risk seems to be a distant memory of bond buyers. Many corporate bond investors have taken the Fed’s bait to reach for yield, regardless of credit risk.

This isn’t the “buyer’s market” that most of Wall Street would have you believe we’re in.

That doesn’t mean that there isn’t a colossal amount of money to be had in stocks right now – if you’re betting against them. That’s exactly what I’m advising my Strategic Short Report readers to do on a daily basis.

It’s time to turn around your investment analysis and look for companies that are poised to crash, not the ones that could rally in the coming months. Once investor sentiment turns back around, you wont want to be on the long side of most stocks.

Regards,
Dan Amoss

October 8, 2009

The Cold Hard Truth About Economic Recovery was originally featured in the Penny Sleuth.

I was in Manhattan last week attending Grant’s Fall Investment Conference. The U.N. General Assembly is meeting there, and the streets were blocked off in places. The NYPD was out in full force. I heard one passerby complain about the inconvenience of it all to one police officer. He responded, “Don’t blame the NYPD, blame the General Assembly.”

With the General Assembly in Manhattan and the G-20 in Pittsburgh, government has taken over the headlines this week. It seems half the world is mostly preoccupied with telling the other half what to do. No doubt, bossiness is in a bull market.

At Grant’s conference, I heard presentations on gold, the dollar, oil, real estate and more by a slate of luminaries, including John Paulson. Paulson is one of the best hedge fund managers in the world. There were many others, including Grant himself, who has created something of a stir lately.

Jim Grant, the host and editor of Grant’s Interest Rate Observer, has turned bullish on the recovery. In a Wall Street Journal piece on Saturday, the great bear turned in his claws and picked up the horns of a bull.

In a phrase, Grant’s thesis runs this way: The sharper the decline, the stronger the rebound. For this, he finds ample evidence in the historical record. The economy bounced back strongly after each sharp contraction — such as those in 1893-94, 1907-08, 1920-21 and 1929-31.

In the current recession, GDP (a rough measure of economic activity) contracted nearly 4% from peak to trough, which is a sharp recession as these things go. So, Grant reasons, the rebound will follow the historical pattern.

Grant loves to challenge the consensus. And the consensus this time around is that the recovery will be weak. I loved the quote he pulled from economist A.C. Pigou: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant.”

Grant makes an eloquent and thoughtful case, as he always does. He goes on to conclude in his editorial: “The world is positioned for disappointment. But in economic and financial matters, the world rarely gets what it expects. Pigou had humanity’s number.”

I hope Grant is right. It is an appealing case, but I don’t buy it. Too many of the problems of the prior boom remain unresolved. There is still too much leverage and debt in the system. And on a more basic level, business is not good across a spectrum of sectors. The contraction is still ongoing. I’m inclined to remember the old bearish refrain that things are never so bad that they can’t get worse.

It’s All About Markets

It’s true we’ve had a sharp contraction, but there is no rule that says we can’t contract more. A nearly 4% decline in GDP could turn into an 8% contraction when all is said and done. The move from 4% to 8% would be painful, indeed. Even then, we would be a far cry from the dark woods of the Great Depression.

In some ways, the whole discussion is irrelevant anyway. As investors, we care about markets, and not GDP growth. There is a great fallacy out there that if the economy does well, stocks should do well (or if the economy does poorly, stocks should do poorly). Hence, too many so-called investors waste an inordinate amount of time talking about recovery, or lack thereof.

It’s possible that Grant is right: GDP does expand strongly. But investors could still lose. We have one glaring historical example: From 1964-1981, GDP grew 370%. And the sales of the Fortune 500 more than sextupled. Yet the Dow Jones industrial average went from 874 on Dec. 31, 1964 to 875 on Dec. 31, 1981.

As Warren Buffett once wrote: “Now, I’m known as a long-term investor and a patient guy, but that is not my idea of a big move.”

For investors, it is all about the price paid. The really relevant question is not one of whether or not the economic recovery is real. The question is: are stocks cheap enough? To answer that, you have to look at stocks and compare them with the alternatives.

My answer is some stocks are cheap and some are not. It is hard to generalize. In my view, investing is a craft of the specific. It is in the picking of the trees in which investing skills pay off the most, not in assessing the forest. There are, undoubtedly, specific stocks that will prove nice investments over the next few years. Finding them is what we are all about.

Sincerely,
Chris Mayer

September 30, 2009

Are the Bears Turning Bullish? was originally featured in the Penny Sleuth.

Super-investor Warren Buffet once said that his investment philosophy was to buy stocks when others were fearful, and to be fearful when others were buying. Right now isn’t the time to be fearful along with the herd; it’s time to stock up on stocks.

As I predicted earlier in the year, right now the market is zooming higher like there’s no tomorrow.

Let’s begin with this chart of the S&P 500, a good proxy for the broader U.S. stock market…

As you can see, shares of U.S. companies have been soaring. In fact, from a low of 667 on March 6 to a recent high of 1033, the market is up a mind-boggling 366 points.

Translation: U.S. stocks have improved a whopping 54.9% in just a matter of months.

The fact is the market made positive moves long before the economy was showing a ton of life. And if you don’t jump in early, you’re likely to miss the best moves.

And now, with the 960 level for the S&P 500 — the top of the resistance range — clearly out of the way, U.S. stocks are now setting their sights on the next big resistance level of 1313, set way back in August of last year.

Now, getting there won’t be a straight line: 300-plus point moves don’t usually happen like that. So there will likely be the occasional, healthy pullback along the way.

But there’s no doubt: From a technical perspective, the 1313 level on the S&P 500 is the next order of business.

And don’t forget: When we make it back to this level, we’re getting very close to the pre-recession highs of 1500-plus. While that’s by no means a done deal, there’s little doubt we’re headed in the right direction at a solid pace.

But it’s not just the market’s technical factors that have me jazzed. The fundamentals are on the right track, too…

Fundamentals Improving Big Time!

For a while now, I’ve said that the housing market got us into this mess and the housing market will get us out.

Well, the facts are in: Housing is beginning to show consistent signs of life.

Sales of existing single-family homes jumped 7.2% in July compared to the month earlier. That’s the largest increase since the National Association of Realtors began tracking data way back in 1999. Plus, it marked the fourth monthly increase in a row.

In other words, the improvement in the real estate market isn’t just a flash in the pan. It’s here to stay.

But that’s not all. Compared to July 2008, home sales were up a solid 5%. That’s the first year-over-year gain since November 2005. And that means the real estate market is showing significant legs, even when dealing with tough year-ago comparisons.

Another positive: The improvement in home sales is geographically broad-based. Take a look at this chart…

As you can see, home sales improved across the board during July. In fact, they’re up 13% in the Northeast, 11% in the Midwest and 7% in the South. Only the West region showed a small 2% decrease.

And it’s not just the real estate market that’s showing solid fundamental action. The broader economy is looking good, too. According to Federal Reserve Chairman Ben Bernanke…

“Fears of financial collapse have receded substantially… After contracting sharply over the past year, economic activity appears to be leveling out, both in the U.S. and abroad, and the prospects for a return to growth in the next year appear good.”

And he’s not alone. According a survey of economists by the Wall Street Journal, 28 of 45 respondents say the recession is already behind us, and 16 say it will end by December of this year.

I don’t know about you, but that’s a hugely bullish factor to me. But there’s more: GDP forecasts are also on the rise. Take a look…

As you can see, economists are calling for a big improvement in GDP over the next year. In fact, even though GDP contracted 6.4% and 1% in the first and second quarters of this year respectively, analysts are looking for improvements for next four consecutive quarters in the 2.1% to 2.8% range.

Bottom-line: Stock prices are zooming higher and are now cleared to take out levels not seen since August of last year. In addition, strong fundamental factors — including an improving real estate market, a huge call for an end to the recession and solid GDP projections — are adding solid foundation to more price surges. And no matter how you slice it, that’s positive for your portfolio.

Best wishes,
Wayne Burritt

September 1, 2009

Stocks Are Set to Rocket in September was originally featured in the Penny Sleuth.