Market timing

http://www.marketwatch.com/story/five-market-sectors-for-the-next-six-months-2009-11-13

SAN FRANCISCO (MarketWatch) -- Any investor who followed the old market adage to "Sell in May and go away" is probably feeling left behind, with the benchmark Standard & Poor's 500-stock index up 25% since the end of April.

No regrets; there may be more where that came from. The period from November through April historically has been the best six months of the year for U.S. stocks, and even better for the market's most cyclical sectors.

Sector investors win in winter

November through April has historically been the best period for U.S. stocks, but that six-month period is even better for the market's most cyclical sectors, says Sam Stovall, chief investment strategist at Standard & Poor's Equity Research. MarketWatch's Jonathan Burton reports.

"Whether you look back to 1990, 1970, 1945 or 1929, the S&P 500's /quotes/comstock/21z!i1:in\x (SPX 1,099, -12.12, -1.09%) performance from November through April substantially outperformed the market's typical price change from May through October," Sam Stovall, chief investment strategist at Standard & Poor's Equity Research, wrote in a recent report to clients.

Moreover, the S&P 500's cyclical, economically sensitive sectors have been the warmest places to invest through the winter. During this timeframe, the Industrials, Materials, Financials, Consumer Discretionary and Information Technology sectors traditionally recorded their strongest price gains and frequencies of beating the market.

Studies reinforce S&P's data. Two researchers at New Zealand's Massey University, Ben Jacobsen and Nuttawat Visaltanachoti, found that while all U.S. market sectors perform better in winter, the season is especially generous to stocks and sectors related to industrial production and raw materials than they are for companies tied to consumer consumption.

This timing tactic didn't work in 2008, of course, as stocks failed on almost every front. History, after all, is only a guide. Still, sector investors can use history to their advantage -- particularly since this calendar pattern, commonly known as the "Halloween Effect," is one persistent strategy that doesn't seem to get much credit. Said Stovall: "Who's going to arbitrage it away if nobody takes it seriously?"

Industrials

/quotes/comstock/13*!xli/quotes/nls/xli XLI 27.67, -0.29, -1.04%
/quotes/comstock/21z!i1:in\x SPX 1,099, -12.12, -1.09%

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Since 1990, the S&P 500 Industrials sector has posted an average gain of 7.9% in the November through April period, versus a 5.9% advance for the broad index.

Industrials have been relatively quiet so far this year. The average industrials-focused mutual fund had gained slightly more than 20%, lagging the S&P 500's 23% return, according to investment researcher Morningstar Inc. A representative exchange-traded fund, Industrial Select Sector SPDR /quotes/comstock/13*!xli/quotes/nls/xli (XLI 27.67, -0.29, -1.04%) , has gained around 19%, while another entry, iShares Dow Jones US Industrial /quotes/comstock/13*!iyj/quotes/nls/iyj (IYJ 52.33, -0.51, -0.97%) , is up 22%.

Industrials' lackluster performance encourages David Kudla, chief investment strategist at financial advisory firm Mainstay Capital Management. He's bullish on the sector's prospects, particularly for corporate giants with a global footprint.

"Those large multinational exporters are going to benefit from government stimulus around the world and from a falling U.S. dollar," Kudla said, noting that he's also optimistic about the Technology and Materials sectors.

"It's hard for me to get away from the basic stuff," added Hugh Johnson, chief investment officer at money manager Johnson Illington Advisors. His favorite Industrials stocks include Caterpillar Inc. /quotes/comstock/13*!cat/quotes/nls/cat (CAT 58.28, -0.76, -1.29%) and Deere Co. /quotes/comstock/13*!de/quotes/nls/de (DE 53.08, -0.62, -1.16%)

Two specialized Fidelity mutual funds have been sector standouts. Fidelity Select Industrials Fund /quotes/comstock/10r!fcyix (FCYIX 17.82, +0.10, +0.56%) was up 33% through Nov. 13, while sibling Fidelity Select Industrial Equipment Fund gained 34%.

Materials

/quotes/comstock/13*!xlb/quotes/nls/xlb XLB 32.66, -0.46, -1.39%
/quotes/comstock/21z!i1:in\x SPX 1,099, -12.12, -1.09%

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The Materials sector has enjoyed an average 9.7% gain from November through April since 1990, according to S&P.

This year the commodity-heavy sector has been on a tear. Materials Select Sector SPDR /quotes/comstock/13*!xlb/quotes/nls/xlb (XLB 32.66, -0.46, -1.39%) , for example, is up 42%, including an 8.5% gain in the first 10 days of November alone. The ETFs largest holdings include Monsanto Co. /quotes/comstock/13*!mon/quotes/nls/mon (MON 79.41, -1.46, -1.81%) and Freeport-McMoRan Copper & Gold Inc. /quotes/comstock/13*!fcx/quotes/nls/fcx (FCX 85.54, -1.78, -2.04%)

Will China dump the dollar?

The U.S. dollar is on our minds these days because it is weak and getting weaker. We hear reports that Chinese officials are actively cautioning, scolding and remonstrating the U.S. on its profligate ways because China has an estimated $2 trillion+ in reserves, much of it invested in dollar-denominated securities.

The falling dollar and China’s concerns raise questions, one of which is, “Will China dump the dollar?” For investors, I believe a better question is, “Can China dump the dollar?”

Role reversal

In the U.S., debt is growing and our government is moving further and further into the private sectors of the economy. On the other hand, the supposedly communist country of China is exhorting us to be more responsible and prudent by cutting spending and balancing our budget. Interesting times aren’t they?

Are investors declining the dollar?

The concerns about the U.S. dollar impact our decisions as investors on many fronts, including such basic issues as the percentage of foreign stocks or bonds to hold. But, from the standpoint of foreign investors, assets in America are on sale to the extent their currencies have appreciated versus the dollar. So, our loss is their gain.

Chinese currency choices

In terms of foreign currencies, I believe there are only two others — the Euro and the Japanese Yen — that China could look to other than the dollar. China’s financial reserves are big enough that the Chinese government has to have its foreign assets denominated in a very large, liquid currency. And, there are not too many of those around other than the U.S. dollar, the Euro and the Yen.

For a variety of historical and cultural reasons, I doubt if the Chinese would seriously entertain putting most of their foreign currency and foreign assets holdings in the Japanese Yen, so the currency choice is between the dollar and the Euro.

Source: Wikipedia Commons

The Chinese are investing in the Euro, but that is happening in an incremental fashion. As long as the U.S. remains a significant trading partner for China’s exports, the dollar will be a major currency for Chinese central bank activities. There are those who think the Chinese will dump the dollar and buy Euros on a wholesale basis, but as I point out below, that is unlikely. However, one other choice is appearing — commodities.

Commodities as a currency alternative

In terms of alternatives for China, there is some evidence that China is stockpiling commodities such as oil and copper as a hedge against inflation and the falling dollar.

Here is a post from Brad Setser, written on his Follow the Money blog (China’s new barbell portfolio: Treasuries and commodities?) in which he discussed China’s dual strategy of buying Treasuries and commodities. Incidentally, Setser is now a senior member of the White House’s National Economic Council. He wrote:

…At the same time, China has sought to ramp up its exposure to commodities. China’s government clearly is adding to its strategic stockpiles — and perhaps encouraging state firms to build up inventory as well. China’s government is encouraging Chinese state firms to invest more abroad, especially in the mining sector. And China’s government is providing financing to cash-strapped commodity exporters (Russia, Kazakhstan, Brazil and no doubt others) to help tide them through a rough patch and, China hopes, to secure future supplies…

However, investing in the volatile commodity market is not without risk for China either, so they are faced with a variety of choices, none of which are without risk.

What if?

Just to finish the thought, what if China did dump the dollar in a significant way? The implications of that are obviously negative for the U.S. economy as the dollar would fall even further under the selling pressure. And, other countries, along with large investors would probably sell dollars, putting more pressure on it. In order to shore up the dollar, the Federal Reserve would be forced to raise short-term interest rates and, though that would help the dollar, it would hurt the economy.

However, consider how these events would affect China. Selling its stake in dollar-denominated securities is something that would take years. So, a precipitous fall in the dollar would reduce the value of all dollar-based securities China continued to hold. Also, assuming the U.S. economy softened under this scenario, exports to America would dry up quite a bit.

Finally, there would be intense political pressure in the U.S. to retaliate by slapping tariffs on Chinese goods and taking other punitive measures. In short, China would also suffer a great deal if it tried to dump the dollar.

What’s next for the dollar?

The big difficulty we face now is that the economy is weak and the Fed likes to have low interest rates to help the economy begin to grow again. Low interest rates are helpful to overall economic activity, but low rates generally hurt the dollar.

If we wanted to help out the weak dollar, the response would ideally be to raise interest rates. However, due to serious weakness in the economy, the Fed is hampered in its ability to respond to this situation and I believe it will opt to keep interest rates low well into 2010 in order to promote economic growth.

You may hear various politicians or pundits decrying the weak dollar. However, for decades, our government’s philosophy during recessions has been to publicly espouse a strong dollar while, at the same time, cutting interest rates to strengthen the economy and give unemployment a boost. This has traditionally been done despite the fact that lower interest rates generally lead to a weaker dollar. I don’t see anything in the cards that appears to have changed that policy. Therefore, I expect continued pressure on the dollar as the Fed seeks to get economic activity going again.

Huge deficits mean more pressure on the dollar

With huge budget deficits as far as the eye can see, the U.S. Treasury has to issue enormous amounts of Treasury securities. To absorb these securities, the Treasury needs buyers. So, we need China to continue investing. As a result, U.S. fiscal and monetary policy will be increasingly tied to keeping China happy. It enforces a discipline of sorts, but our policy options are going to be increasingly limited and necessarily reactive, rather than pro-active.

The road ahead

The dollar is likely to be weak until the Fed starts raising interest rates, which won’t happen until later next year. So, we will continue to hear lots of noise from Washington and parts eastward about the dollar, but I do not think anything drastic will happen soon.

As long as this low interest rate trend continues, the dollar will weaken. And, assets such as stocks, bonds or gold will hold up better than the dollar. However, when the dollar snaps back, as it will (if even temporarily), the move will be very quick.

Just think back to the dollar rebound last fall and earlier this year to get a sense of what could happen. So, be wary of any investment strategy that is built entirely on the prospect of a permanently weak dollar.

See also:

S&P gains, but dollar falls

Invest now to end of 2009

Goldman is increasingly confident in the end of year rally. In fact, a recent piece of research says December could be one of the strongest months of 2009 (not an easy feat considering the year we’ve had). Like other bullish investors, they believe seasonality will be an important influence on year-end action:

As we move into the year end, we take a look at the seasonality effect in equity markets. December stands out as one of the best months for equities, using both long- and short-term data; we think this year will be similar. In years when the first 11 months have yielded good returns, December has tended to be particularly strong.

December yields good returns on average
Based on monthly data going back to 1974, December has on average returned twice as much as the monthly average (1.7% vs. 0.8%). It is the third best month based on average data and the second best one using median data. It is interesting to note that January is also a good month for equities based on long-term data. December and January both yielded a positive return in more than 70% of the cases.

Goldman goes on to note that December is particularly strong when the current year has been strong:

The better the year, the better the December
There have been worries among market participants that the year end could see weakness in equities, following the strong year-to-date performance. However, historical data tell the opposite. In years when the return from January to November has been strong, December has tended to be very strong as well.

How to play it? Don’t rely on commodities to continue their inverse dollar surge. In fact, the best performing assets in big years have been financials cyclicals:

Oil & Gas has underperformed historically in December
Commodity related sectors exhibit the lowest relative returns among all sectors in December. This holds even when restricting the sample to years when the market went up by more than 20% in the run-up to December. Conversely, Financials and selected Cyclicals have been the best performing sectors in December when the market has risen by more than 20% in the first 11 months. Looking at countries, the results are less interesting as the differentiation is less marked than between sectors. Germany stands out as the best performing country on average in
December.

Conditional seasonality: The better the year, the stronger the December
Recently, there has been a lot of talk in the investor community about de-risking and investors locking in their performance for the year. This has resulted in more bearishness going into the year end, as many have questioned the potential for further market upside based on the sustainability of the economic recovery. A seasonal analysis conditional on year-to-date performance tells a very different story. The better the performance has been from January to November, the more positive the return has tended to be in December (Exhibit 5).

Where to play it? Italy and Germany have been the best performers:

Are emerging markets the next bubble?

NEW YORK (Money) -- Question: I'm considering investing in emerging markets mutual funds. But do you think that's a good idea, or are they just going to be the next investment bubble? -- Mario, Atlanta, Georgia

Answer: Last year, The Onion ran a hilarious"news" story about a panel of business leaders appearing before Congress to demand that "the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest."

The article was satire, of course. But what made it so funny was that it hit so close to the truth. It seems we just aren't comfortable unless we can pour our money into something that offers unsustainable returns.

And indeed, given how we've careened from one bubble to another over the past decade -- technology shares to Internet IPOs to residential and commercial real estate to mortgage-backed securities -- you can't help but wonder which investment we'll next infuse with unrealistic expectations that will eventually give way to bitter disappointment and big losses.

Will it be, as you suggest, emerging markets funds, which have already gained a bubblicious 69% for the year to date? Or how about high-yield bond funds? They're up an attention-grabbing 42% so far this year.

Or will old reliable gold step up again? It's already breached the$1,150-an-ounce mark this year and some gold bulls are saying there's no end in sight.

Truth is, though, while it's easy to identify bubbles after they burst, it's hard to know for sure whether you're in one while it's still inflating. You can suspect that returns may be too frothy. But there's always some rationale that not only justifies prices, but suggests why they've got a lot more room to run.

Detecting a bubble

So I don't think it's possible to come up with a foolproof Bubble Detector. That said, I think there are three fairly simple defenses that should at least be able to limit the damage a bubble can do to you.

The first is common sense. Yes, I know it's gone out of vogue in an age where we're supposed to defer to pros in every aspect of our lives. But stepping back from the hurly burly of the investing scene and applying a little old-fashioned independent judgment can often provide a helpful bit of perspective.

Take emerging markets funds. They're up more than 120% since their November 2008 lows. That fact alone doesn't mean they can't gain even more. But you don't have to be an investing genius to know that this sort of sizzle will eventually fizzle. And if you look at the history of these funds, you'll see that they have a habit of generating colossal gains that are followed by huge setbacks.

But reversion to the mean applies not just to emerging markets funds. I'd say you should be wary any time an investment soars to truly outsize returns, especially if people begin piling into that investment like so many lemmings.

For example, seemingly unstoppable price increases triggered a feeding frenzy in housing earlier this decade, which prompted me to write a column warning people about loading up their IRAs with residential real estate. Did I know we were on the verge of a housing bust? No. But I knew that the combination of overheated prices and an insatiable appetite on the part of investors to throw even more money into the sector should make someone more wary than enthusiastic about jumping into real estate with the expectation of continued blockbuster gains.

The second defense is building a balanced portfolio. True, diversifying won't immunize you from bubbles. In fact, the more broadly diversified you are, the more likely you'll own an investment that goes into bubble mode.

But diversification does provide protection in that spreading your money among different types of investments rather than making a big bet on one investment you hope will deliver spectacular gains limits the potential for damage. Part of your portfolio might deflate, but not the whole thing.

So while I don't advocate investing in emerging markets funds because they've recently racked up impressive returns, one can make a case for owning them to diversify an already diversified portfolio even more.

A possible long-term investment

Even then, I'd argue that you should consider flighty investments like emerging markets funds only if you're planning to own them for a long time, say at least 10 years. They're too volatile in my opinion for shorter holding periods. And I'd also recommend limiting your exposure. Highly volatile investments like emerging markets, high-yield bonds and gold are more like spices than main courses, so a little goes a long way. In the case of gold, you're talking maybe 5% to 10% of your overall holdings. In the case of emerging markets funds and high-yield bonds, it's probably more like 10% to 20% of your international and bond holdings respectively.

Your third tier of defense is rebalancing, or selling a portion of investments that have outperformed and plowing the proceeds into those that have lagged to bring your portfolio back to its correct proportions every year or so.

This technique prevents any single investment from becoming too big a part of your portfolio when it's on a roll. It also forces you to be a bit of a contrarian, selling off some of your emerging markets after a year during which they've had a big run-up and buying in after they've taken a beating. Put another way, it allows you to buy low and sell high, which is something investors know they should do, but too often lack the will to pull off.

So to answer your question, I think investing in emerging markets funds can be a good idea if you're doing it for the right reason (more diversification) and the right way (small portions that are part of a long-term asset allocation and rebalancing strategy). That said, I don't think anyone should feel compelled to add emerging markets funds to his or her portfolio. You can do perfectly well without them.

As for the bubble issue, I don't believe there's any way to know for sure if emerging markets funds are now in or will soon reach bubble status. But if money continues to flow into these funds mostly because investors are chasing past gains as opposed to building a better rounded portfolio, we could very well be headed toward another bubble, and, of course, a resounding pop!

The US Economy And Stock Market Continue To Act Disjointed

The current stock market continues to be disjointed from the real U.S. economy. It feels like the current government statistics are orchestrated propaganda. The credit-dependent, consumer-dependent U.S. economy is going down, and the trillions of dollars borrowed and spent by the U.S. government and Federal Reserve to start up a recovery has basically fallen flat.

The US economy needed several trillion of dollars in deficit spending to pull off the meager jobless growth of 2001-2007.The U.S. economy has been dependent on Federal stimulus for years now, both the indirect stimulus of artificially low interest rates, unlimited liquidity, and the direct spending of hundreds of billions of borrowed dollars. Even before the financial crisis of 2008-2009, the Federal government was borrowing and spending $400 billion a year to prop up the US economy to look prosperous.

The primary fuel that supports the U.S. economy is consumer spending which is ultimately based on household income and assets. The US economy is dependent on consumer spending for 70% of the GDP. Earned income has been flat to down for most Americans for years. According to the Bureau of Economic Analysis, real disposable personal income adjusted for inflation and taxes declined 3.4% in the third quarter.

In an economy dependent on consumer spending for 70% of GDP, how can GDP rise by 3.5% while personal income plummeted by 3.4%? If the boost in GDP is real and not just statistical then where did it come from? The answer is from borrowed money. The Federal government borrowed and spent over $1.4 trillion in fiscal year 2009.

During the housing bubble of 2002-2007 households borrowed and spent hundreds of billions. But the consumer, beset by declining assets ($13 trillion lost in the past two years), declining income, falling housing values and horrible employment trends (17.5% unemployment/underemployment, broadly measured). Also add into the mix declining available credit.

Revolving credit (credit cards) decreased at an annual rate of 13%, and non-revolving credit. So while households are still burdened with almost $2.5 trillion in credit card and non-revolving debt, they are paying debt down, not adding more. Less debt spending by consumers means less spending to drive the GDP. And let's not forget that homeowners pulled out about $5 trillion in home equity during 2001-2007, and the home equity ATM has been closed by banks for a majority of Americans even those with excellent credit.

The primary asset for most Americans is a home, and home values are still dropping, foreclosures are still rising and the only force keeping the market from falling faster is the Federal government's quasi nationalization of the entire U.S. mortgage market.

Of the $1.5 trillion mortgage securities issued in 2009 over 90% are backed by the government. The government owns over half the nation's $10 trillion in mortgages via quasi ownership of Fannie Mae (FNM: 1.01, -0.01) and Freddie Mac (FRE: 1.16, 0.02), and it has guaranteed virtually all the mortgages originated in the past year via FHA or VA. Should the Fed reduce their subsidies via the $8,000 tax credit to new home buyers and artificially low mortgage rates the current bounce in the housing market would grind to a halt.

Earning surprises with higher profits, is there real growth going on? By slashing payrolls, R&D and various accounting tricks. Actual revenue growth is still missing in action for the most part. Once the cost cutting activates have run there course it will be much harder for upside surprise earning announcements without true revenue growth. The stock market is rising on the hopes of an actual, real, tangible recovery in household income, home equity and creditworthiness. At some point soon investors will have to take pause and take a hard look under the hood of the US economy and it will not be a pretty site.

The mirage of recovery has been propping up the stock market for nine months I suspect that when investors see through the illusion the market will make a major retracement and head back near the March lows, or perhaps even lower. The major correction of 2010 will simply reflect the state of the real economy. 11/23/2009

Why a Market Crash Doesn’t Matter

Market Generalities

When reading Seeking Alpha Friday, I couldn’t help notice that the most popular article was: Why the Stock Market Should Crash, by Charles Hugh Smith. With all due respect to Mr. Smith, and all the other doomsayers out there, I frankly just don’t get it. In my opinion, fear is a negative emotion that causes more harm than good. My favorite acronym for FEAR is: False Evidence Appearing Real.

People who are worried about whether the stock market will crash or not are worried about a generality. In contrast, the world’s most successful investors are known to deal solely with specifics. Investing giants like Warren Buffett and Peter Lynch are on record as ignorers of the general stock market. Instead, they are only interested in the specific companies they own.

Regarding the stock market, there is also a lot of talk about the so-called “Lost Decade”. I will use the S&P 500 since calendar year 2000 as my proxy for the “Stock Market”, and its dreadful decade in this article. However, my contention is that unless you have all your liquid assets invested in the S&P 500 or some other passive index fund, the general market should be of little concern.

In Figure 1 below, we show the S&P 500 correlated to its earnings since 12/31/1999 to include performance. There are three key factors that are obvious from this graph:

1. On 12/31/1999 the S&P 500 was at 1469 (green arrows) and was overvalued trading at more than 26 times earnings of $55.83 (red arrow.) Therefore, since the normal P/E ratio of the S&P 500 has been 17.5 for the past 20 years, future poor performance should have been expected.
2. The rate of change of earnings growth for the S&P 500 of 2.9% (Red circle), was not strong enough to generate a positive return from such a lofty valuation.
3. From calendar year 2000 to the current, we suffered through two recessions which created above-average cyclicality of earnings for the S&P 500. Clearly, earnings drive the long-term movement of stock price.

Figure 1 S&P 500: EPS Growth Correlated to Price and Price Performance

In his runaway national bestselling book "One Up on Wall Street", Peter Lynch devoted Chapter 5 to the thesis of my article titled “Is this a Good Market? Please don’t ask.” Mr. Lynch clearly and eloquently expressed his disdain for attempting to forecast the stock market. The following snippets from Chapter 5 illustrate the point:

“If you must forecast,” an intelligent forecaster once said, “forecast often.”

What Stock Market?

The Market ought to be irrelevant. If I could convince you of this one thing, I’d feel this book had done its job. And if you don’t believe me, believe Warren Buffett, “As far as I am concerned,” Buffett has written, “the stock market doesn’t exist. It is only there as a reference to see if anybody is offering to do anything foolish.”

Finally Mr. Lynch added:

I’d love to be able to predict markets and anticipate recessions, but since that’s impossible, I’m satisfied to search out profitable companies as Buffett is. I’ve made money even in lousy markets, and vice-versa. Several of my favorite tenbaggers made their biggest moves during bad markets.

Company Specifics

In the long run, earnings determine market price, and valuation plays a prominent role. Utilizing our Fundamentals-at-a-Glance research tool, I offer the following examples that validate the thesis and premises of this article. I will illustrate some stalwart like, solid growing businesses, and will sprinkle in a few powerhouse fast growers. Then I will add two examples of how overvaluation impacted returns even when earnings growth was strong.

I start with Nike (NKE), Figure 2. Note that Nike’s stock price (black line) starts out slightly above the earnings line (green line with white triangles) implying modest overvaluation. However, earnings growth of 13.4% translates into annual 10% appreciation (excluding dividends) compared to a minus 2.9% annual loss for the S&P 500, or the stock market.

Figure 2 NKE: EPS Growth Correlated to Price and Price Performance

In Figure 3 we feature Cognizant Technologies Solutions (CTSH) a fast-growing outsourcer that has no debt and an earnings growth rate of almost 40% (39.8%). Clearly, the stock market had absolutely nothing to do with the returns that Cognizant shareholders enjoyed.

Figure 3 CTSH: EPS Growth Correlated to Price and Price Performance

Figure 4 features TEVA Pharmaceutical Industries (TEVA), an Israel based ADR, the largest generic drug developer in the world. With earnings growth over 29% per year, TEVA shareholders enjoyed annual appreciation of almost 20% even though their stock price (black line) is currently at a discount to earnings (green line with white triangle). Once again, the stock market didn’t matter to TEVA Shareholders.

Figure 4 TEVA: EPS Growth Correlated to Price and Price Performance

Figure 5 features ITT Educational Services, Inc. (ESI). Strong earnings right through the recession rewarded shareholders far in excess of the general stock market.

Figure 5 ESI: EPS Growth Correlated to Price and Price Performance

Figure 6 features Coach Inc. (COH) where 30% growth of earnings translates into a similar shareholder return, regardless of the bad market. Note that both Coach and the S&P 500 are measured only from October of 2000 because Coach was not a public company in 1999.

Figure 6 COH: EPS Growth Correlated to Price and Price Performance

Figure 7 features Google, Inc. (GOOG) and only has a track record since going public in 2004. However, once again, there is no correlation or relationship to Google shareholder results and the stock market (S&P 500).

Figure 7 GOOG: EPS Growth Correlated to Price and Price Performance

Figures 8 and 9 are offered to illustrate the importance of valuation. Both Procter & Gamble Co. (PG), a Peter Lynch stalwart, and Oracle (ORCL), a faster-growing technology company suffered from overvaluation at the beginning of the period. Both of these companies generated returns that were closer to the general stock market. However, it was overvaluation and not the market that affected their respective results.

Figure 8 PG: EPS Growth Correlated to Price and Price Performance

Figure 9 ORCL: EPS Growth Correlated to Price and Price Performance

These are but a few examples of many that could be offered. Remember the stock market is about averages, and as Warren Buffett also said "Who wants to be average?" It is better to focus on what you own and not worry about things you don't. I believe you will find this to be more peaceful and profitable, in the long run.

Conclusion

We, like Peter Lynch and Warren Buffett, believe that all the fuss about what the stock markets in general may or may not do is unwarranted, assuming - of course - that valuation is in line with cash flows. At the end of the day, we feel that all it does is take the investor's eye off the critical ball of what they actually are invested in. Wall Street may climb a wall of worry, but good businesses climb a wall of business success, more commonly known as earnings. Therefore, what the stock market may or may not do really shouldn’t matter to the serious long-term fundamental investor.

Dan's retirement plan

As a way of introduction to explain the rationale for my trading methods, I
retired in September of 2000 and currently live from my investments, both
income and capital gains. Other than social security, I have no pension.
I invest and trade, with boundaries somewhat overlapping. The vehicles I use
are stocks, bonds, options, and futures. I do some day trading on rainy
days, otherwise I stay away from extremely short term trading and do no
Forex trading. I believe that trend following, as a means of market timing,
works, but that is not my subject for today.

I am writing today to comment about Value Investing.

There are companies with many years of consistent and growing earnings ,
little debt and in market segments that are expected to grow, but they are
not necessarily "Value" stocks. Why? Simply because the stock price is too
high in proportion to its current earnings and projected future growth.

As value investors we seek to buy stocks with consistent and growing
earnings in strong market segments, companies that have a reasonable debt to
equity ratio, but companies whose stock price does not reflect the potential
for these companies, in other words, undervalued value stocks.

The problem with this approach is that the inherent assumption made is that
the professionals in the market, for one reason or another, have overlooked
the quality of this company. Even assuming that the above is true, that
investment companies employing legions of research analysts have overlooked
this company that we have found, what is the trigger that will make market
participants realize what we have discovered, and equally important, how
long will it take for this to happen.

For my longer term investments, I eschew any company that does not pay
dividends, and dividends at a reasonable level. A dividend of 1% is
meaningless. I look for companies with many of the same characteristics as
used with value stocks, but with the proviso that the dividend stream is
secure, and expected to grow. Today, I will rarely consider anything with a
current yield of less than 6%. At the time of this writing I have found A
rated bonds yielding over 10%. The A rating implies a relatively low level
of risk while the high yield means they are out of favor. Therefore, any
stock purchases made today should be expected to return, between income and
capital gains, at least that much annualized using a reasonable time frame.

Unlike waiting for the market to appreciate the potential of a non dividend
paying value stock, by purchasing out of favor high dividend paying stocks
or high interest paying bonds, I am earning a fair rate of return on
invested funds as well as expecting a capital gain down the road.

Dan (dan2fl)

2010 outlook: Flat is the new up

By Paul R. La Monica, CNNMoney.com editor at large

November 20, 2009: 12:48 PM ET

Stocks plunged in 2008 and early 2009 on fears of another depression, but the Dow, S&P 500 and Nasdaq have all roared back since March. What's in store for 2010?

NEW YORK (CNNMoney.com) -- If 2008 was the year the stock market almost died and 2009 was the year that the market miraculously sprung back to life, then what will 2010 be?

It could wind up being a boring, relatively stable year. And you know what? There's nothing wrong with that.

Some market experts think that after last year's despair and this year's glee, everyone may take a deep breath and realize that the economy is neither sinking to an abyss nor on the road to a robust recovery.

"I think the market could fall a bit or stay flat during the first half of the year since the economic outlook is still relatively weak. But I'm looking for a strengthening economy sometime in the middle of next year since interest rates should stay low," said Doug Ober, chairman and CEO of Adams Express (ADX) and Petroleum & Resources (PEO), two closed-end funds that invest mainly in U.S. stocks.

Ober said that he's hoping to take advantage of any pullback in the markets over the next few months, particularly in the technology and consumer sectors.

He said that Microsoft (MSFT, Fortune 500) and Intel (INTC, Fortune 500), for example, should benefit from the launch of Microsoft's Windows 7 operating system.

As for consumers, Ober said that because he is not expecting a substantial economic rebound, he's steering clear of retailers and investing more in staples like Coca-Cola (KO, Fortune 500), PepsiCo (PEP, Fortune 500), Procter & Gamble (PG, Fortune 500) and Unilever (UL)

How to grow your 401k portfolio

John Norris, managing director of wealth management with Oakworth Capital Bank in Birmingham, Ala., agreed that investors shouldn't get too optimistic about next year.

"The economy might experience tepid growth of about 2% next year. With 2% growth, people won't be as quick to put money in the market. We've priced in a good recovery and it might not live up to its billing," Norris said.

But that doesn't mean the market or economy are going to fall apart, Norris added. It just looks like a lot of the easy money has already been made in this rally now that the S&P 500 is up nearly 65% since March.

"This year, you just had to be in the market to do well. Next year will be more difficult. At the end of the year if the S&P 500 is up about 8%, that's probably about the best we can hope for," Norris said.

Norris also said that investors have to be more discriminating in 2010 - especially when considering some of this year's hottest sectors and stocks.

The financial services sector, for example, has surged this year. Nearly all banks have bounced sharply from their depressed lows - regardless of how strong their balance sheets really are. As a result, many bank stocks are significantly more pricey than they were only a few months ago.

So a strong focus on identifying winners and losers in an individual sector, and not betting the ranch on an entire group of stocks, may be one of the keys to successful investing in 2010.

Valuations matter once again as well. The S&P 500 now trades at about 14 times 2010 earnings estimates, according to Thomson Reuters.

That's not absurdly expensive by any means. But back in early April, just as the market was beginning to rally, the S&P 500 was trading at only 11 times next year's earnings estimates.

"Everything was cheap in early 2009. Now you have to be a lot more selective," said Blake Howells, director of equity research for Becker Capital Management, an investment firm in Portland, Ore., with about $2 billion in assets. "That's true for the market as a whole."

The Buzz is going on a break: This is the last column for awhile since I will be out on leave for several weeks. But I just wanted to take this opportunity to thank all the readers who have e-mailed me and contributed to the Talkbacks throughout this year.

I appreciate all the feedback and look forward to incorporating more of your comments into the Buzz columns and videos in 2010. Happy Thanksgiving to all and I hope that everyone has a joyous holiday season

Oil at $80

By Colin Barr, senior writer

Last Updated: November 18, 2009: 1:41 PM ET

tos

NEW YORK (Fortune) -- Are cash-strapped American consumers on for another date with energy price misery?

The U.S. economy remains weak and one in six Americans can't find enough work. Yet oil prices have risen steadily this year. A barrel of crude costs $79 and change, more than double its price at the end of 2008.

This year's runup pales in comparison to the one that peaked last summer above $145 a barrel. Even so, some researchers warn we could once again be approaching the point at which rising energy costs will squeeze consumers.

That could complicate recovery in an economy that, despite the tumult of the past two years, remains as consumer-driven as ever.

"If you had to ask me what is the safe driving speed, I'd say $80 a barrel," said Steven Kopits, managing director at energy market forecaster Douglas-Westwood in New York. "We have bigger problems right now, but we shouldn't forget we're still vulnerable to rising oil prices."

After last July's march to triple-digit crude, the recent increases look fairly tame.

The price of a gallon of gas is $2.63 a gallon, according to the latest AAA survey. That's well below the 2008 peak of $4.11 -- but up 25% from a year ago and 63% above last December's low.

What's more, the factors behind this spike seem apt to persist for some time. They include a pickup in global economic activity fueled by massive government spending, a decline in the purchasing power of the dollar as the U.S. holds interest rates near zero, and lack of new oil supplies coming online to meet future demand.

While those trends hardly ensure rising fuel prices, they seem to have been doing their part so far, putting gasoline within striking distance of $3 a gallon.

That's a price that could strain consumers whose spending accounts for two-thirds of economic activity.

"Any time it gets above $3, it's worth watching," said James D. Hamilton, an economics professor at the University of California at San Diego. "When you get to that level, you start to see a change in behavior as budgets get squeezed."

Hamilton said the $3-a-gallon price is noteworthy because it's around the level at which consumers are devoting 6% of their budgets to energy costs. Hitting that point in recent years seems to have prompted Americans to pull back.

Hamilton notes that Americans largely shook off the sharp runup in energy prices earlier this decade, as energy spending remained in the 5% range and homeowners were able to tap home equity lines of credit.

But that window closed when house prices stopped rising and loss-soaked banks started cutting credit.

And though it's futile to single out any one trigger for the recession that started at the end of 2007, the downturn didn't start in earnest until consumers' energy budgets breached the 6% mark in November that year.

As energy prices soared and incomes came under pressure, Americans first stopped buying pickup trucks and then deserted the local car dealer altogether. Car sales plunged in the spring of 2008 before falling off a cliff with the collapse of Lehman Brothers that September.

"The price of oil played a bigger factor in the recession than people seem to be remembering," Hamilton said.

None of this is to say a further rise in energy prices would necessarily send the economy into a tailspin. While consumers are still strapped, behavior changes should make the economy less vulnerable.

U.S. oil consumption has slid 9% since 2007, Kopits notes. Americans also drove 3% fewer miles in the latest year through August than they did two years earlier, according to data from the Transportation Department.

Hamilton points out that car sales reverted to depressed levels after the government's Cash for Clunkers promotion ended in August.

Hillard G. Huntington, executive director at the Energy Modeling Forum at Stanford University, said that while oil markets remain exposed to a possible supply disruption, he believes the memory of last year's record prices is fresh enough that another oil shock is unlikely.

0:00 /1:19Why oil is so high

"I can see a situation down the road where maybe we should worry, but I don't think we're there yet," said Huntington. "You see the most serious effects when the economy is already experiencing inflation."

But Kopits warns that every recession since 1972 has been associated with an oil price surge that took U.S. oil consumption past 4% of gross domestic product. Today, he said, the magic number to get there is $80.

"The historical record says that when prices went up, the U.S. went into recession fast," he said.

First Published: November 18, 2009: 3:50 AM ET

$4.8 trillion - Interest on U.S. debt

By Jeanne Sahadi, CNNMoney.com senior writer

Last Updated: November 19, 2009: 1:05 PM ET

NEW YORK (CNNMoney.com) -- Here's a new way to think about the U.S. government's epic borrowing: More than half of the $9 trillion in debt that Uncle Sam is expected to build up over the next decade will be interest.

More than half. In fact, $4.8 trillion.

If that's hard to grasp, here's another way to look at why that's a problem.

In 2015 alone, the estimated interest due - $533 billion - is equal to a third of the federal income taxes expected to be paid that year, said Charles Konigsberg, chief budget counsel of the Concord Coalition, a deficit watchdog group.

On the bright side - such as it is - the record levels of debt issued lately have paid for stimulus and other rescue programs that prevented the economy from falling off a cliff. And the money was borrowed at very low rates.

But accumulating any more interest on what the United States owes at this point is like extreme sport: dangerous.

All the more so because interest rates will rise when private sector borrowers return to the debt market and compete with the government for capital. At that point, the country's interest payments could jack up very fast.

"When interest rates rise even a small amount, the interest payments go up a lot because of the size of the debt," Konigsberg said.

The Congressional Budget Office, which made the $4.8 trillion forecast, already baked some increase in rates into the cake. But there is always a chance those estimates may prove too conservative.

And then it's Vicious Circle 101 - well known to anyone who has gotten too into hock with Visa and MasterCard.

The country depends heavily on borrowing to fund what it wants to do. But the more debt it racks up, the more likely it becomes that creditors could demand a higher interest rate for making new loans to the government.

Higher rates in turn make it harder to pay off the underlying debt because more and more money is going to pay off interest - money, by the way, which is also borrowed.

And as more money goes to interest, creditors may become concerned that the country can't pay down its principal and lawmakers will have less to fund all the things government is supposed to do.

"[P]olicymakers would be less able to pay for other national spending priorities and would have less flexibility to deal with unexpected developments (such as a war or recession). Moreover, rising interest costs would make the economy more vulnerable to a meltdown in financial markets," the CBO wrote in its most recent long-term budget outlook.

So far, that crisis of confidence hasn't happened. And no one can predict with any certainty whether or when it could occur.

But should it occur, the change could be abrupt.

That's because the government frequently rolls over - or refinances - the debt it has issued as it comes due.

In other words, when a Treasury bond or note matures, the government must pay the investor the face value on that debt. In order to do that, the Treasury borrows money to pay back the investor, which means the debt would be refinanced at whatever the going interest rates are at the time.

Just how much churn is there? Of late, a fair bit it seems. A Treasury borrowing advisory committee reported in early November that "approximately 40 percent of the debt will need to be refinanced in less than one year."

Since rates may well stay low over the next year, it's possible that debt could be refinanced at the same or even lower rates. But that situation won't last forever.

So what will Washington do?

To help mitigate the potential risk of rising rates, the Treasury has said it would start increasing the average maturity of the new debt it issues. That way the debt it refinances in the next couple of years will be locked in at lower rates for longer periods of time.

And the Obama administration has promised to produce a deficit-reduction plan that would aim to bring down annual deficits to roughly 3% of GDP over the next several years, below the 4% to 5% currently projected.

If that happens, the $4.8 trillion in interest payments that CBO estimates for the next decade could go down if interest rates don't increase as much as CBO expects.

"There will be less debt outstanding than if we don't get the deficit down. It may also reduce [the average interest rate on the debt] since less debt means less pressure on interest rates," said William Gale, co-director of the Tax Policy Center.

But whether they can do that within a few years of an economic recovery is another matter. "Even under the president's [2010] budget as evaluated by the CBO we do not get anywhere close to that," Gale said.

That could mean the president's 2011 budget proposals would have to make a lot of changes to get closer to the 3% goal. Unpopular changes like tax hikes and spending cuts.

Budget hawks hope the president will push for a deficit-reduction commission to come up with ways to cut the deficit and then propose legislation that lawmakers would only be able to vote for or against. The reason: There is no political will to make the tough calls. Especially in a mid-term election year.

Market condition

For VV post.
-----
Well, do not give up VV's market timer that fast. Look at the history and my reasoning.

* Confirmed calls are quite accurate but usually two weeks late (a lot of money to be made or lost in these two weeks) for long-term timing in almost all market cycles. If you follow them, you will avoid most (if not all) losses during the market bottoms. It is quite impressive.

* There have 3 reversals of calls in this market this year. Normally only happens about once a year from the 11 years of VV.

* It is a mechanical system. I do not really like any changes.

* Personally I do not follow this time. Why? Market bottom is hard to predict. As in my other posts, I buy at dips and sell when high as DnUp (short-term down and long-term up) is my good friend.

It works so far. It may not always work. It could be the market pattern this time is not a V but a W shape expecting another 15% down. It is a bet that everyone has to take action according to his/her comfort level. When it is 15% down, you need 30% up to break even.

According to chartists, the system should go another 25% below (Elliott wave or other theory) and some fundamentalists thought so too as the conditions had not been improved. Luckily I ignored all of them and Dow moved above 10,000. So experts are not always right and I'm wrong a lot of time but not this time betting on large amount of money on the sideline. I'm still betting on no 15% down very carefully.

Another point to note. Are we into the same pattern of Japan with 10 years of no market growth? It is quite possible judging from the similar economical conditions. Unless I had a time machine, I cannot really tell you exactly what the market is heading. TonyP4

Cash rich companies

At the behest of Tom, I’m going to try to describe to you an investing system that has virtually nothing to do with VectorVest…OK, here we go..

Back in early 2002 I was watching a local semiconductor company stock and saw that the stock was actually trading at less than it’s’ CASH in the bank and it had no debt (cash was around $1.40/share and stock was trading for about a buck)! This was a solid $150M/yr company and its PE was in the red so no-one wanted to own the stock. Interestingly, I knew the companies CEO from back in my youth so I called him about the situation. When I asked why he didn’t cut expenses so his PE would be positive he made a couple of interesting statements, he said something like:

1. what’s the point of having a lot of cash if you can’t use it to gain market share when times are tough?

2. he could easily change the situation but the entire market was in the tank so even a positive PE wouldn’t be rewarded.

3. Also pointed out to me that even though his PE was bad he wasn’t actually using that much cash, most of the losses were coming from equipment depreciation etc, etc.

4. Almost all the semiconductor companies were in the tank at that time

As I thought about it, the situation was such that if you had the money and you could buy all the shares of the company and if you chose to actually shut the company down and make a lot of money! Assuming the entire semiconductor business wasn’t going to go the way of the hulla hoop, it was just a matter of time before the market returned to its love of tech. So I began buying the stock. I didn’t worry about stop losses because if it went down I just bought more (as long as it was trading at less than its CASH in the bank)! By 2005 the stock was up to $10/share (actually I think I sold it on the way up for about $4.00 but roughly 4x what I paid for it).

What’s the lesson here, it’s not always just about PE! This stock would have been bright red on the WIT spreadsheet in early 2002 but it was clearly a good opportunity.

So how do you find these kinds of companies? In the spring of this year I was looking for a search engine that surface these kinds of companies again. The only engine I found that could do it is ‘Stock Investor Pro’ on AAII. http://www.aaii.com/stockscreens/

I ran a search in April of this year and created a CASH rich company portfolio in AAII. Below is a printout of the companies I found in April the cost per share at that time and today’s price. As you can see the total portfolio is up 149%. Actually it’s better than that; SIRF (one of the companies I actually bought) was acquired by a UK company CSR for about $2.20/share (it shows as 0 value on this spreadsheet)

Symbol (name)	Quantity	Cost/Share	Fee	Last	Change	% Change	Total Cost	Market Value	$ Gain/Loss	% Gain/Loss	Detail
SNIC	3,846	1.30	0.00	9.266	+0.136	+1.49%	4999.80	35637.04	+30637.23	+612.77
XRTX	2,632	1.90	0.00	11.54	-0.17	-1.45%	5000.80	30373.28	+25372.48	+507.37
ENTR	10,000	0.50	0.00	2.94	-0.01	-0.34%	5000.00	29400.00	+24400.00	+488.00
SPRD	5,208	0.96	0.00	5.28	+0.04	+0.76%	4999.68	27498.24	+22498.56	+450.00
BFRM	5,102	0.98	0.00	3.67	-0.08	-2.13%	4999.96	18724.34	+13724.38	+274.49
HZO	2,463	2.03	0.00	6.76	-0.08	-1.17%	4999.89	16649.88	+11649.99	+233.00
HILL	8,197	0.61	0.00	1.8948	+0.0548	+2.98%	5000.17	15531.68	+10531.51	+210.62
PDFS	3,356	1.49	0.00	3.52	+0.01	+0.28%	5000.44	11813.12	+6812.68	+136.24
GAIA	1,366	3.66	0.00	7.35	+0.26	+3.67%	4999.56	10040.10	+5040.54	+100.82
REDF	2,488	2.01	0.00	3.20	+0.07	+2.24%	5000.88	7961.60	+2960.72	+59.20
VRAZ	7,463	0.67	0.00	0.94	-0.008	-0.84%	5000.21	7015.22	+2015.01	+40.30
SLRY	2,370	2.11	0.00	2.8001	+0.0101	+0.36%	5000.70	6636.24	+1635.54	+32.71
BPHX	2,475	2.02	0.00	2.55	-0.09	-3.41%	4999.50	6311.25	+1311.75	+26.24
SIMO	1,786	2.80	0.00	3.25	+0.02	+0.62%	5000.80	5804.50	+803.70	+16.07
TOMO	1,742	2.87	0.00	3.23	+0.05	+1.57%	4999.54	5626.66	+627.12	+12.54
PRXI	4,808	1.04	0.00	1.158	-0.022	-1.86%	5000.32	5567.66	+567.34	+11.35
KDE	2,632	1.90	0.00	1.681	-0.069	-3.94%	5000.80	4424.39	-576.41	-11.53
GU	2,500	2.00	0.00	1.36	-0.07	-4.90%	5000.00	3400.00	-1600.00	-32.00
GNPH	1,232	4.06	0.00	N/A	N/A	N/A	5001.92	0.00	-5001.92	-100.00
SIRF	5,308	0.96	0.00	N/A	N/A	N/A	5095.68	0.00	-5095.68	-100.00
							100100.66	248415.16	+ 148314.50	+ 148.17%

My AAII search criteria are as follows: http://www.aaii.com

· Market cap >30M

· Avg Volume >25k

· Cash-liabilities/stock price >1

· Long term debt<= 0

Today’s AAII search for CASH rich companies using the same criteria yields only about 9 companies (many in China where I don’t invest). Out of the current 9 I like DITC, GRVY and LEDR. I think these companies might be ripe to be acquired by other companies who need cash. If you can get enough of these to spread the risk it seems to me like an interesting way to buy the dogs without a lot of downside risk. …..GB