Wednesday, March 25, 2009

TheUgle Step Sister may be your next purchase.

In my last posting, I swallowed hard and said that I thought before this rally was over we would hit about 8,500 on the Dow Jones and 900 on the S&P 500 indexes. As of Friday, March 20, the closing values of the Dow Jones and the S&P 500 respectively were 7,278.38 and 768.54. On Wednesday the 18th, we were just about 1,000 points away from the target for the Dow Jones and less than 100 on the S&P 500.

For those of you who thought I was telling you that we were headed straight up,that was not my intention. I think we are in a bull rally in a serious bear market. Rallies in bear markets can be very explosive and be short lived. The reason we have bull rallies in bear markets is to play with investors' minds. There is a serious amount of cash on the sidelines earning just about zero return. As these markets move up in explosive returns of 50% or more in many sectors that have been beaten down, investors on the sidelines get very nervous that they might have missed the entry point.

If the rally doesn’t peter out, these investors will be overcome by the fear of missing out on significant gain. When the market is near a top you will see an explosion of up volume with a lot of the money pouring into stocks, just at the time investors should be selling. It's kind of like playing “Lets make a deal”. You give up your cash to buy door number three and when the door is opened you find that instead of Cinderella you now have one of her ugly step sisters.

The markets are never fair to investors. Buying stocks has risk and when you don’t know how much risk you are taking, the market almost always takes most of your money. There is no question there will be a time when, if you have cash, you should buy some stocks that are cheap relative to their long-term value. Two postings ago I spoke of GE at the price of a Whopper value meal. Today the value of GE stock is up 36% from $7.00 in just about two weeks. For some investors 36% in two weeks makes it a sell. If you could earn 36% on your money in 2 weeks that is equal to 4 years of return in normal market conditions.

Is it possible that GE could go back to $7 again? Yes, but if it did I would buy more of the stock. The same reason I used for buying GE and other woefully undervalued stocks still exists. The opportunity for the long-term investor is still there. Just over 10 days ago the Dow Jones stood at 6,500, the lowest level in 12 years. It moved 1,000 points up in 7 trading days and as a result this move changed the investor psychology from negative to positive. As we climb the wall to try and get to 8,500 remember who is at the top of the wall. Not Cinderella, but the ugly stepsister and what are you going to do with her?

Dan Perkins

Sunday, March 15, 2009

What Is Next for the Doggie?

I indicated in my last Blog that I thought the market was not giving stocks fair value people could not separate the certificate of a share of common stock from the real company whose name is on the share of stock. I used as an example GE. At the time, I published that Blog the price of GE was around $7.00 a share. GE stock price ended this week at $9.62 or up about 38% for the week. Therefore, the question on everybody’s mind going into the weekend is, “how far or high can the markets go from the amazing week?”.

The short sellers want to figure out how high the markets will go so they can get back in before the market starts back down and test the most recent low of 6,500 in the Dow Jones and 672 on the S&P 500. I am taking a deep breath and I am going to predict that the Dow Jones could rise to about 8,500 and the S&P 500 could go as high as 900 before we go back and test the most recent lows. This is a 20% move from the current level to get to my target numbers for the markets.(No Guarantees)

Some of the things that could happen causing this move over the next 3 to 4 weeks are a change on the up-tick rule and a modification of the mark-to-market accounting rules. I have talked about the up-tick rule in the past. I have not discussed the mark-to-market accounting rules until now.

Let me start with the technical and then move to an example of what happens in mark-to-market accounting. The mark-to-market rule is an accounting rule that public companies, must adjust the value of an asset based on the sale price of a similar asset by another business. This is an over simplification of the rule. If the asset does not have a market, a place were the asset can be bought or sold, then the owner of the asset has to try as best they can to access the value of the asset. In many cases, because some markets are not functioning, it has been difficult to figure out the price of the asset like sub-prime mortgages.

Let me try to use a couple of examples to help you understand this issue. Let us say that your neighbor has to sell his house. He or she has lost their job and they need to cut their expenses. If they miss house payments then the mortgage will have to go to foreclosure and they will loose everything. They talk to a Realtor to try and figure out what is the price at which they can sell their house quickly. Let us also say that the normal market for the house is $300,000, they decide to put the house on the market for $250,000.

Now you have the same house in as good or better shape as the one that just went on the market for $250,000. If we were to apply the current mark-to-market rules, you would have to value your house at $250,000 on your financial statement. If the house were to sell for $200,000 then you would have to value your house at $200,000. Your house might be worth $300,000 in a normal market, but things today are not normal and your house is worth $200,000.

You have heard about all the sub-prime mortgages and that people are not paying these mortgages, houses are being foreclosed on, and as a result, other real estate is considered to have lower values. Here is the point, just because one mortgage is in foreclosure does not mean that all mortgages are in foreclosure. If you are making your mortgage payments and do not have any intention of selling your home, then why should the bank have to lower the value of your mortgage?

The major banks do admit that they have mortgage loans that are not performing (paying their payments). They contend and to a great extent I agree, if people are making their payments on time then the loan is performing and in turn is worth more than a loan where the borrower is not making the payments. If you were in the market to buy a mortgage investment wouldn't you rather own one that was making the payments vs. one that was not making the payments?

The House of Representatives Finance Committee is looking into these mark-to-market rules and the committee members are on record that they want the regulatory agencies to modify the rules for the unusual times we are in now. I believe the rules will be modified on mark-to-market accounting and that will spur the market to the levels I predicted. Only time will tell if I am right. Keep in mind that I think we will, have to go back and test the previous lows. I think the catalyst for that retest will be the auto companies and finding out if, we have the will to bail them out.

Dan Perkins

Sunday, March 8, 2009

How much is that doggie in the window?

Common stocks have fallen so far that the price of the stock doesn’t reflect the true value of the company. If the dividend is solid and in 4 payments you could get back all of your money something is terribly wrong. The market price of Microsoft is $15.28 for a total market value of $135 billion. What most people do not realize is that Microsoft has about $5.35 per share in cash and current assets. If we subtract the cash on hand then Microsoft is worth, based on market price under $10 a share.

I could fill pages of other stocks with similar large cash positions, but the market has seriously discounted the price of the stock. GE has a market price of $7.00 per share and has $4.56 per share in cash. Using the same approach as we used above with Microsoft if we take out the $4.56 per share in cash from the $7.00 price then GE is worth $2.44.

The point of these two examples is to show you how absurd the market pricing is at this moment in time. There is no order or reason in the markets at the moment. Do you realize that the price of GE is less than the price of a Whopper Value Meal at Burger King? The only opportunity with a Whopper is a larger waistline. Once you eat the Whopper it’s gone, at least with GE you have something that may make your wallet grow instead of your waistline. Nobody wants to buy at these prices because they think stock, cars and houses will get cheaper. You hear a lot of fund managers being quoted, “What is the rush to buy now, it will be cheaper later and then I’ll buy.” The problem with that thinking is that history has shown that they don’t buy till well after the market has recovered.

One thing is different this time around about waiting to buy stock. If you wait you have your money invested in cash or cash equivalent. In the past you were paid a reasonable return on that cash investment. The return on cash was not as good as the potential from stocks, but as a parking place while you were looking for something to buy the yields were okay--not so today. The yield on high a quality, Government money market funds is close to zero, if you can get your money invested. Many of the government money funds are closed to new investors. The yields in regular money funds are also falling, so you have little or no return putting your money in cash.

Every day that goes by where you are earning zero on your money makes it more and more difficult to reach a financial goal. There are only two ways that I know of to make money legally--you at work or your money at work. The practical reality is that if your investment account is down 50% - 60% you are going to have to work harder to generate more income to replace what you are down in the market. For most people working more to make up the shortfall isn’t an option.

The President recently said that his solutions will not solve our problems in days or months, but may take years. Some problems are more easily fixed than others Mr. President. The people are scared about what is happening in the economy. With the unemployment rate reported on Friday at 8.1% many people are asking themselves are they next to laid off?

We seem to want to focus on the negative of 8.1% of the work force that is unemployed and ignore the 91.9% of the work force that are working. In the same way we are ignoring the fundamentals of stock pricing and are letting emotions govern the day. Do you really believe that GE could go bankrupt? I could ask this same question of many other stocks so until people step up and ask, “How much is that stock in the window really worth, the one with all that cute cash on is balance sheet?” When we start to evaluate the value of a company based on what it does this market will no longer flounder.

Dan Perkins

Monday, March 2, 2009

When will these bad times end?

The month of February has come to a close and the markets, as measured by the S&P 500, are down about 20% on a year to date basis. “When will these bad times end?” is the title of this blog and the single most asked question by investors and Americans today. I wish I had the answer to this very important question.

What is clear to me is that we as Americans have developed to a very fine level the need for “instant gratification” in all facets of our life. So it is understandable to want a quick solution to our problems in the economy, the capital markets and of course the housing markets. Just because we think our problems should be solved quickly doesn't mean that they will be solved a fast as we want them to be solved.

A client called me this past week to ask my opinion on what I think is going to happen in the markets and the economy. Before I told him what I thought would happen I asked him what he thought and I was very surprised at his answer. He said he didn’t know what was going to happen, but he was very nervous and he was looking for me to tell him what was going to happen. He did make the point that President Obama had only been in office for over a month and people were expecting too much from him. (Instant Gratification) His belief that Obama could turn things around is why he voted for him for president. He has all of his IRA money in short-term CD’s waiting for the opportunity to buy common stocks. He may be waiting, as Chairman of the Fed said about interest rate for an extended period of time before he could buy stocks.

I have been saying on a regular basis in this column that I believe the recovery will come, but I don’t think it will be as strong a recovery as we have seen in the past. I also don’t think it will come over night. I expect to see slow growth, low inflation, and low short-term interest rates for the next 3 to 5 years.

The real issue, that many people are unwilling to accept, is that it took many years for us to get to this point and regardless how much we want a quick solution, none is on the horizon.

Let's get back to my client. His investment account is down but he is getting a high degree of cash flow. He made a great point that if he sold all of his income investments today, he could not get the level of cash flow he is getting today. Also, if he stands pat he has at least a chance over time to get recovery in his investments.

The real financial problem for many investors is that they have very little fixed income assets. Those of you who are my clients know that you have a significant amount of fixed income investments and the checks still come in month after month. As things evolve the need for income to support even a reasonable life style will become more and more difficult to achieve.

The retired will be the most severely affected segment of America. Their Social Security will stay flat and the money they have in the bank and money market funds will pay decreasing returns. Having the ability to generate a high level of income to carry yourself through the difficult times ahead will be very important.

My job is to monitor the investments to make sure they continue to pay the interest and dividends on a timely basis regardless of whether you need the income or not and reinvest distributions to produce more income. One of the reasons the Asian investors purchased our bonds is that they were paying a much higher rate of interest than they could earn in their own banks and government bonds. The American investors will come to better understand the value of income producing investments as we go through this recession.

Dan Perkins