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I thought the headlines on Friday were interesting.  There was ZERO good news about the economy, and all the economic and earnings reports were worse than expected.  But the stock market went up.  Makes no sense to me.

Here are the top headlines from Reuters Business news as of 12:57pm (ET) yesterday.

GM, Ford losses worse than expected, burning cash - 33 minutes ago

• General Motors Corp and Ford Motor Co reported far deeper-than-expected quarterly losses on Friday, and said their rate of cash burn was accelerating, as an extended slump in car sales raised question…

  · Pending home sales fall, tight credit bites - 18 minutes ago

  Pending sales of existing homes fell in September, reversing the previous month’s gains, as access to credit tightened, a private report showed on Friday, adding more gloom to the broader economic…

  · Bargain hunters buoy stocks, but GM slides - 10 minutes ago

  Stocks rose on Friday as investors followed two days of losses in the mood to buy beaten-down sectors, including energy and technology, offsetting a blitz of bleak news indicating economic gloom.

  · Job losses soar, jobless rate at 14-year high - 1 hour ago

  U.S. employers slashed an unexpectedly steep 240,000 jobs from payrolls last month and the jobless rate shot up to a 14-1/2-year high, the government said on Friday in a report underscoring the econom…

  · Microsoft CEO pours cold water on Yahoo interest - 2 hours ago

  Microsoft Corp Chief Executive Steve Ballmer dismissed speculation the software giant might still be interested in buying Yahoo Inc, sending shares of the Internet company down 14 percent.

  · Paulson considering all options for TARP funds - 30 minutes ago

  Treasury Secretary Henry Paulson is considering “all options” regarding implementation of the $700 billion financial rescue plan, including areas of the financial sector beyond traditional b…

  · JPMorgan sees consumer loan defaults rising - 2 hours ago

  JPMorgan Chase & Co (JPM.N) said on Friday it expects consumer loan defaults to increase in the current quarter and sees higher loan loss provisions.

  · Oil rises as U.S. jobs data hits dollar - 43 minutes ago

  Oil prices rose on Friday as the dollar slumped following bleak employment data in the United States, the world’s top energy consumer.

  · Sprint suffers loss as customers flee, shares slump - 36 minutes ago

  Sprint Nextel Corp (S.N), the No. 3 U.S. mobile service, posted a third-quarter loss and a 12 percent drop in revenue as customers fled to rival services.

  · Major banks ask Citadel to post more collateral: report - 28 minutes ago

  Citadel Investment Group, one of the largest hedge funds, is being asked by several major banks to post additional collateral to cover big losses on its investments, the Wall Street Journal said, citi…

The DJIA dropped another 675 points today, bringing it down to 8579.  Exactly one year ago, it was at 14,164 - its’ all time high.  Aren’t you glad you pulled all your money out of the market last year?

What’s that you say?  You didn’t move to cash because you’re in this for the long term, you’re a buy and hold investor?  Oops!

According to a story on CNN.com today, “We are in a free fall right now and fundamentals have been thrown out the window,” said Phil Orlando, chief equity market strategist at Federated Investors.

Ummm….  Wrong.  The “fundamentals” have NOT been thrown out the window Mr. Orlando - the fundamentals are what’s causing the drop.  We’re at the start of the 3rd quarter earnings season, and there’s no doubt that earnings will be drastically lower than Q3 of 07.

So stock prices HAVE to adjust to keep the price earnings ratio reasonable.  I guess the only question is how low earnings will be - which will tell us how low the stock prices will go.

With the latest drop, the S&P 500 is at a PE of about 12 - which is right about the long term mean.  We’ve been way above that for a long time, so I expect to see the PE “revert to the mean” long term, which means we need to go below a PE of 12 for awhile.  Possibly as low as 8 - which is what the ratio was back in the early 70’s and the great depression.

So, how low can we go?  Let me know if you have a guess.  I’m guessing maybe 7500?  But that’s just a guess.

gk

Does this sound familiar?  According to the story, Bank of America CEO Ken Lewis says “that he sees no need for the largest U.S. bank to raise capital or cut its dividend.”

I don’t know why, but it sounds like I’ve heard that before….  Oh yea, now I remember.  Citi Group said that on November 4th last year - then on January 16th they announced a 41% cut.

I’m too lazy to look up the details right now, but if my memory serves correctly, MBIA, AMBAC, Lehmann - and several other financial institutions have said the same thing over the past 6 to 8 months. 

Here’s a fun trip down memory lane.  Read this excerpt from Bloomberg dated August 28, 2007:  Moszkowskicut his estimate for Lehman’s earnings in 2008 by 22 percent to $6.80 a share. That compares with an average estimateof $8.14 in a Bloomberg survey of 19 analysts. He expects the firm to earn $7.07 this year.

Bear Stearns will earn $12.07 a share in 2008, Moszkowski predicts, more than $2 below the average estimateof $14.53. Earnings this year will drop to $11.86 a share from the record $14.27 that Bear Stearns reported in 2006, he said.

Lehman shares declined $3.47, or 6 percent, to $54.28 in composite trading on the New York Stock Exchange. Bear Stearns fell $3.78, or 3.4 percent, to $108.42.

“Merrill’s downgrade is a very good sign that these stocks will bounce from here,” said James Barrow, president of Dallas- based Barrow Hanley Mewhinney & Strauss, the sixth-largest Bear Stearns shareholder. “They’ve made many market-bottoms by putting stocks on sell lists.”

Obviously, Bear Stearns is now out of business (having been bought by JP Morgan for $10/share) - yet James Barrow said that the downgrade was “a very good sign that these stocks will bounce from here” when the stock was at $108.  I sincerely hope that no one listened to him.

How about Lehmann stock?  It was at $54 when this pronouncement was made, today it closed at $19.74.

Don’t you just love the way the market pros can call the bottoms?  (Umm, that’s sarcasm - no need to tell me I’m agreeing with someone who’s wrong.)

I’ve said it before, but it needs to be repeated because I’m tired of people acting like they’re surprised when the market - particularly financials - keep going down.  If you learn nothing else from these rants, please remember this:  Until the financials “come clean” and write off the majority of the toxic “level 3″ assets, they will continue to lose value.

These financial geniuses have leveraged sub prime and “alt-a” loans 20 and 30 times.  When even one defaults, the whole house of cards comes down.  I’m guessing - strictly a guess because none of them are providing accurate numbers right now - that the major banks have written down maybe 30% of the losses they’ll ultimately take.

In other words, this show ain’t no where near over - it ain’t even halftime.  I don’t care how many times Ben Stein says buy and hold, I don’t care how many times Doug Kass says we’re at the bottom, I don’t care if MBIA and AMBAC say they don’t need capital, I don’t care if Lehmann downgrades (or upgrades!) Merrill or Goldman - or vice versa.

Someone needs to say it - These companies are too highly leveraged.  Some will not be in business a year from now.  It’s true that one or two will emerge stronger, but I’m not picking that horse yet.  Better to sit on the sidelines (in cash or gold or silver) and wait to see who’s left when the dust settles.

Right now, I’m long Novagold (NG) strictly as a speculative bet on gold.  I’m also long on FXE - which is a “long-term-no-way-I-can-lose-on-this” type of bet.  That’s it.  Everything else is in cash and silver - real silver coins that I physically have in my possession.

I don’t have the balls to short financials right now - although everything I know tells me to.  Someone (don’t remember who right now) said something like “the market can remain irrational longer than you can remain solvent.”  Good advice, and I rarely bet short - or wager much on hunches.  The dollar going down long term is NOT a hunch.  In my book that’s as close to a sure thing as there is today.

If I had the guts, I’d short XLF from here - it closed at $19.36 today - and take my profits at $17.  But I don’t have the guts to do it, so I prefer to sit on the sidelines until there’s something I can go long on.

Maybe someday the buy and hold crowd - who have cost so many people so much money in the past 8 years - will shut up and go away.  I hope the same goes for those who keep calling bottoms in this bear market.  Buy when the market trends (when the 75 and 200 day EMA cross going up) are on your side - not before. 

Unless you’re a trader or speculator, in which case you don’t care what I say anyway.  Even then, I know traders who use technical indicators - but much faster than 75 and 200 day MA! 

Anyway, I don’t think anyone will get rich bottom fishing at these levels - and you could lose it all. Be patient, wait, buy when the market trend is in your favor, and you’ll be just fine.

gk

I was responding to some comments to a post I made to www.seekingalpha.com a few minutes ago, when I said something that I think needs to be explained further.  I mentioned “leverage” and since that’s been in the news (especially regarding financial stocks) quite a lot over the past few months, I decided to expound on it a bit.

In the comment I referenced above, I said “Let’s say you have $1 million equity in your house, and you take it out in a HELOC. You take that $1 million and put 10% down on 10 other $1 million properties - and you depend on the renters to make your payments.“

That’s leverage.  I just took $1 million in assets (my home equity) and used it to gain control on $10 million in assets.  I used the words “gain control” rather than saying “to buy” because I don’t actually own them - the bank I borrowed the other $9 million from actually owns those properties.

It’s an important distinction, because what happens to my $10 million in assets if just one renter falls behind on their payments?  Suddenly I can’t make my mortgage payments.  It’s only 10% less income, but it causes me to suddenly have to sell the whole $10 million in leveraged assets - because I can’t make the payments.

That’s what happened to Bear Stearns.  They had some assets which they leveraged (borrowed against) in order to buy (with other peoples money) other assets.  When one small part of the initial asset didn’t make their payment, the whole house of cards fell.

In my example, I used a leverage ratio of 10 to 1.  Bear Stearns was leveraged over 30 to 1.  I’ve sen some arguments from pundits (including Ben Stein) where they say the markets have over reacted; that a 10 percent jump in the rate of defaults doesn’t warrant a 20 or 30 percent drop in the stock price of financial companies. 

They’re wrong.  And they’re wrong for the reason above.  When you’re that highly leveraged; when you have 20 (or more) dollars of debt for every dollar of assets; you are hosed when just one percent of the underlying assets doesn’t pay up.

Suddenly you can’t make your payments on all the debt you’ve borrowed.  And since you really didn’t make much of a down payment anyway, you have no equity in the investment.  If you had some equity, you’d have a little breathing room.

But you don’t.  You need every dollar that you’ve counted on to make those payments - because you’ve leveraged your equity. 

And what happens when the value of thoseleveraged assets turns out to be too high?  You’re fucked.  Not only are you highly leveraged, but the base value of thoseassets has dropped, so now you are more leveraged than you were just a monthago.  And so you’re even more vulnerable when there’s a small rise in loan defaults and bankruptcies.

It’s a wild, wild world right now.  I can’t think of a single bank or REIT that I’d touch with a 10 foot pole.  Go ahead and Google the news results for the 3rd quarter of last year.  Check out all the stories that claimed that the 4th quarter was the “kitchen sink” quarter.  Be sure to read how damn near everyone thought that the banks and investment houses have finally fessed up and come clean.

Now watch the headlines during the week ahead.  Let’s se how many additional write-downs there are.  A lot of people have written me saying that I’m overestimating the impact of the sub prime stuff.  Many have told me that all of those losses for the upcoming rate adjustments (for the Option ARM’s and ARM’s written in 2005 through 2007) have been accounted for, and that there’s no where to go but up.

They may be right, but I don’t think so.  I don’t think people truly understand the impact of leverage.  I don’t think they truly understand that just a 3 or 4 percent drop in the base asset (mortgages) can cause a company to disappear.  

I’m not putting my money back into the market until I’m sure that risk has been priced in.  Given the (in my view) extremely optimistic earnings forecasts for 2008 and 2009, that risk is being ignored right now.  I may be wrong (I often am!) but I think I’ll be getting 2 or 3 percent in my money market funds while the optimists are losing 10 to 20 percent (or more) trying to bottom fish the market.

Any questions?

gk

I was reading an article on CNN tonight and happened to see these lines:

But sentiment seems to be shifting as of late.

“It’s still too early to tell,” said Thomas Nyheim, portfolio manager at Christiana Bank & Trust. “But I do think that when you have Ben Bernanke, the IMF, and all these strategists saying we are in a recession or about to see one, and the market doesn’t sell off much, that tells you something.”

I agree that sentiment is shifting - how else do you explain the stock markets’ reluctance to go down in the face of all the bad news?  It’s certainly possible that we’re “climbing a wall of worry” and that the short downturn in stocks is over - but I don’t think so.

There is too much optimism for me right now.  It seems that no matter how bad the news is, the stocks affected rally.  It’s like investors are thinking “At last, this is everything.  It’s all out there now.  Things can’t possibly get any worse, so there’s nowhere to go but up.”

I hate to be the bearer of bad news, but yes Virginia, things can get worse.  And I think they will. 

I’ve been playing with an Excel spreadsheet of earnings from Standard and Poors website.  Their 2007 estimate of $82.54 was high (actual was $70.83) and I think their 2008 estimate of $96.74 is way too high - by at least $20.

In other words, official estimates are looking for 2008 earnings to be HIGHER than the 2007 results.  I don’t think there’s anyway that’s going to happen.  The first quarter results will be a lot lower than last year (overall) and we are still in the early stages of the massive deleveraging that needs to happen as the housing market gets worse.

Stocks might be higher a month from now - but I doubt it.  They might be higher 6 months from now, but I doubt that too.  Unless there’s a massive (1500 to 2000 point) correction in the DJIA between now and then, stocks will continue to trade in the 12800 to 12200 range.

We may go down slowly, or we may see a huge two or three day slide, but stocks WILL eventually correct to reflect the earnings.  I’m just sitting on the sidelines waiting for that to happen.  If it doesn’t happen (I’ll be very surprised!) I’ll get back into the market when the 75 day EMA crosses over the 200 day EMA.  And we’re nowhere close to that happening.

gk

Some headlines from today for perspective.

Fed Officials Saw Contraction in Economy `Likely'

Washington Mutual to slash jobs despite cash injection

Pending home sales index off 1.9% in February: NAR

Credit crunch cost $1 trillion estimates IMF

Basically there was a lot of bad news that came out today, and the US stock markets were down a little for the day.  Given the news today, I don’t understand why they weren’t down more - but you can’t argue with the markets. 

The market is always right (no, I’m not being sarcastic) and no matter what I think are compelling reasons for it to drop, the market will do what it wants to do.  The market is the ultimate arbitrator of right and wrong, because it will do what it wants to do regardless of what I think.

That’s the short term view anyway, and successful traders already know this.  I’m not a trader - I look strictly at long term trends - but I confess to being annoyed when the market doesn’t do what I think it should do based on the fundamentals and the news.

I’ve started to do a little analysis of the S&P 500 earnings based on Standard and Poors own published data.  No conclusions yet, but the estimates for Q4 2007 were way high, and I expect the estimates for Q1 2008 will be even more off base. 

The estimates I’ve seen are for a 12% drop in earnings in Q1.  That’s simply wishful thinking.  I’m expecting a minimum of a 25% drop (year over year) and I will not be surprised if the total S&P 500 earnings ends up 50% lower that Q1 of 07.

Any takers?

gk

“Fraidy Cat”?  C’mon, Walter, can’t you do better than calling people names and making fun of them when they get nervous?

http://money.cnn.com/2007/11/29/pf/expert/expert.moneymag/index.htm?postversion=2007112910

Since this article was posted by Walter Updegrave on November 29th, the market (as measured by the S&P 500) is down more than 7%.  That’s more that it gained during all of 2007.  But Walter says you can’t time the market.  Walter says “That’s why calling turnarounds in the stock market is an iffy business at best. Ultimately, it’s a guessing game that isn’t worth the effort. I say you’re much better off setting a mix of stocks and bonds that makes sense given your planned retirement date and then sticking to that mix regardless of what the stock market is doing at any given moment.”

I say he’s wrong.  I have a very simple strategy - I move in and out of the stock market according to when the 75 and 200 day EMA’s cross.  For example, move out the week of Nov 27th, 2000 (S&P 500 at 1315) and put the money into either money market or bonds or split between the two. (More on how to choose between bonds and money market funds later).  It stays there until the 75 day moves back above the 200 day EMA, which was the week of June 9th, 2003 (S&P 500 at 988).  You stay in until the week of Jan 14th, 2008, when you sell at 1325. 

Note:  I only check the market at the end of the week, so I normally have a clear crossover point if there’s been a change during the week.  I haven’t defined “clear”, but lets just say the lines have crossed by more than 1%.  Look at the direction they’re heading (up or down) if you can’t decide.  Or simply wait another week until the direction becomes clear to you.  A week is nothing in the time frames I’m talking about.  It may mean 1 or 2% difference, but I don’t care about that.

By using this strategy, you’ve captured the majority of the upside, and you’ve missed the majority of the downside.  If there’s not a clear crossover point, you stay with what you were doing.  So if the market has no clear direction (such as in 1994), you’re either in or out - depending on what the last clear crossover point was.  You won’t make much during these times - but you won’t lose much either.

So right now (Jan 28th, 2008) you should be out of stocks.  Yes, you’ll miss a big up day - or even a big up week - but we’re looking for long term trends, not the flavor of the day.  As Will Rogers once said “I’m much more interested in the return of my investment, than the return on my investment”.

But guess what?  By following the above strategy, you’ll beat the snot out of a buy and hold investor - and you won’t be jumping in and out of stocks so often that you end up paying a lot of transaction or broker fees. 

Note: By using this strategy, you will not get out of stocks soon enough to miss huge one day losses, like the crash of 1987, or the big drop in July/August of 1990.  And you’ll be sitting either in or out of stocks when the market has no clear direction, such as pretty much all of 1994.  There will even be times (such as the two instances I just mentioned) where you’ll buy back in at a higher price than where you sold.  Remember, this strategy isn’t for short or intermediate term trading and it doesn’t work for that.  It’s only meant to be a guide for long term trends, such as the bull market of the late 90’s, the bear market of 2000 through 2003, and the bull that took us through 2007. 

Yup, you’ll be sitting on the sidelines on some huge up days, and you’ll be fully invested during some big down days, but you’ll do better than the market as a whole, because you’ll be out of the market when bears are eating everything in sight, and in it when bulls are charging.

How are those buy and hold guys doing since 2000?  If they’re lucky, they’re almost back to even.   If you had put $1000 into the S&P 500 on Jan 1, 2000, and you left it alone (you’re a long term buy and hold investor like Walter!) that $1000 investment is now (Jan 28th, 2008) worth $1011.87.  You made $11.87 TOTAL in the past 8 years.  If you had followed my strategy, you’d have a lot more.   I’m too lazy to do all the math right now, look at a chart and see if it makes sense to you.  I may come back to this later when I have more time.

Anyway, I told you I’d tell you how to choose between bonds and a money market fund.  If interest rates are heading down, as they obviously are right now - at least it’s obvious to anyone with warm blood in his brain - you go into bonds.  The price of bonds rises as the interest rates fall.  If rates are rising, move your money into a money market account.  If you can’t guess which way rates are going, split your money between the two.  You may not make much, but at least you won’t lose much either.

So I disagree with Walter - it’s OK to be a “Fraidy Cat” - just have a plan for when you move in and out of stocks.  I think my plan works well, but you may have something else in mind.  If you have a long term trading strategy that works for you, pass it on.  Post a comment with your strategy for all to see.  Walter will disagree, but others may still find it useful. 

gk