Rooting for the Underdog

What a great Super Bowl game! I have to admit, I was pulling for the
Saints, but mainly because of what the Saints mean for that city. I’m
sure we all remember the horrible aftermath of hurricane Katrina. The
very existence of New Orleans was in question. The Saints considered
moving, and I recall suggestions that only the French Quarter be saved
and made into a corporate convention amusement park.

Of
course, that would have been an absurd commercialization of a proud and
rich heritage. That New Orleans has come back to resemble the city it
was before Katrina is nothing short of miraculous, and now the people
of New Orleans have a Super Bowl trophy to crown their achievement.
Congratulations, New Orleans and the Saints.

It’s
tempting to extend the metaphor of New Orleans to the United States as
we rebuild after the financial crisis. Of course, I have no doubt that
we will recover. But there will likely be no single event that crowns
the recovery like the Lombardi Trophy does for New Orleans.

And
besides, we’re investors. It is our desire to be properly positioned
for a growth in stock valuations, all the while avoiding the pitfalls
of overvalued stocks and worsening economic conditions.

Clearly,
investors have been pondering the potential of weaker economy as some
stimulus policies end, Europe faces debt problems and China moves to
slow its economy. Bloomberg reports that investors pulled $9 billion
out of global equity funds during the last week of January. And
investors have bet heavily on an extended sell-off as evidenced by huge
volumes of put option activity.

At the same time, 73% of
S&P 500 companies have beaten 4th quarter earnings expectations.
That’s the best performance since 1993. Strong earnings, coupled with
the recent 7.3% decline, have left the P/E for the S&P 500 at 18,
down from 24. The forward P/E, based on future earnings expectations,
is below 13.

Unemployent falls and so do stocks

Yesterday’s decline reversed the rally we enjoyed to start the week. The S&P 500 is now below support at 1071. Is that a death knell? No. But it’s not good, either.

Mounting debt problems in Greece, Spain and Portugal are spooking investors. Oil prices are lower as investors worry the global recovery isn’t gaining momentum.

The Labor Department reported that companies cut 20,000 in January. New unemployment claims also rose. But somehow, the unemployment rate fell to 9.7%. I’m not going to call that a “damn lie”, but statistics don’t always tell the whole truth.

We’ve noted frequently in Daily Profit that we can expect to see some pretty wild swings in the data as the housing market and unemployment rate bottom. One month’s positive data gets revised lower, and then the next month’s negative data gets revised higher.

There’s no doubt the economy is improving, but is it happening fast enough? And perhaps more importantly, where will the base-line be?

An unemployment rate around 4%-5% used to be the norm. We’re certainly looking at a higher base for unemployment over the next few years. GDP growth will be lower. Investors will probably support lower P/E ratios and levels for the major indices.

That’s not a disaster, but it does mean you’ll need to be focused on value and not afraid to take profits when you have them.

The Case for Coal

It’s quite a conundrum. America spent around $475 billion for foreign oil in 2008 (2009 numbers are not complete yet, although the total is certainly projected to be lower). It’s clear that electric powered battery technology for cars would allow us to keep more U.S. dollars at home, improve the trade deficit and provide manufacturing and other jobs, too.

We have enough sunlight, wind, natural gas, and coal to generate the power it would take to transition to domestically supported power generation. The long-term benefits are obvious. Wind and solar installations have an upfront cost, but pay for themselves over time. Natural gas and even coal are domestic resources that can and should be leveraged to allow us to be more energy independent.

But getting to the point of energy independence is a difficult path.

It’s easy to look at that $475 billion figure and say if we invested that into the power generation economy, we’d have efficient battery technology for electric cars and plenty of new manufacturing jobs.

However,…

The Forecast for 2010: Looks Like Volatility

Wow. Two strong rallies to kick off
February. It’s great to see some buying interest after January’s
sell-off. But I would caution that 2010 will be more volatile than the
final 9 months of 2009, when stocks were on a one-way trip higher.

You
could argue that stocks are overvalued based on index P/E levels. The
trailing P/E for the S&P 500 is 21. At the same time, companies are
once again beating earnings estimates. Business is better than analysts
expected.

The forward P/E for the S&P 500 is 14. That’s based
on analysts’ expectations of 2010 earnings. If analysts are once again
low-balling the numbers, then the S&P 500 may actually be cheap.
But if unemployment continues to weaken, or if banks don’t loosen up
lending, or if the housing market doesn’t improve, then perhaps stocks
are expensive.

And so, stock prices will very likely be more
volatile this year. That means it’s going to be even more important to
do good research and buy quality stocks at reasonable valuations. It’s
also going to be critical for investors to focus on the sectors that
will outperform this year. Of course, all of this will be part of our
ongoing conversation here in Daily Profit.

When You Hear Hoof Beats…

It sure was nice to see stocks make a nice
move higher yesterday. Especially after I came out yesterday and said
Dow 10,000 and S&P 500 1,071 were support points.

It’s also
interesting that this advance came on the first day of February. Recall
that the positive GDP surprise came on Friday, the last trading day of
January. Investors were not interested in buying stocks in January. But
now that it’s February, the buyers are back.

It might seem
strange, but mutual funds and other institutional investors don’t base
their buy and sell decisions solely on making money. They have to play
the percentages. And that sometimes means taking profits when the
economic data supports better earnings and higher stock prices.

Is
that what took stocks lower in January? Maybe, although it’s a little
too soon to say the upside trend has been re-established. But
sometimes, when you hear hoof-beats, it’s best to think horses not
zebras.

The financial media has a
tendency to think zebras. The writers always want to find the reason
behind the selling. It’s China, maybe it is earnings, or is it economic
data? The list goes on. Of course, I’m not saying that these items
aren’t factors. But at the end of the day, it is institutional
investors that drive market direction. And like I said, they will take
profits sometimes, just because they can.

Earnings this Week

There’s no doubt that there are investors who believe that current
valuations for stocks and an improving economy offer money-making
opportunity. It’s also true that there are plenty of investors who feel
the exact opposite and are selling stock. And for the last three weeks,
the sellers have been winning.

The fact that stocks couldn’t
hold a 1% gain after a stellar 4Q GDP number on Friday is a little
worrisome. That was a lay-up for the bulls, and still, stocks finished
the day with losses.

Volume has been stronger on the down days
lately, and the S&P 500 is now well below its 50-day moving
average, a common measure of support. I expect we’ll see stocks bounce
before Dow 10,000 is breached to the downside.

But at the same
time, there’s nothing magical about Dow 10K. Just because it holds on
the first test or two doesn’t make it an important line in the sand.
The Dow is just 30 stocks. Far more important is the S&P 500. And
interestingly, there is an important support point at 1064 on the
S&P 500. And 1071 actually lines up with Dow 10,000 nicely.

Low Rates to Continue

I managed to catch part of Treasury Secretary Geithner’s
testimony yesterday. I actually thought he represented himself pretty
well. I can appreciate his stance that AIG really was to big to fail.
But that notion that the New York Fed had to make sure all of AIG’s
credit default swaps were paid still doesn’t make sense.

Geithner’s explanation was that if AIG did pay off debts like
the $25 billion that went to Goldman, AIG would get downgraded and it
would become more expensive to unwind the company. Maybe I’m wrong, and
I haven’t checked to be sure, but I’m pretty sure AIG’s debt was
downgraded. And do you even need a rating for a company that’s 80%
owned by the government?

Bottom line: I still think former Treasury Secretary Paulson
made sure Goldman Sachs got paid and it really stinks that tax payers
get taken advantage of like that. Unfortunately, it’s unlikely anything
will come of it.

*****The Fed reiterated its pledge to keep
interest rates low for an extended period. No surprise there, but
investors liked the news. Stocks finished the day with a nice rally.

Still, it’s not like the Fed is keeping the liquidity spigots
wide open. The Fed plans to end its mortgage-backed securities
purchases. With so many stimulative monetary policies in place, low
interest rates will probably be the last thing to get changed.

*****China
is also d oing its part to soothe investors. According to Bloomberg,
China’s banking regulator has told lenders to "….step up scrutiny of
property loans while pledging to satisfy "reasonable" financing
needs…"

Watch ‘Em Squirm

I plan to be unavailable for a few hours, starting around 10 a.m.
this morning. I want to hear the members of the New York Fed try and
defend their actions regarding the AIG (NYSE: AIG) bailouts in front of Congress.

The New York Tines published
some of the prepared testimony of the principal players. I try to keep
a level head, but I’m reaching for my pitchfork and torch right now.

*****Recall
that the New York Fed orchestrated what ultimately became an $85
billion bailout. A good portion of that cash was paid directly to other
companies with which AIG had entered into the now famous credit default
swaps. These were essentially insurance contracts on mortgage backed
securities held by banks and underwritten by AIG.

A full $25 billion in AIG bailout money went to pay off Goldman Sachs (NYSE: GS). Here’s a section from the New York Times (Mr. Baxter s the general counsel for the NY Fed):  

Mr.
Baxter explained that the New York Fed felt compelled to pay out
A.I.G.’s counterparties in full to unwind tens of billions of dollars
in derivative contracts because "there was little time, and substantial
execution risk and attendant harm of not getting the deal done by the
deadline of Nov. 10." That was the date when A.I.G. was scheduled to
report its earnings and could face downgrades from credit ratings
agencies. A downgrade would have led to more collateral calls and even
greater liquidity problems for A.I.G., Mr. Baxter said.

“Burn the Hands”

Yesterday, stocks recovered a little from last week’s sharp sell-off. A little time over the weekend to reflect on the true potential of the "Volcker Rule"

(the name given to the new banking regulations proposed by the President on Thursday) to become law probably helped. 

Stocks gained slightly even though December home sales dropped a worse than expected 16%. That’s a pretty bad surprise, but stocks shook it off. That suggests to me that last week’s sell off may have been a bit exaggerated.

As an aside, I’m not sure why there was concern that Fed Chief Bernanke wouldn’t be re-confirmed to his post. Sure, Geithner might be on the way out, but that’s no big deal. I see zero percent chance that Congress would let Bernanke go at this point. 

*****Fourth Quarter earnings have been good so far. I read that 70% of companies reporting have beaten expectations. But many of the surprises have been met with selling, like IBM (NYSE:IBM) and Google (Nasdaq:GOOG).  

Re-pricing Banks

It’s clear that investors are re-pricing stocks for the possibility that the proposed restrictions on banks’ trading practices will impact their profits in the future. The UltraShort Financials ETF (SKF) has rallied 11% in 2 days.

Yes, bank stocks are getting hit pretty hard. But Obama’s proposed restrictions aren’t yet law, and there’s plenty of reason to believe he won’t get everything he wants. More about that in a minute…

But first, I want to point out that this situation is how the "buy the rumor, sell the news" dynamic starts. Now, granted, this is a reverse example because investors are selling stock in anticipation of bad news rather than buying ahead of good news. Still it’s a good example of how investors are pricing in a worst case scenario now, before any proposals have become law.

I think we can expect to see bank stocks rally once the reality of ay proposed restrictions is finalized. But as we know, investors don’t like uncertainty.