10/08/08   Stocks Enter Death Spiral

Editor’s Corner

Stocks Enter Death Spiral

Ron Rowland

In these fast-moving markets, it is easy to forget what happened even in the past week or so. Consider the Paulson bank rescue plan. Having been told by the Treasury Secretary and Fed chairman that the economy was near meltdown, the House narrowly voted down the plan on Monday, September 29th. They were kind enough to hold their vote during market hours and stocks immediately plunged. Two days later the Senate approved an amended plan, and the stock market held steady.

On Friday, October 3rd, a chastened House approved the revised plan and the president immediately signed it into law. The markets were pleased, right? Wrong. A vicious sell-off ensued and continued into Monday and Tuesday. The Dow broke below 10,000, and the S&P 500 fell below 1,000. Credit markets remain frozen despite a promise that the Fed would begin buying commercial paper. A coordinated global interest rate cut restored some semblance of calm today, but this deeply oversold market was due for a short-term bounce in any case. By the closing bell, today’s rally had turned into another loss.

Why, after throwing a temper tantrum when it seemed the Paulson plan would be defeated, did stocks greet its approval with a Bronx cheer? It is possible that other factors were at work. Investors who wish to panic can choose from a wide variety of plausible reasons these days. Housing prices seem to be far from a bottom; already 1 in 6 U.S. homeowners have negative equity — and 1 in 10 are either in foreclosure or delinquent in payments, according to a new report from Moody’s. Not coincidentally, consumer spending is falling like a rock and unemployment is rising quickly. A severe global recession seems inevitable at this point. Yes, it is darkest before the dawn — but no one knows if the time now is midnight or 5:00 AM.

As noted above, sentiment and volatility indicators reached unsustainable heights in the last week, which in normal times would mean a rally of some kind is probably not too far away. These are not normal times. Yes, phrases like “This time it’s different” come into fashion at both bullish and bearish extremes. A look at the fundamentals tells us that the long-term problems will not be going away anytime soon, but even the worst bear markets have occasional rallies that can last days, weeks, or even months. Today’s action was slightly encouraging. We need to see more.

Treasury yields have fallen sharply over the last week. The 10-Year Note ended September at 3.827%, and it traded as low as 3.400% this morning before moving back up to close at 3.715% today. A worldwide flight to quality — if that word can still be applied to the U.S. government — is driving the Treasury market. Meanwhile, all kinds of non-sovereign debt remains in limbo. Prices are being quoted but are often meaningless. Municipal bonds may be the next to turn sour as state and local governments find tax revenue dropping fast in a weak economy.

The one bit of good news in all this is that energy prices are dropping fast. Crude oil dipped below $90 and appears to be trending lower still. This will soon make its way into gasoline prices, and residents of the Northeastern U.S. may find heating oil prices a little less outrageous than expected this winter. This may be small consolation, but it is a start.

Sectors

Not surprisingly, intermediate-term relative strength declined across the board in our sector rankings. Energy replaced Telecom in the bottom three while Consumer Staples, Health Care, and Financials remain the least-weak sectors, though Financials seem unlikely to hang onto that position for long. The RSM value of -188 for Materials is, as far as we can tell, the lowest momentum score ever posted by a GICS primary sector index. The prior record of -186 was set by Technology in April 2001. Tech racked up a 37% gain in the next ten market days, so now is probably not a good time to short Materials. These extreme values simply cannot be sustained for long — which is another reason to expect a short-term upside correction soon. However, the RSM values will rise even if the sectors simply go sideways for a few weeks.

Styles

The Small Cap style categories slipped down the rankings this week, and Mega Cap now sits on top of the chart. As with sectors, every style category lost momentum since our last report. At -140, Mid Growth has now matched its 2001 negative momentum extreme. Last week’s highest ranked style was Small Value with a -12 RSM value. This week it plunged to -80.

International

The already-ugly International picture became even more so since last week, but on a relative basis the changes were minor. Emerging Markets, China and Latin America are still in their death spiral. World Equity, Japan, and the U.S. are falling somewhat less vertically but are by no means showing any sign of stability. Canada slid down the chart a bit, perhaps as a result of falling energy prices.


Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“After two years in Washington, I often long for the realism and sincerity of Hollywood.”

Fred Thompson (b 1942)
Actor, Former U.S. Senator, & One-time Presidential Candidate


Pick-of-the-Week

When Tobacco is a Good Thing: MO

Brandon Clay

Pick of the Week: MO

Investing can be a complicated affair. You’ve probably become painfully aware of volatility issues in the market. But there are other factors to consider too. You’re not simply buying a company believing it will rise over time. Sometimes you’re buying an idea you believe in. For instance, you may like alternative energy for reasons that transcend profit margins. Your philosophy can direct your investing.

Market commentators have termed this type of investing ‘socially responsible’. Not surprising, groups do not agree what companies should be deemed socially responsible. Most suggest gambling, alcohol, and weapons companies should be excluded from this label, while others disagree. Investor consensus is lacking in this area.

So why do we bring up socially responsible investing in our Pick of the Week? Because this week, we are recommending Altria Group (MO). Altria is the parent company of Philip Morris, an American tobacco company and also a partial owner of SABMiller, one of the world’s largest beer brewers. We think there are reasons to consider owning Altria Group. If it lines up with your investing philosophy, then read on.

Reason #1 to Own Altria:
It’s an Evergreen Company

Altria grows and sells tobacco products across the globe. Like it or not, tobacco buyers are some of the best repeat buyers. If someone smokes, they’ll do almost anything to get their next pack of cigarettes. Tobacco users could be unemployed or unable to make rent, but they’ll usually find money for their tobacco. Moreover, as they expand in the third world, their profits should grow while legal risks would be minimal. With 15 billion cigarettes sold every day to repeat customers, Altria runs an almost-recession proof business. This is good news for stockholders.

Reason #2 to Own Altria:
It’s in a Buying Mood

In this market, you want to own strong companies, not distressed ones. The fact that Altria is buying UST for $10.3 billion demonstrates their confidence in their long-term success. Dow Jones Newswires reported lenders slowing this acquisition because of credit issues, but the deal should still go through. Regardless of when it happens, Altria stands a better chance at consolidating their position in their market, especially in the smokeless arena.

Reason #3 to Own Altria:
Looks like a Strong Company in a Weak Market

Some companies appear weak because of older management or technology. Altria does not appear to suffer from this problem. As mentioned before, they’re looking forward with their latest acquisition. Secondly, they’re showing an interest in effective management by spinning off Philip Morris International in March. Finally, Barclays expects solid gains for Altria in the 3rd quarter because of currency adjustments, market share, and pricing. In addition, Altria is paying out a 6.6% dividend – a huge benefit to investors. In short, Altria looks like a strong company in a weak market.

Every business has its risks. In Altria’s case, there are legal risks with this pick. Altria is always open to more litigation because of their business. However, we think most of that risk is priced in. The fundamentals are driving our pick. Consumer staples, especially consumer ‘vices’, are a compelling option in this volatile market. If all else fails, people will still go to Wal-Mart and buy their Marlboros. For a politically-incorrect pick in a fluctuating market, go with Altria Group (MO).

All the best.


Note:

Keep in mind, the Pick of the Week is usually intended for aggressive investors. Don’t risk money you can’t afford to lose. You will need to decide when (and if) it is time to sell.


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