The S&A Digest: Stocks tank everywhere

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Stocks tank everywhere... Fed puts thumb in levy... Mutual fund managers don't believe it's a recession yet... The Super Bowl indicator... "Why is MBIA still AAA?"... Porter short, Clark long, both right... Position yourself for a recession... 

 Yesterday, stocks around the world tanked hard. The FTSE in London was off 5.5%. Other major world indexes fell 4.5% or more. Today, U.S. stocks tanked hard, too. The Federal Reserve responded by hitting the panic button, cutting the federal-funds rate by 0.75%. The market seemed to like the Fed move. I don't understand why. A rate cut at this point is like throwing a coat of paint on an aging New Orleans levy during a hurricane.

 The Fed's latest rate cut reduces the federal-funds rate to 3.5%. This is the Fed's biggest move since it raised rates 0.75% in November 1994. That was right before a huge bull run from 1995-2000.

 The Fed's surprise move (ha!) was its largest cut since October 1984. That wasn't a bad time to be in U.S. stocks... but they'd been hated for a decade by then. Investors have been in love with stocks for about five years, since 2003. The two had a little tiff from 2000-2003. But before that, investors were head-over-heels in love with stocks from the early 1980s to 2000, almost 20 years. This relationship is due for a cooling period.

 If you're looking for signs of a bottom, be careful not to strain your eyes. Merrill Lynch polled 195 money managers with a total of $691 billion under management. Merrill says 19% of them believe a global recession is either likely or very likely over the next 12 months. That's up from 13% a month ago. Only 8% believe a recession has already begun, up from 4% a month ago. I would expect that 8% number to move high into double-digit territory before the pain is over.

 The CNBC talking heads whined in obnoxiously perfect harmony last week. Donald Trump, Jim Cramer, Larry Kudlow, Mark Skousen, Art Laffer, and others are all in agreement: The bear market and recession are the fault of Ben Bernanke. He's to blame for not cutting rates sooner, for not "taking charge." Bernanke is most famous for saying he'd drop money from helicopters if need be. The helicopters took to the skies this morning. The market seems to have been happy to see them.

Frankly, I can't imagine any rational adult thinking the federal government ought to be involved in the debt market or the banking system. Bank failures were relatively small events before the Fed was created on Jekyll Island, Georgia, by a bunch of rich bankers in 1913. A few dozen banks would fail every now and then, just like any other business. After the Fed was created, half the country's banks failed in a single great swoop during the Great Depression.

Could the Fed's intervention actually cause the cycles of boom and bust? Just asking...

 Maybe the market cares less about the Fed and more about who wins the Super Bowl. According to the Super Bowl Indicator, a win by an original NFL team means an up year for stocks, while a win by an old AFL franchise means a down year. It's happened that way in 33 out of the past 41 years. The New York Giants joined the NFL in 1925, long before the 1970 AFL merger.

 Bill Ackman sent a letter to Fitch Ratings today asking why his massive short position, bond insurer MBIA, is still AAA... "Does a company deserve your highest Triple A rating whose stock price has declined 90%, has cut its dividend, is scrambling to raise capital, completed a partial financing at 14% interest (now trading at a 20% yield one week later), has incurred losses massively in excess of its promised zero-loss expectations wiping out more than half of book value, with Berkshire Hathaway as a new competitor, having lost access to its only liquidity facility, and having concealed material information from the marketplace? Can this possibly make sense?"

Unfortunately, it makes the wrong kind of sense. Lots of people made money off this charade for a long time. It'll take a lot of pain before everyone involved comes clean.

 If you want to know what to do with your money in this miserable environment, look no further. Porter has lots of short targets lined up this year for his PSIA subscribers. His most recent short sell has made readers 24% in less than two weeks. To read more about PSIA, click here...

 Jeff Clark noticed Merrill Lynch last week, saying, "any time a company can announce a $15 billion loss and still see its stock run up 5%, that's a pretty good sign that a bottom is in place. It may not be the bottom. But it is a bottom for the time being." He used the same reasoning to take a long position in a homebuilder. Clark is up 60% on that trade while the rest of the market is getting slaughtered.

 As for me, I'm sticking with Wal-Mart. Wal-Mart released today that 7.3% of its workers report having no health insurance at all (that includes all sources, like government programs and spouse's coverage). That's down from 9.6% a year ago. A company spokesperson credited Wal-Mart's new health plan for the drop. The plan allows employees to customize their coverage, offers premiums as lows as $5 a month, and provides access to $4 drug prescriptions. Wal-Mart has taken flak for its employees' lack of health insurance, even though it offers several different plans, and insures more than a million people. When you offer health insurance for $5 a month, you're clearly going out of your way to lead the horse to water. Whether he drinks is his business. My latest on Wal-Mart is in the December issue of Extreme Value. Read about Extreme Value here...

 New highs: markets were closed yesterday...

 Lots of concerns in the mailbag about what to do with real money. Send your favorite method for handling risk to us at feedback@stansberryresearch.com.

 "Oh, the first week in January was a sad, sad time for me. I followed your advice and it broke my widdle heart. My SA hit its 25% trailing stop and I had to unload it because you said to never get emotional over a stock. Yep, it went down 25%. Of course, I made a 943% gain before it lost its 25% so I ONLY made a 700% gain. Woe is me. I cried myself to sleep. I loved SA, it was good to me, made me feel like a man as it grew and grew, but, alas, I followed my Trade Stop and not my heart. I have also had to trade stop out of several other stocks this month, but still made a gain over all following your advice. My advise... FOLLOW YOUR TRADE STOPS! Especially now with the market doing its upset stomach routine, making it hard to keep some stocks down. If you religiously follow your trade stop, you will gain overall, but don't get an emotional tie to any stock as they are like a fickle lover and will take you down." – Paid-up subscriber Fred Fleming

Ferris comment: Bravo for you, Fred. You took the bull by the horns and stuck to your discipline. If you don't know what you're going to do with a stock no matter what happens, you have to ask yourself if you had any business buying it in the first place.

 "I know about trends. Although we may be in a downward trend, isn't it wise to heed Buffet's words about being fearful when others are greedy and greedy when others are fearful? Isn't everybody as fearful as they've been in a pretty long time? My other question is this, what will a rebound in the dollar do for stocks?" – Paid-up subscriber J. Heath

Ferris comment: Yes, you should be greedy when others are fearful. But are you ready for them to become a lot more fearful than they are right now? Would you become even more greedy or would you capitulate, too? Investing isn't technically difficult at all. But it's emotionally impossible for the vast majority of humans. Try as you might, you cannot substitute another's discipline and fortitude for your own.

As far as a rebound in the dollar, I can only discuss the dollar's intrinsic value, which is whatever the paper itself is worth. I know what my most common use for paper is, and it's not very valuable after I'm done with it. Maybe it could be used as fertilizer, but I doubt that, too.

 "In the Jan 21 Digest, it was reported that Warren Buffett thinks it unfair that his secretary pays a lower rate of tax than he. If it is unfair, what prevents him from paying more? Would he prefer that the government coerce and extort the tax out of him and other wealthy persons? Some people are born blind. That is not fair. So should all seeing persons be required to get our optic nerves snipped for the sake of fairness? This seems to be the way of the left. Use the authority of the government to penalize some, thus bringing everyone down to a common disadvantage. That is fair isn't it?" – Paid-up subscriber Mark Z

Ferris comment: Your comments remind me of a remark made by a visitor to old Soviet Russia several decades ago. She said it was wonderful that everyone was "equally shabby."

Regards,

Dan Ferris

Medford, Oregon

January 22, 2008

How to Protect Your Money During a Recession

By Ian Davis

In the midst of the dot-com crash – from March 2000 to October 2002 – stocks of health care providers rallied 117% and shares of water, tobacco, and beer companies rallied by more than 75%.

You see, during a recession, not all sectors decline equally. In fact, some don't decline at all... So positioning yourself correctly can make the difference between losing 93% – which is how much Internet stocks fell during the last bear market –

and gaining 117%.

So with that in mind, let's compare the performance of various sectors throughout the dot-com crash to their performance so far this downturn, which started on October 9, 2007.

First, the winners: These are the sectors that posted positive returns during the dot-com crash... and are also in the black so far during this downturn.

Now, the losers: These are the sectors that significantly underperformed the market during the dot-com recession and are underperforming the market so far this downturn.

Neither Internet nor mortgage-financing companies are on the losers list. Although Internet stocks performed horribly during the dot-com crash, they aren't performing that poorly today (down 8.4% since October 9, 2007).

Similarly, although mortgage-financing companies are performing dreadfully today, they didn't perform badly during the dot-com crash (they actually rose by 16.8%).

Conclusion

In this study, I only looked for similarities between this downturn and the last in order to answer the following questions:

Which are the most defensive sectors? Which are the most cyclical or sensitive sectors?

And the answers seem to follow mainstream logic...

The best-performing sectors are those that produce items people will not forgo, regardless of how tight money gets – things like tobacco, (a smoker isn't going to quit just because his 401k is shrinking), health care, and soft drinks.

If you want to protect your money in the coming months, I recommend you look into these sectors.

On the other hand, the worst-performing sectors are those producing items people quickly abandon when money gets tight – areas like consumer electronics, consumer hardware, and mobile telecommunications.

These cyclical businesses tend to be hit hardest during a recession and should be avoided this year.

Good investing,

Ian Davis

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