The S&A Digest: Two Reasons for a Year-End Rally"

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Two Reasons for a Year-End Rally... Poor Dickie Scruggs... Selling gold... When will Citigroup bottom?... Smart buybacks?... The national debt is back... Let down by the "sole" leader...

A federal grand jury has indicted Dickie Scruggs for trying to bribe a state court judge with $40,000. We are shocked, shocked by... how little money he was offering. Surely the lawyer who delivered the $200 billion tobacco lawsuit, earning $1.4 billion for his firm and hundreds of billions for the states, wouldn't be so crass as to try and bribe a state official directly? My favorite quote from the case, so far, comes from the wife of an attorney friendly with Scruggs. "We were in the Holy Land seeking edification and returned home to this mess." Yes, they're just innocent pilgrims...

What to do in the midst of a worldwide credit crunch and banking crisis? The European Central Bank sold 42 tons of gold on Friday. As my friend Doug Casey says, if the U.S. dollar is a worthless IOU, then the euro is an "I Owe You Nothing."

How low will Citigroup fall? The stock got below $10 during the last big real estate blow up (1990-1991). And the company is scrambling to raise more capital, selling shares to sheikhs (again), and selling its office buildings. (It sold two Manhattan office buildings for $1.6 billion.) It will probably need to raise even more money. Six of the bank's seven SIVs (with $65 billion in assets) are facing downgrades from Moody's. So... what's your buy price on Citigroup? When will the stock hit bottom? When will you be a buyer? Let us know. If you get it right... we'll come to you for more advice in the future. (What a prize, I know...)

The New York Times reports only 85% of companies are holding holiday parties this year, down 9% from last year. That's the lowest number since the 1991 recession.

We've seen over the years that most management teams are no better than bad investors when it comes to timing the repurchase of stock or making other capital allocation decisions. And some management teams deliberately buy at the wrong time. CEOs will buy back shares in order to meet earnings per share numbers or to "sop up" newly minted stock sold via employee options. Thus we weren't surprised when a Barron's study showed only 25% of management teams that regularly repurchase shares outperform the S&P 500.

On the other hand, a handful of managers do an unbelievably good job at buying back shares at exactly the right time. For example, famous hedge-fund manager Leon Cooperman has singled out former Teledyne CEO Henry Singleton as one of the best. Between 1972-1984, Singleton repurchased 90% of Teledyne's outstanding stock – but he would only buy back shares when they were severely undervalued. When Teledyne's stock was expensive, he would use it to make acquisitions. Although Singleton never received more than $1 million per year in total compensation, he became a billionaire by investing in his own company (and thanks to his remarkably adept buybacks). Cooperman also mentioned three companies that currently do a great job of repurchasing stock: Transocean (RIG), Schlumberger (SLB), and Loews (LTR)... all of which are S&A Oil Report picks.

Our national debt, now totaling $9.13 trillion, is growing $1.4 billion a day – $1 million a minute.

This from Richard Maybury: "Politicians acquire power by promising to defend us against threats. Any threat will do – communism, unemployment, global warming, global cooling, global freeze drying. Most of politics is about the cultivation of threats. A healthy government is one with a big inventory of threats, and a threat shortage is a disaster to be avoided at all costs."

New highs: McDonald's (MCD), Berkshire Hathaway (BRK-A), Advisory Board (ABCO).

In the mailbag... Put on a huge conference for your best subscribers. Allow them to come for free. Pay for all of your best analysts to be there. Buy everyone breakfast, lunch, dinner, and cocktails. Invite several hard-to-get speakers – like the CEO of Seabridge. Give away a handful of investment recommendations you haven't published anywhere else... And what do you get? Complaints... Send yours to: feedback@stansberryresearch.com.

"Kudos to Kristen for putting together a well run meeting in Mexico... The only part that was missing in the whole conference was a professional ending by the sole leader Porter who failed to deliver a final thank you and goodbye to the attendees. It would have been appropriate after all the work and attention to detail by the staff and crew that a sincere thank you from the boss would have made an impression that would have instilled a sense of thankfulness. Follow through and follow up is key to success in small business. Best to all in 2008." – Paid-up subscriber Robert L. Hill

Porter comment: Robert, I don't know how you missed it... After dinner I got up from my table, clanged my glass, and addressed the entire group. I told everyone how sincerely grateful I am for their support and how much I appreciated everyone traveling so far to be with us. I also said that as much as I appreciate our customers, I appreciate my assistant, Kristen Kossuth even more. Without Kristen, there would be no conference... and there would probably be no "sole leader" either.

"You asked: Does anyone know [about the total amount of adjustable rate mortgages due to reset]? Yes I do, and so does anyone who reads John Mauldin. Go to www.2000wave.com go to archives, go to the August 3 article. About half way through there is a table showing by month the mortgage resets through next year. March next year is $110 billion resets." – Paid-up subscriber Jeff Hill

"I have contacted the various companies mentioned in True Wealth & other newsletters about purchasing gold coins. However, as a Canadian I am running into challenges as these companies only ship within the US. I would like to find a reputable dealer to work with in Canada. Is there one (or more) that Stansberry could recommend?" – Paid-up subscriber Cam Tan

Porter comment: Let's see whom your fellow Canadians recommend.

"Like some other readers, I have lost a huge sum on Dan's recommendations. However, I'm not mad yet. When I bought them, I expected to hold these stocks for many years, and it's only been a few months. As Dan explained earlier this year, we would not get good returns in the long run if we did not have occasional bouts of lunacy in the market to scare away large numbers of investors. Were they not scared away, prices would rise to the stratosphere, shrinking our returns. All my other small-cap stocks have been destroyed, too, so it's not as though Dan is messing up. It's just that all small caps are getting clobbered right now. Please don't change a thing! Tell Dan to keep 'em coming. His picks are usually brilliant. I'll keep buying. When the upturn comes, we will all make out like bandits. Maybe that will be three years from now, but that's fine. Let the whiners with short time horizons leave, and the actual INVESTORS who remain will do better for their absence. People who think they'll just automatically make great returns in nine months by buying a small value stock are not being realistic. If they are new to the market, they need to learn this. If they have been in the market a long time and still not learned, then maybe they should be buying Treasury bonds. (Or going to Las Vegas, as the case may be.) Still a big Ferris fan." – Paid-up subscriber Muir Matteson

Regards,

Porter Stansberry

Baltimore, Maryland

December 04, 2007

Two Reasons for a Year-End Rally

Ian Davis

It's been a tough market to trade in...

Daily volatility has increased to frightening levels. In just the last month and a half, the S&P 500 was crushed four times... falling by more than 2% a day in each case.

If you're like most investors, you're probably sweating out your portfolio. But don't panic. If anything, now is a great time to buy a good stock or two, as the market seems to be forming a short-term bottom.

Let's look at two indicators calling for a market rally.

The 'Smart Money' Is Long

Jason Goepfert, over at sentimentrader.com, is nice enough to let me reproduce his indicators from time to time. Sentimentrader.com is a fantastic resource for tracking stock market sentiment. Anyone who is serious about following investor sentiment should subscribe.

As Jason explains on his site, the Smart Money Confidence Index shows what the "good" market timers – investors who are consistenly correct in anticipating the market – are doing with their money. Conversely, the Dumb Money Confidence Index tracks what the "bad" market timers – the folks who guess wrong – are doing.

Jason doesn't divulge exactly which investors comprise the dumb money index or the smart money index... probably to preserve his proprietary indicator. However, he does say the indexes use only real-money gauges – not opinions – and I very strongly suspect he's looking at institutional traders versus small position traders.

The smart money and dumb money indicators give readings between 0% and 100%. The higher the reading, the more confident that group of investors is in a market rally.

Right now, the smart money is 71% confident that the market is headed for a rally. The dumb money, on the other hand, is only 39% confident. Usually these indexes are between 40% and 60%, so any reading outside of this range is worth noting.

Rallies Occur When the "Smart" Money Is Long & "Dumb" Money Is Short

Previously, when the smart money-to-dumb money ratio reached these levels, the S&P 500 has returned an average of 4.2% over the following one month (84% positive returns) and an average of 9.2% over the following three months (86% positive returns).

Investors Are Panicking

The second indicator signaling a market bottom is the investor panic indicator. This indicator signals when investors are in a state of irrational panic. Since these situations are almost never as bad as people think, a short-term rebound is often just around the corner.

Three factors determine the indicator's level: the S&P 500 trading volume, the percent change in the S&P 500, and the percent of stocks advancing on the NYSE.

If the S&P 500 trading volume spikes by 30% or more over the previous 30 days, the S&P declines by at least 25%, and the percent of stocks advancing on the NYSE is 15% or less, then the indicator gives a reading of "three"... indicating extreme panic – a big, broad decline on massive volume.

As the following chart shows, investors panicked after the selloff on August 9 of this year. In the following month, the market rallied by 1.7%.

Not that impressive. However, if you had gotten ready to buy, and bought the first day the market had an up day, you'd have bought the day after the low on August 16.

Here are the numbers on the panic indicator...

Short-Term Corrections Follow Panicking Investors

Previously, when the panic indicator reached these levels, the S&P 500 has returned an average of 3.3% over the following month (69% positive returns) and an average of 8.1% over the following three months (94% positive returns). If you had waited for the market to confirm the bottom (by having an up day, as we did at the end of last week), the returns would have been even more impressive.

Good investing,

Ian Davis

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