The S&A Digest: What Happens Next?

Merrill Lynch downgrades peers... One lucky company... Dan takes it easy... Ian on market dips...

 Thank God, fate, or whatever you like for yesterday's market drop. I love big market drops for the same reason I love outright bear markets. They make stocks cheap enough to buy by the truckload.

 Merrill Lynch dropped the ratings of five major investment banks to "neutral," from "buy." Merrill stated that the risk-averse market would lead to lower profits for the banks. The victims of the cut were Goldman Sachs, Bear Stearns, Lehman Brothers, Credit Suisse, and Deutsche Bank.

Traders, take note: according to our own Jeff Clark, financial stocks like Merrill Lynch tend to lead market declines.

Over the long term, however, these guys are a little bit like Big Pharma. The rankings change, and consolidations happen, but the largest players remain in control of big chunks of the market for a good, long time. That's indicative of a business with an economic moat.

Merrill Lynch is a big daddy among these stocks and is, arguably, in possession of one of the widest moats in the sector. Still, it's a little irritating that it was the only one absent from its own downgrade list. What an enormous missed opportunity for Merrill to build credibility. Had the company downgraded itself, it would have been a huge story, garnering awe and attention. But now, it's only going to garner some more sniggering... just what the industry needs.

 From the New York Times:

China's stock market system is still relatively immature, and trustworthy information about a company's performance is still hard to come by. So the average investor does little or no research. "If I hear a stock mentioned on the TV news I will pay attention to it," says Xu Xiaochen, a 55-year-old retiree. [Hey, Cramer, you listening?] In any case, many investors here seem to believe that the secret to picking stocks is luck and confidence in the government, not the fundamentals of any particular company.

"I don't know how to choose a stock," says a 61-year-old retiree who gave her name as Miss Hou at a local brokerage house a few weeks ago. "But I trust those technology companies. Maybe the names of some companies sound lucky to me, so I choose to buy these stocks."

A lucky-sounding name... Hmmm... Maybe we should create a blank-check corporation called the Chinese Luck Dragon Technology Company and take it public on the Hang Seng.

 America Saves is a nonprofit organization that promotes saving, investing, and building wealth for U.S. citizens. February 25 through March 4 is officially America Saves Week. As if they knew yesterday was coming...

 Stansberry's one new high yesterday: Kodiak Oil (KOG).

 In the mailbag this week, I've received several requests to subscribe to the new S&A Penny Letter, written by yours truly. Funny so many should ask about it. The opportunity for non-Stansberry Alliance members to subscribe to the new letter will hit your inbox in a week or two. Send more flattery to: feedback@stansberryresearch.com.

 "What's happened to SMG since you said to grab this dividend?" – Paid-up subscriber "gcotter"

Goldsmith comment: We recommended it on February 20 at $57.01. It went ex-dividend on February 22. The company paid an $8 dividend, and it's currently trading around $44, for a return of -8% so far.

 "Shouldn't HMA be trading at $10 and change, since it went ex-dividend on February 23, or will that occur on the March 1 payment date?" – Paid-up subscriber Don Pettingill

Goldsmith comment: The ex-dividend date for HMA is March 2. Look for the share price to correct on that date.

 "Okay... Bernanke says the markets may soften and we could be in for a possible recession as early as this fall. I've noticed that several of my positions are selling off and/or may be oversold. I also feel that the U.S. and emerging markets have gone a long way very fast. Seems like at least a correction is in order." – Paid-up subscriber Diane James

Ferris comment: I'm not a macro guy at all, but yesterday looked like a correction to me... or the beginning of one.

 "Guys, I have no idea what your intentions are behind 'New Highs.' Here is your list for the day when Dow lost more than 400 points. Not a single gainer! Every one of them is down from 2-8% today!"

Goldsmith comment: We publish stocks that closed at a high the previous day.

 "With Regard to Dan Peer: Since I've joined the Alliance, I never get those annoying advertisements anymore. Maybe Mr. Peer should pony up the 6K and join the Alliance. It's really chump change when you consider how much money these guys are empowering us to make." – Paid-up subscriber Brian H.

Ferris comment: Brian, you raise a good point about the Stansberry & Associates Alliance. I often wonder if our Digest readers are aware that they can get all of our products for life for one surprisingly low upfront payment, plus a pittance of an annual maintenance fee. When I look around at our annual Stansberry & Associates Alliance meeting, I see Porter Stansberry, Steve Sjuggerud, Jeff Clark, and Rob Fannon, just to name a few of our editors. It's an impressive group I work with here. Plus, we always have a good guest speaker, someone like Mohnish Pabrai. And that's just one of the perks of being a Stansberry & Associates Alliance member. For full details on becoming a member, call Mike Cottet and his team at 888-863-9356.

 "I thought Al Gore's movie won the Oscar for The Best Science Fiction Film!" – Paid-up subscriber Pete Fischer

 "Ferris, easy, big fella! Relax and take a chill pill (make sure with Dr. Eifrig that it is not a generic, though!) Porter will be back soon enough. I, too, get a bit unnerved when I see readers talking about 'delivering' and 'calling off' the barrage of marketing e-mails. However, I have enough sense to see that for a minimal subscription price, I get some of the best research and investment advice on the planet (concepts, not just 'buy this') in exchange for having to use the Delete key more often. A very fair trade-off indeed." – Paid-up subscriber Jeff Persson

 "Dan, my man, don't let these whiners that are castigating you and Stansberry get under your skin. They think they have bought perfect insight into investing by signing up for the Alliance or other letters. The world is full of people looking for someone to blame for their problems. You just happened to get some of them as subscribers. They would feel much better if they joined the crowd that blames all of us for global warming, basking with them in the absolute surety of their view of the future. You, I, and others like us can continue to live in this world where we just hope to be better than 50% accurate in our choices for investment." – Paid-up subscriber Bob Holzel

 "Hey, yo, Ferris, You are the man. Porter can stay away... please don't leave for Nicaragua." – Paid-up subscriber Michael Force

Ferris comment: My wife needs to read this.

Regards,

Dan Ferris

What Happens Next?

How important is a one-day fall of 3% or more? Not very, according to the historical data. Since 1950, the S&P 500 has fallen by more than 3% 51 times. And on average, the market has overperformed in the following months.

One big dip might not mean much, but when large falls (of 3% or more) cluster together, it is often more significant. In the past, these falls have marked turning points in the market:

There were two 3% down days within three months of the S&P's peak in 2000.

 There were seven 3% down days within three months of the S&P's bottom in 2003.

However, isolated occurrences of 3% down days don't seem to have any relevance to the future direction of the market.

Conclusion:

A one-day, 3% fall doesn't mean the stock market is going to crash or that we are entering a recession.

Note:

There are some unique aspects to yesterday's situation, one being the extremely low level of perceived risk in the world going into yesterday's fall. Yesterday's fall will increase the level of perceived risk in the world, especially in emerging markets, which may see a significant revaluation in the coming months.

Good investing,

Ian Davis

February 28, 2007

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