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Friday, July 25, 2008

What's beating the market down?

A lot of things are coming together to cause the market to go down, recently.

One issue is lower earnings forecasts for the 3rd and 4th quarter. Companies reporting 2nd quarter earnings are saying things don't look that great for the rest of the year. This is knocking down stock prices. As investors optimistically begin to look forward to 2009 this fall, I expect the stock market to rally.

Another issue is uncertainty over upcoming elections. Markets hate uncertainty, and until it becomes clear who will win upcoming elections (both Presidential and Congressional) and what those elected will do, the market will do poorly. As that uncertainty clears up this fall, I expect the stock market to recover.

A third issue is the housing market. Housing inventories are very high, home sales volumes are low, and home prices continue to decline. Not only is housing an important part of our economy, it's also a major part of most consumers' wealth. Depressed consumers spend less, and that is reducing stock prices. When the housing market shows concrete signs of recovering, and I have no idea when that will happen (although I'm guessing late this year or early next), I expect the stock market to resume its climb.

A fourth issue, strongly related to the third, is the financial services sector. Banks are seeing their loans to consumers and businesses sour. At the same time, consumers and businesses need the money they put with banks as deposits to cover their needs as the economy slows. This perfect storm is hurting banks in a major way. After the housing market, and thus consumers and businesses, begin to recover, so will the banks.

A fifth issue is energy prices. Although energy prices have pulled back, no one is certain whether they will continue down or climb again. My guess is that high energy prices have both brought more supply online and reduced demand, so I expect energy prices to continue to decline in the short run. If such a decline becomes more clear, I think the market will rebound.

The way I see it, there are both short and long term issues at hand.

One short term issue is the market's transition from looking at 3rd and 4th quarter earnings to looking forward to 2009 earnings. Another short term issue is election season. Those two issues are relatively easy to predict and should tend to lift market prices some time this fall.

Two long term issues are the housing market and financial services sectors. I don't know when these two will recover, but when they do it will be a major and longer term lift to market prices.

Energy is both a short and long term issue. In the short run, I believe energy prices will come down and tend to support the economy and market prices, especially this fall. In the long run, I don't believe it will be easy to find supply to keep up with growing demand, and higher energy prices will tend to undercut the economy and market prices. This dynamic is very difficult to predict.

I expect market prices to continue to decline into early fall, as investors focus on current economic conditions and election uncertainty. Such a decline will be tempered by declining energy prices and accelerated by rising energy prices.

In the longer run, the market will not begin a long term climb until the conditions in the housing market and financial sector improve. I can't predict when this will happen, but it may happen this fall or some time next year.

In the much longer term, as the economy recovers and demand picks up, so will energy prices. This will dampen the market's rally to some degree.

Although I don't use market predictions to time the market, I believe an understanding of market dynamics are useful for investors who are trying to understand what is happening and when it will improve.

The best time to buy is when things look terrible, and the best time to sell is when things look great. Whether the market rallies this fall, next year, or 3 years from now, I believe this is a great time to invest.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, July 18, 2008

Is the banking crisis over?

For those of you who want to see my latest quarterly client letter, it's here.

Banks stocks took a beating over the last several weeks, and it created some wonderful opportunities to buy top-notch banks at rock bottom prices.

Not only was I a buyer, but an eager buyer of certain companies. But, not all banks are equally good, and just because I'm buying specific companies at specific prices is not a statement that banks stocks have hit bottom.

I don't try to pick bottoms because I don't know that anyone can. It's like forecasting the weather, you can get in the ballpark with some guesses, but you never really know exactly what's going to happen.

If you don't believe me, look at the annual hurricane forecasts over the last several years. They are pretty far off on an annual basis, but pretty accurate over 5 year time frames. Sounds like the stock market in many ways....

Back to bank stocks. I don't know if crowd psychology has signaled capitulation in bank stocks in general. I don't believe so. I think poorly run banks will be announcing significantly worse results as the impacts of a slower economy ripple up into more loan defaults and delinquencies.

I'm buying now because good banks hit very good prices, not because I know when bank stocks will bottom. In fact, I may very well have opportunities to buy the companies I just bought at even lower prices.

As the stock market continues to recognize that the 3rd and 4th quarter won't be so peachy, I'd expect it to roll over further. It also wouldn't surprise me that what we're currently seeing is short covering and mere reactions to short term noise.

When will the market and banks stocks really bottom? I don't know, but my guess is that people will be talking less about buying bargains at that point, and more about running for the hills.

As Rothschild said, "Buy when there's blood in the streets."

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, July 11, 2008

Wal-Mart is dead, long live Wal-Mart

Full disclosure: my clients and I own shares of Wal-Mart.

Back on October 3rd, 2007, I posted a blog criticizing a Wall Street Journal article that claimed "Wal-Mart Era Wanes Amid Big Shifts in Retail; Rivals Find Strategies to Defeat Low Prices; World Has Changed."

More specifically, I claimed the author of the article had picked the bottom for Wal-Mart's stock.

On October 3rd, the stock closed at $45.13 per share. The most recent low for Wal-Mart had been $42.27 posted on September 10th, 2007.

Today, the shares trade at around $56 and have been as high at $59.80. At $56 a share, that's a 24% gain in value, not including dividends.

On October 3rd, 2007, the S&P 500 closed at $1,539.59. Today, the S&P 500 is around $1,235. That's a 19.8% loss (once again, without dividends).

In other words, the performance difference between Wal-Mart and the S&P 500 from October 3rd, 2007 until now was a whopping 43.8%!!!

Now, why am I bringing this up? Just to toot my own horn and brag how smart or lucky I got? No (okay, maybe a little).

My reason for bringing this up is the same reason I made the post on 10/3/2007, to highlight how far astray you can be lead by following the popular press for investment advice.

By the time the Wall Street Journal, or any other popular periodical, comes out with news about a company, it's almost always figured into the price and then some.

In fact, the time to buy a company is when the popular press is saying it's dead. The time to sell is when they are singing its praises.

As I said on 10/3/2007, "I'll bet that in a few years I'll be writing a blog saying that I've sold Wal-Mart because the popular press is reporting that Wal-Mart is back at the top of its game again."

Perhaps that time will come sooner than I think...

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Thursday, July 03, 2008

Book recommendation: The Little Book That Builds Wealth

I have a book recommendation to make: The Little Book That Builds Wealth by Pat Dorsey.

Dorsey has helped Morningstar (known for their mutual fund research) develop their individual stock research team over the last several years.

This book is not a quick and easy guide to investing, but a book focused on one of the most important aspects of investing: understanding a company's sustainable competitive advantages.

You see, long term investment research is best done when it focuses on 3 areas: business economics, management and valuation.

This book analyzes a sub-component of business economics, competitive advantage.

Warren Buffett once said that the best businesses are like a castle with a big moat around it. The moat is a company's sustainable competitive advantages. And, that is what Dorsey writes about in the book.

This is probably one of the most if not the most important thing to look at and understand about a business, but it's frequently overlooked because it's not strictly quantifiable. You can't go look up Intel's sustainable competitive advantages on Yahoo! Finance and come back with the answer: 3.

Competitive advantages are not quantifiable, but they are vitally important.

The book is well written and an easy read. He give a lot of good examples and the writing style is relaxed and humorous.

The book makes clear what gives a company a large moat and allows them to keep it. He highlights what are not moats, like management (although I don't entirely agree with him on that point), and how to tell when moats are sustainable.

Dorsey does a great job of spelling out what provides moats, like intangible assets (think patents like pharmaceuticals), switching costs (think software like Oracle), the network effect (think eBay), cost advantages (think Dell), and size advantage (think Wal-Mart).

Dorsey provides a very readable guide of what to look for and why.

Although this is a framework I've been using for years to look at companies, I must admit that Dorsey provided excellent food for thought that will keep my noodle spinning as I look at companies in the future.

A worthwhile read for the layman to the expert, in my opinion.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.