If the economy is limping along okay, then why are FedEx and UPS down so much?

It's always interesting to watch reports about the broader economy and compare them to what's happening to large corporations, like FedEx and UPS, that may more clearly indicate what's really going on in the U.S. economy.

This week, people claiming unemployment insurance declined. Also, leading economic indicators were up for the second month in a row. Perhaps things aren't so bad?

But, at the same time, FedEx reported its first quarterly loss in 11 years and reduced expectations going forward.

The stock of FedEx is down over 20% during the last year. UPS is down around 10%.

How can the economy seem to be motoring along when companies like UPS and FedEx seem to be doing poorly?

When given the choice between economic statistics (that get revised over and over again, and are heavily dependent on many shaky assumptions) and the performance of large corporations, I'll take the performance of large corporations any day.

I think UPS and FedEx are indicating what's happening in the economy better than broad economic statistics, and it isn't pretty. Growth is slowing or declining, and you can see it in the volume and profits of the shippers.

In time, economic statistics will reflect this. In the meantime, I'm watching the major companies and what they're saying is happening instead of focusing on the economists.

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.

It's a great time to invest!

As pessimistic as many of my blogs sound about the stock market as a whole, I must admit I'm very bullish about the specific investments I'm making today.

You see, the market as a whole can be over-valued, or in for a rough ride, and yet you can find specific, long term investments that are very enticing.

I'm finding the best investment opportunities I've seen since the 2002-2003 market trough (when we were coming out of the 2001 recession).

Not only are the investments I'm finding likely to provide excellent returns, they are also higher quality companies than I usually get the opportunity to invest in.

Usually, large, high quality companies are priced at a premium to the market. Today, though, many great businesses are selling at prices that are at distinct discounts to the market and to my assessed business values.

I can't remember a time in the last 12 years where I've been able to buy such premium companies at such low prices!

I don't know when the market will turn, or when my specific investments may out-perform, but I do know I've spent a lot of time assessing their value and I'm very confident that high returns are quite likely over the next 3 to 5 years.

Now, I just need to be patient and wait for the seeds I've planted to sprout and grow. This is a high quality "problem" to have.

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.

What's next for the banking sector?

What's made the stock market so jittery lately? Was it oil prices or commodity run-ups? I don't think so. I think what's bugging investors is: will something bad happen in the banking sector?

So far, the banking sector has suffered from defaults on higher risk mortgage investments. Some of these were subprime, some were Alt A (a step up from subprime, but not prime), and some have been home equity loans. All were bad loans and bad investments to begin with.

Because many market participants were buying mortgage investments with other people's money (read: borrowed money), this part of the market really suffered when it became clear that almost no one knew what the mortgage investments they bought were worth.

But, so far, the banking sector hasn't really suffered from major defaults on business loans, credit card loans, auto loans, prime mortgages, etc. In other words, the banking problems that started in March of 2007 have almost entirely been an investment phenomenon, not a broader bank lending problem, per se.

The question now is: could that change? Could the problems seen so far be the tip of a broader loan default problem? Could the economy be rolling over into recession and signaling that loan defaults will increase across the board?

If the answers to these questions are yes, the the problems in the banking sector, and the rest of the economy for that matter, may only be getting started.

Can the Federal Reserve fix these problems? Many people believe they can, but some strong dissenting opinions, even from within the Fed, are starting to question the validity of this premise.

The Fed may control interest rates and be able to bail out banks, but not without cost. The cost, in most cases, is higher inflation. With soaring energy and food prices, this will not be welcome news.

The other problem is that Fed actions are creating moral hazard. When you bail out stupid risk takers, they learn a bad lesson: they either make a ton of money making risky bets or they get bailed out. "Heads I win, tails you lose." This may be leading to even more bad lending and highly levered investing.

What's next for the banking sector?

It all depends on fundamentals at this point. Either banks have made good loans and have enough reserves to weather tougher times, or they don't.

If they don't, then expect the banking sector to hit new lows as more and more news comes out that broader loans--like credit card, auto, business, commercial real estate, prime mortgages--are hitting higher default levels.

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.

Picking natural resource investments

It's hard to avoid headlines about the price of natural resources.

Oil has been hitting new highs almost every day this week. Iron ore and coking coal have become hot investments because they're major inputs for steel production. Even stodgy agriculture is seizing the headlines.

So, how should one go about picking a natural resource investment to benefit from the boom?

First, it's probably too late to join the party because prices reflect a lot of the boom already. There may be some bargains to be had, though, if the global economy continues to slow down.

What should one look for in a natural resource investment?

The first thing I like to find is low costs. Low cost producers, especially in commodity products, have a huge competitive advantage. The companies with the lowest costs to extract oil, gold and iron ore, or produce wheat, soybeans and corn will exhibit higher profit margins and returns on capital.

Scale may be one reason for such an advantage. Another may be a proprietary production process or unique access to geologic locations. Yet another may be a management team that can motivate and hire more productive employees. One of the most important advantages is a management team that knows how to allocate capital to the best returning projects.

The second thing to consider is the sustainability of such costs. Some advantages are easily competed away as soon as others recognize them. To benefit from a specific cost structure, it must be sustainable over time.

One example is oil sands. Oil sands have much higher costs of production than other oil extraction projects. But, they have reserve lives of 50 years versus reserve lives of 10 to 15 for most large, integrated oil companies. (full disclosure: my clients and I own a position in an oil sands company)

Low costs and the sustainability of a cost structure are very important in looking for natural resource investments. Does that mean you should find the company with the lowest, most sustainable cost structure and purchase it? Emphatically: NO!

It depends on the price you pay for that company. The math behind investing is simple, but not easy to implement. To find the best investment, you have to compare the economics of a business to the price you pay for it. Frequently, this means buying a second tier company whose price doesn't currently reflect its cost structure and sustainability. The best company in an industry rarely goes on sale for a rock bottom price.

Picking a natural resource investment requires a focus on the economics of a business and its sustainability, its management, and its price relative to economics and management. If that sounds like a generalization for picking any investment, that's because it is.

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.

Food prices run amuck!

There's been a lot of interest in food prices spiking, and there are many opinions on why food prices are running.

The most popular "cause" is, of course, speculation by hedge fund managers, futures traders, etc. Although this may be causing some of the short term spikes we are seeing, I don't believe it's the real, underlying cause.

In my opinion, there are significant, fundamental, underlying trends that are causing food prices to run up.

The first, and one I've written about before, is underlying inflation. When the central banks of the world print money to fight various economic problems, the result is almost always inflation.

Another major cause is government policy encouraging (read: subsidizing) bio-fuels production. When almost 20% of U.S. corn production goes to produce fuel instead of food, then food supply decreases and prices will rise (all things equal)--welcome to Economics 101.

Demand itself--especially from the rapidly growing developing economies in Asia, Latin America, the Middle East, etc.--is indeed a major factor in food price increases. We in the developed world cannot expect those in the developing world to continue living on the same amount and type of food they've been living on forever. This trend isn't going away any time soon.

Another less talked about reason is water. Yes, water. Water for growing crops is not as easy to come by in many parts of the world. Saudi Arabia is a great example of a country that must spend tremendous amounts of resources to produce water that can be used for growing food.

A bad crop in Australia is also to blame. Bad crops are not that unusual, though. In fact, they are quite predictable (that they will happen, not when). This only exacerbates the problem. It's not a primary cause.

So, food prices are going up and there are underlying, fundamental causes that probably won't make this issue go away quickly. So what?

If the global economy slows down, as it looks to be doing, then look for food prices to fall back a bit. But, as long as the underlying causes mentioned above persist--central bank money printing, bio-fuel subsidies, demand from developing countries, difficulties in producing usable water--food prices will probably remain higher than in the last 20 years.

Higher food prices matter because they have led to many wars throughout history. This isn't a prediction, merely an observation that when things get bad enough--people don't have enough food to eat--they can become angry enough to go to war.

Food prices don't seem like that big of a deal in the developed world like the U.S., western Europe and Japan, because food makes up only a small portion (10-15%) of the developed world's family budgets. In the developing world, though, food is a huge portion (80%). If 80% of our costs doubled or tripled, as food prices have in some parts of the world, you'd even see Americans ready and willing to go to war.

What's a poor investor to do? Prepare for this possibility. The forces of capitalism will tend to drive prices of commodities down over time. When these forces are interrupted, as described above, you get price spikes, shortages, surpluses, etc.

The backlash caused by food price spikes will, eventually, lead to the removal of the barriers to capitalism. Until these barriers are removed, expect food prices to remain high and perhaps even continue to climb.

As an investor, you can protect yourself by investing in areas with pricing power. Businesses with pricing power can do okay during difficult periods periods, and, if/when food prices decline, they will thrive. Win win.

Trying to bet on commodity price swings is risky business, and I wouldn't recommend it. If you don't know who the patsy is, then it's you.

Instead, look to quality businesses that can raise their prices without crushing the demand for their products. Such companies will always do well over the long term.

Another idea is to invest in areas of the food market that haven't yet benefited from price run-ups. First it was energy, then base metals, now food crops. As inflation works its way through the system each player along the way goes from being hurt to being benefited.

For instance, pork, chicken and beef producers have been hammered by higher input costs--corn, soybeans, wheat--but the price for their end products haven't climbed, yet. They are facing the perfect storm of higher costs and lower product prices! Perhaps this will change as marginal producers go bust and large producers trim back production until it's profitable again. It's Economics 101 again!!! (full disclosure: I and my clients are invested in a large pork producer).

Don't let higher food prices get you down. Invest wisely and you can benefit!

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.

The returns you get on your money matter...A LOT!!!

Although I understand clearly the argument for low cost index funds, especially for more risk averse people, I want to briefly make the argument for going after above average returns.

Why? Because it can have a HUGE impact on your quality of life. Getting above average returns can greatly improve your safety and security both before and during retirement.

Let me give you some a examples to clearly illustrate my point.

Suppose Bob starts saving at 30, retires at 65 and dies at 95. Also, suppose he saves $100 a month from the time he's 30 until he reaches 65. Finally, suppose he gets 7% returns from age 30 to 95. How much will Bob have to live on? Around $13,400 a year from the time he's 65 until he dies at 95.

Now, suppose Fred does the exact same thing as Bob, except he gets 8% returns from 30 to 95--only 1% better than Bob! Fred will have around $18,400 a year to live on from the time he's 65 until he dies at 95. That's 37% more a year to live on!

Using slightly different savings inputs, that's the difference between having $50,000 a year in retirement versus having $68,500 a year! That's HUGE!!!

You can plug any numbers you want to in the scenario above, and you'll get the same general answer. Getting better returns--even mere 1% better returns--can hugely raise your standard of living in retirement, thus giving you more peace of mind, safety and security.

More provocatively, let's suppose you don't know when you're going to die--most people don't! How long will your money last when your retire?

Let's use the same numbers above, except let's assume both Bob and Fred don't know when they are going to die, so they spend $17,500 a year. How long will their money last if Bob gets 7% returns and Fred gets 8% returns? Bob's money will last 17 years--he'll run out of money at age 82. Fred's money will last 38 years--he'll have money until 103 years old!

Can you imagine running out of money at 82 versus having enough to last to 103? That's a huge change in safety and security!

My point here is not that everyone should try to get above average returns. My point is that getting above average returns may REALLY be worth it if you have the tolerance and ability to go after above average returns.

I've been beating the market, after fees, by around 3.5% a year for the past 12 years (past results are no guarantee of future performance). Want to guess what my retirement projections look like? Want to guess how much peace of mind I have?

If you have the right temperament and the right financial situation to go after above average returns, it can have a huge impact on your current and future lifestyle. In my opinion, it's well worth going after.

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.

It's stimulus check time!

That's right, boys and girls, it's that time again to get the economy going with stimulus checks!

But, wait a minute. Where do those stimulus checks come from anyway?

Does the government have a magical money tree that creates value? No, probably not that.

Does the government take in more money in tax revenue than they spend? No, not that, either.

Does the government borrow from others by issuing government bonds? Yes, that's the one.

Okay, so who buys those bonds? Is it savers, foreign and domestic? Yes, indeed.

So, that means the money is going from people saving to people spending, right?

So, the way to get the economy going, forever after, is to stop saving and start spending? Hmmm...that's some interesting logic.

Let's take this to its logical conclusion. Growth comes from consuming, according to this thinking.

So, if we just consume everything we've produced, we've maximized growth?

That doesn't seem to make sense.

Oh yeh! Now I get it! The way to grow is to save some of what you produce, and then use those savings to produce more next time around.

For example, the farmer who eats his seed corn will never grow production. But, the farmer who saves a bit his corn each year as seed for the next year will produce larger and larger crops each year as he saves more and more seed corn.

The only way to have growth is not to consume all you produce, but to save some of it over time and plow that saving back into production. You can't eat corn you haven't produced. You have to produce before you can consume. Production, built from saving, is the way to growth--not consumption.

So, what in the heck is borrowing money from savers and giving it to consumers going to do? Reduce future growth. Does that sound like a good plan for getting the economy growing again?

Only if you measure growth by adding up consumption.

I think I'll put my stimulus check into savings. Then, maybe, we'll have a snowball's chance in hell of competing with the foreigners we're selling the asset of our country to.

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.

Perhaps the Fed should include food and energy prices in inflation?

Since the late 90's, oil prices have rocketed over 1000%. Riots are occurring around the world because of shortages of such staples as rice and wheat. Even Costco and Sam's Club are rationing rice consumption here in the U.S.!

If the cost of such fundamental necessities as food and energy are going up so much, why do economists and the Fed believe that inflation is stable and at acceptable levels?

Quite simply, they don't include food and energy prices in their calculation of "core" inflation (that sounds like the same game as reporting "operating" and "pro forma" earnings that companies were criticized for 8 years ago).

You see, food and energy prices are very volatile, and most of the time their movements make inflation look uncomfortably unstable.

But, what happens if food and energy prices are rising because of real, no kidding inflation? The Fed and most economists have no way to adjust for this. Don't be surprised, though, if they finally get around to adjusting long after we've all been beaten down by "non-core" inflation.

I'm no economist, but I think I understand what makes for a stable currency.

The central banks of the world run the printing presses, and they can print dollars (euros, yen, bahts, pesos, reals, etc.) at almost no cost. This doesn't create value, mind you. What it creates, when dollars are printed faster than underlying growth, is inflation.

In my humble opinion, that's what we've been experiencing at a faster and faster pace over the last 10 years.

The central banks of the world reacted to the Asian contagion by printing more money. Then, they reacted to the fall of Long Term Capital Management with more money printing. Y2k (remember that "crisis"?), more money printing. Telecom, technology and dot-bomb crash, print more money. Housing crash and credit crisis...you get the idea.

I don't think energy and food prices are running up temporarily, I think this is the slow bubbling up of inflation created by the world's central banks over the last 10 years. You can see it bubbling up through the economy from energy to metals to transportation to food.

The easiest place to see this is in the price of gold, which bottomed at around $250 and ounce in the late 90's and is now 360% higher (after peaking 400% higher). Or, look at shipping rates. Or, look at base metals prices. Or, look at iron ore and coke used in making steel. Or, look at wheat, rice, etc. Do you suppose chicken, beef and pork could be next?

Think what you'd like about government bailouts and stable currency, I believe we're getting more and more inflation.

Could this all be the result of higher demand, especially from China and India? In the short term, yes. In the long term, no. That's where the rubber meets the road from a forecasting standpoint. If demand is the cause, then profits and innovation will eventually drag prices back down, as most economists are betting will happen. But, if part or all of the price rise is due to inflation, then expect prices in general to stay higher.

How long before central banks and economists start adjusting inflation for food and energy costs? Don't hold your breath.

I'm expecting prices to go up long term, even if they take a breather as the U.S. and global economies slow down. In time, though, we'll all have to recognize that prices are probably permanently higher, and the it's the result of inflation caused by our central banks. When people start to more generally recognize this, higher interest rates will be another thing to deal with.

Investing in such an environment can be difficult, but also very profitable. I'm glad I prepared myself and my clients for just such a possibility years ago.

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.

Snake oil salesmen

Flipping through the TV channels last weekend, I stumbled upon an info-mercial for training people to make money trading stocks.

The advertisement was designed to get people to sign up for a free seminar being held at 5 Colorado conference centers for 2 days each.

I couldn't believe the stuff these people were saying.

They were guanteeing results.

They were showing people in huge houses, driving exotic cars, hanging out on their yacht, walking away from their private airplane.

Nowhere did I see any warnings about past results not being a guarantee of future performance.

Nowhere did I see any kind of disclosure.

My wife and I couldn't believe it! It was the biggest pile of horse-pucky I've ever seen in my life!

There's no reason for you to know this, but as a professional, I'm not allowed to advertise in any of the ways these charlatans were.

I can't guarantee results. I can't show people living the good life without warning them about the risks. I can't show how much money people made on one trade without disclosing all the other investments made.

So, how do these people get away with this? I have no idea.

I thought it was the most irresponsible advertising I've ever seen. The regulators would kick me out of the business for saying anything these buffoons were saying. Where are the regulators on this one? I have no idea. Perhaps the snake oil salesmen can afford better lawyers than I can.

You know what the worst part is? Trading stocks based on a sales-pitch seminar is probably one of the most sure-fire ways to lose your money. Anyone signing up for such a seminar would have an infinitely better chance of reaching their goals by investing with someone like me instead.

I could never morally or legally advertise the way these yahoos were, and yet they will fill up 5 conference centers over 10 days ripping people off.

No wonder this business has such a bad reputation.

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.

Concentration versus diversification

The academics will tell you to diversify, and they will probably tell you that there's no such thing as too much diversification.

I beg to differ.

It all depends on your objective. If your objective is to match market performance, which, by the way, will beat 80-90% of individual and profession investors, then by all means diversify to your heart's content.

In diversifying, make sure you have all asset classes, including stocks, bonds, real estate, commodities, etc. And, make sure you have subclasses within in those asset classes, like small and large stocks, foreign and domestic stocks, etc. Finally, make sure you keep your costs as low as possible.

But, if you want to out-perform the market, you have to concentrate your investments.

By definition, investing in all the stocks in the S&P 500 will, after fees, never significantly beat a low priced S&P 500 index fund. That seems obvious.

The only way to out-perform the index is to invest heavily in a few stocks that you believe can out-perform the index. Once again, that's definitional.

It makes intuitive sense, too. Is it even possible to keep track--really understand and accurately assess the value--of 500 stocks? Not in this world.

It doesn't seem reasonable to expect your 21st, 51st, 101st, or 501st idea to be as good as your top 5, 10 or 20, either.

It makes as much sense empirically as it does intuitively.

The folks who out-perform the market--really out-perform after fees by a worthwhile margin--are always concentrated on less than 50 or, more likely than not, 20 stocks.

And, they probably size their positions to correspond to the return and probability characteristics of the investments they make. By that, I mean they buy more of the stocks they believe have a high probability of getting outstanding returns and buy less of the stocks they believe have a lower probability of achieving merely good returns.

If you don't believe me, look at Warren Buffett, or Bob Rodriguez, or Wally Weitz, or Bruce Berkowitz, or Glenn Greenberg.

Warren Buffet recently said that if he were managing $50 - $200 million right now, he'd have 80% in the top 5 stocks and 25% positions in the top few. If you aren't as good as Warren Buffet, you probably don't want to be that concentrated, but you get the idea.

Do you have to have conviction to invest this way? You betcha!! And nothing hones your investing focus like putting a lot of your money into a few stocks.

I've been investing this way for over 12 years now, and I've been quite happy with the results. I've beaten the market by a significant margin (past results are no guarantee of future performance), and this has allowed me to grow my net worth quite quickly.

If you want to match the market, diversify broadly and do it with the lowest fees possible.

But, if you want to beat the market, you should concentrate.

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.

Manhattan

On a lighter note, I made my first trip to New York City, and Manhattan in particular, last weekend.

Considering I grew up in Washington, D.C., and love investing and history, it's startling that I made my first trip as a 37 year old.

Wow. Wow! WOW!!! I had an absolute blast (although flying with a 7 month old was a challenge)!

What an amazing place. I did touristy things, like Times Square, Empire State Building, Grand Central Station, Statue of Liberty, Ellis Island, the Metropolitan Museum of Art, Central Park, but I also enjoyed some outstanding dining and just hanging out.

Of course, I made the obligatory pilgrimage to Wall Street. I was awestruck standing in front of the House of Morgan, the NYSE and just being in the financial district of the financial capital of the world.

It's a wonderful place and I'm already looking forward to going back.

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.

Nobody really knows exactly what is going to happen

Despite my forecasts, I don't know exactly what's going to happen. And, neither does anyone else.

When I make forecasts about the future, they are mere probabilities--usually what I consider to be the highest probability outcome.

But, a probability is not the same as certainty.

In fact, a low probability event, like 9/11, can potentially blow all high probability outcomes out of the water!

It's important to acknowledge what I don't know, and the degree of uncertainty in any situation.

When I make investments, I don't know with certainty the outcome. In fact, the best I can do is assign probabilities to several outcomes and then take action based on such assessments.

But, investing is fraught with uncertainty. The economy is too complex for any one person to know exactly what will happen.

The way to make money over time is to formulate probabilities and outcomes with enough accuracy to get things generally right. That's all it takes, but it's not easy.

The economy appears to be entering a recession. I think that is a high probability at this point, but that doesn't mean it's certain.

I think that if we enter a recession, there is a high probability the stock market will end up down much further than it is now. Once again, my high probability assessment--not certainty.

I acknowledge that I don't know what will happen, and have invested accordingly. My goal is to make good returns regardless of whether or not we enter a recession. I've picked investments that I have assessed to be good for the long run. That's the best anyone can do.

Those who just guess and bet big don't remain in the game for long, unless they get blind lucky.

Stick to long term thinking, prepare for the worst and hope for the best, invest so that you'll do well regardless of short term outcomes, and you'll do just fine.

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.

The triumph of hope over experience

The Fed bailed out Bear Stearns and now everything is okay. Right? RIGHT???

Wrong.

The Fed bailed out Bear Stearns in a forced marriage to J.P. Morgan because they feared (and still fear) a collapse of our financial system. That isn't good news.

The Fed cut interest rates another 75 basis points, down to 2.25%, because it's trying to re-ignite economic growth. They are more worried about growth than inflation despite surging commodity prices and a tanking US dollar.

Economic reports this week showed worse employment data, worse leading economic indicators, worse business outlook, worse housing starts, worse producer price inflation, worse capacity utilization, worse industrial production, and worse forecast auto sales.

So why did the market rally this week?

The triumph of hope over experience.

The stock market is simply not reflecting economic reality or previous experience with economic slowdowns. Those who believe we'll ride this out without an even 20% decline in the major indexes need to prepare themselves for a bumpy ride.

I'm not moving into a fallout shelter, but I'm also not ignoring a long and vivid stock market history, either. I'm ready for a rough couple of years that will, eventually, be followed by another economic and stock market boom.

This is not the time to think the Fed and Treasury can solve all economic problems (have they ever really succeeded in the past?). This is not a time to expect a mid-cycle slowdown or light stock market downturn. This is the time to prepare for tough sledding.

I'm ready for a downturn, and I'm finding good things to buy. But, I'm not expecting this to be a pleasant or smooth ride!

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.

Is the stock market projecting a recession?

With the terrible jobs report last weekend and poor retail sales report this week, I would have thought the market would be projecting a recession.

But, the Dow Jones Industrial Average is down only 16.3%, the S&P 500 is down only 18.3%, and the Russell 2000 (the most grossly over-valued of the three) is down only 22.6% from their most recent highs.

These may sound like significant falls, but it's normal for the stock market to be down 30-40% during a recession.

In other words, the stock market still seems to be projecting a mid-cycle slowdown despite a lot of data suggesting otherwise.

How should one react to such a situation? This is a great time to be buying!

I can't forecast the top or bottom of the market. And, I'll let you in on a little secret: no one else can, either.

When there's blood running in the streets, you should be buying. That doesn't mean things won't go down further--they almost certainly will. But, knowing that you can't pick the bottom of the market means you should be greedy when others are fearful and fearful when others are greedy. I'm feeling pretty greedy right now.

This is the time to buy cheaply priced businesses with good economics and management. If you take this path, either yourself or with the help of an advisor, your results will be quite satisfactory over the next several years.

I'm finding value in specific companies whose industries are feeling a lot of pain now. Think retail, real estate, building construction and airlines. I still think it's too early for financial services (except some select insurance companies), but that time will come in the not-too-distant future, too.

I think this is a great time to invest, so if you're looking for someone to manage your money and are curious about my services, contact me soon.

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.

My RSS feed is finally fixed

Thanks to help from my friend, Sean Cayton (Cayton Photography), my RSS feed is back up and running again.

If you already signed up for my RSS feed, or if you have been baffled at why it wasn't working, please sign up again and it should work.

Many thanks to Sean.

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.

Mid-cycle slowdown...or recession?

This question has occurred to me over and over again recently, because some very smart people are coming down on both sides of the argument.

To some, this may not seem very important. In a mid-cycle slowdown, the stock market goes down. In a recession, it goes down even more. If the market goes down either way, who cares?

But, the magnitude and period of decline make this difference very important to people with short term time frames. I'm not one of those people.

The yield curve, retail sales, the housing market, and credit markets all seem to be signaling a recession. The stock market seems to be indicating a mid-cycle slowdown. Employment data and factory activity are near recession levels, but not quite there, yet.

I'm guessing (with the emphasis on guessing) that we're entering a recession. My guess is based on my analysis of past credit cycle declines. Our economy has been increasingly levering itself since the mid-1980's. If deleveraging is occurring--and I believe it is--then a recession seems much more likely.

How does this alter my investment approach? Not much. I know I'm not smart enough to time the market, and especially not to time the economy!

So, how do I invest? Simply put, for the long term. I don't think our economy will go into a 10 year depression. If that were the case, then I'd be building a fallout shelter.

Instead, I'm investing for the eventual recovery that will happen either sooner, or later. Whether sooner or later is less important to me than having selecting good companies--those with good economics, honest and competent managers, that are selling at large discounts to what the company will be worth over full economic cycles.

That's a lot easier to do than trying to figure out what the economy will do in the short term. And, just between you, me and the fencepost...it's also a lot more profitable!

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.

It's the most wonderful time of the year!

Usually this phrase is attributed to Christmas. Not for me.

Today, Berkshire Hathaway's annual report, written by Warren Buffett, will be published! (Full disclosure: I own Berkshire Hathaway both for clients and myself)

I know what you must be thinking, "here's five dollars, go out and buy yourself a life!"

But really, I look forward to this time of year like no other. Every year at this time, I get to sit at the feet of the master and find out what he's thinking. Every year, he explains things in a way that greatly improves my understanding of business, economics, people and investing.

I am quite literally giddy with anticipation, like I am every year. In fact, I'm writing this blog much like a child tries to focus on something other than Christmas morning and all the presents that brings--I'm trying to distract myself.

At 2:30 Mountain Standard time it will be available...what will I do until then...

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.

What investments are looking interesting?

I am not a top-down investor. What does that mean? It means I don't think about the macro-economy and investment sectors first, trying to determine what will happen from a big picture perspective, and then picking individual investments that fit my big picture themes.

I am a bottom-up investor. What does that mean? It means I look at individual companies, one at a time. I try to understand the economics of each business: what are its competitive advantages, does the company generate good returns on capital employed. I try to understand management: how are they compensated, how competent are they, how honest are they, how much of the company have they bought with their own money. Finally, I try to understand what the business is worth: I assess what the business would fetch to an outside investor thinking about buying the whole thing. Only when I can find satisfactory economics, management and valuation do I buy.

Although I am not a top-down investor, I've realized over the years that my bottom-up approach tends to uncover interesting investments areas. All the sudden, I start finding a bunch of cheap ideas in one sector.

In 1998, I found a ton of technology companies selling at dirt-cheap prices because of the Asian contagion and Long Term Capital Management fallout. I didn't go looking for technology companies, I just realized after looking at several cheap technology companies that there was a theme.

In 2000, I found a ton of small cap value companies selling at dirt-cheap prices because everyone was selling small cap value to buy large cap growth and technology. Once again, I didn't decide to look at small cap value companies, it was just where I was finding value.

Where am I finding value now? Not surprisingly, I'm finding value in financial, real estate, retail and building materials companies.

It's probably too early to bite on financial companies. More write-downs are coming and it must be crystal-clear that the business you're buying will survive and thrive in this credit crisis environment.

Some real estate investment trusts are selling very cheaply. I think some babies are being thrown out with the bath water, but you must be very selective to avoid buying dirty water.

Some outstanding retail companies are selling at dirt-cheap prices. Why? Everyone is worried about the consumer and whether they will be able to spend. In the short term, the consumer will be crimped. But, in the long run, the strongest retailers will gobble up market share and emerge stronger during the next up cycle. It may take patience, but it'll work. Once again, avoid anyone with too much debt or poor competitive positioning.

Some building materials companies are looking dirt-cheap. The housing market is getting pummeled, so such companies are scrambling to scale back capacity to avoid losing too much money. Like with retail, the strong companies will emerge stronger and with more market share and greater pricing power. More patience on this, too, but what did you expect, a free lunch?

History has shown that great times to invest are tough times to put money to work. But, that's when the bargains can be found. I'm finding more bargains than I have in years, so I'm happily buying some great companies and waiting for others to come to me as this volatile market unfolds.

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.

Is a double dip recession possible?

Two reports today seemed to confirm that we are probably entering a recession.

The first was the University of Michigan's Consumer Sentiment Index that plunged to lows not seen since the early 1980's and early 1990's recessions.

The second showed that capacity utilization dropped below 80% at US factories. This, too, is usually an early indicator of recession.

Added to this, import prices are showing a continuous upward trend at the same time. Can you say "stagflation" boys and girls?

This got me to thinking about our last recession in 2001, and how I dramatically under-estimated the impact of government stimuli.

Back then, the Federal government provided huge fiscal stimulus in the form of government spending and tax cuts.

At the same time, the Federal Reserve provided huge monetary stimulus by cutting short term interest rates down to 1% (thus spawning the housing and credit boom, and now, bust).

Will the US government be able to repeat these stimuli? I believe they may succeed in goosing the economy in the short term, probably in the second half of 2008 and first half of 2009, but I don't think sending out checks and cutting interest rates will fully fix our current economic problems.

This led me to wonder: could a double dip recession like the one that occurred in the early 1980's happen again now? It's certainly possible.

Our economy, unfortunately, follows the four year election cycle pretty reliably. It's very unusual for the stock market to tank in an election year because politicians are promising and delivering all kinds of goodies to get re-elected.

But, such politicians tend to buckle down after the election is over and this slows things down fairly consistently.

My guess, and it is only a guess, is that fiscal and monetary stimuli will work this year to get the economy going again. But, in 2009 and 2010, things will get ugly.

So, in the mean time, it's probably reasonable to expect a recovering economy toward the end of this year, which will probably mean a stock market rally in the spring to summer time frame.

But, look out for 2009 and 2010, when we just may enter a second leg down of a double dip recession. And, this time, the US government will be out of the ammunition they used to bail things out this time.

I'm not personally betting on this scenario, or any other macro-economic scenario for that matter. I invest for the long term and try to look through boom and bust cycles.

The best protection against market and economic cycles like this is to buy great companies at good prices, and that's what I'm doing for my clients now.

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.

January was quite a month

Every once in a while, the stars align and you get outstanding performance relative to the market in a brief period of time. January was one of those months for my clients and me.

I didn't do it my day trading. I didn't do it by forecasting the economy or market direction.

I bought businesses over the last 3 years that looked cheap relative to my assessment of their value. That's it.

It takes a while for the market to recognize long term value. The average holding period on the exchanges is 9 months. 9 MONTHS!!!

In other words, most institutional and individual investors, as a whole, are trying to forecast what will happen over the next 9 months. I, on the other hand, have a time horizon of 5 years or more.

This investing style takes a lot of patience. But, it pays off.

In January alone, my growth clients beat the S&P 500 by 4.6% and the Wilshire 5000 by 4.7%.

Over the last year, my growth clients have beaten the S&P 500 by 13.3% and the Wilshire 5000 by 13.7%.

Over the last two years, my growth clients have beaten the S&P 500 by 12.4% and the Wilshire 5000 by 13.2%.

Since inception (4/30/05), my growth clients have beaten the S&P 500 by 7.1% and the Wilshire 5000 by 4.4%. (for full disclosure of my performance, please go to my website)

It pays to be patient, and it pays to assess the value of the businesses you buy.

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.

Is the Fed easing interest rates because it thinks we AREN'T entering a recession???

Surprisingly, the market did well this week.

This is surprising, to me at least, because the Fed cut interest rates another 0.5% and the jobs report came in looking pretty bad.

The Fed did not cut interest rates this week because it thinks the economy is doing well. It especially wouldn't have done so after dropping rates between meetings by 0.75% just last week.

The Fed is clearly signaling the economy is in serious trouble. So why is the market rallying on news the Fed thinks the economy is in serious trouble?

In addition, the job report today was simply awful. It showed the first monthly decline in jobs since the economy was slowly coming out of the last recession. Cause for celebration? Apparently so.

In my opinion, market participants are still digesting the market's significant drop during January. They are also digesting recent economic news, government actions and election results.

The reality is that much more deck-clearing is required in the financial sector, credit markets and housing sector before the next bull market can really take off.

In the meantime, some excellent bargains can be found in select places in the market. Troubling times like this are a big opportunity to prepare for the next upswing, regardless of when or how it comes.

I'm seeing some of the best opportunities I've seen since 2003, and I think those opportunities will grow in number and size in the not-too-distant future.

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.

"Hey, the market didn't do too badly this week...maybe the worst is over..."

You keep telling yourself that if it makes you feel better.

The market moves in fits and starts.

During a bull market, as prices go up, there are periodic sell-offs as some people take profits. Then, the market resumes its upward path.

The same is true during bear markets. As prices go down, there are periodic run-ups as bargain hunters buy and short sellers cover their shorts. When the bargain hunters--who are a small minority--and short sellers are done, the market resumes its downward path.

In my opinion, that's all that happened this week. The Fed's reaction (more accurately: people's reaction to the Fed), bargain hunters (all 12 of us) and short covering led the market to remain roughly flat this week.

But, that's just a temporary reprieve. The fundamentals behind the market haven't changed. The housing market is still going downhill fast, with no end in sight. Credit markets are still tight. Banks are still struggling to rebuild their balance sheets. Bond insurers are still in trouble. Employment still looks weak. Retail sales are still poor. Industrial activity is still slowing. The fundamentals haven't changed one iota.

In my opinion, after this "clearing rally" is over, the market will resume its downward path. And, I think it will take years to hit bottom. In the meantime, there are a few great bargains to be had out there, and I've been selectively shopping and buying.

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.

"Are we there, yet, Dad?"

The stock market seems to be finally reflecting economic weakness. The bond market reflected it some time ago, but the stock market only now seems to be coming around.

The question now is: how much farther do we have to go?

I'll be the first to admit, I don't know. But, I do have an opinion on whether we've reached bottom, yet, or not.

It seems hard to imagine that the fallout from a steeply declining housing market and the seizure of credit markets will wash out in less than a year.

Remember the wash-out that resulted from the dot.com bubble? It took from 2000 until 2003 to really hit bottom and turn back up.

Does it seem reasonable to expect the stock market to hit bottom so soon and with so little damage when housing and credit markets are much bigger pieces of the economy than technology? I don't think so.

No, I think we still have some way to go.

First, the subprime mess will continue to spread. A lot of floating interest rate mortgages will reset, and a lot more people will punt their homes to lenders. Credit card debt, auto loans, etc. will also fall apart as credit markets further reflect housing turmoil. That, by itself, will take another year or more to work out.

Next, credit markets will have to absorb all those losses and downwardly spiraling asset prices. That will take another year or so.

Then, a bunch of politicians and lawyers will ride to the rescue, further highlighting the misdeeds of the housing and credit markets. That will take another year or so, too.

In my opinion, we still have at least a couple of years to go on this.

That doesn't mean stock prices won't hit bottom beforehand. They usually do.

That also doesn't mean there aren't good investments to be found. I'm finding some outstanding bargains now and expect that list to grow over the next year or two.

My goal is to be greedy when others are fearful and fearful when others are greedy. The latter kept me out of the housing and credit down-spiral. The former is what I'm looking forward to, but I don't think others are quite fearful enough, yet, to call the bottom.

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.

Recession seems imminent

More troubling economic news this week.

First, the Institute for Supply Management reported that it's manufacturing survey index showed a contracting industrial sector. Any reading below 50 means contraction. The reading was 47.7 last month. The last time it was this low was in April 2003, coming out of the last recession. Readings below 45 usually indicate a recession is occurring. We're not there, yet, but we seem to be on the way.

Next, residential construction spending showed a 2.5% decline in November. The housing market is dropping, that's no surprise. But, it's impact on the economy as a whole still seems under-acknowledged.

Then, initial jobless claims fell 21,000, but the 4-week moving average, which better indicates labor market trends, was up to 343,750. This number is usually up around 400,000 in a recession, meaning we may not be there, yet. The last time the 4-week moving average was this high was in the summer of 2004, during the slow recovery from the previous recession.

Next, shipments of factory goods excluding petroleum and coal showed its fourth decline in 6 months. This indicates that, other than higher energy costs, shipments of factory goods is in a downward trend.

Today, payroll employment came out at +18,000 jobs. That may sound good, but a large part of that number is based on assumptions about jobs being created by small companies. Large revisions in this number are normal, especially at turning points in the economic cycle.

The payroll employment report was accompanied by a report of the civilian unemployment rate at 5.0%. Unemployment hit a cycle low of 4.4% just last March. When the civilian unemployment rate rises from its cycle low to 0.4% above that rate, a recession is usually imminent. 5.0% is 0.6% above 4.4%.

The stock market finally seems to be noticing with the S&P 500 down over 10% from the recent all-time high it hit last October. Although a 10% drop may not seem bad, recessions frequently cause 40% declines in the stock market.

It's not all doom and gloom, though. Although the economy may be rolling over into a recession, this is a normal part of the business cycle. As long as our government doesn't do stupid things to try to "solve" this "problem," we will soon see an upswing in the market and economy.

Usually, the stock market drops long before the economy does. This time, it seems a little behind schedule. Despite this, the stock market also tends to lead the economy as we come out of a recession. Considering that most recessions don't last more than a few quarters, this could very well mean the stock market could end up for the year.

That means this year could very well be an excellent year for bargain hunting!

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.

2007 Year in Review

2007 was a very satisfactory year for me.

I generated significant market out-performance, and that came mostly by avoiding the things that did badly this year.

After waiting since 2004, this was finally the year when the mortgage bankers, mortgage insurers, bond insurers and other financial institutions reaped the consequences of their poor business practices. Although I did not short these investments, I was able to generate significant out-performance simply by avoiding the group.

Unfortunately, several of the Real Estate Investment Trusts (REITs) I invested in were also taken to the woodshed this year. In each case, I think the REITs I've chosen are the babies getting thrown out with the bathwater, and will almost certainly be market out-performers in the years to come.

I look forward eagerly to 2008 and beyond, when I think my out-performance will be generated not just by avoiding bad investments, but also because I've chosen great investments.

I believe 2008 will be another volatile year, as uncertainty about the economy and slowing corporate profits will lead to significant market moves both up and down. It should be a good year to be a bottom-up stock picker.

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.

Recession storm-clouds gathering

Although the latest GDP report showed the US economy grew at a blazing 4.9% in the 3rd quarter, the data looking forward is looking increasingly weak.

The Index of Leading Economic Indicators (LEI) has gone into negative territory. Our economy has gone into a recession every time the LEI has gone negative, except for once in the late 1960's.

The credit crunch, brought on by lax lending standards to subprime borrowers, is spreading to every credit market. Banks are taking HUGE write-offs, and being forced to make fewer loans as they rebuild their balance sheets.

The employment market looks to be rolling over. The four-week moving average of initial jobless claims has risen to 343,000, the highest since June 2004 (except for the spike due to Hurricane Katrina). In June 2004, it was on the way down after the 2001 recession. It's currently on the way up.

Retail sales are looking to be worse Christmas season since the last recession.

Volatility in the bond and stock market has risen dramatically.

Copper prices have been falling.

UPS and Fedex have announced disappointing results looking forward, and the Dow Jones Transportation Average has been diving.

Financial indexes have been tanking, and in a finance-based economy like ours, that's a bad sign.

The one big thing that hasn't confirmed all these dark clouds is the stock market. Either stock investors are more prescient and no recession will occur, or they are deluding themselves into believing things will be okay or the recession won't last long.

My guess is that most stock investors are being overly optimistic, and aren't looking at coming earnings shortfalls.

When companies begin to report earnings next January, I think investors will get an initial shock. Over time, more information will pour out that the economy is in a recession. By the time this evidence is conclusive, the economy will probably be recovering.

Most investors will be scared when they should be greedy. In other words, by the time investors are scared about a recession, stock prices will be low, and it will be 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.

You can't get something for nothing

The market seems to be absolutely focused on the Fed.

Everyone seems to think the Fed has the power to make or break the economy, get lending moving again, support the dollar, etc.

The fact is, the Fed doesn't have that much power. If you don't believe me, go read John Hussman's article on the subject, or read any of his recent weekly commentaries that address the issue.

The thing that surprises me is how many people believe the Fed can take action with no seeming repercussions. As if the Fed could move interest rates, or lend money to banks without any adverse reaction.

The reality is that the Fed can only take action with consequences, just like the rest of us mortals.

When the Fed offers liquidity, they are printing money and creating inflation.

In the long run, the Fed doesn't matter much, although they do have a short term psychological impact on the market.

Even worse than that, the Fed's actions almost always come with some downside, and that long term impact can be profited from by smart investors.

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.