Industrial Production Index Fence Sitting

The news just keeps coming in. Today the Federal Reserve announced the Industrial Production Index (IPI) figures for the month of February. The IPI fell to the level of 99.7298. This is 1.93% above the December 2001 level of 97.8399. Falling below the Dec. 2001 level would bring economic activity to the dark ages for all intents and purposes.

Warning: the following charts may cause severe and/or permanent eye damage. Avert your eyes if you start to feel the signs of fatigue, drowsiness, or nausea.This blog is being featured on www.condron.us, I hope you find this useful.

For all I know this is do or die for the U.S. economy. Because the IPI is a lagging indicator as part of Dow's Theory, we can only guess that as the Dow Industrials and Dow Transports have bottomed on March 9th we might be in the midst of a temporary bottom. How do I know? I don't know. However, the economic data that is coming out recently isn't worse than what would be expected as the "experts" have baked in much of what is known to be on the horizon.

My opinion is that we aren't out of the woods but we are well on our way to a natural reaction to the oversold conditions in the market and the economy. However, be prepared for new and unforeseen realities that the market has to offer. As an example, what would happen if a medium sized holder of treasuries decides to sell all of their holdings? The shock to the financial system would be profound and unexpected since everyone is waiting on pins and needles for China or Japan to pull the trigger.

Usually it is the unexpected and smaller players that can disrupt an entire system like what occurred in Thailand in 1997 or Austria in 1931. As the prevailing logic goes, China and Japan have too much at stake to actually sell their U.S. treasuries, therefore it is fitting that they wouldn't engage in the activity as readily as, say, ______________________(fill in the blank).

As with every snowball, all it takes is a small player to get things started. The rest becomes a matter of flooding the exits. The last thing we need in this economy is rising interest rates due to the forced selling of treasuries. This would be the final blow to the perception that the economic "crisis" can be contained. However, it is this scenario that has the highest probability of occurring as a sort of "black swan" event. Touc.

Uptick Rule and Short Selling Ban

Many market commentators and participants have extolled the virtues of the uptick rule for short selling of stocks. Nothing bores me more than someone who blithely suggests something that actually has little or no impact in today's stock market. My goal is to hammer down the notion that re-instituting the uptick rule will somehow avoid "bear raids" or short sellers taking advantage of a stock that is already in a declining trend. I will also demonstrate the impact of the elimination of short selling on Taiwan stock exchange and compare its performance with that of the Dow Industrials during the same time frame.

Insight on the Uptick Rule

As a person who started my investing career as a short seller, I can say that the uptick rule was a saving grace for me. According to Investopedia.com, the uptick rule is:

A former rule established by the SEC that requires that every short sale transaction be entered at a price that is higher than the price of the previous trade. This rule was introduced in the Securities Exchange Act of 1934 as Rule 10a-1 and was implemented in 1938. The uptick rule prevents short sellers from adding to the downward momentum when the price of an asset is already experiencing sharp declines.

What this meant for me is that I could get the benefit of the stock price rising before my order to sell short was executed by my broker. As a short seller this is exactly what you want as a means of avoiding the common mistake of selling low and buying high.

As the current bear market had gathered its most steam, critics have been saying that the lack of an uptick rule is responsible for the markets free fall decline from October 2007 until the most recent low of March 9th. What these critics fail to recognized is that with stock prices being traded in pennies rather than eighths it almost doesn't matter whether there is an uptick rule or not.

When stocks were traded in eighths a short seller could gain $0.125 on every uptick. Assuming that the stock was going to fall anyway, that actually increases the profitability of the trade. If, on the other hand, the stock trades up by a penny, and then falls, the uptick rule really does more harm than good, for the short seller that is.

Imagine the harm that the uptick rule does to short sellers. With stocks trading on a penny basis, if a stock is in a free fall there is no telling when the stock's price will turn resolutely to the upside. This essentially puts the power in the hands of the big institutional traders to manipulate the market. Notice that when Jim Cramer describes manipulating a stock's price, he mentions doing the manipulation in the options market and not with the actual shares. Cramer only uses the actual shares after pushing up or pushing down the stock price in the futures market. Clearly, this is where the regulation is needed, not with the short selling of actual shares. If, as a short seller, I'm discouraged about participating in the markets because the rules are stacked against me then I will stay away. Surprisingly, this is actually harmful for the markets as will be demonstrated in my second piece about the Taiwan stock exchange's ban on short sellers.

With the uptick rule and stocks trading in eighths, as a short seller, at least you get the protection of seeing the price move "significantly" higher before continuing to go lower. At which point the short seller could more accurately decide if they want to hold on to the position. Without the uptick rule the short seller gets no real-time "heads up" as to a possible reversal of the trend as the trade is being placed. This is how money is lost in short selling without an uptick rule. This may also explain why so many people lose money buying stocks without a "down tick" rule. If only I could place an order to buy and it would only be executed after the stock price traded down...I would be so happy.

Short Selling Ban

Finally, I'd like to revisit the idea of whether short selling drives down the stock market. As I mentioned in my November 22, 2008 article, banning short selling would have no impact on the decline of stocks. As my only way to demonstrate this fact I compared the performance of the Taiwan's TSEC Weighted Index to the Dow Jones Industrial Average.

Starting on October 1, 2008 the regulator for the TSEC banned all forms of short selling in an effort to stop the decline in the stocks. On November 28, 2008 the ban on short selling was lifted with orders for short sales only allowed based on the end of day closing price. In the chart below, Oct. 1, 2008 to Nov. 28, 2008, I have compared the performance of the TSEC and the Dow Jones Industrial Average to see if there was any material difference between the two indices. As expected, there was no difference in the amount of the decline in either index. Furthermore, when the global stock markets started going higher on November 20th the TSEC index lagged the performance of the Dow by nearly 5%.

The following is a critical observation, both indices experienced equal declines but unequal increases. Had short sellers been pressured to buy back stocks at the November 20 low the Taiwanese index would have likely had an equal or better increase than the Dow Industrials. Based on this evidence we should be moving away from the regulatory effort to take away this critically important feature to a liquid and healthy financial market.

Learn more about short selling by reading Bear Markets by Harry Schultz. Touc.

Sources:

• "Taiwan to Partially Resume Short Selling of Stocks Today." AsiaPulse News. Nov 28, 2008.
• "Uptick Rule." Investopedia. Accessed March 15, 2009.

Research Rec.: Helmerich & Payne (HP) at $22.55

Today I bought the oil driller Helmerich and Payne (HP) at the price of $22.58. If you remember, I recommended this stock on September 29, 2006 at the price of $23.03. After the recommendation, I issued a sell recommendation of the stock on August 12, 2008 when the stock was selling around $53.95. I missed calling a sell recommendation at or near the top when the stock was selling for $77.24 in June of 2008.

Keep in mind that my current purchase is strictly speculation due to the fact that we're still in a severe bear market. This means that when, and if, the market and economy continue to go lower, the demand for oil and its price will go down further. However, according to Dow's theory the following upside targets for HP's stock price are:

• $37.08
• $47.12 (50% principal)
• $57.15
• $77.24

We can expect that a bear market rally would bring the stock price at least to the $37.08 level. However, we should never forget the downside risks this stock is likely to face. My expectations of the downside are based on the earnings falling by 50% which would not impact the dividend at all. A decline of earnings should bring a decline in the price of the stock. It is safest for us to assume that the price would fall at least half of the most recent low of $17.01. If you're willing to accept a decline of 62% then this is a great speculation (as opposed to investment) in a quality dividend paying stock. According to MergentOnline, HP has increased the dividend for 31 years in a row.

Some would argue that I should highlight the relevance of peak oil, future inflation due to the government stimulus, increased aggregate demand, and other assorted factors that affect oil. While these matters are important the reality is that the markets rule the day. What I do know about inflation is based on the chart below. I pulled from BigCharts.com the price movement of Helmerich and Payne (HP), Coure D'Alene (CDE), Agnico-Eagle (AEM) and the Dow Jones Industrial Average from the period of 1973 to 1983.

Notice how HP was able to beat out the traditional favorites during inflation like Agnico-Eagle, a gold mining company. Also notice how HP hammered the best precious metal bet on inflation, silver, as represented by CDE. As expected the Dow Jones Industrial Average was a none factor as an investment but was used as a point of reference. If we're headed towards massive levels of inflation, after the wipe out of assets in the current deflation, then HP might be the best of the best when that time comes. Touc.

Various Notes on the Market

The Utility Average

Today the Dow Jones Utility Average had wicked downside action to the tune of 3.18%. It is said that the DJ Utility Average leads the market due to its more sophisticated investors seeking safety and income. This is especially reflected in the October 10, 2008 bottom that was reached in the index which was well ahead of the November 20, 2008 bottom experienced in the general stock market.

Today's action was significant because the Utility Average fell below the closing low of October 10, 2008. If this is any indication, with any follow through in the coming weeks, then we've got lots more to go on the downside.

Market Forecast

On November 21, 2008 I said:

Another factor that is of concern for this market is that the Dow Industrials broke through its 4% yield to finish Thursday November 20th at a yield of 4.12%. We can only guess that the Dow is headed to a yield of 5% or a closing price of 6226.

It looks increasingly like we're going to reach that 5% dividend yield on the Dow Jones Industrial Average. Currently, we're within 500 points of reaching the 5% yield on the index. The only problem is that the yield will have to go back down (4.99% to 4.01%) as the dividend cuts in the index take place. This would result in a lower price on the Dow in order to achieve the same dividend yield.

Bailout Watchlist

If you've been reading this blog for any amount of time you know that the current bailout of the financial system has failed miserably. Over $8.5 trillion has been distributed to various institutions with little or no impact. As the Dow Jones Industrial Average reaches new lows, I want to point out the other bailouts that have passed into history but are not being counted as failures as they should be since they only provided temporary reprieves that would ultimately come back to haunt us in bigger and broader reaching fashion. So far, our stock market, as indicated by the Dow Jones Industrial Average, has managed to fall back to 1996 levels. This means that the following bailouts have been a waste of "market stabilizing" money:

• Airlines (2001) $3.171 billion
• Brazil (1998) $30 billion
• Long Term Capital Management (1998) $3.5 billion
• Thailand, S. Korea, Russia, Indonesia (1998) $141 billion

As we go back in time, I'll add more " market stabilizing" bailout to the tally. Next up is the Mexican Peso bailout of 1994. Unfortunately, we'd have to fall to the high 3000 level in order for that to occur. Please feel free to add to the list of items that were supposed to support or stabilize the markets but so far have been wiped out. Touc.

Delisting of GSEs Looms Large

The day of reckoning is coming for both Fannie Mae (FNM) and Freddie Mac (FRE). The first time delisting of these companies was discussed, on September 8, 2008, the NYSE notified FNM and FRE that they'd have to increase their share price over a dollar or the stocks would be delisted from the exchange after six months. The two previous times that the stocks fell below $1 the government was able to bring them back above the minimum.

While being delisted isn't the end of the world for most companies, these government entities rely on the confidence of the markets to move forward after being seized. If the government has plans for the structured reorganization of mortgages in conjunction with the latest bailout package then being delisted would be a final nail in the failed bailout coffin.

Look for a boosting of the share price to ridiculous levels (anything above $1) or go literally to zero in the next delisting notification process. I believe that the prospect of delisting is going to wipe out these companies and possibly the banking system. Touc.

Sources:

Spicer, Jonathan. "Fannie, Freddie Facing Delisting Threat." Thomas Reuters. September 8, 2008. Accessed February 21, 2009.

When Paper has no Value

The time will come when governments of the world realize, by force in some cases, that more value and confidence can be gained from using gold as the last resort bailout mechanism rather than paper or digital money. However, the gold option is very much the financial equivalent of the nuclear option. No nation wants to actually resort to this feature first because as one nation dips its toes in the water all subsequent nations will follow in its path at ever higher gold prices. It is only the last nation in the pool, with sizable gold reserves, that benefits the most from using gold as collateral. The first nation in the pool becomes the sacrificial lamb. Unfortunately, desperate times call for desperate measures.

As an example, in 1974 the official rate of gold was at $42.22 an ounce. However, the free market price of gold reached $180 an ounce. The free market price of gold increased the borrowing power of bankrupt Italy, which had 2,500 tonnes of gold, from $3.7 billion to $15.8 billion. On September 1 1974, West Germany lent Italy enough money to stave off complete collapse of the nation using the free market price of their gold holdings as collateral. Most interesting in this deal is that West Germany never collected on the gold. It was accepted on faith that if the loan could not be repaid then the gold would be shipped to West Germany. However, as long as Italy was able to make their payments on the loan then there would be no question of whether or not they would ship the gold in the event of default. This gave every incentive for both West Germany and Italy to hope for the rise in the price of gold.

We often hear about how governments would rather not have gold compete with their currency or that gold has no master. Then why are central banks filled with the stuff? The case of Italy in 1974 provides a perfect example of the reason why.

Gold acts as the last resort to combat the global competitive protectionist policies of coordinated rate reductions and domestic stimulus packages that we're seeing today. When a nation is on the brink and there is talk if a loan agreement based on the value of gold then, and only then, can we be assured of the turn in the tide for inflation, interest rates, stocks and the price of gold. Touc.

Sources:

• Lee, John. "German-Italian Deal ignores U.S. Policy." New York Times. Sept. 2, 1974. p.21.
• Hofmann, Paul. "Bonn to give Rome A $2 Billion Loan in Financial Crisis." New York Times. Sept. 1, 1974. p.1.
• Russell, Richard. Dow Theory Letters. June 26, 1974. Letter 601. p. 4.

Volume Observations in Bear Markets

The charts below reflect the peak in the Dow Jones Industrial Average from the week of October 8, 2007 (yellow) and February 7, 1966 (green). We're 72 weeks into the current bear market and all systems are go.

Notice that volume is generally rising in both instances. This indicates that we're still in the early stages of this bear market. This bear market will indicate that it is near the end by having a flat or declining trend in overall volume. Unlike the bear market of 1966, which began rising in the 35th week, the current bear market hasn't seen a sustained rally.

The overall trend in volume is quite fascinating. In both bear markets there is an early above trend volume pattern however, in week 17 and week 12 there is a spike down. There is also a surge in week 47 and week 48 from below trend volume to above trend volume.

All this means that while we may be at the bottom cyclically we're still in a secular bear market. Touc.

Misinformed Market Observations

The information that is being provided on the website dShort.com is top notch. So good is the information on this website that it should be the beginning course for every investor. However, there is a disservice being done by those who take this information but don’t put it in its proper context. The information that I’m referring to regards a Bull and Bear Market Rally Chart that depicts the performance of the Dow Industrials, S&P, and the Nasdaq indices during major declines in history compared to the most recent decline. The reaction to this chart, if you’re a stock market bull is a glazed over, panic-stricken stare. If you’re a stock market bear you’re probably salivating with eager anticipation and excitement.

The problem with this chart is that it is being used by “bears” as a cautionary tale of what is to come (i.e. 1929 to 1932-type decline). However, these indices, while similar (they're all traded in the U.S), are not the same and should not be compared to each other, especially when we have data on the Dow all the way back to 1896.

More important than what is shown is what it doesn’t show. The chart doesn’t show the periods in history when the Dow declined by 40% or more in one move as has occurred since October 2007. In every instance that the Dow has fallen 40% or more in one fell swoop, as it has recently, the market rebounded 50% to 100% every time.

• Jan 19, 1906 to Nov. 15, 1907 decline of 48.3%
• Nov. 15, 1907 to Nov. 19, 1909 increase of 89%
• Sept. 30, 1912 to Dec. 24, 1914 decline of 43%
• Dec. 24, 1914 to Nov. 21, 1916 increase of 107%
• Nov. 21, 1916 to Dec. 19, 1917 decline of 40%
• Dec. 19, 1917 to Nov. 03, 1919 increase of 81%
• Nov. 3, 1919 to Aug. 24, 1921 decline of 46%
• Aug. 24, 1921 to Oct. 14, 1922 increase of 61%

All of these declines and increases occurred within the bear market of 1906 to 1924. This was a period when the Dow started 1906 at 100 and didn't close permanently above 100 until after July 1924. While I understand the dire nature of the markets and the financial system a sucker's rally has to start soon. Every 17-25 year period of bear markets has had similar action and reaction. This means that either we're going to get a sucker's rally or this is really the bottom in the market.

Some could accuse me of being selective but the facts and truth are consistent. 100% of declines in the Dow of 40% or more result in a reaction of 50% or more. If you can find a period that doesn’t meet this criteria then pass it along since I need all the information that I can get. By the way, if you want to school me on 1929-1932 then please read my breakdown of this market decline in my Big Picture Observation and 1929 article.

It is likely that "this time is different" and I'll be proven wrong. However, I feel that a little perspective is necessary on this topic. Touc.

Convergence of Extraordinary Forces

Most people contend the current economic malaise that we're experiencing has something to do with the housing sector of the economy. I believe this notion is an adept recognition of the symptom rather than an acknowledgment of the true problem.

My views is that the banks are the problem and have been since the beginning. After all, homes could not have been bought if the easy financing wasn't available. Furthermore, homes could not have been built if it were not for the financing provided to the homebuilders through the capital markets and the banks. This lead me to the conclusion that the ebb and flow of bank deposits would be an indication of the overall pulse of the economy and the stock market.

To this end I have conjured up the Demand Deposits at Commercial Banks provided by the Board of Governors of the Federal Reserve System. In the chart below the increase in the Demand Deposits indicated a general instability in the banking system. The decline in the Demand Deposits indicates a high level of confidence in the banking system. While these ideas seem useful there seems to be an attempt to show correlation as causation which can be just as dangerous as mistaking the symptom as the problem. We forge ahead regardless.



The chart above shows that since September 2006 there is a parabolic increase of demand deposits at banks. This reflects part of the "flight to safety" that many are describing in the financial press. Flight to safety occurs when savers realize that investments carry unforeseen amounts of risk. According to David Marantette, parabolic moves up or down can only last for so long. The exhaustion of such moves can be attributed to entropy or the second law of thermodynamics.

Entropy is the change of energy from an orderly state to a state of dissipation or death. The parabolic rise in the last two years will have to break down at some point. In the case of Demand Deposits, what we should expect to happen is for the index to dramatically decline in an equally violent fashion. A good example can be found in the low of December 2000 until the peak of September 2001. That parabolic move was followed by a violent decline in the index from October 2001 until September 2002. The September 2002 bottom was offset by a violent rise until August 2003. After the August 2003 peak we see an "orderly" diffusion of the energy expelled during the period from December 2000 until August 2003.

If the stock market is a leading indicator for the economy then it would appear that the Dow Jones Industrial Average anticipated the end of the volatility in the Demand Deposits by hitting bottom in October 2002. From October 2002 the Dow Jones Industrial Average increased from the level of 7286. 27 to the high of 14,164.53 in October of 2007, an increase of 94%.

Not only does entropy seem to be at work with the Demand Deposits, cycles seem to be playing a prominent role in the action of this index. Of the last cycle bottoms since 1959 the average cycle lasted about 5.6 years. Half of the cycle bottom, to find where the top would occur, is equal to 2.8 years. If projected from the September 2006 low, we would expect the most recent rise to peak around June of 2009. The next bottom in the index projected to take place around April 2012.

Finally, seeing this index nearly triple it's move beyond the normal peak from periods past leads me to think reversion to the mean. At the very least this index should fall to the level of the previous high. The current level is at 59% year-over-year percentage change while the previous peak was at 13.6%, a decline of 76%.

The impact of all this information is that starting in June 2009 the stock market will either hit bottom and go higher or trade in a wide range until April 2012. Afterwards the market would head lower in a fashion similar to what we've seen in the last 2 years. Touc.

Six or Half a Dozen?

As I have demonstrated in my October 2008 article and was later confirmed by BloombergMarkets magazine in their Jan. 2009 issue, the old administration (republicans) had doled out at least $8.5 trillion in support of the financial markets. Of this amount, only $700 billion was put before Congress for a vote which was rejected the first time (as it should have) then rejiggered and forced down our throats the second time.

Now, the minority party (republicans) in congress wants to stand opposed to the very thing that the old administration (republican) vehemently said was needed in order to save the economy. The current administration (democrats) is doing everything the old administration espoused (the opposite of change) by using fear tactics and is getting no love from the same republicans who supported the first bailout package back in October of 2008.

What really grinds my gears is the fact that $7.8 trillion never went up for a vote and now the republicans are saying that Obama's $900 billion is going to bankrupt this country. Where were the critics when the $7.8 trillion was going down the drain? Don't misunderstand me, I think that the only money that should have been provided was by the FDIC for bank failures. I knew the bailout was a scam when only $73 billion of the $8.5 trillion was used for FDIC insured instititions. Now there are no bullets left for the very things that were supposed to be government insured.

These politicians, both republican and democrat, are gaming the system and the citizenry. Why are we allowing this, because if we don't then, "the whole financial system would collapse." As I showed on October 2008, the $1.8 trillion that was spent didn't stop Wachovia, Lehman Brothers, AIG, Freddie Mac, Fannie Mae, IndyMac, Washington Mutual, Merrill Lynch, Bear Stearns and a whole host of other institutions from collapse. After the $1.8 trillion an additional $6.7 trillion was thrown into the fire to no avail. Historically, bailout don't work and now we're being gamed right and left.

Don't worry though, if the economy recovers within the Obama administration the three card monty operators, republicans and democrats, will claim that they are responsible for the outcome. All the while they will be bankrupting our country. Touc.

Bank of Hawaii Update

As a follow-up to my earlier research recommendation of Bank of Hawaii there is news that three days afterward, on January 15th, Bank Director magazine ranked Bank of Hawaii as number 4 among the nation's top 150 banks. Bank Director says that,

"Honolulu-based Bank of Hawaii, No. 4 on the Scorecard, has $10.4 billion in assets, making it the largest in asset size of the top five financial institutions. Its impressive 23.24% ROAE is the highest of any large bank or thrift during the four-quarter analysis period. 'They are a much more traditional bank with a good mix of commercial and retail customers,' says Aaron Deer, a San Francisco-based research analyst at Sandler O’Neill, who follows western banks. 'They’re well rounded and they’ve avoided a lot of the pitfalls that many other banks have stepped into.'”

It is nice to know that we might be looking in the right places when it comes to investment opportunities in the banking industry. So far, BOH is up by 3.79% in 26 calendar days. Good luck on your investment research of this quality bank. Touc.

Dow's Theory

Dow's theory is supposed to be the barometer of the market. In general the market doesn't care about one single statistic or policy implementation by the government. The market is the all encompassing knowledge of what the future will be. What does Dow's theory tell us about the prospects for the near term?

Dow's theory is telling us that the markets have hit bottom and are headed higher from here. However, this prognosis has one huge caveat. Only if the Dow Jones Industrial index continues to stay above the low that was reached on November 20, 2008 will the bear market rally remain in effect. Already the Transportation index has fallen below its Nov. 20th low as recently as Jan 20, 2009. Normally a re-confirmation of the bear market would have been signaled if both the Industrials and Transports fell below the Nov. 20 low. The fact that the Industrials hasn't confirmed the Transports by falling below the previous low and the rising volume since December 24th indicates that the markets are poised to move higher.



The risk to my outlook for the stock market is that both the Transports and Industrials fall below the lows of Nov. 20th at the same time. Falling below 7552.29, the Dow Industrials would have 4132.17 as its next resting point. This is not a wish on my part, it is only an observation as part of Dow's theory.

As an investor we need to approach this market with caution. As it stands, the news is very negative and there are more and more layoffs being reported. How are we supposed to commit our remaining investment funds (as opposed to savings) to the market after the painful experience of last year? Such a challenge is best answered by hedging your position by focusing on the strongest dividend paying companies that are out there. This way, if you're wrong about the stock going up at least you could hold and compound the dividends. Compounding only becomes necessary for those unwilling to sell after a certain amount of loss has been experienced. Take a look at my recent research recommendations on February 4th. These companies offer the best hedge against the prospect that the market could fall much lower.

Remember, the Industrials are either going back to 10836.11, a gain of 31%, which would still be within the context of a bear market or the Industrials are headed down to 4132.17 a loss of 50%. Touc.

When was it said?

"...the oil stocks are already the 'whipping boys' of the energy crisis, and Washington is playing the 'windfall profits' theme for all it's worth."

-Richard Russell. Dow Theory Letters. December 5, 1979.

The preceding comment was found in the Dow Theory Letters at or near the peak in oil prices. It seem that politician at the time were doing the same thing that they were doing during the congressional hearings with oil executives back in 2008.

The beauty of all this information is the fact that unlike other types of history, financial history does repeat itself. Of course there are minor difference in the names of the people but economic history points to the direction that things are headed. To me this means that the response by the government to the current economic malaise is only going to extend the pain rather than solve the problem. Touc.

Income Investing in Hard Times

According to the National Bureau of Economic Research, and backed up by the Federal Reserve Bank's Industrial Production Index, the economy officially went into recession starting in the month of December of 2007. Since then, we have seen the economy and the stock market decline in unprecedented amounts never before seen. As the chart below demonstrates, not even the "Great" Depression has seen such a year-over-year decline on a percentage basis.

When it comes to investing in the current economic environment we have to consider the worst case scenario. Below I have included a spreadsheet that considers Dividend Achievers that are close to or within 10% of the 1 year low. These stocks are ideal for consideration as your next research and potential purchase candidates.

What I have done is assume the period which these stocks have accrued the lowest quarterly earnings since the recession began then projected those low earnings to determine if the company can sustain the dividend payment over the coming months and years. Stocks that have a negative number in the column titled "cash remaining" are the least likely to be able to increase their dividend in the coming year. While this does not condemn the stock it does warns us of the danger that might exist. Also, stocks that are highlighted in red are those whose lowest quarterly earnings since 2006, if projected into the future, could not sustain the current dividend payout. These stocks (DBD, PII, KO, PPG, TRH, UVV) are still good companies however, if the recession continues or gets worse then we could see the dividend increase put on hold as well.

My recommendation is that stocks with the lowest payout ratio and the highest cash remaining (based on the lowest quarterly earnings since the recession began) are the best companies to start your research. Don't forget to verify the dividend history before buying these stocks. Touc.

SELL Altria (MO) at the Market

For the extremely conservative investor the time has come to issue a SELL recommendation for Altria (MO.) The stock has performed reasonably since the Research recommendation was issued on December 9, 2008. It is highly recommended that anyone who bought the stock based on my research should re-read the posting. The stock essentially went up from the date of recommendation. From the current level of $17, MO is poised to reach the $20 level with no effort. However, the returns that this stock has provided within the last two months say that it is worthwhile considering alternatives.

MO was recommended when it was trading at $14.99. As of Thursday January 29, 2008 MO was quoted at $17. This equals a return of 13.11% in less than 2 months. Conservatively, on an annualized basis this would equal approximately 78% return. Selling this stock now also generates a return 1 and a half times the amount of the dividend yield if the stock was held for a whole year.

For those that are willing to take the risk of holding on to this stock, MO announced 4th quarter earnings of $0.33 per share which implies annual earnings of $1.32. This equals just enough to pay the dividend of $1.28 with little room for a dividend increase in the coming year. At this point, it is difficult to say that the dividend is secure. However, the recent acquisition of UST, an earnings powerhouse in its own right, is likely to provide some life for MO earnings in the coming years.

It is always recommended that when selling a stock, one should not place an order after hours or when the market is closed. This leaves the seller in the position of being vulnerable to the whims of the market makers. Instead, place your sell orders only as a market order during market hours. Some would complain that a market order during market hours might leave some profits on the table. However, I would rather leave some money on the table rather than have it taken away from me by the trades that are placed by institutions and market makers. Touc.

Disclosure: I hold a 50% position in MO

Industrial Production Index

As expected the Industrial Production Index fell below the level of the September 2008 low of 105.2246. In addition, The IPI pierced the previous peak of June 2000 at 104.2873. Based on this most recent move the IPI is expected to decline at least to the December 2001 level of 97.8399. Thus far, the IPI has fallen 9 of the last 11 months.

What does all this mean? As far as I can tell, we're in for at least another six months of declines in the IPI. This does not mean that the stock market is fated to do the same. As an example, when the Dow Industrials hit bottom in December 1974 the IPI hit bottom in May 1975. We'll have to see if we're only as lucky as prior periods. Touc.

The Art and Science of Cycles

The chart below was pulled from the book Cycles, The Science of Prediction by Edward Dewey and Edwin Dakin. Just so you know, the book was published in 1947 and is surprisingly well written. What is important to gain from this chart is the fact that it accurately predicted the high for inflation in 1979 (blue circles) and the low for inflation in 2006 (red circles).

There are some who feel that the use of cycles in determining trends doesn't stand up to the academic rigor of a finely researched economic or financial treatise. There are others who might say that using cycles to determine the future is hocus-pocus-gooble-dee-gook. However, the fact remains, in 1947 Dewey and Dakin published their findings that predicted that wholesale prices (inflation) would be at its highest point around 1979 and its lowest point around 2006.

These predictions takes into account all human action and reaction to causes and consequences of the conditions at the respective periods. How is this possible? I don’t know, but I find it fascinating and useful since it provides perspective that is necessary under such “crisis” conditions. Touc.

$8.5 Trillion Spent and No Relief in Sight...

The combined effort of the Federal Reserve Bank and the U.S. Treasury hasn't done much towards solving the problems in our banking system. Since my last article about the Fed's action to bailout the financial system there has been an additional $6.684 trillion put to work assisting financial institutions. In the graphic below, from the February 2009 issue of Bloomberg Markets, is a visual of the allocation of all the funds that have been committed throughout the year 2008 until November 25.

Since my last article on the Fed's action in October 2008, the stock of Bank of America has fallen from $38.13 to the current level of $10.20. If the stock market is any indication of confidence in the banking system then Bank of America shareholders demonstrated their clear understanding of the extent of the problem.

Any reduction and/or elimination of bailouts will be the first sign of a recovery in the economy. However, with Bush/Obama asking for an additional $350 billion, the 2nd half of the $700 billion TARP program, from Congress means that we're in for another six months before we can start to look for clear indications of the true state of the economy. Touc.

Source:

• Mark Pittman and Bob Ivry. "How to Get to $8.5 Trillion." Bloomberg Markets. February 2009

Research Rec.: Bank of Hawaii (BOH) at $37.76

Today's research recommendation is Bank of Hawaii (BOH). BOH is described by MergentOnline as, "...the bank holding company for Bank of Hawaii (the Bank). The Bank provides financial services and products mainly in Hawaii and the Pacific Islands." MergentOnline also points out that BOH has increased its dividend every year for 30 consecutive years.

BOH is within 3.96% of the one year low and yields 4.80%. According to Value Line Investment Survey, BOH typically trades around 14 times earnings. At a 9.77 P/E ratio, either of two things need to occur:

• BOH earnings will have to come down
• BOH will have to revert back to selling at 14 time earnings

On January 5th, the investment bank Keefe, Bruyette and Woods (KBW) downgraded BOH because of expectations of lower earnings. KBW says that 2009 and 2010 earnings will be $2.60 for each year. This puts BOH's stock price at $36.40 if it were to trade at around 14 times earnings. Conversely, BOH would trade at $56.84 if it were to revert to the mean based on 2008 earnings of $4.06 (The Bank of Hawaii has estimated fourth quarter 2008 earnings of $0.89).

From the perspective of Dow's theory, BOH has three downside targets from the prior peak of $70 in September of 2008:

• $50.35
• $30.70
• $11.05

In the years from 1990 to 1997, BOH has retraced from the peak to between the 2nd and 3rd retracement levels according to Dow’s theory. If applied to the current price action this would bring BOH down to the level of $20.87. This would be the ideal buying point however we must be ready to pull the trigger anywhere between $30.70 and $20.87.

Considering that we're in a bear market it becomes necessary to decide how much an individual wants exposure to a bank in a deflationary environment. Assuming the worst, BOH could be viewed from the perspective of the "long-term" prospects based on the dividend. At the current dividend yield of 4.80%, BOH would double in approximately 15 years. This means that if you're of the buy-and-hold mindset then you would need to retain this stock for 15 years to recoup all that you have initially invested if you reinvest the dividends. This is a more accurate measure of the "long-term" in case you're wrong about the direction of the stock price. Additionally, BOH exhibits a 7 to 10-year cycle for price movement from trough to peak.

In the accompanying chart we can see that there have been two other major bottoms in the BOH’s stock price that were accompanied by a surge in trading volume. The current volume is giving similar indications as the 1990 and 2000 lows. All we need now is a good collapse in the price to reassure us of the opportunity to buy. That opportunity might come in the wake of BOH falling below the 52-week low of $36.32 reached on November 21, 2008.

BOH’s management has consistently rewarded shareholders for their patience and is likely to continue to do so. There are many ways to examine this company, however, be sure that you’re comfortable with investing in a bear market environment similar to 2008 before deciding to make your next purchase. Good luck in your research of this company. Touc.

Bear Market Rally Targets

The current rise in the stock market is moving along at a much healthier pace than was once seen from November 20, 2008 to December 15, 2008. We are now moving at a rate that will seem to trade in an uneventful range yet move incrementally higher.

As I stated in my post on December 10th, the market has three upside targets. Of the three targets for the Dow Jones Industrial Average, we have crossed the first, at 8943, with strong movement but weak volume. As of the close of market today, the Industrials are 609.90 points away from the next critical level on the index.

The Dow Jones Transportation Average has moved above the resistance level of 3692.57 by closing the day at 3717.26. This movement matched by the Industrials is proving constructive for the direction of the market.

The overall negatives for this stock market is the fact that volume hasn't been overwhelming. We need trading volume in the stock market to pick up in order to help confirm the trend. Also, the Industrial Production Index has fallen to 106.1173 in November from 106.7786 in October. While the Industrials and Transports are supposed to be leading indicators for the economy it would be nice to see the IPI move higher from the current levels but I wouldn't be surprised to see it move lower.

Research Rec.: Sysco (SYY) at $23.60

Today's research recommendation is Sysco (SYY). There are many reasons to like this stock however we're going to address the problems first.

Currently, the overall market is still in bear mode. There have been no clear signs that we're out of the woods yet. SYY has managed to double it's debt position during the years 2005 and 2006. SYY's debt to equity, according to Yahoo!Finance is around 57% which is pretty high in an environment where the capital markets are hesitant to finance even the best run organizations.The long term technical pattern of this stock has formed a massive head and should pattern which indicates that the stock price could fall further. Any decline below the long-term support level of $20 will bring the stock price down to the $9 level at minimum.

Now, let's focus on the redeeming elements of a company that has increased it's dividend every year for 31 years in a row. First, SYY is a surprising inflation hedge. Value Line Investment Survey says that, "...inflation accounted for roughly six percentage points of the total sales gain of 7.1% for the full year (2008)." When I compared the price performance of SYY against Agnico-Eagle (AEM), Newmont Mining (NEM), and Couer D'Alene (CDE) I found that from the period of 1970 until 1983, SYY was slow to get started in reacting to the inflation of the 70's and early 80's but in the end it beat all of these gold and silver stocks by a mile. According to Morningstar.com, on a total return basis, CDE came closest by peaking with a 192% gain in May of 1983 while SYY peaked with a 465% gain in January of 1983.



With a 4% dividend, SYY is yielding twice what Geraldine Weiss, founder of Investment Quality Trends, believes to be an undervalued yield. The payout ratio of the dividend is of particular concern in a deflationary environment like this and SYY has a 46% payout ratio which isn't great but it isn't all that bad either. Essentially, the current payout ratio indicates that SYY could have its earnings cut in half and still make the dividend payment.

According to Value Line Investment Survey dated October 31, 2008, SYY normally sells for 15 times cashflow. For 2008, SYY recorded a cashflow of $2.46 per share. This means that SYY "should" revert back to the mean price of $36.90 at some point in the future.

When Dow's theory is applied to SYY, I could only come up with the following figures for the upsided:

• $27.58
• $31.00
• $34.42

and the downside:

• $9.97
• zero

With SYY within 13% of the low, this stock is well worth considering for the Bear Market Rally that we're in. However, if you're of the mind that inflation is coming down the road, with all this liquidity being injected into the economy, then SYY might be a good "long-term" hedge against inflation. Good luck with your research of this interesting opportunity. Touc.

Altria Update...

Today Altria was down 4.40% in the face of a market that believes the zero interest rate policy of the Federal Reserve Bank isn't a sign that things might be worse than we think. I have managed to get the Dow Theory numbers for Altria's downside risk.

According to Dow's theory, Altria (MO), on an adjusted basis, is expected to fall to the following three levels:

• $11.15
• $8.09
• $5.00

There are those who consider Altria a shadow of its former self due to the spin-offs and the increasingly hostile regulatory environment. At the same time, the regulators will not ban smoking for some reason. Another reason to be cautious of this company is the fact the James Cramer, of CNBC ignobility, has been caught recommending this same company, a real drag on the stock price if you asked me. Watch these prices and do your research. Touc.

A Scheme by Any Other Name

When hearing the latest news regarding Bernard Madoff, head of the $50 billion dollar ponzi scheme, I couldn't help but ask the questions, was it a ponzi scheme or a pyramid scheme? What is the difference between Mr. Madoff's performance and a mutual fund's performance? Weren't they both managed by an investment professional of some sort? I guess one significant difference is the fact that Mr. Madoff was well respected by Wall street while the average mutual fund manager is not so well known or highly respected. I ask myself these questions despite the belief that I think I already know the answers.

First, it might be helpful to get a better understanding of what the difference is between a Ponzi and a pyramid scheme. A Ponzi scheme is described as, "profits that are promised from a fictitious source and early participants are paid off with the funds of new participants." A pyramid scheme is described as, "a money-making scheme in which people are recruited to make payments to others above them in a hierarchy while expecting to receive payments from people recruited below them." Honestly I can't discern the difference between the two but maybe someone can point out to me the distinction. However, this brings to mind what I have always felt is going on in the mutual fund industry.

It seems to me that mutual funds exist for the sole purpose of having new investors or new money added to their funds. If a mutual fund were to have a large portion of the shareholders sell, say 15-20%, then the fund would be forced to get out of stocks that it holds regardless of the high quality and low price that the stock was initially purchased at. As mutual fund shareholders sell then the others who had no intention of selling become fearful and consider withdrawing their funds. Things have gotten so bad lately that some "hedge" funds have withdrawn shareholders ability to get out when they want to. Why are investors not allowed to get out when they want to? Because if too many people got out at the same time then there wouldn't be enough money to go around. Does this not seem like a scheme of the pyramid or ponzi variety? It is no wonder that the prevailing mantra of the mutual fund industry, and their friends in the various media outlets, is buy and hold for the long term.

During the period of the 1960's there were momentum mutual funds that existed solely for the purpose of buying small illiquid companies so that they could push up the price of the stock and then sell those shares when other momentum funds would follow into those previously unknown companies. The value of the stock had no merit for rising other than the fact that a mutual fund was buying into it due to its lack of liquidity. This, of course, was a story that didn't end very well for the investors but it became quite lucrative for the fund managers.

Likewise, the period after 1929 showed that investment trusts, the mutual fund of that period, were essentially a legal form of a investment pool. Although the pooling of money was supposed to be outlawed, investment trusts ran amok controlling the price of company stock and forcing mergers of unlikely and incompatible companies. Another phenomenon of the late 1920's that we're only now seeing emerge and possibly fade just as quickly is the "fund of funds." This concept, the laziest of the lazy investing models, invests in other investment trusts that invest in stocks. If the era of the stock market wipeout in the 1930's is any indication these funds will be eliminated from the investment lexicon for some time or until the next mania in stock begins again.

At the time, all of these ideas seemed great yet in the end it was abundantly clear that the only reason that something is labeled a mutual fund and another is labeled as a ponzi scheme is the duration at which someone is able to hold onto their investments before getting out. Sometimes there is a gain and sometimes there is a loss. For the time being, many people are willing to accept the fact that their mutual fund is a legitimate operation despite the horrendous amount of their losses this year. But there will come the time when investors realize that, in fact, they have been taken for a ride. After all, the whole reason they invested in mutual funds was because they wanted diversification with the help of a professional money manager so that they would not have big losses. What will be the final trigger? What will make people realize that mutual funds are a financial product and nothing more? If an investment manager could lose 30% of someone else's money and be considered a success in 2008 then what will it take for an average person to become a better than average investor for themselves?

If only the small investor allows for the compounding of knowledge of the basics of investing there would be no need to hand money over to someone else to manage their financial affairs. A great book that outlines the exponential benefits of taking the time to learn about investing is titled, "Investing, The Last Liberal Art" by Robert G. Hagstrom. I wasn't introduced to this book until long after starting down this path, however I can attest to the virtue and remunerative benefits that have been accrued by doing my own research on the topic of investing.

Sadly, we're not at the stage where the small investor has learned to back away from the green felt parlor table. If history is any indication, we'll have to see even greater losses before the small investor realizes that the benefits of managing their own money far outweighs giving it away to the professionals for a fee. Touc.

Sources:

• Hagstrom, Robert G. Investing, The Last Liberal Art. Texere. 2000.
• Dreman, David. Contrarian Investment Strategy. Random House. 1979.
• American Heritage Dictionary, Fourth Edition. Houghton Mifflin. 2000.

Market Cycles

In the right hand column I have added the cycles for three different markets. The cycles that I have added are for the stock market, real estate market and inflation. These three are necessary for anyone who is interested in investing, saving or spending their money in the "long-term." As far as I'm concerned the long-term is only as long as you're willing to wait for the next cycle top. If a person doesn't have the time to wait until the next cycle top then they should be in the most conservative "guaranteed money" vehicles that are available. I have a section on the lower right hand column that quotes the most current money market and certificate of deposit rates that can be obtained.

First is the stock market which has, in general, a full cycle of 33 years from peak to peak or trough to trough. In the most recent period, the stock market had a run from the bottom in 1974 to 2007 (33 years). The period when the Dow went from 100 to 1000 took 32 years. When the Dow went from 1000 in 1983 until 10,000 which was accomplished in 17-19 years or half the 33 year cycle range.

Another perspective on the stock market cycle could be viewed from the length of prior bull and bear markets. In the preceding bear market when the Dow stayed at or below 1000 from 1966 to 1982 lasted for 16 years. The bull market in the Dow from 100 in 1942 until the high of 1000 in 1966 lasted for 24 years. When the Dow was at 100 in 1906 and didn't cross over 100 permanently until 1925 lasted 18 years. Obviously there are many ways to view the stock market cycles. I have chosen to use 33 year cycles until better or more convincing information comes along.

Next, we have the real estate cycle. There is only one source that I rely upon for real estate and that is Roy Wenzlick. Mr. Wenzlick's insights and statistical analysis of St. Louis and national real estate is unparalleled. The way that I found Roy Wenzlick was while thumbing through the 1987 book, "The Wall Street Waltz," by Kenneth Fisher. In the last paragraph referencing Mr. Wenzlick's real estate cycle chart we have this quote from Mr. Fisher, "The next long cycle trough isn't until 1990, which means that real estate has some bad years still coming- perhaps until 1992." When you add 18 years to 1990 or 1992 you get the next real estate cycle bottom in 2008 to 2010. As we are already in 2008 the bottom might be in however I'll opt for 2009 or 2010 just to play it safe. How prescient is that? What's more fascinating is that Mr. Wenzlick passed away in 1989 but his research on real estate is still useful. Mr. Wenzlick called almost all real estate cycle peaks and troughs since the initiation of his Real Estate Analyst newsletter in 1932.

Finally, we have the inflation cycle which has an inverse relationship to the interest rate cycle. The inflation cycle is much longer than the prior two cycles and lasts 50 years from peak to peak or trough to trough. As some readers will remember, our last peak in inflation was around 1980. From 1980 we have seen inflation slowly fall from double digit figures to our current level of nearly zero. Presently we are on track towards 25 to 27 years of a reversal in inflation. The only thing left before we're on that path is to get past the next couple years of disinflation/deflation.

A good book to refresh yourself on where we have come from and where we are going to, in terms of inflation, is titled, "Is inflation Ending? Are You Ready?" This book, written by Forbes columnist A. Gary Schilling, was published in 1983 and predicted everything that has happened since. The chapter titled "Apocalypse Now? The Risk of a Financial Collapse" is interesting since the subsection headings have titles that are eerily relevant to today. Some sample titles are:

• Thrift institutions: Why Merging the Strong and the Weak May Be Throwing Good Money after Bad (WaMu, IndyMac and Citigroup)
• Municipalities: Will Defaults Throw the Market into Turmoil? (California, anyone?)
• Financial Markets: Speculative Excesses Could Cause a Panic (Bear, Lehman, Merrill)
• Money Market Funds: The threat of a Redemption Stampede (recent breaking of the buck)

If you could have read this book back in 1983 then you probably wouldn't be surprise by any of the headlines that we see today.

The cycle information that I have provided on the right hand column is intended to be for reference purposes. I expect that as time passes these cycle periods will be reviewed and changed according to the quality research and data that I come across. I feel that as investors we should put all of our investments in perspective especially relative to the "big picture." Investing, saving or hoarding any other way would be spitting into the wind. Touc.

Sources:

• Fisher, Kenneth. "Wall Street Waltz." Contemporary Books. 1987. page 132.
• Shilling, A. Gary and Sokoloff, Kiril. "Is Inflation Ending? Are You Ready?" McGraw-Hill. 1983. page 151.

The Industrial Production Index

There are three components to Dow's Theory, the movements of the Dow Industrials and Dow Transports are the first two. The final piece to Dow's Theory was called Barron's Business Index or the Barron's Monthly Index of the Physical Volume of Industrial Production and Trade. Unfortunately, After contacting the statistics department at Barron's and the Wall Street Journal I was told that the Barron's Business Index was discontinued in 1938 leaving Dow Theory adherents without a reasonable "real-time" measure of general economic activity.

As an alternative, I have decided to go with the Industrial Production Index (IPI) published by the Federal Reserve Board. To get a detailed review of the viability of the IPI as applied to Dow's Theory, I strongly recommend that you get your hands on the book "Priniciples of Professional Speculation" by Victor Sperandeo. The nice part about the IPI is that when compared to the Barron's Index from 1919 until 1938, there is almost no difference between the two economic indicators. The most important concern about a business activity index like this is that it is as close to real time as we could get. The Industrial Production Index lags the real economy by 2 months at the most. This is contrasted by organizations like the National Bureau of Economic Research (NBER) which routinely reports 1 to 3 years after the fact that the economy has either hit a bottom or a top.

On the right hand column, I have added the final piece to the necessary elements of Dow's theory as was originally intended by Dow, Hamilton, and Rhea. You'll see the Dow Industrials, Transports and the Industrial Production Index. When all of these indices indicate that they are either falling or rising, at the same time, then you will know right away the general direction of the market. Also important is the relative values within the market. The relative value of the market is indicated by the Dow Yield indicator. This will tell you that, regardless of the direction of the market, there are either few or many investment opportunities in the stock market.

Now, let us look at the IPI and see what it could be telling us about the real economic activity from a technical analysis basis. On the chart below, I have included the IPI chart from 1996 until October 2008. From the period of Dec. 2001 until Jan. 2008, we see the rise of the index by 14.73 points. Using Dow's theory, the index is supposed to have support levels at 107.66, 102.75 and 97.84. After breaking through the first support level of 107.66 the index fell to the low of 105.95 in Sept. 2008 before rising to 107.29 in October 2008.

On the chart, I have indicated the resistance level (dark blue line) where the index needs to go above to truly confirm that we might be coming out of this bear market. If the IPI cannot go significantly above the 109.26 level, then the potential exists that the economy could contract even further. Any further decline in the economy could take us back to the 97.84 level, a 9% reduction in business activity.

So far we have the Dow Transports and Industrials with lows established on November 20th. The September low of the IPI needs to continue above the 109.26 level to resoundingly confirm the end to the bear market. Remember, the end of a bear market is not the automatic beginning of a bull market. Therefore, once the end to the bear market is confirmed we will also need confirming action in the indices to show us that a bull market has begun. Touc.

Sources:

• Sperandeo, Victor. Trader Vic II- Principles of Professional Speculation. John Wiley & Sons, Inc. 1997.

Dow at 208,210.50 or...

...What the newspaper headlines would have said at the peak back in October of 2007 if the Dow continued at the current pace when it was last trading at the same level back in June 1o, 1997.

This is the best way to determine if we're truly in a bull or bear market. back in June of 1997 when the Dow first crossed the 7539 level it took until April 2, 1998 before it reached the 8986 level. A grand total of 297 days or 4.87 points per day.

We've covered approximately the same number of points, 1381, in a total of 18 days. This averages out to be 76.77 points for each day. If the current rate of gains were applied to the Dow Jones Industrial Average back on June 10, 1997, we would have seen the peak in October 2007 at 208,210.50.

Since we're not in a bull market all that we can expect are bear market rallies which consist of violent moves up and painful moves down. A bear market rally can surge up to 50% or more in a matter of months as opposed to the years that it takes for a bull market.

Be mindful of the fact that in bear markets, buying stocks is the financial equivalent of catching falling knives. I expect this rally to be complete on or around late April 2009. Knowing this market, it could end long before or after that time frame.

The revision to my previous bear market rally upside targets are:

• 8943
• 9625
• 10,836.11

The most recent move to the 8934 was very close to the 8943 level but the Dow moved down in yesterday's action. A failure of the index to move strongly through the 8943 level could indicate significant weakness in the market and the economy over the next few weeks. Touc.

Research Recommendation: Altria (MO) at $14.99

Altria Group (MO), formerly known as Philip Morris, is the largest domestic produce of tobacco and tobacco related products. MO is currently trading within 5% of it’s 52-week low and has increased its dividend 42 consecutive years in a row according to Mergent Online. Because MO has spun-off its Kraft and international divisions within the last 2 years I cannot do a reasonable assessment of the stock price based on Dow’s theory.

According to Geraldine Weiss’ Investment Quality Trends (IQTrends), which tracks dividend paying companies, MO is undervalued when the company yields 5% or more. In periods before 2001, IQTrends viewed MO as undervalued with a yield of 6%. The current yield on MO is 8.5%. At the current yield, if reinvested in the company, the value of current funds invested would double in approximately 8 ½ years. This doubling of the value would occur provided the company maintains the current dividend regardless of whether or not the stock price rises.

WARNING: According to Valueline, MO has a projected dividend payout ratio of 75% for the year 2008 and 69% for the year 2009 after adjustments for the spin-offs. These payout ratios are extremely high for any company except for a utility. Any pressure on the earnings could result in a 100% or more payout ratio, this could result in a burn of the company’s cash stockpile or borrowing at unfavorably high interest rates.

To get a better understanding to the rational of this investment opportunity we need to consider the many external aspects that impact this stock. First, because of the Tobacco Master Settlement Agreement (MSA), MO is mandated to remain profitable so that it can pay its portion of this all-encompassing lawsuit. Furthermore, states have sold future revenue bonds based on the projected income the MSA was to provide. This fact has forced the various state attorney generals to enforce laws against any “illegal” activity from start-up tobacco companies that wish to operate outside of the state that they are headquartered. Because of the numerous laws that have been set up to protect the newly created tobacco oligopoly based on the MSA, MO has a lifeline that it ordinarily wouldn’t have if smoking was simply outlawed altogether. Aside from being outlawed and taxed 1,400% in an effort to end smoking due to its health risks, which didn’t work in England in the 1700’s, let us look at this company from a different perspective.

The very best analysis of a worst-case scenario on Altria is Jeremy Siegel’s research paper “The Nifty Fifty Revisited.” Although Siegel never intended for it to be an endorsement of buying MO, the paper gives the most compelling reason why MO is and always will be a preferred investment choice at almost any price. Siegel’s overall point in the paper is that if an individual were to invest in the highest P/E stocks at the peak of the stock market in 1972 then, despite the 50% decline in the Dow Jones Industrial Average that followed, investors would have come out ahead by a country mile.

Siegel goes on to examine the famous “Nifty Fifty” stocks of that era which experienced the inflation-adjusted loss in the market of 72% from 1966 to 1982. The ’66 to ’82 period was the second largest decline in the stock market since 1929. Despite this fact, MO returned, after-tax and adjusted for inflation, the highest return at a 13.14% compounded annual rate from the high in 1972 to 1995. Delving deeper into the abyss of data for a little more perspective, from the periods of 1920-1987, 1930-1987, and 1950-1987 MO has had a compounded annual growth rate of 11.37%, 12.17%, and 16.24%.

I personally bought MO when it was trading at $19 in early 2000 yielding 10%. Foolishly, I sold MO at $55 in 2002 for a ridiculous gain of over 200% in 2 years. Had I held on to the stock I would have benefited from the most astounding yield from a company that is among the best run companies, which is saying a lot given the amount of animosity it garners. Best regards in your research of Altria (MO). Touc.

Disclosure: I bought MO at $14.99 on 12/09/2008

Sources:

• Fairholt, Frederick William. Tobacco: Its History and Associations. Singing Tree Press. 1968.
  

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Precious Metals Not So Precious

Back in the old days, every good financial planner worth their salt would have recommended that a truly diversified investment portfolio contain at least 10%-15% of gold or gold stocks. This would have included a portion in real state (not REITs), stocks and bonds.

Generally speaking, there are different reasons why a person would hold each type of asset. Stocks would be held for "long-term" capital appreciation. Bonds would be held for income and real estate would be the inflation hedge. Gold on the other hand would be held if the government couldn't pay it's debts. You would never really want to be in the position of having to cash in on your gold position for obvious reasons. Instead, gold would be something that you pass on to your heirs as a just-in-case insurance policy.

I consider myself a precious metal investor of the most basic type. I do have 15% of my portfolio in gold and silver but I don't invest in gold and silver stocks. I consider precious metal stocks perpetual call options on the price of gold or silver. Therefore, I only speculate in the top gold and silver stocks, Barrick (ABX), Newmont (NEM), Agnico Eagle (AEM), Hecla Mining (HL), Silver Standard (SSRI) and Coeur D'Alene (CDE), when I see that the opportunity exists or that an "unimpeded" precious metal bull market is in place. Otherwise I stay out of precious metal equities.

Why do I stay out of gold equities except for the occasional speculative urges? As indicated in my previous articles on silver, dated November 25th, and gold, dated November 17th, there are market factors to consider before committing money to such a volatile portion of my investment portfolio that is dependent on both the price of gold going up and the general stock market not going down.

What confuses me about "gold bugs," as opposed to gold investors, is that as well informed as they are, gold bugs will not acquiesce to the idea that, generally, gold and silver stocks don't, can't and won't go up during a general stock market decline of 10% or more. Some gold bugs are willing to reference periods like 1929-1932 as a rational for why gold is a necessary hedge during a stock market collapse. To respond to such spurious claims from the gold bugs, I have included the price history of gold and silver stocks from 1924 to 1933. This data is from Poor's, the company that pre-dated the merger of Standard and Poor's.

The price data of the 21 precious metal stocks is resounding since it puts to rest the idea that, a decline in the general stock market would result in an increase in the price of gold and gold stocks. Even with the price of gold being fixed at a $20.67 per ounce, investors were not overwhelmed by the idea of jumping into gold stocks as the highest quality blue-chip stocks crashed 89% from 1929 to 1932.

Notice that some gold stocks ran up in price and peaked before 1929. For the remaining stocks that did peak in 1929, take a look at the high and then the low in 1930. All of these stock fell by at least 50% during this two year period. Some stocks would stabilize while the majority would collapse until 1931 or 1932. Once hitting their bottom in 1931 or 1932 the stocks would then recover, along with the rest of the stock market. The only gold stock from this era that still trades on the New York Stock Exchange is Newmont Mining (NEM). Newmont went from the hefty price of $236 in 1929 to $4.63 in 1932. After 1932, all stocks started moving much higher regardless of the industry group the company was in.

The lone glaring exception to this survey is Homestake Mining. I would have loved to have bought Homestake in 1924 at $35 and never have to watch it fall back to where I got in. However, Homestake is a special situation that is completely unrelated to the general conditions of the market. Homestake Mining has become the rallying cry for gold bugs despite the fact that there are numerous special situations that can be pointed out in other industries during the same timeframe. Homestake Mining will be the subject of future postings on this blog for an understanding of the reason(s) why it went up in price in the face of a crashing stock market.

The only reason that gold was a place where money flooded in periods of panic (1807, 1819, 1826, 1837, 1842, 1861, 1865, 1876, 1884, 1893, 1904, 1907, 1932) was because of government price fixing. If I lived through a panic during any of the prior periods and found that everything was falling in value but the official price of gold was being propped by the government then, of course, I would seek safety in gold. However, without a gold standard, the price of gold has proven to be at the whims of the market as a commodity. Unfortunately, gold bugs have mistaken gold as a safe haven during a panic for the wrong reason. This explains why James Dines, the world's renown gold bug, openly wondered in his October 31st newsletter, “…why aren’t the prices of gold and silver commodities higher…”

Again, when the general stock market declines 10% or more then gold and silver will likely fall as well and may actually lead the decline on a percentage basis. The purpose of these articles on gold and silver is ensure that the money invested is done with an understanding of the forces in play. Gold bugs, understanding the dire nature of the government's fiscal and monetary position, might not be taking an investment position in gold but protection against the government recklessness. For everyone else, gold and silver are true commodities and should be treated as such.

The long term trend in gold and silver stocks as demonstrated by the Philadelphia Gold Stock Index (XAU), which was initiated in November 2000, will eventually head permanently higher. The continuation of that trend will be among the key indicators that the bear market in stocks is at or near an end. Touc.

Sources:

• Dines, James. The Dines Letter. October 31, 2008. page 4.
• Poor's Publishing Company. Poor's High and Low Prices 1924-1934, 1934 Edition. 1934.