Rational Thoughts in an Irrational World

On Thursday we saw a continueation of Wednesday's gains. The S*P500 closed up 13.47 points to 1352.07, The Nasdasq was up 44.51 points and closed at 2360.92, while the DOW Industrials gained 108.44 points, closing at 12,378.61. Volume was high, but vastly lower than Wednesday's levels, so this would hardly qualify as any kind of bullish follow through day.

Yesterday's rally was helped along by the news that the White House and Congress have both agreed to provide heroin addicts with free samples of dope to end their withdraw pains...er I mean they are going to give the American consumer some extra money to blow. Tree cheers for stupidity, ready? Hip Hip Horrah!!! Ok, well that was only one cheer, but I'm not all that excited. Between the action that the Fed is undertaking and now congress America is starting to look more and more like a third world emerging market than ever before.

At this point in time we are in a bear market. My only concern with this is that there are a lot of people who now agree with me. The TV stations are dragging out the Prudent Bear Fund (Always bearish no matter what) guy and you are seeing the people who tell you that “In the long term equities always work out” less and less. The crowd is generally wrong, however there can be exceptions to this. Recall the bull market of the late 90's and into early 2000. Everyone knew that equities could do nothing but go up, and do so forever. It ultimatly set people up for heartbreak and loss – but for a certain amount of time the crowd was right, and right in a big way that only massive greed on the part of the crowd can produce. Is it possible that this time we will see the same thing in reverse? I don't know,and I hope not. One thing to keep in mind is that it really is not terrible right now, certainly not as bad as the media and the politicians are making it out to be. If you listen to Hillary Clinton too often you'd be pleased to look out your window and find out that the soup kitchens have not yet arrived in your neighborhood...you must be one of those lucky rich people who makes over $75,000 a year.

The trends overall remain down, and pretty strongly so. Next week the Fed meets again, and they are expected to lower rates half a point again. If they don't produce this rate cut then prepare to batton down the hatches. In a bear market rallies tend to be sudden and swift, often producing large gains. Its interesting to note that 7 of the 10 biggest one day moves in market history have occurred in bear markets.

Currently I think that the best course of action is a cautious one. Ive been 90% to 100% in cash on my client accounts and personal accounts since mid November, and playing with extra caution when I do come out of my bunker. I don't expect that this will change for some time. Yesterday I did buy a small amount of CSX as it broke out of a nice base and continues to show strong EPS growth, though I am a bit worried that Revenue Growth is not keeping up with Earnings, so I will be keeping in on a tight leash. Over the next few days I will also be watching the DXD (Twice Inverse DOW) for a potential entry, but as I have said caution will be my primary stance until I see a change in the market

 

went on a web tv show for cnbc on monday and it was an indian cnbc,one of the ads said check out moneycontrol.com, went there and they said that a lot of asian and indian brokers could not come up with margin and were liquidated and i was surprised when talking heads on U.S msnbc said they sold off because of bush bailout plan the tv website was quicksilverscreen.com and then live streaming{i think}and then news tv options

 

Why the Price to Earnings Ratio of a stock matters.

The Price to Earnings ratio is a simple measure that takes the Price a stock is trading at over the years EPS. As an example if a stock is trading at $10.00 per share and has earnings of $1.00 its price to earnings ratio would be 10. As a general rule short term traders, momentum investors and others are taught that the price to earnings ratio does not matter. I think that this can be a mistake, and the longer out your time frame goes the bigger that mistake can become. Stocks with high price to earnings ratio's are generally over owned and over loved by institutional investors, this can become particularly dangerous in a market route, such as we have seen over the last few weeks, when everyone heads for the same exit at the same time. Many times a stock with a low multiple is one that is not heavily owned yet for any number of reasons: It's average volume might be too small, its sales not high enough yet, market cap considerations and any number of other reasons.

The price of a stock basically can appreciate in one of two ways: EPS expansion and or PE expansion. If you can get both of them working in your favor I tend to think of it as a form of leverage. Let me give you an example. Lets assume we have two stocks, I'm just going to call them A and B. Both stocks are trading at $20.00 per share and will experience EPS growth of 40% over the course of the next year. Stock A is heavily owned and trades with a PE of 25, earnings of $0.80 per share. Stock B has overall sales under $100 million so it is largely overlooked by the traditional players on The Street. As a result it only carries a Price to Earnings Multiple of 10, the over all EPS being $2.00 per share.

As stated above, over the course of the next year the EPS of both companies will expand by 40%. company A will now have EPS of $1.12 per share, while company B's will have grown to $2.80. As a result of Company B's continued growth sales are now above $100 million and certain firms that have overlooked it in the past are now covering it with buy recommendations. This has resulted in more demand for the stock, pushing up the average daily volume which has brought more attention to it and so on. Everything has remained pretty much the same with company A. It now trades at $28.00 per share, based upon earnings growth, and has given a healthy 40% return to shareholders. However, because of the increased attention company B's price to earnings ratio has grown from 10 to 12, so now with its EPS of $2.80 the stock trades at $33.60 per share, a gain of 68% on the year.

Both companies have given shareholders superior returns, and most investors would have happy to have had either company in their portfolio. Company B though had more explosive potential though, the result of being an undiscovered name to most of the street. The examples and figures used above are obviously simplifications used for the sake of example. In real life there are a number of factors that can lead to the Price to Earnings ratio of a stock being lower then that of its peers. Careful investigation as to reason for the low PE is needed, otherwise what looks like gold today could turn out to be nothing but fool's gold tomorrow.

It is worth noting that buying a stock simply for its low PE is probably more foolish than not buying one because of a high PE. There are a number of factors that can cause the stock to trade at a low multiple, some of them favorable to you, most not. It's important to learn how to sort the gold from the fools gold. In another article I will cover what traits to look for, and what traits to avoid, in stocks with a low PE. Until then I hope this have given you some food for thought and will help you head in a more profitable direction with your own trading.

Brandon Fredrickson

 

in oct '87 the pe of the dow was avg 28,that was one of the reasons used to explain the 1000 pt drop from 2800 to 1800,the last 500 in one day, do u know what todays pe is?

 

Something around 18.

 

Despite gapping higher on the open, all three major indexes broke down and closed near their daily lows. The Dow Industrials Closed down 171.44 points to 12,207.17. The Nasdaq Composite, which had gained 2% on the open, suffered a 3 1/2% swing and reversal of fortune, Closing at 2326.20 which was pretty much the low for the day. All of the other major indexes pretty much played out the same way. Volume was lower across the board, both on the Nasdaq and the NYSE, though very erratic volume patterns can be a classic bear market trait.

The trade over the next several days will most likely be marked by anxiety over what the Fed is going to do at this weeks meeting: Do we get a quarter point, a half point, or nothing at all? There are good arguments for each of those scenarios, the least likely in my opinion being no cut at all. Much to our (The American People's) misfortune we seem to have a Fed that is paralysed by the tricky situation it finds itself in. Since we no longer have a real economy, but one based upon services and consumption rates need to be kept low so that homeowners and business' have the easy credit they have grown so used to having. On the other hand the lower rates are leading to a terribly weak dollar and inflationary figures not seen in decades. Of course in the next report they might come up with a new calculation and say “ Well since housing is down so much, its offset everything else and so there is no inflation.”. After all, if they can get away with including food and energy prices in their numbers, I would not trust them to anything. The Saint Louis Fed recently published a study that states that the United States government is very near insolvency. I downloaded the PDF of the report, because I doubt they will keep it on their site very long. If anyone is interested in having a copy of it (its about 25 pages long) email me brandonfredrickson@globalccs.net and I will get you the report.

Each weekend I start off looking at the 197 leading industry groups according to Daily Graphs. I try to spot sectors and groups that are starting to show signs of life, and I must say I did not have a lot of luck this weekend except in one place, and it was an unexpected one: Homebuilders.

With rates back down near historical levels and the Fed eager to bail out Wall Street yet again the fate of many of the homebuilders looks better now than it did just a few short weeks ago. The S*P has a Homebuilders trust which trades under the symbol XHB which traders can keep an eye on. Personally, I have my eye on PHM and TOL. I'd like to see them pullback on light volume to some support. If this occurs I will enter a small position in both of them, possibly offset with some XHB shorts to reduce exposure. Obviously I do not feel this is the time to be aggressively pushing to pull money out of the markets. I know that when brokers are trying to cheer up investors and give them some rah rah rah you hear the saying “You have to buy when there is blood on the street”. Well, I'm here to tell you that I've had a very successful decade long run in the market, and whenever there was blood on the street the only way I did not end up contributing my own blood to the mess was to walk to the next block. Good Risk management and Money Management must always be your primary goals: You won't make anything tomorrow if you go broke today.

 

What in the world is it that makes us think that a bunch of power hungry Washington Political types and money mad financiers could get together and create anything other than a mess? Well obviously we, the people of the good ole USA do. It's worked out so well that our dollar today is worth about 5 cents in 1913 terms (1913 being when we got a central bank). Here is the ramblings of some nut job Randite in 1966 : In the absence of a gold standard, there is no way to protect savings from confiscation via inflation. The financial policy of the welfare state requires there be no way for the owners of wealth to protect themselves.

Of course later in life this Randite discovered that real power lay in DC, he went on to serve as an Economic Adviser to President Ford, and of course later he became the Maestro, and master currency deflater we all know as Mr Greenspan. Mr Bernanke seems to be eager to follow in his steps, and why not? No one is paying attention that they no longer report M3, it did go from $6.6 trillion in January of 2000 to $10.2 Trillion on March 23rd 2006. Another trillion to trillion and a half has been added since then, but because they don't report it maybe its more, maybe its less.

Why is price fixing a crime when business does it, but thats what the Fed is chartered to do? Questions, Questions, Questions...but not much for good answers.

Oh, I've changed my stance on the market now after all this fun. I had become very bearish in November and have spent the entire time from then till now heavily in cash with a few shorts. Overall I'm pleased with the performance.

Over the last few days though we have started to see some beaten down sectors pick up, and started to see decent moves on decent volume. I'll be picking up small amounts of Homebuilders, Semis, Truckers and the like. Small shares for now. The real test will be on the pullback. Internationally both Chile (ECH) and Malaysia (EWM) look like good places to have some money. I also suspect, though I'm not yet prepared to put money on it, that the dollars decline is done for the time being, and that oil is not going to continue going up, that its topped for the near to intermediate term. (USO)

Posted by Brandon at 6:26 PM 0 comments



Monday, January 28, 2008
Trade Ideas
The chart work I did this weekend has led me to think we are in for pretty much more of the same, that is to say selling. The one possible exception to this, as I pointed out in the main post for today, is the homebuilders. Based upon rates being back near historical lows there is some hope that they can recover, thus some of them have rallied strongly and will offer lower risk buying opportunities on light volume selling.

Stocks that I will have orders in for today are all on the short side as of this moment, and I don't see that likely changing. I'll be watching CAT, BA, ERJ, TXT, TWX and KLAC all for short opportunities upon breaking Friday's lows: Be cautious of gaps down however as in that case I do not enter right away, but rather wait for the first pivot point to establish itself and then use that as my entry price.

As I get more comfortable using this blog I will include charts with commentary on some of the picks, which will only be found on this blog and no place else.

 

One of the most powerful tools available to a trader who watches chart patterns is something we call relative strenght. Relative Stregth is a pretty simple concept: How well does this stock, or group of stocks, peform when compared to the major market indexes over the same period of time. A popular method of finding trading opportunities is to look for the stocks that do not pullback much when the market declines, or to look for stocks that do not rally as much when the overall market does. Attatched you will see a chart of AAPL, which over the last several days has shown a strong degree of relative weakness even as the overall market rallied. I will be looking to short it should it trade lower and break the current base.

 

So the economists finally come around to realize what hey!!! We have a ressesion going on. They could have just talked to my dad about that, things in his business have been going downhill for nearly a year. My dad is a contractor. First of all he was hit by commodity prices rising at levels never seen before. He was able to adjust to that though by doing what most other contractors did, which is to not gaurantee the price of copper and other metals. That worked out okey and the world spun just as it should. About six months ago though people stopped paying. A lot of the construction business is done on credit, and contractors depend upon the credit worthyness of their clients, and construction supply stores depend upon the credit worthyness of the constractors. The clients my dad has are mostly business, clients like Sour Danfass, Ball Corp, Pella Windows, Barilla and a host of local business. About six months ago he started to notice that more and more of his clients had accounts past due, about 1/3 of them. Well its gotten even worse and now over half of his clients are at least 90 days past due in payments that they owe him. Some are trying to arrange to pay less, others just ignore his calls all together. His situation is not unique, every one of his friends in the same business are experiencing the exact same thing. This is not in a place that got overheated like Florida, or a state in an obvious recession like Michigan. This is in Iowa, rural Iowa where the ethonol boom is still making some people wealthy beyond what they ever thought could happen to them. So, its good to see the economists finally come around to see what businessmen have known for some time. Another friend of mine owns a t-shirt store near Siesta Beach in Florida, his sales are the worst they have been since the late 80's, he is thinking about just closing the store and finding something else to do.

 

On Tuesday surprisingly bad service sector data did the market in before it really even had a change to get going. American markets joined their global cousins in a route. The Dow Industrials lost 370 points, closing at 12,265.13, while the Nasdaq lost over three percentage points, down 73.28 points, closing at 2309.57. The more broadly based S*P500 also got hit hard, losing a little over 44 points and closing at 1336.64. Unlike yesterdays decline on light volume, volume was heavy across the board today. This would suggest that the Bear Market in Equities remains alive and well at this point. Long term and short and intermediate term investors/traders should remain heavily invested in cash, though some sectors are starting to show some signs of being “sold out”.

To continue reading this commentary please visit my blog @ www.brandonfredrickson.blogspot.com