Stock Market Commentary
May 20-21, 2006 Newsletter originally posted at http://www.BeginInvesting.com.
QUOTE OF THE WEEK
"A collapse in U.S. stock prices certainly would cause a lot of white knuckles on Wall Street. But what effect would it have on the broader U.S. economy? If Wall Street crashes, does Main Street follow? Not necessarily."
- Ben Bernanke
MARKET NUMBERS AS OF FRIDAY, MAY 19, 2006
S&P 500: 1,267.03
10-Yr. Bond: 5.054%
DAVID KORN'S NEWSLETTER EQUITY INVESTMENT PORTFOLIO
This portfolio is based on an asset allocation consistently entirely of equities (when fully invested). It does not include fixed income (i.e. bonds) which would be more appropriate for some investors -- especially those approaching or in retirement.
25% Vipers (Ticker: VTI) Cost Basis: $108.24 (Current Price: $126.37)
25% S&P 500 Index Depository Receipts (Ticker: SPY) Cost Basis: $101.33 (Current Price: $127.08)
10% Spiders Select Technology (Ticker: XLK) Cost Basis $19.44 (Current Price: $20.07)
4% Semiconductor Holders (Ticker: SMH) Cost Basis $36.94 (Current Price: $35.18)
2% Plantronics (NYSE: PLT) Cost Basis: $27.33 (Current Price: $22.07)
2% Time Warner Inc. (NYSE: TWX) Cost Basis: $17.80 (Current Price: $17.45)
4% Applied Materials: (Nasdaq: AMAT) Cost Basis: $17.34 (Current Price: $17.00)
4% Rising Rates Opportunity ProFund (Ticker: RRPIX) Cost Basis $22.17 (Current Price: $22.14)
5% iShares MSCI Japan Index Fund (Ticker: EWJ) Cost Basis $9.80 (Current Price: $14.48)
4% Sanofi-Aventis (Ticker: SNY) Cost Basis: $39.04 (Current Price: $46.69)
2% Microsoft (Ticker: MSFT) Cost Basis: $27.05 (Current Price: $22.56)
**13% Cash Held in Vanguard Prime Money Market Reserves yielding 4.71%)
** See note below reflecting transfer from ING Direct.
DAVID KORN'S WEEKLY STOCK MARKET COMMENTARY: Stocks continued their descent as investors got spooked, whether rightly or wrongly, with inflation jitters. For the week, the Dow declined 2.1%, the S&P 500 declined 1.9% and the Nasdaq Composite declined 2.2%. The Russell 2000 fared the worst, declining 2.7% and the Wilshire 5000 declined 2.0%.
I received more subscriber e-mails this week than I have received in the last three years. There are a lot of nervous investors out there, at least judging from the inquiries I am getting. I believe I have responded to every single e-mail, but if I didn't let me know because it might mean it didn't come through. On that note, and before I get to the topic at hand, I would like some input from you. I still use "Special Alerts" to send out e-mails during the week, especially when I am making a change in my newsletter portfolio, or to discuss something that I think is important. I always wonder whether subscribers would like more of them, or less. If you care to weigh in on this, drop me a line.
Ok, now let's get on with the stock market. The "correction" continues. I purposefully use that term because I am not convinced this bull market is over. Stated differently, I do not think we have begun a bear market descent. In fact, I think this correction was overdue and it coincided with several events including the seasonally weak period of the stock market falling just on the heels of a cyclical bull market high, and at the same time the Fed Funds rate rose to 5.0%.
What is a correction? Let's see how Investor Words defines it.
Definition: "A reversal of the prevailing trend in price movement for a security. The term is most often used to describe a decline after a period of rising prices. A correction is often considered beneficial for the long term health of the market, in that the prices had risen too quickly and the drop put them back to more realistic levels." http://tinyurl.com/gbcq5
The most important part of that definition is that a correction is considered a positive for the market. The benefit of a correction is that it can help prolong a bull market, once the correction ends of course.
What differentiates a "correction" from a "bear market"? For some, the distinction is simply the amount the market declines. For example, Wikipedia, the world's encyclopedia, defines it as follows:
"A market correction is sometimes defined as a drop of at least 10%, but not more than 20% (25% on intraday trading)." http://tinyurl.com/lppwv
I think that definition is a little to rigid, as if you went by that definition it would mean we haven't had any corrections during this entire bull market going back to October 2002. I strongly take issue with that, having personally been fortunate enough to identify several inflection point buying opportunities for my subscribers during that time frame after the market had declined well over 5%. I personally use 3% to define a correction. I do think, however, that the term is really just a matter of semantics.
A 10% or more correction, however, could easily be in the cards. For the last couple of years when my newsletter has included the analysis of the cyclical bull markets that occurred during the last two secular bear markets, I pointed out repeatedly that each of those cyclical bull markets had at least one correction of 10% or more. At least one. In one sense we are overdue.
So, how far has this correction taken us? You might be surprised when you look at the numbers. That's why I like to crunch them daily and weekly.
STOCK MARKET DECLINES OFF OF CYCLICAL BULL MARKET HIGHS
DOW JONES INDUSTRIAL AVERAGE
Closing Bull Market High on May 10, '06: 11,642.65 Close this past Friday, May 19, 2006: 11,144.06 Percentage Decline from Closing High to Present: 4.29%
S&P 500 INDEX
Closing Bull Market High on May 5, '06: 1,325.76 Close this past Friday, May 19, 2006: 1,267.03 Percentage Decline from Closing High to Present: 4.43%
Closing Bull Market High on May 5, '06: 13,457.30 Close this past Friday, May 19, 2006: 12,811.80 Percentage Decline from Closing High to Present: 4.8%
Closing Bull Market High on April 19, '06: 2,370.88 Close this past Friday, May 19, 2006: 2,193.88 Percentage Decline from Closing High to Present: 7.47%
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What do the foregoing numbers tell us? For starters, the Dow, S&P 500 and Wilshire 5000 haven't even corrected 5% yet. I am not trying to minimize the correction, just to simply point out that the correction thus far has been relatively contained.
How does the current correction stack up against history? Well, if you assume we are in the first cyclical bull market of a secular bear market that began in 2000, a good comparator might be the first cyclical bull market that occurred during the secular bear market from February 9, 1966 to August 12, 1982 (which happened to be the last secular bear market).
During the first cyclical bull market of that time frame, which lasted from October 7, 1966 to December 3, 1968, the Dow had several corrections (above 3% according to my definition) in the following amounts:
1st correction: 3.83%
2nd correction: 4.26%
3rd correction: 3.76%
4th correction: 6.27%
5th correction: 9.92%
6th correction: 12.52%
7th correction: 5.85%
If you take the average of those seven instances, the average correction amount would be 6.63%.
The Nasdaq Composite has corrected a little more than the broader market, but nothing out of the ordinary. In fact, I would call the Nasdaq's percentage correction quite normal. During past corrections, the Nasdaq usually ended up being down about twice the level of the broader market by the time the correction was over. The Nasdaq looks to be headed on that normal track and you would expect its declines to be more pronounced given that it is comprised of high tech and growth stocks which are more volatile.
Still, the Nasdaq has its own issues. Notice in the number crunching section, the Nasdaq reached its cyclical bull market high in April, and failed to reach a new high in May when the other indices did. The declines in the Nasdaq now bring it to a level where it is testing its long-term uptrend. Check out the chart, courtesy of the folks at Chartoftheday at this url: http://tinyurl.com/zuovv
Its not just the stock market that has corrected. It looks like the buyers dried up a bit as Gold rose above $700 reaching a 26-year peak of $730. As I stated last week, I certainly wasn't willing to chase gold at those levels and that remains to be the case. Gold plunged this week, with gold for June delivery down to $657.50 an ounce. Gold is in its own corrective mode, having declined about 10%, its steepest "correction" since 1983.
Other metals have seen similar declines. Silver is down 17% from its 25-year high last week. Copper is down 12% since its all-time high close last week.
There is some good news, at least in the short term. The impact on this correction has improved the sentiment picture greatly with investors showing a lot of fear. In fact, some (but not all) of the sentiment indicators are showing very bearish signs which, from a contrarian standpoint, is bullish for the market and would certainly provide support for a bounce in equity prices. Let's take a look.
CBOE Put/Call Ratio: The put/call ratio closed Friday at a very high 1.27. The 10-day moving average is 1.11 and the 21-day moving average is 0.98. I put this sentiment gauge first because we can get a current reading from it (versus a lagging report like Investors Intelligence) and it is my favorite indicator for near-term sentiment. These numbers are very high, showing a lot of fear among options traders. This is very good to see, and could well support a bounce higher in the near term.
HSNSI: The latest readings from the Hulbert Stock Newsletter Sentiment Index (HSNSI), which reflects the average stock market exposure of a group of short-term market timing newsletters tracked by Hulbert Digest is showing some very encouraging readings. As of Thursday, the HSNSI stood at 6.0%.
Contrast that to May 10th (the day before this correction began), when the HSNSI stood at 48.6%. Read Mark Hulbert's article, "The stock market as bucking bronco" at the following url: http://tinyurl.com/mc3v2
Rydex Nova/Ursa Ratio: The Rydex Nova/Ursa Ratio is down to 0.11. That is the lowest level in a VERY long time. A bullish indicator.
Investors Intelligence: In the latest readings, the number of bullish advisors as measured by Investors Intelligence increased from 44.3% last week to 46.3% this week. The number of bearish advisors declined from 26.8% last week to 25.3% this week. Using the formula [(bulls)/(bulls + bears)], the sentiment ratio comes in at 64.66%. The four-week moving average is 61.60%, about the same as last week. Nothing too out of wack on this indicator. I will be very interested to see if next week's numbers show a big decline in the number of bears.
AAII: According to the latest poll conducted by the American Association of Individual Investors, 39.4% of individual investors are bullish and 43.6% are bearish this week. Using the formula [(bulls)/(bulls + bears)], the sentiment ratio is 47.46%. That is a very good number.
Money Flow: According to AMG Data, in the week ended May 17, 2006, equity funds reported net cash outflows of $3.9 billion. Excluding ETF activity, equity funds reported net cash outflows of $388 million with Domestic funds reporting net outflows totalling $1.08 billion.
All in all, a lot of fear from investors who are running scared from the market. From a short-term contrarian standpoint, that is a bullish sign.
Intermediate term, however, is a different story. One possible scenario is we get a good bounce, and then a more serious correction happens a little later. Longer-term, the bull still appears to be in tact for now.
Rising Rates Opportunity ProFund (Ticker: RRPIX)
I will be selling my position in the Rising Rates Opportunity ProFund if it reaches $22.00. I think it has a good possibility of hitting that this week. Even though long term rates were rising, the Fed is clearly committed to fighting inflation and the recent pullback in long-term rates I think reflects that view.
* * * *
Time to check in with Bob Brinker.
TACTICAL ASSET ALLOCATION WATCH
Editorial Comment ("EC"): Here is how the major market indexes have performed (excluding dividends) since Bob Brinker's timing model turned "favorable" based on the S&P 500 Index's close on March 10, 2003, and he recommended investors redeploy their cash reserves into a fully invested position by bulletin issued at 2:00 a.m. on March 11, 2003:
S&P 500 Index: Up 56.91%
Dow Jones Industrial Average: Up 47.24% Nasdaq Composite: Up 71.65%
For those of you who also followed Bob's recommendation to invest anywhere from 20% to 50% of your cash reserves in the Nasdaq 100 (QQQQ shares), here is how those shares have performed based on various times Bob recommended that security:
October, 2000 (Original Recommendation using $83.12 as entry price): Down 52.66% January, 2001 (Second Recommendation using $62.44 as entry price): Down 36.98% March 11, 2003 (Third Recommendation using $24.06 as entry price): Up 63.89%
OPENING MONOLOGUE: OVERVIEW OF LATEST MARKET NEWS
Brinker Comment: Bob opened the weekend noting that there was a lot going on in the markets last week and a lot of volatility. The S&P 500 declined almost 1.9%. There were also big declines in the commodity markets and on interest rates as well. The 30-year yield is now down to 5.14% which is considerably below the levels that prevailed in June, 2004 when the Fed Funds rate was 1.0%. There was also some good news on the inflation front this week. We had a benign reading in the Producer Price Index Reported this past week.
EC: That was the only comment Bob made on the Producer Price Index (PPI).
The PPI measures the costs of goods before they reach stores shelves. In April, the PPI rose 0.9%, following a 0.5% increase in March. However, the good news that Bob was referring to is that excluding energy and food products, the "core" PPI only rose 0.1% for the second month in a row.
Check out the PPI report for April at this url: http://tinyurl.com/njb7a
Brinker Comment: Consumer prices at the "core" level continue to behave themselves with the core CPI coming in at a 2.3% annual rate. That compares almost exactly with the full 2005 core CPI which came in at 2.2%.
Gasoline prices remain high which is starting to have an impact on consumer habits. We saw this occur after Hurricanes Katrina and Rita. Last September and October, four out of ten consumers surveyed reported that the were dining out less and traveling less and 80% of shoppers said they were feeling the negative impact of higher gasoline prices with 60% saying they were going to drive less. Bob found interesting a survey showing that many shoppers were reducing major purchases accordingly. When you get gas prices at these levels, you have less money to spend on other purchases.
The good news is that there are indications that the new Fed Chairman is aware that rising gasoline prices acts as a tax on consumers. Bob said there is no question that it is a counter-inflationary force. Of course it increases the prices of gasoline and oil products and transportation, but it hasn't really spilled over elsewhere. Consider that energy prices are through the roof in the last year, yet the core consumer price inflation is up a measly 2.3% year-over-year which is now updated through the end of April. For all of 2005, it came in at 2.2%.
The headline inflation number, which does include energy prices, is up 3.5% on a year-over-year basis, and even that is down from the time frame after hurricane Katrina, when the headline year-over-year CPI peaked at 4.7%.
There has been a considerable change in terms of that number.
EC: Read the Consumer Price Index report for April at this url: http://tinyurl.com/84b4d
Brinker Comment: The Federal Open Market Committee (FOMC) meeting will reconvene for a 2-day meeting on June 28-29, 2006. The FOMC has stated that future interest rate decisions will be "data dependent." Thus, the members of the FOMC will be pouring over all of the economic data between now and the June meeting in order to make a determination as to whether to make any change in monetary policy. The monetary policy has been stingy for a while and that is the primary reason you have seen inflation contained.
EC: Bob's comments this weekend make clear to me that he still is bullish on the stock market, albeit open to the possibility of a correction as he has stated recently. The main point I took from his comments was that he still views the inflationary picture as benign which is an incredibly important point insofar as his stock market timing model is concerned -- particularly the Valuation Indicator which Bob places the most emphasis on.
Bob's view on inflation is reassuring as traders on Wall Street used the latest inflation data to sell stocks on the news. It wasn't just traders either. St. Louis Fed president, William Poole, said Thursday that the risks on the inflation side "are tilted to the upside." Check out the article entitled, "Inflation risks tilted toward upside: Poole" at this url: http://tinyurl.com/g9z2p
Caller: What do you think about the market's decline the past few days?
Bob said his take on it is what J.P. Morgan said, which is that "stocks tend to fluctuate." Bob said he thinks Morgan had it right with that comment.
EC: This requires a little interpreting, but I think the message is fairly clear. Bob doesn't view the market action as anything other than an ordinary reaction during a sustained bull market. Bob has often referred to corrections of the current magnitude as "noise" meaning they weren't stuff that you really should pay attention to and as far as his timing model was concerned, would be considered a non-event.
ANALYZING RENTAL PROPERTY
Caller: This caller owns a condo outright which he rents out and wanted to know if it was a good investment. Bob said you need to analyze each rental property as its own business proposition and the best way to do it is using a cash-on-cash basis. First you determine the market value and how much you could get if you sold it through a broker. The caller said it could be sold for about $275,000. Bob then asked how much rental income he receives. The caller said after he pays everything (such as taxes, insurance, maintenance, etc.) he pulls in about $5,000. Bob said that wasn't very good as it represented a total return of less than 2%. The only way it could work is if you were getting annual capital appreciation of the property such that you were getting a reasonable rate of return. What's reasonable? Bob noted that you can get 5% on a risk free U.S. Treasury without being required to go that far out in terms of maturity. In Wall Street, the technical academic definition of a risk-free rate is the 91-day Treasury Bill. For purposes of a rental property, Bob said it is fair to use a short to intermediate term Treasury Note. Using the 5% yield on a risk free Treasury, Bob pointed out that you would have to be making about 3.25% capital appreciation each year just to get your return up to a Treasury.
The caller said it had been going up in value, but he didn't foresee that happening going forward. Bob said if he owned property worth $275,000 that was only pulling in $5,000 in cash, with little chance for price appreciation, he would sell it. The other factor you have to consider is taxes. Bob said even if the entire property was all profit, the maximum federal tax rate would be 15% and whatever state taxes that would be on top of that. The good news is that you can reinvest the money and get a market rate of return.
EC: Here is a link to a free web calculator which can be used to examine your return on investment generated by rental property and the effect that mortgage borrowing has on the returns generated: http://tinyurl.com/9vyko
Caller: This caller says he is way way up on his investments in commodities like oil and gold that he purchased a while back, despite the recent drop.
Do you think this might be a good opportunity for buying these commodities?
Bob said it depends if you believe in the Super Cycle theory which says that commodity prices will go straight up because of China which has been expanding dramatically. If you believe that people are extrapolating past trends into the future incorrectly, then you subscribe to the commodity bubble theory.
EC: If this is a topic that interest you, Citigroup Smith Barney has published an article entitled, "China - The Engine of a Commodities Super Cycle" which you can access at this url: http://tinyurl.com/qe8f7
Caller continued: The caller then asked Bob what theory he subscribes to.
Bob said he doesn't really make forecasts on commodities. He has his hands full forecasting the stock market and the bond market. The whole area of predicting and forecasting commodities is not something he is involved in.
EC: Bob may take that position now, but for a long time he was forecasting gold as a bad investment as a search of my newsletter archives revealed to me. Now that gold has gone through the roof, however, I guess he is out of that forecasting game. Also, last year he stated unequivocally that he doesn't forecast interest rates. Query: Can you forecast the bond market without forecasting interest rates?
EC#2: I am of the opinion that certain commodities are going to see a steep decline at some point, so I would lean toward the bubble camp. At least one person who is smarter than me agrees. Warren Buffet in his question and answer session at this year's annual meeting of Berkshire Hathaway said he thought there was a bubble in metals and oil. I am going to link to an article that summarized the Q&A, but here is a direct quote from the article which paraphrased what Buffet said on this issue:
Buffet: "I don't think there's a bubble in agricultural commodities like wheat, corn and soybeans. But in metal and oil there's been a terrific [price] move. It's like most trends. At the beginning, it's driven by fundamentals, then speculation takes over. As the old saying goes, what the wise man does in the beginning, fools do in the end. With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant." http://tinyurl.com/prfj4
Caller: This dental technician and has accumulated a lot of gold scrap from the discarded scrapings and such. He has about 10 ounces which Bob commented could be worth around $6,000. Bob said if he had $6,000 worth of gold scrapings, he would turn them into cash. Bob said he wasn't predicting where the price of gold was going since he doesn't predict gold. This provoked about 15 minutes of Bob and other callers discussing about whether dentists are returning gold to the patients now that the price is so much higher.
EC: Excuse me for a minute while I go floss.
Caller: Every month this caller buys a savings bond for his grandson who won't have access to the money for 20 years. He usually buys I-Bonds, but he saw on the Treasury web site that EE savings bonds will be paying more over then next six months than the I-Bonds. Bob said that is true.
However, EE bonds are not indexed against inflation. Thus, if you buy an EE bond through the end of October you will get a fixed rate of 3.7% for the first 20 years of the bond, but that is all you get. You don't get any inflation protection. Suppose down the road inflation is at 4% or 5%, you will still be getting only 3.7% from the EE bonds and this is where I-Bonds have to be given serious consideration, even though it is true that the yield is only 2.41% for the next six months. The inflation pay-through on the I-Bond right now is very low at 1.0%. Going forward, Bob thinks there will be times when the inflation pay through is much higher. Bob said if he had to purchase a savings bond right now and he had to decide between an EE bond and an I-Bond, there would be no contest. Bob would buy the I-Bond.
Caller: This caller listened to Bob's recommendation and has over $100,000 in I-Bonds. He was disappointed to learn that the new rate on the I-Bond rate is much lower. Bob said on May 1st, the Treasury raised the base rate from 1.0% to 1.4%. But they lowered the CPI to 1.0%. Its calculated twice a year and jumps all over the price. If you look at the I-Bond return over the last year, it comes in better than 4.5%. The caller asked if he should cash the ones he has held for one year and put it in a CD? Bob said the problem with that strategy is that you don't have inflation protection in the CD and with the I-Bond you can defer the taxation out 30 years. Bob said he would continue to hold the I-Bonds he had purchased.
EC: For another opinion, check out this article entitled, "What's Best - Series I or Series EE" at this url: http://tinyurl.com/nb4ck
GNMA GOOD AT THESE LEVELS?
Caller: With the recent correction, is now a good time to dip into the Ginnie Mae Fund? Bob said yes. The GNMA prices have held up great. The overall range for the GNMA fund in almost all cases is $9.50 to $10.50 on the fund he recommends. Right now, the fund is at $10.04, right in the middle of that range, with a yield that is very generous. We have an economy that shows signs of slowing down. Thus, when you get into a situation like that you have a good condition for GNMAs.
EC: Two points to make. First its interesting to hear Bob acknowledge that the economy is starting to slow down. I think its been implicit in other comments he has made, but here he is very clear about it. Second, the GNMA Fund that Bob recommends from Vanguard (Ticker: VFIIX) is currently yielding 5.11% based on the information I obtained from Vanguard's web site just before I wrote this EC. If you do think that the economy is slowing, than you could make the case for bonds and the Vanguard GNMAs do have a long-term reputable track record.
EC#2: Vanguard has an article out this month on their web site entitled, "What's next for the bond market?" which you can find at this url: http://tinyurl.com/s3ubu
Caller continued: The same caller then got a little brazen and asked Bob to enlighten him, as a Marketimer newsletter subscriber, and his radio audience, just how to implement a dollar cost average strategy by investing in something like the Total Stock Market Index. Bob said he is doing that in the context of his newsletter and it is a very difficult thing to do which requires a lot of study, analysis and he will continue to do that in his newsletter, but to do it on the weekend on the radio is not his first choice.
EC: Bob has never been that clear, either on the radio or in his newsletter as to how to implement the dollar cost average approach. What he usually says is to adopt a gradual approach and try to use periods of market weakness. Once, a while back, he acknowledged that you could use a 12 month time frame and dollar cost average into the market with 12 equal payments, but that was in response to a caller who asked him if that was ok to do. Now that we are in the mature phase of this bull market, I don't know that Bob would agree with that approach. Certainly, the market is showing some weakness here, so this would be a good time to do some dollar cost averaging if you were so inclined. If you want to wait for a more significant decline, you will have to hope that (1) it occurs before the bull market is over and (2) have the stomach to go back in at that time.
Brinker Comment: Everybody is waiting for the upcoming hurricane season that begins in June. Usually in the first few months of hurricane season, the storms tend to track into the Gulf of Mexico. The reason that is important is because that is where a lot of oil activity takes place. 2005 was the worst hurricane season in 154 years and there were 27 named storms with devastation along the Gulf Coast. The forecast out of Colorado State University for this year is 17 named storms and 9 hurricanes. Let's hope none hit the U.S.A.
EC: Colorado State University houses The Tropical Meteorology Project which makes such predictions at this url: http://tinyurl.com/54ppp
Brinker Comment: Its a difficult situation because we have been battered for two years in a row by hurricanes. A lot of the protective sand barriers are now gone. Tens of thousands of Americans are living in Government trailers in hurricane-prone areas along the Gulf Coast. There are many living in unsafe beach locations, low-level water and the like. A 20-foot surge will devastate anything in its path. Bob said he saw this first hand many years ago and was amazed by the power. There is an 81% probability that there will be a hurricane strike this year and a 47% probability that one will hit the gulf coast.
EC: In addition to the gazillion financial web sites that I have book marked in my Internet browser, there is one non-financial site that is near the top of the list -- the National Hurricane Center's home page. If you live near a storm, you might want to have it book marked as well for easy reference: http://www.nhc.noaa.gov/
Brinker Comment: Bob noted that your tax money pays for the national flood insurance program which encourages people to get in harm's way. Its folly!
The national flood insurance program has a 40% repeat claim rate for an insurance program that only covers 2% of all the covered property in the country. Why? They are right in the path of the storms year after year.
Taxpayers have been suckered into paying for this by the politicians in Washington. There is no economic basis for people to build in flood zones.
There are 100,000 people in Louisiana and Mississippi that are living in FEMA trailers. Hurricane Katrina struck at the end of August last year, yet still there are thousands in FEMA trailers.
EC: There are a lot of FEMA trailers around, but in many parts of the greater New Orleans area, things are back to normal. Of course, everyone is very wary right now about the upcoming season. I don't know if you saw it, but for what its worth the mayor of New Orleans got reelected. In my opinion, it just goes to show you much people fear change and why an incumbent always has the leg up in elections.
INTEREST RATES AND COMMODITIES
Caller: This caller heard an analyst talking about the negative impact rising interest rates would have on commodity prices and wanted Bob's input.
Bob first noted that there are two rates that are doing opposite things. If you go back to June 2004, the FOMC decided to change its policy of having an emergency Federal Funds rate down to 1.0%. At that meeting they decided to start raising rates to "normalize" it to a level of equilibrium. The gradual steps were the 25 basis point increases. We have now had 16 FOMC meetings since June 2004 and at every meeting the Fed Funds rate has been increased 25 basis points (.25%). That brings the Fed Funds rate to 5.0%.
Those are short term rates which have risen substantially over the last 2 years since the Federal Reserve controls those rates. On the other hand, long term rates have come down. When the Fed started its rate hiking campaign, the 30-year bond was yielding around 5.5%, but now they are now down to 5.137%. The caller said he heard that the expectation is that the FOMC will raise rates at the next meeting. Bob said that is not true. The Chicago Board of Trade shows that there is a 50/50 chance that the FOMC will raise rates. The reason is that the Fed has stated that its data dependent and we have a lot of info showing that the economy is slowing down.
EC: Fed president, Jeffrey Lacker, gave a speech on Thursday and said that he felt the chance of the Fed pausing in June was less likely after the April CPI data.
Brinker continued: As far as commodities are concerned, rising interest rates are designed to combat inflation. The Fed is paranoid about inflation (and deflation for that matter). When rates go up, it provides competition for investment money because you can invest in a risk-free Treasury rate.
But it also tends to slow down economic growth because borrowing money to expand your business is more costly. Rising rates also have a counter-inflationary impact because they have a business slowing impact.
When you look at all of these factors, its not particularly helpful for commodity speculation. However, when you consider that some commodities are in a runaway bubble, that is why you have seen the drop lately.
EC: Check out this article entitled, "Commodity bubble's burst is good for stocks" which you can access here: http://tinyurl.com/9r9tt
REAL ESTATE FEAR
Caller: This caller asked Bob if he was familiar with the new real estate book entitled, "Sell now." Bob said that kind of book doesn't surprise him because some people use fear as business model. The same thing happened with the whole Y2K fiasco. The caller then said that he heard the Federal Reserve Chairman say the real estate market is slowing down. Bob said slowing down is normal and nobody cares about that, the big issue is whether it is going to collapse and that is something that people are just using fear to play off of.
EC: Bob is pretty much on record as saying he doesn't see a collapse in the real estate market, although he has quoted a guy in San Francisco who thinks some California real estate prices could see a hefty haircut. The full title of the book the caller is referring to is "Sell Now!: The End of the Housing Bubble" and is written by John Talbott. Learn more about it on Amazon.com at this url: http://tinyurl.com/oz8b9
Caller: This caller heard Bob talk about the $500,000 capital gains tax exclusion for a couple selling their principal residence. She learned from her accountant that the amount is reduced by any profit that you have carried over from any houses in the past. Bob said that is correct. If your cost basis of your principal residence is $100,000 and then you sell it for $600,000, then the $500,000 gain is excluded. However, if you carried forward under the old law gains from prior houses, of course they are taxed.
EC: I always get a little nervous hearing Bob give tax advice because sometimes he doesn't get it straight. I certainly am not qualified to give tax advice, but I did find a real estate web site which has an "Ask the Expert" section and it has a great Q&A on basic questions about tax implications of rental resale. Check it out here: http://tinyurl.com/n7gxo
CERTIFICATE OF DEPOSIT RATES
Brinker Comment: Bob said we are seeing some excellent yields in certificates of deposit. Bob referenced the Pentagon Federal Credit Union as having a great rates. The 3-year, 4-year and 5-year rates have yields in the area of 6%. The good news is that anyone can become a member of the National Military Family Association and become eligible to join the Pentagon Federal Credit Union. Even if you are not active military, you can join for a $25 fee. The toll-free number is 1-800-247-5626.
EC: Go to the following url to learn more: https://www.penfed.org/
TREASURY ISSUES AND RELATED INFO
Brinker Comment: The tax cut package that just got passed is going to add $50 billion to the national debt. Nobody is calling the Federal Government on the deficit spending, nothing is going to change. The national debt is past $8 trillion and we are paying hundreds of billions just to pay the interest on the national debt.
On Wednesday, there is a 2-year Treasury Note auction. Bob said he expects it to come in within the vicinity of 4.9%. On Thursday, there is a also a 5-year Treasury which Bob expects will come in around 4.9%. You can purchase these through Treasury Direct with no commission.
EC: This auction will be part of the Treasury Direct program which you can learn more about at the following url: http://www.TreasuryDirect.gov/
Brinker Comment: There has been a general softening in the real estate market. Some places still show strength, such as Phoenix and Scottsdale, Arizona and the Orlando, Florida area. A lot of the areas in the country, however, have seen softening and in some areas the real estate market is at 10-year lows. There has also been a decline in new permits. The irony is that we haven't seen mortgage rates move up all that much. The reason mortgage rates haven't gone up that much is because rates on the long-term bond have come down.
Caller: This caller lives in North Dakota and his relatives live in New England. When he buys a home, its to live in. When his relatives buy expensive homes in New England, they go up in value and it operates as an investment for them. How can he keep up with that? Bob said you have to understand that real estate price trends are different in different parts of the country and that changes over time. Unless something changes, you will probably not see anything dramatic in real estate prices in your area. This is based on demand and foot traffic. You look at the economy, new job demand, the weather in the winter and all of these factors go into the demand.
Caller: This 51-year old caller quit her job and has $65,000 in a money market account in a 401(K) and wants to transfer it. Bob said he would contact one of the large no-load fund families and talk with someone there about an IRA rollover. You want to do a direct transfer. The caller asked Bob where he should invest. First, you would make an asset allocation decision. Bob said then he would look at the whole list of funds.
Caller: This caller told Bob that his broker wanted him to open a margin account. Bob said in his opinion individuals should not be fooling around with margin accounts and speculating with borrowed money. Bob said that is not even investing. It is speculation and more akin to gambling.
EC: For a more detailed discussion of what a margin account is, go to this url: http://tinyurl.com/pee7a
Caller: This 64-year old caller remembers the days when the interest rates you got in your accounts at the bank where much higher. What's up with that? Bob said first of all interest rates remain relatively low. Second, even he finds it hard to believe how little banks pay and it makes him angry when he thinks about it. Bob said he tries to keep a minimum amount in banks where they provide 10 basis points on checking accounts. That's nothing!
Caller: This caller has $100,000 to invest in fixed income. Should she put it all in GNMAs? Bob said the GNMAs are looking good right now, but he favors a diversified approach to fixed income, so put some in GNMAs, perhaps put some in CDs from the Pentagon Federal Credit Union, and spread it around.
Caller: What do you think about drilling in America for oil to meet our needs. Bob said we can't do it today because it will take years to get it going. There certainly is a lot of oil in the ANWR region and you could probably get close to one million barrels a day out of it. Bob said he thinks we should be drilling in ANWR and it is unfortunate the politicians can't get it done In addition, Bob would like to see a matching program where we drill for one million barrels a day and conserve a million barrels a day.
On Sunday, Bob had on Jeff Angus, author of "Management by Baseball." If you would like to learn about his book, go to this url: http://tinyurl.com/k38gn
Brinker Comment: Next week, we get the durable goods series which is very volatile. Last month, durable goods were up 6.1%. The consensus for this month is for a drop of 0.4%. New home sales come out on Wednesday and the estimate is for 1.1 million which is down a lot from last month. The evidence continues to show a slow down in the housing market. On Thursday, we get a revision to the GDP number. We know the first quarter was a strong quarter because we saw the rebound from the post-Katrina slow down. We will find out sales of existing homes and Bob is expecting a big decline in that number. On Friday, we get personal income and the consensus estimate is for 0.7%. The reason consensus numbers are of value is they tend to have a more accurate forecast rate than an individual.
EC: This link brings you to the full economic calendar for next week: http://tinyurl.com/zrete
FINAL THOUGHTS FROM DAVID KORN: Have a great week! - David
GLOBEX FUTURES PRICES: Check out this link to try and gauge how the United States' stock market will open tomorrow morning. Remember though, the market sometimes opens very differently than the futures indicate: http://tinyurl.com/4spze