![\"S&P\"](\"http:\/\/www.asiancemagazine.com\/files\/200911_Finance_09-10-09)
<\/a><\/div>\nThis chart is a bit crowded, but let\u2019s try to make some sense of this. You\u2019ll see that the dollar reverses on 10\/23 (in red) and the S&P does as well. In fact, the S&P fell for the next five trading sessions, and by 10\/30, the S&P had fallen 6% – the biggest pullback in recent months. <\/p>\n
By now the technicians were worried. The late October pullback brought us down to the 1,030 range on the S&P \u2013 about where we were in late August, and close to where we were at the beginning of October. If the market didn\u2019t hold this resistance level (see chart), we would be headed toward 980, or almost a 12% correction. Notice also the long trend line drawn under the lowest points in the rally since March. We touched this trend line in July, but bounced off it, and the rally continued. In late October, we fell below this trend line, and the technicians declared the trend line officially \u201cbroken\u201d (see chart). At that time, we also fell below the 50-day moving average, something that hasn\u2019t happened since July. <\/p>\n
Needless to say, the bulls ran for the sidelines while the bears were loudly declaring the end of the rally. As the S&P touched the 1,030 in late October, the technicians were anticipating a \u201chead and shoulders\u201d formation, a classical indication of a market reversal. The head and shoulders is comprised of a high top in the center (the \u201chead\u201d) surrounded by two, somewhat lower, equal-sized \u201cbumps\u201d on each side (the \u201cshoulders\u201d). If you look at the chart of the S&P, you\u2019ll see a possible left shoulder formation appearing in September 2009. The head would be the October \u201cbump\u201d and a possible right shoulder, a mirror of the pattern found in September, could form in November. For the head and shoulder pattern be complete, the two shoulders should be equal size, and the bottom of the shoulder, known as the \u201cneckline\u201d, should be the same. You\u2019ll see that the September shoulder and the October head both, at their lowest levels, approach the 1,030 level on the S&P. So you can see, the technical signs were screaming \u201creversal!\u201d and the bulls were hiding on the sidelines. <\/p>\n
Enter the Fed<\/h2>\n
You can see that at the beginning of October, it was very hard to decide what to do. If you\u2019re a technician, you\u2019re shorting. If you\u2019re a fundamentalist, then what you should do depends on your view of the dollar. <\/p>\n
Throughout the month of October, there were rumblings that the Fed might start changing its stance on quantitative easing, that it might start to withdraw stimulus from the economy. Now most would say, Bernanke, as a student of the Great Depression, would do the exact opposite \u2013 he would keep the stimulus going for as long as possible. That\u2019s because during the Great Depression, they made the horrendous mistake of withdrawing stimulus too early. And by doing so, they basically cut off the lifeline that was keeping ailing companies alive. Truth is, it wasn\u2019t the crash of 1929 that caused the Great Depression; it was the withdrawal of stimulus in the 1930s that really killed the economy. <\/p>\n
So most doubted that Bernanke would be hawkish and start raising rates. Still, no one would bet on it, and the market lingered around the 1,030 level as it waited for the Fed statement on 11\/4.<\/p>\n
The Crux of the Matter<\/h3>\n
Now we come to the crux of the matter, and the reason we went through all these charts about the stock market and the dollar. If you believed that the Fed would be dovish \u2013 that is, that the Fed would continue to keep interest rates low and to stimulate the economy, then the reversal in the dollar is temporary. If the Fed continues its policies, then the dollar would continue to decline, and the right decision at the end of September would be to buy stock during the pullback. <\/p>\n
If, on the other hand, you believed that the Fed might withdraw stimulus and start raising interest rates, then that means the end of the liquidity-driven rally. The dollar would continue to rise, the carry trade would end, and the market would decline as money got sucked out of the system. So if you thought the Fed would be hawkish, then you would sell, short or do both. <\/p>\n
Personally, I want the rally to continue, so I say, fortunately, the Fed was dovish. On Wednesday, 11\/4, the Fed announced that it would keep interest rates low and support stimulus for as long as possible. Then on Friday, 11\/6, the unemployment report came out. Nonfarm employment continued to decline by 190,000, causing the unemployment rate to rise from 9.8% to 10.2%. Despite this terrible news, the market barely budged on Friday. That might not sound like much, but it holding was a win for the bulls. <\/p>\n
Finally, over the weekend, the G20 nations agreed to continue supporting stimulus. That meant interest rates would stay low, and the dollar would continue its decline. All this was bullish for the market, and so on Monday, November 9th, the market rose 206 points on the Dow, hitting a new high of 10,226.94. <\/p>\n
The Way Forward<\/h2>\n
In last month\u2019s article, I wrote that I anticipated 1120-1200 on the S&P by the end of the year. I believe that scenario is still likely. In fact, we may find out very soon if this will be the case. <\/p>\n
There are several reasons for this proposition. Last week, the Fed and the G20 basically gave an all clear and sanctioned a continuing decline in the dollar. That, as argued above, would mean continued liquidity and would be bullish for the market. Also, there\u2019s no more significant news to be had. We will get more economic reports in December, but for the most part, nothing is expected to be a nasty surprise. If anything, a continuing rise in unemployment might dampen markets, but that is, in part, expected. And there are no earnings reports until January. Finally, we have fund managers that will continue to chase performance. The mutual funds closed their books on October 31st, but the hedge funds close their books on December 31st. So there will be continued buying pressure to achieve performance. <\/p>\n
To be fair, we have to consider the possibility that there will be a downturn. If we look at our chart of the S&P (above), you\u2019ll see that the \u201ctop\u201d or \u201chead\u201d of the recent run-up lies at 1,097.91. As of Tuesday, November 10th, we\u2019re at 1,093.01, not very far away. It is possible that we would a hard time breaking 1,100 on the S&P. If we approach this level and the market reverses, then we would have a \u201cdouble top\u201d \u2013 another classical sign that the market is turning downward. But if we can break 1,100 and hold that level, then 1,100 \u2013 1,200 is a very real possibility. We will probably know within a week. <\/p>\n
Before we get all giddy about the possibility of a continued rally, we have to re-examine the trends that have been driving this market. And if we do that, I think we\u2019d have to conclude that change is on the horizon. It may be a month out, it may be a quarter or two away, but the forces that have created and sustained this rally cannot continue forever. We don\u2019t need much proof, either. October\u2019s market weakness, combined with the market\u2019s nervousness, should be evidence enough for concern.<\/p>\n
Evolving Fundamentals, Evolving Macroeconomic Conditions<\/h2>\n
Shifting Fundamentals.<\/b> We are going to have to face several issues over the next several quarters. For one, the problems in real estate aren\u2019t over. There are significant foreclosures in the pipeline – foreclosures that have not yet been recognized by the banks. Instead of initiating the foreclosure process, banks have extended deadlines and payments. This allows the banks to keep these accounts in the active bucket, and out of the foreclosure bucket. This cannot continue, and banks will eventually have to recognize those losses \u2013 in both commercial and residential real estate \u2013 over the next few quarters. This implies the following for investing:<\/p>\n\n- Avoid real estate stocks.<\/b> We may get some benefit from the renewed housing credit and continued low interest rates, and I can\u2019t tell you exactly when these real estate problems will manifest themselves, but I\u2019m staying away from real estate stocks. If we get a rally into the end of the year, it may be a very good opportunity to exit. <\/li>\n
- Avoid banks with heavy loan portfolios.<\/b> As noted in our previous columns, there are \u201chybrid\u201d banks \u2013 those that combine capital markets and lending, and more \u201cpure-play\u201d lenders. I would stay on the sidelines when it comes to the more \u201cpure-play\u201d ones, the banks that are heavily exposed to residential and commercial lending. In fact, even the hybrids that can offset lending losses with investment banking income may take a hit in the coming months. <\/li>\n
- Be cautious when it comes to consumer-discretionary stocks.<\/b> Many analysts like consumer discretionary as we go into the winter holidays. There\u2019s pent-up demand, they argue, for extravagance and spending. They may very well be right. But as we enter 2010, and if real estate problems become more severe, the consumer will take another hit. It\u2019s too early to tell, but here\u2019s another area to consider selling or trimming back as we get into 2010 \u2013 especially if you get a lift going into the winter holidays. <\/li>\n
- \nMacroeconomic Shifts.<\/b> We\u2019re also approaching a period where macroeconomic policies may have to change. Despite the Fed\u2019s dovish stance discussed above, interest rates may have to increase. Consider this: immediately after the Fed declared support for liquidity last week, the 30-year Treasury yield actually went up (meaning that the price went down) after last week\u2019s Fed announcement.<\/li>\n
Now, the Fed doesn\u2019t control the interest on the long-end of the yield curve; it controls the short end, and hopes that the long-end, controlled by the market, will follow. The fact that the 30-year Treasury bond yield went up implies that the market sees interest rates rising, irrespective of the Fed\u2019s dovish policy. Investing-wise, that implies the following:<\/p>\n
Prepare to exit bond investments.<\/b> If you have your money with a money manager, and if that manager does any sort of asset allocation, it\u2019s likely that they\u2019ve placed you in a bond fund. But bonds, like stocks, have had a tremendous run. If you\u2019re not familiar with bonds, you only need to know that yields have been very high, and they\u2019ve fallen as the market stabilized. That means prices of bonds, which move inversely to yields, were low, and as fear of Armageddon receded, the prices of those bonds rose. Now, if interest rates rise, yields will rise, and prices will fall. So bond portfolios will suffer if interest rates rise.<\/p>\n
Going into 2010, it seems to me that the market as a whole will be moving sideways, or will dip. There are companies that will have revenue growth, and will beat earnings estimates. But I don\u2019t think the market as a whole will do that. More likely, we\u2019re going to get separation, and the strong \u2013 \u201cthe winners\u201d – will be offset by weak, the \u201closers\u201d. <\/p>\n
The Opportunities<\/h2>\n
If that\u2019s correct, then there will be opportunities. Here are some of the themes that I like:
\n
\nSecular product cycles.<\/b> These are companies that have products that people will buy, even in a down cycle. I\u2019m going to highlight two of these \u2013 Apple and Goldman Sachs (both of which I\u2019ve mentioned in past articles), but the quick summary is this: these companies are leaders in their markets; have competitive advantages in industries with high barriers to entry; and they have products that will continue to be used. <\/p>\n
There are plenty of other companies in this category, which I\u2019ll label as \u201cideas to investigate\u201d, and I\u2019ll give the quick thesis on each. Meaning, these are ideas, as opposed to more developed analyses.
\n<\/p>\n
\n- Google.<\/b> As advertising comes back, Google will be a beneficiary, traditional print media will be the loser. The fundamentals in this market have shifted, and traditional print will have a hard time reaching its former glories. In many ways, it feels like Kodak in the age of digital cameras, though perhaps not as dire. As the smartphone market grows, look for Google to start making money off cellphone clicks. Still, this would be a 2011-2012 event. <\/li>\n
- Visa and Mastercard.<\/b> The key here is that both of these companies are transaction processors, and they don\u2019t carry any credit risk. As the consumer recovers, they\u2019ll start using credit cards again, and these guys will be the beneficiaries. Plastic is the wave of the future, and will increasingly gain share against \u201ccash\u201d. If the consumer takes a hit in 2010, Visa and Mastercard may pull back in sympathy, but it would be a buying opportunity. There\u2019s also a bit of regulatory risk here, although these stocks will be less affected because they\u2019re not actually extending credit. I am long Visa. <\/li>\n
- The Windows Upgrade Cycle.<\/b> I\u2019m not a big fan of Windows, but that doesn\u2019t change the fact that windows has the lion\u2019s share of the market, and that companies will replace their computers. Don\u2019t expect any fireworks here, it\u2019s a longer, slow process, because companies aren\u2019t in a rush on this. Still, it will happen over the next couple years, meaning that companies such as Intel, Microsoft and Hewlett Packard will benefit. I am long INTC and MSFT. <\/li>\n
- Boeing.<\/b> I\u2019ve mentioned Boeing before, and it remains hated because of its failure to deliver. Still, it will someday, and eventually, the 787 will fly. Currently it is scheduled to take to the air in December. If you want to be a risk taker, you can buy before the December flight. Of course, the risk is that Boeing disappoints again. For less risk, buy after the Boeing 787 flies. Over the next 2-3 years, air traffic will rise and so will airplane deliveries. <\/li>\n<\/ul>\n
The Macroeconomic Plays.<\/h3>\n
There are lots of plays related to macroeconomic trends. Know that generally, these plays have high volatility, and unlike the stocks mentioned above, a consistent long-term trend is less clear. I\u2019ll go through two quick examples. <\/p>\n
\n- Gold.<\/b> It\u2019s not hard to figure out the reasons for buying gold. Right now, the main reason is the declining dollar. In the future, the reason will be inflation. Many expect gold to reach $1,200 – $1,300, and I tend to agree, I think this price range is likely.\n
The problem with this as an investment is two-fold. First, there\u2019s the entry price. Now with gold being fairly popular, pullbacks exist for very short periods of time, making timing key. Not necessarily the best situation for the retail investor. The second problem is the volatility. If the dollar reverses, it\u2019s very possible that gold will take a sharp drop before it rises again because of inflation. Now, it\u2019s possible that the dollar rises, and gold also rises. But you have to be ready for either. So basically, this isn\u2019t an investment that you can make and forget about. You have to watch it carefully and have the stomach for it. <\/li>\n
- The TBT (2x Short 20-Year Treasuries).<\/b> I\u2019ve mentioned this trade before, and when I have, I always stated that it\u2019s for the advanced investor. Reason is, volatility is high, and a strong stomach and consistent attention is necessary. So if you don\u2019t have both, I\u2019d skip it.\n
If you do, this trade is based on the assumption that eventually, money will come out of Treasuries. I\u2019ve been early on this trade, but the volatility actually makes it playable. Also, I would expect this trade to really kick in sometime over the next few quarters \u2013 basically as soon as interest rates start to rise. I currently do not have a position in the TBT. <\/li>\n<\/ul>\n
Apple<\/h2>\n
With the Droid released, we now know the playing field, and consensus is, there\u2019s no iPhone killer in the market. Apple is the clear leader, the Droid is a good phone and will win some followers; RIMM has a franchise, even though it may be deteriorating; PALM has had limited success, and Nokia, Ericsson and other cellphone players do not have a competitively viable smartphone product. People love the iPhone and are addicted; that means to me that people will continue to buy. Keep in mind that distribution will increase as Apple expands beyond AT&T as its main carrier. On the computer side, iMacs are selling well, and slowly but surely gaining share. <\/p>\n
On a valuation basis, Apple, currently priced at $202.98, trades at 26x 2010 earnings of 7.78. Now a multiple of 26x may seem high, but it\u2019s not for a company that is growing earnings at 24%. Consider that Apple is expected to grow earnings 21% in 2011, and trades at 21x 2011 earnings of $9.38. <\/p>\n
Many people shy away from a stock like Apple simply because of the price tag, and I can\u2019t blame them. It takes a bit of getting used to. Still, Apple is the clear leader, and it doesn\u2019t seem (to me) as if there\u2019s a competitor that can stop them. 12-month price targets for Apple run as high as $280, set by Maynard Um of UBS. The way I look at it, if Apple hits $240 in the next year (~ $9.38 in earnings x 26 PE), I\u2019d be a happy man. Based on today\u2019s price of $202, that would be just under a 20% return. For the record, I am long Apple. <\/p>\n
Goldman Sachs<\/h2>\n
So many people hate Goldman Sachs, but there\u2019s no denying that they\u2019ve done a good job managing risk. They\u2019re the leader in investment banking, and the survivor \u2013 the fall of Lehman and Bear is a huge benefit to Goldman because fewer competitors are standing. Moreover, trading and investment banking will continue. Activity in mergers, IPOs and fixed income will continue to drive earnings at Goldman. Finally, keep in mind that Goldman doesn\u2019t have the loan exposure of the commercial banks. <\/p>\n
The stock trades today at $176.51, 9x 2009 earnings of $19.30, and 9.4x next year\u2019s expected earnings of $18.84. The last two quarters, Goldman easily beat, earning $4.93 in Q2 , and $5.25 in Q3. I think that Goldman could continue to earn $5 per share per quarter, leading to $20 in annual earnings. With a 10x PE (after Q3 earnings, the stock traded as high as $192, implying a PE of 10.2x on 2010 earnings of 18.84), that would make Goldman a $200 stock sometime in the next year. <\/p>\n
Disclaimer.<\/b> All trades, patterns, charts, systems, etc. discussed in this advertisement are for illustrative purposes only and are not to be construed as specific advisory recommendations. All ideas and material presented are entirely those of the author and do not necessarily reflect those of the publisher. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representation or implication is being made that using the above approaches will generate profits or ensure freedom from losses. The examples used herein are not intended to represent or guarantee that anyone will achieve the same or similar results. Each individual\u2019s success depends on his or her background, dedication, desire and motivation. <\/p>\n
As always, I encourage you to consult your own investment advisors before making any investments. I don\u2019t claim to be right; I can only present you my logic, and I hope you will take the time to do your own homework and decide if you agree or disagree with the arguments presented here. Also, if you really feel like spending some more time on stocks, there\u2019s more on my blog at www.mingloinvesting.blogspot.com<\/a> . <\/p>\nUntil the next time, sleep well. <\/p>\n
Ming Lo is an actor, director and investor. He has an A.B. from Harvard College, Cum Laude, and an MBA and an MA Political Science from Stanford University. Prior to going into entertainment, Ming worked at Goldman, Sachs & Co. in New York and at McKinsey & Co. in Los Angeles. <\/p>\n
All material presented herein is believed to be accurate but we cannot attest to its accuracy. The writings above represent the opinions of the author, and all readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed may change without prior notice. The author may or may not have investments in the stocks or sectors mentioned.<\/p>\n","protected":false},"excerpt":{"rendered":"
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