Mo 21 Jun 10       Manic Depressive Markets Can Bring Profits to Investors

Comments from Communist Government Lead to Strong Open

We take what our own government says with a huge grain of salt, so how much stock should we put in comments from Communist China? The markets are up strongly this morning on a pledge from China to make its exchange rate more flexible which, in theory, could help level the playing field with regard to the trade balance between the world's first and third largest economies. We don't buy it, and we have heard it all before. However, this allows us to illustrate just how irrationally the markets operate.

After the worst May since 1940, we have actually put a few good weeks together, and are back at "flat" for the year. The statements from China are really no reason for the markets to rally this morning, but we will take it. That being said, someone may utter the words "Greece," or "Spain," or "Portugal" in a negative manner tomorrow and the markets will be down triple digits. That is the way the summer and fall of 2010 will play out. We need to reframe this in a positive light, however.

While average investors and computer trading programs react to the latest news, an astutely-managed portfolio can take advantage of the swings to find new gems which are undervalued, or shave some profits off the table. While the U.S. housing market is still in shambles and consumers still carry too much debt, manufacturing activity is beginning to percolate again. U.S. exports have risen 10 of the past 12 months, and corporate earnings continue to surprise to the upside. Until the uncertainty subsides, unemployment will remain high and the private sector will continue to hoard cash. We continue to look for a strong finish to the year which, considering the blank return slate we now have, should result in nice portfolio growth before entering 2011.

Fr 11 Jun 10       The Problem with Government's Involvement in Consumer Spending

Did the Government Create a Bubble with their Stimulus Programs?

Lousy news on the retail sales front this morning drove the markets down early (they have since come back), but why is lower consumer spending really that bad? After 2008, the American consumer seemed to finally be jolted into some semblance of fiscal responsibility. Penn recommends its clients who are not in the drawdown phase of their financial lives save the first ten cents of every dollar earned and invest it into their "Freedom Portfolio." While the average American saves nowhere near that amount, at least the picture was improving. So we would argue that the talking heads who disparage this morning's numbers don't understand the bigger picture. A consumer over their head in debt will eventually see their fiscal house of cards crumble. Now is the time for more saving, not spending.

How does government interference exacerbate the problem? Take the ridiculous "cash for clunkers" program. What was the net effect? It took older cars that people could actually afford to maintain off the road, destroyed them, and put these people in new cars they could not afford! (All at taxpayers expense, we might add.)What sort of twisted madness is this, and how are we going to hold our elected representatives accountable for this boondoggle?

So the "cash for clunkers" program ended, as did the phony tax credit for new homebuyers, and the tax credit for making your home "more environmentally friendly," and a host of other government programs, and business reporters are having a tough time explaining falling retail numbers? How about the fact that unemployment is still at an effective 17% rate, or that dwellers are still sitting in their homes after 18-months without making a mortgage payment.

The economy in the U.S. is actually improving, despite government meddling. And that will make for a lot of opportunities over the volatile summer and fall months. The $13 trillion debt is very real, though, and Washington does not seem to have the guts to turn off the spending spigot. It really is akin to asking an alcoholic to stop drinking or a thief to stop stealing. It will not happen without intervention. The only saving grace is that our European cousins have a more severe disorder.

Now is not the time to panic, and we foresee a strong finish to the year. However, we must be very tactical in our investment approach, doubling up on some sectors and industries and severely underweighting others (like financials). Americans seem to be at a tipping point, and they understand that the out-of-control spending in Washington must stop. Families realize that they cannot make $75,000 per year and spend $150,000, on the hopes that their financial situation will improve next year. They are about to forcibly apply that realization on elected officials. And this may mean the difference between a return to American exceptionalism and the road to Athens.

Tu 25 May 10       How Would a European Freeze Chill the U.S?

Markets Open Deep in the Red Tuesday after European Selloff

Let's face it...few of us have much faith in government to solve serious fiscal problems. In an effort to "do something," lawmakers often only exacerbate the problem. Having said that, consider this question: do you have more faith in America's ability to handle its problems or the EU's ability to resolve what is going on in Europe? The 27-nation European Union is in disarray. The leader of the pack and perhaps the most stable, Germany, just initiated restrictive short selling rules which will hamstring their markets. Greeks are waging mass strikes while their country goes bust. Portugal, Italy, Spain, and Ireland are in deep trouble. So what does all of this mean to us?

As concerns grow about Europe's ability to pull itself out of the muck, the euro currency continues to fall against the dollar. You can now buy $1.22 for each euro, and we believe it may move close to parity over the coming year. Economists would argue that a stronger dollar is bad, as our goods cost more for international buyers. We say that if our trade deficit was so bad with a weak dollar, perhaps a stronger dollar will kick the crutch out from the patient and Washington will stop using it as an excuse. Let the euro go to parity with the dollar.

There's no question that a crisis in Europe will affect the U.S. markets, but we would argue that our recovery continues, despite the efforts of Washington to quash it. How low does the S&P 500 go? Our bet is that the 1,020 resistance level holds (the index is at 1,049 right now), and a journey up to 1,270 is certainly possible. This would be a 20% rise in the index.

We are overweighting OIL right now and are picking up more shares with each new drop in prices. The price of a barrel of crude on the futures market is $67 right now, down from $86 just a few months ago. We do not believe this is sustainable. Any number of geopolitical incidents could change that trend rapidly.

Mo 24 May 10       After a Rough Week, Markets Fight Back

Friday Brought the Rally We Were Looking For

Heading into last Monday, the signs were pointing to an ugly week in the market, and the major indexes were all down in excess of 4% for the five-session period. However, we also mentioned that the way the markets responded on Friday to the previous rout would be an important indicator going forward, and they responded well. We have breached the 10% down level for the latest drop to be considered a correction, and the S&P 500 is now off 3.4% from the beginning of 2010.

We filter through large amounts of data from various viewpoints on any given day, and were struck by the disparity of predictions over a two-day period last week. One "expert" said the Dow (now at 10,150) was headed for 6,000; another said 8,000; a third said 14,000. Of course, none of them have a crystal ball, but here is what we continue to look for:

• Critical problems worldwide from the massive amounts of government spending and social programs burning through cash at an unsustainable rate.
• A lack of courage among elected officials domestically or in Europe to do what needs to be done.
• A long-term "sideways" market due to the ineffectual leadership of elected officials both here and in Europe as developing markets continue ramping up their economic engines.
• China with several bubbles waiting to burst.
• An explosive mideast situation which Israel will have to deal with soon.
• And, perhaps most importantly, a lot of opportunities for investors to take advantage of in the interim.

We believe the last bullet is the most important, as it is the one we can control. It will take continual monitoring of a very fluid situation, however, and decisive action when a move is needed. Despite the massive challenges, we see strong opportunity between the summer and fall months, and we are prepared to take advantage of it.

Th 20 May 10       What to Look for After a Lousy Market Opening

Market Opens Below 200-Day Moving Average

This morning the S&P500 opened below its 200-day moving average. That is generally not a good sign. Having said that, we reiterate that the six month period between May and October will probably be one crazy ride, with a lot of 100+ point swings in either direction--today included.

Why the turbulence today? Where to begin...a day of nationwide strikes in Greece, a lousy jobs report domestically, the Thai stock exchange on fire. However, it is important to point out that the corporate earnings reports have generally been strong, and the majority of economic signs show no double-dip recession in the cards.

Here's what we want to look at today: the market opens deeply down, but how resilient will it be and what will be the duration. If the market comes back substantially by the end of the trading day or can put together a strong Friday or even Monday (thin trading generally on Friday) it will be a good sign. We continue to argue that the May to October period should be a good opportunity to pick up quality positions.

We 19 May 10       Look beyond the S&P 500 as Europe Reels

What a Weak EU Means for the Index

The Financial Times of London had an interesting take this morning on what a weak European Union means to the U.S. markets. The paper pointed out that a full 50% of earnings for the 500 companies comprising the large-cap S&P 500 now emanate from outside of the U.S. Breaking that down further, a whopping 30% comes from revenue generated in Europe. To further magnify the problem, a strong dollar means that our exports will be more expensive for Europeans to buy, hindering our overseas profits.

This is one of the reasons you do not truly have a diversified domestic portfolio if you are simply buying an S&P 500 index fund. It is also one of the factors supporting our decision to look outside of the index for growth prospects. Many of the smaller companies we add to the Penn strategies are not well-known or familiar names--at least not yet. But a financially sound $1 billion company, which is successfully creating demand for its products and services domestically, can increase its market share more rapidly than a $60 billion multinational firm selling to a saturated or cash-strapped marketplace.

An important part of Penn's investment process is to identify and take advantage of well-managed and dynamic companies which operate below the radar screen of most investors.

Mo 17 May 10       The Next Six Months: Wall of Worry or Buying Opportunity?

Despite Friday's Ugly Turn, a Positive Week

At the close of business Friday afternoon, did it feel like we had just been through a positive week? Not for us. After a euphoric Monday ("this Europe bailout might really work!") doubts began seeping in about the viability itself of a structured, European Union. This really hit home Friday, as the Dow posted a 163-point drop. Although it doesn't feel like it, the Dow ended the week up 2.3%, the S&P 2.25%, and the small-cap Russell 2000 a whopping 6.28% (we are bullish on solid, dividend-paying, small-cap value stocks right now).

Last week was a taste of what we will see for the next six months: seemingly bi-polar behavior in the markets swirling around the same topics. This is where behavioral finance can really pay off. There's no crystal ball, but we believe the choppy markets between now and November will present us with many opportunities to use irrational behavior to our advantage. Good companies will get hammered along with the bad ones on rough days, allowing us the opportunity to buy them at good valuations.

We do not believe a double-dip recession is coming, nor do we think it is time to batten down the hatches. We are still a bit conservative on our asset allocation models (the U.S. cannot keep ballooning the deficit and printing more play money without really bad consequences), but the earnings reports have been positive and the economy is slowly lumbering back to life.

Compared to Europe, the U.S. is looking pretty darn good right now. As fiscally irresponsible as our lawmakers are, we still are not grasping the concept of how bad it is across the pond. In fact, there is so much friction between nations such as Germany, France, Greece, et al., that it is not outside the realm of possibility that the union dissolves. The euro, which had been touted as the new worldwide monetary standard by some, is in tatters. You can now buy just $1.25 for each euro, and that is down further this morning. Bad news for our exports (another topic), but worse news for the state of conditions in Europe.

As the new joint-government takes over in England, there is word that the Labour party--which had been in power for over a decade--left a minefield of "hidden" spending promises scattered throughout the countryside. It will be very interesting to watch the Tory/Liberal Democrat co-government operate, and what type of real spending cuts they are willing to make.

Finally, a word on oil prices. It is hard to imagine that oil could have fallen 17% in value over the past several weeks considering the BP rig disaster, but it has. Unfortunately, it has not caught up to us at the pumps yet, and anyone booking airline tickets may be surprised at the fat premium on travel over a year ago. A couple of factors have driven the price down--high inventory levels and economic concerns. We see a strong buying opportunity at this level, and have added a bullish oil ETF to our models.

We 12 May 10       The Flash Crash--One Week Later

The Flash Crash

We will admit it...as we were watching the "flash crash" of nearly 1,000 points last week, with some of our holdings going to zero value due to technical glitches in the various trading pits, thoughts of nefarious actions crossed our mind. At the very least, it seemed that this would present a serious question of trust which would undermine the confidence of the still-timid investor.

What a difference a week makes. The best possible outcome is essentially what came about from the ordeal, with a problem of disparate trading standards between the major exchanges apparently causing the problem. We say this is the best possible outcome because it is 1) identifiable, and 2) fixable with relative ease.

The exchanges have teamed up with the SEC to provide a series of recommendations, and the creation of standardized circuit breakers should be eased into implementation very soon, hopefully avoiding a recurrence of the problem. The exchanges also moved with surprising speed to "bust" any erroneous trades and place the securities back in client accounts.

Trade Deficit is Rotten

The U.S. trade deficit for the month of March was a staggering $40.4 BILLION. This means that, in one single month, we imported $40 billion of goods and services MORE than we exported. This will only get worse if the dollar continues to strengthen (our goods will cost more overseas), and the excuse of high oil import prices is getting pretty worn. America is still the dominant economic force in the world, and it is time to get our exports up and reduce the trade deficit.

Europe is in Deep Trouble

The recent turmoil in the UK surrounding the vote for prime minister may have abated a bit. The UK must immediately do something to stanch the rate at which funds are flowing out for a host of social programs(sound familiar?), and a few days ago it appeared that a deal was in the works for the two losing parties (Labour and Liberal-Democrat) to form an alliance against the winner, Tory David Cameron. But, with the hapless Gordon Brown involved, talks broke down, Cameron became prime minister, and an alliance between the Tories and the Liberal-Democrats has taken form.

The Tories will fight for spending cuts, but all of the social programs have become so entrenched in the country that we see national strikes rather than substantive cuts as a probable outcome. It will take the Liberal-Democrat party attempting to smooth the way with their base, which will be an uphill battle.

Prime Minister David Cameron

Meanwhile, Greek workers have organized a national day of strike (not to be confused with all of their other ones) on 19 May in opposition to austerity measures i.e. being held accountable for any semblance of fiscal responsibility. Speaking of Greece, we have all heard of the BRIC acronym given to the four emerging markets of Brazil, Russia, India, and China; but did you know that a new acronym has formed (this is not a joke) for Europe's fiscal dogs? More on that later, but suffice to say that Europe is in serious trouble, and they have kicked the can down the road with this $1 trillion bailout fund. We say underweight Western Europe for the foreseeable future.

Th 06 May 10      Something Very Odd and Disconcerting Happened

Greece has no business being in the European Union, and the dirty little secret is that the other nation-states in the group know it. But, the ship has sailed and there is little chance of taking back the invitation, so the EU must watch as a national strike brings the country to a standstill. Even doctors have turned their back on patients and have walked out of the hospitals. 

Fully one out of every three Greek workers is employed by the government, and socialism is on parade in Athens right now. The violence has turned deadly, as a fire-bomb thrown into a bank has killed at least three bank workers. Despite their nation teetering on the brink of insolvency, workers are rioting against proposed cuts being forced by the austerity measures that come along with the bailout by the EU.

Markets were down heavy in early morning trading today and, although they fought back for some lost ground, this situation will not be short-lived or the last we will see going into the heat of summer. As mentioned in previous commentary, a 10% correction is certainly not out of the question.

Although no one can predict the future, the next six months may present some golden opportunities to pick up strong companies at a discounted price. We particularly like some of the big tech names, as companies which held off on infrastructure spending will be forced to update equipment.

We must also look outside of conventional wisdom. For example, global turmoil typically equates to higher oil prices, right? Well, oil futures have dropped from $86 per barrel a week ago to below $79 per barrel now. In soccer, as in many sports, the trick is to not go where the ball is, but to where you believe it is going. This will lead to a proactive--not reactive--mindset, and it is part of Penn's process when selecting investments.

Tu 04 May 10     The European Union and a Summer of Volatility

Last Friday concerns swirled about the Greek bailout, and the U.S. markets tumbled. Monday concerns were soothed about the Greek bailout, and the market soared. Today concerns flared about the Greek bailout and the markets are tanking. Welcome to behavioral finance 101.

Greece accounts for barely 1.5% of the EU's GDP, so why is the world--especially the U.S.--feeling the effects so deeply? There really is no rational answer, other than the domestic markets looking for an excuse to take a breather. In fact, the crisis across the pond has driven down the euro to below $1.30 for the first time in a long time, and the entrenched labor forces and union contracts will make it more difficult for the EU to shake the recession. Compounding this, it now appears that Portugal and Spain (which has been drifting toward socialism for years) will be the next to face a crisis of the first order.

From Penn's point of view, let's analyze what all of this may mean: first and foremost, expect a choppy ride this summer with a pretty serious correction not out of the question. Secondly, we are underweigthing Western Europe right now because their crises will not abate any time soon. Finally, we are overweighting domestic markets, and a substantial pullback could open up some opportunities we haven't seen since early in 2009.

Last year the old axiom "sell in May and go away; come back in November" certainly did not hold true. If we fast forward to November of this year, it might be quite a different story. Investing in turbulent markets requires a proactive, tactical approach. Penn will continue to identify the pitfalls and opportunities it sees on the landscape, and attempt to use this knowledge for the benefit of our clients.

Mo 03 May 10     Consumer Spending Roars Back

U.S. consumer spending increased for a sixth straight month, up 0.6% for April, as consumers dipped into their savings to buy discretionary goods. The dark side of this spending is that the personal savings rate dropped back to 2.7%--the lowest level since September 2008. While we like the consumer discretionary sector, we are also cognizant of the 9.7% unemployment rate and $86 per barrel oil prices.

Su 02 May 10      Stock Market Tumble Buttresses Importance of Risk Management

Friday's 158-point drop in the Dow reminds us just how quickly the tide can turn, how volatile markets can be, and how important it is to manage risk. While risk can never be mitigated away completely (even money markets carry erosion risks due to inflation), Penn implements a multi-layered approach to this challenge. From asset allocation at the macro level, to tactically investing in sectors and industries based on economic trends, to placing "safety nets" on individual investments, risk management is a major component on the road toward goal achievement.

 

The processes used by Penn for this purpose can also be used to maximize returns, as we strive to identify undervalued and unloved industries which appear to be poised for growth. Even in a flat decade (such as in the period between 1972 and 1982), great wealth can be created with a proactive plan of action.

Sa 01 May 10      Oil Spill Disaster

We 28 Apr 10     Greek Drama or Comedy?