The other day, I spent time talking on the phone with a friend of mine (who also happens to be a client).  He is undergoing treatment for a serious illness and taking some time off work, so I am delighted that we have some time now to catch up.

I have to tell you, I really like this guy.  I have learned (over the years) we have much in common: kids roughly the same age, his wife used to work for the same company I did (but in a completely different capacity).  Also, he is a good athlete — and umm, well, I like sports.  Over time, I've learned there are many common threads where our lives cross paths.

Wait a second…what does this have to do with point and figure analysis?

Everything.

I really believe I would have never met him if it weren't for point and figure analysis.  See, like many folks, he was referred to me — by another client.  If I didn't use the point and figure approach in managing the risk for my clients, I am not sure  he would be my client today!

Time out.

Look, prior to learning point and figure analysis (in 1997), I was just like every other financial adviser out there.  The game plan, as directed by the home office, was "gather assets, place the assets with a money manager — or in mutual funds run by "professionals," then go find more assets."

When I was a financial adviser, there were many of those "episodes" where Toto pulled back the curtain and exposed the "Wizard" of the marketing department.  You know what I mean…new product launches (like new mutual funds) would crash and burn, limited partnerships would blow up, stock recommendations would go straight down.  I got tired of watching people's investment accounts getting blown up — through no fault of their own.

It's a wonder anyone made money.

There wasn't "one defining moment" in my 16 years as a broker that pushed me to change.  It was more like a "body of evidence."  And in 1997, I started looking at alternatives to "fundamental analysis."

Let me put it this way: a company can deliver record revenues, record earnings, record profits, raise the dividend twice and announce three stock buybacks in 2 1/2 years.

Fundamentally — that company was doing everything right…right?
But that stock dropped from $60 per share to $22 per share during that same time.

Sooooo…how would you like to own a stock that was doing everything right, but getting carved by two-thirds all the while?

Funny thing, you probably DID own it!
See, the stock is General Electric (GE) from 2000-2002.

You say you didn't own that stock back then?  Ummm…OK.

Oh, say…did you happen to own any mutual funds back then? Did you know GE was one of the most widely held stocks in ALL mutual funds back then?

Hmmm.  Oh well, onward…

Know this: fundamental analysis does have a purpose.  But fundamental analysis will never tell you when to get out. Which is precisely what people have needed to know — especially over the past two years.

What I was able to show my friend — in screenshots — is how the market has moved from a "negatively trending market" to a "positively trending market."

For the first time in about a year and a half!

That darn chart makes it crystal clear there are times you should be "in the market," and times when you should be "out of the market."

Fundamental analysis will never tell you when to get out.  Never.

My friend and his wife (and many other people) spent a significant portion of 2008 with most of their money out of the market…in a time where the major averages fell 35% to 40%.

With all they have going on, I'm happy they sidestepped a lot of potential damage.

And what about you…what's your story?  Is getting a game plan for your investments important today?

This is precisely why I use point and figure analysis… point and figure simply measures price.  And price IS the ultimate indicator — as it reflects changes in supply and demand.

In my opinion, point and figure is the best indicator of risk… which, incidentally, is what we do at Mullooly Asset — we manage the risk in your investments.

Feel better my friend, you are on my mind.

Why didn't we buy…this or that?

Getting calls from some folks who are asking questions like:

"Why didn't we buy GE at $7?"

"Why didn't we buy Citibank at practically zero?"

"Why didn't we…blah blah blah…"

Many of these same folks were screaming "Make it stop!  Make it STOP!" only a few months (and in some cases, just a few WEEKS) before.

Human behavior is a great source for comedy routines.

Look, many people in my line of work want to over-complicate this stuff.  They want to talk over your head and use jargon to confuse you, and perpetuate their existence.  I know, they send "fan mail" to me all time.

Basics.  Just basics.  Look at pictures.  I would like to acknowledge the use of these charts from Stockcharts.com.  You can check them out here.

Would you buy anything that had a pattern like this?

You know this company.  They "bring good things to light…"

The only time I would think about buying a pattern like this would be if it were incorporating writing (selling) covered calls against the stock.  Otherwise, yecchhh…

That's just way too much risk for me.  Do me a favor.  Read the next line carefully:

The definition of RISK, as a verb, is "to act in spite of the possibility of injury or loss."

I don't know about you, but that first chart looks like risk to me.  Take a look at the next chart.

The picture is heading in a completely different direction than the first picture.  Yes, it is heading up!

OK.  But you say…

"I don't buy stocks.  I only invest in mutual funds."

Or,

"I only have 12 different mutual funds to choose from in my 401k plan at work."

Charts are charts.  Doesn't matter if we are looking at a chart of a mutual fund, a stock, or the price of gasoline.

I look at the charts in your 401k plan on a continuous basis.  If none of the charts are going up, here is our plan: we stay on the sidelines.  Pretty simple.  No need to be a hero.  This is money you will have to LIVE on some day.  (You're not counting on social security, are you?)

Today's Lesson: Buy things that are going up.

That's an important lesson, and a lesson MOST people overlook, or forget.

So, good job.  Now take the rest of the day off.

I am not a big fan of Comedy Central or Jon Stewart, I've watched the show a few times.  But on Thursday March 13, 2009 Stewart interviewed Jim Cramer on his show.  And for the first time (at least that I can remember), someone actually tried to hold Cramer responsible for some of the advice he has given, and also for the fact that CNBC has "morphed" into an entertainment channel.  The thrust of the conversation was more toward exposing CNBC (and to some extent Cramer) as shills for Wall Street and no investigative work is done on that channel.

Bravo.  It is truly an excellent piece to watch and encourage you to do so now.

I expect Yahoo and Hulu will chop up this video shortly. So, don't delay, see this video as soon as possible.  It's nearly 20 minutes, so take some time and watch this, it will be worth it.  Here is the link: http://tv.yahoo.com/blog/stewart-vs-cramer-winner-take-all–183

Stewart said "CNBC could be this great financial tool…especially for people who believe there are two financial markets…the people who are told to invest in 401ks and just leave it there…invest for the long term…don't worry about it."  And the other market — that occurs in a back room.  Where giant piles of money are going in and out…" "But you go on TV and pretend (that market) isn't happening."

By the way, if you have not checked out Hulu (http://www.hulu.com) you really should.  Full-length TV shows (and even some movies) are shown online.  Free.  Since they have no business plan to make money, I don't expect them to be around very long.  But worth a look.

I received a phone call this afternoon from someone who found my firm online.  The gentlemen has received no guidance regarding his 401k at work.  Last July, he had $286,000 in his plan.

Today he has $166,000.

I asked him what he had been doing lately.  He had moved his money in recent months from a "Growth and Income" fund.  Now he had 20% each in five different funds:

1. Growth and Income
2. Equity Growth
3. Blue Chip Growth
4. S&P 500
5. Large Cap Value

He also made changes to his new contributions.  So, 20% of each dollar went into each of these five funds listed above.  His primary concern was…

"should I keep contributing to my 401k?"

Sometimes it's a bit stunning when faced with an obvious question.   To his point, he felt he was throwing good money after bad.  But unless you need cash now, you should continue contributing.  This is your money that you will need to LIVE on when you retire.  And every dollar you contribute lowers your overall taxable income.

However, do you need to contribute new money into these same lousy funds?  NO! You can elect to have new contributions deposited into the money market fund, short term Treasury fund, stable value fund, stable income fund, etc.

Now.  How much was actually accomplished by moving the money from a "growth and income" to these other funds he chose?  Not really.  If you take a look at the top 25 positions in each fund, you will find these funds hold many similar names.   So it's really "rearranging the deck chairs on the Titanic."   In fact, it's been written that 70% of all money in equity mutual funds sit in the same 500 stocks…the names in the S&P 500.

To really avoid risk in a declining market, you have to move some money out of the market entirely…not just to another fund in the plan, and consider (if you have a self-directed brokerage option in your plan) using inverse funds and commodity choices (gold, other metals, grains and currencies).  Also, putting assets into long term bonds also invites risk of principal should interest rates move sharply higher.

One flaw that is "baked in" to many 401k plans is a recent change.  Many plans prohibit the amount — or restricting the number — of changes you can make in your account.  Getting "hamstrung" by limiting the amount of moves a participant can make is simply wrong.  Do not misunderstand — I don't condone active trading.  But being limited in the number of transactions you can make in your plan is simply bad policy.

If you would like a free look at your 401k account at work — or your 403b annuity, or section 457 deferred compensation plan at work — call us at 877-223-7300, or email us at support (at) mullooly (dot) net.

What limitations do you have in your plan at work?  Do you have a self-directed option in your plan?

Is the SIPC responsible for helping Madoff clients?

The Securities Investor Protection Corporation (also known as SIPC) maintains a special reserve fund — authorized by Congress — to help investors who had accounts and brokerage firms that failed.

Technically, when a brokerage firm fails, and owes customers cash and securities that are missing from customer accounts, SIPC usually gets involved.  Keep in mind: Bernard Madoff's securities firm did not fail.  His investment advisory practice turned out to be a fraud.

SIPC does not work like the FDIC.  Protection for investment fraud does not exist in the United States.  And since SIPC has a reserve of just over $1 billion, there is simply no way it would be able to compensate all victims in the event of loss due to investment fraud.  The focus of SIPC is very narrow… SIPC was created to help restore funds to investors dealing with bankrupt and otherwise financially troubled brokerage firms.  Not fraud.

I'm not a lawyer and don't pretend to give legal advice.  But it seems to me that if some of the money was restored to the investors who were wiped out through Madoff, then that *could* prevent them from taking a catastrophic loss against their taxes.  As I've noted in another post, taking a catastrophic loss against income might actually be more valuable for some individuals.  But only after consulting with a tax advisor will they know the right answer.

On a related note: the clients who lost money were (technically) clients of Madoff's investment advisory firm — not the brokerage firm.  That point is somewhat confusing.  Keep in mind that Madoff ran a brokerage firm (which was a member of SIPC) — and also ran an investment advisory firm (which was not a member of SIPC).  It seems a bit of a reach to claim that investors lost money through Madoff's brokerage firm.

You can read more about SIPC at their website.
You can read about the SIPC and Bernard Madoff here.

The federal, state and local governments are co–losers with Madoff investors.

Lots of questions are starting to surface regarding Bernard Madoff, and the scam that he's been running — apparently, for years.

I'm starting to read questions like "not charging an advisory fee, only working for the commissions…isn't that a conflict of interest?" Of course it is — and no investment advisor would ever (or should ever) work under terms like that.

Another question that's being asked is "when did this actually stop being an investment program and start becoming a Ponzi scheme?" Until all the details are in, I think people need to assume this has been a Ponzi scheme…all along… from the very beginning.

One more question being asked (which I addressed earlier) is "how can one person run a scheme like this — on this magnitude, and for this length of time — without anyone else being involved, or aware of it?" Of course.  We should all be skeptical.

Another red flag (and how could so many smart people miss this one?): how was it that no dividends were ever reported?  Sometimes you wind up holding a stock through the dividend — by accident!  And not one dividend was reported…ever? The topic I raised on several blog posts elsewhere, took a different slant from the "shock and surprise" many commenters posted.  My point was this: it's probably a safe assumption that people paid ordinary income and capital gains on fictitious transactions — in many cases, for years.  We're talking about a tremendous amount of taxes being recouped by investors who can file amended returns.

Taking that concept one step further: let's assume that everything was fictitious — the statements, the trades, the returns — everything.  What we're really looking at is not losses, but… theft.

I've heard that theft losses can be written off entirely against your income.  I'm not an accountant, and don't give tax advice.  Let's put this in perspective: if you lose money in the stock market, you "net" your gains and losses and can take a maximum of $3000 capital loss each year.  The remainder gets carried forward into the future, until it is completely used up.

However, if you lost $1 million, due to theft, you can write off the entire $1 million as a loss against your income.  And if that wipes out your entire net income for the current year, you can go back the last three years and amend those tax returns — and then carry the remainder forward — until is used up.

Will investors be made whole?  No.  No chance.

Under this scenario, the federal, state and local governments are the co–losers with Madoff investors.  And who will make up the deficit caused by this?

You got it.

Former NASDAQ chairman Bernard Madoff disclosed this week that the investment advisory firm he has run (aside from his market making business) was, in fact a fraud.  It's unknown exactly how much money has been lost, but it appears to be somewhere between $17 billion and $50 billion.

By comparison, think about the money being considered for bailing out the auto makers: $14 billion.

Part of the reason why the entire scam was uncovered was because Madoff posted returns that were quite different from everyone else.

For many years, Madoff reported gains in the vicinity of 1% per month.  In hot markets, sometimes 2% per month.  He rarely (if ever) showed losses.  These numbers (in many years) were "good enough" to attract very wealthy investors.  They weren't the highest returns, they were not the lowest returns either.  Madoff stated that he managed $17 billion in assets, with somewhere between 11 and 25 clients.  These are some very wealthy clients.

One of the clients happens to be Sterling Equities — a partnership between Saul Katz and Fred Wilpon, who own the New York Mets, along with commercial real estate in the greater NYC area.

Two related events exposed Madoff:

First, the general nervousness regarding the stock market in recent weeks led to requests from his clients for redemptions (they wanted their money back).  A Ponzi scheme tends to fall apart when more than a few people want their money back at the same time.  Madoff received requests to return $7 billion in capital, money which he just didn't have.

The second event was his own doing: he posted nearly flat returns during recent months, while claiming to be invested in large cap stocks.  By comparison, his peers posted returns in October of -16%.

Something just didn't add up. As more and more questions were being asked, it became increasingly clear that something was awry.

As the owner of an investment advisory business, I believe it's important to have a "see-through" business: Mullooly Asset Management does not maintain custody of our clients assets.  Our clients assets are always sitting in an account in your name at a discount brokerage firm — or in your own retirement plan at work.  And regular statements are issued only from the brokerage firm or the retirement plan — not from our firm.

If an investment adviser has custody of the assets (which is what Madoff was doing), it's really hard to tell where the assets actually are, and how the money is invested.  All you have to rely on are the periodic statements from the advisor.  That's an enormous amount of trust to place in a single person or firm.  And that is a liability I'd just rather not get involved in — from my perspective, it's not worth it.

If you're not familiar with a Ponzi scheme, here's how it works: you raise money from an initial group of investors, promising to invest the money for them.  You continue to raise money from new investors.  When one of the original investors wants their money back, you take the money from the newest investor and simply "pay back" the original investor…with the newest investor's money.

The original investor sings your praises — after all, you "invested" his money, grew the money, and then returned the money as promised to the original investor.

Going forward, the word begins to spread about your success.  And, as new investors line up, old investors are paid back and the cycle continues.  Eventually, the cycle ends (typically when too many investors want their money back all at once) and the whole scam is uncovered.  Everyone left in the scam (at the end), winds up losing everything.

You can click here to read an interview from 2001 with this fraud.

(Warning: math ahead!)

Covered call writing is when you own a stock (or buy a stock today)

…and also sell (or write) a call option against that position.

The main thing people forget about covered call writing is this: anytime you sell something, you are bringing money into your account.
Just remember that as we walk through the example.

Would you rather listen to this post?
Click the audio bar at the top of this blog post

Say we're going to buy XYZ at $32/share.  1000 shares will cost us $32,000
It's December, so let's look at the April $35 call options.

The April 35 Call options are now trading at $2.40/contract.
We sell 10 of them and bring $2400 (not including commissions) into the account.

Your net cost to buy 1000 XYZ is essentially $29600 ($32,000 less the $2400).

Or, said another way, instead of paying $32, you bought the stock for $29.60/share.

Now what?

Well, there are three basic outcomes whenever you own a stock:

Bad news first…what happens if the stock goes UP?
Between now and April…four months…if the stock moves beyond $35, your stock will get "called" away.

If the company were to be taken over…or cure cancer…or announce some event that would cause the stock to skyrocket, this can backfire.
That's why it's not a good idea to write calls on volatile stocks.  This strategy works better on plodders.
See, when you sold ("wrote") the call option, you agreed to sell the stock if it exceeded $35 between today and the day it expires in April.
So if the stock goes up to $36, or $66, …or even $106…well, your shares are sold away from you at $35.  You only get $35.

But look at it another way: If the stock moves beyond $35, OK, the MOST you can get is $35.  But your net cost was $29.60, and it was sold at $35.
A net profit of 18% within four months.

Oh, and one more thing. If the stock gets called away from you at $35…

Yes, you make 18% inside four months.  That's true.  But you also get $35,000 cash (because the stock was sold) deposited into your account.  To invest again.
Nice.

OK, so…what if the stock does nothing?
Between now and April...four months…if the stock does not exceed $35, the option (which you sold) will simply expire worthless, and you simply keep the money.

Remember, you sold it way back in December at $2.60.  Keep the money in your pocket.  And you still own the stock.  Pretty good!  You put money in your pocket while the stock did nothing!  Now you can do it again!

Yeah, but what if the stock goes down?

Between now and April...four months…if the stock moves below what you paid for it, stop and think for a second…no one will exercise an option to buy the stock at $35. Because they can buy it in the market at the current price.  Remember, you sold that call option way back in December at $2.60.  Keep the money in your pocket.  And you still own the stock — at a net price of $29.60 — so your loss is probably less than someone who bought it at $32 the same day you bought.  Good for you!  You put money in your pocket while the stock actually went down!  Now you can do it again!

By the way, these are not made up numbers.

This is a REAL company that YOU are familiar with — and probably use their product every day.  I do.
It's a stock that virtually everyone in the United States is familiar with and trades on the New York Stock Exchange.

By the way, at $32, this stock carries a current yield of 5.70%, a lot more than money markets.
For more additional information, including the name of the stock, call the office at 732-223-9000.

.

I don't know which side of the argument you fall on…bailout the automakers, or let them fail.  But a very compelling, and well-written editorial was submitted to the New York Times by Mitt Romney.  The question has been asked the last few days, "if the airlines can slink in and out of bankruptcy…why not the automakers?"  In fact, the NYC subway system originally ran as independent lines, until the magic word forced them all together into one wonderful rat hole: money.

One point getting glossed over in all of these discussions is this: there are no showrooms for airlines.  That is, you don't decide "you know…today I'm turning in this old clunker of a 747 and get me a new 767.  They are offering zero-percent financing!"

Cars are sold by, and bought by individuals.  Automobiles are personal statements, to some folks.

Rides on a subway, and flying on a plane (quickly becoming the same thing) are not the same.

There are compelling arguments on both sides.  However, I would like to offer my own solution:

Money…with strings.  No bailout.

But the US can guarantee the automakers loans.  But with the following conditions:

1. A taste of their own medicine.  Zero-percent financing. But for only TWELVE months.  If the loan repayment schedule is not adhered to, a prohibitive "lets-put-you-out-of-business" rate applies (because it will be the end of the road).
2. Senior Management works for one dollar.  But they can get five times their old salary in employee (incentive) stock options…free.
3. Current management must sign resignation letters dated 12 months from the date of the guarantee.  This is it, boys.
4. An understanding from all parties (management, unions and Congress): there will be no more money after today from Uncle Sam.
5. As a condition of the loan guarantee, Uncle Sam takes a preferred stock ownership in each company, much like they are doing with the banks.  However, after twelve months, the shares are sold (or granted)…to the employees, through their retirement plan (and/or) employee stock purchase plan.  Everyone…right down to the janitors…has a stake in the success of the company.

Or not.

Honestly, how much debt can you pile on top of a broken system?  Is more crushing debt the answer?  A better solution than all of these strings would be to see the automakers issue and sell shares of stock at these rock-bottom prices.  Look, any time a company wants to raise money through a stock sale, they have to hit the road and "pitch" the merit of investing in them (management) — and their company.  Which means they need a business plan (which they may not have — or may not have completely pitched well enough for folks to understand).  They have to make a presentation that is credible and believable to get people with money to "buy" into the story.

Would management buy their own stock right now? We will be able to gauge precisely how well management believes in their future by asking them to open their own wallets as the industry is down on it's knees.  Will anyone ask?

Opponents will argue "but a stock sale at these prices dilutes the ownership of current shareholders!"  Technically, that IS true.  But so what? You need a microscope to these stock prices right now.  They are trading right NOW at prices that indicate they will file bankruptcy any day.  Consider this: anyone owning the auto stocks at these levels is either:

• blindly loyal to the company (they would definitely buy more),
• living under a rock, or
• speculating.

Long term investors would be much friendlier (and supportive) of management as well.  After all, it is THEIR MONEY at stake.

The US Auto Industry does NOT need a bailout.  Everyone runs into a cash crunch now and then.  The automakers need to sell (and tell) a better story.  They need to take responsibility.  And they need to get investors behind them.  This means putting together a credible game plan.  NOW.

Don't worry about "why" your investment is falling.

Focus on "what" instead.  What is happening now.

Don’t worry about “WHY”…everyone is doing that.  Gyrating stock prices are getting swung around by deceptive news headlines, faulty stories — all designed to play on your emotions.

Do we really NEED to know “why?”
If a chart is breaking down, giving sell signals, breaking the all-important support line, giving a relative strength sell signal, etc.  Does it really MATTER why?

No.  You should sell.

Everyone is searching for clues, answers, reasons WHY the market is falling or where/when the market will hit bottom.
How many times this week will you hear "The market is down today because _____ ."

Just remember, in most cases, they are guessing!

Financial stocks starting breaking down, giving massive sell signals in April-May 2007, nearly a full YEAR before Bear Stearns agreed to sell to JP Morgan for $2.00.  By the way, Bear Stearns broke support at $140/share (that’s $138 above the price they agreed to sell at).

And the point?
The point is that no one knew in the spring 2007 WHY stocks were collapsing – or how spectacular the meltdown would be.  They just were falling apart, period.  All the charts told us is that there were clearly far more sellers than buyers, and that supply was in control.   That was all we needed to see.

When there is too much supply (of anything), prices are heading lower. You don't need the "why."
So…focus on “what”…like what IS happening now?

People seem to be preoccupied with “what will get the market moving again?”  and “when will the bottom be reached?"  SImply, when buyers outnumber sellers, prices WILL go up.  That's economics 101.

But unfortunately that doesn't sell newspapers.
By the way…we may have ALREADY put a bottom in place – a month ago!

Like crossing the equator on a ship — should buy and hold investors get some kind of recognition (or have some celebration) for crossing the line?  The S&P 500 crossed 1100 in 1998 (twice), 2001 (3X!), 2002, 2004 and 2008.  Look, when I drive around the same block twice, even I ask for directions!  Oh, and today the S&P 500 is at 940.  Ready for 9 passes in ten years?

So, "Buy and Hold" investors have passed the same intersection now 8 times in the last ten years.  Ten YEARS!  Essentially, if you've followed "buy & hold" you have not made money this decade.  And don't forget: Warren Buffet has been stockpiling mountains of cash for the better part of the last ten years.  Think he's been riding the S&P 500 merry-go-round?  Buffet has a 20 to 30 year-plus time horizon.  Do you?

See. we Americans examine our self-worth every month at the mailbox. And Buffet's strategy isn't really "buy and hold," it's "own the business."    We don't have the capital to do that.   But I think his letter to the NY Times last week was right.

Don't misunderstand, we are facing one the single BEST buying opportunities right here.  But "right here" doesn't mean "this week" — or maybe even "this month."  This "opportunity" may be here for several months.

If we learn anything from history of bad markets, the next few months will NOT be easy.  There will be great opportunities, but there will also be stress.  Without knowing — with certainty — that "this is the bottom" it's imperative that all investments come with an "exit strategy."

What this means is anything that is purchased at this point in time needs to have the exit points clearly marked, in case of trouble.

Quick history lesson: Mark-to-the-Market was a practice originally begun by futures and commodity traders in the 19th century.  Essentially, mark-to-the-market means your holdings must be "priced" every night…at the price they can be sold at.

For years, many bank and investment companies carried investments at cost, or even sometimes at the face value.  This never gave an accurate picture of gain or loss.

Today, many balance sheets are filled with untraditional investments, like derivatives (for example, interest-rate swaps).  Harder to price, since these derivatives don't trade every day or carried listed prices (like stocks).  So, most companies that own derivatives would come up values on a monthly or quarterly basis…not daily.  What happened was companies would come up with a "model" and these assets were "marked to the model" instead of marked to the market.

Fast forward to November 2007.

Financial Accounting Standards Board (FASB) Statement #157 "Fair Value Measurements" became effective in November 2007.  This statement was created, partly in response to the Enron scandal.

The bottom line: firms had to value the assets at the price you could sell them for — if you sold them right now on the open market.  That's what something is worth.

And within six months, Bear Stearns checked out.  Within one year, Lehman, AIG, Washington Mutual, Wachovia had all succumbed.  Merrill Lynch cut a deal.

There is no market for investments like subprime loans.  Where there is no information available, the SEC has declared companies can make their own assumption.  Which is why may banks and firms may have been extremely slow to write down these assets.

Understand these bank and brokers are not falling apart because your neighbor is in foreclosure.   Do you realize that there is good cash flow from mortgage-backed securities…even subprime mortgages?

Under FAS 157, many companies had been forced to deeply mark down (reduce) the value of mortgage-backed securities due to their inability to sell them.  This resulted in margin calls everywhere.

In margin-call scenarios, better valued assets get sold, leaving the lousy assets behind.  So the lousy equity remains…not fixing the problem.

The SEC is now acknowledging the market for mortgage-backed securities is simply "not orderly" and fair value standards (FAS 157) should be more liberally applied to reflect the expected value.

Suspending mark-to the-market (FAS 157) doesn't "suspend reality" for the financial sector.  The Paulson proposal would replace mark-to-the-market with net operating losses, which would be a very powerful way to help get banks back on their feet…quickly.

A client called me today, curious about buying shares of Fannie Mae and Freddie Mac.  He said, "I'm sitting at home, watching the stock market channel and I'm amazed.  I am seeing all of the shares of Fannie Mae and Freddie Mac changing hands.  The stock prices are so cheap.  But, Tom, I thought these two companies were gone?  Can I still buy them — and maybe make a few bucks on them?

It's true.  Shares of Fannie Mae and Freddie Mac still trade…and amazingly…they trade at prices between one dollar and two dollars a share.  If these two companies have, essentially, been "nationalized"… how can these stocks still be worth anything?

They're not worth anything.  I have to believe (my opinion) these trades he has seen are purchases that are covering previous short sales, and nothing more.  We saw a similar event years ago when Enron had been completely wiped out, but yet their stock continued to trade around one dollar per share.

My answer to the client was… "yes, you could buy these stocks.  But I won't let you do that."
I was very pleased to hear him say "that's why I have you — looking out for me."

That was the headline I found over at CBS Marketwatch.  As usual, the news media is whipping (anyone who will read) into a frenzy about Lehman Brothers.  More news may be forthcoming about Lehman — between the time I finish writing this and the time you read this.

I have no idea what's going to be the final outcome for Lehman Brothers.  And further — I have no idea what impact that will have on other financial stocks, or the stock market.  But what I can tell you is many financial stocks will be reporting quarterly earnings (or write offs) shortly.

And it also happens to be option expiration week.  So, expect a great deal of volatility the next few days.

But in which direction?  Stay tuned.

It really is pretty amazing to see names like Lehman Brothers and AIG being discussed in the media as possible wipeouts.  This really could be the end of an era, or a changing of the guard.

Additionally, the primary indicators I use to determine whether the market is on offense or defense (the bullish percent index) has just signaled a change (this week) from offense to defense.

By definition, this index measures the percentage of stocks in a group which have a bullish pattern.  If the number of stocks with bullish patterns shrinks, the market cannot possibly go up.  Essentially, fewer and fewer stocks are rising — the tide is moving out.

Over the years, we have seen periods of defense where the market has done nothing, or gone down slightly.  But there have also been times in recent years where the market has dropped a fast 6% to 8%.  And that kind of move can be accomplished in a matter of days — not weeks.  6% of the current Dow Jones Industrial Average (11,421) is 685 points.

We have seen several 300-point swings in a single day this year.

Moving from offense to defense does not necessarily mean that the market will go straight down.  What it tells us is that the risk of losing money is greater today than it has been in the recent past.  The average period of time the market stays on defense is a little more than 60 days… some periods are longer, some periods are shorter.  Just keep in mind that if you buy stocks when the market is on defense it's like trying to swim upstream — it's a tougher direction to go…but it's not impossible.

What should we normally do when the market flips from offense to defense?  In general, we should remove any investments that have poor relative strength, or poor technical attributes.  Essentially, weak stocks will fall apart.  They should be the first to go.

This is what we need to focus on right now.  But remember, moving to defense does not mean "panic."

Another good practice at this stage of the game is to review stop orders.  It's a good idea to have stops underneath stocks that were purchased recently.  If you don't know where stops are (or should be), call me.

Pretty sad story reported recently…but sad, as in pathetic.

Guy Wyser-Pratte, who is known on Wall Street as a shareholder activist and runs a $500 million hedge fund, recently reported that the private banking operation of J.P. Morgan Chase had "somehow" allowed many small electronic transfers out of his personal account, over a period of time (15 months). Each transaction represented only several thousand dollars. However, the total of these withdrawals was more than $300,000. But these electronic transfers were not authorized.

Did he get all of his money back?

No. The end result of his saga, apparently will be a recovery of just $50,000.

Why?

Apparently, Mr. Hotshot Wall Streeter never bothered looking at his monthly bank statement. Look…if you don't contact your bank or broker within 60 days from the date the statement is printed… you are essentially saying "I agree" with everything printed on that statement. And you probably won't have a leg to stand on if you come back six months (or a year), later announcing some discrepancies found on your statement. The responsibility is yours.

Now, Wyser-Pratte claims that since he opened that account "years and years ago" he doesn't recall signing a document agreeing to that "60 day" stipulation.

He's right…he probably didn't sign anything like that. But maybe he should look on the back of his bank statement! It's usually written there…every single month. It ticks me off that some big shot takes his eye off the ball and tries to put the blame on someone else.

If you get a statement from a bank or broker — and you don't do anything regarding a possible discrepancy you may find within 60 days from the date of this statement, you are accepting the statement as it's printed. Essentially, you are out of luck. Please don't tell me you are as careless as Mr. Hotshot Wall Streeter.

Didn't this guy have someone reconciling his bank statements? Scary! Additionally, Wyser-Pratte states that the monthly statements have become so complicated he had trouble deciphering them. Wow! And he manages money for a living?

This is just one of the reasons why I encourage new clients to review their first few monthly statements with me. It's important that you understand what's happening inside your account. The first step is understanding how to read your monthly statement. Look, more and more transactions are taking place electronically. You supply your routing number and account number over the phone and you are giving the keys to your bank account to someone. It's a little scary, but it's 2008. We will have to exercise a little more diligence than we did yesterday, and it comes down to having a certain level of trust.

Or — is it giving away a certain level of trust? What are your thoughts?

Recently, oil and commodities dropped 20 to 25% in four very fast weeks, catching nearly everyone off guard. But as fast as the drop took place, we start to see signs of a reversal back up. These sharp violent corrections often take place in long sustained bullish advances.

What do you do if you are still holding commodities like oil, natural gas, heating oil, grains and agriculture? I'd encourage you to read on. If you don't have a longer-term view, then simply understand this: everything reverts to the mean.

Let me ask you a question…have you ever seen a bell curve?

Here's an example of a bell curve: suppose there are 20 students in a class.
When test-time rolls around, here were the scores in the class:

1 student scored 100
3 students scored in the 90s
12 students scored between 75 and 85.
3 students scored in the low 70s
1 student scored 60


Roughly 60% of the class scored between 75 and 85.
One student of the 20 (5%) scored extremely well (she got 100%).
One student of the 20 (5%) scored very poorly (she got 60%).

Statistically, there's a very good chance that the one student who scored extremely well may not get 100% the next time around. Additionally, the one student who scored very poorly stands a good chance of improving her score in the future. This brings these two extreme results back to the middle of the pack.

The reason why I went through this exercise was to show you that frequently results "gravitate toward the mean." In this case, the mean test score was somewhere between 75 and 85. In fact, 60% of the class fell in that range.

Let's apply this towards your investments.

Two thirds of the time (67%), investments will hang around the midpoint of the range — the middle of the 10 week moving average.

There will be times when your investment scores in the top 5% — this is a situation where your investment is clearly "over-bought." There are also times when your investment will score in the bottom 5%. This is when we say your investment is "over-sold."

The reason why I frequently mention the term "weekly momentum" is because you will see (in a chart) certain times when your investment may get extremely over-bought, or extremely over-sold. This period is usually followed by a time where your investment will revert to the mean.

Knowing these types of patterns and behaviors exist, prevent us from panicking and getting out at the bottom — and likewise, making a rash decision and buying something at the very top. It doesn't always work perfectly, but we do our best to "stack the odds" in our favor.

Maybe it's me, but it just seemed like a funny coincidence that as soon as the media started to talk about oil going to $100 per barrel, we saw a bounce (in two days) from $111 a barrel…up to $122 a barrel.

In one of my most recent posts I discussed the "ready to explode" product issued by brokerage firms called "auction rate preferred securities."

Well, that didn't take long.

In this past week UBS (the parent company of PaineWebber), announced they are spending $19 billion (yes, billion with a B) to buy back auction rate preferred securities their brokers had sold to their clients. Citigroup (which owns Smith Barney), announced they are doing the same — for $7.5 billion. Merrill Lynch announced that they will buy back $10 billion of these securities sold by their brokers over the next few months.

That is $36 billion these brokerage firms have whipped out their checkbooks for… and we haven't even heard from Wachovia or Morgan Stanley yet!

Understand that the auction rate preferred market is a $300 billion market. It's a lot bigger than people realize. And it's been around longer than most people know. I went on sales calls in the 1980s and marketed these investments as alternatives to commercial paper to universities and small publicly traded corporations.

So everyone is feeling the heat from these brokers walking away from this market… individuals can't get out of these investments, which were sold to them as money market alternatives. Some publicly traded corporations have had to show losses on their books along with anyone else who listened to their broker and used these products as an alternative to short-term investments like treasury bills and commercial paper.

One of the best questions you can ask whenever considering an investment you are unfamiliar with, is this: "OK, sounds good. Now how do we get out of these things?"

Exxon reported nearly $12 billion in profits for the previous quarter recently. $12 billion! More net profits in one quarter, than ever recorded in the history of mankind.

And what did the stock do?

It went down.

Numbers like $12 billion generate emotional responses: anger, jealousy, envy, and even pride. The media does a good job of stirring the pot. Once the emotion subsides, a lot of people start to realize that Exxon is one of the largest employers in the United States, along with being one of the biggest taxpayers in the United States as well.

But there was something in the earnings report that really got my attention — maybe you saw it, too.

In addition to reporting record earnings, Exxon also reported their total production declined. Companies like Exxon simply don't have the tools in place — or even available — to do more drilling or exploration. They simply don't have the infrastructure to increase production.

Now let's talk about their stock. And a short lesson in relative strength!

When compared to other oil stocks (Exxon's peer group), Exxon stock has been on a relative strength sell signal since 2001. While this member of the Dow Jones has done well compared to the S&P 500 and the other Dow Jones stocks, Exxon appears to be a weak-kneed Willie getting sand kicked on it by some of the other bruisers in the sector.

And now that Exxon has broken the support line, and the sector is falling out of favor…well, it's really starting to lead the parade out of town.

I suppose $12 billion just doesn't get you what it used to anymore, does it? This company is posting record earnings, record revenues, record profits… and the stock goes down.

Oh…one more thing. Can you guess what stock you will find listed as the first or second largest position (investments) in most large-cap growth mutual funds? Here's a hint…it used to be called Standard Oil.

Go ahead and read the headlines — just don't base your entire investment decision on headlines… like most people do.