Five Wall Street Whoppers And Why You Need To Know Them

By Keith Fitz-Gerald
Editor, Geiger Index
Investment Director
Money Morning Investment News/The Money Map Report

If you’re like many investors, you are probably sitting on the sidelines right now, unsure of what to do. If you want to buy, you may be thinking “let’s wait a little longer.” If you want to sell, you might be concerned about “missing out.”

Either way (and even if you don’t plan on making either move anytime soon), having a sense of what got us here can keep you from repeating the same mistakes and even help you make smarter financial decisions – particularly when it comes to repairing your portfolio and even growing it in the years ahead.

When it comes to understanding exactly “what got us here,” I find it helpful to review some of the key bits of advice that Wall Street kept pitching to retail investors, a series of widely accepted investment adages that somehow became gospel and that I refer to as “Wall Street’s Biggest Whoppers.”

Let’s take a couple of minutes to look at the Big Five – the five worst offenders from a list that I assure you is actually quite a bit longer:

Wall Street Whopper No. 1: Buy and Hold – It was supposed be a simple proposition. Consistently put money to work in the markets, let it ride – and laugh all the way to the bank. The thinking was that you couldn’t go wrong because the markets would go up 10% to 12% a year – each and every year (It’s actually more like 4% to 6% – on average – but that’s another story for another time.

What’s important to understand is that “Buy and Hope” is the greatest myth foisted upon the American public in the last 200 years – the need for American International Group Inc.’s (AIG) retention bonuses, notwithstanding. As millions of investors have found out the hard way, the markets can – and do – frequently go through tremendous periods of readjustment.

This means that timing, as they say, really is everything. And “they” – the brokerage firms, hedge funds, ratings agencies and others that together make up “Wall Street” – don’t want you to know that. Wall Street wants you all the way into the game all the time. It doesn’t care whether you win or lose, just as long as you keep playing. So the collective “they” work together to pitch you whatever’s hot, and then move on when that investment has run its course.

And don’t even get me started about the conflicts of interest. The supposedly independent ratings agencies that rubber stamped everything from derivatives to high-grade debt have been in bed with the companies they’re supposed to be regulating for years. Consequently, millions of investors thought they had the “green light” to invest in supposedly safe institutions that have proven to be anything but during the past 24 months.

Where the rubber meets the road – especially during the down years like we’re living through now – is that the risks of outliving your money go up dramatically if you have to get out. In fact, if you achieve annualized returns of zero or less for the first five years after you retire, your odds of running out of money in the next 30 years more than double from 26% to 57%, a study from T. Rowe Price Group Inc. (TROW) reported recently.

And that’s proving to be a tough reality for millions of investors who thought they had this handled. Which is why I was not surprised to see data from the Employee Benefit Research Institute quoted in Money Magazine showing that more than 30% of near-retirees, or those in the early years of their retirement, had more than 80% of their money invested in stocks at the onset of this crisis.

Many of those investors have undoubtedly sold off assets to finance living expenses while waiting for the market to reverse. And that’s created a “double whammy” of sorts: Not only did they lose money on the way down; but those losses and the subsequent forced sales could well mean that their portfolios won’t be big enough to benefit from the next upturn when it does arrive.

What to Do Now: As I have long espoused, the notion of being able to take on more risk simply because you have more time isn’t what it’s cracked up to be. Instead, it is far more appropriate to make choices based on the certainty of returns, especially now.

And that should start with how you think about dividends and reinvestment. In short: Boring never looked so good. Data from Wharton’s Jeremy Siegel and Yale’s Robert J. Shiller – not to mention from my own research – shows that dividends and reinvestment can be far more stable contributors to overall wealth creation than capital appreciation.

Looking ahead in uncertain times, the best choices remain those businesses with solid management, plenty of free cash flow, and an increasing dividends that are backed up by unstoppable global trends. Not overpaid, arrogant Wall Street executives who engineer risk under the guise of safer returns.

There are still plenty of choices available if you do your homework. And it’s not too late to begin buying them selectively right now. In fact, as I wrote recently, history suggests we’re nearing a once in a lifetime buying opportunity so the odds of an upside move could arguably outweigh additional downside…even if you don’t quite get the bottom right.

Wall Street Whopper No. 2:  Some Debt is Good (aka: The Careful use of Debt is an Appropriate Wealth-Building Tool) – This is one of Wall Street’s biggest and most dangerous whoppers, and yet I almost hesitate to include it because of the e-mail I know it’s going to generate. But at the risk of sounding like a broken record, if you owe somebody money, you’ve still got to pay it off one day. That means any growth you attribute to debt until it’s paid off in full exists only in fantasyland. Ask General Motors Corp. (GM), Lehman Brothers Holdings Inc. (OTC: LEHMQ), or any one of the dozens of world banks that are now coping with the aftereffects of growth through the supposedly “intelligent” use of debt.

And this is just as true on a personal level as it is on a professional and governmental level. I wish our leaders understood this, although – in their defense – they finally seem to be getting the picture in recent weeks. Better late than never, although I would just as soon not have seen millions of investors taken on a white-knuckle ride to begin with.

Perhaps the saddest thing of all – and one of the most important lessons we can learn – is that the lessons we grew up with no longer seem to apply. We were taught that if we worked hard and acted responsibly, we would flourish. But now, even if we were responsible, we’re finding out that we’re now liable for the “other” guys’ debts, too.

What To Do Now: From an investing standpoint, confine your choices to those companies with little or no debt. Steer clear of the ones that are on the U.S. Federal Reserve’s IV drip. Yes, those companies probably have upside, but the real test will be what happens when they are forced to wean themselves off their Fed-administered drugs and operate without the crutch of government financing. History suggests that many will fail – despite the government’s unprecedented efforts to save them.

On a personal note, borrow conservatively and only if you have to. Pay off your credit cards each month or shift to a cash-only, “pay-as-you-go” spending plan if you can’t keep that spending under control. Refinance your house before interest rates begin rising dramatically to cope with the almost-certain after-effects of current stimulus spending. And by all means make sure that whatever debt you take on is debt you can afford to pay off.

Wall Street Whopper No. 3: It Pays to Diversify – The conventional wisdom used to be that if you spread your money around, you’d somehow be safer. This is no more effective than rearranging the deck chairs on the Titanic. It’s better to get off the boat.

In uncertain times, it’s how you concentrate your money that matters. This is an important adjunct to “investing with certainty in uncertain times,” and I’ve long advocated the benefits of stability and consistency as a means of getting ahead of the game – and staying there.

The proprietary 50/40/10 (Base Builders/Global Growth & Income/Rocket Riders) portfolio structure we utilize in our monthly newsletter, The Money Map Report, is a terrific example of what I mean. Not only does this portfolio strategy instill a discipline that forces investors to adhere to a “safety-first” philosophy, it has also proved itself to be far more stable than the broader markets since the credit crisis began. It kicks off higher-than-average income, demonstrates lower-than-average volatility – and still generates all the upside you can handle.

This safety-first discipline, with its dual emphasis on high current income and long-term appreciation, has generated some truly impressive returns.

And t his brings me to a key point: Far too many investors don’t understand how the game must be played right now. They think that investing in rocky times is an all-or-nothing equation.

It’s not.

Instead, it’s about the continual adjustment of positions to reflect changing assumptions related to risk – especially now that the risks of stock ownership have changed.

What To Do Now: In an era of simultaneous collapse, when then stock, bond, housing and credit markets have cratered at the same time, there’s simply no excuse for not hedging your portfolio at all times, not just when it’s popular to do so. Nor is there any reason why you shouldn’t be thinking safety first. That way you have the freedom to screw up on speculative bets instead of being dependent upon them to regain what you lost on foolish moves made during the downturn.

And by all means, learn how to use any of half a dozen specialized tools – like inverse funds, or options – to make low-risk, but-often-spectacularly-profitable choices, even under current market conditions. That way you can plan for the worst , yet still obtain the best of what’s out there.

Wall Street Whopper No. 4: Your Home is an Investment – No, it’s not. At best, it’s a roof over your head that keeps you from being priced out of the local rental markets. At worst, it’s a money pit that provides you with the illusion that you’re doing something sensible with your hard-earned money – despite the fact that an entire industry would have you believe otherwise.

Research from Shiller, the Yale economist, shows that, since 1900, home prices have run sideways or even declined for long periods of time. That means that – except for two steep run-ups – one after WWII and the other as part of the late 1990s lending binge – real estate hasn’t been the winning investment everyone claims it to be. And millions of people are learning the hard way that real estate can, and does, lose value. Seems they’ve conveniently forgotten the lessons Texans in the oil patch learned in the early 1980s or that Japan experienced in the 1990s.

Wall Street Whopper No. 5: Shop ’till You Drop and Save the Economy – The U.S. government wants you to spend money. And Wall Street, together with the credit card companies, want you to save their sorry hides by helping you do just that. That’s why so much of the stimulus planning – if you can call it that – revolves around tax cuts and handouts. It’s all window dressing.

Nothing – and I mean nothing – will matter until the banks start lending again.

Period.

What To Do Now: Keep your powder dry. History shows that the ebb and flow of money has never been smooth. Ever.

So to talk as if what’s happening now is an enigma is to ignore the past. We’ve been here before. There was the Panic of 1873 (sometimes called the “real” Great Depression), the Great Financial Crisis of 1914, and the B anking C risis of 1931, for example. The reason what we’re living through now feels different now is that those events are simply beyond the living memory all but a precious few people.

But take heart, for there are some bright spots to look to.

America’s safe-haven mantra – misguided though our policies may be – is an important indicator that savvy investors should plan for an eventual rebound – even if we’re destined to test new lows in the months ahead, and even if we have to look outside our own borders as a part of that process.

[Editor's Note: The ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will quickly and painfully determine the winners and losers out in the global financial markets. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

In fact, Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." His key discovery: Despite the gloom brought about by the ongoing financial crisis, we may actually be standing on the precipice of the greatest investing opportunities we'll see in our lifetimes. To capitalize, today more than ever, investors need to employ the correct tool.

In his newly launched Geiger Index investing service, Fitz-Gerald feels that he's found that needed device. Geiger Index, developed after more than a decade of work, is a new, computerized trading model that's based on a mathematical concept known as "fractals." This system allows Fitz-Gerald to predict price movements of broad indexes, or of individual stocks, with a high degree of certainty. And it's particularly well suited to the "trendless" markets that are the norm today. Check out our latest insights on these new rules, this new market environment, and this new service, Geiger Index.

And look for Fitz-Gerald's next Geiger Index"Webinar," which will be held Tuesday (March 24) at 4 p.m. For more information on Fitz-Gerald's Web summit, please click here.].

News and Related Story Links:

• BusinessWeek.com:
  AIG’s Liddy: ‘I Asked for Bonus Givebacks.’
• Wikipedia:
  Panic of 1873.
• Money Morning:
  How Dividend-Paying Stocks Can Help You Tame the Bear.
• The Journal of Higher Education:
  The Real Great Depression.
• Princeton University Press:
  When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy.
• Cambridge.org:
  The Credit-Anstalt Crisis of 1931.

Are We Looking at a Stock Market Rebound, or Just Another Bear Market Head Fake?

By Keith Fitz-Gerald
Editor, Geiger Index
Investment Director
Money Morning Investment News/The Money Map Report

For many investors, the last 12 months have felt like a cross between Dante’s “Ninth Circle of Hell” and Mr. Toad’s Wild Ride.

Even so, after Tuesday’s market action – which saw the Standard & Poor’s 500 Index rebound from a 12-year low to gain 6.4%, and the Dow Jones Industrial Average jump 5.8% – many investors are no doubt wondering if it’s time to pile in.

It could well be. But then again, it just as easily could be a precursor to another financial drubbing – the kind of bear-market “head fake” that I’ve correctly warned investors against on a number of occasions during this financial crisis. Given that perspective, I continue to believe the game we’ve been forced to play as a result of the credit crisis is still far from over.

In short: One day does not a rally make.

And that’s why Tuesday’s almost-euphoric run-up in stock prices seems less like a testament to savvy bailout strategies than it is a revelation of how desperate investors are right now for any glimmer of hope. The notion that a single bank – even if it is Citigroup Inc. (C) – could single-handedly cause this kind of an upside rout on a leaked note from its embattled CEO is absurd.

For a true rebound to take place, two things have to change. The first is sentiment. And the second is business conditions. When it comes to igniting a truly sustainable rally, history demonstrates time and again that those two catalysts go hand in hand.

That’s not to say we couldn’t see a rally of 20% or more from here, or that this mini-rally couldn’t last for a while. Bear-market rallies have a nasty habit of doing that just long enough to draw in additional investors, only to chew up their money and leave them with big losses when the rally rolls over.

Bear-market rallies are actually more common than most people realize and the one we experienced late last year is a great case in point. It started on Nov. 21, and advanced a total of 20% in the subsequent seven weeks. Then it headed south again.

Obviously, I don’t know everything and I expect I’ll hear about it if I’m wrong here. But in a market as unpredictable as this one, and with the insights I wish to share with you, I am less concerned with short-term rallies than I am with long-term investing success. That’s why – if you’re thinking about getting in right now – I urge you to first carefully review both sides of the argument.

Five Reasons Tuesday Could Be a Bear Market Rally

In the “no-way-this-is-real” department:

• Major institutions – such as Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM) and Citigroup, among others – are functionally insolvent. While Citi CEO Vikram Pandit’s leaked note revealing that Citi has achieved two months of profitable operations may conform to generally accepted accounting principles, supposedly so, too, did the trillions of dollars worth of derivatives the banking giant accumulated. Show me $45 billion in government aid and I’ll show you a good time too. Nobody ever went broke on accrual accounting. Show me the cash and perhaps I’ll change my tune. 
• The credit markets remain substantially locked up. According to the U.S. Federal Reserve’s January survey of senior loan officers, 60% percent of domestic banks reported reduced demand for commercial and industrial loans. That’s up fourfold from the October survey, when only 15% of banks reported reduced loan demand. Even now, the banks and players like American International Group Inc. (AIG), which have accepted – in some cases, begged for – billions in taxpayer aid are refusing to detail just where the money went. For now, though, the closely watched London Interbank Offered Rate (LIBOR) is trading at its highest levels since Jan. 8 – and, in case you don’t recall from past columns on the subject, the higher the LIBOR rate that banks charge each other, the tighter credit markets actually are. If you take all of these bits of evidence together, it hardly makes a case for a healthy financial system. In my mind, the real proof would be when financial institutions willingly wean themselves from the central bank’s IV hookup. 
• Hedge funds are still selling. In times of business expansion and real recovery, hedge funds buy like there’s no tomorrow. Yet, for the most part, these stealthy operators are still swamped with redemption requests and a cycle of forced selling to meet them. 
• The sentinels of the U.S. financial system haven’t changed. I have a hard time believing that the same career government officials, regulators and ratings agencies that were asleep at the switch when the financial crisis began suddenly and miraculously understand how to fix those problems – especially when most of those folks haven’t got a clue about how the financial markets actually work and most of them have never worked in them. 
• Business conditions stink. There are very few companies that have not been materially affected in one way or another by this crisis. Profits are falling and dividends are being cut. Unemployment is rising, personal debt defaults are cascading through the system, and consumer confidence is in the cellar. Sustained recoveries require consumers who actually have money, have jobs and who feel confident.

Four Reasons the Bull Has Awakened From His Slumber

We’ve carefully studied the reason Tuesday’s updraft may be nothing more than a bear-market rally. Now let’s look at the other side.
In the “this-might-stick” category:

• We’re finally experiencing some good news. Pandit’s Citi memo has provided the first real glimpse of hope in months – fancy accounting aside – and could ignite a rush into stocks as investors fear getting left behind. That could turn into a self-fulfilling prophecy, because… 
• Investors have trillions of dollars in cash on the sidelines. According to some studies, there may be as much as $3 trillion to $5 trillion on the sidelines, held by investors who are just aching to get back into the market. It is widely assumed that this money will come roaring in and that it will somehow help the markets recover faster than they would otherwise. (Personally, I have to be honest and say here that I just don’t see it; the estimated $50 trillion that’s been wiped from the face of the planet during this crisis did not go into some magical holding tank. Those losses are permanent. But that’s another story for another time). 
• Technically speaking, the markets were primed for a rebound. And they remain so by many technical measures. As of Tuesday morning, stocks were nearly 35% below their 200-day moving average and we’ve only seen that on two prior occasions: In 1974 and 1982, both of which were followed by serious reversals that presaged important rallies. 
• From a psychological standpoint, the depth of this market decline begs the question: “How much further can it go?” History shows that the 1929 crash took approximately 80% off the top while the 2000 crash took approximately 80% off the Nasdaq Composite Index. Now key sectors, such as the financials, for example, have fallen more than 80%. It seems to indicate that we’ve arrived at levels that, in the past, suggested enough is enough and that there may be enough upside to begin nibbling again. Of course, one could argue that the overall markets are only down about 50%, meaning there’s more bloodletting to go. And that’s a valid point. But since we’re really focusing here on the possible catalysts for a rebound and rally, let’s focus on the fact that the risks this time around were largely concentrated in financials, which from a numerical standpoint have been suitably punished. That might just be enough.

Corporate Earnings: The Final Arbiter

Going forward, the biggest issue to watch is corporate earnings. Many investors don’t realize it, but the final quarter of 2008 marked the very first time in history that the S&P 500 reported negative quarterly earnings. So, despite all the catalysts we’ve detailed for you, where we go from here will likely be determined by who earns what and when they earn it.

And just where is “here? ” Even after Tuesday’s manic rise, we’re now sitting just above the market’s 12-year lows. History shows we’ve been here twice before: Once following the Great Crash of 1929, and once in the early 1970s. Both cases turned out to be the kind of phenomenal long-term buying opportunities that I said this financial crisis will turn into once the carnage stops.

What’s important now is to maintain perspective and to really decide if you are a speculator in search of short-term gains that can help you recover your portfolio, or a true “investor” who is seeking long-term gains. If you decide you’re the former, you may be sadly disappointed in the months ahead. But if you’re looking for the latter – and you’re willing to ride out the ups and downs that are certain to come – it’s probable that there’s more potential upside available now that we’re at these 12-year lows than there is still more downside.

Moves to Make Now

As regular readers of Money Morning know very well, I’m an advocate of having a disciplined and well- thought- out investment plan that right now ought to incorporate the following elements:

1. Make a wish list of stocks you want to own. Logically these will include companies with strong cash positions, low or no debt, experienced management and attractive valuations. These are the types of companies we’ve written about extensively in the past 12 months and which we write about regularly in our sister publication, The Money Map Report. Obviously, the charts aren’t going to be compelling, but that’s to be expected when hunting for bear-market-rally candidates. 
2. Scale in. Don’t bet the farm on an all-or-nothing assumption that “the” bottom has been reached. For some strange reason, most investors are programmed to jump in with both feet when it’s clearly time to just put a toe in the water. We could just as easily see another thousand-point drop from here as we could a similar increase. 
3. Make the markets “prove it.” In order to break the current downward spiral, we’ll need to see a move above 740.61 on the S&P 500 and several closes above that level to demonstrate consistency. 
4. Don’t confuse the desire to make up losses with an actual long-term investing perspective. If you’re anxious to jump the gun and get in, make sure you’re doing so because you’re going after your “A” list of companies – and aren’t merely trying to recoup losses that require you to take on more risk than you’d otherwise be comfortable with.
   Remember, the reason most people have gotten hurt so badly is that they came into this mess by having too much in stock and, consequently, too much risk. Those investors learned the hard way – and that’s a lesson best not repeated the next time around.

[Editor's Note: The ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will quickly and painfully determine the winners and losers out in the global financial markets. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

In fact, Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." His key discovery: Despite the gloom brought about by the ongoing financial crisis, we may actually be standing on the precipice of the greatest investing opportunities we'll see in our lifetimes. To capitalize, today more than ever, investors need to employ the correct tool.

In his newly launched Time Trader Pro investing service, Fitz-Gerald feels that he's found that needed device. Time Trader Pro, developed after more than a decade of work, is a new computerized trading model that's based on a mathematical concept known as "fractals." This system allows Fitz-Gerald to predict price movements of broad indexes, or of individual stocks, with a high degree of certainty. And it's particularly well suited to the "trendless" markets that are the norm today. Check out our latest report on these new rules, this new market environment, and this new service, Time Trader Pro.]

News and Related Story Links:

• Money Morning Market Analysis:
  A Currency Conundrum: Beware of the U.S. Dollar’s “Head Fake” Rally.
• Money Morning Special Report:
  Special Report: Are We Now Running With the Bulls, or Just Following More Bear Tracks?
• Wikipedia:
  Ninth Circle of Hell.
• Wikipedia:
  Mr. Toad’s Wild Ride.
• Money Morning News Analysis:
  Citi Reports Profit, But Some Analysts Advise Further Caution on Big Banks.
• FASAB.gov:
  Ggenerally accepted accounting principles.
• SeekingAlpha.com:
  Citigroup’s Derivatives Reduce Bailout to a Non-Event.
• Wikipedia:
  Great Crash of 1929.
• Money Morning Special Investment Research Report:
  Goldilocks, Gloom or Doom? Three Views of a U.S. Recovery.
• Wikipedia:
  Technical Analysis
• Money Morning News Analysis:
  Hedge Funds Have Another $200 Billion to go to Complete Their “De-leveraging.”
• Money Morning News:
  Job Losses Continue to Mount in February, Unemployment Rate Soars to 8.1%.
• Wikipedia:
  London Interbank Offered Rate.

Although Experts Said it Could Never Happen, U.S. Crisis Looking Like a Repeat of Japan’s “Lost Decade”

By Keith Fitz-Gerald
Editor, Geiger Index
Investment Director
Money Morning Investment News/The Money Map Report

If you want a real look at what’s headed this way, ask Hideko Toyotomi.

When Japan’s so-called “Lost Decade” began with a bang in the early 1990s, she was an “OL” – an office lady – working in one of Japan’s mightiest corporations and she kept her job, despite the downturn.

She was one of the lucky ones. Her employer was a mainstay electronics producer and a key exporter, meaning the company’s business remained reasonably healthy.

This time around, she’s a housewife and mother. And she’s worried. Her husband, Masao, works at a local manufacturer that’s cut back production to only four days a week. He’s taken a part-time job, schlepping boxes overnight at the local convenience store, to make up for the reduced pay. Their son, Daiki, is headed for college – and for an uncertain future.

“I don’t know if I have the strength to go through this again,” she said. “This time, it’s worse,” noting that Japan never really recovered from its “Lost Decade.”

Anatomy of a Lost Decade

Having spent a substantial amount of time in Japan over the past 20 years, I agree and I’m struck with a tremendously foreboding sense of déjà vu that I just can’t shake no matter how hard I try.

What happened in Japan is being replayed in the United States – in exquisite detail, and with a bit of agony, too. Since 2001, I’ve been warning anyone who would listen that the Japanese experience was only a precursor to what we could experience here.

Naturally, that’s been a controversial view, particularly since it’s virtually unthinkable for an entire generation of politicians and financiers who thought they “knew better” and that it could never happen to us.

But lately, it’s not so unthinkable. In fact, if I were to take the names out of the Japanese experience, the story could easily be the one that’s unfolding now.
In the late 1980s, Japanese companies ran the planet. A strong currency, solid work ethic and close government connections created an unstoppable growth machine – referred to by the U.S. media as the “Japanese juggernaut,” or the “Japanese Superman.”

In the interest of additional growth and financial modernization, Japan deregulated its financial markets and began lowering interest rates. Not surprisingly, the Nikkei 225 stock index more than tripled in less than five years, companies blossomed and the use of debt skyrocketed.

Sign up below… and we’ll send you a new investment report for free: “Credit Crisis Report.”

Sound familiar?

Then all hell broke loose.

At the same time, real estate values began to waver, the government figured out that the entire Japanese financial system was a house of cards leveraged against collateral that didn’t exist and that wasn’t properly valued in the first place. And the Nikkei has collapsed to where it stands today – at one-fifth the value it had attained in 1989.

Once-stalwart companies began defaulting on loans and many went out of business entirely. Individuals couldn’t repay their debts. Real estate values fell dramatically and today remain as much as 50% below their 1989 peak. People simply turned over the keys to their homes to the banks or, like the family immediately behind our house in Kyoto, simply disappeared in the middle of the night, never to be seen again.

Unemployment rose to an unthinkable 5.5%. Suicides soared. And homeless camps, which Japan had never seen before in the post-war era, go-go years, dotted the banks of the rivers that wind their way through major cities like Tokyo and Osaka. In our neighborhood, the Kyoto city government built a brand new bathroom building for the children’s playground only to watch as a troop of six homeless men moved in – and refused to leave for the next four years. We also watched ubiquitous, blue-tarped “houses” appear under each bridge spanning the scenic Kamo River.

They disappeared when Japan’s economy improved in the late 1990s, or early this decade. They’re back now.

Making matters far worse, at the same time all of this was happening, deflation set in with a vengeance and brought matters full circle. Lower prices meant lower margins. Lower margins meant lower production and the need for lower production, in turn, created the need for smaller work forces.

Fast forward to today.

A Painful Replay

This same downward spiral that played out in Japan in the early 1990s seems to have taken hold here in the United States. Economists called this “excess” capacity and said that a short period of readjustment would be followed by new growth. But instead, they’ve gotten just more misery punctuated by a few fits and starts of economic recovery. And the resultant record job cuts hardly point to an imminent turnaround.

Even so, many people here in the United States remain in denial. They simply cannot accept that what happened in Japan appears to be replaying itself out here. They reason that our government is taking more aggressive action than the Japanese government did, that our corporations are better managed, that somehow they’ll pull through based on demand and, my personal favorite, that our bubble simply wasn’t the same as Japan’s.

They’re right … it’s worse.

According to a report in the Global Mail, in 1989 the Japanese economy needed a mere three yen of credit to make one yen of national income. Here in the United States, we’ve needed $8 dollars of credit for every $1 dollar of national income. And we may need more. In Japan, the “bubble” grew for only a few relatively intense years from 1985-1991. Here in the United States, it’s been allowed to fester for 30 years.

When the Japan’s bubble broke, it was a creditor nation, which means, overall, there was more money flowing into Japan than out. At the time, Japan had $1 billion surplus on any given day.

When the U.S. financial crisis started, this country was running a $2 trillion deficit, meaning we’ve spent that much more than we earn as a nation. Now, factoring in the stimulus plans and all sorts of bailouts, we’re arguably approaching $14 trillion.

In 1990, the Japanese were saving 17% of their income. At the moment, Americans have practically no savings to fall back upon and our savings rate has, in fact, gone negative several times in recent years (however, some reports indicate that U.S. savings rates have risen in recent months).

But what really makes me stop and think twice is this: At the time Japan’s bubble burst, the island nation still had extensive trade with its partners, and consumers around the world were spending. So there was a cushion. This time around, spending has ground to a halt and there literally is no safety buffer.
Just last week, in fact, Money Morning reported that Japan’s exports were cut nearly in half last month as the global downturn crushed demand for the country’s electronics and automobiles, a development that increases the odds that the Japanese yen could be poised for a tumble.

That, more than any reason is why the U.S. government – right or wrong – has stepped in to become the risk taker of last resort.

While that may actually be a good thing from the standpoint of intent, it hasn’t been great from an execution standpoint.

In as much as the U.S. stimulus programs being enacted by central bankers around the world will eventually take hold, that suggests that investors should continue to invest – albeit super selectively – throughout this mess in a couple of areas:

• Bond markets are especially overbought and I can’t think of more spectacular profit potential particularly at the long end of the spectrum. The U.S. government may borrow as much as $3 trillion dollars in 2009 alone, and it’s likely rising rates are not far behind.
• The Japanese yen itself seems ripe for a fall, so shorting both the Japanese markets and the yen itself may wind up being an outstanding choice, especially once the reality of falling global demand sets in.
• And, of course, infrastructure. Despite the fact that the world is pulling in its horns, the infrastructure we use is not getting any younger particularly with regard to electricity. Even if expansion plans are put on hold, existing grids will require repair and constant upkeep. The last thing any government will let happen is a complete collapse of the power grid, because it would mean the end of civilization as we know it, thanks to the social chaos that would ensue.

[Editor's Note: Money Morning Investment Director Keith Fitz-Gerald is the editor of the new Geiger Index trading service. As the whipsaw trading patterns investors have endured this year have shown, the ongoing global financial crisis has changed the investment game forever.

Uncertainty is now the norm and that new reality alone has created a whole set of new rules that will help determine who profits and who loses. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive. With the Geiger Index, Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." The Geiger Index system allows Fitz-Gerald to predict the price movements of broad indexes, or of individual stocks, with a high degree of certainty. And it's particularly well suited to the kind of market we're all facing right now. Check out our latest report on these new rules, and on this new market environment.]

News and Related Story Links:

• Money Morning News Analysis:
  Japan’s Exports are Halved by Crisis, Boosting the Odds for a Drop in the Yen.
• Money Morning News Analysis:
  Will the Yen Lose its “Safe Haven” Status as Japan’s Economy Deteriorates?
• Money Morning News Analysis:
  U.S. Making Same Mistakes that Led to Japan’s Lost Decade, Say Analysts
• Money Morning News Analysis:
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it

Will the Yen Lose its “Safe Haven” Status as Japan’s Economy Deteriorates?

By Keith Fitz-Gerald
Editor, Geiger Index
Investment Director
Money Morning Investment News/The Money Map Report

Historically speaking, the Japanese yen has proved to be a safe haven against global turmoil. Right now, however, Japan’s economy is among the worst hit of all the global powers. It is ill prepared to weather the global storm and it’s falling like a rock.

That’s why, this time around, as Japan’s economy falls away, I think there’s a very good chance the yen could drop as well.

Obviously, this would be very bad news for the huge numbers of speculators and institutions that have literally bet their existence on yen-based hedging strategies. But while a freefall in the yen would be a surprise to those institutional players, it would be about par for the course in my book, given the current state of the ongoing global financial crisis.

As Money Morning has reported, hedge funds have so far unwound gold, real estate, easy-to-sell stocks and other asset classes – so why shouldn’t they unwind currencies at some point, too? The same can be said for banks and other financial institutions currently embroiled in the global financial fiasco. With redemptions mounting, continued malfeasance like the $8 billion Stanford Financial scandal coming to light, and the credit markets still essentially locked-up tight, it’s not an unreasonable expectation.

Traditionally, analysts have looked to current-account balance statistics as a guidepost of sorts when the going gets tough. Specifically, analysts like to study surpluses on net foreign assets because those figures have historically indicated which currencies are expected to perform better during times of crisis.
The theory is that the higher the surplus, the more incentive a nation (and the companies in it) have to “repatriate” assets – that is, to bring them home. Therefore, traders tend to go “long” on the strongest, while simultaneously abandoning the weakest – or even shorting them outright.

And they have in record numbers. According to the Bank of Japan (BOJ), the yen remains near the highest nominal trade-weighted level it’s posted since November 2001. And while you’d think there would be some reduction in this “safety first” view of the yen – especially given recent U.S. announcements regarding the stimulus package – the fact is that there really haven’t been any serious reductions in the net-long yen position.

Indeed, the latest data from DanskeBank A/S shows that, in recent weeks, speculative investors have only reduced net long Japanese yen positions to some $6 billion dollars. It also reflects that traders tracked by the U.S. Commodity Futures Trading Commission (CFTC) remain net short all other major currency pairs which directly contradicts what Washington thinks and is telling the public about a recovery.

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In fact, data drawn from the CFTC suggests that not only is the yen still viewed as a safe-haven currency, but that traders don’t buy into a U.S. recovery. In fact, traders are actively betting against a global recovery, at least as far as the major currency trading pairs are concerned.

There’s no similar data available from China, since its currency is partially blocked at the moment, but I’m hearing from traders all over the world that they’re assembling large-scale positions in China’s renminbi (yuan). If that’s true, this development will support my long-held contention that China is the real key to solving this mess, and my belief that China’s currency is poised to become every bit as viable as the dollar or the yen – if not more so, given the current global financial crisis.

The problem is that money is still flowing out of Japan and into foreign equities and bonds when it should still be flowing in. Consequently, some people like the institutional traders and speculators who have assembled the more than $6 billion in long positions in the Japanese yen argue that this is a temporary happenstance and one that, in fact, creates an even greater incentive to eventually repatriate the assets.

But I’m not so sure.

For one thing, the fact that “everybody” expects a stronger yen is the sort of contra-indicator that raises the hair on the back of my neck. Anytime the markets have such unified, blanket expectations, the unthinkable becomes possible, particularly if what everybody believes appears in print.

To illustrate what I mean, allow me to turn to the vaunted “magazine cover-story indicator,” which actually has a statistical basis as a contrarian warning.
Two of my favorite examples include the 1999 Economist cover story, “Drowning in Oil,” which stated that crude oil would fall to between $5 and $10 a barrel, and remain there for the next decade, and the infamous 1979 Business Week cover story, “The Death of Equities.” Less than a year later after the former was published, oil was trading at more than $25 a barrel. As for the latter, it preceded one of the greatest bull market run-ups in history.

Then there’s the fact that the Japanese economy is suffering its worst economic contraction in 35 years, and a recession that may be the worst in 50 years. According to Japan’s Ministry of Finance, the country’s industrial production is tanking to the tune of 30% this year, while its gross domestic product (GDP) may plummet 12% in a mere 12 months.

While this is unfolding, exports plunged thanks to non-existent overseas demand for the cars and electronics that have long been the mainstay of Japan’s industrial might. Overall, shipments to the United States – long Japan’s trading partner of choice – have plunged a staggering 34%.

The Wall Street Journal recently reported that Japan is running its first trade deficits in a generation – five months in a row at last count. This is especially problematic because Japan and China – together with South Korea – are the world’s largest purchasers of U.S. debt.

So at a time when the United States is trying to save its financial system and jump-start its economy by pumping trillions of dollars into the world financial system – and desperately needs global buyers to buy this new debt so that it can forge ahead with its rescue plans – Japan may not have the financial wherewithal to help make this happen. And China and South Korea may simply elect not to buy any more.

By all accounts, the fallout of all this turmoil is staggering. Japan’s economy may contract by 4.6% in 2009, Kyohei Morita, chief economist for Barclay’s Capital (ADR: BCS), told BusinessWeek recently.

Toyota Motor Corp. (ADR: TM) is projecting a worsening situation and a string of mounting losses that will be the first since 1938. Every single digit of yen appreciation is projected to cost the company an additional $450 million in operating losses.

According to The Tokyo Shinbun, more than 30% of Japan’s prefectures (governmental bodies larger than cities, towns, and villages) have already implemented emergency economic measures of their own. Overall, unemployment rose to 4.4% in December, the worst such figure recorded in 42 years. Tent cities are growing and many public parks are now overflowing with homeless people – something I recall seeing during the depths of Japan’s last “Lost Decade.”
My friends tell me that factories in the normally highly industrialized Osaka area have shifted to 15-day-a-month production schedules, and many salarymen (Japan’s iconic office superheroes) are being encouraged to seek “arubaito” – or part-time work – to make ends meet. And those are the people who are still fortunate to have jobs. My mother-in-law tells me that it’s becoming increasingly common to see these workers serving noodles or working in department stores, doing jobs that have historically been done by college kids.

Things are so bad that Prime Minister Taro Aso has an unprecedented approval rating of less than 10% and many normally respectful Japanese, including my ultra-reserved father-in-law, refer to him as an “uneducated blockhead.”

I could go on, but I think you get the picture. It’s bleak and getting worse by the day in a nation that I have lived in during much of the last 20 years and come to love.

That’s why shorting the yen may wind up being one of the most fundamentally successful – and admittedly contrarian – investment choices we can make in today’s mad markets.

I’ll be home in Kyoto in a few months and look forward reporting what I find immediately.

News and Related Story Links:

• Money Morning:
  Financial Crisis May be Creating the Best Investment Opportunities of our Lifetime, Money Morning Expert Says.
• News Analysis:
  Hedge Funds Have Another $200 Billion to go to Complete Their “De-leveraging.”
• Wikipedia:
  Prefectures.
• Money Morning News Analysis:
  Stanford Scandal Ignites Bank Runs in Latin America.
• Wikipedia:
  current-account balances.
• Money Morning:
  Massive China Stimulus is Viewed by China Expert as a Key Attempt to Help the West.
• The Financial Analysts’ Journal:
  Are Cover Stories Effective Contrarian Indicators?
• Money Morning Special Report (Part I of II):
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it .
• Wikipedia:
  Taro Aso.
• Money Morning Special Report (Part II of II):
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it for Profit
• Products:
  Keith Fitz-Gerald – Time Trader Pro

Despite its Decline, Oil Remains a "Must-Have" Profit Play

By Keith Fitz-Gerald
Editor, Geiger Index
Investment Director
Money Morning Investment News/The Money Map Report

Commodities may be down, but they’re not out – and they shouldn’t be out of your portfolio, either.

As the investment director for Money Morning, I’m invited to a large number of speaking engagements each year. It’s something I enjoy, and it’s quite useful, too, for the questions that I get tell me a great deal about investor sentiment and the general tenor of the financial markets. The same is true for the questions I receive daily from our readers.

Lately, the most intriguing questions have dealt with the price of oil and other key commodities. It’s a topic that’s clearly on a lot of people’s minds so I thought I’d share some of them with you today.

Q: With crude oil prices down more than 75% from their record high set in July, do I really need to worry about “peak oil.”

A: Let me be blunt. Producers are operating near maximum capacity every day with 89.5 million barrels per day. We’re using 89 million barrels per day. That means there is essentially no excess capacity anywhere – period. If you factor in war, routine maintenance of pipelines or refining facilities, and diminishing supplies, we’re probably already running at a deficit even though current data does not yet reflect that. There is a very high probability that in the near future demand will outrun supply – and by that I mean permanently outrun supply.

I don’t think this is “just” peak oil. But I do think it’s the investing opportunity of our lifetime.

Q: That sounds alarmist. What about other commodities?

A: There’s a difference between being alarmist and being prepared – and, in this case, we’re talking about the latter especially when it comes to potential profits.

We are in the initial stages of a fight to the death for energy supplies and many other commodities – most notably potable water.

As I’ve noted for years, and as Money Morning detailed yet again in an analysis just last month, China, among other countries, is using its huge currency reserves – and the financial weakness of rivaling other global players – to lock up long-term supplies of commodities. By any stretch of the imagination, I don’t think this is the last we’ll see of this kind of thing.

The bottom line is that the outcome of this battle will affect every nation on earth. Absent truly fungible substitutes, it’s reasonable to expect to see oil nationalized at some level within our lifetime, and the first armed conflicts over water somewhere on the planet possibly as soon as 10 years from now. Certainly there is going to be economic conflict over those two things and on a level that is presently unimaginable. Depletion is happening at a far faster rate than most people realize.

Q: But oil’s still cheap.

A: It’s always been cheap – cheaper, in fact, than a cold soda or bottled water. But at a time when market forces are inevitably diminishing the supply, even as demand continues to grow, we’re looking at a one-way trip over time.

The average American uses two times the amount of oil used by each European, four times the amount used by each Japanese consumer, 12 times their counterpart in China, and 30 times the amount used by the typical consumer in India. And that’s at a point in time when nearly 4 billion people live in complete poverty without the stuff we take for granted…like oil and water.

Supplies are destined to shrink.  And until we can find replacements, we’re stuck with what we’ve got – there’s no more of it.

Q: Isn’t the world working on substitutes as fast as they can – having been shocked by record prices of $150 a barrel?

A: Yes. And they’re making good progress. However, even if substitutes were found tomorrow, we still have to replace trillions of dollars worth of manufacturing and infrastructure processes that have to be changed completely. Some studies I’ve seen suggest that oil is used in more than 60,000 manufacturing processes and it’s much the same with water, in particular.

Even the most wildly optimistic estimates suggest that changing to new technology may take another 30 to 50 years to work through. In the meantime, oil is set to run out 35 years from now using the highest-reserve-level calculations available – and that assumes no demand growth and no population change. It’s even worse when it comes to water. Some predictions suggest that by 2050 nearly 7 billion people will live nearly waterless lives.

Q: That’s pretty forceful thinking.

A: I’ve always operated under the philosophy: “If not now, then when? If not you, then who?”

As the investment director of Money Morning, my job isn’t to “force” anybody to think a certain way, or to take a certain action. It’s to analyze the best data available to me, to make the appropriate recommendations, and to provide you with the insights you’ll get nowhere else.

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I think we have the opportunity to invest in a group of “real assets” (which I define as oil and other key commodities) at a point when supplies are declining as demand is escalating. That combination suggests very rapid appreciation as demand eventually overwhelms production in the next few years. It’s a rare combination, and that’s why I say it may be the “profit opportunity of a lifetime.”

This reminds me of a conversation that I had with my colleague Jim Rogers, not too long ago, when the legendary investor observed that “real assets represent real wealth.”

I agree. And you will, too.

[Editor's Note: The ongoing financial crisis has changed the investing game forever, making uncertainty the norm while simultaneously creating a whole set of new rules that will help determine who wins and who loses. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

As his short essay on long-term profit plays today illustrates, Money Morning Investment Director Keith Fitz-Gerald is constantly on the lookout for ways to turn these seeming negatives into positives that can create market-beating profits. In his new service, the Time Trader Pro, Fitz-Gerald details investment recommendations based on a proven quantitative system of analysis that was previously only available to the so-called "uber-rich." The strategy allows him to recommend positions that simultaneously reduce an investor's risks, as well as his purchase-price points - all of which boosts the investor's returns.

While most investors lament the damage the financial crisis has wrought, Fitz-Gerald says that his research into "chaos theory" and his on-the-ground analysis of investment plays in fast-growing China has made him realize that we stand on the precipice of "The Golden Age of Wealth Creation." And the strategy that he's deploying is perfectly suited to the kind of whipsaw market we're facing today. Check out our latest report on these new rules, and this new market environment.]
News and Related Story Links:

• Wikipedia:
  Peak Oil.
• Money Morning Market Analysis:
  What Companies Are Profiting From China’s Commodities Crusade?
• Energy Bulletin:
  Why does fungibility matter (and where did it go)?
• Google Definitions:
  Potable Water.
• Investopedia:
  Real Assets.

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part I):
  Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years.
• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part II):
  Exclusive Interview: Jim Rogers Continues to View China as the World’s Best Long-Term Profit Play.
• Money Morning Exclusive Jim Rogers Interview From Singapore (Part I):
  Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve.
• Money Morning Exclusive Interview From Singapore (Part II):
  Jim Rogers: China’s Economic Advance is All But Unstoppable
• Products:
  Keith Fitz-Gerald – Time Trader Pro

If You Want a Forecast for China's Economy, Ask a Hairy Crab

By Keith Fitz-Gerald
Editor, Geiger Index
Investment Director
Money Morning Investment News/The Money Map Report

This is the time of year in which many investors really start to study corporate earnings, jobless statistics and all sorts of other state data in an effort to divine what’s next for China.

But I simply prefer to head for the Wan Chai Street Market in Hong Kong, or the Temple Street Night Market across the harbor in Kowloon, and check on hairy crab prices as we approach the Lunar New Year.

These delectable little guys are usually served steamed, with a splash of soy sauce. When China’s booming like it was in recent years, shoppers are hard-pressed to find a store that can keep them on the shelves. And at 720RMB, or $420HK (about $60 U.S.), that’s no small feat for a palm-sized morsel. They’re expensive, and taste great.

A hairy crab, if you’ve never seen one, is usually a bit smaller than the Dungeness crabs many Americans are more familiar with. These freshwater crustaceans start to fatten as soon as the autumn chill cools the Yangtze River Delta. That adds to their taste and desirability.

When China’s feeling pinched, hairy crab sales drop and prices plummet. At the moment, hairy crab prices are off by more than 80%, which is a steeper drop than during the Asian Financial Crisis a decade ago, or during the SARS epidemic in 2003. After the best sales in history last year, that’s significant because of what falling hairy crab sales imply about the state of China’s economy at a time when it is struggling to stave off the effects of a global recession and growth may drop to the slowest pace China’s seen in nearly a decade.

Since hairy crabs are a luxury both in the home and at restaurants, the falling prices suggest that people are “eating cheaper.” Rather than ordering up haute cuisine – including hairy crabs – at such restaurants as Cuisine Cuisine in the International Financial Centre (IFC) Tower, or the famous Jumbo Floating Restaurant in Hong Kong Harbor, most Chinese are eating “cheap” and seem to prefer smaller, more modest places these days.

They’re also apparently “shopping cheap,” too. Call it a Chinese version of the “Wal-Mart Effect” (WM), but that’s what’s happening as savvy Chinese consumers downshift. They’re still spending – as reflected by Chinese retail sales figures, which suggest year-over-year growth of 21% in 2008 – but they’re spending differently.

Nowhere is this change more evident than in those stores where luxury items are sold. Shanghai and Hong Kong store managers I’ve spoken with recently told me privately that such big-ticket brand names as Dior, Chanel, Hermes and others aren’t moving as fast as they were a year ago.

Knock-offs, of course, are still flying off the shelves.

On a related note, many Chinese merchants are actually refusing to take credit cards these days, at least from Chinese consumers. Don’t think for a minute this is limited to convenience store items, either. Big-ticket items like tours and holiday excursions that have long been paid for on credit are now cash or check only as many travel companies – like Hong Kong’s Sincere International Travel Service Co. Ltd. – look to avoid getting caught short.

Many merchants say that banks are hoarding cash and delaying payments on personal credit cards. While no banks would comment officially in response to my inquiries, it’s clear that Chinese lenders are dumping riskier credit-card holders just like their Western banking brethren. Only faster.

Unlike their Western cousins, for whom credit has been a bonanza, Chinese banks have only relatively recently gotten into the credit game after being so cash-centric that the rest of the world’s bankers viewed China’s lenders as antiquated. But now that generation of cautiousness is paying off.

Chinese banks are apparently also going the extra mile to ensure they don’t get burned. Lenders are making credit-card transactions as unattractive as possible for the merchants who process the charge slips and they’re doing so by using the most effective tool of all – delayed payments.

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Only a year ago, most banks paid credit-card transactions in 14 days. But now, according to reports by CNN and other news outlets, it’s not uncommon for a merchant to have to wait 20, 40 or even 90 days to get paid. And that obviously affects cash flow at a time when luxury businesses in China are already under pressure.

This all speaks to something we at Money Morning have talked about repeatedly over the past 12 months: Investing in China is not about luxury as so many investors have mistakenly thought. It’s about the basics. To be sure, luxury items and top-shelf brands have enjoyed a heyday in China that coincides with the dramatic growth spurt the country has experienced in recent years. But luxury brands are hardly the key to steady growth and profits over the long term.

That mantle, instead, belongs to much more basic industries, such as power-generation, railway-and-infrastructure construction, water filtration, and pollution control. All will benefit substantially from China’s $583 billion stimulus package, which is designed to fuel growth that not only benefits the economy, but also staves off social unrest, which is what Beijing’s power elite fears the most. To China’s Politburo, running out of power is a far more significant risk than running out of Gucci.

So for investors who are interested in grabbing the best that the Red Dragon offers while avoiding the risks there, hairy crabs are yet another harbinger of where and how to invest in China in 2009.

[Editor’s Note: Money Morning Investment Director Keith Fitz-Gerald will be personally leading our 7th annual Chinese investment tour this April and invites anybody who wants to sample hairy crabs to join him. It’s a great way to see firsthand how and why China is critical to the global economic recovery and to our individual investing futures – not to mention that it’s also a great opportunity to sample some truly spectacular food. Please click here to learn more.
Fitz-Gerald is also the editor of the new “Geiger Index” trading service.As the whipsaw trading patterns investors have endured this year have shown, the ongoing global financial crisis has changed the investment game forever. Uncertainty is now the norm and that new reality alone has created a whole set of new rules that will help determine who profits and who loses. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive. With the Geiger Index, Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." The Geiger Index system allows Fitz-Gerald to predict the price movements of broad indexes, or of individual stocks, with a high degree of certainty. And it's particularly well suited to the kind of market we're all facing right now. Check out our latest report on these new rules, and on this new market environment.]

News and Related Story Links:

• 12HK.com (The Unofficial Guide to Hong Kong):
  Wan Chai Street Market.
• Hong Kong Voyage:
  Temple Street Night Market.
• Money Morning News Analysis:
  Massive China Stimulus is Viewed as an Attempt to Help the West.
• SFGate.com (The San Francisco Chronicle):
  It’s a Hairy Crab Extravaganza.
•  Wikipedia:
  Asian Financial Crisis.
• TripAdvisor.com:
  Cuisine Cuisine Restaurant.
• Wikipedia:
  The Politburo of the Communist Party of China.
• Money Morning Outlook 2009 Series:
  China’s Red Dragon Turns Financial Crisis into Opportunity.
• Money Morning Buy, Sell or Hold Series:
  Buy, Sell or Hold: For a Defensive Stock, Wal-Mart Plays a Great Offense.

The One Global Market Where There are Gains Behind the Gloom

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

It’s easy to be gloomy when it comes to the financial markets.

It’s even easier to write off China.

After all, the Red Dragon’s markets have collapsed by 70%, businesses are shutting down, lead-laced toys and poisoned medicines have tainted the minds of Western consumers, there’s a growing gap between the rich and the poor, inflationary clouds seem to be gathering, and overbuilding is a growing concern.

And that’s just a partial list.

The situation has gotten bad enough that China’s economic growth rate may slow from 9.6% this year to 7.75% in 2009. For those who are struggling to find the “next” profit opportunity at a time when the U.S. economy is straining to maintain any bit of forward momentum possible, those statistics should serve as a gigantic neon arrow over a lighted sign that reads: “Invest Here.”

Simply and succinctly put: U.S. investors are unlikely to ever see this kind of growth here at home ever again.

On the other hand, China is much like America was at the dawn of the Industrial Revolution. Sure, there are problems – and, admittedly, it’s easy to focus on a whole slew of them right now – but there’s still all kinds of potential, too.

If you’ve ever been to China, you know exactly what I’m talking about. You literally can feel the broad sense that the best is yet to come. Contrast that with the United States or Western Europe, where hand wringing, and finger pointing are the norm.

Why is that?

Because, as I mentioned a few weeks back, Beijing “gets it.” And China’s central government is taking major, decisive steps to ensure that China’s people do, too, an admirable example of the kind of leadership that Washington’s self-absorbed politicians seem no longer capable of delivering. Most recently, as Money Morning reported, Beijing approved a $586 billion stimulus package. In an era of trillion-dollar bailouts, that was almost too small to register on the old Richter scale here in America. But it should have.

If America were to put in place a stimulus plan that represented the same proportionate outlay that Beijing’s will for China, we’d be talking about an infusion of nearly $1.83 trillion, or 10.89 times more than the positively puny $168 billion stimulus that went into the hands of U.S. taxpayers last year. And it would probably dwarf anything that President-elect Barack Obama is contemplating right now.

Think of the pile-driver-like effect a stimulus of that size would have on U.S. consumer spending – which, after all, accounts for 70% of what the American economy does. Billions of dollars in loans could be paid off and consumer debt retired. In that sense, such a massive capital infusion could do what U.S. Federal Reserve Chairman Ben S. Bernanke and his Bailout Boys can’t achieve. The Beijing-like infusion would provide a needed recapitalization of the financial markets – without rewarding those who got us into this mess in the first place. Most important of all, it would help the folks who are caught in the middle – us consumers.

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What makes this particularly ironic is that the nature and composition of China’s stimulus program suggests that Beijing’s communist government understands consumer psychology and capitalist financial markets better than Western governments do right now – particularly the psychology.
For example, because of the credit crisis and relentless coverage of the flagging economy, consumers are scared stiff at the moment. And understandably so. They see factory orders declining and jobless claims spiking to their highest levels in 25 years. They read the news that retail stalwart Wal-Mart Stores Inc. (WMT) – is lowering expectations. So consumers opt to hoard money out of fear, rather than spend it, and that’s what really kicks a recession into gear.

So what will China’s stimulus package do that ours won’t?

For starters, Beijing’s stimulus is designed to encourage spending, rather than reward malfeasance, as our bailout plan is doing. Further, there’s no buying up of bad debt. Instead, there’s an implied recapitalization that will take place through growth. But most importantly, Beijing is sending an ultra-clear message to its people – we will be here for you and we will help you directly – and that’s stoked the confidence in every Chinese contact I’ve talked to since the plan was announced.

And that uptick in confidence is warranted, given all that China is planning, including:

• Improved environmental-protection projects, including new sewage and waste treatment projects.
• More low-rent and affordable-housing projects.
• Distributed healthcare projects, including hospitals, clinics and medical equipment, particularly in the historically ignored rural regions.
• New highways that will more than double China’s navigable area and that will account for nearly 40 million new jobs in the next 24 months.
• New railways and railway-related projects, which will create 6 million jobs during 2009 alone and more after that.

Beijing’s stimulus is geared toward creating 3.0% to 5.0% gross domestic product (GDP) growth to augment the 3.0% domestic-consumption activity, for a total 2009 target growth rate of at least 7.0%.

While China’s stimulus is designed to create valuable growth, the U.S. package is simply concerned with plugging leaks. China’s package is forward-looking, while ours is not.

Clearly though, the effects won’t be immediate and Beijing knows that. And that’s why, based on historical trends, we expect it to be about six months before the money really begins to work its way through the system. Look for an uptick in Chinese demand in late 2009, and acceleration in 2010.
Look, also, for the worldwide ripple effects, particularly for commodities producers and exporters that do business with China, and the infrastructure providers. This package will stop many of these sector skids, and we can look to see them rebound in earnest once demand kicks in and the Renminbi (yuan) start to flow.

Let’s hope that the rest of the world gets the message. Washington’s current bailout plan isn’t large enough to restart the global markets and it sure as heck isn’t large enough to recharge investor psychology.

But China’s plan is. And that’s what Washington should be looking at.

News and Related Story Links:

• Money Morning News Analysis:
  Massive China Stimulus is Viewed as an Attempt to Help the West.
• Wikipedia:

  Industrial Revolution.

• Wikipedia:
  Pile Driver.

The Five Keys to Value Investing Profits

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Value funds have long been viewed as conservative investments. So why are they down an average of 42% during the past 12 months, and what’s wrong with them?

No question, such numbers are scary, especially for large-cap value fund investors who have experienced that 42% drop. And the fact that some of the biggest names in value investing have taken such big beatings has to be especially disconcerting for investors who already have had their confidence badly shaken and their portfolios eviscerated.

Bill Miller’s once-vaunted Legg Mason Value Trust fund (LMVTX) has dropped 62%. Meanwhile, Marty Whitman’s Third Avenue Value Fund (TAVFX) is down 50%. Even the Dodge & Cox Stock Fund (DODGX) fund has tumbled 49% year to date.

For many investors who viewed value funds as comparatively “safe,” low-risk investments, this has to feel like a betrayal. And that’s understandable, given that history has repeatedly shown the value discipline to be one of the strongest, most stable investment strategies available for navigating a bear market.

What’s different this time?

Some managers – like Legg Mason’s Miller, as well as the Dodge & Cox team, for example – simply underestimated the depth and severity of the challenges facing their investments. Adding insult to injury, they concentrated their investments in a relatively small number of core holdings they thought they “knew.” During good times, this concentration strategy can dramatically boost returns when stellar companies that had been trading at deep discounts subsequently rebound. But now, when times are tough, as is readily apparent, stockpiling money in one or two holdings like Lehman Bros. Holdings Inc. (OTC: LEHMQ) or Freddie Mac (FRE) can be devastating.

Others, like Whitman – a gentleman who is often regarded as the “Dean of Value Investing” – simply don’t sell all that often, preferring to ride out market gyrations, which they view as a mere nuisance. So their performance is likely to suffer in line with the markets. But that’s not necessarily a bad thing. In fact, Whitman, who is notorious for looking beyond what the public markets do, doesn’t care that prices have fallen so low. He believes that undervalued companies will be taken over, liquidated or refinanced which, as he pointed out in an interview with Brian Zen last year, is “where you make your money.”

While such strategies put value players on the losing side of the investment ledger for now, it will be a different ballgame when the markets turn, as they eventually will.

In fact, when we emerge from the other side of the current financial crisis – which we will, and probably sooner than everybody realizes – the deep-value choices available today will be some of the highest-performing investments for decades to come.

And for all the right reasons: Many of the underlying companies are still expecting solid business growth, diversified revenue streams and a clear path to higher earnings.

That means that one of the smartest moves a savvy investor can make today is to stick with the value-investing discipline. The historical record suggests that the best choices continue to be those companies with low or no debt, a high proportion of international revenue, and a history of solid dividend growth that pays us cold, hard cash for the ownership risks we take.

That is why there is nothing “wrong” with making value investing a key component of your investment strategy. Especially now.

As for the notion that “value” investing is broken, we don’t buy into that. Studies show that investing styles come and go. For instance, indexing might hold sway for awhile, until it gives way to a total-return strategy. Then the momentum players hold the majority. And so on.

What’s important to understand, however, is that styles don’t work all the time; they work over time, which is why it is more important than ever to maintain a laser-like focus when the going gets tough. The following five guidelines can help you keep that focus.

Five Keys To Consider Right Now

• Be Patient: Investors have fled the markets in droves lately. According to TrimTabs Investment Research, mutual fund investors have pulled $175 billion out of stock funds so far this year, with $56 billion of that capital exodus taking place in October alone. This is the first year that equity flows have been negative since 2002, which reaffirms something we frequently point out: Investors tend to rush in at market tops and out at market bottoms. And that suggests that we may be approaching a bottom – even if it’s not immediately apparent.

• Rebalance: Tough markets can really skew your financial perspective. And your portfolio balance. “Rebalancing” can help you get back on track to higher returns, as we’ve mentioned in the past. Not only does rebalancing force you to take profits, but it also encourages you to put more money to work in areas that have been hit the hardest (and which are also poised for the biggest-potential rebounds, studies show).

• Look For Consistency: As redemption requests mount and conditions deteriorate, some value funds are shifting managerial styles in an attempt to make up lost ground. Not only does this suggest that these funds never had a strategy to start with, but it also suggests a lack of discipline, which is exactly what we don’t want right now. Studies show that value funds, in particular, tend to rebound more sharply than other investment choices because they’re often chocked full of quality stocks trading at deep – but temporary — discounts.

• Make Sure Value Really Is Valuable: “Value” has many different meanings, so it’s important to make sure you understand what the term means when it comes to picking a suitable investment. For some managers, value means companies that are simply trading at steep discounts to other stocks. For others, it means a concentration on those stocks trading in predetermined ranges, perhaps as measured by such indicators as Price/Earnings (P/E) or Price/Book (P/B) ratios.  Different definitions can lead to vastly different types of stocks.

• When Buying On The Cheap, Understand That Near Term Outlook Often Stinks: During good times, value investing is often about buying companies that, at least in the near-term, have fallen on hard times. Now, however, pretty much everything is “cheap,” so the more important issue is identifying those companies with superior fundamentals and improving outlooks that may simply be caught in this bad-market maelstrom.

After all, Wall Street knows the price of everything. But very few people understand the value of anything.

[ Editor’s Note: As Keith Fitz-Gerald’s value-investing commentary underscores, uncertainty has been the watchword in the whipsaw markets of recent months. Just when it seems as if clear patterns have emerged, another bad-news revelation seems to jump up out of nowhere to roil then markets anew. But what if you knew what that next “revelation” was going to be? And you had enough time to prepare a strategy to tackle this new development – or, better still, someone also handed you a strategy with which to capitalize on this event. Money Morning’s latest investment report does just that – it predicts five key “aftershocks” that we expect will emanate from the U.S. financial crisis, and talks about profit opportunities that will flow forth from these “seismic” market events. Indeed, we’re so excited about the potential for these new predictions that we’ve actually launched a news series to watch as they unfold in the weeks and months to come. To read our first installment in this new news series, check out “The Five Financial Crisis “Aftershocks” Investors Can Play for Profit.” Make sure to watch for additional installments of that series. In the meantime, check out our full research report on the five aftershocks investors can play for profit. And check out our just-launched economic forecasting news series, “Outlook 2009” series. The latest installment, our forecast for the U.S. housing market, appears elsewhere in this issue of Money Morning.]

News and Related Story Links:

• Money Morning 2009 Economic Outlook Series (Part II):
  For the U.S. Economy in the New Year, the Pain Will Precede the Promise.

• Money Morning 2009 Economic Outlook Series (Part III):
  Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009.

• Investopedia:
  Rebalancing.

• Investopedia:
  Price/Earnings (P/E) Ratio.

• Investopedia:
  Price/Book (P/B) Ratio.

• Money Morning Aftershock Investing Series (Part I):
  The Five Financial Crisis “Aftershocks” Investors Can Play for Profit.

Market Milestones to Watch for in the Months to Come

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

With the whipsaw trading we’ve seen of late, it appears that the U.S. financial markets are already chewing through the post-election honeymoon. I have to say that I, for one, am relieved that’s the case because it signals that the markets are already returning to normal.

I realize it may not feel that way, but there’s one very important thing to remember: We nearly always seem to receive the best news near, or at, market tops, and the worst news near, or at, market bottoms. Although that seems contradictory, it actually makes sense. And investors can take some solace in the fact that the mounting tide of bad news is an important part of the bottoming process.

Speaking of which, studies show that the most dangerous time for American markets (and U.S.-centric investors) is when one political party controls all the marbles. It doesn’t matter which one, either – Republican or Democrat. The reason is clear: Single-party control typically brings out the very worst in big government in the form of higher taxes, magnified spending, and even war. As my friend, economist Mark Skousen, recently noted, “every one of the major wars involving America occurred during one party rule: World War I, World War II, Korea, Vietnam and Iraq.”

According to studies conducted by researchers at Ned Davis Research, the best thing financially would be to have a divided government and gridlock. In short, the Dow Jones Industrial Average Index logs its biggest net gains with a donkey in the White House and elephants traversing the halls of the U.S. Capitol Building. During such periods – with a Democrat in the White House and a Republican Congress – the stock market generates an average return of 9.6% a year.

People assume that a presidential administration and Congress with matching political affiliations is the best way to get things done, but in reality, the checks and balances of a mismatched pair helps to ensure that governmental agendas don’t go to extremes. Thus, somewhat surprisingly, political gridlock is actually a reality that puts investors at ease and permits the financial markets to operate efficiently.

Obviously, with Democratic President-elect Barack Obama coming into office in the New Year, along with an even stronger Democratic Congress, we’re not going to have such gridlock-generated returns to look forward to.

But fret not: Another interesting conclusion suggested by our own research, and that of Ned Davis and other research firms, is actually quite promising. In stark contrast to what most investors believe to be true – that Republicans are better for the markets – the fact is that the blue-chip-dominated Dow tends to rise nearly twice as fast during Democratic presidencies (7.2%) as it does during Republican ones (3.8%).

The great equalizer, if there is one, appears to be inflation, which rapidly eats away the higher returns to bring them within a few basis points of each other over time.

And with the U.S. government having injected roughly $3 trillion in bailout money into the financial markets, an inflationary environment may well be in our future.

Rest assured, we’ll continue to monitor the markets and keep you informed of all the latest developments. In fact, if you haven’t already, tune in on our just-started “Money Morning Outlook 2009” global investing forecasting series.

Our “Outlook 2008” series was so well received that we ultimately published it as an investment playbook. This year, our series is even more comprehensive. We’ve already published our forecasts for the Obama Administration and how its policies may affect the U.S. market, for the U.S. economy and for the stock market. And we’re planning individual reports on gold, oil, housing, Latin America, China, retail sales, biotechnology, alternative energy, income investments – and more. Stay tuned to Money Morning.

News and Related Story Links:

• Money Morning Market Commentary:
  When Gridlock is Good: Why a Contentious Election and Legislative Bottlenecks Pack a Profit Punch for Investors.

• Money Morning 2009 Economic Outlook Series (Part I):
  Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year.

• Money Morning 2009 Economic Outlook Series (Part II):
  For the U.S. Economy in the New Year, the Pain Will Precede the Promise.

• Money Morning 2009 Economic Outlook Series (Part III):
  Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009.

How to be “Selectively Bullish” – Even in the Face of Financial Crisis

Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Nut job. Alarmist. Fear monger. Dr. Doom.

I’ve heard them all. When you make your living as a financial analyst and commentator, as I do, you aren’t going to get a lot of invitations to the ol’ country club – especially if you spend a lot of time spotlighting the problems that are created by greedy Wall Streeters, sleepwalking regulators, or indentured elected officials.

But when you repeatedly warn investors that the U.S. financial system is on a collision course with disaster, and state that some investors will experience "extinction-level events" – and when you broadcast these warnings when virtually everyone else is in denial and is dismissing the market problems as "minor" – you’re bound to become a marketplace outcast.

Until, of course, your predictions are proven correct.

We may be hearing from my critics again – and soon – for I’ve got another prediction they aren’t going to like.

There clearly are countries – such as the United States and much of the European Union – that are going to collapse into recession, even if only unofficially. But this doesn’t necessarily have to evolve into a global recession – a position that most of the traditional Wall Street establishment disagrees with, by the way.

Let’s take a look at several of Wall Street’s current misconceptions – and see why I’m selectively bullish:

• The Red Dragon (China) is ready to hibernate: Wall Street is worried that a U.S.-induced recession will slay the Red Dragon. There’s no way. If a country can fall into a recession when its economy (as measured by gross domestic product, or GDP) is advancing at a 9.6% clip – at a time when its U.S. counterpart will be lucky to eke out a 1.0% growth rate – well, I’ll eat my hat. The Armani Army, in its infinite wisdom, is worried about a recession in China even though its $1.9 trillion in foreign reserves are more than 32.10% of GDP and external debt is a miniscule 7.6% of GDP (external debt is defined as the amount of debt that China owes external creditors, including consumers, central governments and commercial institutions, according to the CIA Fact Book). By contrast, the U.S. reserves are 4.84% of GDP, while external debt is 84%. The United Kingdom and Switzerland are in even worse shape, with external debt of 382.2% and 279.1%, respectively.
• China won’t be able to survive a drop-off in exports to the United States: Then there’s the myth of China’s export economy. The last time China took a header and export business dropped by 35%, its GDP dropped by less than 1%. I’m betting it will be an even smaller bump this time around, especially since China’s middle class now is increasingly responsible for internal growth – independent of what China exports to the rest of the world.
• The Asian economies are an economic train wreck just waiting to happen: This was true a decade ago, when the United States and Western Europe held all the cash. But no longer. Today, nations such as Singapore, Thailand and Malaysia are running trade surpluses. So is Canada. That suggests that the currencies of these countries are significantly undervalued at a time when their economies are increasingly tied to that of China. What does that tell us? Today, China is the growth engine of Asia; tomorrow, it will be the growth engine of the world.
• The U.S. economy remains the financial center of the world: Today, an estimated 78% of global economic activity takes place outside U.S. borders, which means that even in a recession, an increasing amount of capital circulates beyond the U.S. shores. Indeed, the U.S. stock market now represents less than 30% of total world market capitalization, down from roughly 45% as recently as 2004. Don’t be surprised to see the United States continue to decline in economic relevance. One day, the lion’s share of the financial trades will take place beyond U.S.  borders.
• Because it’s a developed market, the United States remains the world’s safest and most promising place to profit: In the 1980s, the United States accounted for one-third of the global economy; by 2030, that ratio will be cut in half. The reality is that U.S. investors who want to be successful in the years to come will have to learn all they can about markets whose names they can’t yet pronounce.

Wall Street may not agree, but the real adage to embrace and remember is this one: It’s easier to become No. 1 than it is to stay there.

There’s no doubt that the "experts" who are projecting that the world markets will decline further and perhaps even collapse will take issue with my analysis. But it’s important to note that I agree with you – at least in the near-term. Barring a governmentally induced Hail Mary, I think there’s no question that the worst remains ahead of us.

But longer term – I’m talking three, five to 10 years – I am intrigued by the fact that so many emerging markets have collapsed in the chaos, even though the underlying economies haven’t really changed. Everything we know about financial markets history and changes in market behavior suggests that countries backed by high cash reserves tend to emerge from periods of market chaos faster – and stronger – than the economies that had been at the top of the heap when the crisis first struck. [For some insight into which countries have the biggest reserves as a percentage of GDP, take a close look at the accompanying chart].

Where does that leave us? Well, in spite of what Wall Street would have us believe about the Red Dragon, this cash-reserves indicator suggests that China – and countries that have close economic ties with that country – may actually be getting more attractively valued (and not less) by the minute. That’s especially true for longer-term investors.

As for the types of investments that seem most promising, given the troubled times we live in, keep focused on the simple ones. As I’ve long suggested, such simple profit plays have always played well during periods of similar market turmoil. So there’s no reason to believe it will be any different this time around.

After all, the financial history books are filled with notable examples of real earnings and real products enjoying success over long periods of time. Particularly when those profits are being generated by companies focusing on such basic societal needs as energy or infrastructure. Barring a complete collapse in the oil business (or any perfect substitute that’s eventually developed), energy, commodities and infrastructure companies will continue to offer solid upsides.

As for the U.S. dollar, after years of benign neglect, the U.S. Federal Reserve and U.S. Treasury Department will do everything they can to prop up the credit markets, In the short term, most investors will misconstrue this as a legitimate rise, all that’s really happening is that longstanding risks are being overcome by governmental guarantees.

Longer term, the damage has been done. No nation I am aware of in recorded history has done more than temporarily dodge the inevitable by debasing its currency as the United States is doing right now. And that’s why – at the risk of inflaming yet another bunch of Wall Street folks – I’m increasingly of the opinion that the United States is headed for a major currency crisis in the next few years. Wall Street doesn’t see it, and I sure hope that I’m wrong.

For the same set of reasons, I don’t think that investors should be the least bit surprised if U.S. regulators (in conjunction with their counterparts overseas) actually shut down the financial markets for a week or two while they try to sort out the credit crisis and reevaluate currency relationships that are right now being pushed to the brink of oblivion.

While this is regarded as impossibility by many – and simply incomprehensible by others – Bloomberg News reported Oct.10 that Italian Prime Minister Silvio Berlusconi said world leaders were discussing shutting down global exchanges. He later retracted his comments, saying that he didn’t mean what he said.

But I think he (Berlusconi) did, and I believe they (U.S. regulators) are.

There are historical precedents for so-called "bank holidays," even here in the United States. In fact, the New York Stock Exchange closed its doors from March 4-14, 1933 as part of U.S. President Franklin Delano Roosevelt’s forced holiday (Emergency Banking Act), and did so again from Sept. 11-17, 2001 following the terrorist attacks against the US.

In both instances, what’s critical to understand is that the closures were designed as part of a government plan and not an overall solution. If not backed by a plan or ultimate objective, a shutdown would simply delay the inevitable, or move additional losses offshore until the U.S. markets were to reopen. Thus, even though a bank holiday would provoke terror among most investors, a globally coordinated stock market closure could also be viewed as a tremendous sign that central bankers and regulators finally understand the gravity of the situation we’re facing today and literally rewriting the rules of finance in a united, global front.

That’s why this reminds me of iconic investor Warren Buffett, who once reportedly quipped that investors shouldn’t buy anything they wouldn’t want to own for five years, if the markets were to close for that period.

Or something to that effect…

News and Related Story Notes:

• Wikipedia:
  Silvio Berlusconi.

• Wikipedia:
  Bank Holidays.

• Wikipedia:
  Franklin Delano Roosevelt.

• Wikipedia:
  Emergency Banking Act.

• Money Morning Analysis:
  Railroad Play Burlington Northern Hauling Gains for Warren Buffett’s Berkshire.