“Experts” Grow Bullish on Japan …But We See Reasons For Caution

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

Fixed-Income Investing: A Cheaper, Safer Alternative to Equity Indexed Annuities

Fixed-Income Investing: A Cheaper, Safer Alternative to Equity Indexed Annuities

By Keith Fitz-Gerald
Editor, Time Trader Pro
Investment Director, Money Morning

For many investors, the concept of an equity indexed annuity (EIA for short) – which establishes a guaranteed minimum rate of return, and the ability to capture the upside of the next bull market with no risk of loss – is proving irresistible. That’s especially true at a time when the Standard & Poor’s 500 Index is still down nearly 45% from its 2007 high of 157.52 and new U.S. President Barack Obama’s stimulus plan has yet to be finalized.

But at the risk of receiving more than a few sharp emails from industry professionals who sell EIAs, let me tell you that you can achieve virtually the same degree of financial security using nothing fancier than a certificate of deposit (CD) and the SPDR Trust (SPY), which trades on the American Stock Exchange.

 Here’s what you need to know.

First created on Feb. 15, 1995, equity indexed annuities are insurance products that typically promise a set minimum income level or rate of return, plus the ability to capture market gains without any risk of losing money. Theoretically, they’re easy to understand.

You invest a lump sum for a fixed-time period – often 10 years or more – and in return receive a guaranteed minimum rate of return, plus the market upside, with none of the losses if it goes down.

If the market to which an EIA is indexed – like the S&P 500 – rises by more than the minimum promised return, your money is supposed to grow proportionately. In exchange for making the investment, the insurance company offering the EIA guarantees that your money will never drop in value.

The devil, as they say, is in the details.

In reality, the paperwork that explains equity-indexed annuities is one of the toughest financial documents of all to decipher and understand. Not only are the sales documents filled with legalese, but assuming you can get through the 40 to 60 pages of stuff that comes with an EIA, chances are you’ll find a wide range of conditions, restrictions and terms that frequently change over time. There are guaranteed minimums, performance adjustments, participation rates, interest-rate caps and spreads to contend with, for instance. And that’s just a sampling.

In addition, many EIA’s also cap the returns you can achieve, no matter how far the markets rise, which would seem to defeat the purpose of investing in one of these things in the first place. And that means, more often than not, that you’ll be left in the dust if the markets really take off.

To put this into context, if you invest in an EIA with a performance cap of 10% and the markets actually rise 20%, you’ll leave over 50% of possible gains in the insurance company’s pockets … not yours.

Then there are the associated fees and charges, which are quite hefty. In fact, various studies suggest that the purchase of an annuity typically results in a wealth transfer of as much as 15% to 20% from the investors who buy them to the insurance companies and the sales forces who sell them. That’s something not a lot of folks realize when they consider purchasing one of these specialized investments.

Despite these shortcomings, sales of EIAs are better than ever. According to Jack Marrion of Advantage Compendium Ltd. (www.indexannuity.org), investors have plowed more than $123 billion into equity indexed annuities. He added that “more than 90% of EIAs are sold by independent agents,” like one I spoke with who privately told me that sales are “up 25% in the last 6 months alone.”

Another insurance company representative, who also wished to remain anonymous, told me that “fear rules the day, and we know that, so it’s only logical to assume that we’ll sell more EIAs when people are scared.”

Sad but true.

Many investors I’ve talked to over the years tell me that they find it especially frustrating that no two EIAs are exactly alike, which is why apples-to-apples comparisons are next to impossible.  The same is true for performance comparison, even if two competing offerings are tracking an identical index, such as the S&P 500.

The bottom line on EIAs is that the returns you think you’ll be getting if the markets rise may be nothing more than an illusion once all the contractual details are netted out. They’re basically being sold as alternatives to stocks, when the reality is that they’re much more of a bond-related instrument.

In the interest of fairness, EIAs have outperformed the S&P 500 over the last nine years, something Miguel Herce of CRA International points out in the January 2009 issue of Money magazine. But over time – 63% of the time since 1926, to be specific – the markets would have beaten EIAs.

Various studies reinforce this notion. One, in particular, conducted jointly by Dr. Craig McCann of UCLA and Dr. Dengpan Luo of Yale University, reflects that investors would be better off in a simple portfolio of U.S. Treasuries and large cap stocks – a whopping 97% of the time.

Boston University Economics Professor Laurence J. Kotlikoff summed it up nicely, noting in Money that “some of these products might pay off, but even a PhD in finance can’t tell you if it’s worth it because the returns are almost entirely at the discretion of the insurance company [that's offering the EIAs].”

Which is why we’ve never been big fan of these things.

But if the notion of a guaranteed return and all the market’s upside strikes you as compelling right now – like it does us – here’s a dramatically simpler and far less expensive way to achieve financial tranquility.

• First, visit CostCo.com (or your local bank). When I checked, the company was offering Federal Deposit Insurance Corp. (FDIC) insured seven-year CD paying 5.05% APY through Capital One Financial Corp. (COF). Assuming you’ve got $20,000 to invest, you’ll need to plop down ~$14,166.34 now to have $20,000 in seven years. (You can run whatever numbers you want using financial calculators available on the Internet).

• Second, take the remaining $5,833.66 and buy the SPY exchange-traded fund (ETF), which tracks the S&P 500.

That’s it. No extravagant fees. No surrender charges. And, most importantly, no upside-performance caps.

Plus, your investment is now guaranteed by the FDIC, which strikes me as a whole lot safer than a comparable EIA, which incidentally is only as good as the insurance company backing it. And lately, that’s suspect to say the least.

Worst case scenario, you get your $20,000 back in seven years. Best case, if stocks recover from here and achieve 7% annually for the next seven years, you’ll earn an additional $9,367.58, making your grand total $29,367.58.

What’s more, because there’s no complicated contract involved, you will understand what you’re getting into from the get go, and will get to keep 100% of the potential gains to boot.

In closing, it’s worth noting that EIAs are frequently touted as tax-advantaged investments in an attempt to make them more appealing. But if you simply buy the CD and the SPY in your IRA, you’re achieving the much the same thing – but without the 9% commission.

News and Related Story Links:

• Wikipedia:
  Equity indexed annuities.
• Wikipedia:
  Laurence J. Kotlikoff.

Contango Isn’t A Dance In Argentina: It is a Shot at Windfall Profits

Contango Isn’t A Dance In Argentina: It is a Shot at Windfall Profits

By Keith Fitz-Gerald
Editor, Time Trader Pro
Investment Director, Money Morning

Many investors have given up on oil, fearing that a fall from grace precludes a rise in price from the ashes. But it’s worth noting that the oil markets are right now in a rare state of  ’super contango,’ which suggests that the markets expect far higher prices by next year.

Here’s what you need to know.

In case you’re not familiar with the term, ‘contango‘ denotes a normal and very specific condition associated with futures contracts in which the price of oil for distant delivery months from now exceeds the price of oil being traded right now on the spot market. Typically, the price difference is related to the cost of storing and insuring the oil itself.

An example might help. On Tuesday, oil traded at $38.81 a barrel on the New York Mercantile Exchange (NYMEX) spot market. So if we bought a barrel and put it into storage for the next five months, and assumed that would cost us 90 cents per barrel per month, under normal market conditions, we’d expect the June crude oil contracts to be priced roughly at $43.31 ($38.81+ the cost of storage for five months = $43.31).

However, according to the New York Mercantile Exchange, June crude oil contracts settled at $52.14 on Tuesday, which represents a state of ’super contango’ – and an excess potential profit of $8.83 per barrel ($52.14 – $43.31 = Excess Potential Profit of $8.83). But only for traders who can buy oil now and store it until then.

There are obviously wrinkles, of course, depending on where the oil is stored and how it is priced for delivery. But, in general, the spreads we’re seeing now are at, or near, their highest levels since April 2004, when the government started collecting Cushing data. Cushing is the delivery point for all NYMEX futures.

Super contango is a rare situation that causes most traders to drool – myself included – because it signals an arbitrage opportunity that’s literally too good to pass up if you’ve got the means to capitalize on it.

But, as usual, there are all sorts of unanticipated consequences – including a phenomenon we don’t see very often – hoarding at sea.

Tanker rates are skyrocketing as companies literally top off very large crude carriers with the 2 million gallons they’re designed to carry – and then park them offshore until prices rise. In the meantime, they’re also selling the June futures and locking in profits above and beyond what it costs them to buy and store their stash of this ‘black gold.’

Of course, with every tanker that’s stuffed to the gills as a storage container, there’s fewer of the big boats in circulation. And that’s caused benchmark supertanker rental rates to rise more than 56% since Jan. 1. But the perceived profit potential is so high right now, that even investment banks, which are hardly in the market for super tanker rentals under normal circumstances, are getting into the game.

According to recent reports by Bloomberg News, Phibro LLC, the commodities trading arm for Citigroup Inc. (C), has booked two supertankers to hoard crude oil supplies. Phibro recently stationed the 1-million-barrel carrier ‘Ice Transporter’ off the coast of Scotland and the ‘Ashna’ waits patiently on the U.S. Gulf Coast. Assuming they capture the entire $8.83 a barrel in excess profits we cited in our example, that’s a cool $8.8 million in the bank, just from the Ice Transporter cargo alone.

Based on my experience, traders tend to run in packs, so it’s highly likely that all the usual suspects are involved including most notably Morgan Stanley (MS), which owns half of tanker group operator Heidmar Inc. and Goldman Sachs Group Inc. (GS), which executes commodities trades and structures related deals through J. Aron & Co.

As many as 80 million barrels of crude are being stored at sea around the globe, according to Frontline Ltd. (FRO), the world’s largest owner of supertankers. That’s nearly enough to supply the entire world’s demand for a day.

As for what caused the super contango, the most common and widely accepted argument is that falling global demand has caused a current glut in supply that will be rectified by production cuts by the Organization of Petroleum Exporting Countries (OPEC) later this year. That’s certainly plausible and there is no shortage of data to support this contention.

‘That’s really what they’re betting on,’ said Opportunities in Options‘ Paul Forchione, a veteran trader with 30 years in the commodities markets. ‘A significantly higher price for the deferred contract month in excess of storage and insurance costs typically means traders expect demand to grow in the future.’

In his experience, Forchione said that ‘this situation is hardly the panacea that everybody thinks it is because it’s hard to put a limit on how far out of whack prices can get.’

However, there’s also another plausible explanation that seems entirely likely, based on conversations I’ve had with traders, officials and company officers in the oil business all around the world.

Basically, the super contango we’re seeing now could suggest that future pricing is as much about the fear of supply interruption as it is about present demand dropping. And that’s entirely logical given the constant state of warfare in the Middle East, threatened production in Africa, an unsteady South America, and China, which is structuring oil-supply deals with rogue nations as fast as it can.

I know from having addressed crowds of investors all over the world that this seems impossible, but at a time when China and India, for instance, are doing everything they can to stave off a global recession, it’s certainly not inconceivable. Moreover, if this is even remotely true, as a growing trail of evidence suggests, then the present super contango could also imply that traders believe oil will be increasingly hard to find, refine and transport in the months ahead. That, too, suggests higher prices to come

Now for the million-dollar question: What can investors do about it?

The most obvious choice for investors who think prices will indeed be higher come next June is to buy any of the half dozen oil-related ETFs. That includes The United States Oil Fund LP (USO) or iPath S&P GSCI Crude Oil Total Return ETF (OIL).

The problem, of course, is that the spreads companies are counting on for profits could drop rapidly between now and then. This would force companies currently hoarding oil to begin dumping it, thereby reinforcing even lower prices going forward. There is also the possibility that OPEC production cuts never happen, or are ineffective, which would also point to lower prices.

History suggests that far safer bets include mid-process transportation companies like TeeKay Corp. (TK) or land-based alternatives like Kinder Morgan Energy Partners LP (KMP). Both pay healthy dividends that can help stave off a personal recession no matter what happens with oil prices. That’s always important in rough markets.

For futures-savvy investors, there’s an even more direct bet. Data shows that ‘mean reversions’ are particularly powerful phenomena when it comes to commodities, so the fact that spreads have risen to all-time highs suggests that it’s only a matter of time before they reverse. One way to potentially capture that would be to buy March futures while selling June futures.

Risk management is paramount, regardless of which path investors choose. Super contango sounds to good to be true and we all know the old adage: If it sounds too good to be true …

News and Related Story Links:

• Money Morning Outlook 2009 Economic Forecast Series:
  Why Crude Oil Will Present Investors with a Golden Opportunity in 2009.

• Money Morning News Analysis:
  Oil Prices Could be Ready to Rally if History is Any Indication

• Bloomberg:
  Frontline Says Ships Storing the Most Oil in 20 Years

• Bloomberg:
  Citigroup’s Phibro Hires Second Tanker to Store Crude Oil.

• Wikipedia:
  Contango.

• Wikipedia:
  Spot Market.

• Phibro.com:
  Corporate Web Site.

• Star Tribune:
  Oil consumption at the tipping point in U.S.?

Are U.S. Stocks Nearing the “Sweet Spot” for Double-Digit Gains?

Are U.S. Stocks Nearing the “Sweet Spot” for Double-Digit Gains?

By Keith Fitz-Gerald
Editor, Time Trader Pro
Investment Director, Money Morning

With the way stocks are being whipsawed, investors often ask me how to tell when the market is ready for a rebound. While there’s no way to ever be 100% certain, I usually just let history be my guide.

And history has a very interesting story to tell right now.

Just take a look at the following chart. Since 1927, the markets have shown beyond a shadow of a doubt that the worst of times for the U.S. economy have literally proven to be the best of times for stocks when it comes to choosing a time to buy.

The best buying opportunities are typically found when the market is represented by points inside the box located in the lower left-hand corner of the chart. This is when valuations are most favorable, as they were in 1932, 1941 and 1982.

When the markets are anywhere above and to the right of the box, they are statistically more at risk of falling than rising. There are naturally times when the markets rise from points above the box, but those are the historical exceptions.

For instance, take a particular note of March 2000, represented by a point way up in the right-hand corner. Take a minute to drift back in time and recall just what everybody was saying then about U.S. President Bill Clinton’s “New Economy,” the Dow Jones Industrial Average heading to 15,000 (and beyond), the Internet-technology boom, etc.

Everyone was encouraged to buy in. One of the reasons why I refused to buy into that – pun absolutely intended – is because of this valuation chart. I could see that the markets were ludicrously overvalued at that time versus any other period going all the way back to 1927.

The markets certainly aren’t that overvalued now.

GDP Declines Bode Well for the Dow

Interestingly enough, this data is supported from another angle using gross domestic product (GDP) data. Since 1947, of the 11 times the quarter-over-quarter change in GDP was a minus 4% or more, the Dow was higher by an average of 25% one year later and 35% two years later.

What the data in this second chart tells us is that the latest projections suggest we’re right in line with historical norms, given that economists expect that the U.S. economy suffered a mind-numbing decline of 4.35% in the final quarter of last year. When everyone else believes the worst; that’s when you should be buying.

Obviously, we have to take this kind of phenomenon with a grain of salt, but any time one data source corroborates another, it’s worth noting – particularly when there are companies out there that meet our very strict investment guidelines.

One company in particular that I’m jazzed about is pretty phenomenal. Just today, in fact, I released a report on it to the online readers of The Money Map Report. Let me give you some specifics.

I like this particular company because it operates in a “boring” section – and yet the numbers surrounding this company are about as exciting as they come.

It’s got a $4.4 billion market cap, and it’s beaten five of the last six earnings estimates by an average of 32.35%, despite horrific market conditions

In fact, anytime I consider a stock as an investment candidate, I want to see expanding year-over-year sales and earnings figures. More so than any other indicator, I find that what a business does for and with its customers is a solid indication of how management’s handling things.

And by all accounts, this company’s score is “darned good.” Quarterly year-over-year revenue has expanded 33.6%, while earnings have increased 49.5%.

The bottom line: The stock is undervalued. And it pays a steady dividend, so we’ll be rewarded even while we’re waiting for the rest of the market to recognize this company’s inherent worth.

I’ve just released all my research on this company today (Friday) in our current issue of The Money Map Report, which is for subscribers only. But I’ll also be reporting on other opportunities like this in the weeks ahead. I’m hoping to see more of them.

News and Related Story Links:

• Wikipedia:
  Nathan Rothschild.
• IStockAnalyst:
  Blood in the Streets.
• Whitehouse.gov:
  Bill Clinton.
• Wikipedia:
  Dot-com bubble.

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

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

By Keith Fitz-Gerald
Editor, Time Trader Pro
Investment Director, Money Morning

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.

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.

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.

Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009

Unprecedented  Volatility Will Continue to Rock the Stock Market in Advance of a Possible  Rebound in Mid-2009

By Keith Fitz-Gerald
Editor, Time Trader Pro
Investment Director, Money Morning

In the 20 years I’ve been creating stock-market forecasts, I’ve never seen such a contradictory set of forces at work in the markets all at one time. I could just as easily make the case that we’re finally nearing a bottom, as I could that we’re in for protracted downturn punctuated by sharp, quick drops.

The only question in my mind is what shape an eventual recovery will take, for I see three possibilities:

• A “U,” with a slow, methodical reversal that gradually transitions into a market rebound.
• A “V,” with a quick, sharp reversal that marks the start of a powerful rebound.
• Or a sideways “hockey stick,” in which the downward trend ends sharply – but without the immediate upward surge in stock prices that would constitute a strong rebound.

My proprietary analysis and historical precedents both suggest the “hockey stick” is the most probable scenario. At a time when earnings are slowing and all sorts of red flags are flying, there are still too many unknowns to predict a U-shaped or V-shaped rebound.
Therefore, we believe investors will be best served filling their sails with the winds from the world’s most-powerful trends than they will be by trying to catch the intermittent gales. This is a market that will be dominated by large global trends – and the blue chips that follow them – particularly at a time when the so-called “economic cycle” doesn’t matter much.

Position Yourself to Profit

A properly structured and globally diversified portfolio using the 50-40-10 allocation model (50% “base-builder” foundation investments, 40% global growth and income plays and 10% “rocket rider” speculative investments that will perform well in a recovery) we recommend in The Money Map Report – our affiliated monthly investing newsletter – will prove to be an investor’s best friend. And the reasons for that are as simple as they are compelling:

• First, a properly structured portfolio has built in safety brakes that keep us from making overly risky decisions.
• And second, while this allocation model was constructed to minimize our downside in markets such as the one we’re navigating right now, it also positions us to benefit when the rebound eventually gets under way.

During the past year, we’ve repeatedly urged our readers to make sure two other elements are part of their portfolio: Dividend-paying stocks and specialized “inverse funds” that gain when the markets decline.

While dividends are important in any market, they’re downright crucial now because they add to returns during market rallies and help offset losses during market declines. And our commitment to inverse funds was rewarded during the whipsaw month of October: During a month in which the Standard & Poor’s 500 Index lost 16.8%, the Nasdaq Composite Index shed 16.3% and the Dow Jones Industrial Average dropped 13.9%, all 10 of the best-performing exchange-traded funds (ETFs) were inverse funds, which boasted one-month returns ranging from 36.4% to 66.6%, Thestreet.com reported last week.

Now those are admittedly highly remarkable returns – and clearly aren’t the norm. But it does demonstrate the point we’ve been making: It pays to protect y our downside even as you position yourself for gains. And not only do such investments as inverse funds hedge our downside, they smooth out our overall portfolio volatility and help calm roiled waters.

On a more positive note, we’re now getting to the point where true value is finally being revealed, after years of “irrational exuberance.”
But the reality is – and this is hardly new information for most investors – that global markets in general (and the U.S. stock market in particular) remain fragile, and we expect them to remain that way as long as policymakers continue to interfere with their ability to function freely.

Some readers will no doubt take issue with this, believing that the responses of the U.S. Federal Reserve and other central banks have been necessary. While we respect that opinion, we must also point out that the markets have a remarkable history of sorting out problems on their own – if left to their own devices. However, that’s a largely academic discussion that we’ll leave for another time because the government has already charted a course it believes is prudent.

Even if the world’s central bankers get their act together, the damage has largely been done. What’s more, the various bailout packages – especially the $700 billion U.S. banking bailout – while well intentioned, are almost certain to have more than a few unanticipated consequences.

Topics to Watch

The reality is that these bailout programs remain with us, meaning we must factor them into our efforts to scout out profit opportunities. And on that point, we see five primary areas of change and opportunity:   

• The U.S. Dollar: By pumping an estimated $3 trillion into the global financial system, the U.S. government is setting the stage for the mother of inflationary conflagrations. According to classic economic theory, the greenback should be in an actual freefall right now – especially in the current low-interest-rate environment, where there’s the potential for still more rate cuts and for additional capital outlays by the U.S. government. And that’s just with the current administration. President-elect Barack Obama has made it clear that if an additional stimulus isn’t announced before he takes office, he’ll make that one of his first official acts. What’s saving the dollar, at least for now, is that there’s so much global uncertainty that the dollar is retaining its reputation as a “safe-haven” currency. And, for now, at least, a safe U.S. dollar trumps inflationary concerns. However, should global investors regain confidence for whatever reason, expect the dollar to decline sharply.
• Oil: Many people are focused on declining oil prices as a function of a perceived slowdown in global demand. We think that’s an erroneous analysis for three key reasons. First, oil is still largely priced and traded in U.S. dollars. That means that as the dollar has risen, oil has become correspondingly cheaper. In other words, much of the price decline we’ve seen can simply be attributed to a rise in purchasing power associated with a stronger dollar. Second, China, India and other newly capitalist (and still-reasonably robust) economies are still increasing their oil consumption at a rate that more than offsets the decline in consumption we’re seeing here in the United States and in other developed markets. And third, Brazil aside, there hasn’t been a major new discovery capable of offset global demand on anything more than a temporary basis for more than 30 years, and most major oil fields are in decline or soon will be. Increasing demand and diminishing supply are clearly bullish influences over the longer term. More immediately, however, a stronger dollar negates this and may well keep oil under $100 a barrel for much of 2009. Obviously a terrorist attack would change the ballgame significantly, meaning we could see a spike to levels exceeding our multi-year target price of $225 a barrel. A year ago at this time, we called for oil to spike well up over $100 a barrel, and touch $150, which it essentially did. Even with recent price declines, some energy-industry insiders are starting to subscribe to our bullish outlook: The Paris-based International Energy Agency (IEA) last week projected that long-term oil prices would reach $200 a barrel (although we think that will happen much sooner than the IEA does).
• Commodities: The story is much the same for commodities, in general, and we expect that longer-term investors will be amply rewarded. More immediately, the popular – though erroneous – assumption that a global slowdown will negate demand is driving prices lower, and may continue to do so for the next six months. Gold will be the most obvious casualty in this arena, as hedge-fund-redemption requests and margin calls continue to mount, which is why we expect the price of the yellow metal to remain lower far longer than most people expect (We’ll focus specifically on gold in an upcoming installment of the “Outlook 2009” series). When it does rebound, however, the returns will be high.
• Global Markets: There’s no doubt that the global markets have taken their share of lumps along with their U.S. counterpart in recent months. But we don’t expect them to suffer forever. Countries with high cash reserves as a percentage of gross domestic product (GDP) – such as China, India and Brazil – are becoming less dependent on the fractured U.S. consumer almost daily, and the economic decoupling we’ve seen developing for several years may really take hold in the New Year. This stands in direct contrast to the situation a decade ago, when the Asian Rim and South America were economic train wrecks and the United States and Europe held all the cash. Companies with significant global exposure to the Asian Region, Latin America and Europe – in that order – remain the best bets for relative safety and growth in 2009.
• Stocks in General: Many investors are questioning the wisdom of being in stocks at all. While we certainly understand the pain that sentiment is based upon – and are hurting, too – it’s important to remember that the last time stocks really performed this badly was during the 1930s. Investors who decided to “get out” entirely then missed the investment opportunity of their lifetime. Don’t make the same mistake. Data shows, unequivocally, that investors who buy when the world is going to hell in a hand basket –think 1932, 1942, 1982 and 2003 – enjoy the largest returns. That’s even true if you’re “early,” and buy ahead of the specific market bottom. However, history also demonstrates that investors who pile in at the market’s peaks – such as 1928, 1969, 1999 and 2007 — tend to incur the worst returns.
• Global Stocks in Particular: Led by cash-rich China, we expect global blue chips to remain the best relative bets for safety, income and appreciation potential in the New Year. We are especially focused on companies involved with infrastructure projects and with firms that derive substantial portions of their revenues from Asian consumers. The first is a no-brainer. According to the latest studies from a variety of sources, planned global infrastructure expenditures in this area exceed $40 trillion by 2030. There is not a bigger, more unstoppable trend on the planet today. If you want proof, notice that a big portion of China’s just-announced half-trillion-dollar stimulus package is devoted to infrastructure projects. Infrastructure companies there will certainly benefit. So will consumer-products firms that are positioned to benefit from the rise of an increasingly Asian consumer base, which boasts significant savings and pent-up demand. Many of the best companies are beaten down to the point that they now feature single-digital Price/Earnings (P/E) ratios – lower than we’ve seen in decades. Some are actually trading for less than cash value, despite a strong history of growth. And the companies we’re studying have solid cash flow – and excellent prospects of maintaining it.

Now for the $64,000 question – when could we see a rebound?

We don’t know for sure. Nobody does. History demonstrates that the first and second years of any newly elected U.S. president’s term are almost always problematic. When taken in isolation, we could see a scenario where this is countermanded by President-elect Obama’s planned stimulus, but given the potent combination of flagging earnings and slowing U.S. growth, we’re leery of doing so. [For a story that outlines what an Obama stimulus package could look like, check out this related story on the outlook for the U.S. economy elsewhere in today’s issue of Money Morning.]

On the other hand, for a variety of reasons, history also suggests that if we are to see a rebound, however nascent, the probability is highest for a resurgence starting in the middle of next year. First, since the 1970s, the time between the first and last market lows in any given bear market is an average of seven to eight months. If historical trends hold true, this suggests we could see a bottoming out by the middle of next year. That’s consistent and plausible, especially since other data shows U.S. recessions, on average, last 14.6 months – which also points to a bottoming out in late spring or early summer.

But the biggest indicator of all that we may see a bullish rebound in late spring or early summer – however slight – is admittedly based on emotion. Literally. Small investors have fled the stock markets in droves, and so far they’ve yanked more than $175 billion from the markets, with nearly 50% of that coming out during October alone. Granted, this is a mere 3.2% of the $5.5 trillion invested in stock market funds, according to Forbes, but it’s the first year that net equity flows have been negative since … a drum roll please … 2002.

History shows that small investors may be the most telling of all Contrarian indicators. According to TrimTabs, the Investment Company Institute and our own proprietary research, individual investors have a remarkable habit of rushing in near market tops and fleeing near market bottoms.

That means that long-term investors seeking the best wealth-building opportunities should find the immediate price declines we see ahead to be some of the most compelling buying opportunities of their investing lifetimes.

Now for the caveats – and you knew this was coming – we see three wildcards in 2009, and any one of them could prove to be a joker:

• The continued de-leveraging of hedge funds and other financial institutions.
• More credit-default-swap valuation problems.
• And unknowns associated with the ongoing U.S. and global-economic-system bailouts.

There are still huge questions regarding who owes what to whom, how large the debts are, and exactly who’s going to get what help and when. History shows that the most effective bailouts are those that recapitalize institutions and that allow the weak to fail, which is why we are especially leery of the U.S. government’s plan to acquire bad debt while rewarding weaker institutions that should be put out of their misery.

What’s more, as a Money Morning investigative story demonstrated, many banks are using the government bailout money as takeover capital, and not to boost their lending, which at least would have had an expansionary benefit for the U.S. economy. With most of the bailout programs, and through no fault of their own, U.S. taxpayers and investors have been caught in the middle – or left on the sidelines altogether.

The Outlook 2009 Action Plan

For investors who want to get a head start, it’s important to bear in mind that the markets tend to begin their rebound in earnest anywhere from two months to six months before an actual economic bottom. While that doesn’t suggest going “whole hog” into stocks, it does speak to the need to take some steps now to get ready. Here are the top moves to make now:

• Rebalance Now: As markets have declined, many portfolios have done out of kilter, too – not only in terms of value, but in terms of balance. And that lack of balance can seriously dampen returns, even as we await the market recovery – and even more so once the market begins to rally. It’s far harder to catch a moving train than most investors think.
• Think Safety First: There’s no need to rush into the markets. It’s not clear we’ve hit bottom yet. Keep your powder dry for the better days and easier trades we see developing ahead, while bargain-hunting for those stocks with true upside, and that are positioned to capitalize on the strongest global trends.
• Spread your buys over several days: When you’ve found something to buy, wait for a particularly bad day, then place your order in the last half an hour of trading. Leverage the lower prices (and maximize your returns) by spreading your purchases over several days or weeks. That way you won’t get tripped up by committing your entire nest egg when the market looks cheap and will probably get cheaper.
• Go Global: China is still on track for 9.6% growth this year and may, in fact, slow to a “mere” 8.0% next year. Even that reduced growth rate will probably be about eight times the growth rate of the U.S. economy – if we’re lucky. Consider adding exposure to the Asian Rim as part of the rebalancing process, or as a primary focus once the recovery begins in earnest.
• Get Inverted: Continue to use specialized inverse funds to hedge downside risk. We’re not out of the woods by a long shot.
• Stop Your Losses – with Stop Losses: By all means include trailing stops to control small losses before they become catastrophic ones. This market could easily fall further before it gives way to the rally that history suggests is in the making.

News and Related Story Links:

• Money Morning News:
  Money Morning Investment Director to Lead Two-Week Investor Tour of China.
• Money Morning Investigative Report:
  Billions in Bank Rescue Funds are Fueling Buyout Deals, and not the Increase in Loans That Would Help Ease the Financial Crisis.
• BusinessTimesOnline (UK):
  Energy Agency Forecasts Oil Reaching $200 a Barrel.
• Money Morning Special Investment Report:
  Five Ways to Profit From China’s $585 Billion Stimulus Plan.
• Wikipedia:
  Asian Financial Crisis of 1997 (Asian Contagion).
• Money Morning News Analysis:
  Big Oil Digs Deep to Solve a Growing Problem: Where Will Tomorrow’s Oil Come From?
• Money Morning News Analysis:
  Massive China Stimulus is Viewed as an Attempt to Help the West.
• Wikipedia:
  Bear Market.
• Money Morning Economic Analysis:
  Second, and Possibly Third, Stimulus on the Way as Unemployment Poses Next Major Hurdle for the Economy.
• Money Morning Outlook 2009 Economic Forecast Series (Part I):
  Money Morning Outlook 2009: Obamanomics Offers Investors Plenty of Profit Plays in the New Year.
• Money Morning Outlook 2009 Economic Forecast Series (Part II):
  For the U.S. Economy in the New Year, the Pain Will Precede the Promise.
• Money Morning Credit Crisis Investigative Series (Part I):
  The Real Reason for the Global Financial Crisis…the Story No One’s Talking About.
• Wikipedia:
  Inverse Funds.
• Investorwords.com:
  Economic Cycle.
• TheStreet.com:
  Inverse Funds Surged in October.

U.S. CEOs Could Learn From Their Asian Counterparts

U.S. CEOs Could Learn From Their Asian Counterparts

By Keith Fitz-Gerald
Editor, Time Trader Pro
Investment Director, Money Morning

Judging from recent reports that JP Morgan Chase & Co. (JPM) Chief Executive Jamie Dimon and Citigroup Inc. (C) board member Robert W. Rubin will forgo bonuses this year, it appears that at least some U.S. executives are starting to change their habits, as we’ve long suggested they should.

Just yesterday (Monday), in fact, U.S. heavy-equipment giant Caterpillar Inc. (CAT) announced it was cutting executive compensation by as much as 50%, because of weakening global demand.

But let’s be very clear: U.S. corporate leaders still have a long way to go, and many lessons to learn.

In fact, American executives could learn a thing or two from some of their counterparts abroad. Just look at Haruka Nishimatsu, CEO of Japan Airlines Corp for example (OTC ADR: JALSY).

Each morning, Nishimatsu gets down to business immediately after his morning commute to the office – on a city bus.

His desk – like those of all the other Japan Airlines employees – sits in the middle of an “open office.” I know this from personal experience, having sat at a desk just like that when I’ve worked in Japan over the years. He eats lunch in the company cafeteria and hopes – like all Japanese employees – that he’ll have time to eat his meal before it gets cold as he stands in line waiting to pay, says CNN’s Kyung Lah.

This hardly sounds like the life of a corporate CEO, especially when you consider that JAL is one of the world’s top airlines. Nor does the fact that when JAL cut back and asked many of its employees to take early retirement, Nishimatsu first eliminated every one of his own corporate perks, including his own pay – which, at a mere $90,000 (U.S.), is below what JAL’s pilots get paid.

Nishimatsu noted in the CNN interview that many of the affected employees were about his age, 60, so he “thought he should share the pain with them.”

Obviously, that’s very different than in the United States, where top executives regularly make tens of millions of dollars a year, and where some compensation packages actually eclipse the hundred-million-dollar threshold. And some of the top earners are the very same executives who “managed” their companies into financial oblivion – and who took their trusting shareholders along for the ride.

If you want to see the latest example, just watch the parade of corporate-jet-riding, custom-suit-wearing corporate “beggars” that have been appearing (hat in hand) before the House Financial Services committee lately and you’ll see what I mean.

The pay gap between the boardroom and the factory floor – already a longtime topic of controversy here in the United States – has widened to the point that it’s become absolutely staggering. According to a survey conducted by the non-profit group, United for a Fair Economy, CEOs of large corporations made an average of $10.5 million in 2007, which is 344 times the wages of the average U.S. worker. The Economic Policy Institute puts it at only 275 times higher, which is still outrageous when you consider that the average working stiff won’t see in his lifetime what these guys have made in a year lately [To see how that disparity has grown over the past four decades, look at the accompanying chart, “Leaders vs. Workers”].

Capital One Financial Corp. (COF) CEO Richard D. Fairbank took home a cool $73.1 million last year, which is 1,456 times the median household income of $50,233 for taxpayers footing Capital One’s $3.55 billion bailout, according to The Corporate Library.

In Japan – and throughout much of Asia, for that matter – there’s a much more balanced approach, with CEOs more commonly making only 10 times to 15 times more than their base level employees.
“Businesses that pursue money first fail,” Yoshichika Terasawa, a Singapore-based managing director for the Japan External Trade Organization (JETRO) told me when we spoke at his home in that Southeast Asia city-state earlier this year. “Companies that have their employees in mind tend to do better longer and recover faster. We learned that in Japan during our own bubble economy.”

The numbers seem to bear out Terasawa’s assertion. According to a USA Today study, the 10 best-paid CEOs made more than half a billion dollars collectively. Yet, half the members of this stratospheric club were actually heading companies whose profits shrank dramatically.
The poster boy for this club could well be General Motors Corp. (GM) CEO G. Richard “Rick” Wagoner Jr., who closed four plants and posted a $39 billion loss in 2007, a period in which his company’s stock cratered 19%. But in the face of this financial mess, Wagoner’s compensation jumped 64% to reach $15.7 million.And GM apparently had a little something set aside; after all, Wagoner was able to take a corporate jet to Washington to plead for a taxpayer-funded bailout [For a breakdown on the top-earning CEOs of 2007, take a look at the accompanying graphic, “Top of the Charts.”]
.

The numbers, when they’re in for 2008 will probably be more egregious.
JAL’s Nishimatsu clearly understands what his U.S. corporate brethren do not. As the global economy has worsened in recent months, the Japanese executive recounted how he’s dug into his savings like the rest of us have had to, in order to deal with life’s challenges.
“The air conditioner broke, the water heater … and my car,” Nishimatsu said. “My wife is still telling me this is all your fault.”
We can certainly sympathize with him. But clearly, he can sympathize with us. Making the effort to relate to what employees and customers are feeling during such a difficult stretch is very important: It fosters pride in the work force, loyalty from customers and in long long-run, will also win over investors. My guess is that we’ll all be the most sympathetic and supportive of companies led by CEOs like Nishimatsu.
And that might be just what’s needed to get out of this mess. [For additional coverage of the executive compensation controversy, check out this related story in today’s issue of Money Morning that details how the 116 banks that are receiving billions in taxpayer-provided bailout money this year actually paid out $1.6 billion in compensation and benefits to their top executives last year].

News and Related Story Links:

• Reuters:
  JPMorgan CEO Dimon to decline a bonus – source.
• United for a Fair Economy:
  CEO Pay.
• Economic Policy Institute:
  Executive Summary, “The State of Working America: 2008” – See “Wages” Section for Details on CEO Pay Disparity.
• Money Morning Special Report:
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it.
• Japan External Trade Organization:
  Web Site.

• 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

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Stocks May Not be Cheap Enough, Yet; And Here’s Why

Stocks May Not be Cheap Enough, Yet; And Here’s Why

By Keith Fitz-Gerald
Editor, Time Trader Pro
Investment Director, Money Morning

For many investors, a low Price/Earnings (P/E) ratio is a sign of value.

But don’t you bet on it – at least, not yet.

According to Michael T. Darda, chief economist for MKM Partners LLC, analysts have overestimated earnings by an average of 30% to 35% in the last three recessions. For millions of investors who use low P/E ratios as a litmus test for selecting their investments, that’s going to be a rather unpleasant shock.

If Darda is right, and our research seems to suggest he is, so-called “cheap stocks” may not be all that cheap. For proof, we can turn to some plain-old high school math. P/E ratios are calculated by taking the price of a stock (the numerator, or the “P”) and dividing it by earnings per share (the denominator, or the “E”). The higher the denominator, the lower the P/E ratio and, by implication, the cheaper a stock appears.

However, if higher denominators can make stocks appear “cheap,” then the opposite is true, too, and that suggests that stock prices may have a lot farther to fall – despite the fact that they’ve already tumbled 40% or more.

Just how much farther is anybody’s guess, but the outlook is not good.

For instance, according to Forbes writer James Clash, “more than a year into the market downturn that threatened Morgan Stanley’s (MS) survival, the 17 analysts covering the company cut their 2009 mean earnings estimates by 36% to $3.63 per share.” Given Darda’s observations, there may be another 35% to go, which would put total expected earnings cuts at 71%.

That sounds harsh, but it may not be out of line. Thompson IBES reports that the analyst community as a whole has cut 2009 earnings expectations by only 7.5% for the Standard & Poor’s 500 Index. If they are to be believed, that means that the analyst community expects the average S&P 500 company will have to grow earnings by 15% next year to $91, according to Clash.

We don’t know about you, but a time when recessionary flags are flying, we have a hard time buying that (pun absolutely intended).

That’s why – at the risk of igniting an e-mail firestorm – we point out that analysts are paid to have opinions and a huge body of evidence suggests that they’re strongly encouraged to make them bullish. Not only is this a cozy relationship for investment bankers in general, but it has historically helped Wall Street generate huge commissions from an anxious retail investing public that is desperately seeking good news. This bullish predisposition may be especially true at a time when investors are not inclined to buy – and with good reason.

Compounding the problem is the fact that many analysts focused on specific industries or companies tend to become quite myopic. Far too many don’t think outside the box and, as a result, are all too frequently surprised when macro-level events come crashing in on their little world and down on the companies they follow.

Investors who rely heavily on Wall Street analyst estimates are, in effect, driving down the highway using only their rearview mirror. The results are all too predictable.

Among the more infamous examples of these errant estimates was the group of analysts who, back in 2001, continued to recommend Enron Corp. stock all the way into bankruptcy and congressional hearings, based solely on their own “optimism.” Only when Enron shares were trading at less than $1 did the majority of analysts change their recommendations to a “hold.”

When it comes to Wall Street, the fox clearly does guard the financial hen house, so to speak.

In the interest of fairness, we should mention that there were “accounting irregularities” in the Enron case. But that really shouldn’t let anybody off the hook.

What’s happening now – and why we’re leery that things may not be as they seem – is that overall business and economic conditions are deteriorating faster than management is willing to publicly acknowledge (although we’re now watching these same management teams slash work forces and shutter plants at a rate we haven’t seen in years). And since management “guidance” (the sarcasm you detect is intended) is what drives and shapes Wall Street earnings estimates, this is why things are probably going to get worse before they get better. The earnings figures used in most P/E calculations haven’t yet been reduced.

As for the ratings agencies such as Standard & Poor’s, Moody’s Investors Corp. (MCO) and A.M. Best Co., these, too, are problematic when it comes to the earnings and the ratings that help drive them. Supposedly independent, it’s been common knowledge for years on Wall Street that firms wanting higher ratings need only coddle the agencies using a combination of fees and information. Of course the agencies will deny this but history suggests that’s like the pot calling the kettle black.  Historically, for example, Moody’s, S&P and Fitch Ratings Inc., have each earned huge amounts of income from fees being paid by the issuers whose credit they’re supposedly rating. That’s changing, of course, but as the credit crisis has highlighted so aptly, probably not fast enough.

So what does work?

P/E ratios are a start. But that longstanding indicator should be regarded as a relative measure of potential price and performance rather than the do-all stock-screen selector so many investors utilize them as.

When we analyze a company, we prefer to see expanding sales, advancing earnings and plenty of cold hard free cash flow. There’s an old saying on Wall Street that “nobody ever went broke on accrual accounting,” but clearly plenty of companies have figured out lately that they can go broke without cash. The best example may well be Detroit’s Big Three, which are grappling with this seemingly new reality even though we, as individuals, deal with it every day. As my six-year old son recently stated: “No cash … no dinner.”

One other excellent indicator is a so-called “PEG” ratio (the P/E divided by the growth rate) of less than 1.0. While it’s more commonly viewed using 12 month trailing earnings, we find it much more stable when viewed against a historical stream of data that’s a decade or more in length. Not only does this help screen out the volatility associated with much shorter time periods, but we find that companies with low PEG ratios calculated in this manner seem represent good value over the longer term.

Especially when compared to a deflated “E” – earnings.

News and Related Story Links:

• Wikipedia:
  Enron Corp.
• Money Morning Market Commentary:
  Fraud and Greed of Trusted Rating Agencies Helped Spread the Credit Crisis.