Sunday, June 11, 2006

Week 31 Performance - LiveRocket Down -8.61%

Week 31 (versus previous week)
Dow -3.17%
S&P -2.8%
NASDAQ -3.79%
LiveRocket -8.61%

YTD
Dow 1.63%
S&P 0.32%
NASDAQ -3.17%
LiveRocket 20.03%

Since Inception (Nov 4, 2005)
Dow 3.5%
S&P 2.7%
NASDAQ -1.6%
LiveRocket 31.46%

An ugly week as we were stopped out of everything except Disney (DIS) and Zoran (ZRAN).

Sadly, most of our stocks came under pressure because they have had the most run-ups and they are the likeliest targets when it comes to locking in profits.

The 4 week carnage is this: the Dow is down 7.5%, the S&P is down 6%, the Nasdaq is down 11.3%. I was completely wrong when I said 1 month ago that I expected a strong bull market for the rest of the year. Let's re-visit my reasoning and my assumptions, because I am very wrong and I want to know why.
To begin with, the stock market has not reflected the economic performance since the recovery. Although 2003 was a strong bull market, it actually was just a recovery from the over-selling of 2002. I also don't really regard 2004's 3.6% performance as evidence of a bull market.
2000 Dow -5.3%
2001 Dow -10.4%
2002 Dow -20.8%
2003 Dow +21.5
2004 Dow +3.6%
2005 Dow -0.5%

I don't want to get into a technical discussion of Bull and Bear markets. My point is that this economic cycle has not been reflected in the Dow. The Dow has been fixed between 10,500 & 10,900 for 3 years.
It's a simple matter of history - markets rise during boom years and drop during bust years. I look around me and see that we are seeing boom years in the US and elsewhere: Brazil, Chile, India and China. Some of this is cyclical in nature (raw materials in Chile, Brazil etc.), but some of this is also very real and very permanent growth. China and India have arrived as world economies. India lags but will continue to play a role.

I see nothing but strength with pockets of vulnerabilities, not a soft economy with pockets of strength.
* World economy is strong, albeit still dependent on the US
* US economy is strong: unemployment is low, GDP is 4~5%, interest rates are high because the economy is strong

I also don't think that the stockmarkets are overvalued.
* Corporate earnings are strong despite interest rate hikes and higher prices for gas and raw materials. Last quarter, a massive majority of companies had higher than expected earnings. Many raised expectations for this quarter.
* Historically speaking, P/Es are also very reasonable: around 18. The P/E of the Dow hasn't been below 15 since 1991, and that's because of inflation controls and greater global market integration. Could it contract further? Well, even 18 is higher than the highs of previous economic boom time peak P/E. In fact, the P/E has been contracting since the cycle began and has fallen already in half.
* Interest rates are at a historical low. While not as low as they were, they are still mild.

How then to reconcile the strength I see with a market that did an abrupt softening?
I point to exactly two pieces of evidence:
1. Run up in commodity prices and the market AFTER BERNANKE BECAME FED CHIEF
2. BERNANKE HAS BEEN SILENT IN THE FACE OF A 11% NASDAQ CRASH.

In my estimation, this is a running duel. The markets tested the new kid, and he is firing back.

The conclusion I reach is that Bernanke wants to kill asset appreciation: housing, stockmarket, and commodities if and when they threaten the economy. At this time, the commodity price increase is a threat because it raises inflation. Ironically, for the average American, housing prices have had the biggest inflationary impact. Housing's share of disposable income has risen dramatically: 25% of the US population now spend 50% on housing. Housing prices until the 90s matched overall CPI. That is not the case.

In any case, Bernanke is lobbing a shot across the bow with the message: I will do what it takes to stop inflation, damn the economy. The markets see this as more interest rate hikes and possible slowdown in consumer spending.
Their biggest worry is recession (which won't happen - we are barely 4 years out of the last one and the world economy is much stronger).
This means uncertainty, so the institutions are taking money off the table to lock in profits - highfliers being the hardest to get hit. This isn't a flight to value. In addition, the end of loose money always means a reduction in underlying asset value.

The real threat I see is the housing bubble deflation. It is happening. Just as an asset bubble sparked consumption, asset deflation will lower it because the equity in housing will drop dramatically at a time when interest rates are rising. Not only will folks feel not as wealthy, a few million households will be spending a lot more to keep their house.

MY APPROACH
1. Volatility continues. WE STILL HAVE 12 DAYS BEFORE THE NEXT FED MEETING.
2. Institutions will be investing this week as they deal with the end of Q2 and position for Q3.
3. Energy especially oil is and will continue to be a place to invest

I am in no hurry to put down money right now. I am analyzing stocks to see where instutions are putting down money. I am very pro-oil drilling (GRP, ESV, DO, TTI), as well as mining (JOYG), and coal/alt fuels (CCJ, MDR).

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