Ian Woodward's Investing Blog

Warren Buffet once said “You don’t know who is swimming naked until the tide goes out”. 

At this very moment in time there are only two things playing tug of war in the market that matter: 

1. The Earnings season is in full swing and by and large there is no question that the earnings are showing strong results especially in the technology arena.  That on top of the fact that the Tech Sector has been dormant coupled with a weak dollar has given a fillip to the Large Cap stocks. However, I don’t have to tell you that the Small Cap Russell 2000 is being hammered.   

2. The sub-prime fiasco is not behind us by any means.  The latest casualty is Countrywide Credit.  In addition, it seems that the credit market is finding difficulty in closing the Chrysler deal which suggests there is a lot more bad news which will take longer to unwind and will last a lot longer than next week when the majority of the EPS reports will be out.   Let’s cut to the chase as to what matters of all the things that can affect the stock market in the next two weeks:  

1.  The strong Earnings Reports confirm that I was right in the July Newsletter to raise the year-end estimate for the S&P500 Growth Rate from 10% to 15% over 2006.  That is the fuel that is keeping the stock market up, because the P-E is at fair market value.  That is the only reason that this market keeps chugging along at this point in time.  However, that swan song cannot last forever without a pause to refresh.     

2. There is a major disconnect in the opinions of the gurus on the sub-prime stuff regarding the size of the potential damage:

    a. The administration including Ben Bernanke implies things are under control though admits there is a problem.

     b. Bill Gross who is the Bond King has turned bearish and you can read his stuff to your hearts content at pimco.com or look him up on Google.  For him to turn bearish raises most eyebrows, including mine.   

    c. If the markets come to a grinding halt on getting the Chrysler deal together that will favor Bill Gross’ point of view, as that spills over into more than sub-prime alone.  Late breaking news says “The backlog of buyout debt just got a few billion dollars bigger. Chrysler has postponed a $12 billion financing intended to help fund its pending sale to Cerberus Capital Management”.  

My point is that we have only about ten days of grace before we begin to see the tide go out on the former and maybe the latter.  So be patient and play close to the exits and you will soon see which one or both are naked…but, make sure you have your swim suit on and protect your Capital! 

Meanwhile, take great comfort that the EPS Reports are strong and play the long side with stocks that have strong earnings already out and bucking the current volatility.  Or seek out those stocks that have disappointed and are vulnerable.  Never short a strong stock till it is wounded.   However, I note that some stocks such as GOOG, MICC, SNHY, BTJ and SPWR which have all been recent leaders are looking a trifle droopy and that is invariably the best clue that a correction is imminent if not already underway.   It’s always “Your Call”.  

Best regards, Ian.

Investing, Trading or Playing in the stock market is like playing the game of “Snakes and Ladders”.  I remember as a little boy playing Snakes and Ladders – they call it “Chutes and Ladders” in this country.  I’m sure you remember it; you throw the dice and if your marker counts over to the bottom of a ladder you trot up to the top of the ladder.  If you hit a snake (or a chute), down you go the length of the snake.  It was frustrating in trying to get all the way from 1 to 100 on the board, too many snakes!  Somewhat analogous to the chances being few and far between of finding a stock surviving to deliver $1 million, 15 years from now, off your initial bet of $10,000 today.  Also some snakes are longer than others meaning corrections can vary, but can hurt you if they turn into a bear market.

Some prefer that the bird in the hand is worth more than two in the bush; never allow one’s hard earned profits to vanish.  I like to have my cake and eat it too.  With that in mind, if a stock has made 50% gain I will invariably take 70% off the table and let the rest run as long as it does not turn into a loss.  Likewise, I need hardly tell you that if a stock is 100% above its 200 Day Moving average (200-dma), it is invariably very extended and most fund managers as a rule of thumb will take half off.  Both examples take your Capital off the table, and what remains is profit to do as you wish.

My so called “Mattress Stuffers” portfolio comes from stocks that have proven themselves over time, but not before I have taken some profits along the way and I then let the rest ride as long as the stock continues to rise.  They remain so until the company, stock, and market tell me to take profits and have the discipline to get back into the same stock when the coast is clear.  Never let your Mattress Stuffers get lumpy.  Let me elaborate:

We must find ways to avoid the snakes and run with stocks when they land on ladders.  At the start of a fresh game, a fresh bull market, one can be more daring in letting one’s profits run.  When the bull gets tired, play it closer to the vest.  Likewise, if a stock or the market has had a good run, the odds increase that it will correct.  It may be a perfectly good company, but if the stock gets ahead of itself or has a climax run, why give up the profits of a sure fall?  Take the money off the table, wait for the pause to refresh, and hop back on when the coast is clear.

This “pause” may be 6-8 weeks, 6-8 months, 16-18 months, or never; depending on the behav­ior of the market, stock, and company. It is easier said than done.  It takes discipline to stick with such a strategy – our biggest enemies, fear and greed, lead us to mistakes.  I believe the High Growth Stock (HGS) discipline enables one to hop on and off the ladders fairly successfully.  Off the ladder, one’s money is parked safely waiting for the stock to refresh, the market to turn from -MMM to +MMM, i.e., from a heavy correction to a new bull rally, or the company to regain its footing.

Of course the best of us can’t time things that perfectly.  But my point is when you give me 15 years to play the ball game with a fresh and young star of a company like XRX or IBM in the early 1960’s and 1970’s, a WMT or HD back in the 1980’s, or an AMGN, MSFT, CSCO and INTC in the 1990’s, having spotted them in their formative Growth Period there comes a time when either the Market or the Stock or both have matured and then turn sour.  It makes no sense to sit tight through Bear Market Corrections that can eat all one’s hard earned profits up in a short period of time.  We don’t have to go back that far; think about QUALCOMM (QCOM) at $960 back in its hey-day before the dot.com bubble burst in March of 2000, or even Google (GOOG) which is the biggest star of this new century, which will surely do as well in time to come. The major dips one avoids will make up for the few rungs of the ladder one may have missed – by far!

As the song goes, “Learn when to hold them, and learn when to fold them”, but always come back to play another day, especially with stocks that have been profitable for you and are just pausing to refresh.  All the more reason to sell, hopping on again later.  Let your profits run or you never get hurt taking profits are old adages in the Stock Market, but don’t play Snakes and Ladders with your money.

The Market Indexes finished the week on a sour note, particularly in the last hour when they sold off heavily.  Both Google and Caterpillar reported disappointing earnings. This suggests that the Markets may have more on the downside at the start of the week.    

Six important things to watch going into this week:

1. The DOW Transportation Index – Must hold at 5225 and bounce
2. The Semiconductor Index (SOX)- Must hold at 535
3. The Nasdaq 100 (NDX) – Must stay above 1995
4. The Volatility Index (VIX) – Must come back down below 15.00
5. The 10 Year Bond Yield – Must stay below 49.50
6. GOOG, RIMM, AAPL and FSLR – Must hold with minor loss.

Earnings reports will play a big part in this week’s movements in the Market Indexes.It goes without saying that we need strong earnings reports to keep the Markets up.

Goldilocks is still dancing and prancing with Rumplestilskin around the Bonfire.  All the recent song and dance about sub-prime rates going to pot seems to have run its course for the moment and has temporarily run out of steam.  Wonders never cease when the Retail Stores report indicated that the losses were not as high as first expected and triggered a 328 point rally on the DOW.  The next day the Retail Stores were reported to be at their worst in two years, but the market still went up since the other euphoria was the Earnings reports were expected to be better than expected. 

I emphasize again that the work I have done on the QID/QLD total dollar ratio has recently reached new high levels indicating to me that the pessimism is so high that the old adage of “the stock market climbs a wall of fear” is still in play.  We have not yet seen the super optimism which is indicative of a Blow Off Top.  Having blown through resistance after a triple top we must now see if it was a quick short term covering phenomenon and fall back into the base or a continuation up for that final blow off.