September 2008 Investment Strategy  

Richard Schwartz's

PRINCIPLES OF THE STOCK MARKET

A learning, teaching, always evolving stock market letter and advisory service

Seventeenth Consecutive Year of Publication; Letter #1; September 18^th, 1990

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Tuesday, September 2^nd, 2008:  Had lovely, blue sky, humidity down weather to wind up the summer and the long Labor Day weekend.  Indeed, the weather is supposed to stay gorgeous the early part of this week here as well.  But don’t mention the grand weather to Lucy since it’s back to school for her today!

THE BIG PICTURE

Last week I wrote about the necessity of staying positive during a downbeat economy and stock market.  Staying upbeat right when there’s near term problems and long term concern that America is losing status in the pecking order of the new, globalized world we live in.  Hey, America has long encouraged the rest of the globe to go capitalistic and got a massive, all-encompassing global push in that capitalistic direction after so much economic rot was discovered in the Soviet Union sphere after the Berlin Wall came down.  Countries switched and let the marketplace work and, voila, the world started moving forward, growing and getting wealthier.  So now, with so much new global competition around and thriving, America has to respond in kind by redoubling our efforts to efficientize, modernize and improve our own financial, economic, social, and especially our dysfunctional political system(s).  In other words, take our fundamentally solid, well-working capitalistic system and adjust it to today’s new globalized marketplace.  Make some fundamentally sound and foresighted long range decisions about energy, education, health, finance, politics, etc. and then exhibit sacrifice and discipline.  Again, all while seeing the glass half full. 

Schwartz View:  That’s why I’m dismayed by hearing friends, including one back from Iraq duty, tell me it really doesn’t matter who gets elected as the next president of the United States.  Their rationale?  It doesn’t matter since nothing will change anyway.  Maybe my generation and the one coming immediately after us is just too jaded.  But, from longtime trafficking in the stock market, the one thing I’ve found we can bet on consistently is change.  Change does happen.  So, I’d say we have to have hope.  We have to believe that our votes will prove meaningful.  And the youth of America, not being so long disappointed and denied, frustrated and jaded like their elders, us, have responded to this upcoming presidential election.  Grass roots efforts by thousands of inspired youth and the ready adoption of the Internet for fundraising from the masses is how Barack Obama overcame sure bet Hillary Clinton to get the Democrat’s nomination in the first place.  So I say re: politics, energy use, etc., just like in the stock market, we need to keep upbeat that positive change is out there just over the horizon.  So buck up.  The realistic investor can forecast hard times ahead and yet get up each day, plaster a smile on his and her face and still believe that better times are out there, knowing that just like the daily cycle, it’s darkest right before dawn … arrives.

Schwartz Reading Recommendations:  For those of you who are interested in Big Picture investing, by that I mean not the nuts and bolts of everyday stock trading, charting, etc. but, say financial planning, etc. I’d like to add former Fed chief Alan Greenspan’s tomb of the 20^th century, The Age of Turbulence, to my recommending reading list.  It offers up a wonderful history of America growing wealthy, explains how decisions at the Fed are made and gives forward looking guidance to the world ahead.  Also let me add the even newer book, THE POST-AMERICAN WORLD (2008) by Fareed Zakaria, which after I got over my provincial American bias, was wonderful in explaining the world’s likely scenario going forward. a world of shared power with extra kudos to author Zakaria in how he gets into the heads of the Chinese and Indians, explaining how they think, operate and their cultures.  Interestingly, India with its long-established democracy, and Indians in their outlook on life, are extremely close to how Americans think.  Again these books are for those of you interested in longer range financial planning and the like.

THE ECONOMY

Dell Computer’s report last Friday that the US technology spending slump has spread to Western Europe and some Asian countries just confirms all the other evidence showing up that today’s world, economically and financially is very closely intertwined, not decoupled as the Wall Street argument goes.  Of course, this intertwined relationship and what that means isn’t that easy to define, it’s gray, not black or white.  But for the near term, negative economic ripples sent streaming outward last year when the US subprime mortgage market imploded are now being sighted and felt in other parts of the globe.  How severe these global ripples get, these so-called 3^rd-order effects, as economists like to term them, remains to be seen.  Bulls say they will prove minor; bears like me say they will prove more severe; only time will provide the answers.

Still, right now, everywhere one looks negative ripples sent outward from the US tsunami in collateralized asset-backed investments are starting to show up.  One major problematic ripple in the US and globally is the effect being felt by banks and their business.  It isn’t, can’t be “:business as usual” any more.  Banks’ fortunes – with huge paper losses and their opaque, illiquid, very leveraged and still deteriorating loans on the books – are now directly tied to US house prices.  As house prices fall, the value of these locked in bank investments keep tumbling as well.  Leading to write-offs.  It’s all a negative domino effect.  The lingering loss of confidence leads to a continuing reluctance to make loans, thus to lower stock prices and thus also to a growing need for banks and other financials to repair their balance sheets by raising more and more capital.  Which in turn dilutes earnings and the vicious cycle continues.

Schwartz View:  My ongoing view is that this widespread consumer, business and investor loss of confidence, combined with the first bout of problematic inflation and a weakening US and now global economy is not some short term event.  That we’re now in a downward spiral that will take much time to bottom out and reverse.  We’re, bottom line, in an economic event and economic changes just can’t move along anywhere near as fast as stock market participants would like them to.  Thus, we see frustration by strategists, money managers and all the bulls out there to find and call a bear market bottom way too early.  I believe investors have to exhibit extreme patience for the foreseeable future. 

THE STOCK MARKET

Impatient investors keep fishing for a bottom, thus causing the periodic “flashy-splashy” big rallies we get, like last Thursday’s +2% move up.  These big one and two day moves up are actually symptoms and signs of a stock market still on the way down, actually now firmly controlled by the grizzly bear, if you believe a recent report by Merrill Lynch after they studied all the ups and downs of the just completed full stock market cycle, starting with the bear market running from 2000 to 2002 and the following bull market running from 2002 to 2007.  Big pops happen in bear markets but then get completely washed away over time.  Certainly during these bear markets stocks can also cobble together rallies which last for weeks or even months at a time, such as two-month rally we put in from mid-March to mid-May this year.  Or the rally we are now experiencing; so far six weeks long and still alive and kicking although very saw tooth in nature.  Obviously, nothing ever goes in just one direction.  That’s especially so in the stock market whereby prices normally shoot out to extremes, up or down, and then need to balance themselves off.

Right now that’s where I see us.  Stocks balancing off upwards after a downward movement that dropped too far, too fast.  Actually that’s normal in any extended, economically-catalyzed bear market, investors losing confidence periodically, then regaining their nerve, then losing it again.  Again, deteriorating economic trend(s) causing some major decline in stock prices just can’t cycle through its phases anywhere near fast enough to please myopic, very rapidly moving stock market players.  So we get quick moves down, then bounces up or sideways movements to get time & price back in sync.  Then it repeats again. 

Schwartz View:  These bounces are when and where traders try to make their profits during multi-year bear markets.  Most traders early on realize it’s a lot easier and more profitable in the long run to always stay bullish, thick or thin, bull or bear market.  Thus the extreme bullishness shown by a very experienced NYSE floor trader when interviewed late last week by CNBC.  His time frame is so much different than the rest of us, he can be very bullish right now, right in the midst of a firmly entrenched bear market. 

PORTFOLIO STRATEGY

Net, net this six-week rally may last for another month or even two but I wouldn’t get too attached to it.  In fact today, let’s hope the market goes up a whole heck of a lot.  I plan to book some profits.  The first trading day after Labor Day is normally a seasonally strong day but then September can go south very fast and has proven to be the worst overall month of the year on average.  Plus August was our first monthly advance in four months for many key indices so I’d like to take advantage of this normal “rally in a downtrend” and lighten up on some short term trading positions established back in July or early August.  And suggest readers do the same, review everything else you now hold as well to see if any sectors are now timely to get out of.  Again, to take advantage of this recent bear market rally.  For example, please review the technology sector after Dell’s news last week warning it sees spreading, global tech weakness now. 

Schwartz View:  With big players coming back to work this week and with oil resuming its steep decline, we may extend this recent rally.  Rallies can last upwards of three months in bear markets and since this one started on July 15^th, the best case scenario says it can run through October 15^th.  Still, best I can deduce, all we’ve been doing this summer is killing time before the next round of bearish news hits.  So I would continue to book trading profits as you go, sort of imitating the always in traders on the NYSE floor.

Have a grand week!