Tuesday, July 1, 2008 The Smart Profits Report #536
by Martin Denholm, Managing Editor, Smart Profits Report The good news? We’re in the middle of a short week, due to the July 4 holiday, and just got rid of a gut-churning first half of 2008. The bad news? There’s more ugliness to come. The tale of the tape? The Dow Jones Industrials finished down 14% over the first half of the year. In June alone, the index lost 10% – pretty ominous for an index that Richard Russell, publisher and editor of the respected Dow Theory Letters calls the Dow Industrials “backbone of the US economy.” Russell states flatly, “It’s not a good sign when the index breaks down this way.” He’s right. That 10% fall was the Dow’s worst monthly performance since the Great Depression days of 1930 and is also the technical definition of a correction. And from its peak, the index has shed almost 20%, which economists consider to be official bear market territory. Firms like fallen auto giant General Motors (NYSE: GM) have led the way down. From its 52-week high of $43.20 on October 12, the stock hit a 52-week low of $10.57 on Monday – a 75.5% collapse. The Nasdaq Composite has fared little better than the Dow, losing 13.5% so far this year, while the broader S&P 500 is down 12.7%. Unsurprisingly, financial sector stocks are the S&P’s worst performers this year, slumping 28%. And a short week won’t stop Wall Street from worrying about events like the June job report. A Bloomberg panel of economists says the Labor’s Department’s report on Thursday will show that US employers shed approximately 60,000 jobs during June – the sixth straight month of losses, bringing this year’s total to 324,000. Some don’t foresee any job growth for the rest of 2008. As the first half of 2008 ended on Monday, this is just one of several factors weighing heavily on the stock market. And it won’t be long before it’s under pressure from the next major event: Second-quarter earnings season. You know what we need here? A dash of some good, ol’ fuzzy logic. Well, that and some simple protective portfolio measures, too… Applying Fuzzy Labor Logic To Corporate America’s Quarterly Results Every month, the Labor Department releases the latest US producer and consumer price inflation figures. One aspect that I’ve always thought is pretty bizarre is the way the department splits the data into so-called “core” inflation and the overall headline figure. “Core” inflation excludes food and energy prices because their price fluctuations are more volatile. Hmm… last time I looked, energy and food prices were a pretty considerable part of everyday life. So stripping out these two areas is great news… if you don’t heat/cool your home, pay for gasoline, or eat. Fuzzy logic, for sure. But as earnings season gets set to kick off, perhaps it’s best to separate quarterly results into two categories, as well: Financials and non-financials. And given that 28% slump for the sector this year, it might just add some better perspective to the state of corporate America’s finances. Let me give you an example… The Financial Fly In Corporate America’s Ointment In its latest projection, Thomson Reuters expects the combined second-quarter earnings of S&P 500 companies to drop by 10.2% – the fourth straight quarter of falling corporate earnings. Wall Street is already bracing itself for the flurry of financial sector reports that will show yet more massive write-downs and contribute to this mess. In fact, Thomson Reuters says the financial sector’s earnings will plunge by more than half from last year. But just as the Labor Department strips out energy and food prices from its inflation reports, let’s craftily omit the financial sector from the earnings picture for a second. Much better. Thomson Reuters now projects an 8.2% rise for S&P 500 corporate earnings without those pesky financials. Take off those rose-tinted glasses now, however, and the malaise is apparent. Just as investors feel that the bottom is in sight, banks warn of yet more write-downs. And it’s a situation that might not be fully resolved until next year. Sizing Up The Second Quarter Winners And Losers On the flipside, the IT sector should enjoy a 16% earnings boost, while energy firms are expected to capitalize on the sector’s roaring price inflation and book profits of 23%. However, that strength could have the opposite effect on firms that depend more on discretionary consumer spending. This includes retailers, the auto sector and travel sector. In fact, the consumer discretionary sector is expected to see a 15% drop in earnings as Americans cut back amid soaring inflation. So with America’s publicly traded firms set for another round of earnings mania, how can you ensure that your own money is protected from this volatile season? Here are a few tips… Two Quick Tips For Earnings Season Portfolio Protection Earnings season is always a tricky period for investors. Such highly anticipated financial results from companies that have the power to move markets always amps up the volatility. And in tough economic times like these, it’s magnified. While it’s impossible to prevent a stock’s fall, you need to be aware of what is happening – and how it can affect your investments – so you can take the necessary steps to protecting your portfolio. Problem: A company in your portfolio reports terrible earnings after the closing bell. The after-hours trading shows the stock down 15% and the stock is set to get crushed the next day by the time everyone else finds out. Solution: In the case of a severe gap down like this, you certainly don’t want to be holding this stock without adequate protection. That means you must make sure your stop-loss is in place. Many investors set a regular 25% stop-loss, but if you feel earnings will be bad, based on negative sentiment or warnings from the company, you may want to reduce it beforehand. Problem: Of the 20 companies in your portfolio, most of them have reported pretty decent earnings. Nothing too dramatic, or shocking anyway. But with one stock, you allowed your emotions to guide your investment decision and had such high hopes that you plowed most of your money into it. This is a mistake that many rookie investors make, as they search for the quick, home run winner. Solution: Be sensible and don’t take unnecessary risks. Invest your money evenly across all your stocks. If you want to invest in 20 companies and you have $20,000 at your disposal, put $1,000 into each one. Don’t stick down $10,000 on one company that you’re sure will be the “next big one.” A good rule of thumb is to put no more than 1% to 2% of your money at risk on a single investment. My Stock Tanked! What Do I Do? If you do find yourself on the wrong end of a price move, be disciplined and adhere to your stop-loss point. Don’t hang on and hope for a turnaround. See if there was a specific reason for the move. For example, a drug failure, legal action, or SEC investigation will weigh heavily on a company. Sometimes, it’s better to cut your losses. If you’re not stopped out of the position, track the stock’s progress carefully over the following few days to see if the move was just an over-reaction. Earnings reports tend to have a short-term affect and the stock may resume its old pattern after the dust has settled. Re-check the company’s fundamentals and look closely at the earnings report and forward guidance for longer-term warning signs. And if you’re holding a stock that sees a strong price jump, congrats! Whether it’s because of solid earnings, a strong future outlook, a potential buyout, or hefty cash injection from an investor, you may want to lock in some gains while you have them and cash out on half the position. This is exactly what my colleague Marc Lichtenfeld did with one of his Xcelerated Profits Report recommendations. Read all about his strategy here. Before I go, I’d like to wish you a happy July 4 weekend. As an English fellow, I used to spend the day dressed in black, sequestered firmly in the house with the lights out and the shades down, cursing those darn colonials! But having been here several years, I’ve warmed to the occasion somewhat! However you celebrate, have a safe and pleasant time. Martin Denholm
P.S. This week is all about red, white and blue for America. Over in Europe, though, things aren’t quite so colorful – at least in terms of the European Central Bank. It’s so worried about the 3.7% inflation spike in the year to May (almost double the bank’s target rate of 2%) and a projected 3.4% rate for the rest of 2008 that it’s poised to raise interest rates by 0.25% to 4.25% on Thursday. If you’re looking for a quick way to take advantage before the weekend, you could consider an investment in the CurrencyShares Euro Trust (NYSE: FXE) – the ETF that tracks the price of the euro. While a bump higher in interest rates might not do much for GDP growth, it could boost the European single currency – and consequently the fortunes of FXE. Today’s Smart Profits Notes Day 1 of Q3… another typically bouncy day for the stock market. All three major stock indexes ended the day up slightly after flirting with the breakeven line for most of the day. It didn’t help investors’ nerves that oil prices also traded erratically, coming within about 30 cents of breaching Monday’s high of $143.67 a barrel before closing just under $141. “Tight supply” and “increasing Middle East tensions” were the same old reasons given for the volatile moves.
This July 4, claim your financial independence. While the market’s extended break this weekend will provide relief to weary investors, it won’t be long before the stock market resumes battle against a plethora of economic woes. Make sure you’re in a position to profit with a group of professional investors who have the experience and expertise to handle serious challenges like this. They’ll guide you through the minefield, step by step, showing you how to stay protected and profit. For the same price as a couple of decent bottles of wine, you can secure an entire year’s worth of stock and options picks, using the same strategies that Wall Street’s pros use every day to accelerate their wealth. And unlike the stock market, it’s risk-free, too, so you have nothing to lose. Check it out here.
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