Sands through the Hour Glass

At 2:34 p.m., the Dow had moved 306 points higher. It was down just 3 points. Believe me, I was cheering it on. Because a big reversal day is just what we need to recapture the strength we saw at the end of last week. 

Unfortunately, it wasn’t to be. Stocks still finished in the red. But at least we know the bulls are starting to show some fight. 

*****The Federal Housing Finance Agency and major U.S. banks are stepping up efforts to modify mortgage loans to keep homeowners in their homes and paying their bills. 

Clearly, the last thing we need to see is more foreclosures. But at the same time, the FHFA plan is to provide mortgage modification to people who are three months behind on their payments. And this plan can only be implemented on loans owned by Fannie Mae and Freddie Mac. And as it turns out, those two companies have a high percentage of quality loans. 

Fannie Mae and Freddie Mac control nearly 60% of mortgage loans. But the delinquency rate is just 2%. All told, they only control 20% of delinquent loans. 

So not only is that plan not comprehensive, it seems to me it may be helping the wrong people. I don’t mean to sound harsh, but if you’re three months behind on mortgage payments, you need more than a little help. You need a gift. 

The problem is made worse by what happened to sub-prime loans after they were made. To distribute risks, individual loans were carved into pieces, called tranches, packaged with other, higher quality tranches, and then sold as mortgage backed securities. So these non-performing loans are very difficult to track down and re-negotiate. 

It’s pretty clear that the housing mess won’t be solved quickly or easily. 

*****When I advised a Daily Profit reader that it wasn’t a good idea to buy Las Vegas Sands (NYSE:LVS) stock at the outset of a recession, I had no idea how bad things were at the casino. 

The Sands just reported earnings. The $32 million quarterly loss wasn’t the worst part. Not by a long shot. The Sands also announced it was doing a secondary stock offering to avoid default on $2 billion in loans.  

But this was no ordinary secondary. The company proposed a 181 million share sale, plus a preferred stock sale that could result in another 80 million shares of common stock outstanding. That will increase the shares outstanding by nearly 75%. That’s why the stock has dropped $11.66 a week ago to $5.34 yesterday. And I suspect the decline isn’t done. 

*****I have another round of reader mail to answer. I’ve said it before, but I love reading your questions and comments. Daily Profit readers are an astute group. You haven’t panicked, are looking for opportunity and are asking all the right questions. I just wish I had the time to answer every email I receive. I try to choose questions and comments for the Daily Profit that reflect common themes, kind of a two birds with one stone approach. 

Also, when it comes to questions about retirement accounts and retired people looking for more income, I’m not the one to answer that. I don’t have anywhere near enough information to give a responsible answer. I urge anyone with retirement issues to sit down with you financial planner and get the answers you need. And don’t let up until you’re satisfied that your issues are being addressed competently. There’s too much at stake to do anything else. Now, for the letters. 

*****Julie G. asks something that’s on a lot of investors’ minds: Do you have an opinion on… General Motors, or any of the auto companies for that matter? Will they be allowed to go bankrupt? Will people buy cars from a bankrupted company, or will the foreign cars manufacturers get all the market share from now on? I fear that 

would be the deathknell for the American car industry forever. Auto company management was unforgivingly stupid to begin with by playing the short term profit game,  never-the-less considering the pain our economy would suffer, and the loss of jobs for the workers, letting them go bankrupt would be compounding the mistakes already made. Furthermore it would be an extremely high price to pay for our government not to loan them the money?  

These are all critical questions and good observations. Yes, the auto industry in America is vitally important. It’s the biggest employer in the country and a huge percentage of our GDP. Failure at GM could cost 300,000 jobs. 

That’s tragic. And it’s worse when you consider the short-sightedness of American auto companies. GM was trotting out new Hummers while Toyota was introducing the Prius. How did GM not see where the market was headed? 

It seems to me that GM and other made the mistake of letting marketing direct their production ideas. After all, what car better exemplifies the twin American ideal "rugged individualism" and our living-beyond-one’s-means lifestyles than the Hummer? 

In part, this is a cultural issue that has a lot to do with where we are now, economically and financially speaking, as a country. And if you were opposed to the $700 billion Wall Street bailout, it’s consistent to let GM fail. 

If GM, and others, do go bankrupt, it may well be the end of the American auto industry. But don’t forget, a lot of foreign manufacturers make cars in the U.S., so it won’t be the end of the auto industry in America. 

Ultimately, if GM doesn’t get help, I think it’s done for. And that may not be such a bad thing. Capitalism is all about accountability. If you invest money poorly, you lose it. 

I did see an interesting interview with TheStreet.com’s Jim Cramer. He said Obama should nationalize GM and run it as a non-profit for the sole purpose of keeping people employed. I know many people would criticize such a move as socialism. But there are quality of life issues here, too.  

*****I can tell Linda C. has been observantly watching the market. She asks "Can you explain to me how REC works? It was at about $91 three months ago, then shot up to around $270 and then dropped back, hovering around $100-124.   When the general market goes up, this ETF goes down. When the market is terrible, it seems to do well.  Is it inversely connected the rise and fall of general market conditions? I need to understand these kinds of investments.  

The REC is a short fund. The full name is Rydex Inverse 2x S&P Select Sector Energy (NYSE:REC). The purpose of this fund is to give holders inverse returns at double the rate of the Energy Select Index. It accomplishes this by holding a mix of futures and options that appreciate as the benchmark Energy Select Index falls in value.  

Linda notices that when the market goes up, this ETF (Exchange Traded Fund) goes down. That’s a good observation. But this ETF is based on oil and energy. So the actual relationship is that when there’s optimism about the economy, both oil and the overall market go up in price. 

The REC is a trading and hedging vehicle. For a trader, you can profit from drops in the market using short funds. Or, if you’re a fund manager, you can use short funds to hedge your long positions. 

I want to emphasize that such a fund is not an investment. You wouldn’t want to hold a short fund for the long-term. But for individual investors who want to profit from downward moves in the market without the risk of buying options or shorting individual stocks, short funds like REC are ideal trading vehicles. 

*****Finally there’s this comment from Marlene W.: How can we possibly think there will be a recovery next spring?  There are 18 million homes for sales across the U.S. AND  the car lots are spilling over with cars to sell.  Now Europe is preparing for a more severe downturn than the US.  You must be dreaming!  Think I will save this email until next spring. 

First of all, I’m not forecasting a recovery in the spring. And I’ve never understood how statements like "Employment should pick up in the second half" are anything but guesswork. 

All I can do is look at stock valuations, look at economic numbers, and decide whether I think earnings expectations reflect what I see in the economy. 

I’ve been saying for a while in Daily Profit that we won’t see a recovery until unemployment stabilizes. And I also think we’ll see earnings forecasts revised lower. 

But at the same time, the S&P 500 is trading for about 10 times forward earnings. It has averaged 18 times earnings over the long-term and 21 times earnings over the last decade. So by historical measures, the S&P is pretty cheap right now. 

Suppose after Christmas, earnings for the S&P 500 get revised lower by 20%. That’s a pretty big revision. But it would put the forward P/E for S&P at 12. That’s still cheap, and I bet stocks would rally on the news. 

It’s also true that stocks bottom long before there are signs of economic recovery. And most investors are way too bearish to buy when stocks actually hit bottom. So, Marlene, if you save your email, you might read it and wish you had been buying when you wrote it. But I do think you’re 100% right about one thing – there’s no way the housing problems are fixed by spring. 

Successful investing requires one to hold on tightly to what you believe is right, but also to remain flexible and open to new information. And if that sounds conflicted, well, you’re right it is. Successful investing is a science and an art. It is most definitely not easy.