Cash for Clunker Cars Ends, Cash for Clunker Stocks Going Strong

Of course, the Cash for Clunker program ended Monday. But it occurred to me last night that the rally we’ve enjoyed since March could well be called the Cash for Clunker Stock rally… 

*****There’s no way the government can simply replace the wealth that was lost during the financial crisis. Not only would it have to absorb the banks losses, the government would have to reimburse investors for their investment losses and put around 3 million people on its payroll.  

No, America must earn its way back to prosperity. And the government has created an environment where many companies can do just that. For banks, accounting rules were changed so that what once was a loss can now be treated as an asset. Without these rule changes, Bank of America (NYSE:BAC) and Citigroup (NYSE:C) would still be clunkers.  

Credit card companies have been allowed to jack fees for even their best customers. Government backed efforts to modify mortgages has slowed the foreclosure rate dramatically, and the lag time of foreclosed homes coming to market has allowed prices to stabilize in many areas.  

Government guarantees fixed the money markets. And the weak U.S. dollar has put a floor under oil and commodity stocks, even as demand has fallen steadily. (Note: if you’re interested in how a continually weak dollar and coming inflation are fuelling a commodities boom and enriching investors, CLICK HERE.) 

Amazingly, banks even rejected one of the sweetest Cash for Clunker Stock programs – TARP. TARP would have actually given banks money for their toxic mortgage assets. Imagine that! 

*****The Cash for Clunker Stock program has also returned a lot of wealth that Americans lost in the stock market. The government has bent over backward to make it possible for companies to start earning their way out of the hole, and investors are enjoying much improved brokerage reports.  

It’s no coincidence that some of the best gains during this rally have been achieved by some of the biggest clunker stocks. Bank of America has rallied from a low of $2.53 to $17.75, a 601% move. Citigroup has run from $0.97 to $4.90, a 405% move.  

Heck, even walking dead, ward of the state companies Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) have doubled in the last week. Doubled! These two stocks have virtually no purpose except to provide a buyer of last resort for mortgages and make token payments on government loans. And investors are acting like these two companies are actually good investments!  

*****Case in point, on Monday and Tuesday this week, Reuters reports that these four stocks – Bank of America, Citigroup, Fannie and Freddie – accounted for 40% of the trading volume at the New York Stock Exchange.  

One commentator said, "No one is buying them based on their fundamentals, they’re buying based on what the government might do keep them alive."  

Yes that’s what’s moving the stock market these days – the firm understanding that the government has removed risk from even the clunkiest of clunkers.  

Reuters is also reporting that short interest for Bank of America is up 28% in August to 118 million shares and at Citigroup, the short position is up 82% to 624 million shares. Makes sense, but I’m not sure I want to take that bet. At least, not until I know the Cash for Clunker Stock program is over. 

*****It’s Newsletter Advisor Wednesday. Please enjoy the following interview with Jim Nelson of Penny Sleuth.  

Until tomorrow, 

Jim Nelson is the managing editor of the Penny Sleuth e-letter, a free daily newsletter that focuses on small-cap, options and high-growth opportunities. Along with analysts Greg Guenthner and Jonas Elmerraji, Jim is an editor of Penny Stock Fortunes, a premium small-cap newsletter. Jim is also the editor of Lifetime Income Report, Agora Financial’s new income investment advisory that launched in February. 

I recently sat down with him to give us a little perspective on the small-cap market these days. As a big fan of small-cap stocks myself, I’m always interested in hearing what other small-cap experts have to say. Plus he’ll share with you a few of the stocks he’s watching now. Here’s what he had to say… 

Ian: Jim, first and foremost, "penny stocks" are one of the most misinterpreted investments on the market. How do you define them?

Jim: Ian, the term "penny stock" is misleading to many investors. Basically, we consider penny stocks to be any small caps that trade under $10 per share. But share price isn’t the most important thing here – total market capitalization is.

We define a small cap as any stock whose total market cap rings in at $1.5 billion or less. While those cutoffs can be subjective, those are pretty common ranges for penny stocks to trade in.

Jim: Risk is a very important question when it comes to penny stocks. You see, small companies behave very differently than larger companies like GE or Microsoft. That said, the stocks we look at are real companies with growing, sustainable businesses – while they may be subject to somewhat bigger price swings than blue chip stocks, they also bring the potential for much bigger profits because most of their growth is ahead of them.

The vast majority of small caps we look at trade on major exchanges like the NYSE or Nasdaq… only a select few carefully vetted over-the-counter stocks reach our readers.

Jim: For the most part, penny stock performance mirrors the rest of the market. But what’s unique about penny stocks is the fact that historically, they lead the charge out of recessions and into prosperity.

That changeover is something we’ve seen a lot of – probably more than many blue chip investors – in 2009… While we generally focus on broadening Penny Sleuth readers’ "investment toolboxes" in our free daily issues, we do occasionally talk about specific small-cap opportunities in the Sleuth. Two of our most recent mentions were Xinhua Finance Media (Nasdaq:XFML) and GP Strategies (NYSE:GPX) – these penny stocks brought in returns of 45% and 77%, respectively, during a rough time for the rest of the market.

And in Penny Stock Fortunes, our premium newsletter, in which we recommend small-cap plays every month, we’ve closed gains as high as 279% already this year.

Jim: With an economy that’s still far from recovered and credit that’s hard to come by, three of the biggest metrics we’ve been targeting have been a strong balance sheet, positive free cash flow and a bargain-priced price-to-book ratio.

In this climate, we’re after penny stocks that can thrive and not just survive this economy… that’s why a solid balance sheet position and positive free cash flow are so important. We’ve seen scores of businesses deemed "too big to fail" collect emergency funds from Uncle Sam to keep from going belly up; penny stocks don’t have that luxury. That makes ensuring that a small-cap company can pay its bills on the top of our priority list.

And an attractive price-to-book ratio shouldn’t be discounted either… when the stock market "fell through the floor" in 2008, it dragged just about every publicly traded company with it – whether or not the company was overvalued at the time. In the aftermath, we’ve found that there are many companies trading vastly below their fair values. That’s true even today. We’ve been lucky enough to snap up many beaten-down companies early enough that we were left with respectable gains after more mainstream investors realized the value proposition that was going on at the time.

Jim: It’s funny you mention that – a few months back, we set out to create a small-cap recovery index to determine exactly which industries were leading the charge to recovery, as well as how far along recovery actually is.

The project is a complicated one. It involves the selection of hundreds of stocks and additional metrics like unemployment and savings rates. Once these benchmarks are selected and compiled, we will begin to see a picture developing that will reveal investor sentiment and market performance. Eventually, when enough data are compiled, we will have a more accurate picture of where the market is headed. 

Jim: Two industries sure to set fire to the market over the next few years are "green tech" and telecommunications. Green tech stocks are, obviously, on every investor’s mind – especially people who put their money in small-caps. Finding the right ones is the hard part.

For instance, Maxwell Technologies (Nasdaq:MXWL) popped on our radar awhile back. We got in while it was still trading as a penny stock. We’ve since booked our gains on that one, but we’re always watching in case we get a second chance to act.

Telecoms, at least in emerging economies, have the benefit of billions of potential customers and fat profit margins. Just look at Nortel Inversora (NYSE:NTL). This Argentinean telecom is growing its top line in a country where millions of new Internet and phone users are subscribing every year.

Jim: You need a discount broker you can trust – one that won’t charge you an arm and a leg to buy and sell stocks. If you are paying $3 per share and getting charged $50 for each trade, you’re putting yourself in a huge hole from the start. There are plenty of discount brokers, but you need to know what exactly you’re looking for. We keep our Penny Sleuth readers up-to-date on which brokers are out there and of any changes to their fee schedules.

Jim, thanks for spending some time with us today and sharing your thoughts on penny stocks with Daily Profits readers.