Rant of the Year, Part II

After last week’s declines, stocks look set to move higher. Is bouncing off lows a rally? Not really. You need a little optimism to call it a rally. A little enthusiasm. But even if stocks do move higher this week, investors won’t be particularly happy about it. 

Americans are mad – mad at the banks, mad at their financial advisor, mad at the mortgage industry, mad at people who bought too much house. We’re mad at Paulson and Bernanke, Congress and Obama, too. 

By now you’ve probably seen the rant from CNBC’s Rick Santelli I included in last Friday’s Daily Profit. It’s gotten a lot of attention the past few days, even getting airtime on Meet the Press this Sunday.    

Santelli’s not the only one who’s mad. But he seemed to perfectly capture the mood in his spontaneous (or was it?) diatribe against bailing out homeowners who overextended themselves. And he makes some good points. 

Why not let the government take over foreclosed homes and work to get them in the hands of worthy owners? That gets them off banks’ balance sheets, deals with the bad mortgages and may actually help people down the road. Simply trying to make homes more affordable for people who can’t afford them seems destined to fail. And we’ve already seen that a large percentage of modified loans have fallen back into delinquency. 

*****Here’s a really informative interview on Barron’s with Nobel Prize winning economist Paul Krugman. One of the biggest mistakes investors can make right now is to make too many assumptions based on history. By that I mean, for instance, believing that because home prices were high a couple years ago, that they’ll return to those levels when the economy recovers. 

Cisco (Nasdaq:CSCO) was a $70 stock back in 2000. Anybody think it’s headed back there anytime soon? 

Krugman acknowledges Japanese economist Richard Koo as being the first to say the current economic crisis isn’t a housing crisis or a banking crisis but a balance sheet crisis. That’s a good term because it doesn’t seek to place blame or localize the effect. Rather, it tells us exactly what we need to know in terms of expectations.

What happens when you have a balance sheet problem? How do you fix it? 

A balance sheet problem means that you have too much debt and servicing that debt is impairing growth. Imagine a credit card bill that’s so big, it’s eating into your food budget. Vacation? New clothes? Not when you can’t afford basic necessities. 

There’s no way to fix a balance sheet quickly. It takes time, and during that time, you won’t be eating many steak dinners. That’s where we are as a country. The days of steak are over for awhile. It’s beans and rice. And even when our collective balance sheets improve, we may decide we kind of like beans and rice.      

Now, finally, a couple of your questions… 

*****Jerry asks Do you recommend selling stocks that are depleted and well down (taking losses) in order to obtain capital to apply to the recovery portfolio? 

Taking a loss – it’s one of the toughest things an investor has to do. Funny thing though, the peace of mind that comes with getting rid of a losing investment is usually well worth it. I’ve heard it compared to having a necessary surgical procedure. 

You sweat and agonize about having surgery. You pretend maybe you’ll get better, or maybe you can just deal with it. But in the end, you have the surgery and you find you’re better off. No more worry, no more pain. 

So in general, yes, I’m all for taking losses and moving on. Bad stocks tend to get worse, and you’re also suffering opportunity loss, where your money could be working for you right now. 

But without knowing the stocks you’re talking about, I can’t give you a responsible answer for your particular situation. 

*****Jorge asks I read your article concerning the interest you have in investing in GOLD stocks. I have been aware about the future inflation and the possibility that the treasuries will be affected by it. My question is what should we be invested in, at this moment.  

Do you believe the consumer confidence is a good chart to anticipate the duration of this recession? How long do you think this crisis will last? When do you predict growth will start ? have we hit bottom ?? 

Safety in the market? That’s a tough one. There’s only one guarantee, and that’s Treasuries. That’s also why they are trading near record highs. Safety sounds pretty good these days. 

While I always think there are ways to make money in the stock market, investments must be balanced with risk. And right now, there is still much risk out there. 

That’s why my Recovery Portfolio is taking a conservative approach at the moment. There’s no way to know how long the current recession will last. Past recessions aren’t much help because this one is based on fundamental imbalances. Those imbalances have to be corrected before the economy improves. 

I follow employment numbers to gauge the economy. Consumer confidence is unreliable. People will say what sounds good, not necessarily what they actually think or do. 

 *****Bruce writes: I agree with your stance on avoiding financial stocks, however the root of the problem is the financial sector because of their gross mismanagement of their lending business that has caused a severe ripple effect through out the economy, falling house prices are a symptom of their business practices not the root cause. The housing sector bore the brunt of the fallout first and hardest. One economic sector can’t effectively repair the problems of another sector. The financial sector is now the one who must bear the responsibility of fixing the problem. 

Well, I think economic sectors are inter-dependent. Without improvement in the housing market, banks are still underwater with their mortgage-related assets. So long as unemployment is on the rise, there’s not much hope for the housing market. And until consumers start spending, there’s not much hope for higher corporate profits and investments in growth (hiring). And of course, people won’t spend until they feel better about the value of their assets (homes) and employment future.

 Yes, the financial sector mismanaged risk. But if home prices didn’t start falling, all those credit default swaps would have been fine. And if buyers didn’t overextend, home prices wouldn’t have risen, and fallen, as much. 

At this point, there’s plenty of blame to go around. 

*****Steve’s looking at Chinese stocks: Some Chinees Microcap stocks with good fundamentals and low P/E’s (all less than 5) are: CHCG, CNEH, MYST, UTVG, GFRE and SNEN. Please feel free to send this along to your readership unless you feel that they are more conservative and are looking for only large caps with major US exchange listings. 

Chinese stocks do look attractive on a valuation basis. But I still have misgivings about investing in them. China’s economy is still growing, though at reduced rate (6.9%, approximately). What is this growth based on? 

It’s not export demand from the U.S. that’s for sure. And how much is domestic demand in China? We can’t say for sure. China committed 15% of its GDP to stimulus spending, so that’s a big part of the strength in that economy. But those funds will run out. 

Don’t forget, too, that the U.S. is selling massive amounts of Treasury bills that are soaking up much of the world’s available liquidity. Is there enough liquidity to support higher valuations in China? Is China’s risk profile enticing enough to lure what liquidity there is? 

I’m not sold on Chinese stocks just yet, at least for the long-term. There have been some strong gains over the short-term. But I would advise investors in Chinese stocks to act like traders.