Stock Valuations

January 9, 2009

 *****Stock Valuations

*****Graham Corp

*****Recovery Portfolio

On Wednesday, after a few down days in a row, we tried to sift through the various clues to decide whether the selling we saw was investors taking some profits, or whether we were seeing the start of a more serious sell-off based on lowered earnings guidance and the prospect of unemployment running higher than the current consensus of 9%. 

We know that the stock market is forward-looking. That’s because investors attempt to anticipate future prices based on what is known today. If stocks react strongly to news, it means that investors were taken by surprise. They then have to adjust their price expectations. 

When stocks rally on what appears to be bad news, that’s a sign that investors have anticipated that news and adjusted prices accordingly. Investors tend to overshoot, and the news can never be perfectly anticipated – that’s what makes the stock market so interesting. To me, anyway.

*****Sometimes, the stock market crystal ball gets a little cloudy. Like earlier this week. Stocks rallied strongly at the end of 2008 and for the first few days of 2009. Stocks then sold off sharply as several companies lowered their earnings estimates.

 I suggested that we were seeing simple profit-taking after a nice rally that took the Dow Industrials to the top of its trading range, rather than an all out, re-valuing of stocks. 

Yesterday’s action encourages me that profit-taking was the correct answer. After an already decimated retail sector posted worse-than-expected holiday sales, stocks took a nosedive. But buyers stepped in to stage a late day rally that left the Dow with minimal losses and the Nasdaq with a slight gain. 

That rally out of the hole was a good sign that investors are comfortable with current stock valuations, even when there is worse-than-expected news. 

*****If investors are comfortable with valuations, it’s critical to ask why. Why do investors feel optimistic about stocks? Obviously, that’s a tough one, so let’s turn to a colloquialism from my Dad. 

He likes to say that when you’ve got yourself in a hole, the first thing to do is stop digging. For the most part, it appears that investors believe that we’ve stopped digging. The worst has happened. While unemployment may still rise and the housing market hasn’t bottomed, we’ve reached the point where we’re working to get out of the hole.

And I still say that there is some optimism for President-elect Obama’s stimulus plans.

 *****Now, we should remember that investors aren’t always right. There could still be some surprises that will take stocks lower. Rather than economic, I think that some kind of geo-political tension is the biggest threat to economic recovery.

 Russia is getting ornery over natural gas. Israel is creating ill will in the Middle East. And the potential for escalation between India and Pakistan is certainly worrisome as well.

*****Yesterday, I suggested it may be time to take our profits on Graham Corp. (AMEX:GHM). Yes, 12% drops in a day will do that to you. But after Graham rallied yesterday as oil prices dropped, I’m not convinced we have to run for the exits though. 

I suspect that oil has already hit its lows around $35. Plus, Graham has broken above its 50 day moving average. That puts support around $11.50. It’s close to that now. And Jason Cimpl, the junior strategist at TradeMaster Daily Stock Alerts, tells me that if Graham drops below its 50-day MA, it’s probably going to $10 a share. A limit sell at $11.40 might be wise.

*****In the December 29 edition of Daily Profit, I let it slip that I was putting up $100,000 of my own money to show individual investors how they can use "an aggressive approach to conservative investing" and start taking back losses from 2008. 

Well, I’m happy to announce that Ian Wyatt’s $100,000 Recovery Portfolio will launch with a special video presentation on January 22, at 6 pm ET.

 It’s completely free to attend this video conference. And I’d love for you to attend as I discuss my main investment themes for 2009, share wealth-building strategies and show you some of the investments I’m making right now. 

We’ve opened pre-registration. If you’d like to attend, here’s the LINK

*****I know I’m starting to sound like a broken record, but I couldn’t get to the next round of reader mail again. I’ll shoot for Monday. With a whole weekend, I should be able find the time. As always, thanks for your emails.