Investor Bullish Sentiment Continues To Fall

The bullish sentiment reading reported by the American Association of Individual Investors fell over 11 percentage points this week. This week's bullishness reading was reported at 21.64% versus last week's reading of 32.91%. The bull/bear spread widened to a negative 35% versus last week's spread of minus 6%. The equity market performance is contributing to this high level of bearishness and low level of bullishness.

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Source: American Association of Individual Investors

Additionally, as reported at the end of 2008, cash levels were at 18-year highs and cash continues to build. Bloomberg reported in December:

The $8.85 trillion held in cash, bank deposits and money- market funds is equal to 74 percent of the market value of U.S. companies, the highest ratio since 1990, according to Federal Reserve data compiled by Leuthold Group and Bloomberg....

Leuthold Group, whose Grizzly Short Fund returned 83 percent in 2008 thanks to bets against equities, said in its December bulletin to investors that stocks offer "one of the great buying opportunities of your lifetime."

Source:

Cash at 18-Year High Makes Stocks a Buy at Leuthold
Bloomberg
By: Eric Martin and Michael Tsang
December 29, 2009
http://www.bloomberg.com/apps/news?pid=20601213&refer=&sid=ablBbCLneo6o

Standard & Poor's Advises Caution In Chasing Dividend Yield

Howard Silverblatt, Senior Index Analyst with Standard & Poor's, prepared a list of 142 S&P 500 issues that have paid increased cash dividends (xls) for at least ten years in a row or have paid increased cash dividends in at least 20 out of the last 25 years. Additionally, Mr. Silverblatt included information on companies whose earnings covered twice the annual dividend payment.

A video discussion of dividends is available at this dividend video link. Not surprisingly, given the number of dividend reductions, Mr. Silverblatt advises caution in simply focusing on yield when selecting dividend paying stocks.

Source:

Good Dividend, Bad Dividend
BusinessWeek
By: Howard Silverblatt
February 11, 2009
http://www.businessweek.com/investing/insights/blog/archives/2009/02/good_dividend_b.html

U.S. Dollar Continued Headwind For Multinational Companies

One investment factor difficult to predict is the direction of currency moves. In large part, currency moves are impacted by a number of factors that are not necessarily specific to one single country or one single event. As an example, does the price of oil impact exchange rates or does the exchange rate dictate the level of oil prices? Throwing in the demand and supply aspects of oil just adds another twist to the exchange rate question.

One factor is certain, hindsight shows the stronger US Dollar has had a negative impact on earnings for multinational companies in the 4th quarter of 2008. The currency exchange rate impact on earnings will likely have continued negative headwinds through 2nd quarter 2009 earnings results vis-à-vis the comparable periods in 2008.

Standard & Poor's February 18, 2009 The Outlook newsletter ($) reports some currency changes since March 31, 2008 to January 31, 2009 exchange levels:

• U.S. dollar +23% vs. the euro;
• +39% vs. the pound;
• +20% vs. the Canadian dollar;
• +55% vs. the zloty; and
• +33% vs. the real;
• +33%vs. the Mexican peso;
• +23% vs. the ruble

The dollar is down 10% vs. the yen and down slightly vs. the yuan renminbi.

It seems the U.S. has been ahead of other countries in addressing the economic slowdown by being ahead of the curve in lowering interest rates as well as the government providing stimulus to the economy. Below is a table of some of the interest rate levels around the globe.

Full Screen View
Source: World Interest Rates Table

If the U.S. economy comes out of this economic recession before most countries around the globe, it is almost a certainty the Federal Reserve will be raising interest rates. Additionally, the level of government stimulus will mean more U.S. Government debt issuance. With this higher supply will come higher interest rates. So even under a recessionary environment, the higher rates will likely mean continued strength in the dollar and hence a stronger dollar and currency headwinds for U.S. multinationals. One benefit of a stronger dollar is the likely downward pressure this keeps on oil prices.

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Another implication for investors is the impact the negative currency adjustment has on the earnings results reported by multinational companies. Many investors are focusing on high quality dividend paying stocks as potential shelter from this economic storm and dividend payers tend to be multinational companies. Certainly, constructing the foundation of ones stock portfolio with high quality dividend payers/growers is appropriate in this environment. However, investors need to be aware of the percentage of a company's sales that are derived outside the U.S. and understand what the company does, if anything, to hedge currency risk. Exchange rates will impact bottom line results.

Sales Declining Faster Than Inventory

Although businesses are trimming inventory levels, actual sales are declining at a faster pace. The result is a spike higher in the inventory to sales ratio.

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Source: Federal Reserve Bank of St. Louis

One reason for the decline in sales is due to consumers reducing their debt exposure. The consumers' desire to reduce debt is attributable to concern about the future direction of the economy and, for some, the inability to gain access to credit. In the short run, the reduced spending/higher savings is a drag on economic activity, but reducing debt levels is beneficial in the longer term.

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Source: Federal Reserve Bank of St. Louis

S&P 500 Index Still Holding Support

The S&P 500 Index continues to hold support in a short term uptrend channel. The MACD also continues to be positive with the fast moving average line remaining above the slow moving average line. Although up volume on the last two positive trading days is unimpressive, today's volume was higher than yesterdays. The negative aspect of today's trading volume is much of it would seem to be short covering at the end of trading given the market moving mortgage news near the end of trading.

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Near The Bottom If History Repeats Itself?

From a pure technical perspective, the depth of this market decline has mirrored past declines. In terms of duration, the decline is about half as long as the longest market contraction that began in 2000 as noted in the below chart.

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Source: T. Rowe Price (pdf)

During the depression years, the worst back to back yearly contractions occurred in 1930 and 1931.

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Investors Head For The Exit

The market could not find any upward momentum from the beginning of trading today. As more details were gleaned from the stimulus bill this morning, investors began to understand the long term negative consequences of the added unfunded mandates in the stimulus bill. One unfunded mandate, and one that will certainly add additional stress to the government budget (that means higher taxes) was the health care provisions in the bill.

Bloomberg picked up on this and provided commentary on the two new departments created for health care, Federal Coordinating Council for Comparative Effectiveness Research and National Coordinator of Health Information Technology, established out of this bill. The article, Ruin Your Health With the Obama Stimulus Plan, describes the infrastructure that is established out of the bill that will provide for national health care down the road. As the article notes, rationing health care to seniors will result as the new policies are implemented.

It seems the two positives from today's market action are both technical. The S&P 500 Index chart has maintained its positive flag formation as the market closed above the lower resistance line. The question is whether or not the market can maintain this support level around 820. Additionally, the MACD remains bullish although the fast moving average line has hooked downward.

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Wednesday could be an interesting trading day as investors digest all the news out of Washington.

January Was Not Kind To Dividend Payers In The S&P 500 Index

Dividend payers are not getting off to a good start in 2009. For the month of January, the dividend payers in the S&P 500 Index declined 9.40% versus a decline of 3.39% for the non-payers. The once reliable financial sector contributed to the poor performance for the dividend payers. The financial sector alone fell 26.55% versus the S&P's decline of 8.57% in January.

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In the month of January dividend decreases doubled to 10 versus 5 in January 2008.

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Source:

Market Attributes Snapshot (pdf)
Standard & Poor's
January 30, 2009
http://www2.standardandpoors.com/spf/pdf/index/2009_2_SP500.pdf

Stimulus Bill Is Nearly Half Pork!

No matter your political party affiliation, one should be concerned about the so-called stimulus bill making its way through Congress. Nearly half of this bill is earmarks (i.e., pork).

The Political Calculations website has a breakdown of the spending bill in a brief article titled:

• Where The Stimulus Money Is Going.

The article contains the below chart:

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The seemingly "panic" efforts by the White House to pass this bill is representative of their lack of understanding of the the factors that are causing this economic crisis. Todd Sullivan has a brief comment that addresses the mark to market accounting issue in an article titled:

• "Davidson": Panic at the White House.

On one hand, I believe the market price is what it is. On the other hand, the dysfunctional market for some credit investments leads one to price investments far below market value even though all payments are being received. Is it as simple as a revision to the mark to market accounting rules that could ease the credit markets?

Dividends In 2009: Trust But Verify

Today, Standard & Poor's released a report containing a not so favorable outlook on dividends for 2009. In S&P's press release the firm projects dividends on the S&P 500 Index will be down 13.3% in 2009. This would be the worst decline since the 16.9% decline in 1942. The expected dividend rate for the S&P 500 Index is being reduced to $24.60 versus the $28.39 paid in 2008.

Howard Silverblatt, Senior Index Analyst at Standard & Poor's notes, "actual January dividend payments for the S&P 500 were down 23.9%, which speaks to the Q4 decreases, the $13.5 billion cuts year-to-date speaks to future payments."

S&P data shows:

• sixty-two S&P 500 companies decreased their dividends in 2008 by an aggregate $40.6 billion with forty-eight of the decreases coming from Financials ($37 billion).

• Over the previous five years (2003-2007), there were only 12 dividend decreases in the Financials sector amounting to $5.1 billion.

• So far in 2009, fourteen issues (nine of which are Financials) have decreased their dividend rate by over $13.5 billion.

Appropriately, Howard Silverblatt indicates, "the bottom line is that investors need to do a lot more homework than in years past as the prospect for future dividends remains extremely cautious. On former President Ronald Reagan’s 98th birthday, his words still ring true today, Trust but Verify."

Source:

S&P 500 Dividends Projected to Decline 13.3% in 2009;
Worst Annual Decline Since World War II (pdf)
Standard & Poor's
By: Howard Silverblatt and David Guarino
February 6, 2009
http://www2.standardandpoors.com/spf/pdf/index/020609_DividendRateChange.pdf

Investor Sentiment Continues To Decline And Market Grinds Higher

For the fourth straight week investor bullish sentiment has continued to decline. The American Association of Individual Investors reports bullish sentiment declined to 24.63% for the period ending February 4, 2009 versus last week's reading of 25.27%. In the week of January 8th, the bullishness reading stood at 48.70%. The four week bullish sentiment decline coincides with a four week decline in the S&P 500 Index as detailed below in the weekly chart of the index.

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True to form, the sentiment indicator is a contrarian one and as investors have become less bullish, the market has advanced approximately 2.4% this week with one trading day remaining.

Since the November low, the S&P continues to trade within a slightly bullish trend channel. Recent trading though has set up a flag pattern as noted in the below chart. If the S&P can close above 855 and penetrate the top of the flag, the market could see a move towards the top of the longer term trend channel.

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In addition to the positive bullish trend channel, the 50 moving average has begun to turn higher and the MACD portion of the chart has turned positive with the fast moving average line crossing above the slower moving average line.

This is certainly a difficult market, but with all the seemingly bad headline economic news, the market seems to want to grind higher. Keep in mind, this is the technical aspect of the market and fundamentals will win out in the long run.

Financial Innovation Has Benefited Innovators And Not Investors

The recent issue of the Financial Analyst Journal published an interesting interview with John Bogle, the founder of Vanguard Group. The interview covers the current market events relating to everything from creative destruction to the trend in market turnover. The article is an interesting read.

Following are a couple excerpts from the article, Markets in Crisis (pdf):

...And another difference is visible in the trend toward ownership of securities and, particularly, stocks by institutional investors rather than individuals. Fifty years ago, individuals owned 92 percent of all stocks and financial institutions owned 8 percent. Today, individuals own only 24 percent of all stocks and institutions own 76 percent. I think a central problem is that these institutions have not behaved in an appropriate manner....

...Investment principles used to be focused on the wisdom of longterm investing rather than the folly of short-term speculation. Yet, we are witnessing an orgy of speculation in the market, the likes of which we have literally never seen in the United States. For example, in 1928, during the old speculative high, stocks had about a 140 percent annual turnover rate. In the 1950s and 1960s, when I first came into this business, turnover in the stock exchange had dropped from that speculative level to about 30 percent a year. In 2006, it rose to 200 percent. In 2007, it was 280 percent. And this year, turnover of stock is running at 320 percent. In sum, when I came into this business, there might have been two, three, or maybe four days in the course of a year in which the stock market would go up or down by 2 percentage points or more. Since the end of July 2007, there have been not two, three, or four such days; there have been 52 2-percent moves—21 upward and 31 downward....

Source:

Markets in Crisis (pdf)
Financial Analyst Journal
By: John C. Bogle and Rodney N. Sullivan, CFA
January/February 2009
http://www.cfapubs.org/doi/pdf/10.2469/faj.v65.n1.3

Bullish Sentiment Continues To Decline

Investor bullish sentiment continues to decline as reported by the American Association of Individual Investors. The bullishness level is reported at 25.27% versus last week's 27.21%. This is the third straight week the bullishness level has declined. A question is what level will mark a bottom in the market. Sentiment alone will not result in a market turning point, but the indicator is a contrarian one.

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Source: American Association of Individual Investors

GDP Better Than Expected But....

The advance estimate of 4th quarter 2008 GDP came in at a better than expected decrease of 3.8%. The expectation was for a decline of 5.5%. The full release can be found at the Bureau of Economic Analysis website.

The better than anticipated results can be attributed to the real change in private inventories that added 1.32 percentage points to the fourth-quarter change in real GDP. The issue with this inventory build is sales are not keeping pace with the rate of increase. The inventory to sales ratio has increased significantly as noted in the below chart. The data for the chart is through 11/1/2008.

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Source: Federal Reserve Bank of St. Louis

Companies Increasing Dividends Can Still Be Found In This Market

This market cycle has been tough on dividend growth type stocks. A number of past dividend growers have resorted to cutting dividend payouts due to the difficult economic environment. Admittedly, many of the adverse dividend actions have been centered in the financial sector. In this environment though, there are firms that are increasing their payouts to investors.

Below is detail on company's that announced increases in the company's dividend over the last several days. The companies detailed below are McGraw Hill Companies (MHP), Praxair (PX) and Consolidated Edison (ED).

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Money Supply Causing Concern With Future Inflation

Having an understanding of the Quantity Theory of Money (QTM) will provide one with an understanding why some strategist are concerned about future inflation. The factor in the QTM that is holding back inflation at the moment is the fact the "velocity" of money has declined substantially. So what is the Quantity Theory of Money?

The QTM is based:

"directly on the changes brought about by an increase in the money supply. The quantity theory of money states that the value of money is based on the amount of money in the economy. Thus, according to the quantity theory of money, when the Fed increases the money supply, the value of money falls and the price level increases."

The chart below depicts the relationship between the variables that comprise the QTM equation.

The value of money is ultimately determined by the intersection of the money supply, as controlled by the Fed, and money demand, as created by consumers. The above chart depicts the money market in a sample economy. The money supply curve is vertical because the Fed sets the amount of money available without consideration for the value of money. The money demand curve slopes downward because as the value of money decreases, consumers are forced to carry more money to make purchases because goods and services cost more money. Similarly, when the value of money is high, consumers demand little money because goods and services can be purchased for low prices. The intersection of the money supply curve and the money demand curve shows both the equilibrium value of money as well as the equilibrium price level.

The quantity theory of money is based directly on the changes brought about by an increase in the money supply. The quantity theory of money states that the value of money is based on the amount of money in the economy. Thus, according to the quantity theory of money, when the Fed increases the money supply, the value of money falls and the price level increases (emphasis added).

This depiction of the the QTM is a bit simplistic. The one factor that also must be considered is the velocity of money. Velocity is the rate at which money changes hands. The relationship between velocity, the money supply, the price level, and output is represented by the equation:

• M * V = P * Y where
• M is the money supply,
• V is the velocity,
• P is the price level, and
• Y is the quantity of output.
• P * Y, the price level multiplied by the quantity of output, gives the nominal GDP.

This equation can thus be rearranged as V = (nominal GDP) / M. Conceptually, this equation means that for a given level of nominal GDP, a smaller money supply will result in money needing to change hands more quickly to facilitate the total purchases, which causes increased velocity.

The equation for the velocity of money, while useful in its original form, can be converted to a percentage change formula for easier calculations. In this case, the equation becomes (percent change in the money supply) + (percent change in velocity) = (percent change in the price level) + (percent change in output). The percentage change formula aids calculations that involve this equation by ensuring that all variables are in common units.

The velocity equation can be used to find the effects that changes in velocity, price level, or money supply have on each other. When making these calculations, remember that in the short run, output (Y), is fixed, as time is required for the quantity of output to change.

What is the effect of a 3% increase in the money supply on the price level, given that output and velocity remain relatively constant? The equation used to solve this problem is (percent change in the money supply) + (percent change in velocity) = (percent change in the price level) + (percent change in output). Substituting in the values from the problem we get 3% + 0% = x% + 0%. In this case, a 3% increase in the money supple results in a 3% increase in the price level. Remember that a 3% increase in the price level means that inflation was 3%.

In the long run, the equation for velocity becomes even more useful. In fact, the equation shows that increases in the money supply by the Fed tend to cause increases in the price level and therefore inflation, even though the effects of the Fed's policy is slightly dampened by changes in velocity. This results a number of factors. First, in the long run, velocity, V, is relatively constant because people's spending habits are not quick to change. Similarly, the quantity of output, Y, is not affected by the actions of the Fed since it is based on the amount of production, not the value of the stuff produced. This means that the percent change in the money supply equals the percent change in the price level since the percent change in velocity and percent change in output are both equal to zero. Thus, we see how an increase in the money supply by the Fed causes inflation.

So as the above examples states, this 3% increase in money supply would cause a 3% increase in inflation. The key assumption is velocity and output are relatively constant. Recent velocity though has actually decreased as noted in the below chart, thus the immediate concern about deflation.

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When velocity does increase, however, the impact to inflation will be magnified due to the large increase in the money supply. Keeping an eye on money supply and velocity going forward will provide insight into an improving economy (GDP) and equally important, potentially higher inflation. These trends can be reviewed at the St. Louis Federal Reserve's Monetary Trends report. A key will be the Fed's ability to withdraw this excessive supply from the financial system before it causes significantly higher inflation.

Source:

Quantity Theory of Money
http://www.sparknotes.com/economics/macro/money/section2.rhtml

Obama’s Economic Challenge: The Velocity of Hope (PDF)
Fidelity Investments
By: Dirk Hofschire, CFA
January 16, 2009
https://401k.fidelity.com/static/dcl/shared/documents/MKTG_Obama_Economic_Challenge.pdf

Low Bullish Sentiment Equals High Cash Allocation

Investor bullish sentiment ticked slightly lower to 27.21% versus last week's 27.63%. Investors seem to be acting on their low level of market confidence by maintaining high levels of cash from an asset allocation perspective. The nearly 42% cash level is the highest level reported by the American Association of Individual Investors going back to November 1987.

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Source: American Association of Individual Investors

Can The Market Hold Support?

Not much to hang ones hat on in this market at the moment-technical or fundamental. The hope is the S&p 500 Index bounces off its current support as detailed in the below chart. If the market is unable to hold its support at its current level, the next support level would take the market down to the 752 low recorded on November 20th. Maybe we will get a post inaugural bounce on Wednesday.

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Investment Advice Tends To Incorrectly Focus On The Recent Past

Let me first start by saying I am a firm believer the foundation of ones equity investments should be in high quality dividend growth stocks. The attractiveness of these high quality dividend payers is they generate more consistent returns over time. In down markets especially, the dividend growers tend to hold up better than other equity investments.

Not surprisingly then, after the dismal equity market in 2008, a majority of investment strategist indicate investors should now focus their investment efforts on these dividend payers. Strategist find this to be a palatable recommendation since it "was" the dividend growth stocks that generated better returns in the latter part of the last bull market cycle. A similar line of thinking occurred in 2002 when strategists recommended buying technology stocks as they had fallen significantly from their early 2000 highs. Well it wasn't technology that worked in that subsequent cycle, it was energy and materials. Investment advice also follows a similar path when it comes to asset allocation recommendations.

The mantra in 2006 and 2007 was for investors to allocate investments across all equity styles, i.e., large cap, mid cap, small cap, international, etc. This type of recommendation was an easy sell to investors as 2003, 2004 and 2005 saw the rising equity markets lift nearly all markets. The end result in 2008 of this broad diversification among the equity styles was a greater loss of investor capital. It so happens that in down markets, equity correlations tend to move closer to 1. I discussed this topic in a post I wrote in November 2008 titled, Diversification Not Working in this Cycle. So what does this mean going forward?

Investors should keep in mind that what worked in the last bull market cycle is unlikely to work in the next bull market. As the below chart shows, after the 2001-2003 recession, it wasn't the S&P 500 Index (large cap stocks) that outperformed. It was small cap (Russell 2000 Index) as well as dividend paying stocks (S&P's Dividend Aristocrats) that generated the better returns. The S&P 500 Index lagged other investment styles due to the higher concentration of technology stocks in the index at that time and the technology sector's inability to keep pace with the other sectors. How many advisers were recommending energy and material stocks? A similar outcome occurred coming out of the 1990-1991 recession.

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So going forward, when the market exits its current slumber, investors should keep in mind what investment styles perform the best coming out of a recession and not just what worked late in the last cycle. If an investor builds the foundation of their equity portfolio in large cap dividend growth stocks, they can then add incremental exposures to the more volatile sectors like small cap. Historically, small cap stocks do perform well early in an economic recovery.

Dividend Aristocrats Explained Via Barron's Video

I frequently post articles about Standard & Poor's Dividend Aristocrats. Barron's recently prepared a short video that provides detail on these high quality dividend paying companies.

Financial Stocks Continue To Bear Brunt Of Dividend Cuts

For the week ending January 16, 2009, additional financial firms announced cuts in their company dividends. The popular going forward dividend rate seems to be a penny a quarter.

Below is a table detailing year to date dividend rate changes in January. The three cuts are all financial stocks: Bank of America (BAC), Marshall & Ilsley (MI) and XL Capital (XL).

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Source: Standard & Poor's (.xls file)

Some detail on the cuts and impact on the S&P 500 Index:

• Financial sector now accounts for 15.8% of all dividends, down from 34%, makes up 11.2% of the market value (22.3% at year-end 2006).

• BAC's dividend reduced from $1.28 to $0.04 (was reduced last Oct from $2.56 to $1.28 after over 25 years of increases, issues was a Dividend Aristocrat). This reduces the S&P 500 payout (and yield) by 3.4%
  

• BAC was the fifth largest dividend payer ($6.4B), yielding 15.4%, now it yields 0.5% ($0.2B) ranking 202 out of the 369 that pay.

• 2009 S&P 500 dividend expected to be the worst in at least 50 years

Summers and President Elect Obama Crater The Financial Sector

The S&P 500 Index financial sector is down 21.04% year to date through January 15, 2009. Admittedly, a vast majority of the banks and insurance companies are struggling with the fall out from the mortgage crisis. The upcoming administration's approach to dealing with firms that take TARP money seems to be one of micro managing these firms.

Some of the conditions the Obama administration is proposing is essentially telegraphing to the market that equity holders in TARP funded institutions that they are going to shoulder all the risk in turning around the firms and the economy. Some of the conditions, like forcing banks to lend, are similar to requirements that banks underwrite mortgage loans to less qualified first time home buyers. We know where that got us.

Following are some requirements from Mr. Summers' letter (Full Letter Text (pdf)):

• Banks receiving support under the Emergency Economic Stabilization Act will be required to implement mortgage foreclosure mitigation programs. In addition to this action, the Federal Reserve has announced a $500B program of support, which is already having a significant beneficial impact in reducing the cost of new conforming mortgages.

• As a condition of federal assistance, healthy banks without major capital shortfalls will increase lending above baseline levels (emphasis added). The Treasury will require detailed and timely information from recipients of government investments on their lending patterns broken down by category. Public companies will report this information quarterly in conjunction with the release of their 10Q reports. The Treasury will report quarterly on overall lending activity and on the terms and availability of credit in the economy. (more bad loans?)

• Payment of dividends by firms receiving support must be approved by their primary federal regulator. For firms receiving exceptional assistance, quarterly dividend payments will be restricted to $0.01 until the government has been repaid.

I will say firms taking TARP funds should review their company dividend practice and maybe restrict payouts so long as the TARP funds are outstanding. However, there needs to be a balance between these policies so that the policy does not force out free market investors.

Under the proposed terms noted above, the government is essentially making it unattractive for investors to invest in the common equity of the TARP recipient firms/banks. Given the level of outstanding government debt and the current budget deficit, private sector equity investments are needed to assist in the funding as we work through this difficult economic environment.

Investor Sentiment Indecision

This week's Sentiment Survey released by the American Association of Individual Investors indicates individual investors are uncertain about the direction of the equity markets. Two week's ago, the level of bullish investor sentiment was reported at 24%. Then last week the bullish investor sentiment level was reported at 48.70% with a bull/bear spread of +14%. This week's reading recorded a large decline in bullish sentiment to 27.63% and a resulting bull/bear spread of -20%.

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Source: American Association of Individual Investors

Better Investings Most Active Stocks

Better Investing reported the ten most active stocks for the four week period ending January 15, 2009. The below table lists the top ten stocks taken from a small sampling of 91 transactions as reported by Better Investing members.

Source: Better Investing

Stock Profiles:

Stryker (SYK)
Johnson & Johnson (JNJ)
Fastenal Co. (FAST)
Starbuck (SBUX)
Bank of America (BAC)
General Electric (GE)
Archer Damiels Midland (ADM)
Home Depot (HD)
CVS Caremark (CVS)

The Beginning Of A New Bull Market?

It is safe to say last year was certainly a bear market given the market return was one of the worst on record. However, since November 21st, the S&P 500 Index bounced off of its low of 741.02 and climbed to 943.85 on January 6, 2008. This represented a return off the bottom of 27.3%.

From a pure technical perspective, many strategists classify a bull market as one where prices generally are rising faster than their historical average over a period of months or years. Some strategists require the market to rise 20% following a low that resulted in a 20% decline in prices (bear market). Last year was a bear market for sure.

As noted above, the market has advanced from its low to a high point this month that generated a return greater than 20%. As the below chart details, the markets could be in the beginning stages of a longer term trend of higher prices.

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There are some technical positives and negatives that can be gleaned from a quick look at the above chart.

• (-) the market closed below its 50 day moving average
• (-) the fast (green) MACD line has crossed over the slower red line
• (+) market closed above support around 868
• (+) higher volume on up market days
• (+) market still in a short-term uptrend
  

Technical analysis alone is not a certainty, but it does provide insight into the psychology of the market. Other factors need to be taken into consideration, not the least of which are economic ones. However, history does have a tendency to repeat itself.

There have been ten prior market cycles where the market experienced so-called "waterfall" declines like the market experienced in October and November 2008. Ned Davis Research prepared a graphic representation of these ten declines covering 1929 through 2002. Liz Ann Sonders, Chief Investment Strategist at Charles Schwab (SCHW), highlighted NDR's research in a recent strategy article. Liz Ann noted:

In waterfall declines, the Dow loses more than 20% in a short period, and near the end, the 10-day average of NYSE total volume rises to two times its average seen just a few months earlier. In the majority of cases, the end of the waterfall decline wasn't the end of the bear market.

However, in the composite average, the lows were tested but not broken, followed by a basing phase of up to three months before a breakout to a new bull market. The chart below shows the performance of the Dow as averaged from the 10 waterfall declines between 1929 and 2002.

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It is probable the market is in the second phase of the above chart, i.e., a month and a half past the November 2008 low.

The economy and market undoubtedly have "issues" that need to be digested; however, the market tends to be a leading indicator and will forecast an improving economic environment with about six months lead time. Could we retest the November 2008 lows, certainly. Remember though, the news media was touting the fact oil was going to $200 per barrel last year right about the time oil hit its high around $150 per barrel. Today, the news media does not have much to say about the market or economy that is positive. What is important is where is the market going looking forward and not where has it been when looking back.

Source:

"Happy New Year" May Be True In 2009!
Excerpt from Schwab Investing Insight
By: Liz AnnSonders, Chief Investment Strategist
January 2009
http://www.schwab.com/public/schwab/research_strategies/market_insight/todays_market/recent_commentary/happy_new_year_may_be_true_in_2009.html

Disclosure: Long SCHW

U.S. Government Debt/Deficit A Disaster In The Making?

For the U.S. government's fiscal year ending September 30, 2008 the total federal debt level reached $10 trillion. Michael Pakko, an economist with the Federal Reserve Bank of St. Louis, notes in a recent article that the rise in government spending and debt is a ticking time bomb. What contributes to the debt explosion is the rise in entitlement programs.

All told, the shortfall for government social insurance programs (Social Security, unfunded obligations of Medicare Part A & B and Medicare Part D-prescription drug coverage) comes to a present value of $40.9 trillion. This is the government’s official estimate—some private sector economists suggest that the total burden is even greater. Economist Lawrence Kotlikoff has recently estimated the total unfunded liabilities of current federal programs at $70 trillion.

Recent bailout actions are also contributing to the rise in obligations that will need to be repaid by U.S. taxpayers. Forecasts from the Government Accountability Office show the growth of the debt obligations if entitlement reforms are note undertaken. The below graph depicts the growth in expenses compared to total revenue as a percent of GDP out to 2080.

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and the resulting growth in the government's debt:

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The ballooning deficits and debt levels are issues that will need to be addressed sooner versus later in order to ensure healthy economic growth in the long run. Michael Pakko concludes:

Current measures of the federal deficit and the national debt, as dismal as they might appear, fail to reflect full consequences of current-law fiscal policy. The unfunded future liabilities of government entitlement programs imply rising deficits and a ballooning public debt far larger than today’s shortfalls. And debates about the immediate economic impact of government deficits on private savings and interest rates, while of academic interest, fail to address the full importance of these long-run consequences. Fundamental reform of entitlement programs is critical for putting U.S. fiscal policy on a long-run sustainable path.

Take the Fed's Flash Poll:

• What would you do to trim the debt and deficit?

Source:

Deficits, Debt and Looming Disaster: Reform of Entitlement Programs May Be the Only Hope
The Regional Economist
By: Michael Pakko
January 2009
http://www.stlouisfed.org/publications/re/2009/a/pages/debts.html

Stocks Passing The Buffett Test

Many investors attempt to seek out stock investments in the same way as Warren Buffett. Warren Buffett has often cited the screens he uses in uncovering companies that meet his investment criteria. Standard & Poor's created a list of companies that currently meet Mr. Buffett's screening criteria. S&P did add a discounted cash flow screen as an additional factor in in order to eliminate overvalued companies. The screens used by Mr. Buffett are:

• Free cash flow (net income after taxes, plus depreciation and amortization, less capital expenditures) of at least $250 million.

• Net profit margin of 15% or more.

• Return on equity of at least 15% for each of the past three years and the most recent quarter.

• A dollar’s worth of retained earnings creating at least a dollar’s worth of shareholder value over the past five years.

• Ample liquidity. Only stocks with a market capitalization of at least $500 million are included.

• (S&P's) Comparing the five-year discounted cash flow (DCF) estimate with the current price.

The companies passing all the above screens are detailed in the below table.

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Source:

Acing The Buffett Test ($)
The Outlook
Standard & Poor's
By: Howard Silverblatt, Senior Index Analyst
January 14, 2009
http://erecom.standardandpoors.com/ecommerce/multiRegistration.do

Disclosure: Long BCR, MCD, SLB

Post Election Year Market Returns Somewhat Muted

In general, post election year returns for the Dow Jones Industrial Average have been somewhat muted. On average, the best returns in the post election year have occurred from late March through early August. Chart of the Day notes that the post election year returns tend to be weaker because:

"...the party in power will tend to make the more difficult economic decisions in the early years of a presidential cycle and then do everything within its power to stimulate the economy during the latter years in order to increase the odds of re-election."

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Source: Chart of the Day

The Year Of The Vanishing Dividend Increase: 2008

Not only was the return for the S&P 500 Index in 2008 the worst since 1937, but 2008 marked the worst dividend year since Standard & Poor's began tracking dividends in 1956. First, for performance, only 25 company issues in the S&P 500 Index generated a positive return in 2008. In 2007, 245 company issues had a positive return. A breakdown on some of the return characteristics is detailed in the below table.

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In regards to dividends, for the month of December,

• S&P notes the decreases continue to increase and increases continue to decline.

• The last three months of 2008 were the worst months in the Index's history with 288 decrease versus 52 decreases in 2007.

The below table shows positive dividend actions have been on a steady downward trend since 2005.

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Source:

Market Attributes Snapshot (PDF)
Standard & Poor's
By: Howard Silverblatt, Senior Index Analyst
December 2008
http://www2.standardandpoors.com/spf/pdf/index/2009_1_SP500.pdf

Investor Bullish Sentiment Continues To Decline

The individual investor bullish sentiment indicator is referred to as a contrarian measure by investment strategist. Individual investors historically become the least bullish at market bottoms and the most bullish at market tops.

As reported by the the American Association of Individual Investors, this past week's bullishness reading fell to a level below that reported on November 20th. The percent of individual investors that are bullish on the market was reported at 24% versus last week's reading of 28.95%. The 24% level is lower than reported on November 20th: 24.37%. Since November 20th, the S&P 500 Index has risen over 15%. The bull/bear spread came in at -31% versus last week's spread of -15%.

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Data Source: American Association of Individual Investors

Housing Bubble And Personal Responsibility

When I picked up the Wall Street Journal today and began to read Blame Television for the Bubble on the Opinion Page, I thought the editorial was going to be a parody on television and its contribution to creating the housing bubble. To my surprise, I was wrong.

The author of the editorial, Jim Sollisch, actually notes,

"...one culprit continues to get off scot-free: HGTV. The cable network HGTV is the real villain of the economic meltdown."

The editorial continues:

"HGTV is an evil empire that never rests. You can loathe your current domicile 24/7 with programs such as "Stagers" (move a few things around and double the value of your home); "Designed to Sell" (you can sell your house, even if the house next to yours is in foreclosure); "Design on a Dime" (see, it's cheap); and "Property Virgins" (losing your virginity was fun, wasn't it?) Every show features highly attractive hosts who show you how to "unlock the hidden potential" in your home, how to turn a $10 thrift-store table into a "wow" media center, and how to make everything "pop." Pop is the word of choice on HGTV."

What about individual homeowners taking personal responsibility for their own actions. Individuals have lived beyond their means for far too long. It can be argued that the economic growth achieved since the early 1980's is attributable largely to consumers taking on increasingly higher amounts of debt (see below chart). This will have implications for economic growth in the next recovery cycle.

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The increase in debt in and of itself is not necessarily bad; however, the below chart shows household debt as a percent of disposable personal income grew ever higher since the 1980's.

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Certainly some mortgage holders were duped by unscrupulous mortgage brokers. But I would say many real estate buyers thought they could buy more house than they could afford thinking real estate prices always increased. What happened to putting 20% down on a home? What happened to taking out a mortgage where the payments were affordable for the duration of the loan? I saw a 60 Minutes show recently that interviewed a doctor who purchased a number of homes in order to flip them. The doctor admitted not reading any of the loan documents saying she did not have time to do that since she was busy running her doctor practice.

Individuals need to learn to live within their means going forward. Placing the blame on a television show is an insult to ones intelligence.

Source:

Blame Television for the Bubble
The Wall Street Journal
By: Jim Sollisch
January 3-4, 2009
http://online.wsj.com/article/SB123094453377450603.html

S & P 500: Payers Versus Non Payers Performance As Of December 2008

For the month of December and the entire 2008 calendar year, the dividend paying stocks in the S&P 500 Index outperformed the non-payers on an average return basis. In the month of December the payers returned 4.41% versus the non payers return of 3.88%. For the 12-months of 2008, as the below table notes, both payers and non-payers underperformed the market cap weighted total return of the S&P 500 Index.

Source: Standard & Poor's

Given the magnitude of the market's decline, even outperformance to the index seems little consolation in the market environment experienced in 2008.

The Demise Of Wall Street And The Lessons For 2009

An insightful article titled The End and written by Michael Lewis, the author of Liar's Poker, recently appeared at portfolio.com. The article discusses the end of Wall Street in 2008 as a result of the blow up in the mortgage market. More telling is the lack of understanding by Wall Street firms surrounding the risk they were taking. In short, the article implies Wall Street investment bankers didn't care as they were laying the risk off to other investors and the firm's shareholders. The article is a must read!

A lesson in all of this as we go into 2009 is investors must understand the type of investment approach that is being employed in their investment accounts. A particular investor doesn't need to understand the process down to the minute detail; however, they should be comfortable that their investment manager can explain the process in an understandable way. If you are investing in a hedge fund, your adviser should be able to explain the investment approach in layman's terms.

What is for certain as we look to 2009 is investment advisers will try to "sell" new approaches to managing ones investments. Just as advisers were pushing technology stocks at the end of 1999 and asset allocation over the course of the last two years, there will certainly be new approaches pitched to investment clients in 2009. As 2008 was one of the worst investment markets on record, investors may be looking to better understand what their adviser's investment approach was in 2008 and what it will be in 2009. I am sure new buzz words will include terms like rotation, tactical allocation, etc. Asset allocation certainly did not seem to work in 2008 as nearly all asset classes came under severe pressure and had high correlations.

As investors meet with their advisers, asking questions (even the same question in a different way) about the investment approach is a must. If the adviser talks about tactical allocation or rotation, be sure the adviser can articulate the factors behind a particular approach. Also, be sure the approach is not being pitch because it would have worked in the recent past. The investment approach needs to be one that will work going forward and one that has worked over the long run.

Dow Dogs Were Dogs In 2008

With the close of 2008, we can now review the performance of the Dogs of the Dow. The Dogs of the Dow is an investing strategy were one invests in the ten highest yielding stocks in the Dow Jones Industrial Average as of the last trading day of the prior year.

The performance of the Dow Dogs in 2008 was -41.6% versus the Dow Jones Index performance of -36.9%. Over recent years, the Dogs of the Dow strategy has been mixed.

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The Dow Dogs for 2009 are detailed below. New members include Bank of America (BAC), Alcoa (AA), Merck (MRK) and Kraft (KFT). Those companies that were dogs in 2008 and are dropped from the 2009 list are Citigroup (C), General Motors (GM), Altria (MO) and Home Depot (HD).

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Source: Dogs of the Dow

Dow Index Performance In 2008 Third Worst On Record

One good thing about 2008 is the year has come to an end. It is unlikely the market's performance in 2009 will generate the same outcome as 2008, but not a certainty.

The -33.8% return in the Dow Jones Industrial Average for 2008 is the third worst on record. As noted by Chart of the Day:

"[the below chart] illustrates the 15 worst calendar year performances of the Dow since its inception in 1896...Only 1931 and 1907 endured greater declines. It is of interest that major banking crises occurred in 1931, 1907, 2008, and 1930 – the four worst calendar years on record in terms of stock market performance."

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Source: Chart of the Day