In honor of this historic day – not to mention the risks of an unchecked majority in the senate – we’ll start things off with a little humor.

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Mailbag!

There were some excellent comments (as usual) on Friday’s “Signs of a Tradable Bottom” piece. As usual you sent in way too many emails to highlight even a fraction – but I’m grateful for them all.

So now let’s dig into a few…

Excellent article! I agree the market is very tradeable now (excepting my beaten down 401K mutuals). With the money I’ve made on your WOW puts, I bought a lot of shares of Ford and RBS. Prior to that I bought AMD & NVDIA, although they continued down afterwards. I believe good buys now will bear fruit next year if not in the near future. Who was it that said, “Why are stocks the only thing in the world that no one wants to buy on sale?”

Do you know of any other severely beaten down good companies with stock price below $10?

~ TD Reader Kevin C.

Thanks Kevin. Glad to hear that WaveStrength Options Weekly (WOW) is keeping you in clover. I knew we kept that crusty old bear around for a reason. (Just kidding Adam.)

Seriously though, WOW has been a lifesaver in the environment we’ve just lived through. I’ve heard comments on similar lines from many other grateful readers: WOW subscribers who have used big profits from outsized options gains to fund attractive buying opportunities.

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In a trader’s market – and a market like this one especially – it’s good to have access to long and short opportunities. WOW has been a veritable cash machine in that regard.

And while the shorts cleaned up the longs got killed, of course… but things change. The market moves in cycles. Trends breathe in and out. As Robert Bacon, author of the 50-year-old tome Secrets of Professional Turf Betting, says, “The form always moves away from the public.” Just when the majority of folks feel they have the market pegged, things shift. Thus it has been, and thus it shall always be.

The Aggressive Value Portfolio

Regarding the question about stocks below $10: Funny you should ask. I’m actually working on a new special report of sorts for Safe Haven Investor readers. Here is an excerpt from what I wrote to them last week:

It’s fascinating wading through all the beaten-down hard asset stocks out there. Many of the miners in particular have loads of cash, low share prices, and little to no long-term debt… making them ideal candidates for snapping up shares.

I’m thinking of creating a special “Aggressive Value” portfolio for names like these – low-priced shares rich in assets and light on debt that we can just scoop up and hang onto.

The challenge is a lot of these “cash boxes” are too speculative on the business side of things. Multiple times now, I’ve come across a candidate whose balance sheet looked top notch… only to find that their cash pile came entirely from an equity funding round, and the actual mining properties aren’t producing yet.

So I’ll keep digging there. We want cash boxes that have money coming in the door too – not just a pile of equity proceeds with no firm sense of how the company will make money.

The most promising candidate I’ve found so far will be hosting an earnings call next week. I’d rather listen in on that earnings call – getting the “lay of the land” you might say – before jumping in. I’ll report back to you soon.

If you’d like to see what I come up with in the “stocks below ten bucks” department, sign up for Safe Haven Investor and you’ll get the goods – probably at least two picks by the end of this week, with more likely to come. As you might have guessed, I’m excited about the compelling values out there now.

Stocks Revisit the Disco Era

I won’t try to kid you: As far as long only portfolios go, there were no true ports in a storm during the months of September and October. The panic selling hit everything. In order for value to provide a haven, markets have to function. Normally the assigned market value of a strong company is like a rubber band attached to a peg. The rubber band can be stretched high and low, but the peg (intrinsic value) acts as a stabilizer.

In October the rubber band snapped. The peg was abandoned completely.

But that’s why the markets are littered with eye-popping values now, and why stocks are trading below 1970s valuations by some estimates. “Blacktober” wiped off $9.5 TRILLION in market value according to Barron’s. Total carnage so far has been estimated at something like $16 trillion. That’s more than a quarter of the world’s wealth!

The government bungling and mass bloodletting brought a hidden silver lining, though: Due to the white-knuckled nature of credit market cardiac arrest, it took mere weeks and months for stocks to fall to levels that it might have taken years to reach under less harrowing conditions. We have compressed the brutality of past grizzly-bear markets into a much shorter timeframe.

C-notes on the Sidewalk

I was telling a friend, too, how different this environment feels with so many hedgies (hedge fund managers) having been blown up or carried out.

As J. Carlo Cannell observes, at one point there were more hedge funds than Taco Bells in the United States. If a ten-dollar bill landed on the sidewalk, a dozen hedgies would simultaneously swoop down to try and snatch it up.

Now the sidewalks have twenties, fifties, and even hundred dollar bills scattered around with abandon. The pool of opportunistic survivors with cash to deploy has shrunk dramatically. (Good news for survivors.)

Let’s hear another optimistic vote, and then we’ll turn to some skeptics.

Since I’ve discovered that I’m a better trader than investor, I love the volatility here at the bottom. I’ve been gradually building large positions in good companies that have had the stuffing kicked out of them and making money on the swings at the same time. My advice is to buy strongly when the market is at its weakest and sell lightly as it climbs. This leaves me with plenty of capital when I see a stock selling at what I like to call an “are you on crack?” price. I’m up 7% in the past 2 weeks alone. It is beginning to look very much like all the bad news is already priced in however. I may regret not jumping in with both feet here, but since I seldom spend more than an hour a day playing the market I’m pretty happy with the returns thus far. The imminent drop of the USD will only increase my profits.

~ TD reader George

Sounds like a good plan George. I like the mental visual of the “are you on crack?” price. When I was in high school the operative term was smoking plastic, as in “Dude, are you smoking plastic or what?”

A lot of CEOs seemed to be smoking plastic as they dumped tens of millions or even hundreds of millions worth of shares in October. A few poor souls, like Aubrey McClendon of Chesapeake Energy (CHK:NYSE), may well have lost billions. But that, too, was a function of the market panic. Margin calls forced these executives to sell at valuations that probably made them cry. (And I mean literally cry.) More good news for survivors with cash to deploy.

George makes an interesting point, too, about discovering he is a better trader than investor. One thing that I have heard confirmed over and over again in markets, from a wide a variety of sources over the years, is that market success ultimately depends on having a style and a methodology that works for you personally. As traders and investors we always want to be working on our weaknesses, but we need to remember to play to our strengths, too. We address weaknesses to keep from being held back, but the strengths carry us home.

“Dumb First Class?”

Buffett or no Buffett, not everyone is excited about opportunity levels here…

I personally believe the market continues to trade in a “lunatic ” fashion . Buying stocks at this time may be Economics 101, but to me it’s “dumb first class.” The economy is tanking with consumers pulling back from their spending-without-money ways. Since the economy is 70% consumer driven and the housing market not even close to fixed and companies reporting poor earnings and laying off workers, to me it’s idiotic to be buying stocks thinking that everything will be great in 6 months.

~ TD reader Robert T.

Robert, I agree it would be “idiotic” to think that “everything will be great in 6 months.” But who is saying that exactly?

When you buy a stock, you’re basically buying a stream of future cash flows. If the stock pays a dividend, that means you get some of that cash flow back in the short term. If the stock doesn’t pay a dividend, it means the cash flows are being re-invested for growth in the longer term. It’s still all about cash flows either way.

The point is, stocks are priced based on long-term cash flows – that is to say, cash flows over a period of time much longer than six months. This is why the stock market can turn upward while the economy is still in the dumps. The stock market (when functioning properly) acts as a cash flow forecast extending years and years into the future.

Remember, too, that outlook varies widely from industry to industry. There are some industries you wouldn’t want to touch with a ten foot pole… other industries that have come down so far and fast there’s almost no compression left in the coiled spring… and still other industries and companies that could benefit handsomely from what’s ahead.

Expect the Unexpected

What’s more, don’t forget that the market is often driven by factors that investors don’t anticipate.

In the period before World War I, for example – 1890 to 1914 – there was a doubling of the world’s gold stock. The gold mines were going at full steam ahead back then, and there were enough huge new finds in the Americas to expand the supply of gold dramatically. This outpouring of gold had a massive inflationary impact on all kinds of prices, including share prices. In effect it was like Mother Nature imitating the Fed, flooding the system with new money. Starting with a street-level view of the economy, who could have predicted such a thing?

Point being, markets can move (and can stocks can rally) for reasons wholly off the radar screen of most investors. Some of this has to do with basic “plumbing” principles – money moving through markets like water and steam moving through pipes. Between the U.S. dollar, the paper currency outlook and a few other high level “macro” factors, there is more than enough potential for things to get weird.

Macro factors and money flows are too big a topic to wade into here, but just remember too that multi-month rallies in times when few expect them – like in the middle of dark bear markets – are far from unprecedented. It would be more accurate to say they are common place, given the right set of prevailing conditions.

If you’re a trader who can do a little shucking and jiving, this is great news. If you’re an investor with an eye for carefully selected bargains in the right industries – not the toxic ones – you can do alright too.

The Heavy Hand of Uncle Sam

The market will not be the ultimate money-maker, as it was in years past, because of government intrusion. It will ultimately lead to permanent over-regulation, which is never good for the free market. Also we have environmental realities, eg. diminishing fresh water supplies, global warming [etc.] that will prompt more and more conscientious citizens to demand government(s) get involved – meaning even more government demands on the evil-doer companies that supply our creature-comforts. Thanks for the articles…

~ TD reader Julia L.

Thanks for that perspective Julia. (I like your initials by the way.)

Interesting thoughts… Government intrusion is a funny thing. Going back through history, it’s useful to note how perspectives have changed.

Take Federal Deposit insurance for example. FDIC insurance is an unalloyed good, right? Would anyone disagree it’s comforting to know you can deposit funds at your local bank without worrying (too much) about getting that money back? And yet, when blanket deposit insurance was floated a century or so ago, the idea was denounced as an awful socialist sop. There was widespread fear that laxity on the part of depositors would punish good banks and reward bad ones. Funny how attitudes can change…

Also re “years past,” want to hear something really crazy? When JFK took office in 1963, the top tax rate was an incredible 91 percent! JFK shaped himself as a tax-cutting hero by lowering taxes his first two years in office – down to a mere 70 percent!

Talk about socialism… in the late 50’s and early 60’s, a supposed golden time for America, tax policy really was socialist, even as the McCarthy era kicked into gear. And yet we came back from it, and tax levels fell to the “merely confiscatory” levels we’re now accustomed to.

My takeaway is that if top tax rates in the United States can range from 91 percent to zero percent as they have in the last century, over the long run they can go anywhere. (And so can I, courtesy of my trusty passport.)

Surprising huh? History is full of surprises like that… in fact the more I study history, the less convinced I become that anything is permanent, except for the laws of physics and some basic laws of human nature. I agree that regulation trends can expand in frightening directions and stay entrenched for a very long time. But when opportunity is pressed downward in one area, it often pops up in another area – and it’s hard to say what kind of short- to intermediate-term effects all this stuff has.

As far as the problems you listed (fresh water etc.), we’ll have to address those problems. But that’s good news, not bad news, for a capitalist-driven technology sector that focuses on solving pressing problems to earn profits. Not to mention that the heavy hand of Uncle Sam can sometimes lift up entire sectors and industries, sending rivers of cash their way for years. Just look at the past boom years of military defense spending for example. Morality of government aside, there is opportunity to be found in sussing out the winners and losers.

Always enjoy and appreciate your thoughts and commentary. I believe that you gave us some good rule of thumb principles to follow and look for in [Friday’s Taipan Daily piece]. What would be interesting and valuable is to identify the events/data that were the triggers that started the next slide down during the early thirties follow through on the downside from the ‘29 crash. I’ve never read anything specific on what were the events or data that investors realized that the economy and market weren’t out of the woods yet and it was going to be worse. What should we look for to trigger the next leg down or the start of a meaningful sustaining recovery? Any thoughts or insight on this would be much appreciated.

~ TD reader Don S.

You’re right Don – that would be an interesting and valuable area to explore. I will roll up my sleeves on just the topics you propose!

Tomorrow, in fact, I’ll write to you about some surprising market parallels from years past… not in regard to how the roaring twenties ended, but how they began.

Source: Opportunity Extraordinaire or “Dumb First Class?” Responses from the Mailbag