There is plenty of advice flying around. The challenge lies in determining the outlook for the broad markets. Visibility is very cloudy and there are plenty of reasons. Slow to recessionary economic outlook, no bottom in housing, financials in disarray, Fed deciding on inflation fighting or growth promotion, earnings expectations are low, etc. The challenge is the list is so long that on any given day we can find plenty of reasons to sell. The last several trading days have shown the swings that occur from a lack of visibility. This leads me to the question of what should we do now?

Believe me if I had the answer to that question I would be on the next flight to the NYSE and trading my heart out! However, I do have a some suggestions. First, protect your money. With the recent volatility and lack of volume in the markets the best offense is a good defense. Keeping money out of harm’s way is the first priority. One of my primary rules of investing is you can make up for lost opportunities, but it’s a lot harder to make up for losses. So introduce yourself to the sector of cash.

Now let’s address some of the sectors in the news. Energy seems to one of those hot topics. If we look at IYE, iShare Oil and Gas ETF, there was a bounce last week to the upside as crude jumped nearly $6 per barrel. Since we have given most of the move back and we are testing the break above $42.50. It is worth watching to see if we can hold the break higher off support. The key is obviously the direction of crude. So far it seems content to hold support near the $110 mark. Be patient here don’t force trades or positions in the sector just because the consensus is oil has to go higher. That was the same consensus that said technology couldn’t drop 70% from the highs in 2000. While you’re watching this sector pay attention as well to the surrounding pieces. (NYSE: UNG) – Natural Gas, (NYSE: USO) – Crude Oil, (NYSE: UHN) – Heating Oil, and (NYSE: TAN) – Solar Energy.  

Small Cap is an index that showed leadership off the lows in July.  (NYSE: IJR), iShare S&P 600 Small Cap ETF, rose more than 12% off the July low. Over the last week it has given back 4% and is trying to maintain some level of support. Why the pullback? Breaking the index down, 12% is financials, 21% is industrials, and 8% is energy. That’s 40% of the weighting for the index and it has struggled during the last week. Thus, the drop in price. The key catalyst for the index is growth. If we don’t show some improved signs of growth looking forward  I would expect a break of support and a test of the July lows. However, if we find some signs of growth the index could break above the May high and continue the short term uptrend. For an update on the Small Cap Index visit our Sector Spotlight.

Remember the key to successful investing is having a disciplined strategy for building and managing your portfolio. Stay focused and be patient as the visibility clears.

If there is one thing Wall Street loves, its investment themes. I try to discern whether a theme has merit by looking at monetary policy, overall monetary conditions, and the technical action in the market. When the first signs of the brewing credit crisis emerged in the spring of 2007, the consensus was that it would be manageable and limited to just sub-prime loans. Even the Federal Reserve expected the economy to improve in the second half of 2007, as the drag from housing waned. As a result, when the first tsunami appeared last August, few saw it coming. In my June 24, 2007 letter, I suggested selling iin July when the S&P was above 1525, because the technical condition of the market had weakened. After the market bottomed in August and the Fed cut rates, most thought the housing problem had been resolved. Last October and November, investors were strongly advised to buy stocks with overseas exposure, or invest in international mutual funds, since global growth was going to be so much stronger than in the U.S. The favorite picks were to buy the BRICS – Brazil, Russia, India, China – and emerging markets. I noted in my October 25, 2007 letter and November letter that monetary conditions were getting worse in the U.S and European Union, which would result in a slowdown in the U.S. and Europe that would hurt China, India, and other emerging countries. On October 25, the Brazilian ETF was $79.74, Russia $48.14, India $77.80, China $69.20, and the Emerging Markets ETF $52.84. The values as of August 22 – Brazil $73.66, Russia $39.47, India $57.18, China $41.38, Emerging Markets $40.17. If an investor had placed 20% in each of these ETFs to benefit from the global growth story, their overall portfolio would be down -23.2%.

The March low was heralded as the bottom because the market was technically oversold, the Fed had slashed rates further, the $160 billion fiscal stimulus plan would surely lift the economy in the second half of 2008, earnings were forecast to be up 73% year over year, and the demise of Bear Stearns marked the end of the credit crisis, since every previous crisis had ended with the failure of a large financial institution. I thought the March low marked a temporary low, since the current credit crisis appeared to be worsening, and the fiscal stimulus plan was not going to ignite a self sustaining economic expansion.

Since the July 15 low in the stock market, Wall Street has a new investment theme, which is to avoid international stocks, since the global economy is slowing. Their belief is that since the U.S. was the first one into this slowdown, we’ll be the first one out, especially since the Fed has cut rates so much and the other central banks haven’t even started cutting. The best thinkers on Wall Street believe the best way to cash in on this new theme is to buy small cap stocks, since they aren’t dependent on international sales. There are several problems with this advice. Small cap stocks may not be dependent on international sales for growth, but they are dependent on the economic environment in the U.S., which is likely to be hostile. Even strong small companies need bank financing to finance their growth. As noted, bank lending standards are at record high levels for small companies, so getting financing is going to remain difficult for some time. Last week, the National Federation of Independent Business reported that the percent of small companies that plan to increase capital expenditures was the lowest since 1975. Small cap stocks have maybe 5% upside potential, but they could fall more than 20% from current levels.

The stock market is in a cyclical bear market that did not end on July 15. I recommended cutting exposure in July 2007 and October 2007, when the S&P was 1525-1550, and in May when the S&P was 1420-1440. Last month, I suggested a rally to 1310-1325 would present another opportunity to sell. So far the high is 1313. Sooner or later, the Treasury is going to nationalize Fannie Mae and Freddie Mac. Some will proclaim that this signals the end to the housing crisis. Stabilizing the mortgage market, and ideally, bringing mortgage rates down will help. In the short run, this news could help push the S&P up to 1325-1350. If it does, it will provide another selling opportunity. Nationalizing the GSE’s will not reflate the credit bubble, or prevent housing prices from falling further.

Now that Wall Street has abandoned the global growth story theme it might be time to take a closer look. A small trading position in the China ETF (NYSE: FXI) below $38.00 could catch a bounce in the Chinese market, and would be 46.5% from its high. The Emerging Market ETF (NYSE: EEM) is also worth a small trading position under $38.00, or 28.1% from its high. The Oil stocks ETF (NYSE: XLE) is attractive under $69.00, 24.5% below its May high of $91.42.

 

www.welshmoneymangement.com

Wall Street's latest mantra-emblematic of their new spirit of bailouts, especially when it comes to financial firms--is that Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) are too big to fail. I've written before about the potential problems associated with the G.S.E.s' and now it is clear to everyone that these companies are in serious trouble. I thought it would be prudent at this time to write a follow up commentary on why I believe these companies have become too big to let survive.

We have all heard the expression "The road to hell is paved with good intentions."  At no time has that statement been more apropos than with the creation of Fannie Mae and Freddie Mac. Fannie Mae was created in 1938 as part of Franklin Delano Roosevelt's New Deal, while Freddie Mac got its start in 1968. Like most government sponsored programs, the idea sounded ok to most people. The concept was to help expand home ownership by facilitating bank securitization, i.e.  Offering government backed insurance to bond holders in the case of a principal or interest default. The business of the Fannie Mae later expanded to raising funds with an implicit government backing, and hence lowers interest rate, to purchase mortgages outright and hold them as an investment.

So far so good, right? I mean, shouldn't the public sector strive to put as many people in the role of home ownership as they can? Wrong! That's where I find myself wondering how the Republicans have gone so far astray from embracing capitalism. I don't expect Democrats to rail against a program that they themselves enacted but why we have Hank Paulson, George Bush and Ben Bernanke doing back flips to keep these institutions alive is beyond me.  Those republicans, that are supposed to espouse free market concepts, should be asking why the government was meddling in the mortgage business to begin with.

This administration doesn't seem daunted at the fact that FNM and FRE have reported a loss of nearly $15 billion in the last 12 months alone. Instead they find themselves in lock step with Congressman (D-MA) Barney Frank who wishes to expand their powers in order to rescue the real estate market. In my view we have already crossed the Rubicon in regard to the G.S.E.'s.  These monsters now are responsible for 80% of all new mortgages created in 2008 and own or guarantee a total of 42% of the $12 trillion dollar mortgages outstanding. The time to shut down the expansion of the G.S.E.s' is now. We may already have reached the point where the entire real estate market and consequently the economy are beholden to the government's continued involvement in the mortgage market.  Their role now should be to allow FNM & FRE to exist only to the point that they can pay off existing debt holders while making sure they cease writing new business.

When government decides to meddle with free markets, imbalances occur which cause capital to be deployed in ways that are economically unviable and unsustainable. A continuation of such behavior-especially to the degree that FNM & FRE have reached--can lead to massive increases in inflation and an economic collapse. We cannot succeed in reconciling an economic imbalance by fostering its continuation.  We Americans have come to believe that suffering the consequences of our loose lending and monetary policies can be avoided by escalating those same practices. The truth is we have allowed the G.S.E.s' to become too big to survive and our government must seek to eliminate them rather than continue to believe they can dictate what percentage of the population should own a home.

www.deltaga.com

Economists who still proclaim that the U.S. economy is not or will not experience a recession should go into hiding, unless they desire to make an even bigger fool of themselves. Let’s look at how the Commerce Department determined the economy grew 1.9% in the second quarter: Overall growth was 3.0%, and after subtracting the impact of inflation, real GDP grew 1.9%. But was inflation in the real world just 1.1% in the second quarter? At the end of June, Consumer Price Inflation was 5.0% higher than in June 2007. In other words, any reasonable inflation estimate would have pegged real GDP as negative. A weak economy means job losses are going to continue, and the unemployment rate will climb to 6%, and probably higher in 2009. More job losses means more defaults on mortgage and home equity loans, auto loans, credit cards, and corporate loans. There is never one wave in a tsunami.

In the second quarter, exports added 2.4% to GDP. I expected global growth to show more signs oslowing by the third quarter, and the signs are everywhere. Last week, Japan, the second largeseconomy in the world, reported its worst quarter in seven years, as GDP contracted at an annual rate o-2.4%. On August 14, the European Union said its gross domestic product contracted -.8%. In GreaBritain, retail sales have fallen -.9% over the last year, manufacturing output is down -1.3%, and homprices are 9% lower. I noted in my March letter that the U.S., Japan, E.U., and Britain represented 71% of world GDP, which made it nearly impossible for China and India to decouple, since they are export dependent and their combined GDP is just 7.5% of world GDP.

Therefore, it shouldn’t be a surprise that China and India are now slowing. The U.S. economy is in recession, and the contraction in credit creation and future lending is going to keep the economy weak well into 2009.

 

www.welshmoneymangement.com

Earlier today on The Network they had a chap on (whom I seem to recall his being wrong a lot during this bear market) who suggested getting out of or reducing foreign equity exposure due in part to the recent rally in the dollar. Presumably he thinks this trend will continue. The call may or may not be right but it raises several dilemmas for investors. The issues include commission dollars spent, taxes (depending on the account type), where to invest the proceeds and the risk that the dollar rally is a short term snapback in a downtrend. Greenfaucet founder and President of Delta Global Advisors, Chip Hanlon, rang the opening bell today (8-26) at the New York Stock Exchange to christen the new Claymore/Delta Global Shipping ETF SEA.   Also present on the podium were greenfaucet contributors Michael Pento and Bruce Zaro. Congratulations guys! Click the image below to view the clip: Now what? For the last I don't know how many months a consensus seems to have built that once the Olympics ended the markets in China would drop. The logic being that after all the build up, the event is now over, the anticipation has ended and there would be an obvious let down. I heard this repeated many times. One small problem with the argument is that the Shanghai market had already dropped by about 60% by the time the Olympics started. Canada is a nice country - they don't make too much of a fuss and we tend to overlook them from time to time. But the iShares MSCI Canada has had a nice couple of weeks, up 2.2% in that timeframe. Canada is known for vast natural resources, too, and a return to commodities this week has helped push the fund up. Commodity producers and top holdings in the fund, such as Barrick Gold (3.2%) and Suncor Energy (4.3%), were feeling uplifted as a result. There have been several commentaries in the last few months about the energy carry trade, most recently today in the Financial Times.

At first glance the Petrochemical complex looks like a sore thumb in the world of investments. After all, any industry with "petro" in its name must be a margin disaster with oil above $100, right? This conventional wisdom, while true in a vacuum, has created investment opportunities for those willing to exploit old-world market preconceptions. In addition to raising prices, many chemical companies are leaning on technology and innovation, manifested in the form of biomass, to combat margin pressure.

For example, the increased usage of biomass to create ethanol has been well documented so one only needs to go so far to find it. On the other hand, little has been made of the opportunity for petrochemical companies to use the same waste wood and crop trimmings to produce everything from plastic resins to food sweeteners. That is until now. 

Singapore-based Pure Power, a closely-held renewable energy company producing cellulosic ethanol for distribution in Asia, is leading the charge in this field. The company is using the willow plantations it owns in New Zealand to not only grow its ethanol business, but to revolutionize the petrochemical business. In a recent interview with Reuters, CEO David Milroy said the company's phenol substitute (a popular petrochemical used to produce plastics) is cost-effective with oil as low as $70. With oil hovering above $110 after a major sell-off, the company's natural Lignin product offers a real alternative to petro-based Phenol.  Add to this the potential for the high quality sulphur-free lignin to be made into diverse industrial products, such as carbon fibers, and you have another example of a company adapting to higher energy prices.

Now higher energy prices will continue to weigh on company earnings in the near term. That much is obvious. What is much less obvious is that alternative energy companies like Pure Power are getting closer than most people realize to breaking industrial dependence on traditional energy sources.  Whether the company's Xylitol sweetener is used to help patients with diabetes or dental care professionals is beside the point. The point is that it is made from Xylose produced from biomass and Japanese firms have tested the compounds; garnering the attention of major Petrochemical companies.  

Even if Pure Power is off limits for investors due to its private nature, China Biodiesel International (CBI.LON) is a company that you can own as long as you have access to the London Exchange.  CBI is engaged in the production of Biodiesel and is making significant strides in the push to create naturally based "Petro" chemicals.  The company, by way of its two production facilities, has capacity of up to 100,000 tons after opening the first of its Xiamen facilities in June of 2008.

Where we go from here is anybody's guess, but good luck convincing Pure Power and China Biodiesel that the road is paved with fossil-fuel based plastics.