Week of 09/18/2008

In This Issue:

Stocks Plunged, But The Expected Crash Didn't Occur
Many Investors Were Pleased To See Some Bailouts End
A Recession Is More Likely, But It Isn't Assured
Many Companies Are Having A Good Year
It's Time For Bottom Fishers To Unfold Their Nets
The Dollar Rebound May Be Over
The Bottom Line This Week

Looking back at the stock market of last week is like looking at the distant past. Compared to the big changes that have occurred since then, the five day period belonged to a different era. For the record, the Dow and the Nasdaq gained 1.8% and 0.2% respectively.

As everybody knows by now, this week opened with a 504 point plunge after the government failed to find a buyer for Lehman Brothers. The news was a shock because investors expected a repeat of the Bear Stearns shotgun marriage to J.P. Morgan that prevented a stock market quake in March. When the rescue attempt for Lehman fell apart, many investors headed for the door.

There was a brief rebound on Tuesday but stocks plunged another 449 points the next day. High volatility seems likely to continue for quite some time.

Stocks Plunged, But The Expected Crash Didn't Occur

Fortunately, there was a "walk, don't run" mood on the street that stopped short of panic. So far, at least, we haven't had the stock market crash that some advisors have been predicting.

One reason the market didn't melt down is the financial service crisis was well underway and much of the trouble was already priced into stocks. Although investors expected Lehman would be saved, the failure didn't carry the shock that accompanied the collapse of the dot-com industry eight years ago.

Investors Were Pleased To See Some Bailouts End

In fact many investors were relieved that the government decided not to save every financial service company that put itself on the rocks. There is a growing feeling that troubled firms should not have their colossal losses added to America's already overburdened debt. That's especially true since the moguls that ruined their companies are bailing out with millions of dollars in their pockets, at the same time their shareholders are being ruined.

On the other hand, investors welcomed the Fed's decision to make an $85 billion bridge loan to the American International Group, AIG, a company that is of far more importance to the U.S. economy than Lehman Brothers. Despite all the well-deserved jokes about government bungling and fiscal incompetence, it has a fairly good track record with loans.

One of the most successful federal loans went to Chrysler in 1980. The $1.5 billion transfusion allowed the company to retool and recover. Critics were amazed when Chrysler went on to repay its note ahead of schedule. In any event, AIG is profitable and it appears to have enough assets to cover its loan.

A Recession Is More Likely, But It Isn't Assured

Despite the turmoil we are seeing in the markets today, it is by no means certain that the U.S. will be plunged into a deep recession. None of the shocks we've seen so far this year have been able to send growth into negative territory, and some of them have been whoppers.

The record oil price surge didn't bring the economy down. The housing plunge didn't do it. The Iraq war didn't do it. The auto industry meltdown didn't do it - and so on. More importantly, all those problems hit the U.S. at once, and they still didn't trigger a meltdown.

Of course, any economic system has its limits - and ours may have been reached this week. Growth will undoubtedly drop sharply as capital becomes more expensive and harder to find. However, most economists think the economy will manage to expand from 0.5% - 1.0% during the fourth quarter.

Many Companies Are Having A Good Year

So far, countless companies are doing very well. Exporters are having an excellent year. Agriculture is also booming. Many industrial firms are making record profits. Mississippi River traffic is heavy. Railroads are operating 24/7. Energy companies are no longer rolling in money, but profits are continuing to rise.

Lastly -drum roll please- many financial service firms are also making money, a fact that is being obscured by the failures of others in the industry. Wells Fargo, for example, has largely avoided the current turmoil and is up over 50% in price since July. Other firms that didn't join the Russian roulette mortgage market are also in good shape.

It's Time For Bottom Fishers To Unfold Their Nets

Normally we are not contrary investors. The practice of buying what nobody else wants doesn't strike us as being very bright. In normal times there is far more money to be made investing in well-established trends that are gaining momentum.

However, when an entire industry falls out of favor and prices plummet, it can be time to dust off the contrary investment strategy. That is especially true if the industry is essential to the functioning of a modern society and it will definitely recover. In that case, buying what scares most investors can pay off handsomely.

For example, one of our elderly clients purchased essential industries in the 1930's after they had been ravaged by the stock market crash and the Depression. When the outlook for stocks appeared to be hopeless, he sold everything that still had some value and used the proceeds to buy leading railroad, telephone, banking, and industrial companies.

Our client reasoned that if America survived the crisis, it would need the companies he was buying. If the country didn't survive, nothing he owned would be worth anything anyway. So he went ahead with his plan that ultimately made him a millionaire, which was a lot of money in those days.

We have a similar situation today in the financial service industry. There is no way that our country (or the world for that matter) can function without a strong financial service industry. Capital, after all, is what makes capitalism work. Somebody will always supply it. It won't be Lehman Brothers and Bear Stearns anymore, but other firms will take their places.

Accordingly, we think an excellent opportunity exists for long-term investors who buy financial service companies while they are on Wall Street's black list. We think a strong rebound from today's levels is as close to being a slam dunk as the stock market ever offers.

Since it is impossible to know at this juncture who the biggest winners will be, we think the only way to proceed is to take a diversified position in the industry. The best way to do that is with a managed mutual fund that will focus on the leading companies as the recovery progresses.

We think the Fidelity Select Financial Services Fund (FIDSX) is the best in its class. http://finance.yahoo.com/q/bc?s=FIDSX The no-load fund buys banks, savings and loan associations, selected brokerage companies, consumer and industrial finance companies, insurance companies, and others.

The fund holds substantial positions in J.P. Morgan Chase, Bank of America, Citigroup and the other subprime mortgage bunglers that stumbled badly, but are surviving. Of course, those are the companies we want in the fund because they are the most likely to make the biggest recoveries.

The Fidelity fund is down 43.4% from its October 2007 high, and it is off 25.5% this year. We think the steep discount makes the fund very attractive for long-term accounts. Plan on a three year hold, which how long it took the last significant credit crunch to work out. However, FIDSX is likely to rebound much faster this time.

The Dollar Rebound May Be Over

We think the severe financial problems of the past two weeks are likely to stop the dollar's rebound in its tracks. That's especially true since Washington Mutual is also in serious trouble, and so are hundreds of smaller banks and S&L's.

At the same time, the weak U.S. economy, the housing plunge, Washington's colossal debts (that are now much higher), America's ruinous balance of trade deficit, and other problems will bring the dollar back down - probably by quite a lot.

The currency that is most likely to benefit from a weakening dollar is the Swiss franc. EverBank World Markets everbank.com has deposit accounts and CD's in the currency.

The Bottom Line This Week

Lehman Brothers and Merrill Lynch joined Fannie, Freddie, IndyMac, and Bear Stearns on the financial service refuse heap. So far, at least, investors have not panicked and a crash has been avoided. In fact, many brave souls are sifting through the ashes looking for bargains. We think you should join them. A good way to do so is with the Fidelity Select Financial Services Fund that is doing some selective bottom fishing right now.

Until Next Week

The AIA "Advocate For Absolute Returns", a weekly publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next Thursday...


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Posted 09-18-2008 12:28 PM by Research & Editorial Staff
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