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By Andrew Mickey, Q1 Publishing

In just six weeks the S&P 500 has climbed about 30% and the broader, small-cap focused Russell 2000 has soared 40%. It’s the steepest rally in more than 70 years. The bulls are off and running.

Despite it all, very few people believe this rally can last. And it’s because there are still so very few people getting in on this rally, odds are it won’t end very soon.

By this point, most commentators have declared this a bear market rally. The New York Times, Forbes, Bloomberg, and most every major media outlet have gotten on board.

Some of the world’s leading investors agree. In early March we looked at Steven Leuthold’s bold prediction in a:

“These comparisons people make with the Great Depression are totally out of touch with reality, and pretty stupid…We’ve been in much worse, much more panicked and more scary situations in the U.S.”

A pretty bold statement considering the Dow fell below 7,000 and was headed lower. But it’s not just Leuthold. Hedge fund manager, philanthropist, philosopher, billionaire George Soros has been quite vocal about his suspicions in the sustainability of this rally. Soros said:

“It’s a bear-market rally because we have not yet turned the economy around. This isn’t a financial crisis like all the other financial crises that we have experienced in our lifetime.”

If you out more than a few months, all signs point to Soros being spot on. There are just too many problems to work through and an unwillingness to accept the inevitable solutions.

Despite it all though, it’s looking much more likely we’ll see more upside in the short-term than the start of a downturn.

Why? Because we haven’t run through all the phases of a bear market rally.

Three Stages of a Bear Market Rally

Bear market rallies are unique events. They come when their least expected. That can last a few days, weeks, or months. There’s no telling exactly when they will end. But if you pay attention to the life-cycle of past market movements, you can get a good idea of when this one is going to end. That’s why I closely watch the Three Stages of a Bear Market Rally:

Stage 1: “It’s all over”

The first stage of a bear market rally starts when the markets react to bad news as if it was good news. Whether it’s because bad news isn’t as good as bad as expected or it’s one of those “Green Shoots” which provide a glimmer of light perceived to be the end of the tunnel.

This happens when everyone thinks it will never turn around. It’s when many investors throw in the towel and proclaim “it’s all over.” We hit that point in early March. Since then the markets have been so beat up in such a short period of time that any bit of good news can get things rolling higher again.

Stage 2: Popular Declaration of Bear Market Rally

This is the stage where most commentators admit we’re in a bear market rally. The upswing has just been too strong and last so much longer than initially anticipated by most, it’s obvious to everyone.

There are no fundamental drivers and the fundamentals still matter very little in this stage. Dividend yields, P/E’s, growth, and forward estimates aren’t focused on very much. The prevailing “thesis” (i.e. stimulus spending will be great news for infrastructures stocks) is much more important than the underlying fundamental situation – a.k.a. reality.

Most everyone goes on to warn this is a bear market rally and advise against buying too much of anything now. There’s still no It’s also a time when we here things like “this is a trader’s market.” Which any market should be a traders market, given the wide number of strategies which work in bull, bear, and flat markets.

Stage 3 – “All clear! Get in before it’s too late.”

This is the final stage. It’s when the bear market has been forgotten by most. Stocks move up, but the big upswings have disappeared.

This is when the very real risk of “panic buying” sets in. This is a result of the big money fearing 1) it has missed all the chances to buy low, 2) their performance will suffer, and 3) customers will take their money elsewhere.

To make up for lost time, they buy very aggressively. Many of them think short-term and want to deliver the numbers to keep pace with the competition in the money management industry. This is an extremely profitable stage for those who went against the grain and bought during the earlier stages of the rally. You’ll also see a general decline in the VIX. It currently sits at below 34 – well below its recent range of 50 to 90.

Yet when the big money runs out of cash to buy shares, watch out, the end of a bear market rally is near.

What to do Now

It looks like we’re in Stage 2. There are just too many non-believers out there right now, too much money on the sidelines yet to come back into the market, and there has been no build up of false confidence which precedes most market declines.

Just think of what happened last fall. After a sharp downturn, the markets rallied sharply after the presidential election. The so-called Obama rally was a boon for stocks which were looked at as leading benefactors of the new administration’s agenda.

Don’t get me wrong, there are still a lot of problems. Commercial real estate debt, deflation (and the debasing of currencies to prevent it), rising unemployment, and increasing and changing regulation to consistently change the rules and keep entrepreneurs and investors from tackling new opportunities will all be a drag on the economy at every stage of a recovery.

But, as the markets have shown, a bear market rally is not something to bet against. As a result, I recommend searching out three types of opportunities.

One being the safe ways to play a market rally which go up with the markets, but don’t go down nearly as fast (e.g. a covered call writing ETF). Another one being the sectors which have fallen out of favor during this downturn. The final being speculative stocks which have been so beaten down there’s only one way to go up. The old Wall Street saying is a rising tide lifts all boats is true. But when the tide is rising this fast, the most beaten up boats which were steadily sinking (think banks, homebuilders, commercial real estate, etc.) have been rising the fastest.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Andrew Mickey, Q1 Publishing

It’s not too often a product comes along with so much potential. A product with so much pent up demand. A product that is significantly cheaper than alternatives. A product that sells so extremely well right out of the gate the potential to turn a very small speculation into a big score is obvious.

That’s what we’re facing here. The market potential is hundreds of billions. Every retailer who carries has trouble keeping it in stock. It’s the same top of popularity which turned Crocs (NASDAQ:CROX) into a shooting star, made Healys (NASDAQ:HLYS), and pushed sales of Snuggies past the four million mark.

Sounds like it has some potential right?

Well, it does have a lot of potential. That is of course, if the World Health Organization (WHO), the FDA, Big Pharma, Big Tobacco, and a U.S. Senator don’t get it completely outlawed.

Disrupting Smokers

I’m talking about the latest nicotine replacement therapy (NRT), electronic cigarettes, or e-cigarettes.

An e-cigarette is a battery powered device that looks like a cigarette. It has a small vaporizer which turns a nicotine cartridge into a breathable vapor. It’s an alternative delivery form of nicotine which, according to many of the e-cigarette retailers, provides the nicotine of a cigarette without a lot of the other contaminants in a regular cigarette (e-cigarette description and pictures).

There’s just so much potential growth. A recent smoking cessation report from consultancy firm Visiongain says, “E-Cigarettes will revolutionize the face of tobacco smoking and could pose a threat to the smoking cessation market.”

As you might expect, a product like this will be in very high demand.

Another Boom Emerges

Jason Cropper, manager of the Electronic Cigarette Company in the U.K., in an interview with Reuters stated, “We can’t keep up with demand. The demand is phenomenal. I’ve got a website run by a lady in Florida and she’s totally out of stock.”

If you go a bit further, it’s easy to see how well these are selling. At the time of this writing, two out of three e-cigarettes at zerotar.net were sold out. Specialty Retailer magazine reports mall kiosks selling e-cigarettes generate about $50,000 in sales per month. There’s not much data out there, but it’s easy to see sales of e-cigarettes are soaring.

From a cost perspective, e-cigarettes are tough to beat. The initial start-up cost of around $100 for charger, battery, vaporizer, etc. The ongoing costs (buying more nicotine cartridges) are around 50 cents to $1 a day (to get the same amount of nicotine as one pack of cigarettes per day).

When you compare that to the cost of $150 to $250 per month (depending on which state you’re in) though, it’s easy to see e-cigarettes are a much cheaper alternative. As an alternative to gum, patches, sprays, lozenges, and inhalers, e-cigarettes are much cheaper as well. And from a health perspective…I think the answer is pretty clear.

From an investment perspective, this is the kind of “disruptive technology” which has changed the face of industry and created fortunes for early investors. Just think of a product, if successful, reaches just 10% of the 500 million+ smokers around the world. That’s the kind of potential we’re looking at here.

Best of all there is one publicly traded company leading the way in the e-cigarette revolution. More on that in moment. First, there’s a big back story here with a lot of pitfalls. It’s a complicated situation with politics set to play a big role in the near future.

Another Competitor Stifled?

What may surprise you is e-cigarettes may not stay on the market much longer even though they’re still relatively new.

It’s no secret how much Big Pharma and Big Tobacco companies spend on lobbying. We watched the impact yet again this week as the federal government upped the tobacco tax and the House of Representatives passed the Family Smoking Prevention and Tobacco Control Act.

Of course, the bill had the support of Altria (NYSE:MO), the operator of Philip Morris and owner of the world’s best-selling cigarette brand, Marlboro. The act limited advertising (read: protected market share changes for current competitors) and would give the FDA all sorts of new regulatory powers.

And with a name like “Family Smoking Prevention and Tobacco Control Act,” what politician would want to vote against it?

Big Tobacco would naturally be against the e-cigarette’s success. It’s a direct competitor. In this case, it’s more than just Big Tobacco. Big Pharma has a big stake in this battle as well.

The $3 billion nicotine replacement industry has become a cash cow for pharmaceutical companies. All of those patches and gum sales are easy profits and they’re mostly backed by Big Pharma. Nicoderm is owned by ALZA, wholly owned subsidiary of Johnson & Johnson (NYSE:JNJ). Nicorette and the prescription drugs Wellbutrin and Zyban are marketed by GlaxoSmithKline (NYSE:GSK). And one of the latest entrants, Chantix, is marketed by Pfizer (NYSE:PFE). Of course there are many more but you get the point.

They’ve all seen the early success of e-cigarettes. They see the potential impact to their bottom lines. And they are making the moves necessary to stifle the competition.

Unsafe Until Proven Safe

Recently, New Jersey Senator Lauterman tried to put an end to e-cigarette sales in the U.S. According to his press office:

Sen. Frank R. Lautenberg (D-NJ) today urged the Food and Drug Administration (FDA) to take electronic cigarettes, or “e-cigarettes,” off the market until they are proven safe by the federal agency. 

Electronic cigarettes, alternatives to cigarettes and other tobacco products, are battery-powered devices that use a vapor to deliver nicotine to smokers.  When the smoker inhales through the device, air flow is detected by a sensor, which activates a heating element that vaporizes a nicotine solution stored in the mouthpiece. 

Manufacturers and retailers of these products claim that electronic cigarettes are safe, and even that these products can help smokers quit traditional cigarettes.  However, no clinical studies have proven these products are effective in helping smokers quit smoking, nor have any studies considered the safety of these products’ long-term health effects.  While the FDA has indicated it will evaluate electronic cigarettes on a case-by-case basis, it has not taken any enforcement action against these products, which are currently being sold in mall kiosks across the country and on the Internet.

Sen. Lautenberg is one of the Senate’s leaders in protecting Americans from the dangers of smoking.  Sen. Lautenberg wrote the law banning smoking on airplanes, which helped trigger a broader smoke-free revolution.  Sen. Lautenberg is also the author of a law banning smoking in buildings that house federally-funded facilities that serve children. 

This would subject them to FDA approval. The costs of which would stifle the small upstart companies who make e—cigarettes and delay their access to the open market.

Lauterman, who is an active anti-tobacco advocate and the recipient of $128,250 in campaign contributions from Pharmaceuticals/Health Products companies, is not alone here though. According to WTBW out of South Carolina, the “American Cancer Society Cancer Action Network, the American Heart Association, the American Lung Association and the Campaign for Tobacco-Free Kids applaud Senator Frank Lautenberg of New Jersey’s call for the Food and Drug Administration to exert its authority and immediately remove e-cigarettes from the market. “

The Tide is Turning

Despite the past effectiveness of embedding legislation which benefits the current leaders of industry in otherwise popular legislation, this one could face some hurdles.

For instance, David Sweanor, who has worked with many health regulators including the WHO, said in a recent interview, “If there is anyone who believes cigarettes are no more hazardous than e-cigarettes I'd recommend a remedial course in basic sciences.”

And then there’s Dr. Joel Nitzkin. He is the Chair of the Tobacco Control Task Force for the American Association of Public Health Physicians, recently sent a letter to Senator Lautenberg. In it Nitzkin states, “As best we can tell, on the basis of currently available research data, these products [including but not limited to electronic cigarettes] promise a risk of illness and death well under 1% of the risk posed by cigarettes.”

So there is some support for the e-cigarettes to be allowed to be sold. For the time being, this is still a risky place to investing in due primarily to the potential government regulation.

The only thing that somewhat resembles a pure-play on e-cigarettes I’ve been able to find is Ruyan Group (HK:0329). This is the company which has been making e-cigarettes in China and owns most of the patents for e-cigarettes. It also licenses them to international manufacturers. It recently inked a deal with a media company in China to help get the word out to some of China’s 350 million smokers.

On the bad side, it’s a highly illiquid penny stock traded in Hong Kong (it last traded for HKD 0.187). It hasn’t been immune from the economic downturn either. It expects to post a loss when its next report is filed with regulators.

Also, there are dozens of smaller private competitors which have popped up all around the world (and will likely continue to do so). And it has other businesses so it’s not a 100% pure play on the growth of e-cigarettes. So, at this point in time even without the political risks involved, it’s a heck of a risky position to take.

In the end, this is the perfect situation of how a new technology could revolutionize an entire industry.

The established firms are going to pull what strings they can to prevent competition, but they’ll only be able to hold out so long. People want to quit smoking and in countries where e-cigarettes have been outlawed (e.g. Canada) that hasn’t stopped folks from buying them. Change will likely come regardless of the regulation. The regulators just determine who the winners will be and determine when change will be “approved”.

The opportunity in e-cigarettes is astounding (although, I’m holding off a bit to see how the politics plays out a bit further) opportunity to invest in a new cost-saving technology which is sure to be in very high demand.

It’s the perfect example of how change brings great opportunity. At the Prosperity Dispatch we’ve been focusing on emerging technologies like this for a while. Everything from stem cells to human genome applications to viable alternative energy technologies and everything else which have years and years of growth ahead of them as they change the entire landscape of their industries. Now we can add e-cigarettes to the list of “disruptive technologies” to keep an eye on.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Andrew Mickey, Q1 Publishing

Congress moved at record pace today. After a 40 minute debate, the House of Representatives passed a bill to tax 90% of the $165 million in bonuses paid to AIG executives over the weekend. None of them are even trying to hide the intention it was aimed squarely at AIG employees.

The details of the bill include a stipulation which include any company that has received more than $5 billion in bailout money.

Of course, the next question will be what about who AIG had to pay more than $5 billion? Since AIG used the bailout money to pay obligations to Goldman Sachs and dozens of other banks, will their executives be subject to the tax? After all, they indirectly received a good helping of bailout money.

It doesn’t stop there. House Speaker Nancy Pelosi stated, “We want our money back now for the taxpayers. It isn't that complicated.”

Which begs the question, is it Congress’s money or the taxpayers’ money? It certainly sounds like the former from that statement. But I’m not trying to ignite some political debate, I want to look at the impact of this emergency tax bill. In this case, the impact will be popular with constituents but another net cost to the economy.

Looking For a Fall Guy

As the politicians play the blame game, they’re missing the bigger picture.

I think Senator Dodd passed it to the Obama Administration who blamed the Bush Administration which the Republicans have turned into Secretary Geithner’s mistake because he was a key player in the bailouts as head of the NY Fed.

So, is Geithner the fall guy here?

It might be shaping up that way. At Intrade, a web site that allows you to place bets on practically everything, the odds Geithner will either be fired from or quit by the end of 2009 surged to an all-time high today of just over 41. Basically the “market” is giving Geithner 3 out of 5 odds he’ll last throughout the year, down from 3 out of 4 earlier in the week.

Although it may seem small in the bigger picture of $750 billion bailout, a “placeholder” for more to come, and a $787 billion stimulus package, it just adds to the “rule changing” climate which will only slow any recovery.

The Hidden Cost

Back in October we start talking about the tremendous negative impact of uncertainty on the markets and economy. Now with the Dow off another 10% or so, even after the recent rally, it’s becoming an even bigger problem.

Whitney, who really made her mark by rightfully putting a “Sell” recommendation on Citigroup back just as the current mortgage mess started to unravled, laid it all out pretty simply in a recent edition of the Charlie Rose Show. Whitney said:

“If the rules are constantly changing, you’re going to have a freeze in commerce. You’re going to have a freeze in spending…and people are going to be too scared to act. A lot of companies have already behaved that way. They’re too scared to act because the rules are changing on them constantly.”

“The math [shows] the worst is ahead of us…you continue to have credit pulled from the system and until it stabilizes, you have nowhere to go but down.”

In the end, I look at this as just another rule change which is preventing businesses from making decisions to spend, invest, and hire. All of which will have a negative impact in the months ahead and help stunt the current stock market rally.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing