Mar 07, 2009

Properity Dispatch: Q&A

By Andrew Mickey, Q1 Publishing

It’s been a pretty depressing couple of weeks for anyone still holding stocks. Which, judging by the consistent downward trend, there are fewer and fewer every day.

But, quite frankly, this is what we have been waiting on.

It was tempting to go along with the “buy stocks now” and “this is the buying opportunity of a lifetime” crowd, but we kept our mantra the same since last summer: This may be the buying opportunity of a lifetime, but the buying opportunity of 5 lifetimes is coming up.

Well, it looks like the opportunity is on its way. What I call the “big break” finally hit.

You see, there are always one or two pockets of strength somewhere in the market. Since the start of the year, two of the strongest sectors have been healthcare and “for-profit” education stocks. We stayed out of both sectors.

In fact, back in late in January, we looked at Apollo Group (NASDAQ:APOL) – the leading for-profit educator – as “a great ‘short’ position right now.” It’s still falling now along with the rest of the sector.

But that was expected by a lot of people. For-profit education regularly goes through very short-term booms and busts. But healthcare, a sector filled with tremendous opportunities and years of growth ahead of it, was expected to stay strong by many.

Some of the leading growth stocks in the healthcare sector were sporting P/E ratios of 25 or 30. It just didn’t make any sense to me and when something doesn’t make any sense, I’ve done best by just waiting on the sidelines, keeping a close eye on the best of them, and then just waiting.

As you can see in the chart below, we didn’t have to wait long. Healthcare stocks were holding up well, but that all changed earlier this month. While the S&P 500 (green line) was steadily falling, the iShares Dow Jones Medical Devices ETF (NYSE:IHI – blue line) and iShares Dow Jones Healthcare Providers ETF (NYSE:IHF) were up for the year.

We talked about healthcare a lot though that time, but it was always with a patient mentality.

I don’t know if the time to get impatient and start stepping to some of these is a week away, a month away, or a year away, but I do know we’re a heck of a lot closer to that time than we were two weeks ago.

So I’d like to let you know I’ve been working on a full report on healthcare, how it’s changing, and where the genuine opportunities lie (actually, there will be quite few thanks to a slew of new government policies) which should be ready next week. I’m actually going back to work on it after I send this to you and, I’ll admit, I’m kind of excited about it.

Until then though, I’ve set aside some time to get back to all of your recent questions. Now, for legal purposes I can’t offer you individual advice through direct communication (as a financial publisher I cannot offer any individualized financial advice), but I can offer my take on virtually any financial-related subject here.

And that’s what we’m here to do today. Many of you have sent in questions, comments, and critiques (for all I thank you, genuinely) and I promise to answer them all. So I’ve published a Q&A session where we go over them all.

We’ll be hitting on: 

• How low can the markets really go
• The fast growing industry a U.S. dollar devaluation would be good for
• What 99% of investors refuse to understand about gold
• Why sometimes it’s more important to look at sectors than stocks
• Our upcoming interviews (you’ll be surprised at who we’re sitting down with in the next few weeks)

Needless to say, it’s not an easy time to be an investor. It has been a while since we’ve gotten together for a Q&A. So it’s about time we have one.

Here’s the thing, now is not the time to throw in the towel. Now is the time to implement a plan, determine which sectors and areas of growth we should really be focusing on, and learning about and mastering strategies which will perform in different market conditions.

So I appreciate the feedback because it lets me know you haven’t given up yet. Over the next few years, a lot of investors will give up. They’ll take their cash, sock it away in CD’s and vow to never come back into the markets again.

I saw this back in the tech crash. Three to five years later, most of them had come back. And again, they failed to learn their lessons and are feeling the pain once again.

Greed is very powerful emotion. Once everything starts getting turned around, they’ll be back. It won’t be very soon (I’m putting together the big reason why that is – a reason no one seems to be talking about at all – and how to ensure we’re prepared, for Tuesday’s Prosperity Dispatch), but they will come back.

With that in mind, let’s have a look at the questions and (hopefully) helpful answers.

Q: Every week it seems like the markets are going down. You even talk about how there are very few “catalysts” for a rebound. How low can the markets really go? – C.W.

A: It can be confusing. There are a lot of opinions out there and all of them different. There are some dire Dow 3,000 or lower predictions. Steven Leuthold came out the other day and predicted the S&P 500 will rebound to 1,000 by year end. They’re all over the map.

The way I look at it is a bit different. The future is very unpredictable. There are so many unknowns.

What will the regulatory environment look like in a year? What businesses will be decimated by new laws or de facto outlawed (i.e. payday loans, debt collectors, private health insurers, etc.)? When will the big money, banks and lenders be willing to take even the slightest iota of risk?

That’s just to start. The markets hate uncertainty. And with an uncertain future for the economy and a heaping dose of change coming out of Washington without any clarity yet, nobody wants to be the first to move.

As for any big rebound, the prospects get less and less with each passing day.

The stock market has been built on trust. You invest in a company based on the trust that its shares have a good chance of increasing in value. Right now, that trust has been absolutely shattered. But when it comes to trust, it can be eliminated in an instant but takes a long time to be earned. That’s why the old saying, stocks move up a stair case (building trust) and down an elevator (trust broken).

For a direct answer, I remember Mark Twain’s words: History may not repeat itself, but it does rhyme a lot.

And if we’re going back to a period when only a small percentage of Americans are willing to invest in equities, the honest answer is much, much lower.

Remember in the first half of the century, investors were rewarded for all the risks in equities. They were rewarded by earning an average 6% to 8% dividend yield. Even the blue of the blue chip stocks at the time paid higher yields.

So if that’s the case we’re looking at, the markets could fall a lot more. For instance, if we expect the S&P 500 to return to a 6% yield, that would require it to drop to about 400 or 500 (there’s no easy way to say exactly because we have to account for share buybacks – which in accounting terms is the same as a dividend – and further reductions in dividend payments).

Do I think we’re headed back there? No.

Is there a chance? Yes, there’s always a chance.

That’s why we’ll be looking at alternatives to stocks in the coming years. That’s where you’ll find the 10% to 12% returns or greater. Also, stocks in some sectors will do exceptionally well. Not too many, but there will be some.

Q: Thanks for a great article. So Rainwater took $300 million and put $200 million into oil futures and $100 million in stocks. When you jump "all in," will you also be participating similarly? Buying futures? Short and long dated? Stocks? Who do you recommend for a managed futures account, specifically, an oil expert? -J. K.

A: This was in response to our Richard Rainwater profile back when oil was trending back down to under $35 a barrel.

At the time, oil was headed lower, yet oil stocks were holding up strong. This always happens when investors look at oil and oil stocks. They are very different vehicles.

Oil stocks are priced according to the markets’ belief of where oil prices will go over the long-run. Oil prices move according to supply, demand, and short-term speculation. They move differently and when it comes time to go “all in,” we’ll look at which offer the most upside.

We’ve been bearish from a fundamental supply/demand perspective for a while. There have been speculative bounce, but oil prices have always dropped back to where the fundamental say they should be (between $30 and $40 a barrel).

As I told you a few weeks ago though, the facts have changed so I’m going to change with them. Oil prices are likely going much, much higher. And it has very little to do with popular scapegoats like Peak Oil, OPEC, and Big Oil. It all has to do with politics.

What’s the best way to play it, when the time comes? I can’t say today exactly the best way because I don’t know how cheap oil stocks will be relative to oil prices at the time. Here’s one strategy, however, I have been toying around with to get back into oil stocks.

Step 1: Set aside X dollars to invest in oil

Step 2: Buy: Each time

When/if oil drops below $40 – buy 10%
When/if oil drops below $35 – buy another 15%
When/if oil drops below $30 – buy another 20%
When/if oil drops below $25 – go “all in”

Step 3: Constantly re-evaluate, take partial profits strategically, and look for better oil stocks to own

This is the way to “leg in” to a position safely, still be positioned if there is any further drop in oil prices, and capitalize on the natural volatility of oil as an asset class.

Q: Great article. I have been thinking the same about oil. What do you think of international oil company stocks and are there any in particular that you like at this time? – J.M., Oregon

A: There are a lot of oil company stocks I like at this time, but there aren’t any I truly love right now. And in a market like this, something has to be tremendously undervalued or have exceptional upside prospects to make it worth to put capital at risk. Of course, that doesn’t mean we can’t get prepared for when the time to buy oil stocks does come.

I’ll give an example of a lesson I learned the hard way. I’m a big believer in the old saying, “it’s best to go to school on other people’s mistakes,” so here’s one I made.

I bought my first oil stock back in 1999. With oil prices getting slammed, the tech sector looking a bit (cough) overvalued, any new money I was looking to invest would go to where the value is. I bought ExxonMobil (NYSE:XOM) – it was before the Exxon/Mobil merger - around a split-adjusted $40 per share. I closed out the position in late 2007 at over $80 per shares. It was a 100%+ gain with about 20% in dividends paid out while holding the position.

Meanwhile, oil was trading for under $30 a barrel when I bought the shares in 1999. But when I sold them in 2007, oil was over $90 a barrel. So just holding oil would have almost doubled the returns of holding an International Oil Company (IOC) like ExxonMobil.

In the next decade, barring an outright Depression and 25% unemployment, oil prices are going much higher. And if you’re going into something for that long, you should expect to be well-rewarded for the time.

That’s why, when the time is right, I’ll be looking for smaller oil service companies and small oil producers. And considering the tax situation oil companies will be facing (both now and when oil prices surge higher) I’d focus on oil companies outside the U.S.

Q: You mention gold a few times, but always seem to be focused on other places. Other analysts I read, all they ever talk about is gold. Should I put everything I have into gold, stay out of it completely, or what would be your advice on finding a happy medium? – M.V.

A: Anytime I talk about gold, good or bad, I can pretty much guarantee you a slew of comments. Some good, some bad. It is such an emotional asset class and that’s the key thing about gold.

It’s no secret gold has no industrial uses, it has been used as a means of exchange for 3,000 years, and the gold miners are producing less today than they were two years ago.

Despite it all though, the only demand for it is psychological. Gold will only soar to new highs if panic truly sets in, people become genuinely concerned their government issued currency will become worthless, or they all genuinely feel gold prices will continue to go higher. That’s the only way gold will make it past the $1,000 resistance and onto new highs.

Is it possible? Yes, and we should be adequately prepared. Is it a 100% lock, guarantee, sure thing? Of course not – in the financial markets, absolutely nothing is.

For now, it’s tough not to like gold. It’s one of the only things going up and we still haven’t entered the really exciting part of a gold bull market. In a real gold bull market (and as a potential identifier the end of one is near), gold will be extremely volatile. If you talk to anyone who was trading the stuff back in the 70’s they’ll be able to tell you how hectic it is. It will be commonplace to see $70, $100, or $150 one-day price swings in gold. At that time, you’ll want to start looking at taking some profits off the table.

Until we see that, I see gold as a safe haven and will only benefit from the ongoing change and uncertainty in the markets. If you recall, we’ve found a way to eliminate a lot of the volatility with gold stocks. It’s much less stressful and is almost just as profitable in the long run.

Remember the Gold/XAU (index of gold and silver stocks) ratio. It’s getting to the extreme levels we’re looking for when the risk/reward ratio is truly in our favor.

Q: You tell us that India has "a good (and getting better) education system." You don't mention the criteria you use to arrive at this conclusion. I'd be interested to know, because the UN's figures for 2008 quote India's adult literacy rate at a lousy 65 per cent. India is 159th out of the 192 countries listed -- firmly in the bottom quartile. Its neighbors at 158 and 160 are the Congo, and Rwanda.

If the Indian education system is good, as you say, then why are there 400 million illiterates?

Part of the reason is the common belief in India that educating girls is a waste of money. But then, that attitude is in itself a further indictment of the education system, in my view. – J. I., Yantai, China

A: I’ve got to hand it to you J.I., that is a thoughtful analysis. And I agree with you, India is far from a perfect place at this time. Its education system is good, but it’s far too small. Poverty is high and there are a lot of social problems throughout the country.

But India’s greatest advantage is time. India’s population is young. If you recall from our talk with demographer and economist Harry S. Dent, he told us, “China only has favourable demographics for the next 5 to 10 years, but India has favourable demographics for the next 55 years, give or take, in the future.”

India is the youngest BRIC country and this demographic advantage affords tremendous advantages. The biggest one is healthcare. This will be a much smaller proportion of GDP for years to come. As the U.S. is quickly realizing, an aging population is not a boon to any economy. It forces an economy to make some hard choices.

For instance, in the U.S. will we pay higher taxes to be redistributed to retirees (per previous social contracts) or will we allow young people to work in a country with plenty of incentive (read: lower taxes - per previous social contracts). Something has got to give here, choices will have to be made, and compromises worked out. Once you add a growing government to the mix you’ve got the prescription for a long run of economic malaise in this country.

But in India, those choices are decades and decades away. Think of the U.S. in the 1950’s. Economically speaking, opportunities were boundless. In India today, it’s a similar situation, just on a much larger scale.

There you have it. I hope this helps clear a few things up. More importantly though, I hope it helps you get prepared for the weeks, months and years ahead.

I know I say it a lot, but this is as good a time as any to be getting involved in the markets and keeping our eyes on the prize. With all the changes, uncertainty, and volatility, the opportunity to truly make a life changing fortune in the next five years is greater than ever.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing