Energy's Collapse... It's Only The Appetizer
For a change, stocks made little ground in either direction last week as other markets took center stage. And for most, it was a very welcomed change! The overwhelming evidence continues to suggest a very significant bottom was seen on July 15, and that must be respected until proven otherwise. And I actually believe that even if the major indices breach the levels seen that day, which is not my preferred scenario, it would only be temporary and lead to a monster rally.
So the bottom line for stocks is that pullbacks should be bought and rallies should not be sold so quickly, as was the case in June and early July. It looks like we are seeing some fairly violent leadership changes that should become more pronounced over the next 2-3 weeks.
Energy was clearly the big story last week as we continue to see a dramatic decline from all time highs. As I discussed in part I of my series on energy, peaks in commodities are the exact opposite of that in stocks. We tend to see near vertical moves into a top and then a waterfall decline that is as relentless as the last rally.
And this time is no different. It wasn't long ago when wheat rallied nearly 100% in under a year and gave back that entire move in the same period of time. Corn, the commodity that never goes down, has been hit more than 30% over the past month with more downside ahead.
In a piece I wrote last month, I talked about the "magical" $150 level for crude by early July, but much relief on the way before Labor Day. What we are seeing now should be looked back upon as only mild relief when all is said and done. $147 to $123 is a huge move in a short period of time, but given how much prices appreciated, just like the dotcoms, it should only be the beginning of an intermediate-term move below $100.
Now before you get all excited and start celebrating the demise of energy, the commodity is very oversold in the short-term and due for a bounce higher. This is normal and part of the process. Don't be surprised to see crude rally into the $130s over the coming weeks, but for the first time all year, this is a selling opportunity more than a confirmation of a new leg higher.
If my scenario is right or even close, we should see the coming rally fail and price rollover even harder into the election in November, no doubt bringing out all of the conspiracy theorists who think the government is behind everything!
As I mentioned before, I think when crude closed below $135 for the first time, it broke the backs of the bulls in the short-term. When we see a close below $120, I think the intermediate-term bulls are in for a world of hurt, and fast!
While seeing energy prices in a tailspin is a great sign for consumers, it will have some more negative longer-term economic implications; but let's leave that for another discussion.
Stocks rallied hard two weeks ago as energy prices finally got hit, but they did not respond similarly last week as crude's fall continued. A very bullish sign for the stock market will be when energy begins to bounce and stocks continue to make higher highs. That's what we should watch for over the coming few weeks.
TOP
Presidential Election Years Are Historically a Good Time to Invest
Before you write off the potential for further investment gains in 2008 in light of the housing market's continuing slump, high oil prices and a slow economy, there's some promise from a four-year trend known as the Presidential Cycle.
In a nutshell, the Presidential Cycle says that markets tend to go up as elections approach and the current administration does everything it can to stimulate the economy. The goal is to have voters go to the polls with jobs and a feeling of economic well being - increasing the odds that the party in power will remain in power. In the two years following a presidential election, the stimulants have to be paid for and tough economic decisions made. As a result, the first two years of an administration are often the hardest on the financial markets.
A very simplistic cyclical investing strategy is to buy the Dow Jones Industrials 25 months before each presidential election and sell at the end of November, as the euphoria of the election results begins to wear off. From 1942 to 2006, this would have always have produced a gain.
This difficulty in using cycles as a basis of buy and sell decisions is that several cycles can be impacting the market at the same time. Looking at just one cycle gives you an incomplete picture of the forces in action. What gives the Presidential Cycle a little more credibility is the ability of the federal government to influence the economy on a short-term basis. On a long-term basis, it's a different story. The costs of economic stimulus inevitably come home to roost, as is seen in today's housing crisis.
As with any investment approach that looks back at history to determine buy and sell points, past performance is not a guarantee of future returns. There is always the potential for loss as well as gain. The DJIA is an index and cannot be invested in directly.
TOP
Window for Roth IRA Conversions
Roth IRAs have always had three big advantages over ordinary individual retirement accounts.
(1) While contributions to a Roth IRA are not deductible, qualified distributions from a Roth IRA are income-tax free. (Differing income tax laws in some states may result in the Roth IRA earnings being taxed as ordinary investment income by the state.)
(2) There are no minimum required lifetime distributions.
(3) You can leave all of the Roth to your children or grandchildren and they will have years or even decades (depending on their ages when they inherit) to deplete it.
Individuals in the 10 and 15% tax brackets also have a unique opportunity to fund a Roth IRA in terms of a 0% capital gains tax rate beginning this year through 2010. Qualified investors can take a highly appreciated long-term investment, sell it at 0% capital gains and invest up to $5,000 per person ($6,000 if you are over age 50) in a Roth IRA.* That could be up to $12,000 for a couple. The gains from the sale of the original investment and future earnings from those proceeds can continue to grow income tax-deferred for the account holders' lifetimes.
Roth IRAs have been off limits for many Americans with incomes above $100,000. In 2010, that's no longer true. Starting in 2010, the existing $100,000 income test for converting a traditional IRA to a Roth IRA will no longer apply. Individuals who choose to convert an ordinary IRA to a Roth IRA will be required to pay income taxes on the conversion amount, however they will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.
*You must have earned income to fund an IRA.
TOP
The Best Loss Strategy: Move On
Every investor and every investment approach will have losers - positions that drop in value, or never realize their potential. How those losers are managed is typically the difference between a successful or unsuccessful portfolio.
The #1 mistake investors make is holding on to a losing investment waiting to get back to break even. After all, as long as the position isn't closed, it's just a paper loss and somehow that doesn't seem as painful to many investors. But there are two problems with that approach. You lock up capital that could be growing and you risk losing more money.
The poster stock of the fallacy of waiting to get back to break even may well be Lucent Technologies. After being spun off from AT&T in 1996, Lucent Technologies' stock gained 892% in value. A market-beating performance like that naturally wins a lot of fans. Lucent was America's fourth most widely held stock in December of 1999 when it reached a high of $77.78. By January 10, 2006, its stock traded for just $2.76.
Lucent's downfall started with a November 2000 announcement that the company had to restate its financial statements as a result of an internal investigation revealing accounting irregularities. By July 2001, the SEC was investigating its accounting practices, and several former, high-level managers had been sanctioned by the SEC or were under criminal indictment for wrong-doing while at Lucent.
Lucent's rise had been so spectacular that many investors kept their faith in the company, holding on as their investments were whittled to virtually nothing. Ultimately, the company was merged into a French firm, Alcatel, but the merger did little good for shareholders as the combined company posted losses and launched a major restructuring.
The problem with holding on to an investment that is falling in value is that you have no way of knowing how far the decline could be or what factors are behind the decline that might not yet be public. Sometimes the company isn't the problem, it's the sector. But whole sectors can stay down for years. Even if the whole market turns back up, leadership may have rotated to another industry, leaving the investment underperforming.
Making up losses is also a lot harder than many investors understand. It doesn't take a 50% gain to make up a 50% loss. It takes 100%.
Mathematics of gains and losses
| If the DECLINE is |
It takes the following GAIN to break even |
-25% |
+33% |
-33% |
+50% |
-50% |
+100% |
-75% |
+300% |
-90% |
+900% |
At the center of the founder of Investor's Business Daily William J. O'Neil's investment philosophy is a stop loss of 8%. Any time a stock declines 8% from its prior high, it is time to sell, he maintains.
As long as investors limit their losses, they have the opportunity to invest in another company with a positive price trend. If the first stock reverses its trend and shows good price momentum, you can always buy back in. But you can't always count on a recovery. This is the great fallacy of buy-and-hold investing. Many stocks have gone all the way to zero, even in a bull market.
The greatest value of professional management is helping investors know when it's time to sell to preserve your gains and your financial security. We don't look backwards and say "But Lucent has done so well in the past, surely it will continue to outperform." All that matters is how the investment is performing today. We may not be able to see the future, but by actively monitoring client investments we can limit losses and strive to focus your investments in areas that are doing well.
TOP
Email Investment Scams are Huge; Don't Be a Victim
If you use email, you've undoubtedly received at least one email, if not hundreds of emails, promoting investments. Recent statistics show nearly 25% of email spam is currently related to investment fraud. That 25% clearly says there's a lot of money to be made in these scams and that people continue to fall for them.
To make certain you are not a victim, here's a quick primer on "pump and dump," the most common email investment fraud.
The SEC defines pump and dump as the following: "Pump and dump scams involve the recommendation of a company's stock through false and misleading statements (the pump). Misled investors then buy the stock, creating demand for the stock and often causing its price to soar. Fraudsters then sell off their shares (the dump), usually leaving investors with worthless, or near worthless, stock."
There's nothing new about pump and dump schemes. They've been around as long as markets have existed. The difference today is the scale at which they are being plied on the internet and the innovations the spam artists have used to get past spam filters and natural skepticism.
Virus and spam filters look for repetition in messages. Thousands of emails with the same wording or exactly the same image are easy to detect. To get around the repetition, spammers began to use pdf attachments and then introduced graphic images with slight variations. The latest tools include video files, although often the spam is nothing more than a brief message with slight variations to avoid the spam filters.
The goal of the con is to make the recipient think they have intercepted a 
genuine stock tip. Because the emails are sent to millions of addresses, it doesn't take much response to move the stock price, particularly if it is a micro-cap stock trading for pennies. In fact, an investor who takes the precaution of looking at the stock's price action may be encouraged by what appears to be a recent upward trend. But when the dump happens, the trend collapses and the investors are left with a loss, often virtually their entire investment.
Next time you receive an email along the lines of the following, often with grammatical errors...
"Hi I hope this is your email. I was pleased to meet you the other day. I expect you was excited about New York. So much so much happening all the time, lot of great opportunities. And speaking of opportunities, the deal I was speaking about yesterday involves a company known as..."
Or
"This one is on the move. Watch it Thursday 29th of May.
My new big pick is Angstrom Microsystems
Big News Expected out Friday. We expect this to give it a BIG push we are looking for.
AGMSat $1.20
This Company has preformed very well in the past. With all the new intrest in this Company we only see it as a matter of time and this Company should Rocket and show A Strong Rebound. We think the Time has come."
remember that you are one of millions to receive the same message.
If the message is unsolicited, it is virtually certain to be spam. Even if it appears to come from someone you know or a legitimate domain, check first. It is very easy for spam senders to mimic legitimate email addresses.
Never invest on the basis of information you receive in an email or resources such as web sites, phone numbers, etc., included in the email. Look for independent resources and even then question their integrity. Pump and dump schemes have included falsified web sites, fake press releases and analyst reports, misleading news coverage, inaccurate blog postings, false phone numbers to "regulators" and a host of other imaginative techniques.
Most unsolicited spam recommendations involve stocks quoted on the OTC Bulletin Board (OTCBB) or in the Pink Sheets. These stocks are often illiquid, thinly traded and volatile, making it easy to manipulate prices with a pump and dump scam. Information and financials for the companies underlying the stocks are often sketchy at best making it difficult to make an informed investment decision.
As much as you might want to believe in fate or providence, a total stranger is not going to send you a great investment tip. Given the impersonal nature of the internet, they are also not going to feel the slightest remorse for your loss if you act on that tip.
TOP
Block Access to Your Credit Records with a Freeze
Consumers have a new tool that they can use to prevent identity theft - freezing access to their credit reports. A freeze prevents someone from applying for credit in your name, such as a credit card, bank account, loan, cell phone service or merchant financing. Once frozen, potential new creditors can't access your credit record at the three main credit-reporting bureaus without your explicit permission.
Freezing your credit records does not prevent someone from fraudulently using an existing credit account. Nor does it prevent existing creditors or the federal government from accessing your credit history. You could also encounter situations where a lender, merchant or business fails to access your credit report prior issuing credit or a contract in your name.
Because many employers, insurance companies, lenders, automobile sellers, apartment managers and others check credit histories before they will hire, underwrite, sell or rent to you, having your credit frozen can cause some problems if you don't remember to unfreeze it prior to applying.
If you are a victim of identity theft, you are typically entitled to freeze your credit report at no cost. Otherwise, you may have to pay a fee to do so. Procedures and your right to freeze your account differ by state. For more information on your state's credit-freeze laws, along with general guidelines on how to place a freeze, visit www.financialprivacynow.org or log on to the web sites of the three major credit reporting companies, Experian Group Ltd., TransUnion LLC and Equifax Inc. and search for "security freeze."
TOP
Caution When Financing Investment Real Estate
Less than two years ago, one could still find seminars on getting rich by investing in real estate through speculation, rentals, flipping properties, and more. With housing values imploding in many areas of the country, a new issue has come up that the seminars never dealt with - the potential of owing thousands in taxes if a property goes into foreclosure.
Many individual investors financed the cost of a second home, rental or investment property, often through a mortgage on their primary residence. The problem is if that loan goes into foreclosure. The difference between the loan amount and the property's value in foreclosure is considered forgiven debt., i.e. taxable income.
Under the Mortgage Forgiveness Debt Relief Act, effective from Jan. 1, 2007, through Dec. 31, 2009, a homeowner does not have to pay tax on debt forgiven by a lender - if the loan is backed by the property the homeowner lives in. The difference in value between the loan amount and a rental, vacation or investment property is taxable as forgiven debt. Most tax debts can't be wiped out in bankruptcy. They may be reduced, but are still owed at the end of a Chapter 7 bankruptcy case, and must be repaid in full in a Chapter 13 bankruptcy repayment plan.
TOP
2010 Holds Special Challenges For Wealthy
In 2010, the estate tax is scheduled to fall from its current 45% level to 0% for 12 brief months, only to jump back up to 55% in 2011. Given the millions of dollars that will be at stake, a little planning may be in order.
In 2008, the first $2 million of an estate is excluded from federal estate taxes. In 2009 this rises to $3.5 million. The remainder is taxed at 45%. In 2010, the entire estate is exempt from federal estate taxes (state taxes may still apply). Barring new legislation, in 2011, the amount exempt from federal estate taxes reverts to $1 million while the tax rate on the excess will be 55%.
You may want to consider ulterior motives in an heir's suggestion that you take up sky diving or other high hazard entertainments in 2010. It also could be a year when you need a different will, one that takes into account the potentially greater value of your estate without the erosion of taxes. A second issue may be your living will - the document that states what life-prolonging medical care you wish to receive. Depending upon what is at stake, you may want special provisions saying keep me alive until 2010.
We recommend taking a look EVERY year at your current net worth, will, and where you would like to see your assets go if the unforeseeable happens. With a little pre-planning, you can make certain the assets you have worked to accumulate go where you like while minimizing the tax bite.
TOP
