Monday, August 27, 2007

Rove + Gonzales = Trouble for Republicans

A professor once joked that the best way to turn a Democrat into a Republican was to let him graduate, get a job, and see how much he has to pay in taxes. Indeed, when I was in college, most of my classmates had Democratic leanings. I preferred to remain independent. But as time went on I noticed I had more in common with Republicans, and that is the way I usually voted.

Many years later I took a job in Massachusetts. Almost everyone in the state was a registered Democrat, so I decided to register as a Republican. I did so just in time to help elect William Weld, a Republican, governor. I have been a registered Republican ever since.

This is why it pains me to see the Republican party struggling so much in recent months. The Bush administration, in particular, is falling apart. A number of high-ranking officials have resigned. Karl Rove and Alberto Gonzales are only the most recent.

It is becoming more and more difficult for me to believe that the Republicans will be able to hold on to the White House in 2008. There does not appear to be a single Republican candidate who can energize the core of the party and at the same time attract a critical mass of Democrats.

The Democratic candidates have many flaws, yet their constituents appear quite satisfied with them. In my opinion, unless the Democrats completely blow it, this election belongs to them, which of course makes me all the more bearish on stocks. I believe a Democrat in the While House, along with a Democratic Congress, spells higher taxes. I expect stocks to go lower as more and more investors reach the same conclusion.

Friday, August 10, 2007

2% Growth is Bullish?

Brian Wesbury wrote an especially amusing op-ed in yesterday's Wall Street Journal. He argued that the business media are giving too much time to those who are bearish. Citing numerous surveys, he claimed that the vast majority of economists are bullish. Therefore, according to Wesbury, by giving bears and bulls an equal amount of time, viewers are getting the incorrect impression that economists are torn about economic growth.

I found this amusing for a couple of reasons. First, his definition of a bull is one who is forecasting at least 2% GDP growth. Not too long ago, 2% would have been considered bearish. In fact, I've been portrayed as the bear on a number of television debates because I was forecasting less than 3% growth.

Furthermore, he ignores the fact that almost all economists have been ratcheting down their forecasts. They may still be predicting growth, but they are getting less and less optimistic.

He also ignores the fact that it rarely pays for forecasters to disagree with the masses. They want to make sure their forecast is not too far off from the average forecast. This way, if they are wrong, they can simply shrug their shoulders and say, "Hey, that's what everybody was expecting."

As for me, I still think the probability of recession is rather low. I think 2% GDP growth is still a reasonable estimate. So why am I a bear? It is not because I expect a recession. It is because I expect stocks to go lower. Despite the recent sell-offs we've been seeing in the markets, I think there is still a ways to go before we hit bottom.

Saturday, August 04, 2007

Rising Volatility Means Stocks Can Go Lower

Given the sell-off in stocks we are now seeing, I decided to post my recent comments from the Forbes Growth Investor:

Volatility is back on Wall Street. There were 21 trading days in July. The range between the Dow’s high and low exceeded 100 points on 13 of those days. It exceeded 200 points on six days.

The CBOE Market Volatility Index is another way to monitor volatility. This index measures implied volatility from the prices traders are willing to pay for stock options. Implied volatility was rather low during the second half of 2006. It started rising in late February 2007, breaking through its 200-day moving average. It has now reached its highest levels since 2003. Traders love this kind of market. It gives them plenty of opportunity to make quick profits by jumping in and out of stocks. Long term buy-and-hold investors, however, may not pay much attention. They should. Rising volatility can sometimes signal a major turning point in the market. In 2003 it signaled the start of a bull market. Today, it may be telling us just the opposite.

Rising volatility means investors are getting nervous. They no longer feel confident about the market’s overall direction. Of course, much of the current volatility is being blamed on woes in the sub-prime mortgage market and on worries that those problems will spread to higher quality mortgages. Yet even today, there are those who seem to be completely discounting the deterioration in housing. They seem convinced that the housing market is about to bottom and that any further problems—if they do occur—will have only a minimal impact on consumer spending.

Economists will debate exactly how much investors should worry, but one thing is for
sure: This bull market is getting old. As a result, many investors are sitting on sizable gains. When they see stock prices gyrate excessively, they can’t help but think about taking profits. They probably should take some money off the table.

It’s likely that housing prices will continue to fall. In fact, the 10-city S&P Case/Shiller Home Price Index recently posted its biggest drop since 1991. Furthermore, oil is trading for more than $78 per barrel and some analysts predict it will hit $100 within a year. Yet so many otherwise meticulous market watchers are simply overlooking the price of this indispensable commodity. To them, the price of
oil does not matter—until, of course, when it does.

Despite seemingly strong GDP growth in the second quarter, stocks are likely to go lower. Those who are truly worried about further declines, but for tax purposes are reluctant to realize gains, should consider hedging their portfolios. One good way to do this is by buying one or more of the UltraShort ETFs. These move opposite in direction to the corresponding index, but by twice as much. For example, the DXD will rise 10% in value if the Dow falls 5%. The SDS provides a similar hedge against the S&P 500. Readers can learn more about these products at ProShares.com.

Wednesday, August 01, 2007

Taking a Gamble on Hooper Holmes

Several years ago, my wife and I decided to buy some life insurance. The insurance company sent a couple of paramedics over to our house to do a basic medical exam and take samples of blood and urine. These paramedics were employed by a company called Hooper Holmes (HH). Unfortunately, the company hasn't been doing so well. It has no profits and revenues are falling. The stock has been falling, too. It has fallen steadily for about seven years and currently sells for $2.65 per share.

Despite all these problems, I recently started accumulating shares of the company. New management took over more than a year ago and I'm betting the worst is over. The gross profit margin is already showing signs of recovery and there is hope that the revenue decline will moderate. Furthermore, the company has no debt outstanding.

This is not a growth story. HH is not operating in a particularly complicated industry. In fact, it's a rather boring business. It's the kind of stuff Warren Buffett might appreciate. There is nothing high tech about it. It should be relatively easy for this kind of company to make some money. Most importantly, HH needs to get expenses under control and bring them down to a level that is appropriate for the reduced amount of revenue it is now generating. At the same time, it needs to find ways to stem the revenue decline.

The company will probably announce second quarter results in about a week or so. I'm not expecting anything spectacular. If it can simply break even and show that revenues are holding steady, that will be enough to attract some buyers.