Added VLO to FGI and SSS

In my June 2 posting, "Avoiding Oil Related Stocks", I said I was in the bubble camp when it came to oil prices. This is why we had no energy stocks in the Forbes Growth Investor and only one in the Special Situation Survey.

Now that oil prices are starting to ease, we decided it was a good time to add an energy stock to both newsletters. That may seem a bit nonsensical, but the stock we added is a refiner. High oil prices have squeezed margins at refiners. With oil prices falling, margins should expand once again. As a result, we decided to add Valero Energy (VLO) to both newsletters. In fact, in today's earnings release, Valero said gasoline margins (aka the crack spread) fell to $6.60 per barrel in the second quarter of 2008. They were at $28.95 per barrel a year ago. This explains why the stock price has been cut by more than half during the same time.

Of course, the crack spread won't expand if gasoline prices fall as rapidly as oil prices. While we certainly expect gasoline prices to ease, we think they will hold up better than oil because they didn't climb as much as oil to begin with.

While we expect VLO's profit margins to improve, we think the bigger risk over the near term has to do with volumes. Gasoline demand is falling sharply as drivers respond to high prices by cutting back, car pooling, and switching to more efficient vehicles. That's a risk we are willing to take. Low price multiples and a recent dividend increase make this stock extremely attractive.

Supervalu Gets Clobbered

Shares of Supervalu (SVU) took a big hit last week. This is a stock on our recommended list in the Forbes Special Situation Survey. It is also a stock I own personally. The sell-off had nothing to do with any specific news related to the company. Instead, investors sold the stock in reaction to disappointing results from Safeway (SWY) and the Great Atlantic & Pacific Tea Co. (GAP). Safeway beat earnings by a penny, but missed its revenue target. A&P missed earnings by seven cents per share. On the other hand, Kroger (KR) reported strong results a month ago and the stock rallied in response.

Tight economic times are taking a toll on supermarkets. Food price inflation is prompting shoppers to seek out bargains. They are trading down from name brands to store brands. This may depress revenues, but it should also boost earnings since store brands are more profitable. However, revenues are getting a bit of a boost from consumers who are trying to save money by preparing meals at home instead of eating out in restaurants as often.

Our view is that Supervalu has been unfairly punished for Safeway's and A&P's shortfalls. The stock was already undervalued even before the sell-off. Supervalu will announce fiscal first quarter results on Tuesday, July 22. Those who want to play it safe should wait until then. Those who prefer to take some risk, should buy on Monday.

Housing Market is Still Struggling, But Positive Signs Are Beginning to Emerge

With rising energy prices, falling nonfarm payrolls, a plunge in consumer confidence, and a host of other negative indicators, economists have plenty to worry about. Their biggest concern, however, continues to be the housing market. Yet there is finally a little hope that the worst may be over.

According to the S&P/Case-Shiller indices, housing prices are still falling. Furthermore, they are still falling at an accelerating rate. This is the bad news. However, for the second month in a row, the rate of acceleration has declined. While this is not a reason to start celebrating yet, it is a necessary sign before the crisis finally ends. And because there is a two-month delay in the numbers, things may actually be a little better than the available data suggest. Right now, economists are studying April's numbers. The figures for May won't come out until the end of July.

Another encouraging sign is the recent week-over-week increase in mortgage applications for both refinancings and home purchases. While total applications were down almost 23% from a year ago, applications for home purchases were up 2.8% from the prior week.

Some parts of the country are also seeing interest from foreign investors who are backed with stronger currencies; and vulture investors are getting interested in purchasing condos in bulk in places like Miami. The Fed is hoping for more such signs that the worst for housing is over. Because inflation is becoming a concern, the Fed is itching to start raising interest rates. It will not do so, however, until it is believes the housing debacle is nearing an end.

Discussion of Economy on CNBC

There is tremendous debate these days about oil prices. Some say given tight supplies and strong demand, $140 per barrel is fully justified. Others say there is a bubble in the oil markets. I am in the bubble camp.

I don't question that supply is tight and demand is strong. I also agree that there is much less slack than there used to be. Nonetheless, the intraday volatility tells me there is much more going on than simple supply and demand considerations. Federal Reserve policy must take some of the blame for rocketing oil prices. The Fed's policies have significantly weakened the dollar, causing investors to seek ways to hedge the Fed's actions. Oil is suddenly viewed as an investable asset. This is true for a number of other commodities as well. I recently argued in the Forbes Growth Investor that the stock market will not rally until the Fed and Treasury Department get serious about defending the dollar. I discussed this and other matters in a July 3 interview on CNBC with Peter Klein of Fifth Third Asset Management and John Ryding of RDQ Ecnomics (formerly of Bear Stearns). The segment was hosted by Michelle Caruso-Cabrera of CNBC. Steve Liesman of CNBC also took part.

Tempting Warren Buffett

I did an interview this afternoon with WBBM News Radio 780 in Chicago. The hosts, Kris Kridel and Sherman Kaplan, wanted to discuss Berkshire Hathaway. The stock is down about 15% year to date—not the kind of performance one would ordinarily expect from a company run by Warren Buffett.

Berkshire, of course, if heavily invested in the insurance business. Although it owns more than 70 subsidiary companies, many of the non-insurance companies, such as Fruit of the Loom and Jordan’s Furniture, are rather small. Most are dwarfed by the likes of GEICO and General Re.

Buffett warned at this year’s shareholders’ meeting that the insurance business would be quite difficult this year. Berkshire just can’t command the kinds of premiums it did in the recent past. Buffett also warned that Berkshire stock will not generate the kinds of returns it did in the past.

Berkshire also owns more than 40 publicly-traded stocks, but just four stocks account for more than half the value of this portfolio. This group, referred to as the Big Four, consists of Coca-Cola, American Express, Wells Fargo, and Procter & Gamble. Each of these stocks is down more than 15% year to date.

Given Berkshire’s heavy exposure to the finance industry, it is rather impressive that the stock is down only 15%. Compared to the likes of AIG, Citigroup, and the investment banks, Berkshire is doing quite well.

Buffett is sitting on a boatload of cash. Many observers have been wondering when he will put some of that money to work. We know he likes to buy when others are selling. Given, the extent of the sell-offs witnessed lately, perhaps Buffett is getting at least a little tempted. But is he willing to invest in the financial stocks that have gotten killed? With Citigroup, Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Merrill Lynch, and a host of others, there is a lot to choose from. Unless Buffett is completely bearish on the future of America, chances are he is thinking hard about buying one of these companies.