The Tycoon Report

From the Editor: We Told You So?

Monday, July 30, 2007 | Ben Schott

Is it time for an “I told you so” article?

Should I spend our time together today reminding you of all the cautionary articles we’ve been writing in The Tycoon Report?

No. That’s a complete waste of your time. Unless this is your first Tycoon Report issue, you’ve read it all and have duly noted how awesome we are.

What you seek today is an answer to one question: What do I do now?

(Important note: This is a very different question from “What is the market going to do now?” The first question, we can help you with. The second? Be extremely wary of anyone who says they can answer that one.)

Let’s put this in perspective first. What happened between Tuesday and Friday of last week – a 4.8% drop for the Dow and a 4.2% loss on the Nasdaq – isn’t sending anyone but the most highly leveraged bulls among you to the poorhouse.

So if you got hurt last week and are looking at a 4-5% paper loss across the board, NOW IS NOT THE TIME TO PANIC. When an investor panics, he or she is more than likely to make costly mistakes and compound their troubles.

You already know that ... but it’s a heck of a lot easier to “get” such a concept when it’s not being put to the test. Now that you’ve probably taken a little hit, the panic monster is a bit harder to control, isn’t it?


My Quick and Dirty Rules for a Falling Market

1. Don’t Let the Overall Market Determine When to Sell Individual Stocks

If you’re a Fallen Angel Stocks member – or even if you’ve just followed Dylan’s articles here in The Tycoon Report – you probably own some pieces of great companies that you bought at a great price.

Now, just as a rising tide lifts all ships, so can a tidal wave push even the sturdiest ocean liner a bit off course (OK, so I didn’t go to metaphor school, cut me some slack.)

My point is that, if your portfolio includes some great companies that you bought for a bargain, don’t throw the baby out with the bathwater here and sell them now out of some overriding fear of what might happen in the stock market this week. Again, panic is NOT your friend.

You might feel smart to limit your losses here if the market ends up going much lower, but think of how dumb you’ll feel when you’re buying back those same great stocks a few days, weeks or months from now at a much higher price.

2. Hedge, Hedge, Hedge

I spent some time this weekend scanning the headlines online. I wasn’t surprised to find the ubiquitous “How to Play a Market Bottom” articles popping up already.

Please, please, please don’t buy that line.

It was a rough couple of days – yes, the second-worst drop on the Dow in five years – but don’t make more of it than it is. A market bottom?

As Dylan said recently in response to a reader comment, “Let me know when the pain of losing money becomes so unbearable that people are ‘jumping out of windows’ and I'm a buyer also.”

The smartest play here is to take last week’s action for what it is: a reality check and a reminder to be cautious in your trading.

One key takeaway is that you should go back and read some of Chris Rowe’s articles on hedging, particularly how to use options to hedge your bullish positions. I’d start with “Save Yourself from a Sharp Correction” and “NYSE Bears at 76-Year High!”

3. Cash Money, Homey

Randy Moss said it all, didn’t he?

And it brings to mind one of my personal rules for managing my money. It might not be exciting and it might not be earth-shattering in its originality, but I personally believe that when the market is showing signs of weakening, I’d rather make a paltry 5% on my money than lose anything.

(Are you ready for my ground-breaking advice?)

I’ve taken a larger-than-normal portion of my cash and moved it over to an interest-bearing savings account. I use ING Direct myself, because their totally online operations allow them to offer higher interest rates than most brick and mortar banks. But if you’re more comfortable sticking with your current bank, you might find that they have a special program going these days to compete with the online newcomers.

4. Double Down When the “Price is Right”

It’s going to take me a while to get used to Drew Carey hosting the show instead of Bob Barker. Oh, wait, wrong discussion.

I’m going to go out on a limb here and assume that you’ve taken the advice of our writers – notably, Teeka Tiwari – and developed a system for identifying trades that you stick to regardless of what the broad market does.

Assuming that’s the case, then you probably have a short list of stocks that you’re ready to buy as soon as they trade into your buying range. Well, now’s the time to go back and review those. Depending on what happens in the coming weeks, you might find yourself a buyer in short order.

In a related vein, you should apply the same methodology to stocks you already own. While a Munson will start dumping his stocks after a few rough days, a Tycoon might just do the opposite: Double down on the best stocks in their portfolios when all signs point to doom and destruction.


Tycoon Spotlight: Rocky Starr

Do you remember the member article posted a while ago that compared investing to astrophysics?

Well, it was one of our favorites, and I was lucky enough to have a few words with our distinguished reader this weekend, who even managed to sneak in a sweet jab at the investment newsletter industry!

One minor point of clarification: Mr. Starr is not an astrophysicist after all. He’s actually an accelerator physicist who studies the physics of particle beams in high energy accelerators. Silly me ... I’m always getting those two confused!

Editor: How long have you been investing, and how long have you been reading The Tycoon Report?

Starr: I have been investing for about 12 years and reading The Tycoon Report for about a year and a half.

Editor: We loved your article, “Is Trading Rocket Science”, frankly, because it makes us feel smarter that a physicist reads our newsletter. Just kidding. Sort of. But aside from the parallels you drew in your article, I’m curious about how someone who studies the ways of the universe puts investing in perspective as a part of their life. How does investing fit into your life?

Starr: I find it hugely fascinating that so many people around the world are playing this complex and fascinating game (it is more than that) practically around the clock. This is an ecosystem in itself or a mini-universe if you will. There are the steady and luminous stars (e.g. Warren Buffet), the supernovae who are bright and flame out spectacularly (e.g. Jesse Livermore), the dark matter i.e. the average investor present everywhere in large numbers but unseen. I play the game as an average investor with simple strategies but staying abreast of the macro-themes, the global trends and the major players keeps it interesting.

Editor: The lessons you shared in your article suggest to me that you’ve learned some of your lessons the hard way (that’s not a jab, because we all have!). What was your biggest investing mistake, and how did you come away from that better and wiser for the experience?

Starr: Letting small losses turn into large losses. In the late 1990s I owned some of the major tech stocks. Being new to the game I had let the media convince me that those stocks could only go up forever. The losses kept building but hope and denial kept me in them. Some had lost nearly 80% of their value by the time I sold them. Now I have stop losses in place for my holdings. I set my exits on every stock to just below a support level – this usually serves me well although on occasion a stock has taken off after I’ve been stopped out.

Editor: In your article, you said something that I thought was profound: “Imagination is more important than knowledge,” and that “successful investors play the news by making insightful lateral moves while the majority is focused on the main event.” In your opinion, what’s the “main event” today that’s captured the majority’s focus, and what kind of lateral moves are you working on?

Starr: First, you have to credit Einstein with the bit about imagination being more important. Clearly, the melt-down of the sub-prime mortgage business and the impact of the highly leveraged bets by some hedge funds in the news right now. My only insightful move in this area has been to stay out of home-builders and investment banks. I expect though that the bust phase of the real-estate cycle will extend to some other well-developed and/or booming economies. Housing related infrastructure stocks in these countries could be interesting plays now.

Editor: What do you feel is the most exciting macro trend that you’re following as an investor? In other words, where do you think the big money is going to be made over the next 10 years?

Starr: Water, energy, food will be important themes clearly. To my mind though, the latest trends in biotechnology are exciting. Yes, this sector has gone through its own boom and bust cycles. However the science has developed rapidly over the past few years. The human genome has been mapped. The importance of RNA, the role that networks of genes play are better understood, to name only a few examples. I think there will be exciting breakthroughs which, together with the industrialization of very small scale science (nanotechnology), could lead to profitable opportunities.

Editor: What is the meaning of life?

Starr: Glad you asked. Do you want access to the wisdom of the ages from the sayings of the Buddha, the magic of the Cabala, the faith of St Teresa of Avila, the mysticism of the Sufis, the knowledge of the Mayas and more, much more? Then my friend I have a special deal for you. If you sign up within the next 48 hours, then for a mere $6,995 a year, you will receive a monthly newsletter with all of this accumulated wisdom distilled for you in clear, easy to understand language. You may never see such a good deal again, so act now! If this doesn’t work for you, you can always try love and patience and compassion and ....

Ben Schott
Editor in Chief
The Tycoon Report


Mark Your Economic Calendar: What's ahead for the week of July 30, 2007

Tuesday, July 31

8:30 - Personal Income (for June): Consensus 0.5%, Personal Spending (for June): Consensus 0.1%, Core PCE Inflation (for June): Consensus 0.2%

Big Picture: A strong 0.5% rise in income leaves 6.2% yoy growth and supports strong consumer spending.  Weak June spending growth summed up with a -0.9% drop in retail goods while services should leave an overall gain.  Core PCE prices expected to rise just 0.1% and leave a still lower 1.8% yoy gain.  1%-2% is the Fed's "comfort zone".  The savings rate is expected at -1.0% given the weaker spending than disposable (after-tax) income growth.

Implications: Personal income measures income from all sources.  The largest component of total income is wages and salaries, a figure which can be estimated using payrolls and earnings data from the employment report.  Beyond that, there are many other categories of income, including rental income, government subsidy payments, interest income, and dividend income.  Personal income is a decent indicator of future consumer demand, but it is not perfect.  Recessions usually occur when consumers stop spending, which then drives down income growth.  Looking solely at income growth, one may therefore miss the turning point when consumers stop spending.  The income report also includes a section covering personal consumption expenditures, also known as PCE.  PCE is comprised of three categories: durables, nondurables, and services.  The retail sales report will provide a good read on durable and nondurable consumption, while service purchases tend to grow at a fairly steady pace, making this a relatively predictable report, and ranking it well below retail sales in terms of market importance.

8:30 - Employment Cost Index (for Q2): Consensus 1.0%

Big Picture: Steady 3.5% annual growth is the largest since Q1 2005.  Wages are also expected to rise 0.9% as benefits rebound to 1.1% after the mere 0.1% Q1 gain.  Leaves annual wage gains (3.6% yoy) larger than the annual rise in benefits (3.3%), as benefit costs are decelerating (compare to 5% yoy in mid 2005).

Implications: The Employment Cost Index (ECI) is designed to measure the change in the cost of labor.  Since the employment cost index was mentioned by Fed Chairman Greenspan in July 1996, it has risen into the upper echelon of economic reports in the eyes of the bond market.  Its lagging nature still leaves it as a less timely indicator of employment cost trends than the monthly hourly earnings data in the employment report.  But the ECI does add something to this picture: an adjustment for shifting employment between industries, and a look at benefit costs.  These additions are interesting, but typically do not alter the view of the employment cost picture which was left by hourly earnings.  ECI will be much less closely watched during periods when wage inflation is not a serious market concern.

9:45 - Chicago PMI (for July): Consensus 59.0

Big Picture: While March and May brought 2 year highs, a modest decline in new orders and production should still leave levels in a strong 62-65 range.  Employment to show a fourth month above 50 (despite manufacturing payroll declines).  Prices paid may edge higher, but the lack of manufacturing pricing power leaves very little inflation threat.

Implications: There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region.  The New York and Philadelphia Fed's surveys are the first each month followed by the Chicago purchasing managers' report on the last day of each month.  A few, such as the Atlanta and Richmond Fed surveys, are released after the ISM and are of little value.  The purchasing managers' reports are measured like the national ISM -- 50% marks the breakeven line between an expanding and contracting manufacturing sector.  For the New York, Philadelphia and Atlanta Fed indexes, 0 is the breakeven mark.  These surveys can be of some help in forecasting the national ISM.

10:00 - Construction Spending (for June): Consensus 0.3%

Big Picture: This report will mark a small decline after four months of gains and the large 0.9% May rise.  Very different factors are driving the three components.  Residential spending is expected at -0.7%, just below the 4-month average.  Commercial spending is flat after a long string of gains -- and that's the biggest risk.  Total public spending is expected to be under 1%.

Implications: The construction spending report is broken down between residential, non-residential, and public expenditures on new construction.  The monthly changes are both volatile and subject to huge revisions, so this report rarely has any market impact.  Only trends extending over three months or more can be viewed as significant.

10:00 - Consumer Confidence (for July): Consensus 105.0

Big Picture: A large gain here is consistent with preliminary consumer sentiment index data, a tight labor market, and stronger economic growth.  Leaves index just 2% below the 6 year high of February.  Rising expectations is showing a larger lift than the present situation.

Implications: The Conference Board conducts a monthly survey of 5,000 households to ascertain the level of consumer confidence.  The report can occasionally be helpful in predicting sudden shifts in consumption patterns, though most small changes in the index are just noise.  Only index changes of at least five points should be considered significant.  The index consists of two subindexes -- consumers' appraisal of current conditions and their expectations for the future.  Expectations make up 60% of the total index, with current conditions accounting for the other 40%.  The expectations index is typically seen as having better leading indicator qualities than the current conditions index.


Wednesday, August 1

10:00 - ISM Index (for July): Consensus 55.5

Big Picture: A small 0.5 pt gain is expected after June's 14-month high, while manufacturing has rebounded from contractionary levels at the turn of the year.  Both new orders and production are expected to hold near June levels -- they compose 55% of index, and employment is expected to rise from 51.1 (despite payroll declines) as deliveries return to a 50 level.  Inventories are expected to hold below 50 for a full year.  Prices paid are expected to hold near 70, but the lack of manufacturing pricing power leaves no effect on inflation.

Implications: The ISM report is a national survey of purchasing managers which covers such indicators as new orders, production, employment, inventories, delivery times, prices, export orders, and import orders.  Diffusion indexes are produced for each of these categories, with a reading over 50% indicating expansion relative to the prior month, and a sub-50% reading indicating contraction.  The total index is calculated based on a weighted average of the following five sub-indexes, with weights in parentheses: new orders (30%), production (25%), employment (20%), deliveries (15%), and inventories (10%).  The ISM is one of the first comprehensive economic releases of the month, typically preceding the employment report.  Though it covers only the manufacturing sector, it can often provide accurate hints regarding the tone of subsequent releases.

17:00 - Auto Sales (for July): Consensus 5.5M, Truck Sales (for July): Consensus 7.0M

Big Picture: A moderate 4% rise marks the weakest pace since October 2005, weaker than the 12.4 mln YTD average, which stands below the 12.8 mln average in 2006.  Domestic auto sales are expected to rise 3% to 5.4 mln.  Light trucks to rise 6% to 6.9 mln.  Import market share rose to 24% in June from a 22% average in 2006 and 20% in 2005.  Light truck sales continue to be the majority purchase.

Implications: Auto and Truck Sales measure the monthly sales of all domestically produced vehicles.  They are considered an important indicator of consumer demand, accounting for roughly 25% of total retail sales.  Demand for big ticket items such as autos and trucks tends to be interest rate sensitive, making the motor vehicle sector a leading indicator of business cycles.  Each auto maker reports sales individually.  The reports are typically released over the course of the first three business days of the month.  Using the individual reports, a total annual sales pace can be calculated after applying Commerce Department seasonal factors.  It is this annual sales pace that the market refers to when discussing auto and truck sales for the month.


Thursday, August 2

8:30 - Initial Claims (for 7/28): Consensus NA

Big Picture: Initial claims are at their lowest level since the sub-300Ks in early May, and the 4-week average fell to 309K -- a seven-week low.  4-week average in continued claims rose to 2.556 mln -- reaching the year and a half high of early March.  The labor market remains very tight, as shown by the 4.5% unemployment rate, low labor participation rate and small layoffs.

Implications: Initial jobless claims measure the number of filings for state jobless benefits.  This report provides a timely, but often misleading, indicator of the direction of the economy, with increases (decreases) in claims potential signalling slowing (accelerating) job growth.  On a week-to-week basis, claims are quite volatile, and many analysts therefore track a four week moving average to get a better sense of the underlying trend.  It typically takes a sustained move of at least 30K in claims to signal a meaningful change in job growth.

10:00 - Factory Orders (for June): Consensus 1.3%

Big Picture: Volatile factory orders peaked in September, but are rebounding.  The struggling auto and housing sectors added to the softening in business capital investment as orders and production are back on the rise.  Some of the fall-off was due to the drawing down of unwanted inventories as the correction seems largely over.  The underlying fundamentals of flush corporate balance sheets and high capacity use helps support capital investment and factory production.

Implications: Factory orders consist of the earlier announced durable goods report plus non-durable goods orders.  The report is very predictable with nondurables the only new component.  Nondurables consist of such items as food and tobacco products which grow at a fairly consistent monthly rate, so that market forecasts for this report are far more accurate than for the durable orders report.  In addition to seeing nondurables for the first time, the market also watches for revisions to the durable orders data, which can be significant.  At present, durable goods orders sum to about 54% of total orders.


Friday, August 3

8:30 - Nonfarm Payrolls (for July): Consensus 135K, Unemployment Rate (for July): Consensus 4.5%, Hourly Earnings (for July): Consensus 0.3%, Average Workweek (for July): Consensus 33.9

Big Picture:

  * Nonfarm Payrolls:  150K estimate near the 3mo (148K) and 6mo (145K) averages.
  * Manufacturing declines expected to stretch out beyond a year in July.
  * Construction expected to edge lower -- the 3rd decline in four months.
  * Private service producing jobs expected to provide the entire 150K gain.
  * Health, leisure and hospitality to lead the gains.  Temporary help hasn't shown a rise in 2007.
  * The government is expected to add a relatively small 20K.

  * Unemployment Rate:  expected to rise to 4.6% -- highest since last seen in January.
  * March reached a 4.4% low -- lowest during the expansion. 
  * 5% rate generally considered to be inflation neutral full employment (i.e. NAIRU).  

  * Hourly Earnings:  A 0.3% gain expected to leave unchanged 3.9% yoy growth.
  * Reached a six-year high of 4.3% yoy in December.

  * Average Workweek:  A dip back to the 33.8 hours of April and May.
  * Showed some moderate swing over the last half year February's 33.7 to 33.9 hours. 
  * An indicator for real time labor need (prior to hiring/layoffs).

Implications: The employment report is actually two separate reports which are the results of two separate surveys.  The household survey is a survey of roughly 60,000 households.  This survey produces the unemployment rate.  The establishment survey is a survey of 375,000 businesses.  This survey produces the nonfarm payrolls, average workweek, and average hourly earnings figures, to name a few.  Both surveys cover the payroll period which includes the 12th of each month.  The reports both measure employment levels, just from different angles.  Due to the vastly different size of the survey samples (the establishment survey not only surveys more businesses, but each business employs many individuals), the measures of employment may differ markedly from month to month.  The household survey is used only for the unemployment measure -- the market focusses primarily on the more comprehensive establishment survey.  Together, these two surveys make up the employment report, the most timely and broad indicator of economic activity released each month.

10:00 - ISM Services (for July): Consensus 59.5

Big Picture: The non-mfg index has broken away from its more respected mfg ISM sibling given the vast sectoral differences and economic forces driving the two pieces of the economy.  The index isn't compiled from its components but dependent on a single question -- is business activity stronger, weaker or the same as a month ago?  Therefore the index can swing wide of the movement in the components.  The non-mfg ISM readings are a bit suspect given their extremely broad inclusion (entire economy ex manufacturing).  The non-mfg index seasonally adjusts only new orders and employment as the inclusion of all sectors outside of manufacturing leaves plenty of bounce given vast sectoral differences.  A level above 50 marks positive growth in non-manufacturing business
activity.  The index has rebounded from a four-year low in March to a one-year high in June.

Implications: The non-manufacturing ISM report is a national survey of purchasing managers which covers new orders, employment, inventories, supplier delivery times, prices, backlog orders, export orders, and import orders.  Diffusion indexes are produced for each of these categories, with a reading over 50% indicating expansion relative to the prior month, and a sub-50% reading indicating contraction.  The index should be far more indicative of the broader economy given its inclusion of service-producing as well as good-producing sectors outside of manufacturing.  However, the short history of the index dates to only July 1997 and doesn't provide the insight of a longer period inclusive of varied economic climates.  The seasonal adjustment of the index didn't begin until January 2001, with only 3 of the 9 components seasonally adjusted as of April 2001.  The lack of historical data and lack of a tight correlation to the non-manufacturing economy leaves the relatively poor "B-" rating compared to the "A-" rating of the well-respected manufacturing ISM index.


Source:  www.Briefing.com