Archive for October, 2006

The S&P 500 is Running on Fumes

October 31, 2006

Earlier this month, 426 of the S&P 500 stocks were trading above their 50 day moving averages. That figure has declined to a current tally of 398.

Every time in the last three years that more than 400 of the S&P 500 stocks have been trading above their 50 day moving averages, the market has been at or near a short-term peak, and a period of weakness has followed.

Conversely, every time that fewer than 100 of the S&P 500 stocks have been trading above their 50 day moving averages, the market has subsequently rallied.

This relationship can be charted and studied at with the ticker symbol $SPXA50.


A Comparison of Exchange-Traded Foreign Currency Products

October 30, 2006

These new ETFs have been trading long enough to see how they are faring in the market. I have prepared a table which shows the facts. I can’t figure out how to insert the table directly into the blog, but you can view it by clicking the link below.

At this time, only FXE and DBV have enough trading volume to be really liquid. FXF could be traded with careful use of limit orders. The rest are languishing. All of these ETFs except DBV are the synthetic equivalent of owning the currency in a foreign money market account. For example, one share of FXE is equivalent to a deposit of 100 Euros.

DBV is different from the others. It is a synthetic carry trade. They buy the three highest-yielding currencies and sell short the three lowest-yielding. While this strategy can be an effective means of generating profits, I am not at all sure that DBV’s price movements will show a negative correlation to the U.S. Dollar; in fact, there may be a positive correlation.

FXE is clearly the best choice for a low cost, exchange-traded hedge against a weakening dollar.


Crosstex Energy LP (XTEX)

October 28, 2006

I really like Crosstex but my portfolio is excessively overweight in energy, so I’m not going to buy unless the valuation becomes compelling.

XTEX has a ticker symbol and a website that any native Texan will love. The shares have a current yield of 5.79% and a beta of .56. XTEX shares actually consist of units of a master limited partnership, not ownership of Crosstex, whose equity shares are traded separately under the symbol XTXI.

The generous income distributions might involve tax complications in the form of return of capital when the company is losing money, but income from the units is probably safe and there is capital appreciation potential. Crosstex Energy appears to be ideally positioned to gather, process and transport natural gas from new fields in the region, and there is plenty of gas in the ground waiting to be pumped.

According to the company’s website, “Crosstex Energy, L.P., a midstream natural gas corporation headquartered in Dallas, operates over 5,000 miles of pipeline, twelve processing plants, four fractionators, and approximately 168 natural gas amine-treating plants in service and 37 dew point control plants. Crosstex currently provides services for over 3.0 Bcf/day of natural gas, or approximately 6.0 percent of marketed U.S. daily production based on August 2005 Department of Energy data.” This is a small company with a market cap of about $1.5 billion. The website notes that XTEX was named one of the best places to work in 2006 by the Dallas Business Journal.

The “down home” gas business has a completely different set of fundamentals from the international oil business. It can get very cold in Texas and surrounding states in the winter; the people there are not used to being cold, they don’t like it, and they burn gas for heat. Most of this year’s natural gas price weakness can be attributed to last year’s abnormally warm winter, which left gas supplies in storage last spring at unusually high levels and curtailed demand for replacement gas. But one good cold cold snap can get the gas moving in those pipelines at a pretty good clip.

Turning to technical analysis, this security has only been trading for four years but it has done surprisingly well for a MLP, outperforming the S&P 500 by a factor of four. There was a 2-for-1 split in March 2003. The uptrend has flattened out in the last year.

Taking a closer look at the last two years of price data we see XTEX is trading about 18% below the all-time high reached in August 2005. For the last year Crosstex has been bouncing along sideways in a loosely formed ascending triangle with resistance above 38. If XTEX made a good thrust above 38 it would be very bullish. There has been good support and someone has been buying a lot of XTEX on dips all year.

But another mild winter combined with general price weakness in the energy pits could send XTEX tumbling to major support at 30. It would be hard to resist buying some at that price.

The Role of Intuition in Investment Decision-Making

October 27, 2006

We must all deal with our feelings and emotions as a part of the investment decision-making process.

Sometimes intuition will come to our aid: A stock can look like a great investment, and our timing indicators may look perfect, but there is something not quite right about it. So we wait. Very often factors will come to light later showing that the investment would have been a mistake.

We must not confuse intuition with fear or greed. When the bottom has dropped out of the market, and the headlines say the Dow is going to zero, that is the time to buy. We must struggle against a sinking feeling in the pit of our stomachs in order to jump in at the right time.

The feeling of intuition does not have a physical component like fear or greed. It is just a quiet little voice in the back of your mind, saying: look before you leap.

Several days ago, BioHealth Investor pointed out H&Q Life Sciences Investors (HQL), a remarkable closed-end fund that has a dividend yield of 8%, and is selling at a discount to net asset value, while being invested in many of the most promising public companies in the biomedical industry, and also in some privately held companies. The fund holds warrants and convertible securities in addition to common stock. Some of the portfolio holdings look quite attractive:

Gilead Sciences (GILD)
Conor Medsystems (CONR)
IDEXX Laboratories (IDXX)
Cubist Pharmaceuticals (CBST)
Theravance (THRX)
Lexicon Genetics (LEXG)
Genzyme Corp (GENZ)
United Therapeutics (UTHR)
Exelixis (EXEL)
Epix Pharmaceuticals (EPIX)

The long-term chart
shows that HQL has been around since 1992, and briefly traded above 45 in 2000. Since then it has retreated to its former trading zone below 15, and now sells at a 70% discount to the price in 2000.

The fund states it intends to maintain a fixed distribution policy of 2% per quarter, using net realized capital gains; however, if the amount of the distribution exceeds the Fund’s net investment income and realized capital gains, this distribution policy would result in a return of capital to shareholders. This policy will result in significant taxable income and/or tax complications, so it would be best to hold HQL in a tax-sheltered investment account such as an IRA. No problem there.

The short-term chart is a bottom-fisher’s delight. Large investors have abruptly moved a lot of money into this closed-end fund. BioHealth Investor says that includes fund management. There is a clear implication that somebody knows something the market doesn’t know yet.

But my intuition is telling me that something is wrong, so I’m going to leave it alone. There are plenty of opportunities out there and we have to be selective. If HQL goes back to 45 and I miss out on it, that’s okay too; I don’t have to be right all the time.

PowerShares Water Resources Portfolio (PHO)

October 26, 2006

I have been interested in PHO since it started trading last year, and I became more interested recently, when I learned it has been trading with a negative correlation to utilities. Utilities are a major portfolio holding and they seem too high to me right now. I have been looking for a good excuse to establish an initial position in PHO as a hedge and as an investment in its own right. PHO’s 50 day moving average just crossed above the 200 while both are rising, the so-called “Golden Cross”.  So the major trend has turned up, and this may be a a good time to invest for the long haul, although PHO is no blue-light special. It is only trading about 6% below the all-time high of 18.969 reached last May. Nevertheless I am happy to welcome PHO to my portfolio and I expect good things of it.

World water demand is surging due to rising population trends. Many booming economies are already experiencing critical water shortages. Over time, the cost of water must rise to ration supplies. Much money will be made in the discovery, production, purification, distribution, recycling, and sale of water. PHO is a perfect vehicle to invest in the water theme. This is as close to a no-brainer as I have seen for a while.

The PowerShares Water Resources Portfolio is based on the Palisades Water Index. The Index seeks to identify a group of companies that focus on the provision of potable water, the treatment of water, and the technology and services that are directly related to water consumption. The modified equal weighted portfolio is rebalanced and reconstituted quarterly. The underlying index would have dramatically outperformed the S&P500 and the DJIA during the last eight years, but it is much less volatile, with a beta of .68. Of course the underlying index is not subject to fees and expenses, PHO’s portfolio does not exactly match the index, and past performance is no guarantee of future results.

PHO has an expected dividend yield of .78% and an expense ratio of .60. The fund’s current holdings listed by sector can be viewed here.

Note that this ETF invests in foreign as well as domestic equities.

Investment Themes for 2007 and Beyond

October 25, 2006

The U.S. economy is likely to be be weaker than the global economy.
A. The dollar should be flat to lower.
B. This will result in increased U.S. exports and should be bullish for U.S. large-cap blue chip stocks.
C. Increased U.S. exports could also offset weakness of the housing market and result in a soft landing.
D. Major foreign stock market indexes should do well relative to the S&P 500.
E. Assets denominated in major foreign currencies should be flat to higher against the dollar.
F. If the dollar falls, causing commodity prices and inflation to rise, it will be bearish for U.S. bonds.

S&P 500 sectors which are “riding the wave” in scientific research and engineering innovation should outperform the S&P 500 itself.
A. Health Care
B. Info Technology
C. Telecom

If energy, commodity prices, real estate, and U.S. inflation fall in the short term, they are certain to rise in the long term. Accumulate on weakness:
A. Energy producers.
B. Metals and mining companies.
C. Inflation-protected securities.
D. Real estate, forestry companies which own much real estate per share, and possibly homebuilders.
E. Assets denominated in Canadian and Australian dollars.
F. Water resources.

We are likely to see a trend to increased participation by Democrats in the U.S. government for at least several years.
A. Taxes and government spending on domestic social programs will tend to rise.
B. Defense spending and military campaigns abroad may fall.
C. The stock market typically responds well to Democrats and to governments where Democrats and Republicans have equal power.

Buy Savings Bonds Online from the U.S. Treasury

October 24, 2006

Savings bonds from the U.S. Treasury do not trade on the open market so they are easily overlooked. But savings bonds are a safe investment small investors can use for long-term savings, and they might be useful for folks in higher tax brackets too: you can sock away some money you would like to shelter from taxation, which you are sure you won’t need for 5 years, and maybe not for 30 years; while you retain the option to use some of this money to pay for educational expenses later on, without being taxed on the interest.

Savings bonds can not go down. There are no transaction fees, they earn a modest return which can increase if inflation rises, and they pay interest which is completely invisible to taxation for up to 30 years. They are easy to purchase directly from the U.S. Treasury online.

There are two types: EE Savings Bonds and I Savings Bonds. The difference between them lies in the way interest is calculated and paid. EE bonds pay a fixed rate of return, currently 3.70%. Rates for new issues are adjusted each May 1 and November 1. The new rate will be effective for for the full life of all bonds issued in the six months following the adjustment. I bonds pay a variable rate throughout the life of the bond which is periodically adjusted for inflation. The initial rate for I bonds purchased now is 2.41%. The rate is adjusted each May 1 and November 1 based on the CPI. The important thing is that if inflation becomes serious in the future, I bonds purchased now could receive much more interest than EE bonds purchased now.

The two types of bonds have many common features. Both are accrual-type securities; interest is added to the bond monthly and paid when you cash it in. They both offer an interest-earning period of 30 years, and have early redemption penalties: forfeiture of 3 months interest if redeemed within 5 years of purchase. Interest earnings are exempt from State and local income taxes. Savings bonds are subject to federal income tax, but payment can be deferred until redemption. Federal income taxes will not be due if the proceeds are used to pay for educational expenses. There is a $25 minimum purchase and a $30,000 maximum purchase per individual per calendar year.

The savings bonds you purchase online are credited to your electronic account and you can check their value as interest accrues. To open an account with Treasury Direct, all you need is a social security number, a driver’s license number, a checking account, and an email address. You fill out a simple online application and choose a password, then they email you a Treasury Direct account number. About a five minute job if you have your numbers ready.

PowerShares International Dividend Achievers ETF (PID)

October 23, 2006

I bought another batch of PID last week. This ETF is an excellent way to increase exposure to promising foreign stocks while contributing increased dividend yield to the portfolio. PID has been rising steadily since I began buying it, but the current yield is still 2.85% as compared to 1.69% for the S&P 500, and volatility is lower, so I remain enthusiastic about accumulating shares of PID by means of dollar-cost averaging.

PID seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Mergent International Dividend Achievers Index.

“To become eligible for inclusion in the International Dividend Achievers Index a stock must be incorporated outside the United States, trade on the NYSE, NASDAQ or AMEX, and have increased its annual regular dividend payments for the last five or more consecutive years. In addition, Mergent requires that a stock’s average daily cash volume exceed $500,000 dollars in the two month period prior to reconstitution.” The portfolio is rebalanced quarterly and reconstituted annually.

According to charts provided on’s website, PID’s stragegy would have outperformed the S&P 500 and the MSCI-EAFE indexes over the past ten years.

Most of the fund’s assets are concentrated in large-cap value stocks, but small and mid-cap value and growth stocks are also included. The financial sector has the greatest portfolio weight at 34%.

The top ten holdings as of 10/18/2006 are:
Endesa S.A. 5.23%
A.F.P. Provida S.A. 4.59%
Telstra Corp. Ltd. 3.55%
Lloyds TSB Group PLC 3.41%
Unilever PLC 3.05%
Huaneng Power Intnl. Inc. 2.86%
Volvo AB 2.69%
National Grid PLC 2.56%
National Australia Bank Ltd. 2.55%
Barclays PLC 2.44%

What is the Philadelphia Bank Index Telling Us?

October 21, 2006

There is an old saying that no market rally can be sustained for long without the support of the financial sector, especially banking stocks. The Philadelphia Bank Index has been doing poorly compared to the S&P 500 for several months. This relative strength chart shows that relationship for the last year.

According to classical technical analysis principles, a double top formed during June and August. The neckline of that double top has been decisively penetrated. If the ensuing downward movement equals the height of the double top, this ratio could decline all the way to the .0774 area seen last October.

I think this is a bad omen for the stock market in general and for banking stocks in particular.

The bank stocks I have been looking at appear to be overvalued 15 to 20%. Meanwhile they are facing serious obstacles: not only the well-known threats to making money in the banking business, like a slowing economy, a falling housing market, and an inverted yield curve, but also new threats, like peer-to-peer lending on the internet. This phenomenon is growing rapidly and has the potential to seriously disrupt traditional banking if internet giants like Google or Yahoo get involved.

I would not be surprised to see a sharp correction in the banking sector and a general market correction of 7 to 10% by the end of the year.

Washington Mutual (WM)

October 20, 2006

Washington Mutual (WM) is the largest S&L in the country. The company has enjoyed excellent growth over the years (see chart).

However, that growth may be decelerating. A trendline drawn on the chart connecting the stock’s 1990 and 2000 price lows was penetrated in early 2005, and since then the price has moved sideways with a upward bias.

WM has a dividend yield of 5% as of the close on 19 Oct. and the beta is only .77. The company has an excellent history of raising their cash dividend, usually one cent every quarter, and there were six 50% stock dividends from 1986 to 2001. But the dividend payout ratio has been increasing.

After the close of trading on Oct. 18, WM announced that third quarter profit had declined to $0.77 per share as compared to $0.92 per share in the third quarter of 2005. It was stated this had to do with “ongoing efficiency initiatives”, which are expected to continue into the fourth quarter. The company says they are confident they will have stronger performance in 2007 despite the “challenging operating environment” (inverted yield curve and declining demand for loans?) and they have raised their dividend from .52 to .53 per share. This action increases the payout ratio to 69%. Study of the financial summary shows an increase in non-performing assets and a decline in loan activity.

The stock dropped more than 3% on Oct. 19. Still, it is trading less than 9% below its 52-week high.

WM’s dividend yield is tempting, but this is a “challenging operating environment” for investors! I could get interested in WM if the price goes down much more and I see evidence that the inverted yield curve is unwinding.