Investment

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30. Dec 4, 2006 7:13 PM

» Normxxx - <b>Investment Strategy:

Investment Strategy: "Escape from New York Redux" [¹]

By Jeffrey Saut | 4 December 2006

As most of you know, I have been traveling a lot the past few months to speak at various conferences and seminars. This week will be no different as I leave Wednesday for Memphis. Last Friday's sojourn to New York City, however, was of particular interest because I attended, and spoke at, the first ever "Minyans in Manhattan" confab (www.minyanville.com). In attendance were such notables as: Barron's Michael Santoli, Steve Galbraith, Stephanie Pomboy, and Greg Weldon, to name but a few. While all of the speakers' comments were insightful, we found John Succo's (Vicis Capital) remarks about "risk" to be at the heart of what is currently occurring on Wall Street. To paraphrase John's comments:

When participants want to take on more risk in the various markets, they take out additional loans and buy assets with the money. When they want to assume less risk, they sell assets and buy Treasury Bills. That is the real driver of asset prices.

This is not an unimportant point for it suggests there is no need for an increase in money supply to drive assets prices, but rather a shift in "risk preferences" by participants. And maybe, just maybe, that is one of the reasons, when combined with a concurrent crash in gasoline prices, that equity prices have rallied since August despite the fact the adjusted money supply has been relatively flat (reference the St. Louis Fed's Web site). Indeed, as RCM Capital's Rob Parenteau opines:

"It is absolutely essential that you grasp this simple, but fundamental point, or you will spend many years lost in the wilderness searching for the penultimate global liquidity measure that explains any and all asset price movements. Such a Holy Grail to the investing universe does not exist because it is investor liquidity preference (aka risk appetite), not the actual pool of outstanding liquid instruments, that is the dominant force in asset pricing outcomes."

Currently, participants are assuming increasing amounts of risk as can be seen in the attendant chart of the Merrill Lynch Financial Stress Index (Chart 1).

How this "more risk" preference will end is anyone's guess, but history suggests it will not be with a whimper. Other "sound bites" from the conference that made our notes included:

Almost 2% of the NYSE's entire market capitalization has been taken private (read: LBO'ed) since the beginning of this year.

So much money is sloshing around in private equity funds that we now have the Jessica Simpson model of investing- "I don't know what it is, but I want it!"

Private equity funds are looking to "lever" corporate America's under-leveraged balance sheets and exploit them accordingly.

There are now more hedge funds than there are stocks and 60% of those funds are less than 5 years old. This trend will end with mediocre performance by most hedge funds.

Gold is going up against most assets. And, foreign energy stocks are making new all-time highs and "pulling" U.S. energy stocks higher.

The U.S. has the highest "real" (inflation adjusted) interest rates in the developed world, implying capital should continue to flow here.

If current profit margins, and free cash flows, are sustainable, then the equity markets can continue to levitate. However, a "mean reverting" world suggests we are long-of-tooth in this trend.

Sam Zell is not stupid! Therefore, the recent sale of his flagship REIT (EOP/$48.30/Underperform) should be viewed as a watershed event.

Bank indices are deteriorating against the S&P 500 Index (SPX). Since the Financials have roughly a 22% weighting in the SPX, this is troublesome.

If the rumors about a Home Depot (HD/$38.97/Outperform) LBO were for real, the long-dated call-options on HD should have collapsed and that just didn't happen.

Volatility and Risk are currently being WAY under-priced by the markets.

Further comments from the conference may be found at Minyanville's "must have" Web site.

Another conference, where we recently pontificated, was centered on Growth and Technology stocks. This too was an interesting conference given that large-cap growth stocks are cheaper than large-cap value stocks for the first time in 25 years. This conference began with a quote from President John F. Kennedy. To wit, "Change is the law of life. And those who look only to the past or present are certain to miss the future." The future indeed as technology investment themes for the future were the dominate topic of this conference. While space constraints prohibit any discussion of these themes, we think you will get the idea from the following sound bites:

Managing, and/or the storing, of data; the sharing of data (collaboration); a shift from simply published content to a user community asking "what can I contribute?" (i.e., Minyanville's community approach); information aggregators; bandwidth; IT security; telepresence; nano technology; and, incorporating nano technology into healthcare devices leading to radical healthcare breakthroughs.

While there are clearly more technology themes afoot than these, we scribed these as the most important takeaways from the conference. Interestingly, last week's Business Week magazine contained an article titled "The Future of Tech," which contained the nearby chart of "enablers" for the next wave of gadgets and services (Chart 2).

Turning to the stock market, there were some interesting developments in our absence. For example, the D-J Transportation Average (DJTA) continued its upside non-confirmation of the D-J Industrial's (DJIA) "march" to new reaction highs. According to Dow Theory, this is problematic. Meanwhile, the D-J Utility Average (DJUA) tagged a new all-time high as things continue to become "curiouser and curiouser." Moreover, last week's weakness in the DJIA/DJTA caused both of those indices to break down below their respect up-trendlines that have offered support since last summer's lows. Not so the NASDAQ, which successfully tested its respective up-trendline. However, the Dollar Index (@DX.1/82.42) was another story as the greenback broke below this year's lows and looks like it will test generational lows between 78.19 and 80.39 (Chart 3).

Also worth mentioning was the Goldman Sachs Commodity Index's 4.6% weekly rise, driven by Natural Gas (+13.63%), Unleaded Gasoline (+6.51%), and the "grains," on which we remain bullish. The strength in "grains" (corn, soybeans and wheat) is of particular interest since we have been unwaveringly bullish on them over the past few years. The "grains" strength is consistent with our views that given the burgeoning dearth of clean water, emerging countries will have to allocate their shrinking water supplies, implying that countries with abundant water, and arable lands, will become increasingly the suppliers of food to the 5-billion new entrants to the world's economies, but that is a discussion for another time.

The call for this week: As stated, our preferred near-term trading pattern called for a "trading top" during the holiday-shortened week of Thanksgiving leading to a pullback into the second week of December and sinking the foundations for the fabled "Santa Rally" into year end. Whether that plays, or not, only time will tell, but we remain cautious consistent with the old stock market 'saw,' "If Santa fails to call, the bears will roam on Broad and Wall!" We continue to invest, and trade, accordingly . . .

-- posted by Normxxx

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31. Dec 11, 2006 6:28 PM

» Normxxx - "Dr. Doom"

Investment Strategy: "Dr. Doom" [¹]

By Jeffrey Saut | 11 December 2006

Well, it finally happened, last week one of my own gang called me Dr. Doom. I guess it was inevitable because in this business if you are not forecasting "Dow 20,000" you are deemed a "bear." However, the veiled reference to Dr. Doom and Dr. Gloom of an era gone by is not exactly appropriate. Indeed, the dynamic duo of Dr. Henry Kaufman (Dr. Doom) and Dr. Albert Wojnilower (Dr. Gloom) were the market gurus of the day in the 1970s and were predicting the end of the economic world as we knew it. Clearly that has not been our mantra, as anyone reading these missives since 1999 knows.

Verily, we turned cautious with the Dow Theory "sell signal" of September 1999 and looked like an idiot as the markets traded higher into their 2000 "tops." That said, we stayed cautious on the overall averages into the 9/11/01 tragedies despite the fact that we posted decent investment returns over that 24-month period using individual stocks and mutual funds. Following the Trade Towers, we turned pretty bullish on a trading basis and were aggressively bullish at the November 2002 lows and again at the March 2003 subsequent retest of those November 2002 lows. All of our bullish "calls" on the U.S. Indices, however, have been within the context of our "range-bound" stock market thesis. And notably, the S&P 500 remains in a trading range locked between its peak of 1553 and its reaction low of 775.

Moreover, anyone listening to our continuing message of the past five years knows we have been unwaveringly bullish on "stuff" (oil, gas, coal, timber, fertilizer, agriculture, base/precious metals, cement, water, and anything remotely related to our long-standing stuff-stock theme). We have also been steadfastly bullish on the emerging markets over that same timeframe, which has produced some spectacular returns for our clients. Most recently, the emerging markets have continued to outperform their U.S. "brethren," for despite the S&P 500's 12.9% year-to-date gain, Bombay is up 46.8%, Caracas is better by 123.4%, Jakarta has gained 52.7%, Mexico has climbed 44.7%, Brazil has improved by 36.7% . . . well you get the idea.

While we have been wildly bullish on most of these markets, our conservative vehicle of choice to play such venues has been MFS's International Diversification Fund (MDIDX/$16.04), which checks ALL of the investment style-boxes, and has returned 24% year-to-date net of fees. So if you want to "hang" the Dr. Doom moniker on us that's fine, we'll monetize that title all the way to the "bank" content in the knowledge that you have plainly not been listening to our strategic message of the last seven years. Or as one money manager emailed us last week:

"I just listened to your verbal strategy comments of last Tuesday. You said you have been too cautious on the aggregate indices over the past few months. Well maybe that's true, but there were some other successes you didn't mention that have been very impressive (you may have mentioned them on certain calls, but I didn't hear them all because I missed a few): i.e., EWM (you felt strong about Malaysia- low inflation/strong growth); EWC and EWZ- similar; water, water everywhere- VE, SZE, ITT, and WTS; nickel- Inco and Falconbridge; the grains (wheat, corn, soybeans, etc.)- BG; the repeal of PUHCA- POM, ITC, and unofficially ILA; many of the tech stocks "in drag" like ROG, IN, S, TWX, ORCL, AMT, SBAC, etc.; as well, you recommended MANY of the Exchange Traded Funds/Holders, and numerous mutual funds, that have produced HUGE gains for our investors. These are just a few of the ideas I own for myself and many clients that have been very good, and in some cases, great! I know you were only alluding to your caution of recent history, but while we are not doing a lot of 'trading' right here, we are thrilled with the calls you have made and we love your themes!!!!!" . . .

To which I replied- thank you very much!

As for the "here and now," we have deemed the recent performance by the major market indices to be somewhat "unnatural." Markets typically go up, correct by 25%, and then re-rally if they are going to trade higher. This, ladies and gentlemen, has not been the case recently as the averages have "unnaturally" vaulted higher without so much as ANY correction. We have suggested this phenomena was triggered by Goldman Sachs' re-weighting of its much institutionally indexed commodity index last July. Why Goldman would mysteriously reduce the weighting of gasoline from 7.3% to 2.5%, in a gasoline-centric economy, and stage those reductions incrementally right into the November elections is a mystery to us, but there you have it.

Following that, the Department of Energy mysteriously said it would not add to the Strategic Petroleum Reserve (SPR) until after the winter months, even though the SPR was below prudent norms. This is also a mystery to us, but once again there you have it. Then, when it looked like the equity markets were set-up to correct (read: decline) in mid-October, the NYSE petitioned the SEC, and was granted, a mysterious reduction in margin requirements for an already over-margined hedge fund community. And that "mysterious surprise" gave the major market indices another leg-up (read: re-rally). Again, why in the world one would introduce more leverage into an already over-leveraged hedge fund community is a mystery to us! Also mystical is why every time the equity markets look like they are set up for a downside correction, do "buyers from Mars" appear in the futures markets to prevent a decline? We have documented such occurrences in past missives where those "mysterious buyers" have shown up at 6:30 at night and "bid" the S&P 500 futures from 1375 to 1397 (or +22 points) in a mere two minutes, but that is a discussion for another time.

The current unnatural state of the equity markets continues to leave us cautious; although we have learned the hard way it is difficult to "break" the equity markets to the downside during the ebullient month of December. Consequently, our sense is that the markets will consolidate here and then attempt to trade higher into year-end. If the S&P 500 can vault above 1415, with conviction, we can see near-term objectives into the 1440 - 1445 level. While we are disinclined to play the indexes on a trading basis, we have purchased some stocks recently in investment accounts. For example, we bought HCC Insurance Holdings on its options back-dating scandal that caused the company's CEO to resign. At the time the shares had declined to where they were trading at roughly 1.5x book value for only the second time in HCC's history. We also recommended Strong Buy-rated Opsware, on its recent earnings "miss," and concurrent share price decline to $7.80, since the market for its IT automation software is new and un-penetrated, giving Opsware the ability to gain momentum and build its brand awareness. Another name for your consideration is Joy Global, which is rated Equal Weight by our research affiliate Lehman Brothers with an attendant $57.00 per share upside price target. Since the shares are down from their $72 mid-March 2006 high, hopefully they have already been through their respective bear market.

The call for this week: Over the past few weeks ALL asset classes have rallied. However, that "all skate" environment changed last week with most of the commodities we monitor turning down in price. Sill, many of our proprietary stock indicators made new all-time highs, yet the D-J Industrial Average (DJIA) has failed to post a new closing high since November 17th. More importantly, the D-J Transportation Average (DJTA) has not confirmed the DJIA's "march" to new all-time highs. Indeed, the Transport's remain well below their all-time high of 4998.95 that was recorded last May. According to Dow Theory, this is a another cautionary "red flag." Also arguing for caution is the current overbought nature of the equity markets. Meanwhile, the 10-year T'Note bottomed at a 4.40% yield last week, and closed Friday yielding 4.55%, and the D-J Utility Average registered a "buying climax" (read: potential top). Further, we got a short-term "buy signal" on the U.S. Dollar Index last week (read: stronger dollar), and a short-term "sell signal" on the precious metal, as the cognitive dissonance environment continues. We continue to invest and trade accordingly . . .

-- posted by Normxxx

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32. Dec 28, 2006 8:02 PM

» Normxxx - Investment Strategy

Investment Strategy [¹]

By Jeffrey Saut | 26 December 2006

"What are we doing now that might implode, as did the tech boom of the late 90s and the real estate boom of the late '80s? Like everybody, our biggest fear in advising clients is not for the short term, or the to-be-expected pullbacks, but the big mistakes that we make. What might rise up to bite us in 2007?"

Well, the 'fooler,' in 2007, may be that the economy re-accelerates and the Fed actually raises interest rates. That potential scenario was reinforced by our sojourn to Washington, D.C. last week to see old friends on Capitol Hill.

Having lived around "The Beltway," we have a pretty decent sense for how the political winds blow. Last week's visit to "The Hill," however, surprised us. Indeed, we arrived thinking that political gridlock was likely to be the course over the next few years, but that sense changed after a few conversations. Surprisingly, we found many of our Republican and Democratic leaders pretty much in agreement on numerous things. Of particular note was a near unanimous agreement between the Congressional folks from states devastated by companies moving jobs offshore. While said Congressmen can't force companies to keep jobs in their states, one thing they can do is vote for an increase in the defense budget and mandate that those attendant high-paying jobs be kept in the United States. The last time such a defense build-up occurred was during the Reagan years and it led to a BOOM in economic activity punctuated by near 8% GDP growth. And maybe, just maybe, that is what the stock market is "seeing." The quid pro quo is that such a boom would obviously be accompanied by more rate ratchets from the Fed . . . aka, "the fooler."

Whatever the outcome, we have been bullish on the defense sector since 4Q99, and bullish on the homeland security space since 4Q01. While we have recommended most of the major defense stocks over the last seven years, the easiest way for investors to play this theme is via the Exchange Traded Funds (ETFs). Consistent with that, we suggest considering the iShares Aerospace & Defense Index (ITA/52.97) and the PowerShares Aerospace & Defense Portfolio (PPA/18.47). As for homeland security, our fundamental analyst's favorite idea currently is L-1 Identity Solutions (ID/$15.30/Strong Buy). L-1 Identity Solutions, Inc., formerly Viisage Technology, Inc., is engaged in developing technologies to solve identity-related problems. Its customers include government entities, law enforcement and border management agencies, and commercial enterprises.

The call for this week: Just about every major index we monitor was lower in price last week except for the grains (corn, wheat, soybeans, etc.). Particularly troubling was the D-J Transportation Average's (DJTA) break below its 200-day moving average (DMA), leaving the Transports bearishly configured. Combining the Transport's breakdown with economically-sensitive copper's similar slide caused one Wall Street wag to lament, "Can you spell recession?!" While we are still not in the recession camp, we do think the odds of a recession have risen, especially when one studies the nearby housing chart from the good folks at http://www.stockcharts.com. As for this week, "If Santa fails to call, the bears will roam on Broad and Wall."

-- posted by Normxxx

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33. Jul 21, 2007 7:59 PM

» Normxxx - “Food Fight!”

Investment Strategy: "Food Fight!" [¹]

By Jeffrey Saut | 18 July 2007

A man lived by the side of the road and sold hot dogs. He was hard of hearing, so he had no radio. He had trouble with his eyes, so he had no newspapers. But he sold good hot dogs. He put up a sign on the highway telling how good they were. He stood by the side of the road and cried, 'Buy a hot dog, mister.' And people bought. He increased his meat and bun orders and he bought a bigger stove to take care of his trade.

He got his son home from college to help him. But then something happened. His son said, 'Father, haven't you been listening to the radio? There's a big depression on. The international situation is terrible, and the domestic situation is even worse.' Whereupon the father thought, 'Well, my son has been to college. He listens to the radio and reads the papers, so he ought to know.' So, the father cut down his bun order, took down his advertising signs and no longer bothered to stand on the highway to sell hot dogs.
His hot dog sales fell almost overnight. 'You were right son,' the father said to the boy. 'We are certainly in the middle of a great depression!'

. . . Author Unknown

I recalled the aforementioned story as I got off of the plane at LaGuardia last Monday and sauntered up to a hot dog stand. I said, "One hot dog please." He said, "That'll be $3.49." I said, "Isn't that a lot for one hot dog?" He said, "Just wait until next year!" After climbing into a cab and heading for Manhattan I warped into my email and the hot dog vendor's comments became clearer. One email read:

"I bought the last 140 bales of hay in Hume this morning. The hay people in Pennsylvania are out, the hay people in Ohio are out and the Maryland people have been out for a while. The cattlemen are worried because the Rappahannock and the Jordan rivers are dried up, as are most of the ponds. We will have cheap steaks as they take this year's cattle to slaughter and expensive steaks next year. We really need rain. Water is a valuable commodity just in case you didn't know!"

With that, I looked at gain prices year-over-year only to find corn up 40%, soybeans up 50%, and wheat surging 67%. Upon arriving at my hotel I called the ex-CEO of a major meat processor that I used to cover as a research analyst. "Joe," I said, "What's going on with the price of grains and the meat processing business?" His answer was succinct:

"So far the explosion in grain prices hasn't really fed through into the price of meat because we have had commodity hedges in place whereby we bought corn for future delivery when prices were low. However, those hedges are now expiring and nobody, but nobody, can feed a hog and bring it to market profitably at $0.70 a pound with corn above $3.00 a bushel. Consequently, it's just a matter of time until we get a big upside move in meat prices as they have already seen in China (food prices in China account for over one-third of the CPI, but here they are only 14%)."

Disingenuously, however, our government excludes food and energy in the nation's "core" inflation statistics because of their alleged "short-term" volatility, but consider this. Since August of 2004 crude oil has averaged WELL above $50 per barrel. Surely three years is long enough to admit that maybe, just maybe, high oil prices are here to stay and ought to be included in the CPI, a point well argued in last Wednesday's Wall Street Journal. Speaking to grain prices, while their price rise is only a year old, it is hard for us to envision that higher food prices are not permanent as well. Indeed, when you examine the Producer Price Index (PPI) you find that the raw food component was up 25% in April and up more than 30% in May. Ladies and gentlemen, when you get these sorts of price increases it is merely a matter of time until they bleed over into prices at the supermarket. We think you are going to see this trend increasingly reflected in 4Q07 and continuing for the foreseeable future.

For the last six years we have been energy "bulls" and remain so even though we think in the short-term that money flows, seasonality, and tough earnings comparisons are likely to provide a challenging backdrop for energy stocks over the next few months. Likewise, we have been agriculture "bulls" since Bunge Corporation (BG/$84.70) and Potash (POT/$83.51) were "teenagers" and Caterpillar (CAT/$85.13) sported a 5% dividend yield. Unlike energy, however, we don't think the next three to four months will prove difficult for the agriculture complex. Manifestly, we believe that we are in the early stages of the greatest agricultural bull market in history. Even the government's understated inflation figures suggest this could be the case as food inflation is rising at its fastest pace in 15 years. As these increased cash flows accrue to the farming complex, spending on farming equipment, irrigation gear, fertilizer, etc. should continue to rise.

What we are, and have been, suggesting is that the disinflationary environment of the last 20 years is in the "rearview mirror" and inflation is on the rise. How high it rises is unknowable, but it is plain that the pillars suppressing inflation for so long are eroding. And maybe that is what the markets sniffed out last week, for seemingly simultaneously participants sold the U.S. dollar, which broke to new reaction lows, and/or converted their U.S dollar cash reserves to stocks, commodities, base/precious-metals, art, farmland, etc. Even bonds rallied (i.e., lower long-term interest rates), which is pretty strange since it is difficult to find any instance where investors made money buying bonds when agriculture prices were strong. The result left most of the major indices we follow on upside breakouts to new all-time highs. Over the past few months we have suggested this might be the case, often noting:

"As for the equity markets, last week's holiday-shortened environment still saw stocks traveling higher. And, while participants should typically be cautious of drawing conclusions from such a low-volume, holiday-interrupted environment, last week's action was impressive. 'Impressive' because stocks rallied despite a rise in the 10-year Treasury yield from 5.03% to 5.19% as the Bank of England raised interest rates for the fifth time this year to a now 5.75% rate. 'Impressive' because the D-J Transports gained 2.6% for the 3½-session trading week despite crude oil's 3% weekly gain to a 10-month high of $72.81. 'Impressive' because crude oil continues to trade higher while natural gas continues to trade lower. 'Impressive' because private equity firms continued to pay some pretty fancy multiples for public companies. 'Impressive' because . . . well just plain impressive! The result left most of the indices we follow higher for the week and us with a short-term 'buy signal' on the S&P 500 (SPX/1530.44)."

Speaking of upside breakouts and buy signals, General Electric (GE/$39.50) tagged a new reaction high last week, as did Intermec (IN/$27.06/Outperform), NII Holdings (NIHD/$87.00/Strong Buy), and Covanta (CVA/$26.10/Outperform), to name but a few of our recommendations. For the ETF/closed-end fund crowd, Thai Fund (TTF/$14.30), PS Water Shares (PHO/$21.73), and PS Aerospace & Defense (PPA/$22.29) continue to perform well. As for our numerous recommendations in the open-end mutual fund arena, in addition to many of the Quaker Funds, Pimco Funds, Ivy Funds, MFS Funds, etc., confidence in our newest addition, the MFS Sector Rotational Fund (SRFAX/$19.83), was bolstered last week by a GREAT article in last Thursday's Wall Street Journal titled "Asset-Allocation Funds May Help Returns." The gist of the article noted that, "Investors are likely to hold asset-allocation funds substantially longer than either equity or fixed-income funds, the 20-year analysis showed." And don't look now, but our position in the MFS International Diversification Fund (MDIDX/$17.89) is up 14.82% for the year sans commissions.

The call for this week: We'll say it again; we are having one heck of a year, not because we have been so prescient on the major market indexes, but due to stock picking. And even though we have been too cautious on the major averages due to their optimistic valuations, last week's upside breakout of the potential triple-top by the S&P 500 reinforces our continuing mantra that, "the upside should be given the benefit of the doubt." Indeed, back in May with the Wilshire 5000 (WILL/15700.95) at 15300 we stated that the Wilshire's price objective was 16000 and evidently the "bulls" that live by the side of the road are listening and not paying any attention to the bear growls.

M O R E. . .Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

-- posted by Normxxx

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34. Aug 14, 2007 2:28 PM

» Normxxx - The Panic of 1907

"The Panic of 1907, or The Bankers' Panic" [¹]

By Jeffrey Saut | 13 August 2007

Early in the 20th century most banks were prohibited from forming and administering trust accounts. Therefore, trust companies were created to deal/invest in businesses, stocks/bonds, commodities, etc. By definition, a trust account is, "An account established under a trust agreement containing funds administered by a trustee for the benefit of another person or persons" (if that sounds a lot like our modern day hedge fund business, it should). Initially, these early century trusts were conservative in nature, but over time they morphed into highly speculative vehicles using leverage (read: margin accounts) to become heavily invested in the various markets. Unsurprisingly, as their popularity and profitability grew, trust companies became intertwined with the banks via bank board members, directors, wealthy clients, etc. who could indeed own trust companies. Consequently, by 1906 the web of interconnectivity between large/rich market speculators, trust companies, and banks had become almost invisible.

[ Normxxx Here:

This was the 'invisible web' that caused all markets suddenly to correlate and cooked LTCM's goose.

]

The increasingly speculative investment binge being driven by the burgeoning "trusts," and amplified further by the "new era" mindset ushered in with the Wright Brothers' historic flight in 1903, lifted the "Industrials" (now called the D-J Industrials) from their low of 42 in 1903 to their high of 97 in the fall of 1906. Similarly, the "Rails" (now called the D-J Transports), which was the major index back then, rose from its 1903 low of 88 to a high of 138 over the same time frame. And then it happened, the U.S. Government began anti-trust suits against Standard Oil of New Jersey and American Tobacco. While these are clearly not the investment "trusts" to which we have been referring, the government's intervention/regulation seemed to "prick" the market's speculative bubble as stocks traded sideways into year-end and then started to decline in January 1907. The decline accelerated over the course of the year and turned into a full-blown panic in the fall of 1907.

At the center of the panic was Montana's "copper king," F. Augustus Heinze, who had sold most of his mining shares for the tidy sum of $12 million in 1906, moved to New York City, bought a bank, and became involved in banking and trusts. It was already a sluggish time on the "Street of Dreams" with the economy muddling, credit contracting, stocks stalled, new bond issuance almost non-existent, and everyone reluctant to loan money. Amid that environment Mr. Heinze attempted to "corner" (read: gain control of) the shares of United Copper. His attempt failed and with that United Copper's share price fell 76% in two days. The headlines read, "Copper Breaks Heinze." Since Heinze controlled a chain of banks, it was rumored those banks were involved in the attempt, causing frightened depositors to withdraw their funds. Those fears were contagious, since Heinze's failed scheme revealed a web of interlocking directorships between banks, brokerage houses, and trust companies, and the "run" on New York City's banks/trusts grew.

With the stock market in full retreat "margin calls" proliferated and the "dash for cash" spread across the nation, sending "call money" interest rates from 6% to over 100%. Because the banks were in direct competition with the trust companies, the bankers had no vested interest in attempting to bail-out the "trust" and when Knickerbocker Trust Company failed the financial fires roared out of control. While not the worst financial crisis the country had seen, it was one of the most important, for it led to the creation of the Federal Reserve System in 1913.

We revisit the "Bankers' Panic" this morning not because we are predicting similar events, but because even after 100 years the parallels are interesting. As stated, we think the seeds for the 1907 panic were "planted" in 1906 with the government's anti-trust intervention. Coincidentally, we have often repeated that our biggest worry currently is the government's increasing movement towards protectionism, intervention, and regulation. That movement can be seen in the ill-advised political-pandering toward protectionism, as well as the potential intervention/regulation of the hedge fund community. Granted, one could substitute the words "hedge funds" for their 1907 counterparts "trust companies" and draw some interesting parallels, but with the country's banking complex in good shape the comparisons stop there.

Nevertheless, credit is tightening, the economy appears to be slowing, stocks are stalling, and the spider web of finance between banks, hedge funds, and private equity is legion. Moreover, there appears to be a seizure in the financing mechanism often referred to in these missives as the "Tinkers to Evers to Chance" sequence. In this case, however, we are not referring to the fabled double-play baseball artists of an era gone by, but Tinkers (being the investors needing the money) to Evers (the banks creating the loans) to Chance (the investors buying those loans). Recently, however, this financing sequence has been called into question, causing one savvy seer to exclaim, "What happened to Chance?" What happened to Chance indeed, for it appears that Chance has walked off the field and is waiting to see if the price decline in the "loans" is contained or if it is spreading.

Plainly, the "loans" in question are of the subprime flavor, which as measured by certain indexes have lost roughly 70% of their value over the past few quarters. For leveraged investors attempting to eke out incremental returns in the subprime mortgage complex the result has been a disaster. Last week the subprime contagion spread abroad as a number of investment funds "froze" withdrawals of investors' money. The situation is concerning because since the beginning of the year our understanding is that only $200 billion worth of such adjustable rate mortgages have repriced their interest rates at higher levels. It is forecast that over the same seven months in 2008 an anticipated $600 billion will reprice.
Consequently, it is difficult to envision just how "contained" the situation can be.

Certainly the bond market thinks there is a problem given the decline in the 10-year T'note's yield since mid-June. Alarmingly, those lower interest rates have done little to stabilize stocks with a top-to-bottom price-decline for the Russell 2000 of 12.6%, an 8.2% S&P 500 slide, and a 6.7% Dow Dip. All three of those indices peaked on July 19th, making last Friday the 16th trading session off of the "top." Despite investors' panic, we have argued that on a short-term basis participants should take heart, for our work suggests that these selling-stampedes tend to run only 17 - 25 sessions before exhausting themselves on the downside. While a few such skeins have extended for 25 - 30 sessions, anything over 30 sessions is rare. Therefore, this week shapes up as a pretty key week.

Consistent with these thoughts, we think the averages will make a trading bottom shortly. As to whether the Fed cuts interest rates to precipitate that bottom depends on if the indices are involved in a mini-crash or not. Failing a crashette, we seriously doubt the Fed cuts rates. Rather, we believe the markets will merely exhaust themselves on the downside. Of more importance is if the subsequent "throwback rally" sustains itself above S&P "1500." Our fears of sustainability center on the ferocity of the three-week heart attack decline combined with the unusual occurrence of three 90% downside-days where points lost, and advance/decline figures recorded, showed over 90% negative daily readings since the July 19th highs. In fact, if the downside day of June 7th is included, there have been four downside days without an intervening 90% upside day. This is not an unimportant point, for as the Lowry's service notes, "Multiple 90% Down Days serves as an important reminder of a critical change in investor psychology."

The call for this week: Ralph Waldo Emerson once noted, "Most men gamble with her (fortune) and gain all, and lose all, as her wheel rolls." Regrettably, Frederick Heinze was not satisfied with his $12 million fortune prior to the "Panic of 1907" and lost it all. We, however, are not so greedy! Our portfolios are "up" nicely this year with the Analysts' Best Picks List better by 24.5% and the Strong Buy List gaining 9.9% while the Focus List has improved by 10.0%. We believe that risk appetites are now falling, implying risky assets are likely going to underperform going forward. This should give retail investors a huge "leg up" on institutional investors since they can re-jigger their portfolios more quickly. We continue to invest accordingly.

-- posted by Normxxx