Southwest Ranch Financial, LLC
February 2008 Update
The S&P500 is at 1378 on 31-January-2008

This page can be linked to at   ( www.swranch.net/emails/2008-02.htm ).

The Southwest Ranch Financial Market Alert Timing Model is out of the stock market. 

Year to date, the S&P500 index is down 6.0% and the SWR Balanced Portfolio is down 1.5% (with half the stock market risk.)

Here’s the year to date performance of the SWR Balanced Portfolio by asset class.

As of 1/31/08

Market Alert Model
The SWR core model is out of the stock market.

Year Ahead Timing Model
The YAT model is used to indicate periods of buy opportunities within the Market Alert Model’s timing cycle. The SWR Market Alert Model always trumps the YAT model. The YAT model is negative.

Interest Rate Model
The SWR Interest Rate model is negative on interest rates and long bonds.  

Gold Model
The SWR Gold Model is positive on gold.

I issued the following alert in January.
17 January 2008 Southwest Ranch Financial, LLC S&P500 at 1333

[ March 2008: The SWR stock model subsequently gave a sell signal in early Februay. The market decline still amounted to 15% which is is larger than the 12% desired limit. It was premature to say the model didn't work - it worked later than I expected. ]

With all the major stock indexes in steep downturns, it's necessary to acknowledge that my Market Alert Timing Model has not properly flagged a turning point. My rule of thumb was that the model should be able to detect a greater than 10-12% correction. The S&P500 is now approaching a 15% decline from the most recent peak. My Market Alert Model has not given a sell signal despite the decline. I've observed the market's deterioration over the last several months and the disconnect with my stock market model. For that reason, I have repeatedly warned investors to take a very conservative position.

It's also possible that the published government data is inaccurate or irrelevant and market participants now act upon intuition or other data sources. Despite claims by some, I'm not willing to state the government data is wrong unless I see convincing proof. Therefore I must accept the most logical explanation. It's more likely that we are experiencing a unique confluence of events. The series of asset bubbles we've experienced over the last ten years is symptomatic of an economy propped up by reckless spending and financed by IOU's (public and private) that will never be paid off. The dollar is a very sick currency and the disease is debt. Housing related debt gets the most attention, but installment loans are also in serious trouble. There's no plan of action from Washington and probably because there is no plan that will work. Lowering the Fed Funds rate will accomplish very little, but will cause the dollar to fall faster and gold to rise even more.

The Fed should raise rates to support the dollar, but must answer to an election year Congress and a president trying to salvage anything he can after eight years of failure. Never before has the US experienced a falling stock market and a falling housing market. These are the two main pillars of a finance economy comprised of 75% consumption as measured by GDP. The government doubled the national debt in six years after the 2001-2002 market crash - they can't do it again. They can't turn things around with interest rates and can't spend their way out. The markets fear a dollar collapse or an out of control inflation. The next several months could see a strong rebound in stock prices resulting from various types of stimulus.

This is a presidential election year so expect extreme actions to prop up the markets until the politicians are re-elected. I believe investors should sell into strength when possible. We are likely headed into a global bear market of unknown depth. A bear market ratchets down and then gives a little back only to decline more. This could take traditional measures of valuation to historical lows. Considering the facts, I believe caution is warranted until the debt liquidation phase is exhausted. I have personally exited the US stock market and have sold most foreign stocks. Hold cash for now and don't sell gold. Dividend paying blue chip stocks are good assets to hold, but aren't immune to a panic. Despite the dollar's international weakness, all debts in America are denominated in dollars and depreciated assets will later be sold in dollars to people that have them. Wait for better opportunities.

Market Commentary
The US economy is losing steam. I expect stock prices to ratchet gradually downward over the next 18 month. The combination of falling home and stock prices will very likely result in an accelerating vicious cycle of falling consumer confidence and falling asset prices. I discussed this in some detail last month. This scenario calls for a change in investing tactics with a switch to dividend paying stocks of high quality companies. As the market is hit by occasional waves of selling, it offers opportunities to pick up blue chips at high yields. I believe investors should sell the broad stock indexes and move money into a balanced mix of currencies, commodities, cash and dividend blue chips. I would avoid US treasury bonds.

I just purchased General Electric.

General Electric (GE). Yield 3.6%, Indicated Yearly Dividend $1.24, Price @ 1/31/08 = $35.00, Expected dividend growth rate = 8%
Rated an A++ for financial strength and a 1 for safety by Value Line and with many years of rising dividends. The current yield is the highest in over 15 years and perhaps ever. GE is positioned well for the huge changes ahead in energy delivery. It is into nuclear development and alternative energy. Value Line expects earnings to grow at double digit rates. The stock is down over 12% from its recent peak and close to a 52 week low.
Recent price trend:
30 days (-5%), 90 days (-14%), 180 days (-12%)

I'm watching several other blue chips too. I'm a bit late, but will post the Dividend page on the site with my buy recommendations. The great thing about buying these firms in the current market is we can lock in a yield higher than the inflation rate and benefit from their broad international exposure. As the stock market slips, more and more of these great firms will become cheaper. These stocks also offer a means to hedge against further declines in the dollar.

And Down We Go
Presently, the government is intent on spending $150B as a fiscal stimulus to prop up the economy for the election. It's too late now for this cash to have any meaningful effect on economic activity as the self-reinforcing economic down-cycle has already been set it motion. The money giveaway is a November insurance policy for the politicians. I prefer to think of it as $1.5 billion per senator. As for the political candidates, not a one speaks the truth about the nation's economic decline except for Ron Paul. I especially liked the comment from the purportedly Lincolnesque Obama. To paraphrase, "We'll spend $150B and if that doesn't work then we'll do it again". No wonder he was endorsed by Ted Kennedy. The Republicans are just as bad.

After 2009 we will see tax increases. Combined with a weak stock market and falling house prices, this will be a triple whammy. Meanwhile, the Fed insists on lowering short term rates thus creating a negative interest rate environment. Remember, negative rates are when the rates paid on safe CD's and money market accounts are below the inflation rate. In such an environment people move cash to speculative investments to avoid losing to inflation. The government hopes small investors will move cash into the stock market and prop things up until the election. This behavior by our elected officials should be classified as criminal activity because it cheats the savers in society to benefit the big banks. The news media is too dense to catch on. The goldilocks commentators on Fox news and CNBC don't get it and even praise Bernake's actions as providing the lift needed for the economy. Ridiculous. Interest rate stimulus is worthless in a falling consumer demand situation. It's all about the election so don't get suckered in. This commentary article hits the mark.

What To Do About the Dollar
We have to prepare for the eventual move away from the dollar as the world reserve currency. This won't happen next year, but is likely over the next five years considering the current rate of fiscal mismanagement. The European central banks are resisting massive spending programs despite prodding by the US. This will strengthen the Euro. After 2009, expect tax increases to slam the middle class. The politicians will be reluctant to raise taxes on corporations because Europe has corporate tax rates of about 25% - lower than America. However, the need for revenue will cause bad policy - the piper must be paid.

I wouldn't be surprised to see major firms relocate their headquarters out of the US to avoid taxation and also as a result of foreign investors using their offshore dollars to buy controlling interests. It's really ironic that the US squandered $5 trillion on Middle Eastern wars and other waste since 2001 and the likely result will be US firms moving their headquarters to Dubai.

We're at the point where investors have to act on their dollar holdings. It's clear that our politicians will spend recklessly and manipulate interest rates to get themselves elected. Do you think they will ever have the will to cut spending to bring the fiscal house into order? I don't. It's very likely we are headed into a prolonged inflationary recession. At the other end may, we could see a greatly diminished dollar. That's not a certainty, but it seems wise to hedge our bets. The Middle East oil producing nations are working on a replacement for the dollar and the Asian countries are working on a unified Euro-type currency. Oil and most commodities are priced in dollars. When these new currency arrangements are enacted, there will be less need for nations to hoard dollars to pay their oil bills. The dollar could fall like a rock. Meanwhile, oil depletion is playing out as a reality with oil production down 4% from a year ago. This decline will accelerate. Oil is now at about $90 a barrel and will steadily go higher in the years ahead.

Since we can't be certain how things will play out, I believe investors should own commodities, blue chip stocks, and foreign currencies plus some dollars. In the commodity area you can buy PCRIX, RJI, DBC or GSG (very heavy on energy). (A minor concern about RJI is its an exchange traded note which means it's backed by a Swedish bank rather than the underlying commodities. The bank says it has no exposure to bad mortgages and that appears to be true). To hold a basket of currencies, try the unhedged world bond ETF called BWX (+2.8% ytd) or Pimco has a fund PIGLX. 2008 will be a year of crisis and 2009 will be worse. We haven't a lot of time to act. If a run on the dollar commences, the government will likely enact capital controls to prevent US citizens from exiting the dollar. This won't affect the super rich who have their cash offshore.

Uneasy Times
The housing decline will go on longer that many expect. Already, many homeowners are underwater on their loans. An enterprising firm is now offering people advice on how to walk away from their mortgage without incurring penalties. Their plan takes advantage of anti deficiency statutes in some states that make mortgage loans non-recourse. That means if you give back the keys the lender can't come after your other assets. YouWalkAway will probably do good business over the next few years and especially in California.

Many people listen to Jim Cramer on TV. He says now is the time to buy stocks because the market has hit a bottom and he's reportedly touting financial stocks as great buys. Cramer's knowledge is a mile wide and an inch deep according to one pundit. The stock market is not a good buy. Financial stocks will benefit short term from the Fed's rate changes, but they have a core problem. Their profits of the last five years were expanded by vigorous consumer borrowing and business financing. Those revenue streams are contracting. So, even ignoring all the bad loans, the income side of the equation is dubious. Stay away.

Holding cash for the long term is a losing strategy. We have to spread it around. The coming corporate transitions plus the falling dollar and rising dividends is why we want to own some blue chips. Over the next 18 months we should be able to gradually transition our stock portfolio allocations into dividend stocks by buying on general market weakness. In addition, holding commodities and foreign currency is a way to diversify and get a rate of return. That said, Europe and Asia will not be immune to a US slowdown so be conservative.

I am not a fan of foreign dividend paying stocks. In America, firms try never to cut the dividend as it's a sign of failure and the stock gets pummeled. In Europe and Asia, they change the dividend all the time depending on business conditions - it's not reliable. The dividend puts a brake on a falling share price and provides a margin of safety. You only get that in America so stick with what you know.

For Americans, buying foreign bond funds and owning commodities and gold would seem like speculation in prior decades, but these aren't normal times. The US is facing an enormous fiscal deficit problem which requires federal spending cuts. If addressed, these spending cuts will ripple through the economy and cause job losses and falling profits. The government will resist acting responsibly while operating under the delusion that it is still the master of the universe. Other nations understand the underlying weakness and will quietly act in their self interest. That's what gold is telling us. Oil prices can only go up and are a major input cost into everything from commodity extraction to consumer goods production. Multinational firms that pay dividends, like GE, are an excellent hedge. Diversify assets, but don't go to extremes unless you're supremely confident of what the future holds - I'm not. Doing nothing is not a reasonable option.

Rising inflation in China means the era of cheap imports is coming to an end. The tide is going out on America's consumer lifestyle and standard of living. The leading economic indicators are plummeting and a recession is now a certainty. The recent rebound in US stock prices provides a life saving opportunity for you to balance your stock and mutual fund portfolio. Don't listen to the financial news entertainers on television. They get rich selling optimism and hyping the news. The facts tell a different story.

Best Regards,
Southwest Ranch Financial, LLC    (www.swranch.net)
Tom Gleason, Manager & Researcher

Author of: How To Invest If You Can't Afford To Lose

To unsubscribe, send a blank email to: alerts-unsubscribe@swranch.net

Disclaimer:.
Investing involves risk and the future performance of the models cannot be guaranteed. SWR is not a registered investment advisor and nothing published by SWR should be considered personalized investment advice. Any investment recommendations made by SWR should be made only after consulting with your investment advisor and only after reviewing the prospectus or relevant financial statements.  SWR does not receive any compensation for mentioning stocks, funds, or financial products.

Privacy Policy: SWR never shares user information or email addresses with anyone - period.