by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Monday, January 5, 2009: Issue #910

Media pundits keep reminding us how tough 2009 will be economically. Nevertheless, I predict this will be a good year for the stock market.

How can this be?

The stock market is a leading indicator. It generally falls before consumers and investors realize just how bad the economy is.

It also recovers long before economic activity picks up. Perversely, that means stocks often plummet during good economic times and rally during recessions… or worse.

In the January issue of The Oxford Club Communiqué, for example, I note that:

• In the 13-month recession in 1926-27, the market went up 41.1%.

 

• In the eight-month recession in 1945, it went up 19.5%. In the 11-month recession in 1948-49, it went up 15.2%.

 

• In the 10-month recession in 1953-54, the stock market went up 24.2%.

 

• In the 10-month recession of 1960-61, it went up 20.3%.

 

• In the 16-month recession in 1981-32, the market went up 14.6%.
• And so on.

The stock market doesn’t always rise during a recession, of course. And right now is particularly tricky because there is simply no precedent to today’s economic mess. We’ve never seen a real estate/mortgage crisis create a meltdown in the credit markets this way. Nor have we seen the Federal Reserve take such extreme measures to set things right.

However, investors can take some reassurance from one of the best - and most accurate - buy signals in the stock market. Here’s how it works…

20th Century Investing - Buying High-Yielding Stocks

Investors in the first half of the 20th century found that if you did nothing more than buy stocks when their yield exceeded the yield on Treasuries - and sell them when the yield on Treasuries exceeded the yield on stocks - you would have been in for every major rally and out for every major correction.

The returns were huge - and the system made sense. Stocks are riskier than bonds, market participants reasoned, so they should yield more to compensate for greater volatility and the likelihood of occasional losses.

The system worked like a charm until 1958. Then stopped cold. Stocks never yielded more than Treasuries for the next 50 years.

Public companies began using their cash flow to fund operations and acquisitions rather than paying out dividends to shareholders. With stock yields sharply lower, most analysts reasoned that the indicator was dead, that the yield on stocks would never again top bonds.

But after more than five decades, they have…

The S&P Yields More Than Treasuries For The First Time In 51 Years

Beginning on October 13, the 3.74% yield on the S&P 500 exceeded the yield on the 10-year Treasury for the first time since 1958.

If history is any guide, that means stocks are an excellent long-term buy and Treasuries - which have become a complete bubble (and table-pounding sell) in my estimation - are due for a long period of relative underperformance.

Don’t get me wrong. U.S. economic growth is likely to be negative over the next 12 months. But - shocking and surprising most investors - stocks should do well. And high-dividend paying stocks - especially those outside the troubled financial sector - may perform best of all.

One caveat, however. When focusing on yield, buy only healthy dividend-paying companies - those with rising sales and earnings - and reinvest those dividends for maximum total returns.

I’ll be highlighting many of these companies in the Communiqué in the weeks ahead.

Good investing,

Alex

P.S. There’s never been a time like right now to join The Oxford Club and get the Communiqué. In fact, members just received information on a little-known government loophole enacted in 2006 that ensures that you can make an extra $400 or more every month - starting in February. Find out more about The Oxford Club.

Already an Oxford Club Member? Go here to get your latest research reports.

Today’s Investment U Crib Sheet

Louis Basenese recently gave us six ways to invest in companies with healthy income. From undervalued REITs, to Master Limited Partnerships there are plenty of opportunities in income earning equities right now. To get all six, and the company with an 8.7% yield, check out Investment U Issue #889, 32 Billion Reasons The Average Investor Will Fail.

Louis hasn’t been the only one finding bargains. Dave Fessler showed us a rare bank - without defaults - just last month, which reported third-quarter income rose almost 14%. It just raised its dividend for the thirty-first consecutive year. To find out more about this unique bank, see Investment U Issue #904, A Rare Bank Without Defaults.

But there are easier ways to invest in healthy companies and increase your monthly income. For example, take a look at this government-authorized gas rebate program. It’s quietly reimbursing a handful of Americans for all the money they spent on gas.

Related Articles:

• Your Individual Retirement Account (IRA): Resolutions for Wealth & Happiness in 2009
• The 4 Biggest Investment Myths of 2008
• Small Cap Stocks: The Most Important Trend Headed into 2009

Investment U Archives

Based off the last news reports, without Steve Jobs, the multi-billion-dollar enterprise that is Apple (NYSE: AAPL) would simply cease to exist. Every new report of his health is followed in the market, and Apple’s stock price takes corresponding hikes and plunges.

But Apple isn’t the only corporation with similar founder/leader issues.

Berkshire Hathaway (NYSE: BRK.A), and Dell, (NYSE: DELL), for example, both have stocks tied to the brand name of their founders - Warren Buffett and Michael Dell.

And when investors worry about the health of these figureheads, they send the stock price plummeting. But does this mean that the fundamentals of these companies are also in danger?

Far from it.

Microsoft (NYSE: MSFT) hasn’t collapsed since Bill Gates stepped down. Martha Stewart’s Martha Stewart Living Omnimedia (NYSE: MSO) hasn’t gone under because of her legal troubles. And Sam Walton’s Wal-Mart (NYSE: WMT) is up 324% since his death in 1992.

Too many investors still believe that if something happens to their stock’s leader, the company will fail. But, in fact, operations will continue, dividends will be paid, profits will be made and the stock will correct itself.

A smart investor will use these irrational plunges to buy these companies when emotion, not logic, spins out of control.

Companies mentioned in this article: AAPL, BRK.A, DELL, MSFT, MSO and WMT.

Blackboard Archives

by Dr. Mark Skousen, Advisory Panelist, Investment U
Friday, January 2, 2009: Issue #909

Three weeks ago, in Investment U Issue #898, I promised you a 30% return on my “Keynesian investment strategy” of buying a deeply discounted fund, the John Hancock Preferred Income Fund (HPI).

Guess what? It’s already achieved the goal of 30% return (including a nice dividend).

Today, I’ll show you how to keep your hard-earned profits from being stolen by some unscrupulous broker or money manager through financial fraud.

Sadly, quite a few wealthy individuals lost their entire fortune and are now penniless because they invested their money with Wall Street veteran Bernie Madoff. He is alleged to have lost $50 billion.

By taking some simple preventative steps, you can avoid being wiped out by financial fraud and financial scam artists…

Vital Financial Fraud Lessons From the Madoff-Ponzi Scheme

There are some vital lessons to learn from this incredible Madoff-Ponzi financial fraud scheme.

First, you can’t count on the federal government, especially the Securities & Exchange Commission (SEC), to protect your hard-earned money. The feds are like the police: They are better at finding criminals than preventing crime.

In fact, there is a fundamental reason why the SEC misses most fraud cases: The SEC is often in bed with the investment houses. George Stigler, professor of economics at University of Chicago and long-time colleague of Milton Friedman, demonstrated this many years ago. Over time, regulatory agencies are corrupted by the companies they regulate.

Not surprisingly, many ex-SEC employees are hired by broker/dealers to keep the SEC at bay. That’s apparently what happened at Madoff Investment Securities. A team of SEC lawyers investigated Madoff’s broker/dealership a few years ago and found nothing amiss.



Second, the Madoff case is so large and hurtful to so many investors, from Steven Spielberg to small Jewish foundations, that the Democratically-controlled Congress will have another big reason to impose another heavy dose of regulation on Wall Street. Sarbanes-Oxley will look like a band-aid compared to what’s coming down Pennsylvania Avenue.

Who’s To Blame For Financial Fraud?

Of course, looking back, investors have only themselves to blame if they got caught losing their shirt in bad investments and/or financial fraud. Sure, Bernie Madoff had impeccable credentials on Wall Street. If you can’t trust the former chairman (founder) of Nasdaq, who can you trust?

But there were plenty of red flags:

• Refusal of promoters to reveal exactly how Madoff made money: Clients were always told that his option strategy on index funds was “too complex” to explain. Smart investors will avoid managed accounts they don’t understand.

 

• Accounts made money too consistently. Madoff’s managed accounts showed steady returns of 10-12% year in and year out, through bull and bear markets. Madoff promoters claimed that Madoff’s funds “never” lost money - no such guarantee is possible with managed accounts.

 

• Madoff’s managed accounts had no separate custodian and no independent outside auditor (other than a small 3-man accounting firm).

3 Simple Rules For Avoiding Financial Fraud

How can you avoid financial fraud? There are three simple rules:

• Manage your own funds as much as possible with large, reputable discount brokers where the federal insurance guarantees accounts.

 

• If you are still tempted to turn your money over to another’s management, I urge you to make sure you diversify into several managed accounts. It’ll ensure that no one account is so large that it leaves you penniless if financial fraud happens. Managed accounts should also include publicly-traded, no-load mutual funds and exchange traded funds/notes, whose value can be tracked daily.

 

• And most importantly, you should make sure all managed accounts have separate custodians and independent, outside accountants to audit your accounts.

Good investing,

Mark Skousen

Today’s Investment U Crib Sheet

One of the foundations of Investment U is to give you the knowledge to make informed decisions about your investmetn portfolio. It’s the kind of practical know-how that we’ve been teaching for almost 10 years - advice that could have saved Madoff’s investors billions.

Our mission is to analyze and discuss all the important financial tools at your disposal and to make sure that you can use them effectively: to jump-start your net worth, cut your investment costs dramatically, reduce your risk profile and, most importantly, achieve and maintain total financial independence.

It’s a shame, really, that much of what is offered here - at no charge - isn’t taught in the public schools. Why is it that you can graduate in the top of your class and know next to nothing about credit card debt, adjustable-rate mortgages, or 401(k)s?

If you have a friend or family member who you think could benefit from our analysis, simply send them to sign up to Investment U. They’ll get our impartial, no-nonsense advice four times a week. It’s quick, it’s simple… and it’ll help them build long-lasting wealth - a resolution we can all agree on.

Related Articles:

• Your Individual Retirement Account (IRA): Resolutions for Wealth & Happiness in 2009
• The 4 Biggest Investment Myths of 2008
• Small Cap Stocks: The Most Important Trend Headed into 2009

Investment U Archives

Restaurateurs were hit with a double whammy of increased costs and dropping sales in 2008. But looking back at the carnage, there are a few bright spots. Although the restaurant sector dropped by 20%, it still beat the S&P’s 38% loss.

In fact, there is one restaurant that advanced in 2008.

Fast food icon McDonald’s (NYSE: MCD) closed up 4.5% for the year, with a sales increase of almost 8%. “Mickey D’s” also shares a distinction with Wal-Mart (NYSE: WMT) of being the only two stocks in the Dow Jones Industrial Average (.DJI) to close up for the year.

Value conscious consumers have driven sales higher at discount chains. And as costs drop, these fast food outlets have been cranking up their profit margins. While they may not be great for waistlines, apparently cheap eats are good the wallet.

Wendy’s (NYSE: WEN),Yum! Brands (NYSE: YUM) and Burger King (NYSE: BKC) have all risen by over 30% over the past few months.

Time will tell if that gives local gyms a bump in sales.

Companies mentioned in this article: MCD, WMT, WEN, YUM and BKC.

Blackboard Archives

by David Fessler, Advisory Panelist, Investment U
Wednesday, December 31, 2008: Issue #908

Tonight, we look to the New Year and, hopefully, our resolutions for wealth and happiness in 2009. For many, it could be as simple as saving more and contributing to an IRA account. It’s one of the easiest ways to secure a comfortable future.

Unless you’ve just arrived from another country, most of you reading this know IRA stands for an Individual Retirement Account. It’s probably a safe bet that many of you have them and make regular contributions to one, or to a similar workplace retirement account.

Perhaps you have plans to ultimately use the money to fund your retirement, help out with children or grandchildren’s education, or perhaps to purchase a second home.

Suffice to say, it’s never too late - or too early - to start contributing to an IRA. And I can’t think of any reason not to contribute the maximum amount possible. My father used to say, “If you don’t have it, you’ll never miss it.” In addition, many employers will match your contributions to some level, some as high as 50%.

I’m not going to spend time talking about the virtues of contributing to an IRA, or about the miracle of compounding. My colleagues at Investment U have written on this at length. You can read about it in Investment U Issue #785, Your Retirement Plan: Have You Calculated Your Number?

But regardless of whether you are starting out, currently contributing or looking to start making withdrawals, it pays to know a few of the mechanisms behind how you can get to your money. Here are some of the things you need to consider…

When to Use a SEPP Program With Your IRA

Barring any unfortunate circumstances, you will eventually reach the age (normally 59 ½) when you can start voluntarily withdrawing funds from your retirement account.

If you decide to take funds out earlier than 59 ½, you’ll owe ordinary income tax on them, and you’ll be assessed a 10% early distribution penalty.

But like just about everything else in our complicated tax code, there are exceptions to this rule. One of them allows an individual to take assets out under a SEPP Program. SEPP stands for Substantially Equal Periodic Payment and it allows you to take funds out of an IRA regardless of your age.

If you have a short-term need for cash, you should consider other alternatives. A SEPP program, once started, must be continued for a minimum of five years, and you’ll be paying income tax on any and all funds you take out.

The participation period could be much longer if you are younger than 44 years old when you start the program. The reason is that the IRS requires you to continue the SEPP program for a minimum of five years, or until you reach 59 ½, whichever happens last.



If you terminate your SEPP program before the deadline, you’ll have to pay all penalties and taxes that were originally waived on the entire amount taken under the program.

Depending on how much you took out, this could be a tidy sum indeed. The only exception to the early termination rule is if you become disabled, you die, or your assets become depleted due to loss of market value.

Your Individual Retirement Account - What’s an RMD?

Many investors, either out of necessity or because they enjoy it, work well beyond minimum retirement age, continuing to put money into an IRA. Let’s assume you’re in good health, have income other than your traditional IRA to live on, and you are 70 years of age.

You are fast approaching the point at which you must start taking distributions from your IRA. Even if you don’t need the money, the IRS states you must begin to withdraw the Required Minimum Distribution (RMD) by April 1 of the year in which you turn 70 ½.

In subsequent years, you can take your distribution any time prior to December 31. Penalties for missing an RMD or not taking enough are severe, and are equal to half the amount you should have taken out.

The only exception to taking out RMDs from a workplace retirement plan is if you are still working for the company that provides it when you reach 70 ½, and you own less than 5% of the company.

IRS Publication 590 (insert link here) describes in detail how to calculate your RMA amount.

So whether you have already retired, are retirement planning, or are still working, it pays to keep abreast of the constantly changing IRS rules regarding IRAs. After all, it’s your money…

To a prosperous New Year,

David Fessler

Today’s Investment U Crib Sheet

Adding more to a retirement account - regardless of your age - is never a bad thing. If you’re at the point when you’re required to start making distributions - but don’t need the money - we’ll have plenty of ways to put that money back to work for you in 2009. (Exposure to the White Cap Index is our first recommendation.)

But for those who are still contributing, or just starting out, it can be difficult to figure out what kind of IRA account to open. Here are a few of the basics.

• An IRA isn’t a type of investment, it’s a type of account. Many still believe that if they open an IRA, the decisions are already made of what to invest in. This is false.
• Think of an IRA like an umbrella. It allows you to put almost any investment under it: stocks, bonds, mutual funds, precious metals, etc. The difference between an IRA and an ordinary brokerage account is that the taxman doesn’t pay regular visits - you can grow your money tax-free

Which brings us to the two types of IRA accounts: a Traditional IRA and a Roth IRA. What’s the difference between them?

• Roth IRAs allow you to invest post-tax money (up to certain income limits), and when the money comes out, it’s tax-free.
• Traditional IRAs allow you to deduct your contributions from your taxes, but when the money comes out, its earnings are taxed.

One of the biggest decisions investors make in their retirement accounts comes down to whether they need tax deductions, or whether they will need tax-free income. It’s a personal choice and there is no one-size-fits-all answer.

However, there are some easier answers when it comes to investment choices. To increase your monthly income, for example, take a look at this government-authorized gas rebate program. It’s quietly reimbursing a handful of Americans for all the money

Related Articles:

• Target Retirement Funds: How to Put Your Investment Portfolio on Autopilot
• Early Retirement Planning: Are You Ready for “Extreme Early Retirement?”
• Planning For Retirement: 5 Steps to a Cash-Rich Retirement

Investment U Archives

Trillions and trillions of new paper is flooding Wall Street. While it’s working to stabilize world markets in the short term, it will result in longer-term debasement of paper currencies. And it’s making gold the place to be right now.

Here’s the interesting thing. Gold is normally a hedge against inflation and financial catastrophe, but it’s really not acting out its part very well. Gold stores are up. Investors are so preoccupied with the financial meltdown and the short-term weakness in the economy, that they’re ignoring the coming inflation.

Gold has moved up a little over the past few weeks, but it pulled back yesterday and gold stocks have been hammered mercilessly. This is partly due to the drop in commodity prices that have negatively impacted gold shares.

Now is a great time to establish a position in undervalued, low-cost producers of gold.

The currency markets can’t to be trusted to reflect the true nature of this reinflation and currency debasement. The reason is simple - all the major currencies - yen, dollar, Euro and pound - are inflating in unison, so it’s not just more dollars out there. There are trillions of new pounds, Euros and yen as well.

Yamana Gold (NYSE: AUY), Kinross Gold (NYSE: KGC) and Agnico-Eagle Mines (NYSE: AEM) should all benefit from growing gold demand. And if inflation does start to rear its ugly head again, gold should be the place to be.

Companies mentioned in this article: AUY, KGC and AEM.

Blackboard Archives

Nuevo-indices, like Estee Lauder’s (NYSE: EL) “lipstick index,” the bartender index or the video game index, all have their day in the sun during market downturns. Often they’re dismissed as distractions, or excuses for poor performance.

But their fundamentals are based on real consumer trends and psychology.

Areas like entertainment, clothing and luxury items are often cut back during downturns. But that doesn’t mean they aren’t replaced with substitutes. Frugal doesn’t mean spendthrift. Consumers are still buying.

Purchases are justified by their reduced cost, or the “savings” from not spending money elsewhere. Entertainment like Netflix (Nasdaq: NFLX) carries a cost – but nothing like going to a movie three times a week. It’s this mentality that we can find profits in.

Many companies have benefited from cost-conscious shoppers and savers, and others are benefiting from negative psychology.

Kraft Foods (NYSE: KFT) and General Mills (NYSE: GIS), for example, are profiting from demand for comfort foods and a falling cost of goods. 

In fact, discount retailers like Wal-Mart (NYSE: WMT) and Dollar Tree (Nasdaq: DLTR) have actually increased their sales projections.

When the market turns trading and investing rules upside-down, like it has over the past nine months, it’s nice to know that some habits can be counted on. And who knows? Tomorrow you could be hearing about the “Netflix Index” as the newest economic gauge.

Companies mentioned in this article: EL, NFLX, KFT, GIS, WMT and DLTR.

Blackboard Archives

by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Monday, December 29, 2008: Issue #907

Pessimism about the U.S. economy and financial market is so thick right now you could cut it with a knife.

I’ll be the first to admit that times are tough. But Americans have seen tough times before. And we have always prevailed.

Too many investment myths have gone unchallenged lately. Today I plan to refute them - and explain why financial markets are likely to perform much better than most investors believe in the year ahead.

Let’s begin by examining the four biggest investment myths circulating right now…

Investment Myth #1: The Era of Free Markets is Over

It’s true that many of the apostles of free-market economics have begged Congress for government intervention during the current credit crisis. But nobody is seriously arguing that Uncle Sam should nationalize the economy, set wages and prices, or establish production quotas.

The free market still constitutes the best means of securing prosperity over the long term. (Just ask the Chinese. Three hundred million people there have been lifted out of poverty over the past three decades.) We will find ways to make free markets work better - not abolish them.

Investment Myth #2: The United States Has Lost its Competitive Edge

The reality is the United States continues to lead the world in innovation, technology, higher education, worker training and the ability of the labor force to move from one job to another.

Three months ago, the Swiss-based World Economic Forum released its global competitiveness report and, once again, the United States topped the list. The study further noted that our strong productivity will help us “ride out business-cycle shifts and economic shocks” better than most countries.

Investment Myth #3: The United States is No Longer an Attractive Market for Investment

Yes, the Fed’s move to take interest rates near zero has predictably knocked the dollar for a loop again. But that isn’t deterring foreign investors. Perhaps they know that the biggest bargain of all is inexpensive assets in a cheap currency.

According to the World Bank, the United States attracted more than $2 trillion worth of foreign direct investment last year. Britain, Hong Kong and France - the next three top finishers - each registered less than half as much. The United States remains the economic engine of the world - and smart capital will continue to seek a home here.



Investment Myth #4: U.S. Financial Markets Will Take Decades to Recover

In the more than 200-year history of equity investing in the United States, stocks have never taken decades to recover. Those who argue they have always omit dividends. Dr. Jeremy Siegel of the Wharton School points out that even if you invested a regular amount in the Dow every month beginning at the market peak in 1929, within four years you would still have outperformed someone who invested the same amount each month in T-bills. (The key is regular investment and reinvested stock dividends.)

The Nikkei 225 in Japan, of course, is still down more than 70% from its peak in 1989. Could the United States be headed for the same long, deflationary spiral? That’s extremely unlikely. The Japanese real estate and equity bubble was much bigger, government action there was clumsy and ineffective, and the banks were not cleaned up quickly or efficiently. Congress and the Federal Reserve are being much more proactive here.

It’s true that the economy is in for a few rough quarters. Understandably, the media is focused on the bad news. We all know that hundreds of thousands of jobs have been lost. Venerable names in banking and finance are no more. American automobile manufacturers are begging Congress for a lifeline. Residential real estate and the stock and corporate bond markets have all taken it on the chin.

But there are reasons for optimism, too. Oil has plunged from $147 a barrel to less than $40. Low interest rates will ultimately make it cheaper for businesses and consumers to borrow. A cheap greenback boosts exports and makes U.S. assets inexpensive to foreign buyers. And fundamental valuations on stocks are the cheapest they’ve been in 17 years.

Make no mistake, 2009 is going to be a tough year for the economy. But the financial markets - always looking forward - have already discounted this and could surprise you in the year ahead.

So don’t get waylaid by the gloom-and-doomers. There are always attractive investment opportunities out there and right now is no exception.

We’ll be highlighting dozens of new ideas - here and in our Oxford Club Communiqué - in the weeks just ahead.

Let’s buck the trend together - and look forward to a happy, healthy and prosperous New Year!

Good investing,

Alex

P.S. There’s never been a better time to join The Oxford Club. In fact, members just received information on a little-known government loophole enacted in 2006 that can give you an extra $400 or more every month - starting in February. To find out more, just go here to read the full report. If you’re already an Oxford Club member, you can log in here to see all of our Urgent Investor Reports..

Today’s Investment U Crib Sheet

New Year’s resolutions are on the minds of many as we close out 2008 and look to 2009. And while many resolutions include losing weight and living better, we’d like to recommend you consider one of our own:

Use the Four Pillars of Wealth to ensure your New Year is a profitable one.

To review, our Four Pillars are:

• Pillar 1: Stick to an Asset Allocation Model
• Pillar 2: Adhere to a Sell Discipline
• Pillar 3: Understand Position-Sizing
• Pillar 4: Always Look to Minimize Investment Expenses and Taxes

We all want a Herculean body on a Krispy Kreme diet. But that’s not going to happen. And neither is predicting the very next move of the stock market, oil, interest rates, or foreign currencies. That’s why you need to have a specific strategy going into next year. And it’s why The Oxford Club uses the Four Pillars.

Find out more about The Oxford Club, and its other strategies for limiting risk and increasing returns.

Related Articles:

• Small Cap Stocks: The Most Important Trend Headed into 2009
• I.O.U.S.A & The Coming Entitlement Meltdown: Why We Face $53 Trillion in Unfunded Liabilities
• Stock Market Investment Advice: The Two Most Profitable Secrets of the World’s Greatest Investors

Investment U Archives

On Friday, Treasuries posted their first weekly loss since October - even as Middle East tensions pushed yields up again. As the year draws to a close, Treasuries have come out as the clear asset-class winner in 2008.

But they may have reached their peak in popularity when investors rushed to get a 0% yield. The rest of the market hasn’t been so popular. The Dow, S&P 500, and Nasdaq are all down more than 36% for the year.

Unfortunately, just because Treasuries become less popular doesn’t mean there’s a market uptick in our future. But the bond market does give a glimmer of hope for the New Year.

When investors become less risk averse, the spread between the yields of Treasuries and corporate bonds becomes smaller. The spreads have narrowed, and are almost half what they were months ago. Investors are starting to lend to corporations again.

The market hasn’t responded immediately to this loosening of corporate credit. But it has started moving back into preferred stocks. In fact, since November 20, the iShares S&P US Preferred Stock Index ETF (NYSE: PFF) has gained over 33%.

But if you look closer at the index’s makeup, it’s almost 87% financials: Wells Fargo & Company (NYSE: WFC), Citigroup (NYSE: C) and USB Capital (NYSE: USB) are the top three holdings.

Time will tell if the financials will be the catalyst to bring the market out of the crisis they helped create. But as preferred shares gain in value, an increase in common stock prices shouldn’t be too far behind in 2009.

Companies mentioned in this article: PFF, WFC, C and USB.

Blackboard Archives

by Louis Basenese, Advisory Panelist, Investment U
Associate Investment Director, The Oxford Club
Wednesday, December 23, 2008: Issue #906

Yesterday we got confirmation that the U.S. economy contracted by 0.5% in the third quarter. And most economists expect the downturn to accelerate, with GDP checking in as low as negative 6% in the fourth quarter. Here’s why I’m not concerned…

A more important trend is emerging. Remember, on November 19 I told you to consider going big, by going small with small caps. Well, the markets didn’t leave much time for preparation.

In that short span, small caps jumped 6.38%, almost tripling the returns of large caps, based on the Russell 2000 and Russell 3000 indexes. Of course, it’s too early to declare a full-blown rally. But we shouldn’t be ignorant to the subtle shifts in market leadership.

Remember, the market’s a forward-looking beast. And that means even in the darkest hours we need to be thinking about the next bull market… and positioning ourselves to profit.

The more I research and monitor the markets, the more convinced I become that the time for small cap stocks is upon us. In the next two columns, I’ll do my best to convince you of the same.

Today, I’ll focus on the why. Next week, I’ll show you how to screen for the most potent opportunities, as well as provide a few specific recommendations.

Before we get to it…

Making Sure You’re Ready To Buy Small Cap Stocks

Before I lay out the case for small cap stocks, we need to make sure you’re ready to buy. After a brutal 2008, I fear many of you may have packed it in for the year. But sitting cash heavy right now is a big mistake…

First of all, two of the fastest-rising bull markets occurred in the 1930s. So don’t kid yourself. Times are tough. The economy’s in the tank. But this market, just like during the Great Depression, could turn on a dime, too.

That means if you’re not positioned ahead of time, you’re certain to miss out.

As Minneapolis investment research firm The Leuthold Group reveals, in the first year of every new bull market since 1900, the Dow jumped an average of 41%. Keep in mind, the average total bull market gain over the same period was 84%. In other words, bull markets are heavily front-loaded.

And Standard and Poor’s agrees. They estimate most investors make back 82% of their bear market losses in the first year of a bull market.

Bottom line - being late to the next bull market comes with a big price tag. And I don’t want you to pay it.

Why 2009 Will Be a Small-Cap Stock World After All

Now that you’re primed, let me tell you why jumping into the deep-end and buying traditionally riskier small cap stocks is actually the smartest bet right now. I’ll let the data, not my own personal convictions, do most of the talking…

• Coming out of recessions, nothing beats small caps. Last month, the National Bureau of Economic Research (NBER) made it official. The U.S. economy is in a recession. No matter when we make the calculation (after one month, six months, one year, even three years) small cap stocks trounce their larger brethren coming out of slowdowns, according to the data crunchers at Old Mutual and Morningstar.

• Even if the economy doesn’t recover in 2009, small cap stocks should shine. The latest from Citigroup Global Markets indicates small caps could care less about the underlying economy. Even in years of flat or negative GDP growth (up to 2%), small caps return an average of 44%.

 

• One month can make a difference. Based on the 10 worst years for stocks since 1927, small caps jumped 18.17% in January alone. Meanwhile, large caps barely showed up for the much-heralded January effect. They only muster a 3.1% gain, on average, according to Cambria investments. I don’t know about you, but the prospect of one-month double-digit gains, especially after this year’s drubbing, excites me. The fact that they could come just weeks from now is even more tempting.

In the end, only time will tell if a small-cap rally is truly underway. By then it will be too late. I suggest you heed the data that keeps piling up in favor of small caps. I’m not saying you should invest in nothing but such stocks. But you should at least consider increasing your exposure.

Here’s one last data point to chew on: Since 1926, Morgan Stanley found large caps return more, on average, when they trail small caps. When large caps lead the way they only return 7% per year on average. When small caps shine, large caps return 13% per year, on average.

Put more plainly, a small-cap rally is a win-win. Their strength brings our large-cap holdings along for the ride, too.

Next week, I’ll provide more proof, detail my favorite ways to screen for small-cap investment opportunities and, in true holiday spirit, I’ll also share my favorite recommendations headed into 2009. So stay tuned.

Good investing,

Lou Basenese

Editor’s Note: So far this year, Lou’s White Cap Index is up 135%. He just released the next five companies about to be added to it. And one of them is already up 87% over the last 47 days. Get exposure to the soaring White Cap Index today, with the White Cap Report.

Today’s Investment U Crib Sheet

The financial industry traditionally uses small, mid and large caps to describe and classify companies. But as investments have become increasingly specific, so have the definitions. These have expanded to include nano, micro and mega caps.

Market Capitalizations

• Nano Cap: Below $50 Million
• Micro Cap: $50 Million to $300 Million
• Small Cap: $300 Million to $2 Billion
• Mid Cap: $2 Billion to $10 Billion
• Large Cap: $10 Billion to $200 Billion
• Mega Cap: More than $200 Billion

To calculate a company’s capitalization, simply multiply the share price by the amount of shares it has. For example, a company with 10 million shares, trading at $50, has a capitalization of $500 million - making it a small cap. You can find this information through Google Finance or any other stock quote site.

As Lou mentioned above, small caps have a history of being some of the first stocks to move upward in a new bull market. Their size enables them to react, make changes and return to profitability faster than a large company can.

Imagine a large- or mega-cap company as an oil tanker and a small cap as a speedboat. You can picture how easy it would be for the small boat to change direction, and how hard it would be for big corporations.

If you’re trying to figure out when the market might begin to recover, there’s another indicator Lou recently gave us. To find out why the Baltic Dry Index is the only indicator you should be looking at right now, check out Investment U Issue #884, The Baltic Dry Index: The Only Economic Indicator Worth Tracking Right Now.

Related Articles:

• I.O.U.S.A. & The Coming Entitlement Meltdown
• Small Caps: It’s Time to Think Small
• The January Effect: Another Wall Street Investment Scam

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