02/08/2006
This past week saw plenty of selling in the commodities sectors. Oil, gold, natural gas and many other high-flying commodities finally experienced that sharp selloff that, in my opinion, was long overdue. With the fall of oil came a sharp pullback in oil service sector stocks. Now this sector took off at the beginning of the year, and in just five weeks surged over 20%. It's no surprise to me that these stocks, despite solid earnings reports, have given back a good chunk of those gains in just one trading session.
Yesterday a listener to my radio show called to ask me what he should do with his position in oil services stock Nabors Industries (NBR). The stock fell 7.5% in Tuesday's session despite a near doubling of its Q4 earnings from the prior year. The answer to the question of what to do with a stock depends largely on your cost basis. If you bought NBR back four months ago in the low 60s, then you can weather a day or two of selling. But, if you just recently jumped on the bandwagon, taking a position in the mid-70s, then you've got to manage your risk and think about taking a small loss right here.
The same applies for one of the key stocks of the most recent market runup -- Google (GOOG). If, for example, you got Google at $100, you don't feel that bad about Tuesday's near-$20 drop in the price to $367. You're already holding a nearly quadruple gain, so you can play with the house money and let it ride. If, however, your cost basis on Google is above $400 -- you know who you are -- you need to take action and manage your risk by getting rid of your position during this steep correction in the stock.
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Right now I am watching stocks like Google and Apple (AAPL), along with small caps, as they have been leading the market forward in this most recent run. If this leadership starts to falter, it could mean an end to rising stock prices in the short run. Do you have a strategy in place that will protect your recent gains, or are you going to watch it all evaporate because you were afraid to act? Don't let your fear of inaction dictate your investment strategy.
Last week President Bush unveiled his budget for the fiscal year 2007. While there was some good news on the budget front in terms of eliminating many government programs, the budget didn't do nearly enough to correct the deficits we'll be running in the coming years. In the State of the Union speech last week, the president said we are on track to cut the deficit in half by 2009, but based on the spending both he and Congress have slated for next year, there is simply no way, in my view, that this goal will be achieved.
Consider these staggering numbers. The total federal budget is nearly $2.8 trillion. According to even the rosiest of White House projections, there will be a deficit of over $400 billion in 2007—and that's if all goes well and no new disaster or war spending is needed. Think of it this way, if there is roughly a $400 billion budget shortfall that means we are only bringing in $2.4 trillion in revenue. That translates into a binge of overspending along the lines of nearly 15%. To put it in personal terms, let's say you will earn $85,000 this year, but your plan is to spend $100,000. So what about that extra $15,000? No problem, we'll just put it on a credit card or pull it from our home equity line.
Well, you can see that this wouldn't be very prudent money management for you personally, and it isn't prudent for government either. The only difference is when the feds borrow money they do it in the form of issuing Treasury bonds, and that further increases the debt, and further increases the debt burden on taxpaying individuals and corporations. This vicious debt cycle can hurt the stock market, and by extension the value of your retirement dollars. The bottom line here is that Washington does not have its fiscal house in order, and the repercussions will be felt by everyone, especially those unprepared for the consequences.
On Tuesday home building bellwether Toll Brothers (TOL) announced weaker-than-expected first quarter orders, while also telling The Street that it expected lower new home deliveries for the rest of 2006. The stock fell sharply on the news, as traders speculated that this could be the beginning of the end of the run in housing issues. Toll Brothers is now trading 30% below its 200-day moving average. If you were a trend follower, you would have sold this stock long ago, when it first fell below its 200-day average. That means you would have spared your nest egg a 30% hit!
More importantly, the Toll Brothers announcement is a sign that this housing slowdown is indeed for real, and that the housing bubble I've discussed so much on the radio show is indeed about to deflate. This could be the start of some real bad news on the economic front, because if the housing bubble either bursts, or merely starts to leak air, one of the biggest drivers of the U.S. economy will likely grind to a halt. Nobody knows for sure how to calculate this, but for the past several years borrowing on home equity has kept a constant flow of stimulus into the economy. But with interest rates rising (it now costs almost 7.5% to borrow against your home equity line) and home values beginning to decline, that spending spigot may soon be cut off.
This potential looming slowdown is why you must have a strategy in place to deal with market risk in your portfolio. If the housing market cools off sharply, we could see a growling bear in the market's future. Combating the bear is a matter of preparation and risk management.
But having a risk management strategy in place is not limited to just your investments in the stock market. The strategy begins with making sure you've got your home financed properly. If you've got an interest-only loan, a negative amortization loan or a home equity line of credit, you've got to call home buying coach Josh Lewis for your FREE mortgage risk analysis. Josh will help you determine if you are prepared for combating the potential hazards of a busted housing bubble. Don't hesitate any longer, call Josh now at 800.218.9217, or e-mail him at jlewis@stearns.com for your free housing bubble risk assessment.
Although the timing was somewhat poor with this week's sell off in commodities, a new Exchange Traded Fund (ETF) has hit the market that deserves to be checked out. It is the Deutsche Bank Commodity Index Tracking Fund (DBC).
This ETF uses futures contracts to mirror the performance of the Deutsche Bank Liquid Commodity Index, which is tied to crude oil, heating oil, gold, aluminum, corn and wheat. This is significant because it is the first time there has been an ETF based on futures contracts.
The Deutsche Bank tracking index has base weights of 35% crude oil, 20% heating oil, 12.5% aluminum, 10% gold, and 11.25% each in corn and wheat. The index is rebalanced each November. Short-term Treasury bills provide collateral for the futures. The fixed-income portion of the portfolio generates yield, which according to Deutsche Bank could be used to offset fees.
One thing I don't like about this new ETF is its relatively high fees. With an expense ratio of 1.5%, it is high compared to other ETFs. But because of the yield from the fixed-income portion of the portfolio, these fees are somewhat offset.
This new fund is bound to cause the creation of more new and innovative ETF tools in the near future, and that is all good news for investors. Now I am NOT recommending that you buy this commodity fund right now, so don't go out and call your broker. But what I am saying is that Wall Street is finally realizing what we've been saying for the past several years now -- the ETF revolution is here to stay, and it's getting stronger nearly every day.
“Unquestionably, there is progress. The average American now pays out twice as much in taxes as he formerly got in wages.”
--H. L. Mencken
I wish we could say there's been progress since Mencken's cynical words, but looking at the federal budget for 2007 -- well, you be the judge.