Do Americans Want To Buy Fuel Efficient Cars?

There appears to be debate on this question, which is puzzling to me. I think many people are mistakenly under the assumption that "small, fuel efficient" cars equate to miniature so called "smart" cars that we see every so often on the road and in Europe, as opposed to simply something other than a gas guzzling SUV or crossover vehicle. In fact, most sedans today are very fuel efficient.

Will U.S. consumers buy these cars? Well, that question has actually already been answered. As you can see from the chart below, the top 5 best selling cars in the U.S. get more than 30 miles per gallon on the highway, and #6 on the list isn't too far behind:

"Buy and Hold" Doesn't Work If You Completely Ignore Valuation

The current bear market resulted in the first negative ten-year period for the U.S. stock market in a long time. This has prompted many people to declare that the investment strategy of buying and holding stocks for the long term ("buy and "hold" for short) is all of the sudden "dead" or no longer viable.

Personally, I find this death pronouncement a bit odd. Just because stocks went nowhere from 1999-2008 means that investing in stocks for ten years is flawed generally? Since when does one instance of something not working render the entire concept flawed? I don't think a 100 percent success rate is required for one to declare it a viable strategy.

The reason "buy and hold" became popular is because, over long periods of time, stock prices mimic corporate earnings, which have risen over business cycles since the beginning of our economy. Legendary fund manager Peter Lynch continually reminds people that it is no coincidence that over decades the gains in the U.S. stock market are practically identical to the gains in corporate earnings (stock ownership represents a proportional share in profits generated by the firm).

The key point here is that the relationship only holds over long periods of time. In any given year, there is virtually no correlation between earnings growth rates and equity market gains. That is why "buy and hold" is a widely accepted investment strategy. If you invest over the long term, the odds are extremely high that earnings and stock prices will rise, and do so at higher rates than other investment alternatives.

I bring this up today because a former CEO of Coca Cola was a guest host on CNBC this morning. He and the CNBC gang discussed the fact that shares of Coke are actually down over the last ten years (since this person left the CEO post), as the chart below shows.

The CNBC commentators were quick to point out that Coke's earnings have more than doubled over the past decade, but the stock has actually lost value. Does this example support the idea that "buy and hold" is a flawed strategy, or is there something else at work here?

The latter. Coke stock carried a P/E ratio above 50 back in the late 1990's, during the blue chip bull market. Even when earnings grow dramatically, if P/E ratios are in nose bleed territory, "buy and hold" may not work, as was the case with Coke.

As a result, "buy and hold" does not work blindly. If you dramatically overpay for a stock, there is a good chance that you won't make any money, even over an entire decade. From my perspective, this does not mean that "buy and hold" is dead (the long term relationship between earnings and stock prices is unchanged), it simply means that valuation is important in determining future stock price returns (statistics show it is the most important, in fact).

The takeaway from this discussion is that "buy and hold" investors are likely to do very well over the long term, as long as they don't grossly overpay for an asset. The U.S. stock market in the late 1990's was more expensive, on a valuation basis, than at any other time in its history. Buyers during that time can't be saved from their own poor decision of paying too much for a stock, even by a proven long term investment strategy. Unfortunately, most non-professional individual investors don't focus on valuation when picking stocks for their portfolios, and often pay the price as a result.

Full Disclosure: No position in Coca Cola at the time of writing, but positions may change at any time

After Huge Rally, Market Digests Earnings Season and Bank Capital Raises

With most first quarter earnings reports having already been released, along with bank stress test results, the action in the market has died down considerably. After a 40% rally, the S&P 500 has been consolidating between 875 (a key technical support level) and 930 (the recent high). Such backing and filling is a strong sign. One would expect a pause after such a huge move, and despite the fact that the banks are rushing to issue billion of dollars in new shares, the market is absorbing that new supply fairly well (the stocks are down from their highs but they seem to be building a base and fear has subsided).

As for earnings season, first quarter results largely exceeded reduced expectations. Bulls and bears will continue to debate whether beating those low estimates was a positive or not, but merely stopping the earnings decline would serve to put a floor on stock prices. If the rate of decline in both the economy and corporate profits can decelerate, we could very well see sideways market action for a while. With the S&P 500 up from 666 to nearly 900, that would be welcomed by most investors.

The recent rally has been predicated on the idea that Q4 2008 and Q1 2009 will turn out to be the worst quarters for the economy. If GDP can rise sequentially throughout the year, and turn positive on a year-over-year basis by the fourth quarter, corporate profits will likely have hit a bottom. This scenario is priced into equities, so we really need it to play out that way for the S&P to hold the 900 area in coming months.

There are still plenty of people who are negative on the economy and either don't think a rebound will occur later in 2009, or if it does, it will be short-lived and we will see even worse times in 2010. If that proves true, we could very well see a retest of the March lows, as the bears are expecting.

Where do I come down? I think there is a decent chance we do not see 666 on the S&P 500 again. By "decent" I mean, say, between 50% and 67%. The rest of 2009 could very well be rocky though, so we could certainly get a correction or two, especially after a 40% rally in the market. As a result, I am holding some cash (10-20% right now in many cases) in order to take advantage of any other leg down if we get it. That cash number will likely increase if the market rally continues and we approach my own fair value estimate (1000-1050 on the S&P).

In general, I think a solid path would be for the market to trade sideways for a while. Digesting the big move we have made, rather than simply seeing another large sell-off (which was the typical course over the last year or so) would send a signal that the worst may be behind us and we can slowly recover. I agree with many who believe an economic recovery will be neither particularly fast, nor violently strong, but simply muddling along with little or no GDP growth would go a long way to supporting stock prices at their current level and take the calls for 600 on the S&P off of the table.

Trucker YRC Applies for TARP Funds, Don't Hold Your Breath

For those who don't know, YRC Worldwide (YRCW) is the former Yellow Roadway. Here is some of what the Wall Street Journal is reporting:

"YRC Worldwide Inc., one of the nation's largest trucking companies, will seek $1 billion in federal bailout money to help relieve pension obligations, the chief executive said Thursday. Chief Executive William Zollars said the company will seek the money to help cover the cost of its estimated $2 billion pension obligation over the next four years. Under a complicated system that Mr. Zollars labeled unfair, roughly half of YRC's contributions to a multi-employer union pension fund cover the costs of retirees who never worked for the Overland Park, Kan., company."

Awfully presumptuous of him, don't you think, applying as a trucking company without any indication Treasury would ever widen TARP to include any U.S. corporation? I would be shocked if this were approved, and if somehow it is, TARP would be completely out of control.

"Mr. Zollars declined to comment on YRC's specific strategy in seeking the funds, other than to say the company shouldn't be forced to pay the pension benefits of employees who never worked for YRC."

This seems like an odd explanation. I don't know the details of the "complicated, multi-union" pension plan in question, but it strikes me as probable that if half of YRC's contribution goes to people who didn't work for YRC, then the other truckling companies are in the same boat and are paying for some of YRC's former employees. Does Zollars want to stop paying for non-YRC pensions while still having his competitors subsidize YRC's pension obligations? The whole thing is bizarre, to say the least.

Full Disclosure: No position in YRCW at the time of writing, but positions may change at any time

Meredith Whitney Quitting Oppenheimer Helps Show Contrarian Indicators Still Work

As my clients know well, I am a contrarian when it comes to investing in the market. To me, buying a stock is no different than shopping for a new house, car, or wardrobe at the mall. You get your best deals when you are either buying things other people don't want (store sale racks, foreclosed properties), or buying things when other people aren't shopping for them (winter coats well into the season).

As a result of natural human behavior, many market participants use contrarian sentiment indicators to guide their investment strategy. Measures of investor bullishness and consumer confidence, for example, are proven contrarian indicators. Sometimes certain events can even mark emotional extremes.

Consider banking analyst Meredith Whitney's decision on February 18th to leave her sell side job at Oppenheimer to start her own firm. Prior to October 2007, few people even knew who Whitney was, but after she became one of the first analysts to point out a possible capital shortfall at Citigroup (C) she immediately became the face of the banking crisis (thanks to the financial media) and has been extremely bearish on the group ever since.

So, we have a relatively unknown banking analyst make a good call on a large bank stock, the media picks up on it and runs with the story for months, and less than 18 months later she has enough of a following to start her own firm. These kinds of events often mark extremes, in this case, the depths of the banking crisis. For an analyst who made her career by being unrelentingly bearish on banks, it stands to reason the banking sector would be struggling mightily around the time she quit her job to go out on her own. It makes sense to question whether negative sentiment would be peaking around that time.

Of course, I wouldn't have used this example if it didn't serve as a positive data point for the contrarian indicator thesis. We won't know for another year or two if Whitney quitting actually was a great contrarian indicator or not (it's too soon to call the bottom in the banks), but it took only 12 trading days for the bank stocks (and the market itself) to put in a fierce and dramatic bottom on March 6th. Since then the market has risen 36%. Financial stocks have fared even better, soaring 105%.

Another contrarian indicator I follow is the number of worried emails and phone calls I get from my clients about their investment portfolios. If I get a few clients expressing concern over a period of days, that signals to me that sentiment is extremely negative and a bottom may not be far off. This personal indicator of mine peaked on March 2nd, merely four days prior to the market's bottom.

All in all, contrarian indicators measuring sentiment among investors and other market participants can still be a very valuable tool when managing one's investments. I recommend keeping them in mind as you continue to follow the market and your portfolios.

Full Disclosure: No position in Citigroup at the time of writing, but positions may change at any time

U.S. Bank Stress Test Cheat Sheet

All we've heard about this week has been the stress tests, so I figured I would summarize the important aspects for everyone. Hear is what you need to know if you are following the large cap U.S. financial sector.

Capital Ratio Requirements: Banks must have enough capital to maintain the following ratios:

*Tier 1 Capital of 6.0%

*Tangible Common Equity (TCE) of 4.0%

Deadlines: For banks that need more capital, here is their timeline:

*Articulate plan for raising capital by June 8th, 2009

*Implement plan by November 9th 2009

*Maintain target capital ratios through December 2010

Sources of Additional Capital:

The regulators have indicated that raising private capital is the preferred source of raising capital. The banks may also choose to sell certain assets and use cash earnings to reach the targets. If those options are not sufficient to reach the desired capital levels, the banks may convert their TARP preferred capital into mandatory convertible preferred stock, which can be converted, on as needed basis, into common equity in order to boost capital levels to the needed levels.

Here are the results:

As for individual stocks, I have long been writing positively about COF, PNC, and USB on this blog. COF and USB passed and PNC needs to raise the least of all the banks, a meager $600 million. These results are not surprising to me, and I continue to like all three stocks long term.

Full Disclosure: Peridot Capital was long shares of COF, PNC, and USB at the time of writing, but positions may change at any time

Credit Cardholder "Bill of Rights" Looks Like Sensible Regulation

One of the biggest concerns from conservatives since President Obama's election has been the possibility of new, overly burdensome government regulation on various aspects of the economy and financial markets. While this should be a real concern, it is unfair to assume new regulations will be over-the-top before any of them are actually drawn up, passed, and enacted.

Among the first is a credit cardholder "bill of rights" which is supposed to protect consumers from unfair and deceptive credit card issuer practices. The U.S. House of Representatives overwhelmingly passed its version of the bill (the Senate is working on possible modifications), so I thought I would go through the summary of its contents to see how reasonable it is. Below are the details:

Interest Rate Increases

1) Limits interest rate increases on existing balances to those cardholders who are late with their payments, have a promotional rate expire, or have a card with a variable rate

2) Requires card issuers give consumers 45 days notice to any interest rate changes or significant contract changes

Credit Limits

1) Lets consumers set their own fixed credit limit

2) Prevents over-the-limit fees for consumers who have set a limit or for "hold" transactions

3) Limits (to 3) the number of over-the-limit fees issuers can charge for the same transaction

Penalties for On-Time Payers

1) Ends "double cycle" billing - interest charged on balances that were paid on time

2) If cardholders pay on time and in full, prevents issuer from charging left-over interest fees

3) Prohibits additional fees for paying over the phone or internet

Allocation of Consumer Payments

1) After the minimum amount due, payments must be allocated proportionally to high interest and low interest balances, not exclusively to the lowest interest rate debt

Due Dates

1) Billing statements must be mailed 21 calendar days before the due date, payments received by 5pm local time on the due date must be considered "on time"

2) Extends the due date to the next business day if the due date falls on a day the card issuer does not accept or receive mail

Misleading Terms

1) Establishes standard definitions for terms such as "fixed rate" and "prime rate" so as to ensure clarity in marketing materials

2) Gives consumers who have been "pre-approved" for a card the right to reject the card prior to activation without negatively impacting their credit score

High Fee, Subprime Cards

1) Prohibits issuers of subprime cards (cards with fixed annual fees that exceed 25% of the card's credit limit) from charging those fees to the card itself, which often results in consumers going over their limit

Issuance to Minors1) Prohibits card issuers from knowingly issuing cards to individuals under 18 who are not emancipated minors

After reviewing this "bill of rights" I was pleased to conclude that none of these measures, in my view, would be considered excessive regulation by the federal government. I think we all need to take more responsibility for our actions and our financial situations, and empowering the consumer with information and the ability to avoid certain products if they choose to can only aid in that process. Kudos to Washington on this one (hopefully the Senate doesn't mess with it).

You Can't Go Broke Taking Profits

A common saying on Wall Street, and for good reason. Although the stock market has been acting very well in recent weeks and today's 200-point gain is a good start to this week, I am not going to be bashful about taking some chips off of the table for my clients and you shouldn't be either.

It is a contrarian move (not surprisingly, coming from me), as the market is breaking through upside support levels on a technical basis, but I want to have some cash on hand to make purchases during the next correction. When will that drop take place? I have no idea but it certainly will come. I would not be surprised if it was soon. After all, the S&P 500 has rallied from 666 in early March to 907 in early May, a gain of 36%. Still, we are up less than 1% for 2009.

Trading in Dendreon Stock Shows Why Short Term Trading Is Such A Gamble

You may have heard about Dendreon (DNDN), a small money losing biotechnology company that is in the process of getting its cancer vaccine, Provenge, approved by the FDA. Full results from a crucial phase three study were released yesterday afternoon in Chicago, but about half an hour prior to their release, shares of Dendreon fell off a cliff for a couple of minutes and trading was halted for "news pending." Between 1:25pm and 1:27pm ET Dendreon stock fell from above $24 to as low as $7.50, and were halted at $11.81 per share.

Immediately investors were baffled. The most plausible explanation was that the full study results somehow were leaked early, someone learned they were bad and sold their stock, which in turn caused others to panic and sell too. That would have been an odd turn of events, however, because the company had indicated recently that the study results were clearly favorable.

When the news was finally released to the public there were no surprises, which makes those trades just before 1:30pm very strange. The NASDAQ exchange quickly investigated the trades to see if any were made erroneously, but they found nothing wrong and the trades will stand. Today the stock reopened and is currently fetching about $24 per share.

This story only serves to further my personal belief that short term trading in the stock market is so speculative that it is really nothing more than gambling. Evidently somebody somewhere thought they saw or heard something that was negative for Dendreon, others followed suit and sold their shares like lemmings jumping off a cliff, but in reality there was no news at all.

Undoubtedly some investors quickly hit the sell button during those few short minutes yesterday afternoon, fearing that if they didn't their stock would fall even further (Dendreon stock sold for $2 in March, so many people had huge gains). They lost between 50% and 75% of their money for no reason. Other investors surely had large paper gains in Dendreon and had stop loss orders in place to limit any future losses. Many of those stops were triggered as the stock collapsed from $24 to $7 and rebounded to $12 and those investors also lost big time.

As you can see the market is very complex and sometimes things happen that are not rational and should never have happened. Speculating on near term movements of stocks (especially small biotech companies) is a very risky endeavor. All the market needs is a willing buyer and a willing seller to agree on a price in one split second. Reality need not apply in such a case, but millions of dollars can be lost in a matter of minutes, as was the case with Dendreon yesterday.

Traders beware. In some cases Wall Street can look very much like a casino.

Full Disclosure: No position in Dendreon at the time of writing, but positions may change at any time

Look For Swine Flu Related Opportunities

To me this swine flu outbreak looks a lot like avian bird flu; fairly contained and overhyped. Of course anything is possible, but as Wall Street frets about swine flu (Dow futures are down 150 this morning), investors should be on the lookout for investment opportunities. Worries over bird flu led to numerous bargains, especially in the poultry industry. We'll have to see what stocks, if any, are adversely affected by swine flu worries. Chances are they will excellent investment opportunities just as were available when SARS and bird flu were the worries of the day.