WHERE SHOULD YOU HAVE PUT YOUR MONEY IN 2006?

A weekly newsletter based on the fact that stock market sectors are made up of industries, that industries are made up of individual stocks, and that individual stocks in the same industries and sectors move as a group. The proven best way to profit from the stock market is to keep your funds invested in the stocks of top performing sectors/industries at all times, and the best measurement of performance of these sectors/industries is their price movement over the previous six months. Below you will find commentary of Sectors, Industries, and Stocks based on the most recent 6-month period as well as updates on the past week’s action...

June 16, 2006

Dot.Comm-odities

Take a look at the following chart. Substitute almost any high-tech, biotech, or telecommunications stock for the period of 1999-2000, and you'd swear it was deja vu all over again. 

We don't have anything against the fine people who work at or own shares in Empire Resources (EMR). We aren't picking on them. As a matter of fact, we'd like to use them as an example of how the markets really work. From what we've been able to find out, the company is a distributor of aluminum products. We all need aluminum. No argument there. But a quick glance at the chart tells us that from a price around $6 in October 2005, with only a few thousand shares changing hands daily, it soared to over $60 a share last month, where several million shares a day were trading at the mania peak.

By our calculations, that's close to a 1000% gain in about 7 months. Considering the market's long-term annualized return is around 7%, savvy investors should have had every reason to take the profits and run well before the collapse.

Is this an oddity? A rare exception? Not in the least. If you look back in stock market history, you will find that eruptions similar to EMR occur regularly - whenever we need more products and services. As a matter of fact, it's the stocks (and sectors) like EMR combined with the losers of the day (of which there are many) that work out to the market "average" which so many of our professional money managers seek to attain. 

During the 12 months while EMR was rising 1200%, whole industries such as Iron & Steel, Semiconductor Memory Chips, and Oil & Gas Equipment & Services, rallied over 90%. But to average things out, industries such as Radio Broadcasters, Hospitals, and Music & Video Stores dropped by over 20%, including Movie Gallery (MOVI) falling from $30 to $3. Add up the pluses and minuses, divide by the number of factors, and you get the average - something every non-average investor should avoid like the plague. 

When the bowling craze hit in the 50s, Brunswick soared from a split-adjusted price of about $0.60 in 1953 to over $65 in 1961. When the airlines got their jets in the 60s, Delta Airlines shot up from a split-adjusted price of $2.75 in 1962 to a 1966 high of $44. When oil became the hot commodity of the 70s, Schlumberger climbed from a split-adjusted price of $1.25 in 1970 to a high of $44 in 1980. When consumerism came to full bloom in the 80s, Toys R Us jumped from a split-adjusted price of $0.88 to a 1990 high of $36. When the New Economy of the Internet hit in the 90s, Cisco Systems multiplied from a split-adjusted price of around $0.06 a share to over $80.

Yes, it's a market of stocks. And so far this decade, it's been commodities, commodities, and commodities - oil, mining & minerals, construction materials. Why? Because in addition to our own demands, the second and third world economies of the world are building infrastructure. When the prices rise sufficiently so that enough stuff is produced, things will settle down. That's how the world gets built.

Everybody wanted to bowl in the 50s, so the bowling companies grew and multiplied, supplying us with balls, pins, and alleys. In the 60s we took to the air. In the 70s we needed more oil to energize a growing population. In the 80s we all went shopping. In the 90s we built the Internet. Whatever James Surowiecki's The Wisdom of Crowds wanted, Malcolm Gladwell's The Tipping Point showed the way. Then both eventually succumb to Mark Buchanan's Ubiquity - explaining why in the long run it all falls apart. Smart investors are always tuned into the latest trends, because that's how the world of tomorrow gets built and that's where the profits are...for a while. Then the world moves on.

Additional historical listings of leading industries and stocks can be found in Rule #23 and Rule #77 of 80 Rules For Taking 40% A Year Out of Wall Street.

Beating a Dead...House

Investors familiar with these pages know that the homebuilders have been one of our favorite sectors and also one of our favorite subjects of discussion. Not only are they a highly visible part of our economy, but they also exhibit strong group cohesiveness. They rise and fall together. They compete against each other, but they also benefit from the same macroeconomic forces that put a housing boom into motion, and bring it to an end. A rising tide raises all ships, and all that. 

Since 2002, predictions of a housing bust have been making headlines. But it wasn't to happen for three more years. Strong trends have a way of maintaining their direction. Call it momentum. As Keynes said, "Markets can stay irrational longer than you can stay solvent." The industry's financial results bore out the stock trends for a long time as the companies booked record sales and earnings year after year. Only recently have cracks begun to appear in the foundations. 

Now it appears the time has come to do an autopsy on the homebuilders. As described so clearly in Edward S. Jensen's Stock Market Blueprints (1967), stocks move in groups of industries or sectors. In each group there are the Early Leaders, the Total Return Leaders, and the Catch-Up Candidates.

Let's take apart the top 12 domestic homebuilders'  half-decade move from bottom to top to see how it played out. Ranking order is  based on market capitalization.

*Beazer topped out in January 2006 rather than July 2005 with the rest of the group. (Calling a 700+% return a "Laggard" during a time when the indexers were content with 7% is probably not politically correct, but the table shows you just what was available so far this decade.)

No doubt total returns are helped by big gains made early. It's easier for a stock to go from $10 to $20 than from $50 to $100 - although both gains equal 100%. Percentages do play a big part here. But the lesson to be learned is that the stocks which are first out of the starting blocks frequently remain the best gainers for the whole move. By the summer of 2000, Residential Construction had bolted into the top 25% of performance rankings of price movement over the past 6 months, and the Early Leaders were in strong uptrends. Although the homebuilders did suffer several setbacks during their 5-year run, they always came back and even now rank as one of the top money makers for investors so far this century. As a matter of fact, as of today, they are number 5 out of 209 industries and number 9 out of 31 sectors despite the fact that they have fallen some 50% from their 2005 highs. 

We will miss them but look forward to additional profits from the industries and sectors that have taken their place.

FOR THE WEEK...looking for a bottom

The Dow Jones Industrials held in the 10700 - 10750 area as expected. Now comes the bounce. Overhead resistance awaits. The Generals have held the line. The Soldiers are regrouping. We'll just have to wait to see whether the formation can get back together again or whether this is the first break of many more to come.

Metals & Mining bounced all over the place but stayed in 1st place. Gold took a harrowing dive on Tuesday, down into the $575 support area. After the carryover selling Wednesday morning, it righted itself and tried to regain its balance, albeit on unsteady legs. Tuesday reminds us of the trading floor's bawdy humor of "When they raid the house, they take all the girls." Definitely, mid-week saw everything under pressure. 

Aerospace maintains the Number 2 spot, having had a good year so far. Transportation holds strong in 3rd place and in the Top Ten since last November. Manufacturing, also in the Top Ten since last November, comes in at Number 4. We can see a trend here: "Made in America, transported in America." The Number 5 spot belongs to Automotive. We can't understand it. But ours is not to question why.

Real Estate is a fluke at Number 6. New blood in the presence of Leisure in Number 7 and Media in Number 8 should hold interest for the future. Numbers 9 and 10 are purely defensive sectors, Tobacco and Food & Beverage.

With everything (stocks, bonds, commodities) in retreat except interest rates, it's not a pretty picture. We don't expect any quick resumption of the rally. However, since so much damage has been done lately, we don't expect a sudden collapse either unless geopolitical events set off a crisis. Perhaps a back-and-fill summer rally is in store. But we harbor serious concerns as we go into the late fall elections. Again, this is the mid-year of the election cycle, and the markets don't look very healthy. Keep your ear to the ground and your eye on the Beltway.

THE TOP TEN...