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...

September 15, 2006

Storytime 

Everybody loves a good story.

Can you imagine living without stories? They're the analogies of life. We continually tell each other stories. We explain  the complexities of our world through stories. It's how we learn, communicate, think, and live.

An investment is a story for and about the future. You do X. Then Y happens. Eventually, you end up with Z as a result.

Every stock has a story. All markets have stories. The bulls and bears each have their stories. 

The better stories come from the bears because fear is usually a more captivating and motivating factor than optimism. Optimism is about maybe gaining something in the future you don’t have now. Fear is about losing what you already have, right now, or in the immediate future.

I learned an interesting lesson about stories over 30 years ago that I have never forgotten. Back in late 1973 - early 1974, I was a young stockbroker working for Dean Witter on K Street in Washington, D.C., during the depths of Watergate and the Arab Oil Embargo. To say the least, times were tough. 

One afternoon, I, and other new brokers (mostly retired military) were working late. Dean Witter's research department had just published their latest recommendations and the name of Merck was high on the list. One of the older guys summarized the 5 main reasons to buy the stock out loud and announced that he was going to call all of his prospects right then to let them know what a great story Merck had. None of us were in a very good mood, and my grumpiness came out as a "Yeah, and I can give you 5 good reasons not to buy Merck!"

All heads turned to me. In truth, it hadn't taken me very long in the brokerage business to learn not to trust fundamental research. That distrust had already influenced me to move toward technical analysis (watch what they do, not what they say) of the markets. One of the guys challenged me and I promptly came up with 5 good reasons not only not to buy Merck, but also not to buy any stocks at all. I just pulled ideas out of the major news stories of the day and embellished each a little as to how it influenced the stock market. To my surprise, most of my audience agreed that I had made my point, and we all went back to work trying to sell Farm Credit Bank paper at 5.8396174% - the only security you could interest any prospective client in talking about.

On my way home that night, I realized that my negative interpretations of the news were no less relevant (or influential) than our analysts' positive interpretations. Who was right? Neither, and both. As events unfolded over the next few months, bullish and bearish stores were borne out by who, what, when, where, how, and why.

Thus, my fate for later life was sealed that day by learning that stories were just that - stories, and better belonged between book covers or on the silver screen. The rubber really met the road only in the heat of bids and offers, as I later learned on the floor of the Chicago Board Options Exchange.

When dealing in stories, we must always consider which came first (no, not the chicken or the egg) - the story or the investment position? Frequently, on the exchange floor, we traders would debate each other over the prospects for the stocks we made a market in. I'll never forget one incident when a new trader was carrying on loudly about how such-and-such was about to happen. Just then a large order came into the pit and he ended up hogging a goodly portion of it, which happened to be exactly contrary to what he had just prophesied. He had been exceedingly bullish, but he had just taken on a decidedly bearish position. One of the other traders, who had been cut out of the order, challenged the guy on why he'd gone contrary to his own stated belief. The new trader was at a loss to explain himself and just shrugged his shoulders, to which the other trader said, "You %#*&! idiot! Don't your positions have anything to do with what you believe? You won't last down here through the end of the month." And he didn't.

The bulls' stories:

Much work has been done recently to prove that Wall Street research is biased to the buy side. (Well, duh!) One study put out by the Journal of Psychology and Financial Markets contends that upwards of 95% of all recommendations are either to buy or to continue to hold securities. Few, if any, advocate a sale. But this is news? Isn't this to be expected? To think otherwise would be to walk into a Men's Wearhouse and be surprised that they're interested in selling you a suit. Wall Street creates securities to sell. That's their job - to sell the securities to you. Why in the world would they be looking for reasons for you to sell?

The same can be said of professional money managers - mutual funds, pension funds, trust departments, insurance companies, etc. These are people who get paid very well to buy and hold securities. When investment pros get interviewed and say they like X, and Y, and Z, and that they're very bullish, and that they're 98% invested, what else would you expect? By job description, they have to buy stock, so they'd better be bullish or else they're on a one-way trip to the shrink. Anytime you hear professional money managers sound the bullish horn, you can be sure they are hostage to their positions, regardless of what they think. They have no choice. And thus their stories can be taken with a grain of salt.

If prices of stocks are rising, bulls continually find reasons why prices will continue higher...forever. And if prices are heading lower, bulls come up with stories why things are about to turn around. Seldom is reality visited. In a bull's world, there are no business cycles, long tails, reversals of fortune, train wrecks, bad policy decisions, mistakes, or anything else of a negative nature. All news can be interpreted with a positive spin. And thus their stories are worthless other than entertainment value. 

The bears' stories:

Here, we have a different set of people. Bears are frequently more intuitive, more investigatory, more critical, and better writers. But here you also have to be more careful. Here is where you have to watch out whether the analysts' positions influence their stories or their stories influence their positions. All too often I've seen bears come to believe that the world is about to fall apart, buy into  bearish positions for good reasons, then fail to reconsider the facts when they turn around and point in the opposite direction. They become locked into their mindset, and like the professional bulls, refuse to change when the world changes. 

Moral of the story? Beware of prognosticators with vested interests.

The best bears (and bulls) are those who continually look at both sides. At various times during the cycle, the bullish story is the relevant story. At other times, the bearish story is relevant. The problem with all stories is that only in hindsight, through autopsy, do we really get a glimpse of who was right and who was wrong...and why. And even then, history is being constantly rewritten by opposing agendas.

You see, neither you nor anyone else can ever adequately process all the necessary information to understand the real underpinnings of what is happening right now that really influences investments. There are too many undercurrents in motion for objective analysis. As soon as you think you've got a handle on the immediate, you realize you've missed the "bigger picture" which always keeps getting bigger as you solve the "next" step in the problem. Complexity and chaos are two concepts trying to describe to the world we now occupy. 

Of the two predictors, the bears' stories are the most pertinent. They serve as the canary in the coal mine, the flashing signal urging caution ahead, or the backseat driver that yells, "watch out!" Markets have long been known as a discounting mechanism. A much-quoted quip is, "The stock market has predicted 9 of the last 4 recessions," meaning the market sold off in anticipation of bad times ahead...which didn't materialize. Perhaps the worst did not materialize because we, concertedly, took evasive action to head off the threat when we saw the warning signs.

A big problem with stories is the "facts" they're based upon. As I referenced in my review of The Secrets of Economic Indicators, most government-generated economic and financial information is late, inaccurate, and misleading (try another word - obsolete). Privately generated information is often no better because we all suffer from the problems that helped bring down the Soviet Union - lack of relevant and accurate data due to the size of the required sample. "Cherrypicking," or "data mining," are terms used to describe the molding of the information to an analyst's purpose. 

The question of stories really comes down to not only who is telling the story, but also why are they telling the story, and how accurate the information is that they are basing their story upon.

Louis Rukeyser (God rest his soul) was particularly adept at holding predictors to close scrutiny. Panelists on his long-running Wall Street Week were expected to make assessments of the future concerning stocks, interest rates, the economy, etc. At the end of the year they were confronted with their past predictions. The best part of that annual event was watching them try to wiggle out of why they were so wrong. To Ruykeyser, it was all good sport, and you felt deep down that his point was to prove that nobody really had a very good handle on the long-term stories they told.

Anyone can come up with a story. The Internet has spawned a whole new genre of conspiracy theorists who can make an air-tight case on why everything you thought you knew about from as far back as the beginnings of time to the latest revelation on 9/11 is wrong. 

Who's right? Who knows? And what difference does it make unless it concerns you personally?

What does concern you is where your stock is going in the future. And that brings us back to  Simplespreading. Since we have long since given up on relevant stories to make investment decisions, we must replace stories with something else. That something else is actual investor supply and demand for specific stocks. Relative strength tells us that other people are buying right now, not at some unknown time in the future. Prices tell us what stocks are being driven higher on each succeeding rally. Chart formations tell us where we expect sufficient buying power to come in to turn a stock around.

We only care that a stock meets our criteria, not why it does, or what its story is.

We must always remember that the purveyors of stories are like a stopped clock that is right twice a day. Each story we encounter has a grain of truth in it, but is it relevant to our investments today? We may be told that housing is in a bubble and that housing stocks are going to crash. Yet, it may be several years until the truth of that prediction is borne out. In the meantime, maybe we could have made money investing in housing stocks. Maybe we are told that gold is a barbarous relic that has no real value. But over the past few years, we could have made a lot of money as gold stocks skyrocketed. Maybe we are told that the economy is strong and that stocks are undervalued. But then why do we lose so much money when the markets suffer through a vicious selloff? We may be told that the economy is about to fall off a cliff, yet why does the market continue to rally, giving us numerous opportunities to profit in the mean time? 

Stories will always be with us. They are as much a part of our lives as the oxygen we breathe. But when it comes to making investment decisions, they usually aren't worth the paper (or bytes) (or air waves) they're sent to us on. 

In closing, I've got a few gems of  wisdom for you:

1) The stock market will rally strongly into the fall as Republicans retain both houses of Congress and the Iraq War cools down.
2) Interest rates will subside, giving way to another housing boom that will take home prices to yet higher levels.
3) Inflation will drop back to near zero as worldwide business' efficiency delivers on the New Economy's promises.
4) China will become an even more important ally as our and their economic destinies mesh in harmony.
5) New technologies will enable everyone to forget disease and live to whatever age you desire.

Or:
1) As we go into the fall elections, America will erupt into ethnic violence and the stock market will crash.
2) Interest rates will skyrocket as defaults on overpriced housing drive lendable money out of the marketplace.
3) Inflation will rear its ugly head again, more virulent than during the 1970s.
4) International geopolitical troubles come to a head as China, the Middle East, and Latin America combine to dethrone our position in the world.
5) New plagues, driven by globalization, will terrorize large cities, killing millions.

Am I right? Only time will tell.

Remember, you too, can be a storyteller. But does it influence your investing?

FOR THE WEEK...Expiration Day

Yesterday, there were over 115,000,000 equity calls trading on the six exchanges. Today, approximately 15-20 million of them will expire. Covered call writers will collect the premium they sold during the past nine months as pure profit. Whether they also made money on the underlying stocks depends on whatever happened to the stocks during the time investors held them. All in all, September will be another very profitable expiration for Simplespreaders. 

With the winter and spring's leadership (Manufacturing, Transportation, Metals & Mining, and Energy) in tatters, one could reasonably say that the market's internals are changing. As we have been broadcasting here for several months, Energy and Metals & Mining have overstayed the norms we usually see in market leadership. History shows that leaders over a 2-3 year period frequently become laggards going forward. 

The question then arises of what sectors are positioning themselves for new leadership. Current leaders, Tobacco, Utilities, Food & Beverage, are historically defensive plays - stocks that do well when the economy and the rest of the stock market do poorly. So, we can't count on current leadership to lead us higher.

The Health Complex is making strides toward the top of the list. Also, Media and Telecommunications look to make it a race. A third area of interest could be high tech - Electronics, Computers, and Internet. All three have perked up recently. Short covering, or real investment interest? 

As for the market, we should keep in mind that Mr. Market doesn't adhere to the game plan when everybody already knows the drill. September and October are historically weak, as reported on practically every market airwave and broadband line known to man. Also, everybody is equally aware that the mid-term election year is historically weak. Additionally, warnings have been going out from everybody, including the local taxi driver and the IMF, that the US and world economies are due to take a bath thanks to enormous financial imbalances. And we all know that housing is headed for a crash, as well as the dollar is going to sink like the Titanic. With this amount of bad news already factored into investors' minds, you have to conclude that it is going to take a shocker to knock the legs out from under stocks. 

Or...does everybody wake up shortly and realize that the market is living on borrowed time - the music stops, and everybody heads for the exit at once. 

Two good stories. Which one will carry the day?

Tobacco maintained its #1 position for the ninth week in a row. Utilities remained in the #2 spot. The #3 position welcomed Media which has made a dramatic sprint over the past month. Food & Beverage stayed put in the #4 spot. Real Estate spent its second straight week in the #5 position.

Insurance moved up to the #6 spot. The Dow Jones Industrial Average positioned itself at #7, indicating just how weak much of the rest of the market is. Aerospace/Defense held on to the #8 position. How Automotive moved up to the #9 position boggles the mind. Chemicals made it up to the Top Ten at the #10 spot for the first time since its brief appearance in June. 

THE TOP TEN...