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Richard Young's INTELLIGENCE REPORT
9420 Key West Ave., Rockville, MD 20850.
Monthly, 1 year, $249.
Richard Young: "You know the importance I place on the Presidential Cycle. The tough years in the current four-year cycle are 2005 and 2006. With history as our guide, the big years should be 2007 and 2008. Thus it is probable that as 2006 progresses, stock market risk will be reduced. Interest rates in 2006 will not be the problem they were last year. You need to set yourself so that by the close of 2006 you have for you what is a satisfactory exposure to equities. Conservative investors will always stick exclusively with dividend-paying stocks. Given the structurally weak position for the US$ and the U.S. trade deficit, a substantial international portfolio component is mandated. And natural resources, including precious metals, work well in this regard. My Top-10 Common Stock Countdown is your place to look first for new names to add to your equities list. Current Top-10 include: Macquarie Infrastructure Co. (NYSE MIC), Equity Residential (NYSE EQR), Norfolk Southern (NYSE NSC), Rio Tinto (NYSE RTP), Rayonier (NYSE RYN), Union Pacific (NYSE UNP), Archstone-Smith (NYSE ASN), Alcoa (NYSE AA), Hutchinson Whampoa (OTC HUWHY.PK) and McCormick & Co. (NYSE MKC). President Bush is doing a whole lot better than the liberal media would allow."
NATE'S NOTES
P.O. Box 667, Healdsburg, CA 95448.
Monthly, 1 year, $150.
What might affect investor confidence?
Nate Pile: "Given the growing number of things investors may choose to worry about in the months ahead, I believe it makes sense for us to lock in some of our profits and start raising cash that can be put back to work once conditions start to look more favorable for stocks.
Though investors have thus far managed to shrug off the following issues, I believe each of them has the potential to act as the catalyst that may trigger a sell-off in the market. In no particular order, some of the more important situations to keep an eye on are:
- The Middle East. Personally, I am amazed that the market has not responded more strongly to recent developments in the Middle East. Between Hamas' victory in recent elections and escalating levels of anger and violence towards the West in response to the cartoons that were initially run in the Danish press, I think it is fair to say tension levels are increasing rather than decreasing in the region. Add Iran's current stance on its nuclear programs to the mix, and I believe the potential is there for a major crisis to erupt if the right "spark" comes along. I do not know what the spark will be, but I worry that there is the potential for major instability (and corresponding uncertainty on the part of investors) to spread across the region if anything "bad" happens (an assassination of a key political leader, a major political confrontation between the U.S. and any of a number of groups Bush & Co. have designated as "concerns," a successful large-scale terrorist attack on U.S. troops stationed in the region, etc.).
- Oil and Commodity Prices. With or without a major crisis in the Middle East, I believe there is still the potential for us to see another run-up in oil prices, and if such a move develops, I think it will put a damper on investor optimism. On a similar note, most commodity prices still appear to be in an uptrend, and though the immediate effects of this on investors' enthusiasm for stocks are hard to predict, higher costs for raw materials ultimately work their way into earnings reports and have an impact on the Federal Reserve's interest rate policies. Which brings us to...
- Rising Interest Rates and The Federal Reserve. Though it appears the Fed may be close to done raising interest rates for awhile, the fact that there is a new Chairman at the helm means there is a chance Wall Street will go through a six- to twelve-month period of uncertainty with regards to Mr. Bernanke as he attempts to establish his own vision for the Federal Reserve after stepping into some very large shoes left behind by Alan Greenspan. Though I do not expect any major shifts in fed policy over the near-term, change often brings uncertainty, and if there is one think Wall Street hates, it is uncertainty.
- Housing. While it is true there are differences between owning real estate and owning stocks, the psychology of markets is the same whether you are talking about land or tech companies, for example, and it is hard to argue with the idea that in many areas of the country, "investing" in real estate has become "speculating." As interest rates continue to rise, this game gets harder and harder to play, and at some point, I think it is inevitable that we will undergo a significant cooling off period for this sector. How severe the correction becomes remains to be seen, but history certainly suggests that excessive moves to the upside in any market are almost always followed by periods of underperformance...and if the "free money" many Americans have been tapping into by borrowing against their much appreciated homes starts to dry up, I believe it will increase the likelihood that we see a slowdown in the economy over the next twelve to eighteen months.
- Lack of Confidence in Government. Whether one is sitting on the left or right side of the political spectrum, I think it is fair to say that there is growing pessimism on the part of the public with regards to confidence in our leaders. The pitful response of government officials at all levels in response to Hurricane Katrina, for example, raised public awareness of the fact that, despite four years of efforts to "improve homeland security," our government really does not seem prepared to cope with any sort of large-scale disaster. In addition, the fact that the GOP is currently spending a great deal of its time and effort dealing with what may or may not turn out to be "scandals" is not doing anything to bolster investors' confidence in our leaders. Though history never repeats itself exactly, the credibility crisis faced by the Nixon Administration over thirty years ago certainly had an impact on the stock market, and if it turns out that Cheney and/or Bush did, in fact, authorize the leaking of a CIA operative's identity...or the President's domestic spying program is, in fact, found to be illegal...or that Mr. Bush does, in fact, have significant ties to Jack Abramoff...it will not matter whether each of us individually approves or disapproves of their actions - the bottom line is that investor confidence will suffer and this will likely have a serious impact on stock prices.
- The Cost of the War. Again, whether one is for or against the war, the bottom line is that our government is spending a tremendous amount of money on the campaign, and though only time will tell exactly how things play out, the cost of the war is going to have a significant impact on our economy (which in turn will affect interest rates... which in turn will affect the housing market...which in turn etc.). As mentioned above, Wall Street hates uncertainty, and as the economic impact of the war becomes more "real" (and our government is forced to either cut domestic programs, raise taxes, or do both in order to continue funding the war) I expect it to have a negative impact on investor optimism.
Phew! I never thought I would sound like such a grumpy old man, but alas...my job as Editor requires me to "calls it likes I see it," and for now, I believe there are more reasons to lighten up on stocks than add to our positions. However, please keep in mind that I have been wrong before, and consequently, I believe we are better off scaling out of our positions over the next few months rather than doing it in one fell swoop. If the market manages to start hitting new highs again, for example, it will mean we are, in fact, probably in the early stages of a bull market, and we will be glad we left a few chips on the table after all."
THE PERSONAL CAPITALIST
6911 S. 66th E Ave., Ste. 301, Tulsa, OK 74133.
1 year, 24 issues, $195.
Sean Christian: "Now, the hard part! What bold ideas will we have to confront a year from now?
For the market, we are either very patient or simply stubborn. Our forecast for 2006 is for the DJIA to surpass 12,000 and the Nasdaq to top 2,500. We believe that economic strength will continue to create earnings improvements and that this will result in higher stock prices. Our three areas of concern are:
1) Political Scandal (as the Abramoff investigations progress), 2) Terror Incidents (always a consideration), and 3) A Flu Pandemic (that could hamper economic growth).
We believe that each of these will be in the headlines, but that the market will climb this "wall of worry."
As for the economy, we expect more of the same. We see GDP advancing at a 3-4% rate for 2006 with minor disruptions. In regard to inflation, we believe that the rate will appear mild at the start of the year but could at points top 4%, ending the year near 4%.
We predict that the unemployment rate will fall further in 2006, with a move to 4.6%, further tightening the labor market and adding additional inflation pressure.
We will be a little more cautious in our political predictions this year. However, we do foresee continuing attacks on the Bush administration and Republicans in general. Despite this we believe the Republicans will hold power after the November elections."
DOW THEORY FORECASTS
7412 Calumet Ave., Hammond, IN 46324.
1 year, 52 issues, $279.
Richard Moroney: "For many, the bullish case for U.S. stocks hinges on the booming global economy. Partly because of rapid growth in China and India, along with solid growth elsewhere in Asia and in Europe, bulls expect U.S. economic growth to remain healthy despite the Federal Reserve's rate increases. U.S. corporate earnings growth should hold up even better, argue the bulls, because of exports and profits from foreign subsidiaries.
Until recently, financial markets have provided plenty of corroborating evidence for this line of thinking, as assets sensitive to global economic growth have rallied. With prices for most such assets down meaningfully from late-January or early-February peaks, the areas noted below merit watching as barometers of a potential shift in the market environment:
- Energy prices and energy stocks. Rising energy demand from China, India, and other developing nations explains much of the surge in oil prices in 2004 and 2005.
- Commodity prices ad materials stocks. Rising overseas demand has triggered much-improved prices for materials.
- Foreign stock markets, especially such resource-oriented markets as Canada and Australia.
- U.S. transportation stocks. Airfreight, trucking, and railroad companies have benefited from a healthy U.S. economy and growth in export and import volumes.
- U.S. capital-equipment stocks. As foreign customers have boosted capital spending, U.S. equipment providers have benefited.
All five of these areas weakened in recent weeks, though U.S. transportation stocks have already rebounded to all-time highs. If the other four can rebound to new highs, it would suggest that recent weakness was merely profit-taking, that the bullish case for the global economy remains intact. With protracted downturns in these areas, however, new leadership will be necessary to sustain the U.S. bull market."
Stock Trader's ALMANAC INVESTOR
79 Main St., Ste. 3, Nyack, NY 10960.
Monthly, 1 year, $295.
2006 Outlook: Limited upside
potential with greater downside risk
Jeffrey Hirsch: "Our 2006 Annual Forecast calls for limited upside potential with greater downside risk. Modest gains in the first half of 2006 to the area of Dow 11500, S&P 1350 and Nasdaq 2500 will give way to faltering market internals and economic turbulence. A major buying opportunity should present itself at the midterm lows around Dow 8500, S&P 950 and Nasdaq 1750 in Q2-Q3. The market should snap back from these levels as a major rally gets underway finishing the year positive back up near Dow 11000, S&P 1250 and Nasdaq 2500.
We continue to recommend stocks cautiously, to take profits where appropriate and tighten stops in advance of the expected decline so we'll be flush with cash when the 2006 buying opportunity presents itself."
Forbes/Lehmann INCOME SECURITIES INVESTOR
6175 NW 153 St., Ste. 201, Miami Lakes, FL 33014.
Monthly, 1 year, $195.
Tax talk: Dividend reporting
on Canadian oil and gas trusts
Richard Lehmann: "As you receive your year-end tax Forms 1099 from your broker, examine it carefully. A major problem arose last year in distinguishing preferred dividends which are eligible for taxation at the reduced 15% rate (QDI) from those which are not. This has not yet been sorted out completely. Brokers have been relying on a study they commissioned by a big four accounting firm to identify the proper tax treatment of all outstanding issues. The problem is that when they weren't sure, they treated the dividend as fully taxable. You can check the eligibility of your dividends on our web site www.incomesecurities.com to identify issues where tax treatment advice differs. You can then try to argue the point with your broker, but be prepared to waste a lot of time. A second, more serious error encountered on the Form 1099 is the treatment of the dividends on the Canadian oil and gas trusts. These are fully eligible for the 15% tax treatment. The web sites of the various trusts clearly tell you this. Trying to convince your brokerage firm of this is often a waste of time. Ameritrade, Scottrade and Schwab seem to have it right. Fidelity and TD Waterhouse have not and are reportedly refusing to budge.
One warning I can give investors from personal experience has to do with how dividends are reported on Form 1099 when the brokerage firm lends out your shares to short sellers. In these instances, you receive your dividend amount as a "substitute payment in lieu of dividends or interest." There are two problems with this as it pertains to Canadian oil and gas trust dividends - the amount is considered ordinary income so you lose your QDI tax status on such payments and, to add insult to injury, they credit you back the net amount after the Canadian withholding tax of 15%, thus losing your right to recover the 15% tax on your US tax return. This is money straight out of your pocket and you should demand that they either reclassify the dividends or reimburse you for your loss. If you have this problem and can't get satisfactory resolution on this issue, write me with the specifics. Whenever you get a no answer, demand the answer in writing.
Another issue regarding the Canadian trusts is the fact that a portion of your distribution is considered a return of capital and therefore not subject to income tax until you sell your shares, i.e. it is an adjustment of your cost basis. Granted this is complicated and may require you to have a tax accountant, but it can be significant. I see from the web site of PrimeWest Energy Trust (PWI) that their 2004 distributions were 55% eligible for treatment as return for capital. The percentage for 2005 has not yet been posted so you should continue checking until it is."
The Elliott Wave FINANCIAL FORECAST
P.O. Box 1618, Gainesville, GA 30503.
Monthly, 1 year, $228.
Steve Hochberg and Pete Kendall: "The past phase of the credit boom has provided a rising wall of liquidity that is fueling a rally in traditionally disparate markets. This is the "all-the-same-market" scenario that was first introduced in Conquer the Crash. This rally is ending now. The recent January 11 highs mark the start of the next leg down of the ongoing bear market that started in 2000 in the major stock indexes. The decline should pick up downside momentum as the year progresses. Our forecast for a widening in the spread between junk debt and U.S. treasury debt remains intact. Municipal bonds appear particularly vulnerable to the coming economic contraction. Gold is forming a top at current levels. The next significant move should be at least a $100 decline. Silver is thrusting higher from a recently completed triangle pattern. The sharp rally underway should lead to an equally sharp reversal. A break of $9.00 would eliminate any remaining short-term bullish potential. The Primary degree rally in the U.S. Dollar Index that started the final day of December 2004 remains intact. Once the current near-term pullback is complete, the dollar should push to a new recovery high."
MONEYLETTER.com
479 Washington St., P.O. Box 6020, Holliston, MA 01746.
1 year, 24 issues, $150.
Walter Frank: "When the Federal reserve began raising the short-term rate more than one year ago, the buzz-word was "neutral rate." We were told that the Fed was heading for a neutral rate, a sort of Goldilocks rate, one that was neither too low (stimulative) nor too high (restrictive).
Well, the last rate increase appears to have gotten us into the neutral zone, if not right at the precise neutral rate. At least, that much was implied by the statement issued after the January 31 meeting, when the short-term rate was raised to 41/2%. The Fed changed the wording it had repeated again and again, and Wall Street concluded that it means the automaton-like march to higher rates is over.
Based on the economy, it appears to us that we are headed for some further increase in rates from the Fed. If we just look at last quarter's anemic growth, of course, that would seem to be overkill. But last quarter's numbers, as we stated in the Hotline, were misleading, in our opinion, an accident of the calendar.
In any case, this quarter is shaping up to be a very strong one. Again, this is somewhat misleading. What we need to do is to average out the two quarters. When we do, we will get a growth rate that will be perfectly acceptable to the fed. In itself, that does not call for higher rates.
The trouble is that the economy will be building up momentum. We see one or two more rate increases coming as insurance against the inflationary consequences of too rapid growth.
The markets surprised us all by their strength last month, and payback time is here. Earnings season has been good, but not spectacular, and spectacular is what the U.S. market needed. More than one domestic small- and mid-cap fund turned in gains of 8%-10% last month, and such gains simply could not continue without huge profit surprises. Given the outlook for profits this year, the funds had a year's worth of gains in one month.
The spotty earnings reports are bringing the market back to earth. What we have to be careful about is whether the analysts' profit estimates for the rest of this year are not still too optimistic. For the moment, the estimates continue to show value in the U.S. market, profit stumbles and all."
CONTRA THE HEARD
42 Rivercrest Rd., Toronto, ON M6S 4H3.
1 year, 4 issues, US$450.
Includes 15-20 E-mail bulletins. www.contratheheard.com.
Ben Stadelmann and Benj Gallander: "Income trusts should be a major story in 2006. And notwithstanding a little RCMP investigation, there is so much in this sector to feel good about. Take, for instance, the stock brokerage firms and investment bankers who implored the government to maintain these financial instruments, lest the defenceless senior citizens who own them have to consider cat food a delicacy. Good thing, too, because seniors across this great land of ours have seemingly become as ecstatically addicted to trusts as felines to catnip.
Ottawa, after much fretting and protesting about the endangered flow of dollars to federal coffers, committed The Big Waffle, allowing the existing regulations to stand for now. And just to keep things "fair," the Goodale Gang lowered the tax rate on dividends - further stanching the flow of funds to government coffers. How illogical is that? The upshot is that trust IPOs have been breeding like rabbits gone amok, while an insatiable public can't get enough.
How quickly things change. Around the millennium, as technology stock valuations grew by leaps and bounds, dividend-paying stocks were written off as relics of the Stone Age. Around that time, Benj was coining one of our favorite lines: "Dividends help me to be stupid longer." How true it remains: if a stock price does not reach the target price for years and years (if at all), at least one can take solace in the annual payout. Of the stocks currently in our portfolio, more than a third pay dividends. In our point tally assessment system, a point is awarded to companies that tip their hats to shareholders in this way.
When tech was pummeled to the canvas, investment bankers recognized that it was necessary to find another golden goose to pay for the Lamborghinis, and investment trusts, with their high dividends - er, distributions - fit the bill. "Hurray!" responded the public, faced with barren returns on their GICs and like-minded investments. "Sounds mighty attractive to us!"
The history of these investments in Canada would fit a slim volume. It begins in 1985, with Enerplus, through which Marcel Tremblay and John Brussa pursued a strategy of selling aging oil wells to retail investors. In 1995, when Labrador Iron Ore Royalty Trust was spun off from Norcen Energy Resources, the first mining trust was born; two months later, there was the first corporate conversion: Enermark Income Fund, which was devised to avoid the company being gobbled in a hostile takeover. Today, there are about 250 business trusts, with lots more in the pipeline.
Why are they so popular? Well, for those in the finance industry pushing the IPOs, the rich fees cannot be overlooked. Owners of enterprises love them because of the jackpots they received, which are much higher than the prices professional buyers would pay. Lawyers and accountants also reap revenues from them. Once you get past all that (easy, eh?), tax advantages are at the core - and, all things being equal, these accrue both to the operating entity and to investors. The names themselves - "income trust," "real estate investment trust" - seduce many investors into thinking that they offer very limited risk. If only it were so.
Income trusts have become so a la mode that they are no included in the S&P/TSX Composite Index. Some investors might instinctively be reassured by this. Unfortunately, while the index does have extensive rules and methodologies, not enough attention is paid to an astute analysis of balance sheets, financial ratios and the potential for ongoing success.
This is not to put the kibosh on the whole trust sector, because there is no question that there are some that make perfect sense. The best have stable, dependable cash flow and income, as well as reasonable payouts, far below cash flow. Debt loads should be nominal, and assets must be plentiful enough that the rate of depletion is not a significant danger. Ideally, the underlying business will not be cyclical, and economic conditions will not have a major impact. Changing interest rates will not quash them. Capital-spending requirements should not be onerous.
Many of the newly minted issues are not of this ilk, and to add insult to injury, they are bundled up and sold when the enterprises are near their peaks, garnering the greatest riches for the sales people.
Want an example? The first trust to go bankrupt was Heating Oil Partners Income Fund, three years after the initial offering. When this turd was foisted on an unsuspecting public, it had lost money for three straight years. After the IPO, it lost money for three more. A year before the grand finale, $30.2 million worth of additional units were sold. What could those making the offering have been thinking after so many years of losses? Perhaps, like a hometown announcer commenting on a batter in a major slump, their attitude was, "Hey, he's due." Or maybe, all they could see were the banking fees of $9.3 million.
Now that the sector is in a veritable frenzy, even Air Canada is getting in on the act. This IPO is the farthest thing possible from what a trust should be. It's hard to imagine who might sell this piece of bird splat with a straight face, but CIBC World Markets and RBC Dominion Securities will step up to the plate. The current distribution, in the range of 9.5-10.5 percent, won't last - we're as certain that it will be vastly reduced, if not at all the way to zero, as we were when we pronounced Air Canada an excellent short on ROB-TV.
To prevent the further bastardization of this sector, and thereby protect investors, we thought it would be useful if there were certain preconditions that must be met before an income trust can be formed.
1. The organizations must have existed as a stand-alone entity for at least five years. Rationale: Without a track record, it is difficult to anticipate future performance.
2. Neither the trust nor its parent can have gone bankrupt for at least ten years. Rationale: If this has happened, one can assume that the enterprise is not stable.
3. It must have been profitable for a minimum of four of the past five years. Rationale: We'll allow one bad annum, but any more than that and it should still be a corporation - but heck, it can still pay dividends.
4. In four of the past five years, the enterprise must have had a net profit before tax equal to or greater than the proposed level of distributions. Rationale: Inability to sustain distributions is the bane of these organizations.
5. If a trust eliminates payouts within five years, those involved in issuing the trust must use fees earned to cover half the distributions that would have been paid (based on the initial distribution), to a maximum of those fees. This will help to insure that the issuing organizations truly do their due diligence before selling these offerings.
Will our recommendations be followed? We hear the guffaws from the peanut gallery. However, if major investor grieving in 2007 follows the record number of IPOs in 2006, the popularity of trusts will sink like a stone. That would ultimately spur some new regulations to protect clients, but it's a pity that regulators will only be moved to action after the wreckage has occurred and the movers and shakers have moved on to the next big thing."
The Peter Dag PORTFOLIO STRATEGY & MANAGEMENT
65 Lakefront Dr., Akron, OH 44319.
1 year, 24 issues, $389.
Commodities remain strong,
Bullish on long-term bonds
George Dagnino: "Commodities remain strong. They are rising for the reasons discussed in previous reports. The global economy is picking up strength, the US manufacturing sector is strong, and money is still cheap.
This reliable mix of forces points to strong commodities across the board. The strength in commodities remains our main investment theme at this time.
Inflation is under control. The employment cost index and unit labor costs are slowing down. This is very unusual at this stage of the business cycle.
High-grade bonds. I remain bullish on long-term bonds. Some major Wall Street gurus are turning bullish, finally. This is the asset class that will provide solid returns in 2006.
Low-grade bonds are not attractive when short-term interest rates are rising. The best strategy is to wait before investing in this asset class."
THE GRANVILLE MARKET LETTER
P.O. Box 413006, Kansas City, MO 64141.
1 year, 46 issues, $250. www.GranvilleLetter.com.
Joseph Granville's OBV Indicators are signaling a sharp decline ahead. Only the fundamentalists will be dragging their tails, completely unaware of what is about to happen. "I have forecasted Dow 10,000 in the first quarter, 8400 in the second quarter, and 7100 in the fourth quarter." Granville, the "Top Gold Timer of the Year." Advises buying his list of 23 gold and silver stocks and sell half of all doublers. All portfolios should contain the 91-day Treasury bills." See the Granville ad on page 4 for a Special Offer for Bull & Bear readers.
Stock Trader's ALMANAC INVESTOR
79 Main St., Ste. 3, Nyack, NY 10960.
Monthly, 1 year, $295.
Jeffrey Hirsch: "March is prone to early strength and second half weakness. We would not be surprised if this coincided with the bull market top. The day before St. Patrick's Day is much luckier perhaps as it often falls on Triple Witching Day (March 17th). This year it may be time to heed that infamous warning to Caesar.
The week after Triple Witching is downright frightful as the Dow has dropped 14 of the last 18 times. March's last trading day is also prone to selloffs as end-of-first-quarter portfolio restructuring has an impact.
Last day of March Dow down 12 of last 16 with major losses.
Our 2006 Annual Forecast calls for limited upside with greater downside risk."
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-- MARCH 2006