Monday, November 26, 2007

News Letter 11/26/07

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The Economy:

Fear was the overriding sentiment in the month of November. During the month of November the stock market gave up most of the gains achieved earlier in the year. Click on the chart below to check stock market index performance to date.


The drop in November was caused by the credit crunch, recession fear, dropping house values, and the high oil prices discussed in the last News Letter. Many financial institutions such as Countrywide, Washington Mutual, Bear Stearns, and Citi Bank wrote down Billions of dollars of bad loans as losses on their balance sheets. As a consequence financial stocks took a beating and took down the entire stock market with them. Multiple write down headlines drove markets continuously down at a fast pace. Such headlines scared investors into selling off stocks and moved their money into Bonds and fixed income securities to protect their assets. High oil prices trading near the $100 per barrel level exacerbated the situation. The high oil prices were driven by the fear that the oil supply may be disrupted due to tensions between Turkey and the Kurds in North Iraq and the threats and counter threats between the West and Iran. The low dollar is also a factor in the price of oil and other commodities such as Gold. To add to the fear sentiment the Fed released a report indicating reduced economic growth in 2008 which means lower than expected earnings for companies and lower price targets for stocks. The University Of Michigan Consumer sentiment Index came in lower in November as well indicating reduced economic activity in the near term. Some economists are forecasting a recession in 2008 as a result of the credit crunch and the consumers holding back on spending. A few positive indicators were Wal-Mart and HP beating analyst estimates with their quarterly earnings releases, low unemployment rate, and dropping borrowing interest rates. The core inflation rate remained low despite high commodity prices worldwide. Surprisingly, producers are absorbing the high commodity prices and are not passing on the higher costs to consumers thus far.

Future Outlook:

As usual the outlook is mixed among economists. Some economists are forecasting a recession based on the economic indicators discussed above. The Fed may intervene in December and lower Interest rates one more time to stave off a recession but such a move will weaken the US Dollar and increase inflation further leading other economists to believe that the Fed will not lower rates in December. Other economists are forecasting a reduced growth but higher stock prices nevertheless. They claim that the recent stock market drop is an adjustments and an overreaction to two sectors of the economy namely financials and the housing industry. They see the correction as an opportunity to increase holdings in stocks. They maintain that stocks are undervalued despite the reduced growth forecasts. It is my opinion that barring any major events such as a terrorist act or a disruption in the oil supply, the markets will continue to grow modestly. Long term investing in a balanced portfolio of stocks and bonds is the best strategy and any market drops are a dollar cost averaging opportunity.

Stocks:

The same stocks that were recommended previously are lower and present a good investment opportunity. GM’s recent $39 Billion write down was misinterpreted by the markets as a cash write down. It was actually a change in the forecast of the company’s use of carry-over net operating losses and that forecast is reversible. The GMAC write down of bad loans did affect GM’s earnings in Q3 because GM still owns 49% of GMAC. That was a one time write down and should not affect the turn around plan. GM employees should be careful not to invest a large portion of their savings in GM stock to maintain diversification. Also, Google’s target has been revised higher due to the introduction of the G-phone, yet the stock is lower recently. My new favorite stock is the QQQQ the NASDAQ 100 index. I believe the index is undervalued and has been beaten down lately.

Disclosure: I am a GM employee and own a small number of shares of GM stock.

Mike Katto
CERTIFIED FINANCIAL PLANNER™
Registered Investment Advisor
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