"Round Two" Survival Guide

Thisbearmarketisnowherenearover. SinceitsMarch10lowof666in2009,theS&P500rallyhasbeenalmost unstoppable.Punditsandmediacommentatorsalikehavetakenthistomeanthat thebearmarketisoverandthatstocksshouldonceagainbetheprimaryassetclass forinvestors. Noneofthemknowswhattheyretalkingabout. Overthelast30years,theUShasbuiltuprecorddebtsonapersonal,state,and nationallevel.Consumersthoughttheywerefinanciallystablesolongastheycould covertheinterestpaymentsontheircreditcards,statescreatedprogramafter programfewifanyofwhichtheycouldafford,andtheFederalGovernmentissued $3050trillionindebtandliabilities(countingSocialSecurityandMedicare). Thisallcametoascreechinghaltwhenthehousingbubble(arguablythebiggest debtbubbleinhistory)implodedin2007.Sincethattime,stockshavestagedoneof theirworstyearsonrecord(2008),oneinfiveusmortgageshasfallenunderwater (meaningthemortgageloanisworthmorethanthehomeitself),andsometrillions inUShouseholdwealthhasevaporated. Theseissuesseemtobedistinct,butinrealitytheyallstemfromadebtproblem. Andasyouknow,thereisonlyonelegitimatewaytodealwithadebtproblem: Payitoff. However,insteadofdoingthis,theFeds(theFederalReserve,TreasuryDept,etc.) havebeenproducingEVENMOREDEBT.Heresabriefrecapoftheirmovesthusfar: TheFederalReservecutsinterestratesfrom5.250.25%(Sept07today) TheBearStearnsdeal/Fedbuys$30billioninjunkmortgages(March08) TheFedopensvariouslendingwindowstoinvestmentbanks(March08) TheSECproposesbanningshortsellingonfinancialstocks(July08) TheTreasurybuysFannie/Freddiefor$400billion(Sept08) TheFedtakesoverAIGfor$85billion(Sept08) TheFeddolesout$25billionfortheautomakers(Sept08) TheFeds$700billionTroubledAssetsReliefProgram(TARP)(Oct08)

Financial Crisis

AndthatsaBRIEFrecap(ImsureIleftsomethingout). Inanutshell,TheFedshavetriedtocombatadebtproblembyISSUINGMORE DEBT.Theyrepumpingtrillionsofdollarsintothefinancialsystem,tryingtoprop WallStreetandthestockmarket.Theyvemanagedtokickoffarallyinstocks ButtheyHAVENOTADDRESSEDTHEFUNDAMENTALISSUESPLAGUINGTHE FINANCIALMARKET. StocksareheadedforanotherCrash,possiblyasbadastheonewesawinOctober November2008.Asyouknow,thatCrashwipedout$11trillioninhouseholdwealth inamatterofweeks.TheresnotellingthedamagethisSecondRoundwillcause. TheFedshavethrowneverythingtheyvegot(includingthekitchensink)atthe financialcrisisandthingsarefundamentallynobetterthantheywerebefore: mostmajorbanksareinsolvent,oneinfiveUSmortgagesisunderwater,andthe stockmarketisbeinglargelyproppedupbyinhousetradingfromafewkeyplayers (GoldmanSachs,UBS,etc). Makenomistake,wearerapidlyheadedforuglytimesinthefinancialmarkets.The timetoprepareyourselfisNOW!AndIvelocatedseveralinvestmentsthatwillnot onlyprotectyourportfoliotheyllalsohelpyouturnaprofitwhenthishouseof cardswecallamarketrallycomescrashingdown. Ivedetailedalloftheminthisreport,TheFinancialCrisisRoundTwoSurvival Guide.

TheFedbuyscommercialpaper(nonbankdebt)fromnonfinancials(Oct 08) TheFedoffers$540billiontobackstopmoneymarketfunds(Oct08) TheFedsbackstopsupto$280billionofCitigroupsliabilities(Oct08). Another$40billiontoAIG(Nov08) TheFedbackstopsup$140billionofBankofAmericasliabilities(Jan09) Obamas$787BillionStimulus(Jan09) TheFeds$300billionQuantitativeEasingProgram(Mar09) TheFedbuying$1.25trillioninagencymortgagebackedsecurities(Mar09 10) TheFedbuying$200billioninagencydebt(Mar0910) CashforClunkersI&II(JulyAugust09)

TwoWaysStocksPay:InflationandDividends

Beforewegetintothespecificinvestmentsuggestions,itsimportanttotakeabig pictureofstocksasanassetclass.Thecommonconsensusisthatstocksreturnan averageof6%ayear(atleastgoingbackto1900).

However,astudybytheLondonBusinessSchoolrecentlyrevealedthatwhenyou removedividends,stocksgainsdroptoamere1.7%ayear(evenlowerthan thereturnfromlongtermTreasurybondsoverthesameperiod). Putanotherway,dividendsaccountfor70%oftheaverageUSstockreturnssince 1900.Whenyouremovedividends,stocksactuallyofferLESSrewardandMORE riskthanbonds.Ifyoudinvested$1instocksin1900,youdhavemade$582with reinvesteddividendsadjustedforinflationvs.amere$6frompriceappreciation. SoasmuchastheCNBCcrowd(andoutserialbubbleblowingFedChairmanBen Bernanke)wouldliketobelievethatthewaytomakemoneyinstocksisbuyinglow andsellinghigh,therealityisthatthevastmajorityofgainsfromstocksstemfrom dividends. Theremaininggainshavecomelargelyfrominflation. BillKing,ChiefMarketStrategistM.RamseyKingSecuritiesrecentlypublishedthe followingchartcomparingREALGDP(lightblue),GDPwhenyouaccountfor inflation(darkblue),andtheDowJonesperformance(black)overthelast30years. Whatfollowsisaclearpicturethatsincethemid70sMOSToftheperceivedstock gainshavecomefrominflation.

Whichbringsustotoday.Accordingtoofficialdata,theS&P500iscurrentlytrading ataPricetoEarnings(P/E)ratioof20andyields1.7%.Inplainterms,stocksare expensive(historicaverageforP/Eis15)andpayinglittle. Inotherwords,thereislittleincentive,otherthanfutureinflationexpectations,for owningstocksrightnow.

Withthisinmind,nowisthetimetobepruningyourlongholdings.Wevehada spectacularruninstockssincetheMarch2009lowandthelikelihoodofthis continuingmuchlongerisrelativelyslim.

RunningOutofBuyers
Bymosthistoricmetrics,themarketisshowingsignsofasignificanttop.Hereare justafewkeymetrics: 1) Investorsentimentisbacktosuperbullishautumn2007levels. 2) Insidersellingtobuyingratiosarebacktoautumn2007levels(insidersare sellingthefarm). 3) Moneymarketfundassetsareat2007levels(indicatingthatinvestorshave goneallinwithstocks). 4) Mutualfundcashlevelsareatahistoriclow. Thisfinalpointiskey.Mutualfundsarethebigboysoftheinvestmentworld.If theyhavebecomefullyinvestedinthemarket,thismeanstherearefewbuyersleft topushstockshigher.Thisisevidentinthefactthateverytimemutualfundcash levelsdropped,stockscollapsedsoonafter(seechartbelow).

http://home.comcast.net/~RoyAshworth/Mutual_Fund_Cash_Levels/Mutual_Fund_Cash_Levels.htm

 Inplainterms,theoddsarehighthataTopisforminginstocks.Withthatinmind, ifyourportfolioisheavilyinvestedinstocks,nowisatimetobetakingsomeprofits. Ifyoucan,considermovingasizablechunkintocash. ThemarketisextremelytiredandthesystemicrisksunderlyingtheFinancialCrisis areinnowayresolved.Withinvestorcomplacency(asmeasuredbytheVIX)backto preCrashlevels,theFedwithdrawingseveralofitsmoresignificantmarketprops, andlowparticipationcomingfromthelargerinstitutions,thismarketisripefora seriouscorrection. Imnotsayingthiswillimmediatelyhappen.Butatsomepointtherewillbeanew roundtotheFinancialCrisis.Whenthathappens,weWILLhaveanotherCrash. Indeed,itisquitepossiblethatstocksaremakingaVERYsignificanttop,sobeing heavilyinvestedinstocksgoingforwarddoesntmakemuchsense.Takesome moneyoffthetable.Ifyouneedaplacetoputit,IsuggestphysicalcashorGold/ Silverbullion.

IfYouMUSTStayLong,ShifttoQuality

IfyouDOhavetostayinvestedinstocks,nowisthetimetobeshiftingoutofjunk intoquality.ThemarketrallyfromMarch2009haslargelybeenleadbyjunk companies(financials,retailers,etc).Meanwhile,qualityhaslaggeddramatically. Asanexample,letscomparetheperformanceofCoke(KO)toBankofAmerica (BAC). KOisoneofthebest,mostprofitablebrandsintheworld.Thecompetitivemoat aroundthisbusinessisextraordinaryanditremainsoneofthemosteasily recognizedfranchisesontheplanet.YoucandrinksixglassesofCokeadayandstill enjoyitthenextday.Thatqualityisalmostnowheretobefoundinanyotherfood/ beverageontheplanet:evenchocolatewouldgetoldaftersixbarsaday. BAContheotherhandhasswallowedCountrywideFinancialANDMerrillLynchs garbageassets.Itiseffectivelyinsolventbasedonitsderivativeexposurealone(the companyhasderivativesequalto3,000%ofassets).BACsbalancesheetislikean opensewerandwithoutseriousgovernmentinterventionthecompanywouldnot evenexistrightnow. Andyet,BACsstockhasrisennearly200%sincetheMarch09lowswhileKOis uplessthan50%.

 Thisrelationshipworkstothedownsideaswell.WhatImeanisthatwhenstocks comeunhinged,Quality(Coke)thenoutperformsGarbage(BankofAmerica)hands down.

So,ifyouHAVEtoremaininvestedinstockstothelongsideforwhateverreason, nowisthetimetobemovingintohighqualitycompanies.Thismeansfinding companieswithlowdebt,lotsofcash,strongresults(KOactuallyGREWrevenuesin 2008),andsignificantcompetitiveadvantages. Also,andthisiscritical,lookforcompanieswithstrongbalancesheets:companies thatwillstillEXISTiftheresanotherCrisis.Depressionorno,peoplewillstilldrink soda,alcohol,smokecigarettes,andneedmedicine.Ivecompiledalistofcompanies youshouldconsiderifyouneedtoremaininvolvedinstocksgoingforward: Company Symbol Sector Price/Cash Dividend Flow Yield Coke KO SoftDrinks 15 3.2%

Budweiser BUD Alcohol 14 N/A J&J JNJ Medicine 10 3.02% WalMart WMT GeneralRetail 8 2.16% ExxonMobil XOM Oil 11 2.51% Youllnotethatmostofthesecompaniespaydecentdividends(comparedtothe S&P500s1.7%).Thisiscriticalgoingforward.Withstocksovervalued,youwantto makesureyoureatleastgettingpaidforremaininginvolvedinthemarket. However,thereisanaddedbonustoowningQualitystocksrightnow.Becausethis marketrallyhaslargelybeendominatedbyGarbagestocks,Qualitycompanieslike Cokehavenotyetrisentoextremevaluations.Thus,youcanstillbuythemat relativelycheaplevels(lessthan15timescashflow).So,inasense,theyareagood investmentbasedonpricingaswell. IwanttostressthattheseinvestmentsareonlyifyouHAVEtostayinstocksfor somereason.Ifthereisanothercollapsethesecompanieswillfalllikeeverything else.However,theywilllikelyfalllessthantherestofthemarket(seethechart comparingCokeandtheS&P500below).

source:YahooFinance

SowhileIdonotexpectthesepositionstomakealotofmoneynow(thesearenot shorttermtrades),theyshouldshelteryoufromlosingtoomuchmoneyshould anotherCrashhit.Indeed,ifthemarketDOEScollapseandthesecompaniesfall10 15%acrosstheboard(whilethemarketfalls30%+)Iwouldconsiderthese investmentsevenMOREattractivethantheyaretoday. Letmeexplain. Volatilitycaneitherhurtyouorbeyourfriend.Mostpeoplewouldsellapositionif itfell2030%.Thisiswiseifyoureinvestingbasedonmomentum.However,if

youreinvestingbasedonvalue,thendoingthisiscompletelyantitheticalto attaininghighreturns. ConsiderCoke.LetssaytomorrowCokecollapsedfrom$55to$25pershare.Most investorswouldpanicandsell.I,ontheotherhand,wouldbebuyinggreedily.Why? BecauseCokesbusinesshasafundamentalvalue.EvenduringaFinancialCrisisand Depression,peoplewillcontinuetodrinksoda. SotheopportunitytobuyCokeat$25ashare(whichwouldbe78timescashflow) wouldbetrulyanextraordinaryopportunity.Indeed,fromanincomeperspective alone,theopportunityherewouldbefantastic. Considerthatin2009,Cokepaidout$1.76individends.Withsharesat$55,this meansadividendyieldof3.2%(roughlythreetimeswhatyoudgetbyleavingyour moneyinasavingsaccount). However,ifCokesharesfellto$25,that$1.76suddenlybecomesa7%yield ($1.75/$25.00).Thatsaheckofareturnfromanincomeperspective.Evenif globallytheworldenteredasharpDepressionandCokesincomefellby30%, pullingitspayoutsdownto$1.23,yourestilllookingata5%yield. Indeed,companieslikeCokeofferthepotentialofREALvalueshouldtheirshare pricesdrop.TheirfundamentalsalmostALWAYSoutperforminvestorsentiment. WhatImeanbythisisthatshouldtherebeanotherCollapse,Cokessharepricewill almostcertainlyfallMOREfromitscurrentlevelsthanCokescashpayoutsor incomewillfromtheirs. During2008,Cokesharesfell30%orso.However,CokeactuallyINCREASEDits dividendthatyear.AnyonewhoboughtCokeinOctober2008,nowcollectsa4% yieldontheirshares(fourtimeswhatheorshewouldgetfromabankaccount). ThisiswhycompanieslikeCokeremainsostrongduringtimesofCrisis.Withthe FDICbrokeandmostUSbanksinsolvent,investorsdesperatelyneedaplacetopark cashthatwillstillEXISTinafewyears.CompanieslikeCokeareareasonable alternativetoasavingsaccountinthesensethatyourepaidahigheryieldforyour deposit(now3%,but5%orhigherifCokesharesplunge). Ofcourse,becauseCokeisastock,youcanlose1015%ormoreifsharesdrop andyousell.InaCrisis,plainoldcashwilloutperformjustaboutanything. ThisiswhyIvesuggestedmovingmoneytocash,ifyoucan.ItsalsowhyI suggestedbuyingCokeandtheothercompanieslistedaboveonlyIFyouHAVE tobeinstocksrightnow.

CatastropheInsurance:TradesForWhentheCollapseHits

NowisalsothetimetobetakingoutsomeCatastropheInsurancebycompilinga listoftradestomakeoncestocksbegintocollapse.Letmebeclear,thesearenot tradesthatyoullmakerightnowthesearetradesyoullmakeWHENstocks collapse. Personally,IfavorUltraShortETFs. IfyoureunfamiliarwithUltraShortETFs,theseareinvetsmentsthatreturn2Xthe inverseofaparticularETF.Letstakeanexample,theUltraShortFinancialsETF (SKF). SKFreturns2XtheinverseoftheFinancialsETF(IYF).SoifIYFfalls5%,SKFrises 10%.IfIYFfalls10%,SKFrises20%.Inthissense,SKFisagreathedgeormeans ofplayingFinancialstockstothedownside. However,theresanaddedbonustoUltraShortETFslikeSKF:theseinvestments ALSOtradebasedondemandfromthemarketplace.Soifstockscollapsesay30%, youmightactuallyseegainsGREATERthan60%(2Xtheinverse)duetoinvestors pilinginastheyseektoprofitfromthecollapse. ConsiderSKFsperformancein2008,forexample.In2008,financialstocks(as measuredbytheFinancialsETF:IYF),fellroughly50%.

However,ifyoudboughtSKFoncetheCrisisreallytookhold(lateSeptember),you couldhavemadeMOREthan100%intwomonthstime:

ThisiswhatmakestheUltraShortETFssohandywhenaCrisishits:becausethey trulyskyrocketasinvestorsstampedelikeelephantsintosafety. However,IMUSTSTRESSthatthesearenotinvestmentstobuyandhold. Instead,theseareshorttermtradesyoushouldmakeONLYoncestockshave beguntotrulycollapse.Simplyaddthemtoyourondecktradestomake oncethenextCrisishits. Youreprobablyaskingyourself,howcanIdistinguishbetweenanordinary correctionandaREALCrisis? Letsseewhathistoryshowsus. Ifyourecallfrom2008,stocksdidntgostraightdown.Insteadtheydropped, bounced,andthenbegantheseriouscollapse.Lookingbackatthattime,the50 DMAservedasausefulmetricforgaugingthataseriousdeclinewasabouttobegin:

 Asyoucanseestocksrolledoverandbrokebelowtheir50DMAinlate2007.After that,the50DMAactedasstrongresistance.Indeed,therewasonlyonebounce abovethislevel,whichlastedroughlyamonthandahalf.Therealtroublebeganin thesummerof2008,andinvestorsweregivenadecentwarningwhentheS&P500 collapsedandthenbouncedtotestthe50DMAandfailedtobreakit. Similarwarningsappearedbeforethe1987Crash:

 TheTechBubble:

Andthe2008Crash:

 Thus,thistellsusthatthe50DMAisastrongmetricforgaugingwhenrealtrouble hitsstocksagain.Onthatnote,thetriggeryoushouldbelookingforintermsof whenthenextCrashwillhitwillbeadecisivebreakBELOWthe50DMA followedbyastrongbouncethatFAILStobreakaboveitagain. Withthatinmind,herearesometradestoputondeckforwhenthenextroundof theCrisishits.

Trade #1: Short the Russell 2000

The Russell 2000 is perhaps the junkiest index in the US. Many of the companies that comprise this index dont even MAKE money and most likely should have never been taken public in the first place. This is the risk index, the index of companies that are garbage. For that reason, the Russell 2000 will collapse most when stocks truly begin rolling over. The below chart compares the Russell 2000s performance against that of the Dow Jones Industrial Average during the 2008 Crash. As you can see, the Russell dropped significantly more:

For this reason, I suggest buying the UltraShort Russell 2000 ETF (TWM) when the market begins its next real collapse. The UltraShort Russell 2000 ETF (TWM) returns 2X the inverse of the Russell 2000. So if the Russell 2000 falls 5%, TWM returns 10%. If the Russell 2000 falls 10%, TWM returns 20%. Its a terrific means of playing the collapse in small cap stocks. Again, wait for stocks to enter a free fall before opening this trade.

Trade #2: Short Financials

By now you know that the current Crisis has centered on the financial sector, specifically the banks. The Protect Your Savings report details the issues extensively. However, as further proof, the below chart shows that US banks are about to get slammed with another round of mortgage defaults from the residential housing sector (Im not even going to bother including the commercial real estate market which is a multi-billion time bomb in of itself).

Suffice to say, Financials have a lot of issues coming their way in the future. For that reason, when the next Round of the Crisis hits, I suggest buying the UltraShort Financials ETF (SKF). SKF returns 2X the inverse of the Financials ETF (IYF). So if the IYF falls 5%, SKF returns 10%. If the IYF falls 10%, SKF returns 20%. Its a terrific means of playing the collapse in financials stocks. Again, wait for stocks to enter a free fall before opening this trade.

Trade #3: Short the Retail ETF

TheUSconsumeraccountsfor70%ofUSGDP.Realunemploymentiscurrently closeto17%.FoodStampusageisaroundarecord38million.Taxreceiptsfor2010 sofarareLOWERthan2009slevels(didnteveryonethinktheentireworldwas endingbackthen?). Andyet,retailstocksarebacktotheir2007highs:

 Asyoucansee,retailstocksingeneralareupnearly200%duringtheworst recessionindecades.Itssimplystaggering.Forthatreason,IsuggestShortingthe RetailETF(XRT)whenstocksstarttocollapse. XRTgivesbroadexposuretotheretailsector.Itstopholdingsare: Company %ofAssets CaseyGeneralStores 1.9% Gamestop 1.9% JosABankClothiers 1.8% Netflix 1.8% TractorSupply 1.7% AnnetaylorStores 1.7% LimitedBrands 1.7% ChildrensPIRetailStores 1.7% BestBuy 1.6% AbercrombieandFitch 1.6% ShortingthisETFgivesyoutheopportunitytoshortretailacrosstheboard. However,ifyouremoreinclinedtoshortspecificcompanies,Idfocusonapparel andclothingretailerslikeGap(GPS),LimitedBrands(LTD),Nordstrom(JWN),and thelike. Aswiththeothertrades,onlyentertheseshortswhenthemarketbeginstoentera freefall.

Trade #4: Short the Emerging Markets

EmergingmarketshaveleadedtheUSonthislatestrally:theybottomedbackin November2008,whileUSstockscontinuedtoplungeuntilMarch2009.Thatsnot theonlyleadingemergingmarketshavedone.WhiletheS&P500isupsome60% fromitsMarchlows,China,BrazilandtheirkindhaveallmorethanDOUBLEDfrom theNovember2008lows. This relationship will reverse in the next Crisis. During times of Crisis, the flight to safety involves institutional investors dumping their foreign shares to load up on Treasuries or other perceived safe havens. Consequently, emerging markets are hit hardest when the markets collapse. For that reason, when the next collapse begins I suggest shorting emerging markets via any number of inverse Ultrashort ETFs. The most popular ones are: 1) The UltraShort Emerging markets ETF (EEV) 2) The UltraShort China ETF (FXP) 3) The UltraShort Brazil ETF (BZQ) All three of these return 2X the inverse of an underlying index: the MSCI Emerging Markets ETF, the FTSE/ Xinhua 25 ETF, and the Brazil ETF, respectively. As such, they represent a great way to pocket major gains when the emerging markets collapse along with the rest of the financial world during the next Crisis. Aswiththeothertrades,onlyentertheseshortswhenthemarketbeginstoentera freefall.

Conclusion

Thisconcludestheourreport.Ifyoufoundthisinterestingyoumightwantto considerdelvingintoourotherFREEreports.Allofthemareavailablefor downloading.Simplyclickhere. Good Investing! Graham Summers Chief Market Strategist Phoenix Capital Research