Start the conversation
By William Patalon III
Money Morning/The Money Map Report
I sat down last week with market analyst and Money Morning Contributing Editor Keith Fitz-Gerald for our monthly interview. In our last discussion, in mid-October, Fitz-Gerald specifically warned that stock prices in China could correct in November – just as they've done. China remains the greatest long-term growth story on Earth. But Fitz-Gerald warns that investors must research their investments well, and must be patient, as it "won't be a straight ride up."
Here are some highlights from our interview…
WP: Keith, in our interview last month, in some of the columns you've penned for Money Morningand in the many discussions you and I have had, there were three recurrent themes – each of which has played out as you anticipated. We had the slight sell-off in China, a sell-off here in the United States, and a continued escalation in oil prices up to that psychologically important $100 a barrel price level.
So, what's your take on what's happening right now? And, more importantly, what's next? Is this all just one of those periodic corrections that keep markets honest – and healthy? Or is it the start of something much more dramatic?
KFG: Well, those are very important questions.
In order to really get a handle on what we're dealing with, I believe we need to look at the markets on two levels: fundamental and the technical.
From a fundamental standpoint, we've clearly got some challenges. That's also true from a technical perspective. As a result, investors need to be thinking about how to protect their capital as well as where the next profits are likely to be found.
WP: Can you elaborate?
KFG: Absolutely. Fundamentally speaking, our markets are struggling with the triple specters of high oil prices, what I like to refer to as "an attention to deficits disorder" originating at the highest levels of our government, and lastly a dollar that has weakened to levels that were previously unthinkable. Each of these phenomena are well documented.
What's really roiling the markets right now, though, is the fear of the unknown as it relates to the credit crisis and the potentially broad fallout any such spillover could have on the U.S. economy.
My belief is that the next shoe is ready to drop and that it's going to spook a lot of people when it does. In fact, we're seeing a little of that already.
WP: How so?
KFG: Well, Bill, as you've written yourself, many banks, homebuilders and financial institutions have yet to really come clean and put a real number on their credit-crisis exposure – direct or indirect.
WP: In some cases – and this is really worrisome – it's clear that some of the players can't even quantify what they're facing. Others just seem to refuse to.
KFG: Well that's just it. In particular, the largest financial institutions sell something called "collateralized debt obligations," or CDOs for short. These nasty little instruments are made possible by something called "conduits," which are really highly specialized financial instruments collateralized by mortgage debt and other assets. And here's the important part: Most of these are being carried "off" the company's sheets.
In real terms, this means that even though companies are not yet reporting them, they could potentially have hundreds of millions of dollars of exposure that has yet to be reported.
As long as these institutions keep selling their debt, the money will keep moving and this will not be an issue. However, if the buyers go away, the institutions originating the CDOs could be held liable for their funding in which case all of this money would have to be accounted for on the balance sheets. This will have a big impact on income statements, as well.
WP: This has to relate to the technical picture you're seeing right now.
KFG: Clearly, the two are related. The trick though is that Monday's post-holiday trading brought us down dangerously closer to the 1410 area on the S&P 500 Index. We view that as something called a "balance point" in our proprietary analytics. Should we fall below 1410, the picture really could become unpleasant.
WP: The market's been flirting with that level all week. It seems as if the outlook is pretty bleak at the moment. Is it? Also, this might be a good time to talk about your strategic use of stop-losses. You're one of the few investment pros I've interviewed through the years who spends as much time focusing on managing risk as you do on positioning yourself for maximum returns.
But let's start with the market outlook. Your analysis sounded kind of dire.
KFG: I don't think things are exactly "bleak," and I'll give you two reasons why that's so:
- First, if you've been using trailing stops as we all advocate here at Money Morning and The Money Map Report, you should be carefully taking profits as the markets fall. If not, it's not too late to put stops in place in your portfolio – both to minimize losses and to safely move profits to the sidelines as market uncertainty escalates.
- Second, should we break through the 1410 level, you'll actually be able to turn the correction into a major positive by using it as an opportunity to diversify your profits – and profit opportunities – in the months to come.
WP: Can you explain what you mean by that?
KFG: Many investors are currently sitting on portfolios dominated by U.S. stocks. As the U.S. market retrenches and the trailing stops I've mentioned gradually reduce their U.S. holdings, these investors can take those profits and use them to diversify into internationally oriented securities that are poised to advance no matter what happens here in the U.S. market in the month to come.
WP: Can you give some examples?
WP: With Pepsi, you were one of the few to understand the huge upside investment potential of that very slick marketing campaign that "unofficially" capitalizes on the upcoming Summer Olympics in Beijing. [To read that investment report on Pepsi, and how it may have "outfoxed" rival Coca-Cola Co. in China, please click here. The report is free of charge.]
KFG: What you're looking for are companies like Boeing, Yum, Pepsi, and ABB that are presently growing their overseas sales by double-digit rates. In particular, you want to home in on those companies that derive a substantial portion of their sales in markets outside the United States and which benefit from virtually unstoppable global trends.
WP: Such as China's ongoing emergence, which will continue for decades…
WP: And you always note that these typically should be viewed as long-term investments, and not something timed for a quick payoff.
KFG: That's exactly right. That's why you have to manage your risk in the near term, since that gets you into the long run, where the dividends and profits really compound returns.
WP: I know you're not really a fan of these strategies, but should investors be dollar cost averaging or doubling down right now?
KFG: As you said, I'm not a huge fan of doing that. Instead, I advocate a properly diversified portfolio with up to 50% of investable assets in something that I call the "safety and balance" category. Another 40% [roughly] should be focused on income, which has been shown to substantially dampen market volatility. And, finally, having covered those two bases, around 10% should be invested in carefully chosen speculative plays.
Despite what you hear from the pom-pom squad, it's too early to wade – whole hog – back into the markets on the assumption that everything's going to be hunky dory.
WP: What else can investors do?
KFG: If they are feeling opportunitistic, they can invest in any of half a dozen ultrashort ETFs that benefit from falling markets. My favorites right now include the Rydex "URSA" [Latin for "bear," as in "bear market"] Inverse S&P 500 Strategy Investment Fund (RYURX), which grows as the S&P 500 falls, and the brand new PROSHARES US FTSE/XI (FXP), which appreciates as the iShares FTSE/Xinhua China 25 Index (FXI) falls.
Of course, more-seasoned investors can also utilize "put" options, but those are an entirely different animal.
WP: Of course, you do quite a bit of that in your VIP trading services, such as The New China Trader. With that kind of service, it doesn't matter what direction the markets are headed….you can always find profit opportunities.
KFG: That's correct. We're even starting to do a bit more with options in our monthly newsletter, The Money Map Report, although that still remains more of a globally focused newsletter that uses conventional equity strategies.
WP: Thanks for your time, Keith.
KFG: My pleasure – as always….
WP: We'll sit down and chat with Keith again next month.
News and Related Story Links:
- Money Morning Investment Guru Interview:
China: Bubble or Bull Market?
- Money Morning Investment Analysis:
Avoid the ‘Resurgent' Homebuilding Sector and Go Global for Profits.
- Money Morning Investment Research Report:
Pepsi "Goes Red" in China.
- Money Morning Investment Research Report:
How to Profit on an Earnings Surprise From China's Rise.
- Money Morning Investment Research Report:
China's Growth Will Clear $340 Billion Worth of Airliner Sales for Takeoff Over the Next 20 Years.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.