After The Debate

On Friday, Wall Street ignored the Fannie Mae disaster …

brushed aside the Merck stock collapse …

forgot about the recent torrent of earnings warnings …

paid no attention to gold’s surge to nearly $420 …

and didn’t even bat an eyelash when oil closed at $50.12, the highest level in history.

Instead, investors saw that George Bush did OK in the presidential debate the night before. They breathed a collective sigh of relief that the political landscape had not changed significantly. And they jumped in to buy, driving the Dow up 112 points … the Nasdaq up 45 … and the S&P up almost 17.

So will politics now be the primary driver of the market in the weeks ahead? What lessons can we learn from these latest events? Where should you look to conduct a reality check on the market? Here are my answers …

Presidential Election Extremely Volatile

Wall Street’s assumption Friday that the political landscape had not changed was proven wrong in less than 26 hours.

Saturday evening, at 6:04pm, Newsweek posted a story on the web headlined “The Race is On.”

By 9:30 am Sunday morning, CNN picked it up with its story, “Bush Post-Convention Lead ‘Erased’.“

And by 7:39pm the cable network was out with its own CNN/USA Today/Gallup poll showing similarly dramatic changes.

So right now, whether you prefer Bush, Kerry, or neither, you must take a serious look at the latest poll numbers:

* CNN/USA Today/Gallup says the two contenders are tied at 49% among likely voters. That’s an 8-point gain for Kerry since the last Gallup poll conducted September 24th through 27th.

* Newsweek reports that 47% of registered voters now say they would vote for Kerry compared to 45% for Bush. That’s a massive, 13-point swing from a similar Newsweek poll taken four weeks ago. Newsweek also reports that …

* Kerry’s favorability rating jumped to 52%, while Bush’s dropped below the 50% mark for the first time since July.

* 62% still said Bush had strong leadership skills, as compared to 56% for Kerry, but even this represented a six-point gain for Kerry.

This is precisely what Wall Street was hoping would NOT happen.

Valuable Lessons

But it’s also a turn of events that yields some valuable lessons …

Lesson #1. Wall Street can and will ignore the real world from time to time. Investors put on blinders. They brush aside negative news. And they climb a wall of worry, driving the stock market higher. This has happened before … and it could happen again.

My view: If it does, don’t be fooled. It’s just another bubble that could pop at any time.

Lesson #2. This year’s presidential campaign is like a cross between Hurricane Jeanne and Mount St. Helens: It’s fickle, highly explosive, and … full of hot air. You’ve just seen the sudden, 13-point reversal in a critical national poll. In the next 30 days, you could see more reversals – in both directions.

Lesson #3. The volatility of the campaign will feed directly into volatility in the stock market. So as we approach the election, expect more market surges and crashes.

Lesson #4. But don’t let one day’s, or even one month’s, events shake your basic, long-term investment plan. Instead, remember recent stock market history:

1990s ……. the greatest boom of all time
2000-02 … the deepest bear market since the 1930s
2003 …….. a sharp rally
2004 …….. a dead zone between the top and bottom of recent years

See the huge, dramatic swings the market has undergone? See how we’re now temporarily caught smack in-between those extremes? If so, then you must recognize the unprecedented risk that’s still built into stocks. And if stocks rally further, they will only be that much riskier.

Lesson #5. Given this high level of risk, even if you don’t agree with me that the market is headed lower … you still owe it to yourself to take protective action. At least get rid of your most vulnerable stocks and then park the proceeds into the safest investments you can find, such as U.S. Treasury bills or money market mutual funds dedicated to short-term Treasuries. Some examples of these specialized money funds:

* American Century Capital Preservation Fund (CPFXX)

* Dreyfus 100% U.S. Treasury Fund (DUSXX)

* Fidelity Spartan U.S. Treasury Money Market Fund (FDLXX)

* USGI U.S. Treasury Securities Cash Fund (USTXX)

* Vanguard Treasury Money Market Fund (VMPXX)

Or, consider our own Weiss Treasury Only Money Market Fund (WEOXX).

And don’t let the current low yield on these funds bother you. As the Fed continues to jack up interest rates, their yields should rise accordingly.

Lesson #6. Whether you’re bullish or bearish, diversify beyond just ordinary stocks. For example, reach out to investments that profit from surging gold and oil.

Lesson #7. Above all, don’t get sucked into Wall Street’s latest group think. Scan the horizon and perform your own, independent reality check, paying particular attention to the largest, trend-setting corporations.

Right now, I am looking at two such corporations – Fannie Mae and Intel. Each could make or break the economy and the markets almost single-handedly …

Fannie Mae

Last week, I told you how Franklin Delano Roosevelt’s dream of home ownership is turning into a nightmare.

And this week, in the Sunday New York Times, Gretchen Morgenson picks up on the theme and carries it several steps further in her hard-hitting, must-read article, “A Coming Nightmare of Homeownership?“

The article brings out six key points …

Point #1. Fannie Mae’s credit operations grew too big, too fast. For years, the regulators have allowed Fannie Mae to expand its business and portfolio to the maximum size at the maximum speed. Thanks in large part to Fannie Mae’s torrid growth, the market for mortgage securities now surpasses that for Treasury securities.

Point #2. Maybe so many mortgages were not such a good idea after all. The decades-long effort to push a mortgage on people that otherwise could not have afforded one could transform the American dream of home ownership into the American nightmare, trapping people in their homes.

Reason: If incomes don’t rise … if home values don’t keep rising … or if interest rates rise considerably, we could quickly end up with significantly more people under water with their mortgages and unable to pay.

Point #3. Big changes ahead. Fannie Mae’s business model is likely to change drastically. The company is likely to experience several years of curtailed growth, a rebuilding of capital and stricter government oversight.

Point #4. The company’s finances are shaky. As its debt ballooned, Fannie Mae maintained a capital reserve of just two percent of assets, far below the eight percent held by comparable banks. Now, however, accusations that the company manipulated its financial results mean that the days of minimal capital levels at Fannie Mae are over.

Point #5. The home mortgage market is overextended. The median loan to value of a home (a measure of the debt burden) rose to 58.7 percent in 2003 from 33 percent in 1979. Plus, Census Bureau data shows that the percentage of home mortgages in which the loan is equal to or exceeds the value of the property has grown from only 2.1 in 1993 to 5.4 percent last year.

Point #6. Many homeowners are vulnerable. Fannie Mae played a key role in the dramatic shift of recent years toward more relaxed credit terms, such as zero-down payment options. In some cases, even closing costs can now be borrowed. But today, homeowners who relied on easy money are much more vulnerable to losing their homes.

Bottom line: Fannie Mae’s troubles could be the harbinger of a serious shake-up in the home mortgage market, with dire consequences for investors, lenders, and homeowners.

For my money, real estate and related investments are a landmine – prices overblown, Fannie Mae in trouble, and interest rates rising.”

Intel

Intel, a Dow 30 company, is one of the most widely held stocks in America:

* America’s mutual funds hold a mountain of its shares – about 900 MILLION, according to Morningstar.

* In the most recent reporting period, these funds were still buying Intel like mad: Fidelity OTC (5.9 million shares), Fidelity Magellan (5.3 million), Fidelity Dividend Growth (3 million), Morgan Stanley Dividend Growth (1.8 million), Putnam Growth & Income (1.8 million), Oppenheimer Balanced (1.5 million), American Balanced (1.3 million), and Vanguard Equity Growth (1.2 million).

* Some mutual funds have gone even further: Pioneer Strategic Growth has 12.9% of its assets in Intel; American Growth, 9.4%; Alliance Growth, 4.7%; Oppenheimer Balanced, 4.3%; Putnam Voyager, 4.1%; and Harbor Capital Appreciation, 3.7%.

Problem: Computers simply are no longer the mysterious technological marvel they used to be. They are effectively appliances, being sold at lower and lower prices, like microwave ovens or TVs.

Most people couldn’t imagine life without a microwave oven … a lawn mower… OR a computer. So I don’t doubt the longevity of the PC industry. But the stocks of companies that manufacture these mundane products no longer deserve to sell for high multiples.

Right now, for example, Maytag shares are selling for 0.3 times sales … Whirlpool – 0.3 … Hitachi – 0.2 … and Black & Decker – 1.3.

But guess what Intel sells for: About FOUR times sales! That’s a VERY rich valuation for what’s, in essence, an electronics company selling to a shrinking number of customers, for a sinking price, in a mature industry.

Of course, Intel fans will claim that computer chips are sexier than microwaves and lawn mowers. And they’ll boast that Intel deserves a sky-high valuation because it’s a “growth machine with unlimited potential.”

I beg to disagree.

In July, Intel shocked Wall Street when it admitted that 2004 profits were going to be lower than previously forecast and that its profit margins were shrinking. Naturally, Intel chiefs told Wall Street not to worry. “Inside our business we’re seeing no evidence of a problem,” said CFO Andy Bryant.

Oh, really? Consider some of the pressing problems that Bryant glossed over …

Skyrocketing inventory: Intel’s inventory of chips ballooned by 15% in the second quarter. That was a $427 million higher than Intel had on hand in the first quarter, bringing Intel’s total inventory to $3.2 billion, or nearly 40% of the next quarter’s sales!

Overcapacity: Chip fabrication plants cost more than a billion dollars to build. So when Intel sinks that much money into a plant, they feel they have no choice but to produce like crazy in order to keep the average price of their products down.

Weak demand: Intel admitted in September that demand was weaker – not just in a couple of isolated areas, but globally. “What we are seeing is pretty uniform around the world,” said CFO Bryant. And this was supposed to be the hot, back-to-school sales season?

Stiffer competition: Intel has been milking its 32-bit, x86 chip architecture for more than a decade without any major, revolutionary innovations. That has opened the door to competitor Advanced Micro Devices (AMD), which now supplies the chips in 50% of all the computers sold in retail stores.

The Rest is Up To You

You’ve seen the dramatic changes unfolding in the presidential election campaign … in the markets … and in some of the biggest companies in the world – like Fannie Mae and Intel, just to name a couple.

You’ve seen what can happen to your investments if you just sit back and complacently let things ride.

Now, it’s time to convert that vision into action. Don’t wait. Protect your hard-earned assets by seeking safety and true diversification.

Good luck and God bless!

Martin

Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com

Martin Weiss and “Martin on Monday” are non-partisan. Third-party ads do not necessarily represent their opinion and should not be interpreted as an endorsement.

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