From the Editor - October 06

The commentary below is from our monthly newsletter and is provided here as a convenient reference for our readers.

Fickle Markets

Energy is out. That’s what the investment world seems to have concluded. Now that the price of oil is “only” $60 per barrel and went “all the way down” to $58, it’s clear to Wall Street that energy stocks are now a bad investment. To make things worse, Merrill Lynch recently downgraded the sector. So now traders and investors are headed for the exits. Not great for our Model Stock Portfolio since almost a third of our holdings by weight are in the energy sector (over a third if you use our “Target Allocation”). There was one recent “expert” predicting that oil would hit a low of $27/barrel soon, and others who say we will never see $70+ per barrel oil again. This is a far cry from recent opinions that oil might exceed $100/barrel in the not-to-distant future.

Is it time for we prudent investors to dump our energy stocks as well? Probably not. Many of the energy stocks we hold never had $70+ per barrel priced into their share price in the first place. It’s unfortunate that they have taken a hit, but such is the indiscriminate nature of Mr. Market. He punishes the good and bad equally in panic times. We think that energy stocks will very soon represent a buying opportunity for us as sanity slowly returns and investors once again realize that we need oil to make things run. At least for now. Nuclear powered cars are not yet perfected.

Commenting on Our Stock Model Portfolio

For the first time since we began this newsletter, we have added cash to our “Target Ownership” in Table 2 rather than purchasing two new stocks to replace CAO and ENH, which we sold this month. We did so in part to hedge our bets in October. October, as you probably know, is historically the worst month of the year to own securities. This may or may not be true this year, but there are enough uncertainties right now over the economy, mid-term elections, and other geo-political events that it seems a prudent thing to raise a little short-term cash. Cash, after all, is a pretty decent investment at present with the Fed funds rate over 5%.

Another departure from our normal procedures was to allow the gap between “Target Ownership” in Table 2 and “Actual Ownership” to widen more than 2% for HERO, HLX, and HES. All three are energy stocks. Most of the time, once the gap between these two columns exceeds 2% we adjust our ownership by buying or selling to bring our target and actual ownership back in line with one another. However, there is an old axiom that you should never try to catch a falling knife. Given that many energy stocks are in a near-freefall state right now, and especially since that freefall is happening as we head into the month of October, we thought we’d wait just a bit before making the adjustment. More than that, both HLX and HES are now on our “watch closely” list since both have had recent earnings estimates cuts. If you are looking to make any energy stock purchases, HERO and ERF may both be at very good valuations now.

Our current plan is to become fully invested by November 1, taking our cash holdings down to 0%. Historically, the period between November 1 and April 30 is a strong one for the stock market. Although this time around there is the growing worry of a softening economy (even a recession?), the stock market may stay robust as long as it thinks the Feds will begin lowering interest rates early next year. Expect some higher-than-normal volatility in the meantime.