A “Must Know” Strategy For Investing In Volatile Markets

For the past few weeks, there has been a lot of discussion about the stock market’s direction and what could be the extent of this correction we’re apparently in the middle of.

The correction has been officially identified by many market professionals. Last week I too discussed it, in light of the market’s (rich) valuation and historical perspective. I then mentioned in my “What to do?” concluding thoughts the concept of “taking advantage of lower prices to pick up solid long-term holdings…”

Well, that phrase could use further elaboration. I gave you some broad words of solid wisdom, and today I will try to explain in more detail.

There is a well-known tactic that long-term investors use for building their positions over time. I’m sure some of you are at least familiar with what is known as “Dollar Cost Averaging” or “DCA.” (I really hope most of you are already incorporating dollar cost averaging into your stock purchasing methodology.) In fact, through direct investment plans, IRAs and 401(k) type programs, you may be doing DCA and might not know it. And with less visibility and the markets going up and down so much, DCA makes more sense now for most investing efforts.

Let’s look a little closer at some Safe Haven Investor examples to better convey the importance of (and strategy behind) dollar cost averaging.

DCA Defined

Dollar Cost Averaging is a sound buying (and selling) strategy that works well when stocks prices are moving up and down.

Let’s say you were a long-term reader of Safe Haven Investor and back in November of 2008, you took our advice and added HudBay Minerals (HBM:TSX) to your portfolio.

HudBay Minerals is a Canadian integrated mining company that has been a great addition to the Safe Haven portfolio, up 113% since we recommended it on Nov. 7, 2008. But I don’t want to talk about that awesome return - I want to talk about DCA.

On that date the HBM price was $6 a share. You could have made a lump-sum or “one time” purchase, say of $3,000 worth, for 500 shares.

That’s great, but sometimes you gradually want to add to your position. Perhaps you don’t have all the money at once, or you want to do it monthly or quarterly. Deducting a set dollar amount out of your monthly paycheck to purchase shares is a common example. That, simply, is dollar cost averaging.

With dollar cost averaging, you add to (or reduce, if the case may be) a position periodically, effectively “averaging” your total dollar cost. This works great if you’re buying a stock and the price tends to be lower than your “one time” price.

This is kind of important. If you have a comfortable and ongoing strategy of dollar cost averaging, than you pay less attention to dips in the stocks you are buying. As long as you are still comfortable with the investment rationale behind buying the stock, and nothing material has changed with the company and its fundamentals, then dollar cost averaging will let you buy with confidence. As Peter Lynch suggests, “The key to making money in stocks is not to get scared out of them.”

On the other hand, if the stock starts rising, then your average cost could be higher. But in this environment, if that happened to be the case, I might not mind paying a higher price when there is a near-term risk of the stock dropping down lower. If the stock does go higher, you are buying fewer shares at that higher price with the same dollar amount.

Also, if there is a chance your investment (temporarily) turns sour, at least you will be entering at a lower and lower base, allowing the opportunity for positive returns sooner.

The HudBay Example

Back to HudBay for a moment. In the chart below, using $3,000, we compare a lump-sum purchase at $6/share vs. dollar cost averaging for six months since the Nov. 7 recommendation.

With Dollar Cost Averaging, our “average” price would have been $5.17, allowing us to own 528.6 shares, compared to a lump-sum purchase on Nov. 7, 2008, where the “average” price was $6, giving us 500 shares.

Having an average price of $5.17 vs. $6 is a major difference! Actually, by dollar cost averaging, you would have been up 16% already, which over the long run and with larger dollar amounts would have a meaningful impact on your portfolio. And in HudBay’s case, this is before the stock doubled and made its run to the low teens.

So, now you know about Dollar Cost Averaging - which in this market could serve you well.

5 Ways ETF Investors Can Overcome Liquidity Issues

Although exchange traded fund (ETF) investing has become easier, millions of smaller investors are experiencing some of the pitfalls when it comes to the costs of illiquid investments.

Both institutional and individual investors like ETFs for their ease of trade and efficient index tracking, however, there are potential problems that can arise if you’re not on the lookout.

Eleanore Laise for The Wall Street Journal highlights some of the recent issues with liquidity, including:

• Funds that give exposure to the more esoteric areas of the market, such as high-yield bonds and commodity futures, have posed several obstacles, making trades more complex.
• Strong investor demand for certain ETFs can cause liquidity issues. Many new funds now launch with the bare minimum level of assets-often just $2.5 million or so.
• Regulatory scrutiny by the Commodity Futures Trading Commission (CFTC) led some funds to change their objectives or suspend the creation of new shares, which led some ETFs to trade at a premium.
• A lack of liquidity can lead to wide “bid-ask spreads,” or the gap between the price buyers are willing to pay for shares of an ETF and the price sellers are asking. The wider the spread, the bigger the bite taken out of investors’ returns every time they buy or sell.
• A lack of liquidity also may cause the ETF to trade at a large premium or discount to net asset value, or NAV-the value of the fund’s underlying holdings. That means an investor buying the fund may overpay for that portfolio, or an investor selling could get less than that basket of securities is worth.

So what should investors look for?

• By sticking to the popular and highly traded ETFs, the liquidity issues are not a concern. ETF assets and trading volume are highly concentrated in just a handful of funds.
• Use a “limit order” when buying and selling ETFs, which means that your trade will only go through if it’s in a price range you determine, instead of automatically defaulting to the market price.
• The underlying holdings of any given ETF are at the core of the liquidity issue. The harder it is to trade those holdings, the more likely investors will see gaps between the share price and the NAV.
• If your trade is more than 10% of the fund’s daily volume, call in the experts for assistance. The ETF provider, liquidity providers and your brokerage are all there to assist you in getting the best price.
• Watch new ETFs, suggests Matt Hougan at IndexUniverse. If you’re worried about liquidity, monitor new launches that intrigue you and let them gain their footing before you dive in.

Stock Buy: Whirlpool Corporation

Whirlpool Corporation (WHR: 82.08 0.00 0.00%) recently reported fourth quarter sales growth of 12.72% as the emerging markets in Latin America and Asia boosted the bottom line. It was Whirlpool’s fourth big beat in a row.

Company Description

Whirlpool manufactures home appliances, such as refrigerators, dishwashers, cooking and countertop appliances. The company owns many iconic brands such as Maytag, KitchenAid, Jenn-Air, Amana, Bauknecht and Consul.

Whirlpool has 67 manufacturing and technology research centers worldwide.

Whirlpool Surprised By 26.15% in the Fourth Quarter

If you’ve been reading our Rank Buy profiles on Whirlpool both on the Value and Momentum side of the equation the past month, you were not surprised by Whirlpool’s outstanding earnings report on Feb 2.

Just as the third quarter alluded to the growth potential in the emerging markets, as emerging market sales offset some of the decline in the North American and European markets, so the fourth quarter has now confirmed that Whirlpool’s strategy is on track.

Latin American sales jumped 52% to $1.2 billion. Excluding currency translation, sales rose about 28%.

Brazil has been the hot market due to the expanding middle class and home ownership that is being pushed by several government incentive programs. Whirlpool expects Brazilian appliance shipments to rise 5% to 10% in 2010 compared with 2009.

Asian sales also jumped 34% but Asia is Whirlpool’s smallest segment. Sales were just $188 million for the quarter. Whirlpool is forecasting growth of 3% to 5% in unit shipments for 2010.

But even the North American and European markets, which had been a drag on results, saw sales growth. North American sales were up 4% and Europe rose 2% over the year ago quarter.

Outlook for 2010

Whirlpool is optimistic about 2010. The company issued earnings per share guidance of between $6.50 and $7.00 which is much higher than the current Zacks Consensus Estimate of $6.36 per share.

Look for covering analysts to revise their estimates in the next few days.

Value Fundamentals

Whirlpool continues to exhibit strong value fundamentals. The #1 Rank (strong buy) stock has a forward P/E of just 11.96 and a price-to-book ratio of 1.53. Whirlpool’s 5-year average return on equity (ROE) is also an outstanding 17.18%.

Bear Of The Day: AES Corporation (AES)

Our Underperform recommendation on AES Corporation (AES: 12.90 0.00 0.00%) takes into account the significant international presence of its fossil fuel power plants in several emerging markets, thereby exposing it to both foreign currency and political risk.

The company’s predominantly long-term contracts preempt any rate base growth in the near term for its regulated utilities. Also, with lower electricity demand due to a tepid global economy, the fate of spot wholesale markets is not encouraging.

As a result, we expect shares of AES Corporation to Underperform the broader equity markets in general and the utilities and merchant generators in particular.

Paulson On Mark To Market Accounting

During former Treasury Secretary Paulson’s interview with Larry Kudlow last night, Larry asked him about the role of mark to market accounting in the financial crisis. Secretary Paulson defended mark to market accounting.

However, his context and his examples came from his many years of investment banking at Goldman Sachs (GS: 157.23 0.00 0.00%) where assets are traded daily and, obviously, should be marked daily. Those of us who railed against the rigid application or mark to market accounting, or fair value accounting, during the crisis were talking specifically about commercial banks, not investment banks.

As I’ve written about before, Alan Greenspan argued passionately about the inadvisability of applying mark to market to commercial banks whose business model was to make loans or purchase investment securities to hold. He made his appeal in 1990, and was supported by Treasury Secretary Brady, the Chairman of the FDIC and other top officials at the time. These people, with their staff experts, were not arguing against mark to market for all financial institutions, but for banks. More recently, Paul Volcker and FDIC Chairman, Sheila Bair, have spoken publicly about the destruction of mark to market applied rigidly to banks.

Those of us who wrote about and testified on the issue last year, including former FDIC Chairman Bill Isaac, were careful to distinguish between commercial banks and trading financial institutions. In fact, we conceded that, even at commercial banks, securities held for trading or subject to trading should be marked accordingly.

I bought Secretary Paulson’s new book yesterday, and it looks to be excellent. From the index, I found several brief supporting references to mark to market, but they also came in the context of trading.

For those of you who might be familiar with my ongoing commentary about book prices, the U.S. dollar price of the book is $28.99; the Canadian dollar price is $34.99. The Canadian price is 21 percent higher. That is less than the differential a couple of years ago, but it is still substantial.

Forex Trading: EUR/USD’s Bullish Retracement Within Downtrend

Price action on EUR/USD, a 4-hour chart of which is shown, has made yet another bullish retracement within the context of the new overall downtrend. The current leg of this new downtrend extends from the January 13th high, and has formed a valid bearish resistance trendline. Within the context of this downtrend resistance line, price has made several breakdowns of both short-term uptrend support lines and horizontal support levels.

As might be expected, these breakdowns have continued the dominant downtrend with significant downside follow-through. If the current leg of the prevailing downtrend is to continue, a key continuation trigger would be a breakdown below the current short-term uptrend support line. A significant breakdown of this nature could target further downside support in the 1.3800 price region.

To the upside, within the context of the current overall downtrend, in the event of any significant breakout above the current downtrend resistance line, the key 1.4000 psychological price region should serve as an immediate resistance area.

Analyst Interviews: U.S. Banks Stock Update

After enduring extraordinary shocks in 2008, the U.S. banks entered an exceptional state of turmoil in 2009. Starting as a credit issue in the subprime segment of the mortgage market, the sticky situation infected almost the entire financial services industry, and all corners of the globe. In other words, the financial crisis ultimately morphed into a massive economic crisis, which has had major ramifications across the whole world.

Entering 2010, although the banking industry is dealing with liquidity and confidence challenges, it is now comparatively stable with financial support from the U.S. government. The government had taken several steps, including programs offering capital injections and debt guarantees, to stabilize the financial system.

We believe that the worst of the credit crisis is now behind us. After more than a year of initiating the $700 billion Troubled Asset Relief Program (TARP), a lot has improved with respect to the economic crisis.

But the banking system is not yet out of the woods as there are persistent problems that need to be addressed by the government before shifting the strategy to growth. We believe that the U.S. economy will regain its growth momentum once these issues are resolved.

While the bigger banks benefited greatly from the various programs launched by the government, many smaller banks are still in a very weak financial state and the Federal Deposit Insurance Corporation’s (FDIC) list of problem banks continues to grow.

Despite the government’s strong efforts, we continue to see bank failures. As the industry tolerates bad loans that were made during the credit explosion, the trouble in the banking system goes even deeper, increasing the possibility of more bank failures.

Furthermore, government efforts have not succeeded in restoring the lending activity at the banks. Lower lending will continue to hurt margins and the overall economy, though the low interest rate environment should be beneficial to banks with a liability-sensitive balance sheet.

Out of the $247 billion given to banks, $162 billion has come back from the healthy banks who have repaid their TARP funds. Banks have paid an additional $11 billion in interest and dividends. Also, taxpayers have received decent returns on many of its financial-sector investments. Repayments under the TARP have generated a 17% annualized return from stock-warrant repurchases and $12 billion in dividend payments from dozens of banks.

Many of the financial institutions that have already repaid the bailout money include JPMorgan Chase (JPM: 40.29 0.00 0.00%), American Express (AXP: 38.33 0.00 0.00%), Goldman Sachs (GS: 157.23 0.00 0.00%), Morgan Stanley (MS: 27.89 0.00 0.00%), Capital One (COF: 36.55 0.00 0.00%), BB&T (BBT: 27.80 0.00 0.00%), US Bancorp (USB: 24.46 0.00 0.00%), Bank of America (BAC: 15.53 0.00 0.00%), Wells Fargo (WFC: 28.14 0.00 0.00%) and Citigroup (C: 3.37 0.00 0.00%).

Following the U.S. Treasury’s announcement requiring the world’s banks to maintain stronger capital and liquidity standards by the end of 2010 to prevent a re-run of the global financial crisis, 15 large banks that control the majority of derivative trading worldwide have committed themselves to maintaining greater transparency in the $600 trillion market that needs stricter oversight in the interest of the global financial system.

Moreover, in mid-January 2010, the Obama Administration proposed a tax on about 50 of the nation’s largest financial firms in order to recover the losses incurred by the government on its $700 billion bailout program. On approval of the Congress, the tax, which the White House calls a “financial crisis responsibility fee,” would force the banks to reportedly pay the federal government about $90 billion over 10 years.

Targeting banks to recover the shortfall in bailout money can be considered justified, as they are the major beneficiaries of the taxpayers’ largesse. Most of the bailout loan was provided to financial institutions, as they form the backbone of the economy and were the primary victims of the crisis.

If the economic recovery tails off, high-risk loan defaults could re-emerge. About $500 billion in commercial real estate loans would be due annually over the next few years.

Above all, there are lingering concerns related to the banking industry as well as the economy. Continued asset-quality troubles are expected to force many banks to record substantial additional provisions at least through the end of 2010. This will be a drag on the profitability of many banks for extended periods, which will further stretch their capital levels.

For the last few quarters, the banks have mainly suffered from the losses in mortgages and Commercial Real Estate (residential construction) loans. Housing prices have continued to decline, and given the sharp increase in unemployment we anticipate continued losses in these portfolios.

While the state of the economy is showing signs of recovery, a lot remains to be done. The Treasury continues to have huge direct investments in institutions like American International Group (AIG: 23.79 0.00 0.00%), Fannie Mae (FNM: 1.01 0.00 0.00%) and Freddie Mac (FRE: 1.19 0.00 0.00%).

In conclusion, we expect loan losses on commercial real estate portfolio to remain high for banks that hold large amounts of high-risk loans. Also, as a result of a rise in charge-offs, the levels of reserve coverage have fallen over the past quarters and the banks will have to make higher provisions at least in the near term, affecting their profitability. We think that the financial crisis is far from over, and we will have to wait awhile to write the end of this crisis story.

OPPORTUNITIES

The Treasury’s requirement of focusing banking institutions towards higher-quality capital will help banks absorb big losses. Though this would somewhat limit the profitability of banks, a proper implementation would bring stability to the overall sector and hopefully address bank failures.

Specific banks that we like with a Zacks ranking of 1 (Strong Buy) include BancFirst Corporation (BANF: 38.24 0.00 0.00%), First Capital Bancorp, Inc. (FCVA: 8.02 0.00 0.00%) and Bridge Capital Holdings (BBNK).

There are currently a number of stocks in the U.S. banking universe with a Zacks ranking of 2 (Buy) including 1st United Bancorp, Inc. (FUBC), Ameris Bancorp (ABCB), Doral Financial Corp. (DRL), Tennessee Commerce Bancorp Inc. (TNCC), United Bankshares Inc. (UBSI) and North Valley Bancorp (NOVB).

We favor Commerce Bancshares Inc. (CBSH) in this space since this company is one of the few names that did not report losses even during the current financial crisis. We believe that Commerce is one of the best-capitalized banks in the industry and will generate positive earnings throughout the credit cycle. While the bank had a decent growth in deposits in the most recent quarter, trends in its credit metrics were negative.

WEAKNESSES

The financial system is going through massive de-leveraging. Banks in particular have lowered leverage. The implication for banks is that the profitability metrics (like returns on equity and return on assets) will be lower than in recent years.

Furthermore, the current crisis has dramatically accelerated the consolidation trend in the industry. As a result, failure of a large financial institution will be a major concern in the upcoming quarters as weaker entities are being absorbed by the larger ones.

We think banks with high exposure to housing and Commercial Real Estate loans, like Wilmington Trust Corporation (WL), KeyCorp (KEY) and Zions Bancorp (ZION), will remain under pressure.

Also, there are currently a number of stocks with a Zacks ranking of 5 (Strong Sell) including Southwest Bancorp Inc. (OKSB), Texas Capital BancShares Inc. (TCBI), Bank of Hawaii Corporation (BOH), Cathay General Bancorp (CATY), Central Valley Community Bancorp (CVCY), Pacific Continental Corp. (PCBK) and Summit State Bank (SSBI).