Navigating The Bond Market

Where should people invest these days?

Are we to believe the price action in the equity markets?

With short term rates on CDs and money market funds ridiculously low, where does one turn to make a safe investment with limited risk?

Prior to putting any money to work, always make sure you look at an investment in the context of an overall portfolio. Diversity and prudent risk management never go out of style and should be the cornerstones of any portfolio.

Sense on Cents recommends short to intermediate bond funds.  I am concerned about longer maturity interest rates moving higher (in fact they have moved considerably higher this morning). As such, I would stay away from bond funds with longer maturities in the underlying investments.

What are some of the road signs investors should look for in navigating the bond market? The Wall Street Journal provides a very handy overview this morning, The New Bond Equation:

As the financial crisis heads into its third year, investors in bond funds are facing some difficult choices.

Investors usually turn to these funds for safety. But bond funds are facing a host of pressures that are driving down returns, raising long-term risk-and making it tougher to settle on the right investment strategy.

Let’s navigate!

1. Default Risk
Do not be presumptuous and think the portfolio manager is carefully managing individual exposures in a bond fund. Investors need to look into the actual portfolio of bonds and ask brokers or financial planners on questionable credits.

2. Interest Rate Risk
In the presence of a massive fiscal deficit and the likelihood that the deficit will grow, interest rates are likely to head higher. A rising rate environment means declining bond values, which is why I recommend short to intermediate maturity bonds which will be less impacted.

3. Passive Investing via Index Funds
Maximize diversity and minimize expenses.

4. What About the Perils of Inflation?
Gain some exposure to TIPS (Treasury Inflation Protected Securities) and commodity funds.

5. Should Investors Try to Time the Market?
Sense on Cents ALWAYS recommends a dollar cost averaging or value averaging approach, in which an investor puts in a set amount of money every month. NO investor or portfolio manager is so good as to pick the top or bottom in a market, despite what you may hear.

Discipline is critical every step of the way. Do your homework prior to investing. Make sure the execution at point of investment is handled properly. Monitor your investments as you move forward.

What Yahoo, Microsoft Alliance Means For Tech ETFs

One of the most potentially significant deals in internet history has gone down between Yahoo and Microsoft. But what it will mean for exchange traded funds (ETFs) and shares in those companies is up in the air.

Microsoft (MSFT: 23.56 -0.27 -1.13%) and Yahoo (YHOO: 14.55 +0.211 +1.47%) have reached a 10-year web search deal and advertising partnership after years of speculation about a delay. Microsoft is the world’s biggest software firm and Yahoo is the leading online portal, and together, they could create a major rival to Google (GOOG: 449.61 -2.60 -0.57%).

The alliance may be a boon to both companies. The Economist explains that Microsoft will significantly increase the use of its search service, Bing, as well as its online advertising platform. This means Yahoo will no longer need to spend money on its search and ad technologies.

Here are more highlights, according to Barry Schwartz for Search Engine Land:

• Microsoft will acquire an exclusive 10-year license to Yahoo’s core search technologies, and Microsoft will have the ability to integrate Yahoo search technologies into its existing web search platforms.
• Microsoft’s Bing will be the exclusive algorithmic search and paid search platform for Yahoo sites. Yahoo will continue to use its technology and data in other areas of its business.
• Yahoo will be the sales force for both companies premium searches, however, each company will maintain its own separate display advertising business and sales force.

After regulatory approval, the deal will be in place and in working order by 2010.

ETFs may be the best play on this deal, because questions still remain about its ultimate impact. Will Google continue to thrive, or will this new alliance shrink its search engine market share? An ETF can cover all your bases.

• Technology Select Sector SPDR (XLK: 19.86 -0.11 -0.55%): up 29% year-to-date; Microsoft 10.3%; Google 4.9%; Yahoo 1.3%

• iShares Dow Jones U.S. Technology (IYW: 48.956 -0.324 -0.66%): up 37.8% year-to-date; Microsoft 12.2%; Google 6.5%; Yahoo 1.3%

Buy, Sell Or Hold: Coca-Cola (KO) Continues To Deliver Knockout Profits

Back on Feb. 17, as the market was on sell-off mode, I recommended buying The Coca-Cola Co. (KO: 49.75 +0.15 +0.30%).

The stock is up some 16% from our entry point.  That’s because Coca-Cola recently reported a near-20% jump in profit, which soared to 67 cents a share, excluding restructuring charges.

Coca-Cola beat earnings, increased guidance, increased dividends and reinstated its stock buyback program.  The company plans to repurchase $1 billion in shares of stock in the second half of 2009.  What more do we need?  The answer is: Consistent performance.

As I tracked the developments in Coca Cola and their global markets, I ascertained that my original view remains unchanged and Coca Cola should keep growing profits consistently, which should keep propelling its stock up.

Remember, on March 9, a few of weeks after our Coca Cola recommendation, I called the U.S. market turn by recommending a pro-cyclical energy play with Diamond Offshore Drilling Co. (DO: 91.54 -0.95 -1.03%).  That call coincided with the turn on Diamond Offshore stock as well, which has since soared about 67%.

Earlier, on October 27, I had called for the turn on iShares MSCI Brazil Index (EWZ: 60.69 +0.30 +0.50%), which has since soared more than 90%.

The point is that emerging markets, as was my thesis, are going to turn around much faster and come back much stronger than developed economies.

Prudent emerging economies - like Brazil and Chile - having enjoyed a few years of exponential growth in commodity prices did not over-extended themselves. Instead, they captured a sizable portion of those huge price increases and turned them into huge national savings, improving their fiscal positions.  They kept their banks clean and disciplined and became net creditors to the world.

So, while the advanced economies are saddled with debt, many emerging economies are the exact opposite.  Their fiscal positions are strong; their social security systems are not in peril, and their population growth means strong economic growth.

So, my initial thesis was predicated primarily on the fact that strong growth in emerging markets would lead to success for major international players.

While it’s true that Coca-Cola’s soft drinks are consumer staples, which are very resilient in economic downturns, the company’s biggest advantage is that a full 75% of its income is generated abroad.

Additionally, Coca-Cola is the most widely recognized brand name in the world.  With a distribution network that covers more than 200 countries and a 50% of the global market for carbonated drinks, Coca-Cola is the poster-child of a multinational.

What’s more, having kept its rival PepsiCo Inc. (PEP: 59.12 +2.92 +5.20%) at bay by beating them in the market, their price wars are not an issue any more.  This is crucial because pricing power has returned.

The strong U.S. dollar shaved 14% off of operating income during the quarter, but this is a temporary phenomenon, since the dollar is likely to remain week in the months to come.

Meanwhile, Coca-Cola continues to excel in emerging markets, just as we anticipated.  While overall volume growth was 4%, up from 2% in the first quarter, emerging markets took the prize: China was up 14%, India 33% and Brazil up 5%.

India, for example, has a high birth rate and 1 billion people with an average age of 25 years, and going lower.  This is a very receptive crowd for carbonated, sugary drinks, especially as their income soars.

Hence, with the strong recovery in China, India, Brazil and Russia, and many more emerging markets, plus the renewed weakness in the U.S. dollar, Coca-Cola should continue to perform in the second half and beyond.

Coca-Cola stock closed Friday up 17 cents, or 0.34%, at $49.84 a share.

Recommendation: Buy The Coca-Cola Co. at market (**).

(**)  Special Note of Disclosure: Horacio Marquez holds no interest in The Coca-Cola Co. (KO: 49.75 +0.15 +0.30%).

Markets Make Significant Progress In Transition From Bear Markets To Bull Markets

The transition from a bear market to a bull market is just that; a transition. Transitions take time and are not binary events like turning a light on or off. Transitions in any market can be frustrating and stressful, but if we continue to focus on the most important and telling indicators, the market should get us pointed in the right direction and aligned with the primary trends.

While there are numerous signs which can indicate the possible transition from a bear market to a bull market, the following two milestones are of uppermost importance:

• When the 50-day moving average crosses, and more importantly holds above, the 200-day moving average,
• When the slope of the 200-day moving average turns positive.

During an established bull market, a good way to eliminate less attractive markets or investment alternatives is to discard those that have a negatively sloped 200-day moving average. At the end of a bear market, it takes time for a market to send signals of the potential staying power of a rally via a positive change in the slope of a 200-day moving average. As shown in the chart below, even though stocks began to bottom in mass in March of this year, we only started to see positive changes in the slopes of 200-day moving averages in the last two weeks.

The significance of the slope of the 200-day moving average can be shown via the three charts below. The 200-day moving averages are shown in red.

As we have stated in the past, in a bull market:

• Price tends to stay above the 200-day moving average (MA) (red line).
• The 50-day moving average (blue line) tends to stay above the 200-day moving average.

In a bear market, where conviction is lacking to push prices higher:

• Price (black line) tends to stay below the 200-day moving average.
• The 50-day moving average tends to stay below the 200-day moving average.

The table shown below allows you to visualize the transition that has taken place between March 1, 2009 and August 2, 2009. In March (far left side of the table), most markets had the characteristics of a bear market. Currently (right side of table), numerous markets look much more like an early bull market than an on-going bear market.

The Dollar’s Move Supports Inflation-Friendly Assets

Notice on the left side of the chart above, the U.S. Dollar had bullish characteristics as investors looked for relatively safe havens and avoided risk. The chart below illustrates the possible on-going reversal of this trend.

The charts below show bullish moves related to the slope of 200-day moving averages (shown in red).

While we are not expecting the current bull market to last as long as the 2003-2007 bull market, it is not unrealistic to believe that markets could run further in 2009 after the slopes of their 200-day moving averages have turned up. The purpose the chart below is to suggest further gains may be possible, not to suggest the magnitude of the potential gains during the balance of 2009 and beyond. Obviously, conditions in 2003 were different from current conditions, but the basic concepts of the transition from a bear market to a bull market still apply in 2009. The chart below can help us overcome the fear of the current bull having little room to potentially run from current levels.

S&P 500’s Recent Retest Is Very Important To Bullish Case

The S&P 500’s correction between mid-June and early July and subsequent highs were important steps in the possible transition from a bear market to a bull market.

The Bears Can Make A Strong Case Just As They Could In 2003

Even in the most bullish of economic and financial market conditions, it is easy to find bearish commentary and bearish forecasts. Therefore, it is not surprising that in 2009 it is easy to find support for the bearish case. We understand and respect the bearish case. However, the market is currently aligned with the bullish case. To illustrate the possible pitfalls of being overly reliant on bearish commentary and any forecast, we present the following bearish commentary and arguments from a balanced USA Today article, Many wonder if this stock market rally is sustainable (May 8, 2003). As you read the comments below, keep in mind the S&P 500 stood at 927 when its 200-day moving average turned up in May of 2003 (and when the comments below were published). The new bull market that began in 2003 did not end until the S&P 500 reached 1,565 in 2007. After the bearish commentary below was published in 2003, the S&P 500 gained roughly 70%.

But for every potential positive, there is an offsetting worry. Brian Belski, fundamental market strategist at U.S. Bancorp Piper Jaffray notes that betting on an economic recovery has been a losing strategy. And with analysts still expecting double-digit profit growth in the second half of the year, and still no concrete signs of a full-fledged economic recovery, the likelihood of the rally fizzling is high. “It’s unlikely the market can sustain the type of run it’s on,” Belski says. “The major upside move is over,” at least for now.There are other bugaboos lurking that could short-circuit the rally. One big potential negative is if the economy falls into a deflationary spiral. On Tuesday, the Federal Reserve said they could not rule that out, although they say the risk remains small. Deflation is a profit killer. “In a deflationary cycle,” says Al Schwartz, an analyst at Schaeffer’s Investment Research, “businesses have no pricing power, (and) consumers are hesitant to spend because they know prices will be cheaper tomorrow.” The result is that companies fail to hire workers, setting in motion a painful economic spiral. Burdensome debt loads become too much for people to handle, so they sell assets such as stocks and real estate to meet the payments. That, in turn, causes a tumble in prices of stocks, bonds, real estate and other assets.

Hochberg of Elliott Wave also says this is just another bear market rally. He won’t deny it’s been a good rally the past few weeks. But the key words are “has been,” he notes. His firm has studied every financial mania, from the tulip bulb craze in the 1600s to the 1929 U.S. stock crash to the Japanese implosion that began in the late 1980s. The key finding: “All manias have one thing in common: They all slide back below their starting point.” If the 1990s tech bubble follows the same pattern, there is more pain ahead.

John Bollinger of Bollinger Capital Management calls this “the giant sideways.” If that is the case, investors who want to make money must get out of stocks during rallies and get back in during slumps.

We should point out that USA Today also presented the bullish case for their readers in 2003. Despite the bearish commentary and analysis above, the market did not go down, nor did it go sideways; it went up further than most could have imagined in May of 2003.

Fundamental and Technical Alignment

In 2009, the market is sending numerous bullish signals that compare favorably with the end of a bear market and the beginning of a new bull market. The market is recognizing that earnings have been coming in well above expectations. Numerous economic data sets are pointing to the real possibility of positive GDP numbers later this year or early next year. Currently, the market is clearly supporting the bulls in terms of their fundamental arguments, which include some evidence of a bottoming process in housing, stabilization in unemployment, and some improvement in the earnings outlook. As long as the bullish signals remain in place, it is prudent to pay attention to them. If the market deteriorates and the signals migrate back to a bearish stance, we must be open-minded enough to accept the possibility of the return of the bear.

With Its Economy Ignited By Stimulus Spending, China Is Leading The Global Recovery

With Its Economy Ignited By Stimulus Spending, China Is Leading The Global Recovery