Scary Days

The stock market has pulled back sharply over the past few weeks.  Wild up and down trading signals a major division of opinion among investors.  Chances are both sides are right.  The next few weeks is anybody's guess.  But looking a little farther out, where fundamental variables will be able to exert their gravitational pull on stock prices, the picture seems clearer. 

Benjamin Bernanke and most mainstream economists remain way off the mark.  Conventional theories haven't begun to explain what's taken place since 2006 and there's no reason to listen to them now.  The conventional analysis predicts 3%-4% GDP growth in the U.S. over the last six months of 2011 with further gains next year.  That's not going to happen.  But a major disaster isn't in the cards, either.

The European Central Bank is well positioned to prevent a financial meltdown.  Its bond buying and other support measures will impact economic growth, because the price the Bank is extracting is austerity measures.  If Italy, Spain, Ireland, and the others don't achieve the milestones the Bank has set out as a condition for its support, the support will be withdrawn.  So there's a high likelihood of compliance.  But that will bring down economic activity in the short run.  Japan isn't bouncing back in a big way from the earthquakes, either.  So that's not going to pick up the slack.  And while China has maintained momentum to date it's exports are bound to moderate, which could put the brakes on its import growth as well.

In the United States a downturn began in Q1.  Bernanke and crew didn't anticipate that and now say a rebound will emerge in Q3.  In truth, even slower growth is on the horizon.  The budget deficit negotiations are likely to keep a lid on fiscal stimulus.  And the Federal Reserve is out of ammunition when it comes to monetary tricks.  By the first quarter of 2012 GDP growth could slip all the way to zero, sending unemployment up to 10%.  West Texas oil prices could drop another $15 a barrel to $70.  Personal income could flat line.  Corporate earnings probably will contract despite the management heroics which have kept performance intact so far in the recovery.

A decline to 10,000 on the Dow Jones Industrials is possible.  The average might not go that low, considering the cash and other balance sheet assets that are in place.  But investors should be willing to ride out a move to those levels if they want to stay in the game at this point.  The high potential growth stocks we focus on in Growth Stock Insider might be dragged down with the pack.  But their earnings power is likely to continue rising while much of Corporate America slows down, creating even greater investment opportunity.

Downside risk appears manageable at current market levels.  The payoff for staying in the market could come in 2012.  The economy itself probably will take some time to really get rolling.  But there appears to be an excellent chance that lower corporate tax rates will be one result of the deficit commission.  That could be the rocket fuel the economy and market needs.  Once things start moving in a positive direction, moreover, consumer spending should pick up with the lower gasoline prices, cheap interest rates, and a pile of pent-up demand.  Corporate cash reserves will go to work.  A repatriation scheme could amplify capital spending by allowing companies to bring foreign earnings home at little or no tax liability.  And by then it's possible the housing market may start to clear in much of the country, boosting mobility and freeing up a lot of skilled workers who today are stuck where they are.

External factors could disrupt the rebound.  Global warning is getting worse and could cause unpredictable disasters.  Seismic experts are bracing for a major earthquake along the U.S. West Coast.  A war in the Middle East could start, not necessarily including Israel.  Putting that stuff aside, a fantastic buying opportunity could be in the making.  If you want to try and time the market, go ahead.  But it's tough to buy when the headlines scream trouble.  It's never as easy as it sounds.

Our advice is to remain invested in the type of high performance growth stocks we highlight in Growth Stock Insider.  Plan to start using the cash reserve we built up in the spring.  Valuations already are reasonable.  The long term outlook is tremendous.  The rate of return on technology already is improving and could skyrocket over the next decade.  Most investors today are afraid of the future, and stock prices reflect that.  It would be great time to be an optimist even if prices were high.  Things are going to be great.  The fact you can buy that future at a discount, well, can't beat that with a stick.

Walter Ramsley
Executive Editor

 

Lower Corporate Tax Rates

Former President Bill Clinton approved the idea of reducing corporate tax rates to 25% in a televised interview last week.  That cut would be offset by the elimination of special interest tax deductions, leaving the immediate impact on Government revenues unchanged.  The measure actually might be enacted as part of the debt ceiling negotiations that currently are underway.  The deal could be structured so that both political parties could claim victory.  The American economy probably would benefit, too, by the more transparent and equitable system, and the lower marginal tax rate. 

Growth companies promise to be the biggest winners.  Most fast growing corporations pay cash taxes equal to the posted rate.  Larger, slower growing operations typically are the prime beneficiaries of tax dodging maneuvers.  The way things are set up now the Government effectively is draining cash from companies that earn the highest rates of return and subsidizing those with the lowest. 

The new approach, if enacted, would start to reverse that.  It also could provide a stock market jolt to the types of fast growing companies we focus on in Growth Stock Insider.  Earnings could rise 15% right off the bat due to the lower tax rate.  The availability of more cash to re-invest also could accelerate future income gains, perhaps causing P/E multiples to widen.

It remains to be seen if a deal will be made.  Things seem to be moving in that direction, though.  The overall stock market could gain as a result.  Growth stocks have the potential to make the largest moves.

Walter Ramsley
Executive Editor

Tinkle Down Economics

The United States economy reduced speed in the March quarter.  That was unexpected because the Federal Reserve was in the middle of a gigantic money printing operation ("Quantitative Easing - Part Two") which should have drawn idle resources back into productive use.  It also marked the culmination of two years of fiscal stimulus that drove the Federal budget deficit to $1.6 trillion, an unprecedented 11% of the nation's GDP.  Together those moves should have led to an acceleration in real growth, on the order of 4%-6%.  In reality the Q1 figure came in at 1.8%.  And a full percentage point of that was an inventory build-up that counts in the statistics, but didn't happen on purpose.  GDP growth might be impacted in Q2 as inventories are worked back down to normal levels.

The international economy is cooling off, too.  Benjamin Bernanke's money creation project wound up flooding Communist China with more cash than it could use, despite the fact it was growing at a 10% rate when the program started.  That amplified the Middle Kingdom's inflation rate, which already was climbing due to a free for all real estate market and rapid industrialization.  Interest rates and reserve requirements went up, putting pressure on a lot of marginal borrowers.  The United Kingdom also implemented tighter policies to get its house in order.  The European Union slowed down, as well, due to its uncertain debt situation.

The game plan should have been for the United States to take the lead at this stage.  The rest of the world was due for a breather.  It should be drafting off our recovery.  The stimulus spending and money printing of the past two years should be kicking in, boosting incomes, lifting employment, and driving down the budget deficit.  Regrettably, the Obama Administration squandered its opportunity.  Little of the pump priming cash was invested productively.  Instead of laying a foundation capable of generating recurring revenue and income growth most of the spending went into one shot bailouts, or just completely down the drain.  The Administration is laying the blame on bad weather, temporary inflation spikes, Japan's earthquake, and whatever other special factors it can think of.  Experienced investors know those excuses always are smokescreens for more serious problems.  A downturn is underway.  It remains to be seen if it will affect the stock market.  But a cautious approach is warranted under the circumstances.

Our nickname for the Obama Administration's economic policy is "Tinkle Down Economics."  The U.S. Treasury and the Federal Reserve Board have flooded the capital markets with fresh money, paying face value with cash for securities.  Billions of those securities were impaired, moreover, so the sellers got a huge bailout in the process.  Additional bailouts supported various public and private unions, state and local governments, and huge companies dangling on the edge of bankruptcy.  None of that money went into venture capital, private equity, new business formation, incentives to help genuine growth companies expand faster, or anything that might have generated a high rate of return.  There was lots of big talk about "shovel ready" construction projects.  But in the end few of those got off the ground.  A variety of one size fits all housing market initiatives were implemented.  They didn't work because real estate is a series of local markets, all of which are unique.  The Administration could have spent resources going zip code to zip code in 2009 to stabilize housing, to get the problem under control.  Instead it redesigned the medical industry, boosting its share of GDP to 18% from 16% before.  (Europe has healthier people and pays 9%-12%).

Prices are rising faster than incomes.  All that new money has sent the Consumer Price Index up by 6% since January 2009.  Unfortunately for the average American, it hasn't helped wages.  Incomes are up just 1%.  The standard of living has declined by 5% as a result.  Unemployment still stands at 9.0% compared to 8.2%  when the administration took over.  The CPI hit 4.0% in Q1 (annual rate).  That measure may trend higher in upcoming periods.  No turnaround is on the horizon.

All that liquidity could keep the stock market afloat.  Business conditions won't be as vibrant as they should be.  And marginal companies no doubt will encounter problems, either diminished demand or rising costs.  But a wholesale decline in share prices isn't certain.  Our advice is to remain invested in a diversified portfolio of Special Situation stocks, with a cash reserve to take advantage of future opportunities.  The political scene may be a different story.  It will be interesting to see how long today's 20-30 year olds will accept having their aspirations thwarted.  For that matter, we'll see how long the 50-60 year olds being laid off every day put up with it, either.  At least with Ronald Reagan's "Trickle Down Economics" the rising tide lifted all boats.  With "Tinkle Down" the only things we're getting are higher prices, anxiety, and disillusionment.

Walter Ramsley
Executive Editor

Further Gains Possible

The U.S. stock market has advanced sharply since September 15, 2010, the day we began publishing Growth Stock Insider.  Back then economists were engaged in a lively debate; one side arguing the country was headed into a double dip recession, the other saying it wouldn't be quite that bad.  The experts also predicted doomsday scenarios in Europe, slowdowns in China and Brazil, and an onslaught of tariffs and protectionist measures.  Equity analysts on Wall Street dialed back their earnings and sales estimates to reflect the "New Normal."  Then, people started to realize it wasn't the end of the world after all.  Business was moving along, despite what the computer models said.  Third quarter financial results came in ahead of consensus expectations.  Corporate executives couched their forecasts to acknowledge the academic concerns, and the negative reporting in the media.  But the guidance they issued was positive, often better than the market anticipated.  Interest rates remained low, moreover, and the Government picked up the pace of its money printing operation, pouring liquidity directly into the capital markets with its Quantitative Easing II program.  The supply and demand for stocks almost had to tilt to the bullish side as the Government removed existing securities from circulation and replaced them with hot money.

The Dow Jones Industrials are up 17%.  The S&P 500 has climbed 19%; the Nasdaq Composite, 23%; and the small cap Russell 2000 has led the way, advancing a remarkable 28%.  The Nasdaq and the Russell have regained everything they lost since the last market peak in 2007.  The big cap indexes still have a ways to go.  The stocks that we've presented in Growth Stock Insider have appreciated by an even greater amount.  Assuming an equal Dollar amount was invested in each security, the group's performance is up by almost 50%.  And our average holding period is more like three months than five, since we wrote up the stocks as we went along.

The stock market is in an uptrend and could keep rising for an extended period.  The interest rate and liquidity dynamics remain unusually positive.  Business fundamentals continue to be robust.  And while investor enthusiasm for equities has improved, skepticism still abounds.  Confidence in the future remains a scarce commodity.   And rightfully so, when you get right down to it.  Money printing and borrowing isn't a sustainable strategy.  The flow of funds inevitably will reverse course, exerting pressure on stock prices.  There are bound to be some downs along with the ups in the future.  It needn't be a disaster.  But when the big picture turns south the general market averages are bound to be affected.  That's why we focus on small fast growing Special Situations that can produce exceptional results under all kinds of economic conditions.  Our advice is to stay invested in a diversified portfolio of emerging growth companies and not worry about the general market.

Walter Ramsley
Executive Editor

Welcome to Growth Stock Insider

            “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”  (Charles Dickens, A Tale of Two Cities)

     Once again, the world is in transition.  And when things are changing, there’s money to be made.  Here at Growth Stock Insider our focus is on small up-and-coming growth companies that can take advantage of today’s opportunities.  The past decade has been a grind in the United States, and elsewhere.  In general, incomes haven’t expanded much because capital has been diverted overseas to low-cost economies, especially Communist China.  Financial engineering and the housing industry consumed much of the rest.  New American companies were starved for money as a result, crushing the venture capital and IPO markets.

            Despite the rough environment a number of American companies survived and prospered.  They’ve invented new products, boosted productivity, lowered costs, and built thriving industries that still have a long way to go.  The bad economy of the past few years has limited the amount of competition they face, moreover.  Now that things are picking up again, those Growth Companies are in prime position to cash in.  Another batch of high potential businesses has emerged in Israel, fueled by more conducive government policies that encourage companies to expand.  And even in places like China there are some innovative outfits that can compete on the world stage without the protectionism and other crooked deals that are common to that nation.

            Growth Stock Insider is here to tell those stories.  For these growth companies, it truly is the best of times.  There’s a huge need for productivity if living standards are to improve.  Most of these companies have well established track records.  Those with shorter histories typically offer even greater appreciation potential.  Overall equity prices remain low following the Bernanke 2008 Crash.  (The Fed Chairman was on the job for two and a half years before things fell apart.)  So while much of the world is struggling with unemployment, trade deficits, budget deficits, and a host of additional problems that current economic theory can’t explain or rectify – these companies are sprinting ahead.

            It’s an incredible opportunity.  Don’t worry about the overall market.  Stay invested in a diversified portfolio of fast growing high potential emerging growth stocks.

Walter Ramsley

Executive Editor