Everything You Need to Know about Insider Trading

by Insider Alert Research Team

Insider trading.

You might have heard the term back in 2011 when Peter Schweizer’s book, “Throw Them All Out,” first caught the attention of 60 Minutes and quickly ignited a firestorm of controversy.

In “Throw Them All Out,” Schweizer detailed numerous examples of congressional corruption, including our lawmakers’ habit of legislating themselves exclusive loopholes to profit off of the rules and regulations they shackle the rest of us with. That includes insider trading.

Let me explain…

Insider trading, at its very basic, is when somebody with special knowledge about a company decides to either buy or sell shares or security of said company. Usually this is somebody high up on the corporate ladder but, as Briefing Investor explains it, it can also include “officers and directors of companies, owners of restricted stock, and owners of more than 10% of a company’s stock.”

What’s wrong with that, you might ask?

Well, that’s where things start to get a bit more complicated.

You see, when the stock market crashed in 1929, setting off the Great Depression, a lot of blame started flying around pretty quickly as blame usually does. And while the government was in part responsible for the mess and definitely for the ensuing chaos, it didn’t want to acknowledge that blatant fact.

So, for better or worse, it began meddling in the private sector more than it already had been.

In 1934, Congress passed the Securities Exchange Act, which was promptly signed by President Franklin Delanor Roosevelt. Arguably the first of its kind – at least on the federal level – it placed strict controls on publicly traded companies with the stated intention of evening the playing field against the “fat cats” on Wall Street and in favor of main street.

Among the long list of regulations the Securities Exchange Act outlawed were:

• Using any “device, scheme, or artifice to defraud,” investors, essentially requiring companies to list all relevant information about their businesses, profits, etc. or, as Cornell University Law School explains it, anything “that investors would think was important to their decision to buy or sell the stock”
• Manipulating the market to suggest that stocks are worth more than they actually are
• Employee purchases or sales of ownership in a company without first making the public aware of the transaction, also known as insider trading

Altogether, the Act was supposed to force companies to behave more ethically and investors to act more intelligently, with the combined result of keeping the markets from crashing again. The same was true for the Sarbanes-Oxley Act of 2002, which demanded even more transparency from businesses, adding additional paperwork for them to fill out and information they had to release.

Obviously, neither have prevented very much, as evidenced by the multiple stock market crashes and recessions 1934, corporate scandals such as Enron, WorldCom and Satyam, as well as the government-connected Fannie Mae and Freddie Mac, corporate crooks such as Bernie Madoff and Jon Corzine, and Raj Rajaratnam and the other 55 people who have been charged with insider trading since 2009.

And those are just the ones who get caught!

That also isn’t to mention that company’s are really quite clever about following the letter of the law rather than the spirit much of the time. (Though it’s hard to blame them sometimes when they have to follow so many of said laws.)

As Cornell University explains:

Section 9 of the 1934 Securities Exchange Act “addresses manipulation of the stock market by traders… However, modern market manipulation is accomplished through methods that are more subtle and harder to detect… [partially because] investors must prove that the price was actually affected by the manipulation, and that the defendant acted willfully. Proving damages also involves proving the actual value, since successful claimants may recover the difference between the actual value and the price they paid.”

And the same can be said of many other aspects of insider trading law, as discussed further on.

Their Insider Pain Can Be Your Outsider Gain

Regardless of whether either the Securities Exchange Act of 1934 or the Sarbanes Oxley Act of 2002 were right or wrong, helpful or harmful, effective or ineffective, or even selfishly or selflessly motivated, they are the reality that the publicly-traded business world has to operate under in the United States.

As the aforementioned “Throw Them All Out” by Peter Schweizer pointed out, Congress doesn’t have to abide by any such rules since they loopholed themselves right out of any such responsibility or accountability, but that’s another topic for another article.

In the meantime, average investors can get ahead of the game if they only have the know-how and commitment to utilize their resources properly. (For anybody who doesn’t have the time or inclination to not only look into the following resources but follow them up and research the company as well, consider Alex Green’s Insider Alert, which does all of that work for you. For more information about the Oxford Club service, click here.)

Unless you want to get into the world of shorting stocks, forget paying that much attention to when insiders are selling. Partially that’s because there are at least a dozen good reasons for company employers or head honchos to sell what they have. And most of them are personal, having nothing to do with the company’s short-term, mid-term or long-term growth.

The chief financial officer might have a daughter going off to college, the CEO might be buying a new house, or the vice president’s young son might require a costly medical treatment. And an easy way for any of them to get the finances necessary for any of those purchases is by selling off some of their shares.

Now, if the CFO, CEO and VP are all selling at the same time, that’s reason to think twice about investing in the company. But if it’s just one or even two corporate insiders offloading some shares, more than likely, it isn’t in any danger of becoming the next Lehman Brothers.

On the other hand, there is only one reason that insiders buy, and that is that they expect their company to do well in the near future. And, let’s face it: Out of all of the analysts, investors and industry experts who like to spout their opinions at every opportunity, it’s the insiders who should know the best how their company is really doing and what it is really capable of accomplishing.

Back in 2009, Alexander Green, who edits the Insider Alert, wrote how, in 2008, he discovered that:

“David Abrams, a Director of Crown Castle International made the single-largest insider purchase in the nation. He bought 4.5 million shares at a cost of more than $60 million.

“Based in Houston, Crown Castle leases cell towers and antenna space to wireless communications companies. Most of these are in the United States, although more than 1,400 are in Australia.

• The company has more than 24,000 towers in prime markets and is actively building more to lease.
• Recent earnings, released earlier in the month, contained a few surprises.
• While earnings were in the red, revenue was still growing at 9%. And I noticed that site rental revenue, gross margins and recurring cash flow all exceeded expectations.
• Moreover, the company had lost three-quarters of its market value and was selling below book value.”

Triggered by the SEC filings that Abrams legally had to file within two days of his purchase, Alex was able to identify it as a potential growth stock worth targeting. But he didn’t stop there, taking the additional necessary step of researching the company from what it did to how and how well it did it.

Then he recommended Crown Castle International to his Insider Alert subscribers and he watched it.

Of course, the markets weren’t behaving well in 2008. At all. Yet two months later, the stock had shot up 58%. And Alex was able to lead subscribers to that significant short-term gain all because he was paying attention to what the insiders were doing.

Insider Activity Isn’t So Easy to Find

As previously mentioned, while insider trading can prove extremely lucrative, it isn’t always the easiest task to interpret or even find.

For starters, the SEC – in typical governmental fashion – doesn’t just have one generic form for insiders to fill out whenever they’re making a transaction. They have multiple ones, including:

• Form 3 filings, which officially record how much an insider owns
• Form 4 filings, which officially record any changes to what an insider owns
• Form 5 filings, which basically sum up everything recorded in Form 4 filings for the year
• Form 13D filings, which have to be filled out as soon as a shareholder owns 5% or more of a company’s shares or securities
• Form 144 filings, which officially record the POSSIBLE sale of what an insider owns (No sale actually has to be made, so someone like a CEO can just keep filing Form 144s every 90 days just in case he does want to someday sell something.)

Starting to get the picture?

And it gets even more complicated than that…

As Briefing Investor says: “Unfortunately, even if you could access all insider filings electronically as an Internet investor [which you can’t, considering that much of the data doesn’t ever have to make it onto the internet or any traditional news source either], the time requirements on these forms does not always prove helpful. Form 144s must be filed in advance of the actual sale, but it may be done as early as the morning of the sale.”

In other words: not helpful at all. The same goes for Form 4 filings, which are submitted to the SEC after any changes are made, not before or even during.

Any savvy businessperson or anybody with access to a decent legal advisor can easily get around the rules and regulations – though not the paperwork – to profit just about as nicely as he or she would if the government didn’t meddle as much as it does.

Clearly, researching insider trading with the intent of capitalizing on it can easily become a complicated and unhelpful mess for anybody who doesn’t know exactly what they’re doing or at least knows somebody who does.

But for those who can successfully navigate the complicated, convoluted world of insider trading, there’s major money to be had.

The Great Minds of the Market: Charles Dow

The Great Minds of the Market:
Charles Dow

by Alexander Green, Investment U Chief Investment Strategist
Monday, January 23, 2012: Issue #1692

This week I’m beginning a series about the great men and women – often unknown – who shaped the modern investment landscape.

Why should you care about these individuals, especially since many of them are dead? Because Sir Francis Bacon was right: Knowledge is power. This is especially true in the financial markets. And, as you’re about to learn, the type of knowledge you accumulate is likely to be a primary determinant of your success as an investor.

So let’s kick things off today with a man whose name is legendary on Wall Street:

Charles Dow.

Dow is a significant figure in the annals of financial history for two reasons. He created the first financial bible, The Wall Street Journal, and the first market barometer, the Dow Jones Industrial Average. In doing so, he revolutionized the way we talk about the financial markets.

(By the way, Charles Dow is sometimes credited with creating Dow Theory, too. This is not so. The market-timing strategy was extracted fom his WSJ editorials 20 years after his death by a market technician named William P. Hamilton.)

Charles Dow founded Dow Jones and Company with a partner in New York in 1882. At the time, most financial data was simply outdated news and unreliable gossip. But Dow Jones and Company published daily financial updates in a two-page newspaper called the Customers’ Afternoon Letter – The Wall Street Journal’s predecessor.

It was in the Letter that Dow first published his average, initially comprised of 14 companies – 12 railroads and two industrials.

Today the Dow consists of 30 large companies meant to reflect the U.S. economy. (There are, however, few holdings in heavy industry – and no railroads!) The average, price-weighted to compensate for stock splits and other adjustments, is the most closely watched benchmark for tracking stock market activity.

Yet the Dow is actually a poor representation of the broad market. If you’re looking to capture its performance, you’re much better off owning the better-diversified S&P 500 (NYSE: SPY) or the Wilshire 5000 (NYSE: TMW).

The most important thing we can learn from Charles Dow is the primacy of financial information. More than a hundred years ago, he realized that it was essential for investors to have not just opinions, rumors and forecasts, but verifiable facts. You simply must be well informed and up-to-date beyond this week’s headlines.

I’ve known investors who will buy a stock and not keep abreast of how the company is performing relative to its competitors, the direction of sales, or even the growth in profits. This is an act of faith, not rational investing.

Charles Dow created a daily business publication to give investors essential facts. Today, of course, you can get your financial news in real time off the internet. But the important data isn’t today’s government statistics or a new pronouncement by Ben Bernanke, but rather the hard numbers that tell us how individual businesses are performing.

The kind of investment news you accumulate is crucial. Listen to economic analysts, for example, and you’ll hear gloom and doom about high unemployment, the housing slump, consumer confidence, or problems in the Eurozone.

Listen to market analysts and you’ll hear trivia about short-term trends, changes in volume, support and resistance levels, and so on. This is not the type of information that will not make you rich.

But listen to business analysts today and you’ll hear plenty about corporate innovations, new medicines and technologies, and, not incidentally, all-time record corporate profits.

Is it any great surprise that investors who follow business news are making a lot of money in this market and those who listen to economic and market forecasts are sitting on their hands and earning miniscule returns?

Charles Dow knew better. And you should, too.

Good Investing,

Alexander Green

Why Most of the Investment Advice You’ve Heard is Wrong

Why Most of the Investment Advice You’ve Heard is Wrong

by Alexander Green, Investment U Chief Investment Strategist
Friday, January 20, 2012: Issue #1691

A conversation with a friend last week sounded numbingly familiar.

“I just can’t seem to win for losing in the stock market,” he confessed. “Five years ago, my broker had me fully invested in stocks and I took a drubbing. Then when things were bottoming out a couple years later, he talked me into making my portfolio more conservative. As a result, I didn’t get much of a pop on the rebound. Now he’s trying to get me to reshuffle again. But I’m too scared to do anything.”

Since he was a friend, I felt obliged to tell him the truth: He’s getting lousy investment advice. Not because his broker failed to outguess the market… but because he’s guessing at all. As if that wasn’t bad enough, there’s a good chance that the advice he’s getting is tainted by self-interest.

Here’s what I mean…

It still astonishes me that the vast majority of investors – even ones who have been active for decades – still don’t understand that stock market success has nothing to do with figuring out the economy.

Look back at history. There’s no correlation between economic growth and stock market performance from year to year. Equities routinely plunge during the good times and rally during the bad. If you know this – and truly understand it – why would you invest your money based on someone’s economic forecast?

The same is true of market timing. It’s easy to look in the rearview mirror and see when you should have been in the market and when you should have been out. But when you look ahead, it is always a blank slate. No guru or trading system can change that.

Even if you could somehow divine what the stock market was going to do next – which you can’t – you still wouldn’t know which stocks would outperform and which ones would lag.

The only way to determine that is to look at business fundamentals. Companies that are doing all the right things – increasing sales, compounding earnings at high rates, growing market share, improving operating margins, paying down debt, buying back shares – will post superb returns, regardless of what the economy or stock market are doing. And those that are doing the opposite – experiencing flat or negative sales, lackluster earnings growth, small margins, high interest costs and diluting existing shareholders with new stock issues – will be laggards.

In short, stock market success is about analyzing businesses not investing in some self-styled expert’s macroeconomic forecast. Yet that’s exactly what the mass media and much of the investment advisory industry encourages people to do every day.

The media does it to attract viewers – and thus advertisers. The advisory industry does it sometimes out of ignorance but often just to justify its fees. This is especially true when you have a transaction-based relationship with an advisor where the more you trade the better he or she is compensated. Trust me. That doesn’t generate satisfactory long-term returns.

Every time you hear a pundit talk about “the new normal,” the rally just ahead or the prolonged economic slump we’re likely to endure, understand that you’re listening to opinions that are no more helpful than a weather forecast for three weeks from Sunday.

Both pieces of advice are worthless. But one is a lot more expensive – and harmful – than the other.

Good Investing,

Alexander Green

The Best Buy Signal of 2012

The Best Buy Signal of 2012

by Alexander Green, Investment U Chief Investment Strategist
Monday, January 02, 2012: Issue #1677

Investors are scared right now and it’s not hard to see why.

Economic growth is anemic. Unemployment is high. Banks are saddled with toxic assets. Problems in the Eurozone continue to fester. Residential real estate is sinking in a mire of short sales and foreclosures. And both federal and state governments – not to mention consumers themselves – are drowning in a sea of red ink.

We have all heard these negatives repeated daily and cycled endlessly in the national media.

However, these reports often leave out or play down the good news: Inflation is low. Short-term rates are near zero. Energy and food prices are declining. Emerging market economies – which are end markets for the developed world – are still booming. Corporate profits are at an all-time record – and have been for seven quarters now. And stock valuations are low. (The S&P 500 has historically traded at an average of 16 times earnings. Today it’s less than 14 times earnings.)

Last year I shared another key insight with you. It has always been a positive indicator for stocks when the Dow yields more than Treasury bonds.

This makes sense when you think about it. Shares are riskier than bonds. Investors should demand a higher yield. Yet almost never since 1958 have stocks yielded more than Treasuries. Today they do, however. The 10-year bond yields just two percent. The Dow yields 30 percent more.

If you’re still not convinced that equities are a good place to be in 2012, let me draw your attention to one of the strongest indicators of all…

Contrarian Investing Works

It’s a truism that no one consistently predicts the stock market. (That’s why money manager and Forbes 400 member Ken Fisher calls it “The Great Humiliator.”) However, there’s a straightforward system that offers a reasonable prospect of timing the market reasonably well in the future.

A 25-year study published last year in The Journal of Financial Economics found that if you had simply invested in the S&P 500 when equity fund flows were negative (redemptions exceeded new investments) and into 90-day Treasury bills when fund flows were positive (new investments exceeded redemptions) you would have substantially outperformed the market while spending nearly half the time in riskless T-bills.

In other words, contrarian investing works. This system would have you do the very inverse of what the great mass of investors is doing. (It turns out they have god-awful instincts, so it pays to buck the consensus.)

Bear in mind, if you’d followed this system, you wouldn’t just have earned higher returns than being fully invested. You would have done it with far less risk, spending nearly half the time in riskless T-bills.

I mention this because the Investment Company Institute recently reported that investors are yanking billions out of equity funds virtually every week and pouring the money into ultra-low-paying money market accounts. The Wall Street Journal further reports that “investors have continued to consistently pull money from U.S. equity funds since August.”

I’m trying to contain my glee. Who says no one rings a bell in the stock market?

The fear and pessimism about both the economy and the stock market are way overdone and fully discounted in current stock prices. If you can’t be stirred by low interest rates, low inflation, low valuations and record profits, you really should ask yourself two important questions:

1. Is logic or emotion governing my decision making about my portfolio?

2. If I don’t invest in stocks – the greatest wealth creator of all time – how am I going to meet my long-term financial goals?

We’ll talk more about these issues in the weeks ahead. But, for the record, I think 2012 will be a good year for the stock market and – although virtually no one expects or believes it – perhaps even a barnburner.

Good Investing,

Alexander Green

Why This Market Truism Just Isn’t True

Why This Market Truism Just Isn’t True

by Alexander Green, Investment U Chief Investment Strategist
Monday, December 5, 2011: Issue #1657

In my first book, The Gone Fishin’ Portfolio, I made a confession that startled some readers…

I retired from the investment services industry while I was still in my early 40s, but many of my clients had not become financially independent. This was not because I advised them poorly. I dealt with my clients honestly and gave them the best advice and service I could.

Yet, in many ways, they operated at a disadvantage. Some had a poor understanding of investment fundamentals. Others found it impossible to commit to a long-term investment plan. Many were simply too emotional about the markets, running to cash at the first hint of danger.

Contrarian instincts are rare, too, I learned. Few people are emotionally stirred by low stock prices. But every time there was a correction, a crash, or financial panic, my Scottish blood would surge, my pulse would rise, I’d rub my hands together, and start buying.

My clients, on the other hand, often did just the opposite, sometimes because they were too nervous but often because they bought into the old chestnut that a good investor doesn’t buy into a market downturn.

“The trend is your friend,” they’d say. Or “Don’t try to catch a falling knife.” This is surely the conventional wisdom in some quarters, but it’s not particularly wise. Here’s why …

For the last several months, traders have obsessed over problems in the Eurozone and the strength (or perceived weakness) of the U.S. economy. Taking a decidedly downbeat view, the market had a pretty horrendous November. But sentiment can turn on a dime and stocks can put on a furious – and completely unexpected – rally.

If you don’t already own stocks, it’s tough to catch the train after it has left the station.

Yet many gurus, including growth-stock advocate William O’Neill and his widely read publication Investor’s Business Daily, often insist that you shouldn’t but a stock unless the market itself is in a confirmed uptrend.

That may make sense in theory, but it often fails in practice. For instance, on page one each day, that paper reports whether the market is in a confirmed uptrend or downtrend. (And sometimes hedges, using language such as “Uptrend Under Pressure.”)

As we all know, this has been a volatile year for the market with the major indices bouncing up and down repeatedly. But you could hardly have chosen a worse strategy than to wait until the market was in a confirmed uptrend before buying. All that meant was that you bought into every short-term spike and then hit your trailing stops over and over again. (It must feel like banging your head against the wall.)

The Oxford Club has hit a number of its stops this year, too, sometimes protecting profits, other times protecting principal. But by buying great companies when the market was under pressure, we ended up with a lot of attractive entry points and plenty of both realized and unrealized profits.

True, if stocks go into a secular bear market, you can end with losses no matter how well you timed your entry points. However, you can never know whether a market drop is merely a correction or something more ominous until you are looking in the rear-view mirror.

You have to stick your neck out occasionally, pick your spots and buy stocks. If you don’t, what are you going to do? Buy bonds yielding 2.5 percent? Hold a money market paying less than one-tenth of one percent? It’s tough to beat inflation or meet your financial goals that way.

Let me make one thing clear, however. It’s most definitely a mistake to buy a troubled company that’s in a downtrend, no matter which way the broad market is heading. (That only works for those with exceptionally long time horizons – and often not even then.) But buying great companies when the broad market is a downtrend gives you a chance to obtain good prices on fine long-term investments and take advantage of tradable short-term rallies, too.

The next two months are traditionally one of the strongest periods for the stock market. No one can say, of course, whether that tradition will hold. But it’s a reasonable strategy to buy great companies when the market is down.

If your goal is to sell high, you have to start by buying low. And market corrections – like the one we’ve seen lately – give you an excellent opportunity to do just that.

Good investing,

Alexander Green

How to Beat “the Mania of Pessimism”

How to Beat “the Mania of Pessimism”

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, September 12, 2011: Issue #1598

Two weeks ago, I opined that the biggest obstacle a stock market investor faces today is “headline risk.”

That is, relentless media negativity.

The idea seems to be gaining traction. On last week’s “This Week” on ABC, Pulitzer Prize-winning columnist George Will said, “The very least the media should do right now is not detract from the nation’s understanding or add to the synthetic hysteria.”

In the September 17 USA Today, James Paulson, Chief Investment Strategist at Wells Capital Management, said, “We are in the middle of a mania of pessimism. The nation is suffering from “Armageddon hypochondria.”

Again and again, the media reminds us about the weak dollar, high unemployment, the soft housing market, problems in the Euro Zone, political dysfunction in Washington, trouble in the banking sector, and the down-and-out consumer. After a few hours of this, you’d expect to walk outside and see bread lines and angry mobs.

That’s not what you see, however. What you see instead are ordinary people going about their everyday business – and getting bombed periodically with media sensationalism calculated to attract viewers and sell advertising.

It works, too. In fact, it works so well that few people see all the positives that exist today.

“Positives?” a friend asked me the other day, genuinely perplexed.  “What positives?”

Exactly. We’ve gotten to the point where people have had so much downbeat news dripped on them for so long that they can’t even imagine there is a positive side to recent events or that any logical case can be made for owning stocks to meet their financial goals.

So let me take a stab at it now.

For starters, realize that it is not possible for anyone to accurately and consistently predict economic growth or stock market performance. But here’s an insight you can take to the bank: Share prices follow earnings. (Earnings, of course, are the net profits of a business.)

In the third quarter of last year, the companies that make up the S&P 500 reported all-time record earnings. In the fourth quarter, those record earnings were exceeded, as they were again in the first quarter of this year… and yet again in the recently reported second quarter.

If you didn’t hear that we’re in a period of all-time record corporate profits, you really ought to think twice about who’s delivering your newsworthy information. Or at least who’s providing your investment guidance.

As investment legend Peter Lynch once noted, “People have all this data and yet they look at all the wrong things… It’s about earnings. They need to follow the earnings.”

Of course, just because corporate earnings have hit an all-time record four quarters in a row, it doesn’t mean they will continue. And, conversely, it doesn’t mean that they won’t.

If you can’t imagine why stocks would rally from here, just imagine what will happen if the much ballyhooed double-dip doesn’t appear.

• There are plenty of good reasons to be bullish on stocks right now. But if you’re developing your investment perspective from gloom-and-doom media reports, you may not recognize the positive factors. So I’ll tick off four big ones for you now:

• Interest rates are at historic lows and inflation is negligible. That isn’t likely to change any time soon.

• Energy and food prices are moving lower and Ben Bernanke has pledged to hold short-term rates at zero for two more years.

• Valuations are cheap.  When the S&P 500 traded at these levels eleven years ago, it sold for 44 times earnings. But because profits have hit new records lately, the S&P 500 today sells for just 13 times trailing earnings, well below the long-term average of 16.4.

• Investors are anxious and afraid. This may seem like a negative but it’s not. Investor sentiment is an excellent contrarian indicator, especially when accompanied by low valuations. Think back to the market low of March 2008, when the consensus was that the world was coming to an end and the Dow briefly traded below 6,500. From that point the market put on an impressive rally, essentially doubling in two and a half years. As investment pioneer John Templeton rightly said, “Bull markets are born on pessimism, grow on skepticism, peak on optimism and die on euphoria.” Do you know anyone who’s feeling euphoric right now? Not me.

• Mutual fund investors have yanked money out of stocks over the past six weeks. It may seem counter-intuitive but that’s yet another positive. A 25-year study published last year in the Journal of Financial Economics found that if you had simply invested in the S&P 500 when equity fund flows were negative (redemptions exceeded new investments) and into 90-day Treasury bills when fund flows were positive (new investments exceeded redemptions) you would have substantially outperformed the market while spending nearly half the time in riskless T-bills. In other words, it pays to buck the consensus.

Don’t get me wrong. More bad news from the Euro Zone and political wrangling here at home will still push stocks around from day to day. That’s not important. What is important is whether you’re confident – as The Oxford Club is – that the companies you own are set to report dramatically higher profits in the weeks ahead.

You may be reluctant to invest in stocks. I understand. It takes nerve and resolve to go against the trend and invest in times like these. But you should.

FDR was wrong about some things. But he got one big thing right. The only thing you have to fear… is fear itself.

Good investing,

Alexander Green

Will You Fall Prey to “Headline Risk”?

Will You Fall Prey to “Headline Risk”?

by Alexander Green, Investment U Chief Wealth Strategist
Friday, September 2, 2011: Issue #1592

In the last couple of months, millions of investors have done a 180. It happens all the time. And – just as in the past – they will surely come to regret it.

The story is as old as equities themselves. When the market is an uptrend, investors focus on opportunity and considerations of risk go out the window. When the market is in the tank, they focus on risk and forget about opportunity.

This is the very opposite of what you should be doing.

During my 16-year career as an investment advisor and portfolio manager, I used to show new clients a 200-year chart of the stock market and ask them to identify the best buying opportunities.

Invariably, they pointed to the periods when the market had cratered.

I asked if they would be willing to step up and take advantage of such opportunities in the future. Most nodded vigorously and assured me that they would.

Few actually did.

Why? Because you can never imagine the news backdrop that will accompany a major stock market decline.

When the market recovered – as it always does – these same investors kick themselves for not scooping up bargains when stocks were cheap. Yet when the market declined again, they would generally react the very same way.

Nothing could be simpler than to say, “buy low, sell high.” But pulling the trigger when times are tough isn’t easy.

How to Avoid Headline Risk

It’s easy to fall prey to “Headline Risk.” Here’s what I mean…

On August 9, national newspaper and television headlines shouted that the Dow had plunged 634 points the previous day. That was not an insubstantial drop. It amounted to a 5.5 percent decline in the index.

Yet few sources reminded investors that the Dow was still up 66 percent (excluding dividends) from the market lows 2 ½ years ago. Or that the drop wasn’t even in the top 50 for largest daily percentage losses.

Similarly, the media made a big deal about the market sell-off the week of August 1 to 5 representing an evaporation of more than $4 trillion in world equity values. That’s a big number. (Unless you’re a Congressman, apparently.) Yet the total value of all stocks worldwide is approximately $55 trillion. And, for the overwhelming majority of investors, these were temporary paper losses.

Where was the context? There wasn’t any. The media needs sensationalism to grab viewers’ attention. Newspapers, magazines and television shows aren’t interested in helping you reach your financial goals. They’re interested in helping their marketing departments sell advertising. Sensationalism does just that.

Understand this and you can inoculate yourself against “Headline Risk.” Scary headlines create strong emotions. But strong emotions are usually the prelude to bad investment decisions.

Flee common stocks – the greatest wealth creator of all time – and where will you go? Into 10-year Treasuries yielding 2 percent? Into money market accounts paying next to nothing? Into gold which has already risen six-fold in the past 10 years? Into residential real estate which is mired in a sea of foreclosures?

High quality stocks are still your best bet to meet your long-term financial goals. National headlines are screaming just the opposite, of course, just as they have during every major buying opportunity of the past 75 years.

The truth is your greatest risk is not market fluctuations. It’s that your money fails to keep up with inflation – or that your investment portfolio kicks the bucket before you do.

Consider that before extravagant headlines prompt you to do something foolish.

Good investing,

Alexander Green

The Best Buy Signal in 53 Years

The Best Buy Signal in 53 Years

by Alexander Green, Investment U’s Chief Investment Strategist
Thursday, August 25, 2011: Issue #1586

Just weeks before the stock market made a dramatic bottom in early 2009, I wrote an Investment U column entitled “One of The Best Buy Signals in 51 Years.”

It was one of our most widely read columns that year – and syndicated many other places, as well.

I have no idea how many readers acted on my analysis at the time. After all, the financial crisis was in full swing and investor sentiment – to quote Jed Clampett – “was lower than a hog’s jaw on market day.”

But those who bought stocks on this signal made gobs of money in the months that followed. After all, the market essentially doubled between the lows of 2009 to the highs earlier this year.

Now – for only the second time in 53 years – this uncanny signal is flashing again. Here’s what it is and why you should take advantage of one of the best and most accurate signals in stock market history…

Market Yields: Stock vs. U.S. Treasuries

In the first half of the twentieth century, investors found that if you bought stocks only when the market’s yield exceeded the yield on 10-year Treasuries, you would have been in for every single major rally.

The returns were huge – and the system made perfect sense. Stocks are riskier than bonds, market participants reasoned, so they should yield more to compensate for greater volatility and the likelihood of occasional losses.

The system worked like a charm until 1958. Then it stopped cold. Why? Because for the next 50 years, stocks never yielded more than Treasuries.

Public companies began using their cash flow to fund operations and acquisitions rather than paying out dividends to shareholders. With stock yields sharply lower, most analysts reasoned that the indicator was dead, that the yield on stocks would never again top bonds.

And, indeed, it took a full blown financial crisis but two and a half years ago to finally happen again. With the luxury of hindsight, we can see that was yet another superb buying opportunity. And today it’s happening yet again thanks to both the tremendous rally in government bonds and the socking that stocks have undergone. For only the second time since 1958, stocks are yielding more than bonds.

Granted, it’s a squeaker. As I write, the 10-year Treasury is yielding 2.07 percent. The S&P 500 yields 2.16 percent. Of course the S&P 500 Index was only created in 1957. It was the Dow that investors used in the first half of the last century. And the yield on the Dow is more than 50 percent higher at 3.24 percent.

History Says… Stocks Are a Terrific Long-Term Buy

If history is any guide, that means stocks are a terrific long-term “Buy” right now and Treasuries – which have become a complete bubble and a table-pounding “Sell” in my estimation – are due for a long period of underperformance.

True, GDP growth is likely to be anemic in the months ahead. But – shocking and surprising most investors – stocks (and especially dividend-paying stocks) should do exceptionally well.

There are no guarantees in the world of stock market investing, of course. But as Patrick Henry famously said, “I know no way of judging the future but by the past.”

Good investing,

Alexander Green

Editor’s Note: So how can you capitalize on the best buy signal in the last 53 years? As Alex said, it’s important to focus on dividend-paying stocks… And the best way to read Alex’s favorite picks and his regular market commentary is to join The Oxford Club…

Is It Different This Time?

Is It Different This Time?

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, August 22, 2011: Issue #1583

Investment legend John Templeton famously said that the biggest mistake an investor can make is to say “this time it’s different.”

In some ways, this statement may seem a little strange.  On the surface, every market correction is different. For example, when the stock market imploded on October 19, 1987, falling over 22 percent in a single session, that was unexpected. After all, no government failed that morning. No currency collapsed. No President was shot. To this day, pundits still argue about why the stock market crashed.

Or how about the bear market of 1990? No one foresaw Saddam Hussein rolling into Kuwait that August, taking over the country and its oil fields. Investors worldwide speculated that the Middle East would go up in flames. (And, indeed, many Kuwaiti oil fields did.) That was certainly different.

Then there was the collapse of hedge fund giant Long-Term Capital in 1998. Fed Chairman Alan Greenspan feared that unwinding the fund’s highly leveraged positions would turn the bond market upside down. He worked behind the scenes to get major Wall Street firms to help bail out the fund. That was something new.

Or how about the March 2000 to October 2002 bear market that started with the collapse of technology and Internet stocks? It was the end of an era, the deflating of a bubble. We hadn’t seen anything like that in modern history.

Or how about 9/11? Who woke up that day suspecting that a group of zealots would fly planes full of people into buildings? Not me.

The mania for residential real estate six years ago was something curious, too. And so was the collapse of sub-prime mortgages. That led to an unprecedented financial crisis and a harrowing drop in the Dow. You don’t see something like that every day.

So was Templeton out of his mind when he declared it foolish to say “this time it’s different?” Of course not. Templeton well understood that the particular events that cause a market decline will always vary. What shouldn’t vary is the way you respond to it as an investor.

If you bought into the market crash of 1987, you did very well over the next few years.  After the bear market of 1990, stocks went on a remarkable 10-year run. If you bought into the secular bear market of 2000 to 2002, you also made out handily over the next five years. And, of course, the market almost doubled from the lows of the financial crisis in 2009.

Here we are today and the stock market has swooned again, this time due to sovereign debt problems here and in Europe. Nothing like this has happened in recent history.

So the question you face now is whether to take advantage of the sell-off and buy great companies at bargain prices or… to insist “this time’s it’s different.”

The choice is yours.

Good investing,

Alexander Green

I Was Wrong About Gold and Internet Stocks and Real Estate

I Was Wrong About Gold and Internet Stocks and Real Estate

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, August 15, 2011

In the summer of 1999, I warned my friends that they were playing with fire, that the rip-snorting bull market in Internet and technology stocks was likely to end badly.

Most of them scoffed – and were glad they did. After all, Internet stocks weren’t anywhere near a peak in the summer of 1999. I was early. It would be nine long months before the scaffolding began to shake.

I never dreamed the mania could go for so long. But it did. And it taught me a valuable lesson. You can’t make a rational estimate of when irrational behavior will end.

The same thing happened with the housing bubble seven years ago. Almost no one was buying my skeptical take. I talked to realtors who had been in the business their whole lives and had never witnessed anything like the dramatic run-up in prices that was occurring. Yet most managed to convince themselves – and their clients – that prices would only keep rising.

Which they did. Until, of course, they didn’t.

Now we’re in the midst of a spectacular run in gold and silver. When I bump into typical investors at cocktail parties or backyard barbecues, they invariably tell me they are loading up on precious metals. “It’s a no-brainer,” a Merrill Lynch broker told me just last week.

I agree. I think some investors have left their brains with the hat-check girl. Here’s why …

• The price of gold and silver are now way above the marginal cost of production. When that happens, you get new supply. Yes, it takes time but, trust me – it’s coming. (High commodity prices always sow the seeds of their own destruction. Have you checked out agricultural prices lately?)

• Unlike oil, a depleting asset, all the gold ever mined is still around and is available to be sold.  If consumers rush to cash in on higher prices – or (ahem) falling prices – supply can quickly swamp demand.

• Higher inflation does not necessarily portend higher prices for precious metals. Gold hit $850 an ounce in January 1980. Although inflation hit 12.4 percent that year, the yellow metal was $300 an ounce lower in December. That was a 35-percent hit. And yet that was just the beginning of the end. Gold didn’t bottom out until almost 20 years later. Silver took an even more spectacular ride, hitting a high of $48 an ounce in 1980 and losing 90 percent of its value by 1982.

• Or take a look at gold equities.  While the price of the barbarous relic keeps rising, you’ll notice the gold stock index is no longer tagging along. Here’s the chart… Gold has pushed ahead over the last three months. But blue chip gold stocks have fallen, even though most of the big producers have removed their hedges. The smart money is betting that today’s high prices won’t be sustained.

• And how about the smartest money of all? Warren Buffett isn’t buying any nonsense about gold being “undervalued” at current levels. He openly scoffed at the idea in this April clip. And gold is only more expensive now.

Some readers might remind me (and should) that I was bearish on gold several months ago. Yet gold and silver have only pushed on to higher highs. Just as Internet stocks did. Just as residential real estate did. Just as tulip bulbs did.

Don’t get me wrong. Everyone should own some gold as a hedge against economic or political catastrophe. But if you are piling into gold and silver now – or if it makes up a quarter or more of your portfolio – you are truly living in Las Vegas.

I could be wrong, of course. Maybe gold and silver are still in the early stages of a tremendous run-up. But what if I’m not wrong? A 60 year old who jumped into gold in 1980 was down more than 60 percent on his 80^th birthday, if he lived that long. And that’s ignoring inflation, something gold bulls are not traditionally inclined to do.

The truth is no one can tell you where gold will be in a month or a year. Still, it wouldn’t hurt to heed the words of Mark Twain:

“History may not repeat itself. But it rhymes.”

Good investing,

Alexander Green