The worries of the housing sector are starting to show overseas.  Today the Bank of England announced a package very similar to the Federal Reserve’s action to swap treasuries for mortgage debt.  The BoE acted to fund up to $100 Billion of government bonds for trade with mortgage backed securities.  This comes just weeks after Northern Rock was absorbed by the English government and the Federal Reserve’s actions for swap plan.

The Bank of England has been resetting rates alongside the Federal Reserve.  Since December, the Bank of England has lowered rates 3 times in an effort to spur borrowing and cut into liquidity problems that are plaguing banks and borrowers alike.  The Federal Reserve offered $200 Billion in guaranteed loans which is double the amount the BoE is currently offering, though there are many more houses and thus owners who are upside-down on loans in the US than in the UK.

This is comparatively good news for the United States.  As we’ve seen in recent weeks, the stock market has rallied on comparative news, that the market has gotten better though still doing worse than the long term average.  While we’re much better off now than in late 2007, many lenders are still writing off huge amounts of debt and assuming large losses.

It is hard to say how this will affect things in the UK.  The Pound has favored well against the other currencies, trading at nearly twice the value of the USD but losing much of its value to the Euro.  Investors who sought protection from a fallout in the US markets fled to Europe, many into the Eurozone and a few into the UK.  If housing problems persist in England, the chance of a drop in the value of the GBP becomes even more likely.

A quick fix of $100 Billion will help English lenders, but at the cost of inflation.  US consumers have already seen the cost of high inflation on the price of commodities such as food and oil but also on consumer goods which require more and more money to ship and produce.  The new funds will be made available to banks who want to temporarily “loan” the government their bad loans while using the new funds for further investment or to ease negative liquidity.

The US dollar has been strong, very strong up until the last five years.  Now that the US dollar is making new lows, trade has increased for many US based companies that can now compete with foreign manufacturers.  The low value of the US dollar is great for many industries, automakers, travel and resort companies and now chipmakers.

IBM released very promising news today that their first quarter earnings jumped 26 percent from a year ago.  The higher sales are attributed to a weak dollar which allows IBM to compete with countries like Japan and China which have enjoyed devalued currencies to grow their tech industry.

Automakers
Automakers are the companies that can benefit most from a cheap dollar.  GM and Ford sell many of their compact cars in Europe, now that the Euro is worth twice as many dollars as it was just a few years ago, more orders are likely to flood these US based businesses.   Even after pension costs of over $1000 per car for General Motors, the currency market should bring more business from foreigners.  This turnaround of trade certainly helps these two businesses, but the US economy as a whole.  Devalued currency brings more trade to the United States.

Travel and resorts
Travel companies also benefit from a weak dollar.  Europeans are quick to take advantage of cheaper US vacations.  Popular travel sites in the United States are bringing in less Americans but more travelors from Europe and Asia.  While a hotel room might have cost 100 Euro in 2003, that price is now down to 50 Euro.

A weak dollar is not entirely bad.  Although domestic inflation might worry some Americans, its helping US exports gain an advantage against cheaper nations.  We might finally see a shift from made in China to made in the USA.  This can be nothing but good.

The merger between Delta and Northwest will create the largest airline in the world.  Both companies are struggling financially and through a steady loss of customers and government security, but will the two companies be allowed to merge and create one large, super airline?

Much evidence suggests that the company will not be able to merge just because of the sheer size of the two companies.  If the merger were to go through, it would be like Pepsi and Coca-Cola merging only to leave the small independent soda makers to try to fight through a monopoly.  I doubt very seriously that the companies will be able to turn a profit even when working together, neither of them suffers severely from competition.

Other than the banking industry, no other industry besides airlines has seen this much consolidation.  After 9/11, new security measures and a scared public has sent people away from airlines and back to ground transportation.  High fuel costs disproportionally hit airlines which only make a few hundred dollars each flight from passengers, the majority of their income comes from extra services and mail carrying.

I see little to gain from a merger between these two mega giants other than less pilots with a job and higher ticket prices.  There will be little regional competition on other airliners as these two control much of the domestic flights in the United States.  At this rate, I don’t think this merger stands a chance with the monopoly regulations in place.

GEs report of lower earnings stunned the street but shouldn’t have surprised anyone familiar with the company.  Amongst light bulbs and appliances, GE has a huge credit portfolio from credit cards to car loans and even home loans.  GE money bank is one of the largest in the world and has huge exposure to the subprime industry.

Many store cards meant to be used in only one department store are issued by GEMB.  These cards generally have low limits (as low as $200) and issued to nearly anyone who applies.  Many of these card users are people without the credit to get an all purpose card or those who like to get the benefits of a store card.  Rarely do high credit score borrowers look for these kind of cards as they are known to lower the amounts you get from premium credit card issuers.   It is believed that American Express or other high end offerings don’t like to give cards to people with store card only experience.

While GE does lead the world in many different technologies, namely the compact fluorescent light bulb, the manufacturer has way too much exposure to the financial industry.  When most people think GE they don’t think banking, the stock was able to escape the financial sector bust but now the bill is coming due.

I wouldn’t consider owning GE for a variety of reasons, first and foremost being its exposure to the subprime lending industry.  If we do in fact go into a recessionary period, there are going to be even larger write-offs and lower expectations for the company.

Next is its huge market cap.  Even after shedding 12% of its value in just one day, GE trades at a market cap of $320 Billion.  To make any considerable amount of money, this stock has to build up a lot in equity.  A 10% gain would be a $32 Billion difference, to make 50% we’d have to see an increase in value of $160 billion.  As you can see, its just too hard to sustain such growth, especially when the stock already sells at a PE ratio of 14.   That’s a pretty high value for a company of this size.

In my opinion, GE has a lot more to lose at this point than it stands to gain.  Its likely that the subprime crisis will affect all parts of its business.  Lesser demand for its manufactured goods like refrigerators and air conditioners and failing payments in its credit division makes GE an even worse investment.  The worst part about the situation is that the company likely holds plenty of debt on its own products.

GE is a neither buy or sell at this point.  Economic outlook is rather bleak, so the company is unlikely to rebound any time soon.  Its credit division will certainly continue to take a beating, especially no secured credit cards and other personal loans.  If its manufacturing core does well, it will only help pare losses in the credit market.  No position, even at a 12% discount from yesterday.

Oil prices are soaring and its affecting every business.  Food prices are out of control as much of the worlds food supply is now being used to produce ethanol, rather than to food the world.  Energy prices affect the cot of nearly every commodity because it must first be shipped to market to be sold.

Many companies including UPS are now restating their earnings reports and forecasts to adjust for higher oil prices.  For a parcel service such as UPS, energy is one of the biggest expenses for shipping goods.  Corporations like UPS and Fedex will continue to get battered as the price of oil goes up.

Their main competitor, US Postal Service which is state owned, can be subsidized by tax dollars to keep the price low.  While the Federal government has always sought to run the postal service at a nominal profit, the losses continue to pile up.  Unlike Fedex and UPS, the postal service can subsidize fuel costs and keep prices low.  If fuel prices continue to rise, shipment through the two independents will be considerably more than USPS which can keep costs low by using tax dollars.

Airlines are also losing heavily on the higher oil prices.  Airline ticket prices have skyrocketed after September 11th and new security measures.  Now with high oil prices, the airlines must again raise ticket prices.  Loyal customers hate to see rate increases and the security and pricing troubles are certainly weighing down the whole industry.

The price of oil can affect nearly everything we buy.  Every item at the store will go up in price as oil costs rise, airline tickets are rising, and so is the cost to send a package cross country.  In this day and age its impossible for even the non-driver to avoid high oil costs.

The sentiment that the market always goes up has long been in play and is still the fact used by most professional money managers to assume positions in beaten down companies.  The average is about 10.5% a year for large cap stocks over the long run, some 100+ years.

Market timing is something that is critical for a short term trader and not so necessary to the retirement fund manager.  The short term trader needs to show huge daily profits from relatively small movements in price.  A move from $25 a share to $26 would be a gift from the heavens for most full time traders.  For the long term investor, that’s just a 4% return, very unlikely to make a considerable difference in the long run.

When the markets get beaten down, look at the last few months, the new favorite term is “timing the market.”  Many investors tried to time the real estate market only to get trounced, many ran out the commodity boom and the USDJPY carry trade watched their profits unravel as it broke down.  Market timing can be a difficult thing to learn but can bring huge gains for correct timing.  The losses can be huge as the gains, many investors lose big by chasing returns.

Short term traders do not profit from the difference in value in a company, they profit by merely buying X stock and selling it for more than they paid.  Traders, unlike investors, just want to flip their shares for a profit rather than hold on for the long term.  For this reason, data such as corporate earnings and economic outlooks play a very minor role in the short term trader.  Long term analysis is unlikely to affect a trader’s short term perspective.

For the rest of us, market timing really isn’t that critical.  As much as we’d like to follow the world’s best investments and be invested in each of them, its entirely impossible.  Most of us have our retirement portfolios invested into a series of profitable companies rather than the hot biotech down the street.

There is some role for market timing in a bear market, especially for the long term investor.  A bear market is likely to bring down the values of all stocks, even those with strong fundamentals.  A boring market in the US looks like a great opportunity for foreign countries.  Fundamentals remain strong even amongst this very technical-driven investment cycle.

As things weaken on the American front, there are still many great investments that have become oversold due to market sentiment rather than an actual difference in company quality.  Take for instance the deep-discounters, the fall in prices was due mostly to a market event than an internal event.  If anything, the balance sheets of deep-discounting corporations have never looked better.

And as much as the market hates the financial sector as a whole, there are still many great investments.  Firms with limited exposure to subprime mortgages have been hit just as hard as those with maximum exposure.  The rebound for these companies who managed their investments wisely will be huge, driven by profits rather than the rumor-mill.  Just by being in the financial industry it is likely to see a stock price tank by 20-30% without any hard evidence that the company will be doing worse.  This kind of sentiment is easy to beat with high quality, profitable stocks which are still lingering in the mess of illiquid lenders.

This past week produced economic data that looked bad to say the least.  Job losses are the highest since hurricane Katrina and the amount of people seeking benefits is actually higher than the months after the catastrophe.  Job losses are both a lagging and a future economic indicator as they judge how corporations are cutting back and also shows that the production of wealth is also limited.

Wealth can only be generated by producing more than you need.  In this case, lets take a lemonade stand as an example.  Sally has a lemonade stand, to do business she need her factors of production, lemons, water and sugar (promotion not included).  She buys $5 worth of lemons water and sugar which will produce 5 gallons of lemonade that she can sell for $3 per gallon.

Sally’s investment is a mere $5 but she is able to produce $15 worth of lemonade.  In this example she can sell her $15 in lemonade and produce a $10 profit, which is wealth.  She provides a good or service that people want (lemonade) for a higher price than it costs her to make.  Customers are happy because they have their lemonade and she is happy because she has produced a profit.

The job market slowdown shows either an increase in productivity, unlikely, or a decrease in overall business activity.  Workers are needed to produce goods and profit for a company, so when they are laid off, it appears that business activity and wealth creation are temporarily slowed.

A corporation could lay off workers for a variety of reasons, but it is usually to cut costs and limit the amount of one good they can produce.  Corporations would much rather have a smaller workforce work at 100% capacity than a much larger force work at 70% capacity.  The difference between 70% and 100% is waste to a company.

When the job market slumps it is indicative that the “wealth creators” are also taking a slump.  If this is the case, the overall size of an economy is shrinking because it is no longer producing as much as it once was.  In this case, 80,000 jobs were lost indicating that the economy will shrink as it produces less.

No wonder why job losses have Wall Street in an uproar.  A cut of 80,000 jobs means less is being produced.  The economy is by all definitions shrinking, or showing the effects of a recession.

Bernanke’s acknowledgement of a future recession worries many on the street but it also provides the chance to get into several major deep discounters.  Deep discounters such as Big Lots and Family Dollar surge when economic news gets worse.  When people make less, they flee to these two stores for big savings on items.

Just as the housing bubble helped grow Target’s middle to upper class customer base, an ongoing recession will do much to line the pockets of Big Lots and Family Dollar which buy merchandise in bulk for dirt cheap to turn around and sell again for much lower than competitors.  These two companies are known for their low income customer base and benefit when the economy looks less than par.

Both these companies have a strong branding image and are known for their low prices.  Both stores offer brand name products with a much lower price than can be found at stores like Target or even WalMart.  The companies benefit by buying product that is overstocked and take in merchandise from other stores that might be out of season.   The loss of other retailers quickly becomes the gain of deep discounters.

I like deep discounters much more than regular dollar only stores because they have the ability to negotiate prices.  A dollar store that switches to a deep discounter usually faces tough marketability as consumers lose interest as prices rise.  Deep discounters are not as prone to losing money when the dollar falls, as the dollar loses value, the dollar only stores must cut the amount of their product or raise prices.

Big Lots reported very good earnings last quarter and set high marks for the next year.  The company has seen steadily increasing business as consumers look to cut costs by shopping at the deep discounter.  Biglots trades near its lows in share price at a tiny PE ratio of 14.  This kind of value is rarely seen even in deep discounters, especially with such high growth rates.  A PEG ratio of .7 is comforting that the company will continue to grow even amidst an economic downturn.

Family Dollar is another strong stock with much room to improve.  When the downturn of 01-02 came, Family Dollars stock moved up to the upper $40s to settle at record highs.  As you can see, this company proves to be very solid in periods of economic downturn and fluster as the market stabilizes.  Currently the stock trades at $21.40 per share, about the same price it traded before the internet bust.  This one trades even cheaper than  Big Lots at a PE ratio of 13 but has a much lower growth rate than Big Lots at a 1.26 growth rate.  Either way, if history repeats just like it did during the internet bust, this company is set to boom.

Beating the market in a downturn is much easier than in an upturn.  If the economy follows through with expectations, both companies can expect higher earnings and better than expected growth.  Both brands are known for their low prices on brand name products.

Last year brought much news about the USDJPY carry trade, or holding a trade merely to gain interest.  At the time, the Japanese lending interest was far below the borrowing interest paid by US banks, investors could simply borrow in Japanese yen to deposit into US accounts and make money on the interest.

Carry trades are usually highly leveraged, forex accounts allow up to 400:1 leverage at some brokers.  This kind of leverage allows an individual to control $1,000,000 in currency with just $250 down.  This kind of investing is very dangerous and also compounds the effect when the markets turnover, or the trade becomes unprofitable for carry trade investors.

The dollar faces a critical problem, at this point the Federal Reserve Board is pushing rates so low that it may soon be privy to being the new carry trade currency.  This has already happened with the Eurozone and the pound as the dollar is now pushing low interest rates that are a few points lower than the central bank rates in other countries.  This creates unnecessary selling pressure when investors go to sell dollars and buy other currencies to profit from the interest rate difference.

When the USDJPY carry trade broke down, investors quickly bought back Japanese Yen to cover positions.  This caused the yen to advance by 20% in 2007.  As rates were lowered and investors lost confidence, the dollar was sold to buy yen which moved the exchange rate from 120 yen to the dollar to less than 100.

This puts a daunting strain on an already hurting US Dollar.  If the same carry trade that perpetuated with the yen persists in the opposite direction with the Euro and GBP, the value of the dollar will continue to slide.  In this kind of position, investors borrow dollars to deposit in Euro banks.  This puts artificial selling pressure on the value of the US Dollar, causing it to correct.

Further action by the Federal Reserve to cut interest rates will only hurt the dollars value, pump up the price of commodities and cause a dollar sell off in favor of other currencies.  The difference between interest rates is still tight, but a further move of 50 or 75 basis points will be the beginning of a large, multi-year carry trade.  We’ll have to see how the Fed responds, surely they know that further action will create a large difference in interest rates and more selling pressure.

Investor confidence and market direction can be predicted just by watching the inflows and outflow of money from large mutual funds. When money floods the street, prices become inflated and stocks rise, an outflow causes large drops in stock prices as equity is taken out. After the last few months of decline, it is now apparent that outflows are huge. Investor confidence in big banking and anything related to mortgages are at all time lows.

A quick glimpse at a four week chart shows that equity funds tanked in February with the weekly outflows topping $12 Billion. Investors lost confidence in the market and thus started taking cash out of stock funds and at the same time loading up in money markets. While stock funds tanked, money market funds were taking in an extra $40 Billion a week. This shows that investors only felt safe in guaranteed return investments, even if the yield was as low as 3-4% per year.

Bond funds dipped at the same time as stock funds, either investors lost confidence in corporate holdings or they were wary of mortgage backed securities which are essentially mortgage debt repackaged as a bond. The monthly repayments of the mortgage were used to secure the bond interest, but as that money slowly dries up, the possibility of repayment drops.

Coincidentally the amount invested in money market funds has dropped with every FED rate cut, but the figures still remain positive. Net inflows to money market accounts were around $15-20 Billion a week, half as much as they were before the FED rates were dropped. Throughout the latter parts of February and into March, investors turned away from money markets and bought back into the market at bargain basement prices. Up until this week, there were heavily inflows of cash to equities of about $4 Billion a week, still much lower than money markets.

It appears that investors have again begun to take money out of equities and now back to money markets. From this viewpoint it looks like investors will start fleeing the market again, probably in droves when the Dow and other large indices drop. The impressive gains from last week are going to be wiped away if investors continue this sell off.

Watching these key statistics can help you better time the market. When the inflow/outflow statistics are weighted by a 4 week moving average, the charts flow smoothly. Very rarely do the charts move down and then back up, instead they move down and keep moving down or move up and continue up. This shows that the market is following the returns, investors don’t know where to put their cash.

Gauging just a few months history, equities are going to get killed in the coming weeks. Inflows topped at $7 Billion a week and now down to just $4 Billion a week, next week will probably go negative. If this continues, the next month will be filled with more 200 point losses. Hold on tight.