The Inside Story

A recent study found that insider buying activity differs as a forecaster of future gains. Multiple purchases by several executives within a three-month period have signaled big gains to come.

So have purchases at small companies with limited analyst coverage. Buys that followed recent upside earnings surprises paid off nicely.

The biggest returns were found after insider buys of undervalued stocks (judging by price/earnings ratios) with strong share-price momentum over the past 260 days.

NOTE: Insider stock buys may be a better indicator than insider selling activity because the latter might be dictated by other concerns, such as the expiration of stock options or portfolio diversification plans.

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Bank Warns of Depression

The Bank of International Settlements (BIS) is warning that the global economy could be on the brink of a major depression similar to the one that occurred in the 1930s.

The BIS said that years of loose monetary policy have fueled a dangerous credit bubble leaving the global economy more vulnerable to an economic catastrophe than is generally understood.

In its 77th Annual Report for the financial year April 1, 2006 - March 31, 2007 that was submitted to the BIS' annual general meeting held in Basel, Switzerland on June 24, the BIS - which one source described as "the ultimate bank of central bankers" - noted that the Great Depression that began in 1929 caught many off guard and unprepared.

Several worrying signs, including mass issuance of new types of credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors and entrenched imbalances in the world currency system, have all made the Bank wary the global economy is at serious risk.

The BIS pointed to China as a possible spark that could cause a sudden global downturn. The BIS said "China may have repeated the disastrous errors made by Japan in the 1980s when Tokyo let rip with excess liquidity. The Chinese economy seems to be demonstrating very similar, disquieting symptoms," the BIS claimed, noting China's credit and asset boom.

The bank described China's booming economy as "unstable, unbalanced, uncoordinated and unsustainable" - a comment apparently made by Chinese premier Wen Jiabao.

The BIS also took a swipe at the U.S. Federal Reserve, noting that the central bank was rethinking the easy credit policies of former Fed chief Alan Greenspan.

The BIS was not sanguine about the dollar, citing America's huge trade and deficit imbalances with U.S. external liabilities growing to over $4 trillion from 2001 to 2005.

Worrisome too is the bubble created by private equity deals and hedge fund activity.

"Sooner or later the credit cycle will turn and default rates will begin to rise," the BIS said.

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The Discipline of Reading

Some things in life are optional, and some things in life are mandatory. Taking your next cruise to the Caribbean is optional, but building your very own personal investment library and becoming an excellent reader is mandatory. This no longer is something you can choose to do or not do. It is absolutely, positively essential and indispensable to your success as an investor!

Many people do not read very much. Fifty-eight percent of adult Americans never read a nonfiction book from cover to cover after they finish school. The average American reads less than one book per year. In fact, according to a Gallup study of the most successful men and women in America, reading one nonfiction book per month will put you into the top 1 percent of living Americans.

It takes regular, persistent reading and studying for you to improve, to move to the front of any field - and investing is no different - it is not optional!

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Bondholders Beware!

It's very important to be ultra-careful when buying corporate bonds. This is because private equity buyers aren't friends of the bondholders of companies they acquire. These buyers tend to load too much credit on their acquisitions, thus hurting the credit quality of existing bonds.

Before abundant credit became the order of the day, buyers of corporate bonds were protected by covenants that forbade over-leveraging the balance sheet. That's no longer the case, so bond holders are vulnerable - as soon as an LBO deal is announced, the bonds of the target company often plunge in price.

So if corporate bonds are unappealing, you might want to hold municipal bonds in a taxable account and Federal government issues in tax-deferred accounts.

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Is Intel Back On The Rise?

That's what we read on page 33 of the latest (June 25,2007) edition of Barron's. Staff writer Eric J. Savitz recently visited Intel's Campus in Santa Clara, California, for the annual Research@Intel Day. The article details what the author saw during his visit and ends with the following summation:

Intel has manufacturing strength, a new focus on cost controls, a wounded rival (AMD) and a vision of the future. In short, as you look out over the next few years, your portfolio really should have Intel inside!


NOTE: We commented on an article in a recent copy of FORBES, at our meeting last Thursday, and that article also praised the changes that Intel management has been making in order to turn this troubled giant around. So I would agree with both publications that the future indeed looks very promising for Intel!

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The Wealth Ritual

There is a way to become wealthy without ever increasing your income, and it's a lot easier than you think. By learning to enjoy and manage what you already have, getting more becomes easier and more fun than ever before.

Once you learn to hold on to some of your economic power in the form of saving, your focus will shift. You'll stop worrying about every nickel and begin to find enjoyable ways of creating substantial wealth. Just allow yourself the freedom to enjoy what you do have right now, knowing that mastering this level of wealth conservation is a prerequisite to moving on to the next financial level.

If you want abundance in life, you must stop focusing on your lack of money and begin focusing instead on your abundance of financial resources.

Think about this: Wealthy people focus on their excess and how they can use that power; impoverished people focus on their lack!

So if you wish to grow your wealth, one action you absolutely must adopt is spending less than you earn so that you can keep some for yourself and your future. To most people this sounds awful. It makes them feel like they'll have to give up things they love and put themselves on a strict budget. But the sad truth is that most people waste money on things they really don't need and deprive themselves of the things they really deserve because their spending priorities are out of control!

If any of that sounds like you, then you need to make a financial change, and here is a 3-step process for accomplishing this:

1. Realize that where you are right now financially is not exactly where you'd like to be.

2. Create compelling reasons to make a change.

3. Write a well-thought-out plan of action and then stick to it.

The easiest and most effective way to make sure you always find the money to pay yourself first is to control the outgo. There is a simple way to do this: Write it down.

Write down in a notebook everything you buy and every dollar you spend, and you'll gain an enormous amount of control over your finances. What immediately happens is that you will talk yourself out of making certain purchases because you anticipate the guilt you'll feel when you write them down. You'll find yourself saying, "how could I have spent money on something so silly?"

This type of self-awareness is great because it saves us from the type of impulse purchases that burn holes in our pockets.

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Tricky Investment Terms

Don't be fooled by the term "alternative investment."

Some brokers and advisers are promoting currencies, commodities, options, real estate deals and other risky investments, implying that they are acceptable alternatives to traditional stocks and bonds.

Reality Check: There is nothing new about these investments. Many are high-risk and generate significant commissions, fees and profits for the people who sell them, but not necessarily for investors.

Bottom Line: Make any investment only when you fully understand it and are confident that you have made the correct decision!

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Personal Finance Test

Last year, the Jumpstart Coalition for Personal Financial Literacy conducted a nationwide test of high school seniors who were able to answer only 52% of the personal finance and economics questions correctly.

The test determined that the average student who graduates from high school lacks basic skills in the management of personal financial affairs.

Many are unable to balance a checkbook and most have no insight into the basic survival principles involved in earning, spending, saving and investing.

Students who took a high school course in personal finance actually did worse on the exam than those who did not.

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A Smart Strategy

Buying stocks at their 52-week highs has been a smart strategy historically. These stocks often have momentum that can move them still higher. And a study taken by the Chicago Tribune found that of 256 firms whose shares hit 52-week highs on the New York Stock Exchange in mid-January, more than half outperformed the S&P 500 through the end of the first quarter, and one-tenth rose by more than 15%.

But choosing the right stock is crucial because some stocks at their highs are poised to fall, while ones with rising earnings that exceed analysts' forecasts and strong cash flow could go still higher.

Bottom Line: Look for stocks with price-to-earnings ratios under 15, which more often than not indicates a potential bargain.

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The Point Spread

If you refinance a mortgage, any points you pay must be prorated and deducted over the life of the loan. Many people deduct the first year's portion of the points, and then make the mistake of forgetting to follow through in subsequent years.

Another error: failing to deduct any un-deducted points when a refinanced loan is refinanced. Either way, you can file an amended tax return (Form 1040-X) for the year in question to claim the deduction.

In order to claim a refund, you must file an amended return by three years from the due date of the original return or by two years from when you paid the tax, whichever is later.

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Watering the World

In its latest (June 18, 2007) edition on page 17, BARRON'S mentions that more than a billion people around the world are without decent drinking water, which helps explain the flood of exchange-traded funds now focusing on international water interests.

The latest is the PowerShares Global Water Portfolio (ticker: PIO), which began trading Wednesday along with four other new PowerShares ETFs. A Texas water consultancy, Palisades Water Index Associates, developed Global Water's underlying index, a sector-weighted list of 41 international companies providing water or treating it, plus firms making technology or offering services related to water.

The PowerShares fund will update its index quarterly to reflect public offerings that can make a splash, and to rebalance sector weightings as new projects and regulations move stocks.

Competitor Claymore S&P Global Water Fund (ticker: CGW) updates holdings once a year. So far, it has quenched investors' thirst nicely, rising nearly 3% just since its launch in May. It's based on the S&P Global Water Index, a 50-stock list. Half the companies represented are water utilities or infrastructure plays, and the other half produce water equipment and related materials.

Other water ETFs focus on U.S. companies, some with global reach. PowerShares Water Resources Portfolio (ticker: PHO), established in late 2005, is up about 12% so far this year, and First Trust ISE Water Index Fund (ticker: FIW) is up nearly 7% since its May listing.

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Credit History

Your credit history consists of two elements: your credit report and your credit score. Know them!

Credit Report

The creditor's main purpose for reviewing your credit report is to help decide if they want to extend credit to you. Within this report you can expect to find personal information such as your name, current address, Social Security number, date of birth, phone number, and current and previous employers. Also credit information from your creditors such as date the account was opened, amount borrowed, credit limits, and payment history. And this report can also include public records like tax liens, bankruptcies and court awarded judgments against you. And this report will also include a listing of all parties that have requested a copy of your credit report.

Credit Score

Your credit score can be both your best friend as well as a thorn in your side. Your goal is to maintain a good credit score, as these scores are the additional consideration creditors use when they are deciding whether or not to extend a line of credit to you.

The credit scores generated by the credit bureaus are often referred to as "FICO" scores, and these scores range from 300 to 850 - the higher, the better.

Over the years, this three-digit scoring has emerged as a way to compare how the information on your credit report compares with each bureau's credit history on hundreds of thousands of other consumers. In a nutshell, the credit score generated informs creditors how likely you are to repay your debt.

Each credit bureau uses their own methods of calculating your credit score based on all of the criteria listed above. And yes, each credit bureau has multiple ways of calculating the same credit score.

Additionally, it's quite probable that at any given time, each credit bureau will report a different credit score for you. They all attempt to remain as current as possible, but the resulting score is only as accurate as the information that they have available on you can provide. This is why you should check in on your credit score from time to time. And www.AnnualCreditReport.com will issue one free copy of your credit report to you each year upon request.

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Two Ways Not To Make Money In The Stock Market

1. By making your buying decisions based on no research whatsoever, and just jumping headlong into any investment the media is high on at the moment.

2. Being the kind of investor who reads everything for years and years until he's loaded with information about the market - but he really hasn't made any serious money because he's too insecure to trust the knowledge he's gained and try to use it.

Bottom Line: If you have solid research to back up your investment decisions, then there's no reason not to jump in and start making money!

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Rising Interest Rates?

These seem to be the sentiments expressed today by two separate guests on WBBM's Noon Business Hour. One of the guests even went so far as to say that he expects the Fed to raise interest rates by no later than this coming September!

Separately, in an e-mail received from a very reliable source today who was reporting on his private meeting with former Fed chairman Alan Greenspan, he told of Greenspan's forthcoming new 640-page memoir, The Age of Turbulence: Adventures in a New World - due out this coming September, in which Greenspan promised to deliver some "shocking surprises."

Indeed, we appear to be living in interesting times... stay tuned!

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Family Values

The nation's median home price has doubled since 1993, to $212,800. In the case of younger buyers getting help from their parents in the form of shared equity deals, the parent typically makes a 20% down payment so the buyers can qualify for a conventional 30-year, fixed rate mortgage.

The parents eventually will get back their initial stake plus 10% to 50% of any profits. In many of these arrangements, the younger people occupying the house make the mortgage payments and take the tax deduction.

Negotiations will determine whether one party or another will pay the property tax or whether that cost will be shared.

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NEXT MEETING: Thursday - June 21, 2007

We meet at DePaul University, located at 150 West Warrenville Road in Naperville, Illinois. Our meeting begins at 7:00 PM and ends at 9:00 PM. The room number will be posted on the easel standing near the reception desk in the main lobby.

We welcome anyone who shares our interest in learning and talking about investing. It is not necessary to be an AAII member in order to attend our monthly meetings.

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Taxing Moments

Few tax code provisions are as complicated as the rules regarding the taxation of Social Security. If your income (counting tax-exempt interest but only half of your Social Security benefits) is in between $25,000 and $50,000 (for single filers, or $32,000 and $60,000 on joint returns), planning might be helpful.

One tactic is to invest in low-dividend and no-dividend stocks. If you buy and hold, they will produce little or no income, which can hold down the tax you'll owe on Social Security benefits.

Taking stock losses also will help because they can offset any capital gains you might incur while net capital losses up to $3,000 can be deducted from other income.

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The 4-Year Presidential Election Cycle

The Presidential Election Cycle provides an historical basis for investors to be optimistic in 2007.

The stock market has not posted a loss in the year before a Presidential election since before World War II. And going back nearly two centuries, the third year of a president's term has on average been the best one for investors.

The "Stock Trader's Almanac 2007" concludes that wars, recessions, and bear markets are more common in the first half of a president's term. The stock market has on average posted gains during those years, but they were relatively small.

It's been the third year that has been the most prosperous, with the markets gaining nearly 11 percent on average. 2007 marks the third year of President Bush's current term.

The Presidential Election Cycle has proven to be one of the most reliable market predictors. While its patterns are not certain to repeat themselves at every opportunity, knowledge of history can help investors to better understand the financial markets.

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Thinking Both Healthy and Wealthy

Consumer-directed health plans (CDHPs) usually come in one of two forms: Health Savings Accounts (HSAs) or Health Reimbursement Arrangements (HRAs). Either way, they generally begin with high-deductible health insurance.

Because coverage won't kick in until the insured individual or family has experienced a considerable amount of out-of-pocket costs, patients may spend sparingly because their own dollars are at stake.

For someone who is very health conscious, such plans can make perfect sense!

NOTE: Both HRAs and HSAs are offered by employers, but HSAs can also be chosen by someone buying individual or family health insurance.

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An Investment That Could Turn Ugly

The latest edition of BusinessWeek tells how big firms - having spent two years devising the right formula - are now targeting individuals, and the mutual fund managers who cater to them, with the latest investment gimmick: collateralized debt obligations (CDOs). These complicated investment pools, which are generally filled with such risky assets as subprime mortgages and junk-rated corporate loans, have usually been sold to hedge funds, insurance companies, and the like. Now several firms, including fund manager Highland Capital Management and affiliates of Kohlberg Kravis Roberts and investment bank Bear Stearns, are pitching publicly traded vehicles that hold CDOs.

But a close look at the preliminary prospectuses shows that these aren't the same kind of CDOs that the pros have been feasting on for years. Add to that the very real possibility that the credit cycle will soon turn, along with the fact that some of the underlying holdings are potentially toxic, and you have the recipe for a retail nightmare.

The market for CDOs has been piping hot. Big investors are attracted to the bond-like securities because their returns beat the market (at least recently). A dozen CDO funds managed by Highland have historically paid dividends of 19.6%, according to an IPO filing with the SEC. Eighteen CDOs in which a Bear Stearns' affiliate has invested have average annual returns of 24.5%, according to a company filing. Some $550 billion worth of CDOs were sold last year, more than triple the amount in 2004.

But it's a dangerous game for small investors. CDOs are generally divided into different tiers, with the so-called equity portion sitting at the bottom of the pile. Investors in that part of the structure get higher returns, but they can be hurt badly if something goes wrong and borrowers can't make their payments. Those equity investors are the first to absorb any losses and can be wiped out because CDOs use a lot of leverage.

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Varying The Risk

Variable annuities promise some minimum level of annual return, typically in the neighborhood of 5% or 6% of your investment, even if the investments you select perform poorly.

If the investments perform well, you can either cash in those gains or get a higher level of guaranteed income.

If the issuer permits it, investing 100% of this money in stocks is a rational strategy. You can aim for high returns with a safety net in case the market goes against you.

NOTE: Some variable annuities have extremely high fees, so you should shop for a relatively low-fee selection, such as that offered by TIAA-CREF or VANGUARD. In any case, you never want to pay a fee any higher than 1% for a variable annuity.

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Morgan Stanley says, SELL, SELL, SELL!

On Wednesday, June 6, 2007 - Morgan Stanley issued a "full house sell signal," saying three of its leading indicators - bond yields, Institute for Supply Management new orders, and valuation and risk - showed it was time to sell.

Such a full house sell signal across these three indicators is rare and has occurred only five times since 1980.

Equities have always been down in the next six months on average by 15 percent, following such an announcement. Previous occassions include September 1987 and April 2002.

Which side of these odds do you choose to be on?

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The First Secret of Successful Investing

In order to be successful while investing in stocks, you must have and use an exit strategy - one that will force you to methodically cut your losses and let your winners ride. If you follow this rule, you'll have the best chance of outperforming the markets.

The exit strategy we advocate is simple. Ride stocks as high as you can, but if they head for a crash, use your exit strategy to protect yourself from serious damage. You do this by means of a Trailing Stop Strategy which is set at 25%, and here is how it works.

What you are doing with this method is to discipline yourself to sell any and all positions at 25% off their highs. And this works as the price of the stock moves in either direction. For instance, if you buy a stock at $50 per share and the price begins to drop, you would sell your position when the price hit $37.50 per share. No emotion and no second-guessing. Conversely, if you bought a stock at $50 per share and it began to rise setting a new high at $100, you would then re-adjust the exit point to $75 and would sell that position if and when the price should drop to that level.

Two important points to bear in mind when using a Trailing Stop Strategy:

1. Use end-of-day prices only. This way, if the investment closes the day below your trailing stop, you can simply sell the next trading day.

2. Never place STOP orders, because NYSE traders are known to pile up stop orders and then execute them all at a horrible price.


NOTE: One tool that you can use to keep track of your trailing stops is Yahoo Finance's Alert Service, which will send you an e-mail when your stock hits a price you specify.

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Something To Think About

A bank is a place that will lend you money if you can prove that you don't need it.

-Bob Hope

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When One Plus One Can Equal More Than Two

About 50 years ago, the late great economists Merton Miller and Franco Modigliani broke fresh ground in the study of corporate finance by proving that a firm's value is determined by its investment policies, not its financing decisions. Also, it does not matter how much relative debt or equity a company maintains, and the issuance of stock, bonds, warrants, and dividends has no effect on the company's aggregate worth.

With that said, and before looking at whether stock splits somehow add value to a corporation, it is useful to consider why companies split their stock. And there are three main arguments offered by stock split proponents:

1. To bring the share price of a skyrocketing stock back to earth, enabling the smaller, retail investor to purchase shares he might otherwise ignore because he couldn't afford to buy at least 100 shares of it at the elevated price.

2. To signal to the world that the company is a high-flyer and attract attention from stock analysts who might otherwise ignore it.

3. To improve liquidity and smooth out volatility in the stock by increasing the number of shares available to trade, and attracting new money to dilute the influence of institutional investors. It is assumed that the bid-ask spread will tighten, and volatility will be tempered in the presence of the larger number and more diverse base of potential investors.



So should investors ignore stock splits?

Absolutely not. Although the underlying principles upon which splits are based may seem without merit, there is a market opportunity in these cases that should not be overlooked. It appears that stocks that split tend to go up in both the short and long run by significantly more than the expected "buy-and-hold" amount. In fact, a 1996 study which tracked 1,275 listed stocks between 1975 and 1990 that split 2 for 1 showed that the immediate returns are 3.38 percent higher than what otherwise might be expected. More importantly, splitting firms generate excess returns of 7.93 percent in the first year after the split and excess returns of 12.15 percent in the three years following the split. And a follow-up study in 2002 confirms the findings of the initial study.


So why not take all your money and only invest in stocks that split?

Well there is really a different and far more important question: Can an investor rely on a single indicator, particularly when there appears to be such a high probability of success? This is an important question with no easy answer.

In the case of buying every stock that splits, there is a danger in that some split stocks will not show an excess return, and one ought to consider carefully all relevant variables before committing capital to a position. In particular, if one is looking for a short term pop, the risk is much higher of suffering a loss. Those who can wait for a year or longer are far likelier to appreciate a gain, but there are no guarantees, of course, that any stock will be worth more in the distant future than it is today.

That caveat being given, the excess returns when a company splits its stock appear to be substantial and reliable and a good place to start as any in constructing a profitable investment strategy. While researchers seem stumped as to why companies want to split their stock, to an investor searching for profits, it doesn't much matter as long as the end result is one that enriches.

Maybe the answer is that most companies with high prices that split their stock are simply good companies; the fact that a company's stock price is high is not always evidence that it is a good company, but in many cases it is the best evidence. After the stock split, a good company is still a good company, and there is no reason to think its share price will stop appreciating in value. The lesson here seems to be, at any price buy a good company, but especially at a split price.

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Poor Values

An article in FORBES magazine suggests that today's "value stocks" are way overpriced. The cheapest 125 stocks among the S&P 500 normally have a price/book value that's 50% of the ratio of the entire index. But now those "clunker" stocks go for 65% of the index level, more expensive than at any time in the past 40 years.

Beyond the S&P 500, small-company value stocks are even more expensive because small companies tend to have less stable returns and lower profit margins. Therefore, it's time to buy growth stocks that (1) have shown impressive earnings growth and (2) trade at price/earnings ratios far below the levels of 1999.

NOTE: Many promising large growth stocks are in technology, but retailers such as Home Depot and Wal-Mart also may be priced well.

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