Agora Financial’s Rude Awakening

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Baltimore, Maryland

· Could small-caps lead the market out of its slump?
· Three tiny companies with rock solid fundamentals and P/Es under 7,
· Limited inventory I.O.U.S.A. DVD giveaway and plenty more…

Greg Guenthner, reporting from Baltimore, Maryland…

A couple of weeks ago, I huddled with some of my colleagues to discuss the state of the financial markets and to exchange investment ideas. Meetings like these are always interesting, but rarely dramatic. However, this particular meeting had a decidedly different feel to it. Only one individual in the room – a short seller – had been enjoying himself during the previous weeks. Everyone else had been suffering some amount of pain and frustration.

“What’s next?”…That was the question on everyone’s lips. That’s still the question today.

This financial meltdown is mauling almost every asset class. Stocks are trashed. Corporate bonds are a wreck. Emerging markets are crushed. Energy prices are tumbling. Commodities generally are in the dumps. Safe havens? Get outta here!…Even gold is trending lower. There has been nowhere to hide…except T-bills.

But there is a ray of sunshine; stocks have not been this cheap in more than twenty years…and many stocks are as cheap as anything you could have found at the market lows of 1974. No, we don’t think your should borrow a massive amount of money to invest, hoping for a quick turnaround. But it is time to cautiously look at the opportunities the market presents…

Often, it is the small companies that lead the charge toward market recovery. Just take a look at what some of the market specialists are saying:

“When you look back over the last 10 recessionary environments, what tends to lead back on the upside is small-cap equities.”

— William Greiner, Chief Investment Officer of UMB Asset Management

“Like springtime crocuses, small-cap stocks flourish once the harsh cold of a bear market is over… Because small-caps are undervalued once the market turns around, they benefit disproportionately from an earnings recovery.”

— Larry Light, Wall Street Journal

Now, who knows when the bear market will end, or when the stock market will find a bottom? After the Dow’s 1,000-point rebound on October 13, we all hoped the worst was over. That rebound, however, proved to be nothing but a tease. Over the following weeks, the Dow proceeded to give back every one of those 1,000 points. Then stocks rocketed higher again…and then tumbled again.

Despite these 1,000-point gyrations, the Dow has managed to crawl almost 9% above its bear market low of 8,175. Unfortunately, the beleaguered index would need to gain another 60% to return to its all-time high! So that gives you some idea how far the mighty have fallen. And many of the less-mighty – the small cap stocks – have fallen even farther. But this is where our sad story takes a turn for the better: A lot of very fine stocks are wearing deeply discounted price tags.

Just look at a stock like Neenah Paper (NP: NYSE), a small-cap paper manufacturer that saw its share price slide 80% despite very solid fundamentals. Or look at stocks like chip-maker Silicom Ltd. (SILC: NASDAQ) or chemical manufacturer Buckeye Technologies (BKI: NYSE), both of which have solid fundamentals and P/Es under 7.

Even though the markets have been anything but kind to investors lately, a few courageous (and historically successful) investors are making a good case for buying up some undervalued stocks right now.

Warren Buffett, who has never claimed the ability to predict short-term stock market action, is one of the investors who is beginning to make some purchases. “A simple rule dictates my buying,” the Oracle of Omaha explains, “Be fearful when others are greedy, and be greedy when others are fearful.”

We agree…and we think it’s time to get greedy…at least a little greedy.

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Betting on Gambling
By Greg Guenthner

Warren Buffett amassed his multi-billion-dollar fortune by investing in companies that were both exceptional and exceptionally low-priced. In other words, he did not merely buy low-priced stocks; he bought the low-priced stocks of great companies.

In last year’s letter to shareholders, Buffett explained that he looks for businesses that he can understand, have favorable long-term economics, able management, and a sensible price tag. If you want to play off of Buffett’s strategy, the first thing you’ll want to look for is a business model you can count on.

Understanding what you own is an essential part of investing. During the tech bubble, as Internet companies grew at an impressive clip, Buffett stayed away, simply because he didn’t understand their business prospects. The decision turned prophetic when the bubble burst and online companies went belly-up one by one.

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down,” explains the Oracle of Omaha.

The computer hardware industry is also a prodigious consumer of capital, as is the auto industry. But the gaming industry is quite the opposite, which is one reason we like it, especially when the economy falls on hard times.

When the going gets tough, people count on Lady Luck to turn their misfortunes into riches. A Rockefeller Institute of Government study cited in a recent New York Times article reveals lottery revenue has experienced steady growth over the past decade. Even more telling is lotto’s highest rate of growth: during the post-Sept. 11 recession of 2001-2002.

Some may call it a case of misplaced priorities…but in times of financial stress, more people resort to gambling on lottery tickets to pull themselves out of economic hardship. In other words, you might not have the money for a new high-def flat-screen TV, but you can still pull a couple of dollars together every week for a chance at millions.

Even though most players know the chances of hitting that multimillion-dollar jackpot are slim, they’re willing to stay in the game… Here’s a telling quote from the piece in The New York Times:

“‘When people view themselves as doing worse financially, then that motivates them to purchase lottery tickets,’ said Emily Haisley, a postdoctoral associate at the Yale School of Management who in July published a research paper on lotteries in the Journal of Behavioral Decision Making. ‘People look to the lottery to get back to where they were financially.’”

Scratch-off tickets offer those with little disposable income a quick gambling fix. State-run lotteries have taken notice and have expanded their offerings to include slightly pricier scratchers with multiple chances to win. Costing anywhere from $5 to even $50, these tickets offer multiple chances to win bigger prizes. And the tickets still have the instant-win draw of the traditional $1 scratcher.

Massachusetts, the state with the highest per-capital ticket sales, recently introduced new instant-win tickets — a move that helped the lottery hit record sales topping $4.7 billion for the fiscal year. These new and improved scratchers are enticing many low-budget gamblers to take their chances locally, instead of traveling to casinos. Make no mistake about it — this is a huge draw.

The lotto industry’s recent bump in popularity coincides with a recent slump in national casino revenues. Take the grand-daddy of them all, Las Vegas. In 39 of the last 40 years, Vegas’s gambling revenues rose. Only one time during those 40 years did they fall. But this rare occurrence is about to repeat itself.
Revenues in 2008 are lower than last year’s. Apparently, Vegas is not as recession-proof as it used to be.

But most of the gamblers who can no longer afford the trek to Sin City can still afford to buy a scratcher or two. That’s why the lottery business is one of the very few that can flourish in good times and bad. I’d call that a solid bet.

Warren, if you’re reading this column, I’ve got some recommendations for you.

Joel’s Note: Greg is currently recommending one pure lottery play to his Bulletin Board Elite readers. The stock trades for less than a dollar and right now you have a chance to get in on it before it makes the jump…but you’ll have to be nimble. Grab all the Details Here

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[Rude Endnote: Investors saw an early mob rush after the weekend renegotiation of AIG’s taxpayer-funded lifeline. As has been the case with every single bailout since all this commotion began, the market rallied…and then realized what had just happened.

After an early mini-rally, the Dow resumed its seemingly endless downward spiral to close the session 70 points lower. Realizing they’d been had, Asian and European promptly surrendered Monday’s gains overnight too. The Hang Seng gave back 4.75% and the Nikkei 3%, while the Aussies and Brits coughed up 3.4% and 2.5% respectively.

Emergency sirens are not a cause for celebration, Rude reader; they are a reason to be fearful. When you hear politicians blabbering on about One World Economies, United Fronts Against Financial Crises, Universal Bailouts and the like, it might help to imagine them as an ambulance speeding towards your residence.

Before you cheer their arrival, ask why they are heading to your house in the first place. Then, when you find them in the living room affixing an oxygen tank to grandma, be sure to ask what they are filling it with.

Until next time…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com