Fagan Associates Archive for November, 2007

During this holiday shortened week of trading on Wall Street and amidst the recent carnage, indeed thus far a November the likes of which investors have not experienced since 1987, in a perverse manner investors should be ever cognizant for what to give thanks. It is with this in mind that we have created a short list of what, we as investment advisors are thankful for as we enter the final week of November.

The first thing we are thankful for is the fact that there remains only one trading week left to this miserable month! Going into trading this past Friday the Dow Jones Industrial Average had fallen 8.12% since the close of October. To find a month nearly as dismal we had to go back to 1987 when the Dow fell 8.02% during the entire month of November. One might ask, then why be thankful. It is with the belief that the next six months will be similar to the six months ending April 1988, a period of time that included that 8.02% plunge during November 1987. Those six months ended with the Dow Jones Industrial Average up nearly 11.00% from the lows set during that November! What would this mean for the Dow at their current levels? It would mean that the Dow would climb back neat its pre-correction drop of 14,190 by the end of April 2008.

The second thing that we, as investors are thankful for is the high degree of anxiety in the stock market as evidenced by the Chicago Board of Options Exchange Volatility Index affectionately known as the “VIX.” This index measures the implied volatility of the S&P500 over the next thirty days. Furthermore, it is an inverse predictor of the direction of the stock market. In other words, the higher it goes the more likely the stock market is bottoming out. We took a look at the recent level of “30%” registered on registered at the close of trading on November 12^th and compared this reading to similar levels over the past seventeen years and discovered of the 286 times volatility was this high, or in other words investors were as pessimistic, twelve months later the Dow Jones Industrial Average was an average of nearly 19.00% higher. Furthermore the Dow advanced 248 of the 286 times or nearly 87% of the time. Interestingly of the 38 times where the VIX was at least 30% and the market fell over the next twelve months, 36 occurred during 2001 when we were in the midst of the worst bear market in more than twenty-five years! Therefore, if you don’t think we’re entering a period of prolonged recession, the increased VIX is reason for optimism.

The third thing that investors should be thankful for is the strong global economy and the fact that our economy now represents less than 40% of total global economic activity as compared to 70% one-quarter of a century ago. Long ago investors adhered to the belief that “when the United States sneezes, the rest of the world catches a cold.” Although the recent economic slowdown in the U.S. is some cause for concern about the global economy, be thankful that we are less of 40% of global economic activity. The true engine of global economic activity is not the United States but rather the “BRIC” countries represented by Brazil, Russia, India and China, four countries whose total population exceed 2.75 billion people! The United States economy has a vested interest in moving these countries from third world to second world thereby creating a middle class. By helping to create a middle class in these countries through “fair trade” we are securing our own.

Finally, like all investment advisors, we are thankful for our men and women who are so valiantly serving in the military around the world, protecting our freedom. Being a history buff, this reminds me of that famous rallying cry of “freedom isn’t free!” Best wishes for a Happy Thanksgiving weekend!

Immediately after purchasing a stock, it is imperative to establish, monitor and sometimes adjust upward (but rarely downward) the price at which you are willing to sell.

The following scenarios may be cause for concern.

The revenue and per share earnings of the company fail to live up to Wall Street estimates for a given quarter. Ours is an industry of expectations and should a company fail to live up to these expectations, chances are that for some time the stock will have a difficult time making headway until it re-establishes its credibility. We apply the cockroach theory inasmuch that where you find one cockroach, there are usually many more. Furthermore, quite often, one bad quarter begets another. Despite the above, what would cause us to hold on to a stock is if the stock price responds positively despite the bad quarter. This is typically a sign that the stock has bottomed out.

There is a shake-up in upper management. Reorganizations quite often precede bad news and such a shake-up could be a telltale sign that some bad news is coming. The accompanying press release usually states that “so-and-so is retiring to ‘spend more time with his/her family.’” Once again, watch how the price of the stock reacts to the news of a change in management. Be observant, quite often, this could be a time to buy.

The reddest of flags pertains to undefined or defined accounting issues. Should a company (see Enron, Worldcom or Tyco) announce that they are conducting an internal investigation or, more worrisome, that the Securities and Exchange Commission is conducting either an informal or formal investigation into the accounting practices of the company, run for the door. Remember, when you sell a stock, you are not saying “no to the investment forever,” but rather “this doesn’t make sense right now.”

The final reason noted in this column pertains to the company changing its strategic direction. Quite often, when a company embarks in a new direction it is because the old direction was not working and that this new direction should be the panacea. However, this “new direction” is often laden with pot holes as the company finds its way. Better for an investor to step aside and take a wait and see approach rather than to continue on the same course.

Finally, as noted above, don’t just blindly sell a security should one of these events occur. Rather, wait and see how the stock reacts to the announcement. As mentioned, quite often, the reaction of other investors to these issues should ultimately determine your course of action. Should the stock rise, watch closely, but wait to sell. Should the stock fall, perhaps you should also exit. Either way, be disciplined in your approach to investing. Emotional decisions usually prove wrong.

Given the nature of our business, in our opinion the most obvious and effective way to give to a charitable organization is through a gift of appreciated stock. This is a win-win situation for both the taxpayer and the charity. The taxpayer can deduct the market value of the stock on the date of the gift and the charity gets the donation. Furthermore, by donating the appreciated stock rather than selling the stock and donating the cash proceeds, the taxpayer also avoids any capital gains tax. Please note that this only will work with appreciated securities within taxable accounts. Should you hold a stock that has depreciated in value, it is generally wise to sell the stock and donate the cash proceeds. Utilizing this method, the taxpayer can write off the capital loss up to current IRS limitations.

Readers will note that the above paragraph does not pertain only to appreciated stock, but rather to all appreciated assets, including bonds, mutual funds and real estate.

The Pension Protection Act of 2006 enables taxpayers age 70 ½ to exclude from adjusted gross income qualified charitable contributions up to $100,000 per year from either a traditional or Roth IRA. It is important to note that this provision within the Pension Protection Act is applicable only to charitable contributions made during calendar year 2006 and 2007 and is currently scheduled to expire on December 31, 2007. Prior to the passing of this legislation, a taxpayer would have to first withdraw the money from his IRA and then make the contribution. Many times this withdrawal resulted in the taxation of the Social Security Benefits of the taxpayer, reductions in property tax assistance and reductions in other government sponsored programs. This new law allows the taxpayer to circumvent this step thereby eliminating the prior pitfalls noted in the preceding sentence. Additional benefits to rolling over the IRA distribution directly to a qualifying charity is that this donation qualifies toward the owner’s minimum required distribution, but does not count toward the IRA owner’s maximum 50% cash contribution limit as a percentage of their adjusted gross income. (Please note that it is the responsibility of the donor to insure that the charitable organization meets the qualifications of the legislation.)

One final way to get into the charitable giving mood this holiday season is through gifts of life insurance policies. To accomplish this transfer, the current owner must name the qualified charitable as either the new owner or the irrevocable beneficiary. If the owner does one of these then he/she is able to obtain a tax deduction on the present value of the insurance contract or his/her accumulated premium payments, whichever is higher.

As always, please be sure to check with your tax advisor prior to making any sizable charitable contributions.