2007 YEAR END REVIEW©

JANUARY 2008

KJT INVESTMENTS SCORES “GRAND SLAM” IN 2007 AS WE CORRECTLY FORECAST FOUR MAJOR INVESTMENT EVENTS AND PROFIT FROM EACH ONE. FORECAST FOR 2008

In golf and tennis, a player is considered to have won the grand slam when he/she wins four major tournaments in one year. Since there were only four major investment events in 2007 and we correctly forecast and took steps to profit from each one, we feel justified in using the analogy. The four events and our strategies are as follows:

FIRST: Subprime mortgage meltdown: We have been advising our clients that the real estate situation was approaching a disaster for a few years. As a matter of fact, we successfully encouraged our clients to sell their residential real estate and a few took our advice and sold in 2006, just after the market peak. Last year, it became evident to us that the mortgage problem was reaching blow off territory so when others were predicting that MGIC (MTG) Mortgage Guarantee Insurance Co. was going to earn over $7.00 per share in 2007, we felt that was ridiculous and would probably earn only $ 3.50 as the losses in the mortgage insurance business started to increase. In November 2006, before the problem hit every one else’s radar, we sold the stock short. Then, in February 2007, when MGIC aligned with Radian, which had an even larger exposure to sub-prime mortgages, the stock shot up to $70 per share and we added to our position. Our average sale price was $64 per share. As the stock slid we watched it and on August 10, we covered our short position at $ 34 per share resulting in a 50 % profit. It might be noted that both Wachovia and Merrill Lynch rode the stock all the way down and it was not until August 10, the very day we covered Merrill Lynch finally issued a sell warning.

SECOND: Stocks were strong in the first half of 2007: We maintained our 100% exposure to stocks until July 24, 2007. We had forecast that stocks would be strong in the first half and then profits would peak and it would be time to move to Treasury bonds in the third quarter. When the Dow Jones Industrial Average rose to 14,017 and the S&P Index hit 1550 on July 19 and we had 5 days of good economic news but the indexes traded lower, we decided that it was time to move out of most stocks and sold 70 % of our portfolio at less than 2 % below the market peak. Two days later, the DJIA sold off over 400 points and that was the beginning of the downward move we had forecast. By the end of the year the DJIA had declined to 13,100 and the S&P index was at 1450.

THIRD: Return on Treasury Bonds beat stocks for the first time since 2002: The return on treasury bonds was so strong in the second half of the year that it beat the return on stocks for the entire year. As you all remember, we exited the bond market in early 2003 and started to build our new portfolio. We had taken all but 20 % of our profits from exiting the stock market in July and bought long term treasury bonds.

FOURTH: The decline in stocks made going short a profitable strategy: We replicated our short strategy that we had done regarding the mortgage collapse by taking 20 % of clients’ assets after selling in July and buying the ProShares Ultra Short S & P. By the end of the year that had resulted in a significant profit.

OUTLOOK FOR 2008-2009

We look for a down year for the stock market in 2008 and probably 2009. The reasons are both many and evident. Throughout our career, we have repeatedly made the point, and rightly so, that the stock market values were based on earnings and everything else is nothing but noise. This has been proven time and time again. For example, during the dot.com insanity or the late 1990’s, the analysts and academics invented new ways of looking at stocks and called them “new metrics.” There were such terms as “clicks” and “eyeballs”. This was because most of these new companies had no profits in their business models, and in order for the people on Wall Street to be able to sell the securities to the unwary public, they had to invent some way to assign a value to the securities. In 2000 this proved to be totally wrong as the NASDAQ index plummeted and now 8 years later is still down 50 % from its peak. Currently most of the analysts quoted are predicting earnings of around $90 for the S&P 500 stocks. The Index at 1450 is priced at a multiple of 16 times those predicted earnings. However, those expected earnings figures are absurd and show that most analysts are not playing with a full deck. We expect earnings to be slightly above $70 when the fourth quarter earnings are compiled. That will be down from earnings of over $80 in the fourth quarter in 2006 or over 12 %. This year we expect further earnings declines not increases. There are hundreds of billions of dollars of bonds on bad mortgages and derivatives such as Level 3 debt, collateral debt obligations (CDO’s), collateral mortgage obligations (CMO’s), structured investment vehicles (SIV’s) and other too numerous to mention that still have to be written down by the financial companies. They were able to escape the write-down’s last year because of accounting rules, but they will have to take them this year. For example, when Bear Stearns released their quarterly earnings, the company transferred $12 billion dollars from level 2 securities to level 3 and thus avoided having to take a write-down on their balance sheet and earnings. At this time Bear Stearns now has $25 billion on their books as level 3 securities and the company is capitalized at $12 billion; this means that if these level 3 securities only lose ½ of their value, which is probable, the company’s capital base will be wiped out. We also believe that the benefit that large companies have been enjoying due to currency exchanges will not occur this year. As the dollar declined over the past few years, international companies would receive a benefit when they reported earnings. We believe the dollar does not have much more to go on the decline and thus the artificial boost that earnings received will be mostly eliminated this year. Adding to that, the slowdown in the international economies will also lead to a decline in the earnings in the industrial section of the S&P 500 stocks. As an example, Sony (SNE) receives over 25% of their profits from sales in the United States. When we slow down on our purchases this cannot fail to have a deleterious effect on Sony’s profits.

Kevin J. Tierney
Registered Investment Advisor

 

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