By Keith Fitz-Gerald
Editor, Geiger Index
Investment Director
Money Morning Investment News/The Money Map Report

For many investors, a low Price/Earnings (P/E) ratio is a sign of value.

But don’t you bet on it — at least, not yet.

According to Michael T. Darda, chief economist for MKM Partners LLC, analysts have overestimated earnings by an average of 30% to 35% in the last three recessions. For millions of investors who use low P/E ratios as a litmus test for selecting their investments, that’s going to be a rather unpleasant shock.

If Darda is right, and our research seems to suggest he is, so-called “cheap stocks” may not be all that cheap. For proof, we can turn to some plain-old high school math. P/E ratios are calculated by taking the price of a stock (the numerator, or the “P”) and dividing it by earnings per share (the denominator, or the “E”). The higher the denominator, the lower the P/E ratio and, by implication, the cheaper a stock appears.

However, if higher denominators can make stocks appear “cheap,” then the opposite is true, too, and that suggests that stock prices may have a lot farther to fall — despite the fact that they’ve already tumbled 40% or more.

Just how much farther is anybody’s guess, but the outlook is not good.

For instance, according to Forbes writer James Clash, “more than a year into the market downturn that threatened Morgan Stanley’s (MS) survival, the 17 analysts covering the company cut their 2009 mean earnings estimates by 36% to $3.63 per share.” Given Darda’s observations, there may be another 35% to go, which would put total expected earnings cuts at 71%.

That sounds harsh, but it may not be out of line. Thompson IBES reports that the analyst community as a whole has cut 2009 earnings expectations by only 7.5% for the Standard & Poor’s 500 Index. If they are to be believed, that means that the analyst community expects the average S&P 500 company will have to grow earnings by 15% next year to $91, according to Clash.

We don’t know about you, but a time when recessionary flags are flying, we have a hard time buying that (pun absolutely intended).

That’s why — at the risk of igniting an e-mail firestorm — we point out that analysts are paid to have opinions and a huge body of evidence suggests that they’re strongly encouraged to make them bullish. Not only is this a cozy relationship for investment bankers in general, but it has historically helped Wall Street generate huge commissions from an anxious retail investing public that is desperately seeking good news. This bullish predisposition may be especially true at a time when investors are not inclined to buy — and with good reason.

Compounding the problem is the fact that many analysts focused on specific industries or companies tend to become quite myopic. Far too many don’t think outside the box and, as a result, are all too frequently surprised when macro-level events come crashing in on their little world and down on the companies they follow.

Investors who rely heavily on Wall Street analyst estimates are, in effect, driving down the highway using only their rearview mirror. The results are all too predictable.

Among the more infamous examples of these errant estimates was the group of analysts who, back in 2001, continued to recommend Enron Corp. stock all the way into bankruptcy and congressional hearings, based solely on their own “optimism.” Only when Enron shares were trading at less than $1 did the majority of analysts change their recommendations to a “hold.”

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When it comes to Wall Street, the fox clearly does guard the financial hen house, so to speak.

In the interest of fairness, we should mention that there were “accounting irregularities” in the Enron case. But that really shouldn’t let anybody off the hook.

What’s happening now — and why we’re leery that things may not be as they seem — is that overall business and economic conditions are deteriorating faster than management is willing to publicly acknowledge (although we’re now watching these same management teams slash work forces and shutter plants at a rate we haven’t seen in years). And since management “guidance” (the sarcasm you detect is intended) is what drives and shapes Wall Street earnings estimates, this is why things are probably going to get worse before they get better. The earnings figures used in most P/E calculations haven’t yet been reduced.

As for the ratings agencies such as Standard & Poor’s, Moody’s Investors Corp. (MCO) and A.M. Best Co., these, too, are problematic when it comes to the earnings and the ratings that help drive them. Supposedly independent, it’s been common knowledge for years on Wall Street that firms wanting higher ratings need only coddle the agencies using a combination of fees and information. Of course the agencies will deny this but history suggests that’s like the pot calling the kettle black.  Historically, for example, Moody’s, S&P and Fitch Ratings Inc., have each earned huge amounts of income from fees being paid by the issuers whose credit they’re supposedly rating. That’s changing, of course, but as the credit crisis has highlighted so aptly, probably not fast enough.

So what does work?

P/E ratios are a start. But that longstanding indicator should be regarded as a relative measure of potential price and performance rather than the do-all stock-screen selector so many investors utilize them as.

When we analyze a company, we prefer to see expanding sales, advancing earnings and plenty of cold hard free cash flow. There’s an old saying on Wall Street that “nobody ever went broke on accrual accounting,” but clearly plenty of companies have figured out lately that they can go broke without cash. The best example may well be Detroit’s Big Three, which are grappling with this seemingly new reality even though we, as individuals, deal with it every day. As my six-year old son recently stated: “No cash … no dinner.”

One other excellent indicator is a so-called “PEG” ratio (the P/E divided by the growth rate) of less than 1.0. While it’s more commonly viewed using 12 month trailing earnings, we find it much more stable when viewed against a historical stream of data that’s a decade or more in length. Not only does this help screen out the volatility associated with much shorter time periods, but we find that companies with low PEG ratios calculated in this manner seem represent good value over the longer term.

Especially when compared to a deflated “E” — earnings.

[Editor’s Note: The ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will help determine who wins and who loses. Investors who ignore this “New Reality” will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive — they will thrive.

Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as “The Golden Age of Wealth Creation.” But Fitz-Gerald brings more than a realization — and an understanding — to the table, here. After a decade of work, he’s also developed a new computerized trading model based on a mathematical concept known as “fractals.” This system allows him to predict price movements of broad indexes, or individual stocks, with a high degree of certainty. And it’s particularly well suited to the kind of market we’re all facing right now. Check out our latest report on these new rules, and this new market environment.]

News and Related Story Links:

• Wikipedia:
  Enron Corp.
• Money Morning Market Commentary:
  Fraud and Greed of Trusted Rating Agencies Helped Spread the Credit Crisis.

Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Nut job. Alarmist. Fear monger. Dr. Doom.

I’ve heard them all. When you make your living as a financial analyst and commentator, as I do, you aren’t going to get a lot of invitations to the ol’ country club – especially if you spend a lot of time spotlighting the problems that are created by greedy Wall Streeters, sleepwalking regulators, or indentured elected officials.

But when you repeatedly warn investors that the U.S. financial system is on a collision course with disaster, and state that some investors will experience "extinction-level events" – and when you broadcast these warnings when virtually everyone else is in denial and is dismissing the market problems as "minor" – you’re bound to become a marketplace outcast.

Until, of course, your predictions are proven correct.

We may be hearing from my critics again – and soon – for I’ve got another prediction they aren’t going to like.

There clearly are countries – such as the United States and much of the European Union – that are going to collapse into recession, even if only unofficially. But this doesn’t necessarily have to evolve into a global recession – a position that most of the traditional Wall Street establishment disagrees with, by the way.

Let’s take a look at several of Wall Street’s current misconceptions – and see why I’m selectively bullish:

• The Red Dragon (China) is ready to hibernate: Wall Street is worried that a U.S.-induced recession will slay the Red Dragon. There’s no way. If a country can fall into a recession when its economy (as measured by gross domestic product, or GDP) is advancing at a 9.6% clip – at a time when its U.S. counterpart will be lucky to eke out a 1.0% growth rate – well, I’ll eat my hat. The Armani Army, in its infinite wisdom, is worried about a recession in China even though its $1.9 trillion in foreign reserves are more than 32.10% of GDP and external debt is a miniscule 7.6% of GDP (external debt is defined as the amount of debt that China owes external creditors, including consumers, central governments and commercial institutions, according to the CIA Fact Book). By contrast, the U.S. reserves are 4.84% of GDP, while external debt is 84%. The United Kingdom and Switzerland are in even worse shape, with external debt of 382.2% and 279.1%, respectively.
• China won’t be able to survive a drop-off in exports to the United States: Then there’s the myth of China’s export economy. The last time China took a header and export business dropped by 35%, its GDP dropped by less than 1%. I’m betting it will be an even smaller bump this time around, especially since China’s middle class now is increasingly responsible for internal growth – independent of what China exports to the rest of the world.
• The Asian economies are an economic train wreck just waiting to happen: This was true a decade ago, when the United States and Western Europe held all the cash. But no longer. Today, nations such as Singapore, Thailand and Malaysia are running trade surpluses. So is Canada. That suggests that the currencies of these countries are significantly undervalued at a time when their economies are increasingly tied to that of China. What does that tell us? Today, China is the growth engine of Asia; tomorrow, it will be the growth engine of the world.
• The U.S. economy remains the financial center of the world: Today, an estimated 78% of global economic activity takes place outside U.S. borders, which means that even in a recession, an increasing amount of capital circulates beyond the U.S. shores. Indeed, the U.S. stock market now represents less than 30% of total world market capitalization, down from roughly 45% as recently as 2004. Don’t be surprised to see the United States continue to decline in economic relevance. One day, the lion’s share of the financial trades will take place beyond U.S.  borders.
• Because it’s a developed market, the United States remains the world’s safest and most promising place to profit: In the 1980s, the United States accounted for one-third of the global economy; by 2030, that ratio will be cut in half. The reality is that U.S. investors who want to be successful in the years to come will have to learn all they can about markets whose names they can’t yet pronounce.

Wall Street may not agree, but the real adage to embrace and remember is this one: It’s easier to become No. 1 than it is to stay there.

There’s no doubt that the "experts" who are projecting that the world markets will decline further and perhaps even collapse will take issue with my analysis. But it’s important to note that I agree with you – at least in the near-term. Barring a governmentally induced Hail Mary, I think there’s no question that the worst remains ahead of us.

But longer term – I’m talking three, five to 10 years – I am intrigued by the fact that so many emerging markets have collapsed in the chaos, even though the underlying economies haven’t really changed. Everything we know about financial markets history and changes in market behavior suggests that countries backed by high cash reserves tend to emerge from periods of market chaos faster – and stronger – than the economies that had been at the top of the heap when the crisis first struck. [For some insight into which countries have the biggest reserves as a percentage of GDP, take a close look at the accompanying chart].

Where does that leave us? Well, in spite of what Wall Street would have us believe about the Red Dragon, this cash-reserves indicator suggests that China – and countries that have close economic ties with that country – may actually be getting more attractively valued (and not less) by the minute. That’s especially true for longer-term investors.

As for the types of investments that seem most promising, given the troubled times we live in, keep focused on the simple ones. As I’ve long suggested, such simple profit plays have always played well during periods of similar market turmoil. So there’s no reason to believe it will be any different this time around.

After all, the financial history books are filled with notable examples of real earnings and real products enjoying success over long periods of time. Particularly when those profits are being generated by companies focusing on such basic societal needs as energy or infrastructure. Barring a complete collapse in the oil business (or any perfect substitute that’s eventually developed), energy, commodities and infrastructure companies will continue to offer solid upsides.

As for the U.S. dollar, after years of benign neglect, the U.S. Federal Reserve and U.S. Treasury Department will do everything they can to prop up the credit markets, In the short term, most investors will misconstrue this as a legitimate rise, all that’s really happening is that longstanding risks are being overcome by governmental guarantees.

Longer term, the damage has been done. No nation I am aware of in recorded history has done more than temporarily dodge the inevitable by debasing its currency as the United States is doing right now. And that’s why – at the risk of inflaming yet another bunch of Wall Street folks – I’m increasingly of the opinion that the United States is headed for a major currency crisis in the next few years. Wall Street doesn’t see it, and I sure hope that I’m wrong.

For the same set of reasons, I don’t think that investors should be the least bit surprised if U.S. regulators (in conjunction with their counterparts overseas) actually shut down the financial markets for a week or two while they try to sort out the credit crisis and reevaluate currency relationships that are right now being pushed to the brink of oblivion.

While this is regarded as impossibility by many – and simply incomprehensible by others – Bloomberg News reported Oct.10 that Italian Prime Minister Silvio Berlusconi said world leaders were discussing shutting down global exchanges. He later retracted his comments, saying that he didn’t mean what he said.

But I think he (Berlusconi) did, and I believe they (U.S. regulators) are.

There are historical precedents for so-called "bank holidays," even here in the United States. In fact, the New York Stock Exchange closed its doors from March 4-14, 1933 as part of U.S. President Franklin Delano Roosevelt‘s forced holiday (Emergency Banking Act), and did so again from Sept. 11-17, 2001 following the terrorist attacks against the US.

In both instances, what’s critical to understand is that the closures were designed as part of a government plan and not an overall solution. If not backed by a plan or ultimate objective, a shutdown would simply delay the inevitable, or move additional losses offshore until the U.S. markets were to reopen. Thus, even though a bank holiday would provoke terror among most investors, a globally coordinated stock market closure could also be viewed as a tremendous sign that central bankers and regulators finally understand the gravity of the situation we’re facing today and literally rewriting the rules of finance in a united, global front.

That’s why this reminds me of iconic investor Warren Buffett, who once reportedly quipped that investors shouldn’t buy anything they wouldn’t want to own for five years, if the markets were to close for that period.

Or something to that effect…

News and Related Story Notes:

• Wikipedia:
  Silvio Berlusconi.

• Wikipedia:
  Bank Holidays.

• Wikipedia:
  Franklin Delano Roosevelt.

• Wikipedia:
  Emergency Banking Act.

• Money Morning Analysis:
  Railroad Play Burlington Northern Hauling Gains for Warren Buffett’s Berkshire.

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

I’ve been predicting record oil prices for a number of years now, so when crude oil prices recently plunged from their record highs, I warned investors and consumers that the decline was nothing more than a temporary respite.

But the fallout from the current $700 billion banking bailout pact now strongly suggests that my prediction will come true.

As the curtain closed on the third quarter yesterday (Tuesday) – leaving many investors worried that the long-feared “Super Crash” was imminent – crude-oil futures were staring at their first decline in seven quarters and their biggest quarterly decline in 17 years, thanks to worries that a slowing economy would curtail global demand. By the end of trading yesterday, crude oil for November delivery had dropped $39.36 a barrel – or 28% – during the third quarter to close at $100.64.

It’s been a volatile market, too. Oil traded within a $56 range during the quarter, reaching a record $147.27 a barrel on July 11 and retreating to as low as $90.51 a barrel on Sept. 16, Bloomberg News reported. Oil futures moved 5% or more during one quarter of the trading days.

Analysts repeatedly said this decline was merely the beginning, and that with a global economy that had been severely singed by the U.S. credit crisis, oil prices had nowhere to go but down.

But I continued to make the opposite argument. And a week ago, the markets made my point for me. On Sept. 22, crude oil futures for October delivery soared $16.37 a barrel, or 15.7%, to close at $120.92, after trading as high as $130 a barrel – thanks to a steep decline in the U.S. dollar and to speculation that the Bush administration’s plan to bail out the financial sector might actually jump-start the U.S. economy, fueling inflation in the process. The gain surpassed the previous record single-day-price gain of $10.75 a barrel, a move that occurred on June 6. [The biggest-ever percentage gain in a single day - 20.9% - was recorded on Jan. 3, 1994, according to FactSet Research Systems Inc.]

This record one-day surge a week ago caught many by surprise and jump-started speculation about whether oil prices will rise or fall from here.

Any disciples of doubting Thomas must only look at the reaction to the different phases of the bailout negotiations this week to see that the market has spoken again. Crude oil for November delivery dropped $10.52 a barrel, or 9.8%, to close at $96.37 on Monday after the House of Representatives rejected a Bush administration bailout plan. But that was a knee-jerk reaction to a worry that the lack of a bailout pact might spawn a recession.

Yesterday, however, crude oil futures rebounded $4.27 a barrel, or 4.4%, after analysts realized, upon reflection, that the U.S. economy – together with the global demand for oil – wasn’t about to just disappear. And that wasn’t even an actual bailout proposal in place. When a pact is signed – as most analysts figure it will be – crude prices will likely rebound even more.

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The Outlook for “Black Gold”

In the extreme short term, oil’s probably going to bounce around the psychologically important $100-a-barrel mark – if not a little higher – as the U.S. government works to sort out the financial crisis.

The reason is that any “recovery,” or bailout, is intended to strengthen the flagging U.S. dollar. And a rising dollar tends to push crude prices lower because crude is traded mostly in U.S. dollars around the world.

So, as much as most of the world looks to Organization of the Petroleum Exporting Countries (OPEC) to determine the price of oil, the more important influencers in the near term actually are U.S. Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. – the Batman (Bernanke) and the Boy Wonder (Paulson) of Washington’s bailout set.

The $700 billion banking bailout package proposed by this “Dynamic Duo” directly impacts the flagging U.S. dollar. And the dollar, for reasons we’ve just explained, helps determine oil prices.

There are exceptions, of course, but the relationship between currencies and oil prices generally suggests that 90% or more of the decline in price that crude oil has experienced since mid-summer can be accounted for simply by how much the dollar has risen since July.

But here’s the trick – the reverse is also true.

We mentioned inflationary pressures before. Well, if Congress actually passes the bailout plan, another $700 billion would be pumped into the world financial system. And that would mean far higher prices are ahead. We’re talking Econ 101 here: Every one of the bailout bucks dilutes the buying power of every other dollar already in circulation. That erosion in buying power is the textbook definition of inflation.

In fact, that’s just how it played out this week. When the bailout plan was rejected Monday, meaning those bailout bucks wouldn’t be joining the financial system, oil prices fell precipitously, since there would be no additional inflationary pressures. But when investors started to rethink that thesis Tuesday – meaning they believed some sort of new bargain would be reached – oil prices reversed course and rose in anticipation of that money possibly being pumped into the financial system.

While a bailout could jump-start the financial markets for a while, history suggests that over time the “cost” of the liquidity Bernanke and Paulson have cobbled together may manifest itself in the form of far higher oil prices. Other commodities would rise significantly, too. Investors have only started to see this outcome.

So, what happened back on that Monday, Sept. 22, when oil prices made that record one-day run?

My experience as a professional trader makes me think that somebody simply got trapped on the wrong side of the markets and was trying to cover a humongous position at any cost.

And what I saw on my screens seems to confirm that. It was a late-session spike at a time when traders either had to get in line for delivery or unwind their positions before the October crude futures contracts expired. With a mere 30 minutes remaining, there were no sellers to balance prices, while the market makers who normally would provide a modicum of orderly behavior were nowhere to be found amidst the chaos.

Five Points to Bank On

What’s likely to happen longer term? Simple. In fact, here are five points you can take to the bank.

• First, global oil demand is still accelerating and, according to the United States Energy Information Administration (EIA), will reach more than 115 million barrels per day by 2030 – even with conservation efforts and high prices stunting demand.

• Second, daily production has probably peaked right now at nearly 90 million barrels a day, or will peak in a few years at the very latest. While experts once debated the reality of the “Peak Oil” concept, they now accept it and only question when it will take hold.

• Third, the world’s fastest growing economies, China and India, are still increasing consumption at double-digit rates, and that more than offsets any conservation efforts that are under way elsewhere around the world. And their governments want to buy oil at any cost – even if that means there’s none left for us.

• Fourth, the world will learn one day – probably sooner rather than later – that Saudi Arabia’s vaunted reserves are nowhere near what it claims them to be, and those reserves are certainly not at the levels long held as “gospel” in the oil business. Matthew Simmons, chairman of the Houston-based investment bankSimmons & Co. International and author of the seminal 2005 book, “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy,” has been most vocal about this alleged shortfall, and I respect his work, especially since I’ve spoken behind closed doors with several OPEC figures who privately acknowledged that this may be their worst nightmare. Simmons recently predicted that oil prices would rally to $500 a barrel.

• Fifth, Bailout Ben has dropped trillions into the system to stabilize the Wall Street while Paulson has broken out his bazooka which suggests that as much of 95% or more of oil’s price drop can be attributed to nothing more than the dollar’s rise since July. Nothing else has changed.

Should traders see through the smoke and mirrors or simply decide to run for the exits, we can expect to see the dollar shrink to new lows and oil to rise to new highs in a perverse flight to quality.

Only this time, this “quality” is literally quite crude …

[Editor's Note: With the U.S. financial markets in such disarray, Money Morning is looking for profit opportunities beyond U.S. borders: For instance, just check out this new report on a Wisconsin-based company we've discovered that's posting quarter after quarter of earnings surprises - while the rest of Wall Street tanks. Not only does this company have a lock on China - the fastest-growing market on the planet - this corporate gem is also riding the profit wave of the most-powerful global trend that we're following right now. If you act on this opportunity now - as an added bonus - you'll also receive a free copy of CNBC analyst Peter D. Schiff's New York Times best-seller, " Crash Proof: How to Profit from the Coming Economic Collapse."]

News and Related Story Notes:

• Money Morning News Analysis:
  Crude Oil Futures Post Record Gain as “Peak Oil” Expert Calls for Rally to $500 a Barrel.
• Bloomberg News:
  Oil Plunges Most in 17 Years in Third Quarter on Economic Woes.
• Wikipedia:
  Organization of the Petroleum Exporting Countries.
• Wikipedia:
  Energy Information Administration.
• Money Morning Special Investment Research Report:
  Special Report: Hit the BRICs for a Global-Investing Double Play (Part I – Brazil and Russia).
• Money Morning Special Investment Research Report:
  Special Report: Hit the BRICs for a Global-Investing Double Play (Part II – India and China).
• Wikipedia:
  Peak Oil.
• Money Morning Market Analysis:
  Crude Oil Futures Post Record Gain as “Peak Oil” Expert Calls for Rally to $500 a Barrel.
• Money Morning Special Investment Research Report:
  Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China.

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

If there’s one lesson you can take away from this financial crisis, it’s this: Whenever the U.S. Federal Reserve squares off against the financial markets, it ends up as the loser.

In recent weeks, I’ve written several articles suggesting that the credit crisis isn’t over and detailed the three indicators that led me to this conclusion – despite what the politicians, the pundits and all the other so-called "experts" would have you believe.

Now, there’s a fourth.

It should come as no surprise that there’s more distressed debt trading right now than at any other point in history – nearly $184 billion worth. And that’s just the "official" tally; we know that the actual total is much higher – it just hasn’t been fully tallied and reported, yet.

Historically, large levels of distressed debt have preceded record numbers of bankruptcy filings – including some of the biggest corporate bankruptcy filings in history. Default ratios usually peak 12-24 months after the distressed-securities ratios reach their own apex. In other words, both the level of junk debt and the classification of distressed securities can be viewed as leading indicators.

And what they suggest for 2009 isn’t good.

In an era of trillion-dollar problems, a mere $184 billion doesn’t sound like much, but that total actually is 11.52% higher than the $165 billion in distressed debt reported immediately after the last bankruptcy boom, according to Moody’s Investors Service (MCO).

Analyst Christopher Garman, former head of high-yield strategies at Merrill Lynch & Co. Inc. (MER) recently told Reuters that the current level of distressed debt suggests nearly $97 billion in defaults could be headed our way next year.

Even now, the problem is so acute that one in every three junk bonds is now trading at "distressed levels" – defined as an interest rate that’s 1,000 basis points or more above comparable Treasury securities. That means that 33% of the junk bonds out on the market aren’t worth the paper that they’re printed on.

At a time when the U.S. economy is struggling with a credit crisis, high energy prices, these distressed-debt issues could end up squeezing profit margins, increasing default rates, and dramatically boosting borrowing costs – any or all of which could feed into a self-repeating cycles.

General Motors Corp. (GM) and Ford Motor Co. (F) lost their investment-grade debt status years ago. But for other companies embroiled in the derivatives markets and the subprime mess, this is an uncomfortably new phenomenon. And that’s why their leaders are "shocked" to find that normal financial channels are no longer open to them.

No wonder so may CEOs are sitting behind their finely turned mahogany desks, feeling the waves of panic rising inside themselves as they realize the bond markets are telling them that they won’t be around long enough to collect on their gilt-edged retirement plans (Ironically, however, the same signals may be telling those same CEOs that it’s increasingly likely they’ll be collecting on their "golden parachute").

Obviously, there are two sides to the story here.

On one hand, U.S. Federal Reserve Chairman Ben S. Bernanke, and now U.S. Treasury Secretary Henry M. "Hank" Paulson Jr., have literally pulled out all the stops to keep this from happening. Clearly, this "Dynamic Duo" believes that by saving individual companies via their "bailouts for (almost) all" strategy, they will save the entire economy. So what they’ve done is to make it possible for firms that are in such deep trouble that they can’t obtain loans anywhere else to be able to borrow from the federal government – and on very favorable terms.

Ostensibly, this is a very good thing – or, at least, the feds would have us believe so.

But a super-close inspection suggests the opposite is true.

Of course, in the process the Fed Bailout Brigade has put every U.S. taxpayer in the recovery business to the tune of $10 trillion (or more) – but that’s another story for another time.
 
The scramble to save American International Group Inc. (AIG) has resulted in an $85 billion bailout package with terms so onerous that one analyst likened it to a "controlled bankruptcy."

And where there’s smoke there’s fire. As the assets of Lehman Brothers Holdings Inc. (LEH) and AIG are both sold into a depressed market, the net effect will be a spread of this contagion to the rest of the financial-services sector – which includes investment banks, thrifts, and hedge funds holding similar assets. That will further pressure already-skittish markets.

Unfortunately, history shows that more often than not when the Fed has squared off against the markets, the Fed ends up as the loser. That’s why we’ve been such vocal critics of the central bank’s moves since this crisis began, stating that its unprecedented interventions would do nothing more than delay the inevitable pain.

We wish the opposite were true.

News and Related Story Links:

• Wikipedia:
  Distressed securities.

• TheStreet.com:
  Leading Economic Indicators.

• Wikipedia:
  investment-grade

• Wikipedia:
  Golden parachute.

• Wikipedia:
  Henry M. "Hank" Paulson Jr.

• Bloomberg News:
  AIG Falls on Concern Shareholders Will Be Wiped Out.

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

During a two-year stretch every 20 years or so, the Standard & Poor’s 500 Index can be expected to lose 35% or more of its value.

In 1974, according to research by Ibbotson Associates, that truism manifested itself as a 37.25% downdraft. It was even worse in 2002, when investors received a 41.65% haircut.

As bad as those downturns were, they were a mere shadow of the poleaxing investors received in 1932 – during the depths of the Great Depression – when the U.S. market plunged 80%.

But uncertainty breeds opportunity – and in the financial markets uncertainty can bring with it some of the biggest profit opportunities you’ll find. Investors who are able to strike a balance – managing their risks as they capitalize on the opportunities the uncertainty creates – will position themselves for some potentially handsome long-term profits. To help you strike this balance, I’m breaking out my market-survival kit – what I like to refer to as my “Three Keys to Success in Volatile Markets”:

• Control what you can; manage what you cannot.
• Always remember that it’s harder to get out of a trade than it is to get into one.
• Ban wishful thinking from your investment analysis.

Let’s take a look at these one at a time.

First, there’s a reason I say to “control what you can, manage what you cannot.” Financial markets can – and often do – fall much more frequently than we’d care to admit, and often for reasons well beyond our control (even though we’d like to believe otherwise).

What this means, in very plain English, is that big declines are part of the investing landscape and that we need to be prepared for them – not just some of the time, but all of the time.

When investors read this rule, their initial thought usually is that it’s meant as a warning – telling them to avoid big losses. The reality is that this rule was put in place to ensure big gains.

Time and again, history demonstrates two key facts:

• The biggest stock-market returns go to investors who put capital into play when the markets are at their worst – think of the profits reaped by investors who took the plunge in 1932, 1942, 1982 and 2003.
• And that the worst returns go to those who invest when markets are highest – think 1928, 1969, 1999, and 2007.

The trouble is that – as sound and clear as this bit of market wisdom actually is – it runs completely counter to what investors’ emotions tell them to do (or not to do) in their quest for profits.

Sign up below… and we’ll send you a new investment report for free: “The Three Best Investments in Asia.”

That brings us to volatile-market success key No. 2: It’s harder to get out of a trade than it is to get into one.

Few things are as intimidating as selling an investment, particularly when it’s one we “love” to own. Once again, the “why” of this reality really doesn’t matter, although psychologists who study this sort of thing suggest we hate being “wrong” more than we hate losing. Of course, that’s why “the crowd” is wrong much more often than it’s right.

And that (at least partially) explains why so many people would rather go off the cliff with the herd than step aside when it’s appropriate to do so. It’s easier to be wrong with the crowd than to risk going against what “everyone” believes to be true.

When push comes to shove, there are all kinds of rational decisions we should be making, but don’t, because of how we’re hardwired inside.

We’ve all made the same mistake and held on to an investment when we shouldn’t have – all too often riding what should have been a small loss into a very big one, because we couldn’t bring ourselves to sell, even though we intuitively knew that was the right move to make.

That last point is precisely when we repeatedly counsel investors to instill a kind of structured discipline in their approach to investing. The best way to do this is through the use of so-called “trailing stops” at all times. Not only can they keep small losses from turning into big ones, trailing stops can also lead to significantly higher portfolio returns over time by making sure you lock in at least a portion of your gains on a profitable position.

Some experts, such as Investor’s Business Daily’s William J. O’Neill, advocate rather tight stop-losses, or trailing stops, of 7% to 8%. Others, like my good friend Alex Green – the Oxford Club investment director and author of the new book, “The Gone Fishin’ Portfolio“ – suggest 25%, depending on market conditions. Even the “Wizard of Wharton,” Jeremy Siegel, agrees with their use, and notes in his best-selling book, “Stocks for the Long Run,” that there is “no question” [the use of trailing stops] even with transaction costs, avoids large losses while reducing overall gains only slightly.”

Finally, I tell investors to ban wishful thinking from their analysis for a simple reason – it clouds their judgment.

 In March 1994, Money magazine published a list of the “Eight Investments That Never Lose Money.” Back then, as now, the stock market had dropped, interest rates were rising and the dollar had cratered.

By the end of that year, six of the eight “can’t lose” investments were, well, losers – and in the red.

So, what are some concrete steps you can take to incorporate these three snippets of wisdom into your investments? Let’s take a look:

• To control risk that would otherwise swamp your portfolio, invest in a good balanced fund and make it the cornerstone of your entire investment portfolio. Our favorite, hands down, is Vangard Wellington (VWELX). Since 1929, this powerhouse has captured more than 80% of the stock market’s returns, but with nearly 50% less risk, thanks to the 60/40 split it maintains between stocks and bonds.
• Mandate the use of a 25% trailing stop (or some other percentage that fits your ability to tolerate risk). But use the stops. That way you’ll keep small losses from becoming large ones and probably capture more than a few big gains in the process.
• Concentrate on what the markets are actually doing rather than what you think they ought to be doing. And remember, as Warren Buffett so eloquently said, “it’s better to be approximately right than precisely wrong.”

Especially in today’s markets.

News and Related Story Links:

• Investment U:
  Alexander Green.
• Amazon.com:
  “The Gone Fishin’ Portfolio: Get Wise, Get Wealthy…and Get on With Your Life,” by Alexander Green.
• Wikipedia:
  The Great Depression.
• Investment U:
  Trailing Stops.
• Wikipedia:
  William J. O’Neill.
• JeremySiegel.com:
  Professor Jeremy J. Siegel.

[The Second of Two Parts.]

 Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

VANCOUVER, B.C. – Despite its many problems, China remains such a strong long-term profit play that giving up on that country now would be like selling all your U.S. stocks at the start of the 1900s – before America created massive wealth by evolving into a world superpower, global investing guru Jim Rogers said in an exclusive interview with Money Morning.

“I have never sold any of my Chinese companies,” Rogers said. “You know, selling China in 2008 is like selling America in 1908. Sure, let’s say the market goes down another 40% – so what! You look back over 100 years, you look back from the beauty of 1928, or even 1938 [in the depths of the Great Depression], and there is somebody who bought shares in 1908. He was still a lot better off having not sold in 1908.”

During a 40-minute interview during a wealth-management conference
in this West Coast Canadian city last month, Rogers also said that:

• The anti-travel policies China has put in place to reduce gridlock and slash pollution during the Summer Olympic Games may
  actually have created a “bottom” in China stocks – possibly creating a great entry point for long-term investors.
• The 34-day worldwide Olympic torch relay leading up to the opening ceremonies likely re-awakened China’s deeply felt nationalism – which will be key as that country strives to build demand for its domestically produced products.
• And noted that the country must still deal with such problems as pollution, rising inflation and an overheated economy.

A long-time China bull, Rogers first made a name for himself with The Quantum Fund, a hedge fund that’s often described as the first real global investment fund, which he and partner George Soros founded in 1970. Over the next decade, Quantum gained 4,200%, while the Standard & Poor’s 500 Index climbed about 50%.

It was after Rogers “retired” in 1980 that the investing masses first really got to see him in action. Rogers traveled the world (several times), and penned such bestsellers as “Investment Biker” and the recently released “A Bull in China.” He also made some historic market calls: Rogers predicted China’s meteoric growth a good decade before
it became apparent to everyone else, and he subsequently foretold of the powerful updraft in global commodities prices that’s fueled a year-long bull market in the agriculture, energy and mining sectors.

Rogers’ candor has made him a popular figure with individual investors, meaning his pronouncements are always closely watched. Here are
some of the highlights from the exclusive interview we had with the author and investor, who now makes his regular home in Singapore:

Keith Fitz-Gerald (Q): There’s a lot of talk that the Chinese will
use the Olympics to launch a new wave of nationalism and to move ahead. Are the Olympic Games as relevant as some
people think?

Jim Rogers: They’ve already got tremendous nationalism. But the international reactions about Tibet and the Olympic torchbearers re-awakened it.

And the politicians, of course, need it because they’ve got their own problems with
inflation and overheating and [pollution and] the rest of it.
So, like politicians throughout history, they fan it – do their best to say: Hell, it’s not our problem. It’s the evil farmers. It’s the French. See that store over there: It’s their fault. It’s the Americans.”

So that is happening, anyway.

As far as the Olympics themselves, they’re irrelevant.

America had the Olympics in
’96 and it had no effect on the American economy – before or after. Some people in Atlanta were affected before and after. And some people who were involved with the Olympics were affected before and after.

America at that time had 270 million people. China’s got five times as many people, and it’s a much bigger country geographically.

Sydney, Australia had the 2000 Olympics. It had virtually no effect on the Sydney, or on the Australian economy – even though Australia had 18 million people. It’s tiny … nothing. Yes, it had an effect on some people.

Greece, in 2004, had the Olympics. You haven’t heard stories of a major collapse or a major revival of Greece in 2005, because the fact is that the Games didn’t have much of an effect – not a noticeable effect, anyway. It had spot effects only, so I ignore the Olympics as far as the Chinese economy – and its stock market – is concerned.

(Q): Are you still bullish on China?

Rogers: Oh, yeah. I never sold anything in China. In fact, I bought more. I bought Chinese Airlines (PINK: CHAWF) last week. I flew one coming here. Maybe I made a mistake [with the investment], because it was emptier than I thought it would be.

(Q): Any thoughts why?

Rogers: One thing, you know, is that China’s made it extremely difficult to get a visa right now. In the past, it’s been hard to get a seat because Chinese airlines were so full. On this flight there were empty seats.

That brought home to me that they are cutting back enormously on visas right now. Discouraging travel, trying to clean the air, trying to protect against somebody blowing up the Forbidden City, et cetera. So the fact that planes are empty right now may be smarter than I thought.

Maybe I did get the bottom on the airlines, because if they are going to reissue the visas again, after all this, after September [after the Olympic Games have concluded], then the planes are going to fill up pretty quickly again. I would have picked the stock up at a bottom.

(Q): Yes.

Rogers: Anyway I’m still around China. I have never sold any of my Chinese companies. You know, selling China in 2008 is like selling America in 1908. Sure, let’s say the market goes down another 40% – so what! You look back over 100 years, you look back from the beauty of 1928, or even 1938 [in the depths of the Great Depression], and there is somebody who bought shares in 1908. He was still a lot better off having not sold in 1908.

[Editor's note: After interviewing legendary investor Jim Rogers
at his home in Singapore back in March, Investment Director Keith Fitz-Gerald caught up with Rogers again in July - this time in Vancouver, where both were speaking at the Agora Wealth Symposium. In Part 1 of this two-part series, Rogers talked extensively about the ill-advised bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and the potentially ruinous fallout from the financial "Super Crash" that's about to engulf the U.S. market. In this second installment, Rogers emphasizes China's long-term profit promise - something he highlighted in his recent bestseller, "A Bull in China," which contains detailed research on dozens of China's top stocks. To find out how to get a report on the once-in-a-lifetime profit plays available in China - and how to also get a free copy of "A Bull in China" - please click here. Part 1 of this Money Morning interview with Jim Rogers ran yesterday (Tuesday).]

News and Related Story Links:

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part I):
  Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years.
  |
• Money Morning Exclusive Jim Rogers Interview From Singapore (Part I):
  Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve.

• Money Morning Exclusive Interview From Singapore (Part II):
  Jim Rogers: China’s Economic Advance is All But Unstoppable

• Wikipedia:
  The Forbidden City.
• Official Web Site:
  Beijing Summer Olympics.
• Wikipedia:
  The Great Depression.

[The First of Two Parts.]

Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

VANCOUVER, B.C. – The U.S. financial crisis has cut so deep – and the government has taken on so much debt in misguided attempts to bail out such companies as Fannie Mae (FNM) and Freddie Mac (FRE) – that even larger financial shocks are still to come, global investing guru Jim Rogers said in an exclusive interview with Money Morning.

Indeed, the U.S. financial debacle is now so ingrained – and a so-called “Super Crash” so likely – that most Americans alive today won’t be around by the time the last of this credit-market mess is finally cleared away – if it ever is, Rogers said.

The end of this crisis “is a long way away,” Rogers said. “In fact, it may not be in our lifetimes.”

During a 40-minute interview during a wealth-management conference in this West Coast Canadian city last month, Rogers also said that:

• U.S. Federal Reserve Chairman Ben S. Bernanke should “resign” for the bailout deals he’s handed out as he’s tried to battle this credit crisis.
• That the U.S. national debt – the roughly $5 trillion held by the public– essentially doubled in the course of a single weekend because of the Fed-led credit crisis bailout deals.
• That U.S. consumers and investors can expect much-higher interest rates – noting that if the Fed doesn’t raise borrowing costs, market forces will make that happen.
• And that the average American has no idea just how bad this financial crisis is going to get.

“The next shock is going to be bigger and bigger, still,” Rogers said. “The shocks keep getting bigger because we keep propping things up … [and] bailing everyone out.”

Rogers first made a name for himself with The Quantum Fund, a hedge fund that’s often described as the first real global investment fund, which he and partner George Soros founded in 1970. Over the next decade, Quantum gained 4,200%, while the Standard & Poor’s 500 Index climbed about 50%.

It was after Rogers "retired" in 1980 that the investing masses got to see him in action. Rogers traveled the world (several times), and penned such bestsellers as "Investment Biker" and the recently released "A Bull in China." And he made some historic market calls: Rogers predicted China’s meteoric growth a good decade before it became apparent and he subsequently foretold of the powerful updraft in global commodities prices that’s fueled a year-long bull market in the agriculture, energy and mining sectors.

Rogers’ candor has made him a popular figure with individual investors, meaning his pronouncements are always closely watched. Here are some of the highlights from the exclusive interview we had with the author and investor, who now makes his home in Singapore:

Keith Fitz-Gerald (Q): Looks like the financial train wreck we talked about earlier this year is happening.

Jim Rogers:  There was a train wreck, yes.  Two or three – more than one, as you know.  [U.S. Federal Reserve Chairman Ben S.] Bernanke and his boys both came to the rescue.  Which is going to cover things up for a while.  And then I don’t know how long the rally will last and then we’ll be off to the races again.  Whether the rally lasts six days or six weeks, I don’t know.  I wish I did know that sort of thing, but I never do.

(Q):What would Chairman Bernanke have to do to “get it right?” 

Rogers: Resign.

(Q): Is there anything else that you think he could do that would be correct other than let these things fail?

Rogers: Well, at this stage, it doesn’t seem like he can do it.  He could raise interest rates – which he should do, anyway. Somebody should.  The market’s going to do it whether he does it or not, eventually.

The problem is that he’s got all that garbage on his balance sheet now.  He has $400 billion of questionable assets owing to the feds on his balance sheet.  I mean, he could try to reverse that.  He could raise interest rates.  Yeah, that’s what he could do.  That would help. It would cause a shock to the system, but if we don’t have the shock now, the shock’s going to be much worse later on.  Every shock, so far, has been worse than the last shock.  Bear-Stearns [now part of JP Morgan Chase & Co. (JPM)] was one thing and then it’s Fannie Mae (FNM), you know, and now Freddie Mac (FRE). 

The next shock’s going to be even bigger still.  So the shocks keep getting bigger because we kept propping things up and this has been going on at least since Long-Term Capital Management. They’ve been bailing everyone out and [former Fed Chairman Alan] Greenspan took interest rates down and then he took them down again after the “dot-com bubble” shock, so I guess Bernanke could try to start reversing some of this stuff. 

But he has to not just reverse it – he’d have to increase interest rates a lot to make up for it and that’s not going to solve the problem either, because the basic problems are that America’s got a horrible tax system, it’s got litigation right, left, and center, it’s got horrible education system, you know, and it’s got many, many, many [other] problems that are going to take a while to resolve.  If he did at least turn things around – turn some of these policies around – we would have a sharp drop, but at least it would clean out some of the excesses and the system could turn around and start doing better. 

But this is academic – he’s not going to do it. But again the best thing for him would be to abolish the Federal Reserve and resign.  That’ll be the best solution.  Is he going to do that?  No, of course not.  He still thinks he knows what he’s doing.

(Q): Earlier this year, when we talked in Singapore, you made the observation that the average American still doesn’t know anything’s wrong – that anything’s happening. Is that still the case?

Rogers:Yes.

(Q): What would you tell the “Average Joe” in no-nonsense terms?

Rogers:  I would say that for the last 200 years, America’s elected politicians and scoundrels have built up $5 trillion in debt.  In the last few weekends, some un-elected officials added another $5 trillion to America’s national debt.

Suddenly we’re on the hook for another $5 trillion. There have been attempts to explain this to the public, about what’s happening with the debt, and with the fact that America’s situation is deteriorating in the world. 

I don’t know why it doesn’t sink in.  People have other things on their minds, or don’t want to be bothered.  Too complicated, or whatever. 

I’m sure when the [British Empire] declined there were many people who rang the bell and said: “Guys, we’re making too many mistakes here in the U.K.”  And nobody listened until it was too late. 

When Spain was in decline, when Rome was in decline, I’m sure there were people who noticed that things were going wrong.

(Q): Many experts don’t agree with – at the very least don’t understand – the Fed’s current strategies. How can our leaders think they’re making the right choices? What do you think?

Rogers: Bernanke is a very-narrow-gauged guy.  He’s spent his whole intellectual career studying the printing of money and we have now given him the keys to the printing presses. All he knows how to do is run them.

Bernanke was [on the record as saying] that there is no problem with housing in America.  There’s no problem in housing finance.  I mean this was like in 2006 or 2005.

(Q): Right.

Rogers:  He is the Federal Reserve and the Federal Reserve more than anybody is supposed to be regulating these [financial institutions], so they should have the inside scoop, if nothing else. 

 (Q): That’s problematic. 

Rogers:  It’s mind-boggling.  Here’s a man who doesn’t understand the market, who doesn’t understand economics – basic economics.  His intellectual career’s been spent on the narrow-gauge study of printing money. That’s all he knows. 

Yes, he’s got a PhD, which says economics on it, but economics can be one of 200 different narrow fields.  And his is printing money, which he’s good at, we know.  We’ve learned that he’s ready, willing and able to step in and bail out everybody. 

There’s this worry [whenever you have a major financial institution that looks ready to fail] that, “Oh my God, we’re going to go down, and if we go down, the whole system goes down.”

This is nothing new.  Whole systems have been taken down before.  We’ve had it happen plenty of times.

(Q): History is littered with failed financial institutions.

Rogers: I know.  It’s not as though this is the first time it’s ever happened.  But since [Chairman Bernanke’s] whole career is about printing money and studying the Depression, he says: “Okay, got to print some more money.  Got to save the day.”  And, of course, that’s when he gets himself in deeper, because the first time you print it, you prop up Institution X, [but] then you got to worry about institution Y and Z.

(Q): And now we’ve got a dangerous precedent. 

Rogers: That’s exactly right.  And when the next guy calls him up, he’s going to bail him out, too.

(Q): What do you think [former Fed Chairman] Paul Volcker thinks about all this?

Rogers: Well, Volcker has said it’s certainly beyond the scope of central banking, as he understands central banking.

(Q): That’s pretty darn clear.

Rogers: Volcker’s been very clear – very clear to me, anyway – about what he thinks of it, and Volcker was the last decent American central banker.  We’ve had couple in our history: Volcker and William McChesney Martin were two. 

You know, McChesney Martin was the guy who said the job of a good central banker was to take away the punchbowl when the party starts getting good. Now [the Fed] – when the party starts getting out of control – pours more moonshine in.  McChesney Martin would always pull the bowl away when people started getting a little giggly. Now the party’s out of control. 

(Q):  This could be the end of the Federal Reserve, which we talked about in Singapore. This would be the third failure – correct?

Rogers: Yes. We had two central banks that disappeared for whatever reason.  This one’s going to disappear, too, I say.

(Q): Throughout your career you’ve had a much-fabled ability to spot unique points in history – inflection points, if you will. Points when, as you put it, somebody puts money in the corner at which you then simply pick up.

Rogers: That’s the way to invest, as far as I’m concerned. 

(Q): So conceivably, history would show that the highest returns go to those who invest when there’s blood in the streets, even if it’s their own. 

Rogers: Right.

(Q): Is there a point in time or something you’re looking for that will signal that the U.S. economy has reached the inflection point in this crisis?

Rogers:  Well, yeah, but it’s a long way away.  In fact, it may not be in our lifetimes. Of course I covered my shorts – my financial shorts.  Not all of them, but most of them last week. 

So, if you’re talking about a temporary inflection point, we may have hit it.

If you look back at previous countries that have declined, you almost always see exchange controls – all sorts of controls – before failure. America is already doing some of that. America, for example, wouldn’t let the Chinese buy the oil company, wouldn’t let the [Dubai firm] buy the ports, et cetera.

But I’m really talking about full-fledged, all-out exchange controls.  That would certainly be a sign, but usually exchange controls are not the end of the story. Historically, they’re somewhere during the decline.  Then the politicians bring in exchange controls and then things get worse from there before they bottom. 

Before World War II, Japan’s yen was two to the dollar. After they lost the war, the yen was 500 to the dollar.  That’s a collapse.  That was also a bottom.

These are not predictions for the U.S., but I’m just saying that things have to usually get pretty, pretty, pretty, pretty bad. 

It was similar in the United Kingdom. In 1918, the U.K. was the richest, most powerful country in the world.  It had just won the First World War, et cetera. By 1939, it had exchange controls and this is in just one generation.  And strict exchange controls.  They in fact made it an act of treason for people to use anything except the pound sterling in settling debts. 

(Q): Treason? Wow, I didn’t know that.

Rogers:  Yes…an act of treason.  It used to be that people could use anything they wanted as money.  Gold or other metals. Banks would issue their own currencies.  Anything.  You could even use other people’s currencies. 

Things were so bad in the U.K. in the 1930s they made it an act of treason to use anything except sterling and then by ’39 they had full-exchange controls.  And then, of course, they had the war and that disaster.  It was a disaster before the war.  The war just exacerbated the problems.  And by the mid-70s, the U.K. was bankrupt. They could not sell long-term government bonds.  Remember, this is a country that two generations or three generations before had been the richest most powerful country in the world. 

Now the only thing that saved the U.K. was the North Sea oil fields, even though Prime Minister Margaret Thatcher likes to take credit, but Margaret Thatcher has good PR. Margaret Thatcher came into office in 1979 and North Sea oil started flowing.  And the U.K. suddenly had a huge balance-of-payment surplus. 

You know, even if Mother Teresa had come in [as prime minister] in ’79, or Joseph Stalin, or whomever had come in 1979 – you know, Jimmy Carter, George Bush, whomever – it still would’ve been great. 

You give me the largest oil field in the world and I’ll show you a good time, too.  That’s what happened.

(Q): What if Thatcher had never come to power?

Rogers: Who knows, because the U.K. was in such disastrous straits when she came in.  And that’s why she came to power…because it was such a disaster.  I’m sure she would’ve made things better, but short of all that oil, the situation would’ve continued to decline. 

So it may not be in our lifetimes that we’ll see the bottom, just given the U.K.’s history, for instance.

(Q):  That’s going to be terrifying for individual investors to think about.

Rogers: Yeah. But remember that America had such a magnificent and gigantic position of dominance that deterioration will take time. You know, you don’t just change that in a decade or two.  It takes a lot of hard work by a lot of incompetent people to change the situation.  The U.K. situation I just explained…that decline was over 40 or 50 years, but they had so much money they could have continued to spiral downward for a long time. 

Even Zimbabwe, you know, took 10 or 15 years to really get going into it’s collapse, but Robert Mugabe came into power in 1980 and, as recently as 1995, things still looked good for Zimbabwe. But now, of course, it’s a major disaster. 

That’s one of the advantages of Singapore. The place has an astonishing amount of wealth and only 4 million people.  So even if it started squandering it in 2008, which they may be, it’s going to take them forever to do so.

(Q): Is there a specific signal that this is “over?”

Rogers: Sure…when our entire U.S. cabinet has Swiss bank accounts.  Linked inside bank accounts.  When that happens, we’ll know we’re getting close because they’ll do it even after it’s illegal – after America’s put in the exchange controls.

(Q): They’ll move their own money.

Rogers: Yeah, because you look at people like the Israelis and the Argentineans and people who have had exchange controls – the politicians usually figured it out and have taken care of themselves on the side.

(Q): We saw that in South Africa and other countries, for example, as people tried to get their money out.

Rogers: Everybody figures it out, eventually, including the politicians.  They say: “You know, others can’t do this, but it’s alright for us.” Those days will come.  I guess when all the congressmen have foreign bank accounts, we’ll be at the bottom. 

But we’ve got a long way to go, yet.

[Editor’s note:  After interviewing legendary investor Jim Rogers at his home in Singapore back in March, Investment Director Keith Fitz-Gerald caught up with Rogers again in July – this time in Vancouver, where both were speaking at the Agora Wealth Symposium. Rogers talked extensively about the ill-advised bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and the potentially ruinous fallout from the financial “Super Crash” that’s about to engulf the U.S. market. To find out how to get a report on the once-in-a-lifetime profit plays that will emanate from this so-called "SuperCrash" – and to also get a free copy of noted market analyst Peter D. Schiff’s New York Times bestseller "Crash Proof: How to Profit from the Coming Economic Collapse" – please click here. And look for Part 2 of Money Morning’s latest interview with Jim Rogers tomorrow (Wednesday).]

News and Related Story Links:

• Money Morning Exclusive Jim Rogers Interview From Singapore (Part I):
  Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve.

• Money Morning Exclusive Interview From Singapore (Part II):
  Jim Rogers: China’s Economic Advance is All But Unstoppable.

• Wikipedia:
  Long-Term Capital Management.

• CBS News:
  Dubai Firm Outlines Port Sales Plan.

• Wikipedia:
  The Dot-Com Bubble.

• The San Diego Union Tribune:
  Chinese Thwarted on Unocal Deal.

• Wikipedia:
  The Great Depression.

• Wikipedia:
  Paul Volcker.

• Money Morning Financial Commentary:
  (Jimmy) Rogers and Me: The Latest Wisdom From a Global Investing Guru.

• Wikipedia:
  North Sea Oil.

• Wikipedia:
  U.S. Public Debt.

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Depending on your perspective, U.S. equities are either at the edge of another cliff or at the dawning of a new bull market.

We could make the case for either. But in as much as that would be an interesting exercise, the more relevant question is what the data suggests.

Let’s take a look.

Since their 52-week highs last October, the Dow Jones Industrial Average Index has lost 18.5%, the S&P 500 Index is off 18.2% and the Nasdaq Composite Index has fallen 15.1%. At the same time, the broader U.S. economic picture has darkened considerably with gross domestic product (GDP) a slim 1.9% and consumer confidence in the toilet bowl rather than the punch bowl.

Adding insult to injury, sentiment is worsening. Even perma-bulls are tempering their expectations and volume remains decidedly concentrated on the downside.

Yet, at the same time, the Dow puts in two barnburners like those last Tuesday and Friday when the index rose 331.62 and 302.89 points respectively.

Which begs the question… what do we make of the rallies?

Two words – “bear trap.”

David Rosenburg, an investment analyst with Merrill Lunch & Co. Inc. (MER), points out something we know from our own proprietary research to be true. There’s never been a 300-point rally in a bull market. Let alone two of them in one week.

Sure we’ve seen larger proportional percentage gainers in the past but the point remains. Massive up days suggest significant short covering and further downside ahead.

You can see that in the following data.

If history holds true, then there are three key takeaways:

• Until the rebound reflects stronger earnings, sales growth and a generally improving economic scenario, rapid upside moves like those last week are nothing more than king-sized bear traps ready to snare the unsuspecting.

• Companies are girding for rougher times ahead by selling into strength. This would not be the case if things were truly getting better. Nor would London Interbank Offered Rate (LIBOR) /Treasury spreads be widening the way they have been recently.

• What we are experiencing now is nothing more than a continuation of the broader bear market patterns that began in 2000 and which may continue through 2012 or 2015.

What to do now:

While this sounds terrible – and admittedly it’s sure not going to be fun – this too shall pass and probably when most people least expect it to.

Which means that rather than concentrating on hitting home runs, investors would be better served by playing a “defensive” strategy for the foreseeable future.

The best choices remain overseas equities and, in particular, companies doing business in Asia for the simple reason that we have not witnessed the same economic fall off in many parts of Asia that we have in the United States.

Not only are the consumer classes of these Asian markets still growing in strength, but also they’re becoming a force all their own. Which means that these markets will likely lead the way out of this mess even if they take a few hits in the meantime.

News and Related Story Links:

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By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

"Why don’t my traditional analytics work as well anymore?"

It’s a question I get a lot. But chances are, it’s not your analytics that have broken down. It’s your execution that’s not keeping up.

Let me explain.

In the past several years, we’ve witnessed an explosion in do-it-yourself trading platforms. Ironically, many are offshoots of the very platforms institutional traders use to trade anonymously (and to great advantage) in the so-called "dark pools" I wrote about recently.

So you could say that it’s easier – literally – than ever before to "trade."

But what Wall Street doesn’t tell you is that the "big boys" have an additional layer of sophistication at their disposal. And it’s one that gives them the upper hand when it comes to profits: Order execution algorithms.

If you’ve never heard of these things before, don’t feel bad. Most people who don’t trade for a living or who aren’t intimately connected to the markets on a daily basis haven’t heard the term, despite the fact that nearly 30% of all EU and U.S. equities volume is traded this way today. And that number is increasing – almost 50% of those equities will be traded in this manner by 2010.

Order execution algorithms are sophisticated quantitative routines that combine actual analysis with the buying and selling process. This method of trading is widely used by hedge funds, mutual funds, pension funds and other institutional traders in order to manage market impact, opportunity cost, and "price risk," meaning their sole function is to obtain the best prices possible.

And, in a manner that would make Gordon Gekko proud, many such order execution algorithms are also designed to camouflage actual buying and selling decisions. This increasingly allows large traders to gain the upper hand when they want to move in and out of certain financial instruments because the rest of the market will neither see them coming nor going.

The reason such secrecy is important is that when other traders know a stock is "in play" they can manipulate the price to their own advantage and at these volumes, sometimes a penny or two is all it takes per share.

To an average investor, paying a few more cents per share may be immaterial but to an institutional trader moving hundreds of thousands or even millions of shares at once, there’s a huge impact that can mean the difference between winning and losing.

But where order routines are really effective is that many incorporate elements of artificial intelligence – I know this first hand because I helped write some of the first order routine algorithms used to beat Wall Street at its own game.

This means the computers can place orders based on electronic information – many times before their human masters are even aware of the information. This gives them a huge quantitative advantage for obvious reasons.

And that, in as much as stock selection, is the name of the game when it comes to today’s markets.

So what can we do about it?

Ironically, that’s the easy part.

First, despite the fact that institutional investors are increasingly focused on short-term execution risk, none of the long-term relationships governing stock price and selection are rendered invalid.

That means investors who lengthen their time horizon and who do something as simple as use dollar cost averaging – or use its close cousin, value averaging – to buy into a position or utilize rudimentary options strategies may actually be able to beat the institutions at their own game.

Second, even though algorithmic trading has made short-term pricing swings more violent, it’s ironically made longer-term information more clear. If prices are going up, the big boys are buying. If they’re going down, chances are they’re selling.

So the key is something we stress daily:

• Find those companies with superior fundamentals,
• A substantial portion of their business outside the US (which will be hurting for a long time to come),
• And then buy selectively.

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By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

For all their talk about change, the ultimate irony in today’s markets is that Washington is so afflicted with legislative gridlock that the “Beltway Boys” couldn’t “change” the channel on their flat-screen televisions.

And yet, as frustrating as legislative gridlock is for many voters (myself included), the data suggests that politicians’ inability to act might actually be good for the markets.

The bottom line: Legislative gridlock translates into higher profits for investors.

We realize that this runs contrary to the conventional wisdom on the subject but, as we point out so frequently, sacred cows frequently make the best burgers.

Our proprietary research suggests that markets tend to run in long cycles averaging 17-21 years in length, while the White House political cycle runs in eight-year increments – at best. That means the political cycle is considerably shorter than dominant market cycles.

Our takeaway: In the long run, there’s really no correlation between who holds the White House and successful long-term investing because the political and market cycles are rarely in sync over such disparate periods.

Are the results any different in the short run?

Nope. Here, too, the data suggests that it doesn’t really matter which political party is in control really doesn’t matter (a conclusion that’s supported by the accompanying chart, which includes data from Ned Davis Research and some analysis by Money Morning).

What this data demonstrates is that the stock market’s highest performance (a 9.6% growth per annum) occurs when there’s the most political turmoil - in short, a Democratic president and a Republican Congress.

That suggests a finding that’s so surprising we weren’t sure we believed our eyes either: The Dow Jones Industrial Average Index logs its biggest net gains with a donkey in the White House and elephants traversing the halls of the U.S. Capitol Building.

Another interesting conclusion suggested by our own research, and that of other firms such as Ned Davis, is that in stark contrast to what most investors believe to be true – that Republicans are better for the markets – is that the blue-chip-dominated Dow tends to rise nearly twice as fast during Democratic presidencies (7.2%) as it does during Republican ones (3.8%).

The great equalizer, if there is one, appears to be inflation, which rapidly eats away the higher returns to bring them within a few basis points of each other over time.

People assume that a presidential administration and Congress with matching political affiliations is the best way to get things done, but in reality, the checks and balances of a mismatched pair helps to ensure that governmental agendas don’t go to extremes. Thus, somewhat surprisingly, political gridlock is actually a reality that puts investors at ease and permits the financial markets to operate efficiently.
With regard to the elections set for this fall, we see two potential outcomes:

• If U.S. Federal Reserve Chairman Ben S. Bernanke fails in his current efforts to strike a balance between inflation at one extreme and recession at the other, the incoming president will inherit a long-drawn-out economic slowdown (and possibly even an era of stagflation). If that happens, history suggests an environment that’s conducive to a Democratic president and, strangely enough, a Republican Congress. It also suggests that we’ll see more downside ahead before things become “gridlocked” enough that we can enjoy the historically documented 5.6% net increase noted in our chart.

• If, however, Bernanke’s “Hail Mary” recovery pass is successful, and we avoid a full-blown recession (which seems more doubtful by the day), the historical election-year patterns suggest a brief decline followed by a strong fourth-quarter rally. That would mean that the worst of what the stock market can bring to bear could already be behind us.

Psychologically, we’re just as likely as most readers to hope for good markets and a clean political environment; after all, having the two together just flat out makes one feel better. But in our most candid moments we realize we must get read for the opposite – especially now that the Fed and the Beltway Boys are tripping over one another in an effort to regulate “free” markets.

We wish the politicians would focus on something else, especially since the data suggests that their doing so is “good” for the markets.
Never mind the lies we tell ourselves about elections and our money; sometimes the truth is stranger than fiction.

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