A Fine Time For Buying

Last month was busy for us as we sought to build a portfolio for what I expect to be a strong winter in the market.

Since we bought them, Investments are shown only to KELLY LETTER subscribers. Click to try the letter for free. have all dipped lower, providing you with an opportunity to get a better deal than I got if you haven’t already invested. If you have, don’t fret. It’s normal during an acquisition phase to see prices fluctuate slightly into the red as the market finds its footing. These companies will more than recover; they’ll provide us with good returns.

Our additional shares of Investments are shown only to KELLY LETTER subscribers. Click to try the letter for free. and new position in Investments are shown only to KELLY LETTER subscribers. Click to try the letter for free. are already up slightly. Our Maximum Midcap strategy is up 16% so far this year. That’s after gaining 60% in 2003 and 29% last year. Since I implemented it here at the end of 2002, the Maximum Midcap strategy is up a total of 131%. I’m proud of our permanent portfolios. They beat nearly every investment service and professional, yet are the very picture of simplicity.

The biggest disappointment last month was PXRE Group. My post-Katrina investment idea to buy the reinsurance company went sour as Katrina was followed by Rita. My initial analysis was of PXRE’s valuation compared to what I considered to be inflated damage estimates for Katrina. The stock looked to be a bargain. Then Rita’s damages entered the equation and the bargain didn’t look so cheap anymore. I tried holding out at -9%, but with all eyes on Rita’s approach the pressure on the stock was too forceful and I placed a stop order at -11%. It executed, locking in our loss at that level. It is rare for that to happen around here, but looking back we seem to have handled a bad situation intelligently. PXRE Group closed 10/3 at 13.33, a full 21% lower than our sell price of $16.91. Had we not sold, we would now be sitting on a 30% loss. This is a good example of how managing the trade is just as important as choosing the investment.

I never believed that Katrina would have a lasting impact on the U.S. economy, and I still don’t. The evidence is coming in strong to support that view. For instance, Wal-Mart said over the weekend that its same store sales were up 3.8% in September. That’s entirely post-Katrina, and very encouraging news that consumers are still alive and well in America. There was some fear that U.S. consumers would dry up. How a hurricane in New Orleans would affect shopping habits in, say, New York, New Hampshire, New Jersey, and Nevada was never clear to me. But knee-jerk reactions are common in the market. At least now we have solid numbers showing that fear to have been unreasonable.

The other potential hindrance to the consumer is high energy prices. Whenever I want a mainstream consumer’s view of the state of affairs I call my mother, who lives in Colorado. She said last week, “It costs fifty dollars to fill up my tank. Can you believe that? Just two Christmases ago you gave your sister twenty-five dollars for gas and it was enough. Remember? And when I was in college…” You know how that line of thinking ends, with nostalgia for the days of using pocket change to buy gas. While those days are long gone, the doubling in gas prices from “two Christmases ago” is new and dramatic. Will it crimp crucial holiday spending?

The consensus is that an additional 2% of a consumer’s overall spending has been added to energy. It was at around 4% two years ago and is around 6% today. That’s 2% that won’t be going toward shopping.

Does 2% seem terribly high to you? It doesn’t to me after two years of higher oil headlines. It becomes even smaller when considered in terms of the national economy. Yes, energy prices have been high for the past two years, yet the economy grew at 4.4% in 2004 and is up 3.5% so far this year. Americans have adjusted to a higher cost of energy, as well they should have. It’s here to stay. The economy is also here to stay, though, and has proved resilient.

Meanwhile, business investment is clipping along at a good rate and earnings are coming in strong. Profits have been healthy over the past two-year high-energy time frame. The S&P; 500’s earnings growth for the third quarter is shaping up to be around 19%. Remove the booming energy sector and earnings still grew at 12%. That’s on top of the 12% they grew in the first half of the year. Those figures are not pretty good. They’re fantastic.

Yet, the S&P; 500 is up a mere 1.4% so far this year. With profits growing and prices remaining flat, valuations have come down. We get more for our money when we invest now than we did at the beginning of the year.

Conditions looked almost exactly this way a year ago and we got a strong November-December rally. I think we’re going to see that again this year, which is why I’m buying aggressively.

From the beginning of last November to the end of last December, we rode the winter rally to a 15% gain in our Double The Dow strategy and a 20% gain in our Maximum Midcap strategy. From our early-November 2004 buys, we eventually booked a a 65% gain in Maxtor and a 12% gain in Profunds Ultra Semiconductor. It was a fine time to be in the market.

It’s a fine time again.

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