Still Building

It was a busy week for us in a market that continued to decline. That’s fine by us, as we’re in the middle of a sustained portfolio-building effort. I’ve been trying to pick up investments on the cheap that look poised for outperformance over what I still expect to be a strong winter rally.

On Wednesday, we bought Investments are shown only to KELLY LETTER subscribers. Click to try the letter for free..

On Tuesday, we began building a position in Japan with a 1/3 buy into Investments are shown only to KELLY LETTER subscribers. Click to try the letter for free.. It’s good that we tiptoed in as it fell along with the Japanese market during the latter half of the week. Our initial 1/3 investment is down some 6%. Counterintuitive though it is, we should be happy for this short-term trend. It enables us to get cheaper prices with additional money waiting to go in.

Over the week, the Nikkei 225 fell 2.4%, a move not entirely unexpected, hence our gradual entry. So far, though, the down move has been relatively muted for a market that’s up 35% in four months.

“The market is still showing some strength. This is supported by expectations of a further rise,” said Mitsushige Akino, chief fund manager at Ichiyoshi Investment Management. “The pattern of the drop [Friday] is very similar to that in spring. But [the economic fundamentals are stronger now].”

Akino said that most investors in Japan were waiting for the U.S. employment report that came out today, adding that if the data came in as expected it might support another rally in Japanese stocks next week.

The employment report came in better than expected. A drop in September payrolls of 150,000 was expected, but they dropped only 35,000. That’s a much smaller Katrina impact than analysts foresaw.

A higher-than-expected level of payrolls is also bright news for the economy. The August payroll gain came in at 211,000, a full 42,000 higher than predicted. That means that September was actually higher than August, despite Katrina.

Finally, retailers showed strong same-store sales growth this week, running counter to the ubiquitous theme of higher energy prices clipping annual holiday sales.

So, while the current mood maintains a sour focus on inflation from higher energy prices, that mood is destined to change. The fundamentals of the American economy remain strong, and we’re set to see a positive earnings season just ahead.

Getting back to Japan for a moment, there are two items of interest in our growing position there.

First, prompted by a sharp rise in recent stock trading activity, the Tokyo Stock Exchange will increase the capacity of its order-processing system to around 7.5 million trades a day starting next Tuesday. That’s important because increased volume is a necessary component for long-term recovery. Also, brokerage firms are setting up new shops in anticipation of Japanese people returning to their own market. So far, the driving force has been foreign money. To get this market up another 40% or 50% in the next two years, we need domestic investor participation. It’s good to see the infrastructure being put in place for it.

Second, on Oct. 24 Goldman Sachs Japan will start selling a financial product that will invest in 11 of Japan Post’s business partners which are expected to benefit most from the postal privatization plan. In last week’s “Kelly Report: The Recovery of Japan” sent to subscribers, I wrote that reform of Japan Post is a critical part of the country’s recovery. That Goldman is so confident of its passage that it’s creating a new product specifically targeting its beneficiaries is a positive sign. If the investment is available to U.S. investors, I may consider using some of our Japan money there.

Our winter rally portfolio is having a rocky time. We’re still in correction mode, so prices are dropping overall. For most of the portfolio, this is perfectly normal and nothing to be concerned about. If you’re looking to put new money to work, I suggest Investments are shown only to KELLY LETTER subscribers. Click to try the letter for free., down 6% from our buy price.

Overall, things are looking pretty good for us. There’s probably more weakness ahead before we get to a solid winter rally. Both Investments are shown only to KELLY LETTER subscribers. Click to try the letter for free. are below our watch prices. We may yet pick them up on sale.

This process is playing out as it usually does. We targeted companies that we wanted to buy at prices that were lower than their market prices. Some were slightly lower, some were significantly lower, and some were far lower. First we picked up the slightly lower-priced ones. The market kept falling and put those in the red, but allowed us to pick up the significantly lower ones next. The market has continued falling and put those in the red, and we are now coming to the next phase of picking up shares that are far lower than when we started watching.

After that, we’ll hold tight for the recovery as each phase of acquired investments goes green and we make a good profit over winter.

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