Doing Well

Colorado’s aspen leaves were sublime and seeing my family was wonderful, but it’s good to be back at work in Japan. Let’s jump right in.

This week, the market moved higher on indications that the economy remains strong.

For the week:

Dow +1.5%
Nasdaq +1.9%
Nasdaq 100 +1.9%
S&P; 500 +1.1%
S&P; Midcap 400 +1.3%
S&P; Smallcap 600 +1.3%

September ended up:

Dow +2.6%
Nasdaq +3.4%
Nasdaq 100 +4.7%
S&P; 500 +2.5%
S&P; Midcap 400 +0.5%
S&P; Smallcap 600 +0.8%

On Monday, the Dow fluttered above its former record high before settling slightly. There was a hush of nervousness in the air as crash-happy October opened following such a surprisingly strong September. Would the piper need to be paid this month? For this week at least, the answer was no.

Falling oil prices were a big part of the strong stock market in September, yet their continued plunge on Monday didn’t offset the jitters. Venezuela and Nigeria decided to pare production, but traders thought that would have a negligible impact on the supply glut. Crude oil futures dropped 3% to $61.

Then Wal-Mart (WMT) guided below the midpoint of its September same-store sales projections. That was another reason to hold back, it seemed, because it could indicate a hesitant consumer as we head into the holiday season.

The Dow slipped 0.1% and the Nasdaq slipped 0.9%.

Tuesday saw the Dow reach a new all-time high on falling commodity prices again. Money moved from oil and gold stocks to financial and cyclical stocks.

Merrill Lynch downgraded the energy sector to underweight as oil fell another 3.8% to its lowest price in seven months. Falling oil prices bode well for consumer spending, one of the economy’s pillars and a factor that’s especially important ahead of the holidays. Less money spent at the gas pump and in keeping the house warm means more money for presents under the tree.

Halliburton (HAL), the oil services bellwether, hit a 52-week low and so did Newmont Mining (NEM), a gold major.

The Dow gained 0.5% and the Nasdaq gained 0.3%.

On Wednesday, Federal Reserve Chairman Bernanke gave an optimistic view of the economy and sent stocks soaring. It looks as if interest rates are not going any higher.

Prior to that, the Institute of Supply Management reported that the services index dropped to 52.9 in September, a level not seen since April 2003. Economic growth is slowing, and that takes some of the inflation pressure off, an idea confirmed in the chairman’s speech.

From Econoday:

He specifically pointed to a “substantial correction” in the housing market as the key force behind a slowing in second half GDP. Bernanke indicated he believes the drop in housing will cut about a percentage point off second half growth and moderate the expansion in 2007. The Fed chairman also stated that he remains concerned about inflation but still expects inflation to come down. He sees the non-housing portion of the economy to remain healthy, noting that even in construction that the nonresidential component is quite strong. Essentially, Bernanke appears to be saying that the possibility of additional interest rate increases this cycle by the Fed currently is remote.

Oddly, among all this optimism, oil prices rose. An explosion at a Texas refinery coupled with violence in Nigeria sent oil up 1.3% to $59.50 per barrel. That wasn’t enough to stop the party, though.

The Dow rose 1.1% and the Nasdaq rose 2.1%.

Thursday saw the Dow close at yet another record high. Not a bad time to be in our permanent Double The Dow portfolio, eh? This is why. The Dow will never cease to be a solid long-term performer because the editors of the Wall Street Journal make sure that the compact list of 30 companies always contains the best in business. That, coupled with the relative undervaluation of large caps is pushing the Dow along at a good clip these days. Our doubling of that good clip is profitable, to the tune of an 18% gain so far this year.

Starbucks (SBUX) reported a 6% rise in September sales and said it plans to double its size by 2010. The stock rose 7.4%. Then Target (TGT) offset Wal-Mart’s (WMT) below-midpoint guidance earlier in the week with September comps up 6.7%. It said that Q3 will be better than expected.

Not to be seen as spreading good news for too long, the Fed sent out Philadelphia President Charles Plosser to talk tough on interest rates. He doesn’t vote, though, so his words held little sway on the street. They did re-phrase Fed Governor Kohn’s Wednesday warning that investors shouldn’t dismiss the Fed’s inflation concerns, although that point was hard to swallow following Boss Bernanke’s point that rates are done rising. It’s hard to pin down that august council of economists, so investors, unsure what to make of this indicator grab-bag, just moved on from Mr. Plosser’s grousing.

Oil rose to almost $61 on incorrect reports that OPEC was planning to cut production for the first time in two years.

The Dow eked out a 0.1% gain and the Nasdaq rose 0.7%.

Friday saw a bit of consolidation.

The September employment report left the labor market looking fine and the odds of another interest rate hike low. However, strength in wages and salaries means that the odds of a rate cut are also low.

Econoday reported that “economic growth appears to be on a moderately healthy trend but it likely is going to be the middle to latter part of 2007 before interest rates might come down.”

The only corporate news was that Tracinda Corp. will not try to buy another 12 million shares of General Motors (GM) now that the car maker has dropped its cooperation talks with Nissan and Renault. Evidently, Tracinda head Kirk Kirkorian is not pleased with the direction that GM is heading. One of his advisers, Jerome York, resigned from GM’s board “citing a board room environment unreceptive to extensive probing and ‘grave reservations’ about GM’s abilities against Asian competitors,” according the Associated Press.

The Dow lost 0.1% and the Nasdaq lost 0.3%.

Since the September issue of The Kelly Letter, we’ve done well:

—– WINNERS —–

Student Loan Co. +32.8%
Debt Collector +14.9%
Computer Security Co. +11.6%
Semi Cap Equip Co. +8.7%
Software Co. +7.9%
Double The Dow +6.4%
Media Co. +4.9%
Computer Co. +3.1%
Maximum Midcap +2.0%

—– LOSERS —–

Media Co. -13.6%
Dow One -0.2%

With upward momentum like that, it’s easy to understand why we were hard-pressed to find bargains coming into range. Instead, we watched our already-deployed capital appreciate. The one position that did lurch lower, Investments are shown only to KELLY LETTER subscribers. Click to try the letter for one cent., we scooped up at a price that it’s already risen above.

All in all, good work.

The question in front of us is whether the market has already embarked on its year-end recovery, or if a correction looms. I wrote last month that I think we’ve already embarked. That’s why we put new money to work.

However, the best approach is to avoid answering the question at all, and to just keep an eye out for bargains where they appear. They may come in the form of rising prices that have finally broken through overhead resistance and look set to keep going up, or in the form of counter-trend movers that get cheap as the market goes up.

I have said all year and continue to believe that the year-end rally will be led by technology. That’s why we dili
gently stuck to buying tech shares in down months and holding them through stormy headlines. I want to concentrate even more on the sector.

_______________

Market Telescope

From Barron’s:

As for the seasonal patterns, Morgan Stanley strategist Henry McVey calculates that of the 25 Septembers since 1945 that showed positive returns, 22 were followed by positive fourth quarters. But the median fourth-quarter gain of 4.9% was somewhat smaller than in years when there was a September pullback. Just a guess, but if we don’t get a correction fairly soon, any fourth-quarter rally might well peak early. In 2005 the year-end run peaked the day after Thanksgiving at 1268 on the S&P.; Seven months later, that benchmark was lower.

From Forbes Growth Investor:

The Dow may have reached an all-time high, but the rest of the market isn’t there…Let’s take a more sober look at the data. The Dow is indeed at a high. But that means it has returned virtually nothing for almost seven years. The story is even worse if you consider inflation. Furthermore, General Motors, a money-losing company, is the best-performing stock in the Dow so far this year. The next two best performers, AT&T; and Merck, have had serious troubles of their own. In addition, while the Dow is finally reawakening, most other indexes are nowhere near their highs. The Standard & Poor’s 500 is still 12.5% off the mark it set on March 24, 2000, and the Nasdaq is 55% off its March 10, 2000, high-water mark.

_______________

‘Tis The Season For Tech

I like tech. I’ve always liked it. I’ve made most of my money in the past ten years from tech stocks. I’ve been saying all year that tech is on track for a bang-up 4Q, and here we are.

Recently, there’s been a lot of ink spilt on the issue of whether tech will have a solid year-end. I say yes. So do most others. A few say no. Par for the course.

Birinyi Associates shed some light on the subject, which helps clarify why the ducks are in a row for a rally. The firm points out that in the last 16 years, the market’s most lagging sector from the first three quarters has leapt to the front in the fourth, with an average gain of 12%.

Guess what sector was this year’s most lagging in the first three quarters? Tech. It should be a solid play in the next few months. Even more to the point, within tech the internet subsector has provided the strongest 4Q rally over the past ten years. Here’s the breakdown, according to the Stock Trader’s Almanac:

Internet +39.5%
High Tech +28.5%
Computer Tech +24.3%
Semiconductors +22.1%

So then, what to own? Here at The Kelly Letter, we already have several tech positions. Even if we didn’t put one more dollar to work in the tech sector, we would do fine in a tech rally.

However, I want more of the internet sector.

I’m eyeing a position in Investments are shown only to KELLY LETTER subscribers. Click to try the letter for one cent..

It closed Friday at $81.06. It reached almost $95 last April and bottomed at $67 in August. Now it’s right in the middle. Historically, it has dipped in October before embarking on a nice end-of year run.

Last year saw it go from $72 in October to $96 in January. The year before, it went from $58 in October to $81 at the end of December.

I think there’s a chance for a pullback before the seasonal chug higher. Therefore, I’ve set our watch price at $73.

_______________

Our New Energy Play

We bought Investments are shown only to KELLY LETTER subscribers. Click to try the letter for one cent. on Sept. 25 at $35. So far, we’re down 2.9%.

This was not a good week for this stock. Oil prices continued falling, which is not good for an oil services company. The talk has turned to $50 oil, which has all players in the industry worried.

Rumors of an OPEC reduction in oil sent the sector higher on Thursday. So far, the rumor has proven false as no coordinated effort from the Middle East has materialized.

However, I think such a move would be likely in the event of a further deterioration in the price of crude. The cartel can’t do a lot to push prices lower, but it has a history of sending them higher whenever it wants.

For instance, in Dec. 2004, OPEC cut production by 1 million barrels per day. A week later, oil prices were 14% higher. If oil keeps coming down to, say, $55, there seems a good chance of another cutback from OPEC. I doubt that we’ll see $50 per barrel. Indeed, futures contracts prices from December 2006 through spring 2008 range from $61 to $67 per barrel.

All of which is to say that the recent volatility in this stock should stabilize. We bought it cheap at $35, more than 36% below its May peak at $55. A year ago it traded at $32, its 52-week low. There’s strong support just below where we bought.

Too, let’s not forget the company’s solid fundamentals. Its forward P/E is less than 9, it has a 20% profit margin, it’s growing revenue at 36% per quarter, and it has $150 million in the bank with a debt/equity ratio of 0.17.

From Fortune two weeks ago:

[This company] ranks…on Fortune’s 2006 list of the 100 Fastest-Growing Companies. The…company saw profits rise at a rate of 196% and revenues grow 28% with a stock return of 56% on average annually over the past three years.

That never hurts.

Around here, we always do well. We don’t get everything right, we take our lumps, but in the end we make money. Why don’t you join us for a month to see what makes us different? It’s just a penny, as you can read here.

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