3 Big Investing Questions And Answers

09/01/2011 11:00 am EST

Focus: MARKETS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Now is a good time to ask some of the bigger questions and use their answers to help position your portfolio for maximum performance, writes Elliott Gue of Personal Finance.

The stock market is driven by two primal human emotions: fear and greed. When fear is in the driver’s seat, a crash is never far away.

This latest mini-crash stemmed from panic related to concerns about US economic growth, fears that the EU’s sovereign-debt crisis will blossom into a debilitating credit crunch, and Standard & Poor’s downgrade of the US government’s credit rating.

The bad news: The recent market panic has taken a significant toll on many investors’ portfolios, and economic risks have risen.

The good news: Panics of this nature tend to be short and to wear themselves out—eventually, cooler heads prevail, and the market refocuses on fundamentals. We’re already seeing some of that as the market swings settle down this week.

If you can master your fear, periodic sharp sell-offs offer tremendous opportunities for you to buy into select stocks and industry groups at attractive prices.

One of the many ways I help my Personal Finance subscribers navigate volatile markets like this is by answering their most pressing questions.

Today I thought I would share some recent answers that I think will also help you.

Question: What’s driving the big sell-off in the stock market?

Answer: I’ve heard dozens of explanations for the recent stock-market decline, from the EU credit crisis to the US sovereign-debt downgrade and concerns about the financial system. But have you noticed that these rationales seem to change daily based on the hottest news story or the most exciting conspiracy theory?

In reality, the explanation is far simpler. Investors worry that the US and EU economies could slip into recession.

US economic data has softened since spring, and the Bureau of Economic Analysis (BEA) slashed its estimate of gross domestic product (GDP) for the first two quarters of 2011. The latest revisions indicate that the US economy barely grew in the first quarter.

But fears of a second recession are vastly overblown; many investors have mistaken slow growth for a contraction.

I expect the BEA to revise first-quarter US GDP numbers higher eventually, as near-zero growth is not consistent with data on employment trends, railcar loadings, manufacturing output, and consumer spending in the first three months of 2011.

Although GDP expanded at a sub-par rate, the economy was a lot healthier in the first quarter than the updated GDP number suggests.

Meanwhile, economic data has yet to reach levels that indicate a recession is looming. The Institute of Supply Management’s gauge of business activity in the manufacturing sector suggests that the economy continues to expand, albeit at a snail’s pace.

Moreover, the Conference Board’s Index of Leading Economic Indicators (LEI) edged higher in July, and is up over the past six months. If the economy were heading into recession, LEI would decline for at least several consecutive months.

Ironically, US economic data has begun to improve just as the market tanked.

Encouraging retail-sales figures from July suggest that consumers have benefited from falling gasoline prices, while the latest industrial production data indicates that manufacturers have ramped up activity as supply-chain shortages abate.

However, consumer sentiment remains weak, though that’s hardly a surprise given the barrage of negative headlines. Sentiment can turn on a dime.

The odds still heavily favor the US economy skirting recession and reaccelerating in the second half of the year. With that outlook in mind, I expect the stock market to rally toward year-end.

Question: This sell-off looks a lot like 2008. Should I sell my portfolio to and go to cash?

Answer: The recent mini-crash may be eerily reminiscent of the dark days of late 2008, but the economic environment bears little to no resemblance. In 2008 the economy was mired in a deep recession, credit markets had seized up, and corporate profits were in free fall. None of these conditions are present right now.

Selling in a temporary downdraft transforms paper losses into real losses. Heed Warren Buffett’s classic advice: “Be greedy when others are fearful, and fearful when others are greedy.”

When the markets swooned last summer, I spoke with plenty of investors who lost their nerve and sold out. Most regretted that decision when the market soared to new 12-month highs a few months later. History shows that you don’t need to liquidate your portfolio months ahead of a recession to avoid the worst of the correction.

But selling in a temporary panic can cost you big time. Keep a cool head and react to facts rather than the sensationalist stories on television. Focus on the current market sell-off as an opportunity.

Question: Where’s the bottom for crude-oil prices? What’s driving the downside?

Answer: Crude oil should bottom at $100 per barrel, provided that the global economy doesn’t slip into recession (which, as you know, I think is unlikely).

In that case, the combination of high prices and slowing economic growth would crimp demand.

Some readers might wonder if our fact checker fell asleep on the job. West Texas Intermediate (WTI) crude oil—the US benchmark that to which futures traded on the New York Mercantile Exchange are linked—trades in the low $80s per barrel.

But a peculiar combination of local factors has eroded WTI’s validity as a proxy for global supply-demand dynamics. WTI generally commands a slight premium to Brent crude oil, but that relationship has reversed over the past 12 months.

Local supply conditions at the physical delivery point in Cushing, Okla. are the culprit: Rising US imports of Canadian oil, higher domestic output from shale oil fields, and an uptick in ethanol production have prompted pipeline operators to add new lines or reverse the flow of existing lines to carry crude south to Cushing and other refinery centers.

This shift has not only glutted storage facilities at Cushing, but the reversed pipelines have limited flows out of the hub. When an influx of crude oil overwhelms refining capacity, stockpiles build, and the price of WTI declines.

This logistical logjam can only be resolved by the construction of new pipelines to move crude oil from Cushing to the Gulf Coast.

Investors instead should monitor the price of Brent crude oil, an important international benchmark that currently goes for $110 per barrel. This price is well off its 2011 high of almost $130 per barrel, but well above the $80 per barrel it commanded a year ago.

Rest assured that oil companies are basing their strategic direction and capital expenditures on Brent crude oil.

In August, Brent crude oil traded as low as $103 per barrel. A tight supply-demand balance in the global oil market should prevent prices from sinking further.

Although analysts have lowered their projections for near-term oil demand because of economic weakness in the developed world, supply constraints should buoy oil prices.

Lower oil prices should also encourage a bit of a recovery in demand. The International Energy Agency lowered its projection for non-OPEC supply growth by a greater percentage than its demand forecast.

Meanwhile, OPEC is struggling to offset the loss of Libya’s 1.5 million barrels of oil exports. Any reduction to spare productive capacity is also bullish for oil prices. Barring a global recession, oil prices should eclipse their 2011 high in 2012, and possibly retest their 2008 high.

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