Chicago, IL – August 26, 2009 – Zacks Equity Research highlights Intuitive Surgical (ISRG) as the Bull of the Day and Cost Plus Inc. (CPWM) the Bear of the Day. In addition, Zacks Equity Research provides analysis on Ford (F), Honda (HMC) and The Gap (GPS).

Full analysis of all these stocks is available at http://at.zacks.com/?id=2676

Here is a synopsis of all five stocks:

Bull of the Day:

Intuitive Surgical’s (ISRG) story is improving. A new product was developed as an upgrade to the existing daVinci Surgical System. Furthermore, the company enjoys a virtual monopoly in robotic surgery without direct competition.

The company's razor/razor blade business model ensures recurring revenues even during difficult times. In the second quarter, earnings of $1.62 per share were higher than the Zacks Consensus Estimate of $1.27.

Growth in revenues was witnessed across all the segments. We believe the company will continue leveraging its monopoly position in the industry. We rate this stock Outperform with a target price of $260 per share.

Bear of the Day:

First quarter sales and earnings per share for Cost Plus Inc. (CPWM) were slightly above our estimates. Even so, the company's sales declined 9% year-on-year and it reported a net loss of $20 million.

The company is closing stores, cutting costs, and trying to preserve cash, but those moves will do little reverse its weak sales trends and merchandise margins. In addition, management's guidance for the second quarter cautioned investors to prepare for more of the same.

Cost Plus expects same-store sales to decrease 9.5%-14.5% and a pre-tax loss from continuing operations of $14-$21 million. We have an Underperform rating on CPWM shares. Our six-month target price is 50 cents per share.

Latest Posts on the Zacks Analyst Blog:

Gaining Confidence

The rise in consumer confidence means that "animal spirits" may be returning to Main Street, not just Wall Street. If consumers feel more confident, they are more likely to go out and spend, particularly on big-ticket discretionary items. This will greatly help retailers and the companies that make discretionary items.

Even with the "Cash for Clunkers" program running out again, it means that some folks might just feel confident enough about the future to go out and buy a new car from Ford (F) or Honda (HMC), even if they are not bribed to do so by the Federal Government. It means they might go do their back to school shopping at The Gap (GPS) instead of at the Salvation Army.

In the process, they will increase demand and put people back to work. Those workers will then have incomes that they can spend, further increasing economic activity. In short, a vicious cycle would be turning into a virtuous cycle.

Get the full analysis of all these stocks by going to http://at.zacks.com/?id=5507.

About the Bull and Bear of the Day

Every day, the analysts at Zacks Equity Research select two stocks that are likely to outperform (Bull) or underperform (Bear) the markets over the next 3-6 months.

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Carla writes the Dividend Opportunities newsletter for our partner, StreetAuthority, and has some good insight on yields for the stocks within the Dow Jones Industrial Average.

-Charles Rotblut, CFA
Senior Market Analyst, Zacks.com

The 30 stocks in the Dow Jones Industrial Average ($DJI) sport some attractive yielding stocks -- many with more than twice the average yield of the S&P 500. But the question is: Which company has the safest dividend in the Dow?

General Electric's (GE) double-digit dividend yield looked pretty juicy a few months ago -- that is, until they slashed it by -68%. And Citigroup (C), which recently got kicked out of the Dow, had a once-rich yield. Now its quarterly dividend payment stands at one lonely penny per share.

But rest assured, there are still plenty of solid Dow dividend payers -- companies that should continue to deliver yields of 6% or more for years to come. And I've sorted through the blue-chip index and applied several stringent criteria to arrive at the safest one.

Following last year's dismal market performance, investors are understandably cautious. Both Wall Street and Main Street are looking for something they can be sure of in the year ahead. And for income investors, that means finding a safe and rewarding dividend yield.

It used to be that dividend payers themselves were the thing investors could be sure of. Tucked in the shadow of more aggressive and volatile Wall Street darlings, these venerable firms conducted their business, generated solid cash flows, posted their earnings and paid their dividends.These companies all made money the old-fashioned way. They earned it. High-flying? No. Dependable? Yes.

But last year was a tough year for dividend payers. Sixty-one of the companies in the S&P 500 Index cut their dividends in 2008, equating to $40.6 billion in lost dividend income. But it's time to apply last year's hard lessons and take a clear-eyed look at risk, performance strength, dividend coverage and, lastly, potential return.

The Dow Jones Industrial Average represents some of the strongest names in America. The 30 members of the Dow are worth a collective $2.83 trillion and are considered to be the market leaders in their industries.So these corporate titans are a good place to start searching for the safest dividend.

Safety Criteria No. 1: Yield

Considering the challenges of the current economic environment, it's not surprising that this analysis takes five more companies out of contention.

We're left with just two firms: Kraft and Verizon.

Safety Criteria No. 3: Dividend Coverage

Remember, safety is the first and most important criteria I look at when examining a dividend-paying stock.With that in mind, I decided to look into the most recently reported quarter for each company and compare net earnings to total dividends paid. We must exclude any company that paid more in dividends than it earned. That sort of arrangement is unsustainable. Any company whose dividend costs exceed its net earnings lacks the margin of safety that conservative income investors in this market must demand.

This is a tough hurdle to clear:The first quarter of 2009 presented extremely difficult operating conditions.Any company able to comfortably maintain its distributions in such a challenging environment clearly has demonstrated a wide economic moat.

Here are the results:

• Kraft earned $662 million and paid out $426 million for a payout ratio of 64.7%.
• Verizon earned $1.6 billion against its $1.3 billion dividend obligation for a payout ratio of 79.4%.

Amazingly, both companies are trading at almost identical discounts to their five-year average P/E. If each stock returned to its average P/E, Verizon would appreciate +37.1% while Kraft would appreciate +37.2%. Apparently that's not going to break a tie.

Verizon does yield 1.9% more than Kraft, although Kraft has grown its dividend at a faster rate. Both companies also outperformed the S&P 500's annualized total returns for the past five years. But Verizon out gained Kraft by +1.7% a year -- by almost the same amount as its dividend premium over Kraft.

As a telecommunications provider, Verizon is an essential service with high subscriber loyalty. Kraft Foods includes strong consumer food brands like Kraft cheeses, Oscar Mayer meats and Nabisco cookies. Both companies boast of above-average yields and both dividends passed my stringent safety criteria.

If pressed, I'd have to tip the scale to Verizon for the safest dividend in the Dow. Its higher 6.3% yield has made a positive impact on its total returns. And that difference is something we income investors can take to the bank.

-- Carla Pasternak
Editor, Carla Pasternak's Dividend Opportunities

P.S. I know of one stock whose yield is even higher than Verizon's -- and just as secure. I've been recommending this security to my readers for years, and it has rewarded us handsomely. Right now it's yielding a hefty 9.5%. But the best part about this stock is that it pays monthly... AND it's never cut its dividend. Go here to get the full story on this stock now.

In her testimony before the Joint Economic Committee today, Dr. Romer, Chair of the CEA, presented an explication of the progress of the financial crisis and the economic downturn, the anticipated effects of the measures undertaken and planned, and the outlook going forward. On most points, we're in agreement, so I'll only highlight some key issues of interest.

I would characterize the description of the economic outlook as guardedly optimistic. We can't say much more, since Dr. Romer -- in line with historical practice -- did not provide specific forecast numbers associated with her testimony. She did indicate that the CEA forecast is in line with the Blue Chip forecast, of -2.1% annualized growth in 2009Q2 and leveling off in 2009H2. What specifically "in line" means is up for some debate; in early March, I observed that -- given the dispersion in individual private sector forecasts -- the CEA's short term outlook seemed well within the consensus range.

I think Dr. Romer is right to be guardedly optimistic with regard to this near term outlook, despite the fact that yesterday's annualized GDP growth rate of -6.1% was toward the bottom of the range of forecasts. In addition to the factors she identified, including housing starts and consumer confidence, I would look to the point Jim Hamilton highlighted, namely that inventory disinvestment accounted for negative 2.8 percentage points of the growth rate. To the extent that inventories are now at quite low levels, production is more likely to ramp up next quarter. In addition, the rebound of consumption growth suggests that there will be some demand to sustain continued increases in production.

Is (was) there a credit crunch?

The testimony devotes some attention to describing the unfolding of the crisis. It's a narrative I largely agree with. One notable passage contains to this retrospective glance:

Last fall, there was some debate about whether credit was actually all that important. Some pundits suggested that we should just let the financial system fend for itself because it really didn't matter. The horrific falls in employment and production over the last five months have largely ended that debate. Shuttered factories across the country simply scream that Main Street and Wall Street do indeed intersect.

As one who heard a surprising number of academic macroeconomists dismiss the importance of the freeze in the credit markets, I think this particular quote calls for some economists to reassess the usefulness of their theoretical framework for assessing this particular downturn. It should also signal that, going forward, in determining who we pay attention to, we should look to their previous record of statements.

While I agree with the view there is some cause for optimism, especially after the passage of the ARRA, I do believe there are two major risks to the outlook. The first concerns the effectiveness of interventions aimed at restoring the solvency of the banking sector, and spurring the resumption of lending. In light of the increase in the IMF's estimate of financial institution losses ($2.7 trillion vs. January estimate of $2.2 trillion for assets and loans originating in the United States), it is not at all clear that the US government currently has sufficient resources to recapitalize the system, and thereby restart lending.

Dr. Romer's testimony clearly indicates an intellectual understanding of the perils confronting us:

...Japan's experience in the 1990s shows the costs of skimping on bank rescue. Until banks are cleansed of highly uncertain assets and robustly capitalized they will be hesitant to lend, and lending is what we need them to do...

So far, we can't be sure that the appropriate steps to avoid this path will be taken, given the popular resistance to further resource transfers. Certainly, the incipient rebound in financial sector bonuses, and bank management resistance to additional regulation, seems likely to make it harder to build up a constituency for the difficult choices that will likely have to be made in the near future.

As Dr. Romer pointed out, there is a synergistic aspect to the measures undertaken; stimulus without repair of the financial system will, on its own, be insufficient to pull the economy out of recession. Similarly, repair of the financial system will be much more difficult if asset prices continue their decline. On the first point, we have little experience with measuring the effectiveness of fiscal policy in conditions of severe financial distress. The range of estimates that the CBO uses in generating its high-low forecasts pertain to the results obtained over periods when the financial system was operating in a normal or near normal manner. As one can see from the CBO's assessment of the effects of the ARRA, this range of impacts is quite large:

Figure 1 from CBO, Estimated Macroeconomic Impacts of the American Recovery and Reinvestment Act of 2009, March 2, 2009.

In times of financial sector stress, households and firms may opt to rebuild balance sheets instead of increase consumption and investment, thereby short-circuiting the Keynesian multiplier process. A recent IMF analysis suggests that two years after a peak in output, on average output will be 3 percent lower in a recession occurring in conjunction with a financial crisis compared to a recession occurring in the absence of financial crisis. (I will note as an aside that if one believes this effect is operative, then government purchases of goods and services is then a relatively more effective mode of stimulus than tax cuts, unless those tax cuts are directed to highly liquidity constrained households -- see here)

We have not witnessed declines of this magnitude for over 30 years.

It's clear that we have some challenging times ahead of us. In my view, the Administration's made the first right steps. But in some respects, the biggest challenges lay ahead.

The second major concern is the international economic outlook. The IMF’s most recent estimates project world output growth this year (q4/q4) to be -0.6%. World trade is predicted to shrink by 11%.

The contractionary impact on the United States was highlighted in yesterday’s advance GDP release. Annualized real export growth was an estimated -30%, following a -24% rate in the last quarter of 2008. The trade deficit continued its precipitous decline mostly because imports continued its even more rapid decline; non oil goods imports were down by an estimated 39% (on an annualized basis) in the first quarter.

As the effects of global monetary and fiscal stimulatory efforts work their way into Wall Street and Main Street, it will be more apparent as to the direction of the global economy. However, we do anticipate emerging markets to start recovering late in '09, which would spur new demand for electricity and steel, driving coal stocks higher.

We believe that ACI will trade around current levels for the first half of 2009. Therefore we are downgrading our recommendation and are lowering our six-month target price to $16.00 per share.

Read the full analyst report on ACI.

[Joel] Prakken added, "This month's employment loss was driven by the goods-producing sector which declined 126,000 during October, its twenty-third consecutive monthly decline. The manufacturing sector marked its twenty-sixth consecutive monthly decline, losing 85,000 jobs. These losses were compounded by an employment decline in the service-providing sector of the economy which fell by 31,000, the first loss in the serviceproviding sector recorded by the ADP Report since November of 2002."

"Large businesses, defined as those with 500 or more workers, saw employment decline 41,000, while medium-size companies with between 50 and 499 workers declined 91,000. Employment among small-size businesses, defined as those with fewer than 50 workers, declined 25,000. This is the first outright decline in small business employment reported by the ADP Report since November of 2002, and the largest percentage decline since the economy was emerging from recession in early 2002," said Prakken.

Here is a graph breaking down the employment declines.

And here is a figure depicting the implications for the nonfarm payroll employment figures, keeping in mind the loose correlation between the ADP numbers and NFP numbers.

I think Prakken's last point regarding the downturn in small business employment is of substantial interest as policymakers consider options going forward -- and not only because it puts to rest the dichotomy between Wall Street and Main Street. The appropriate policies depend, in part, upon the reasons for why employment is declining -- credit crunch vs. recession. Obviously both are probably at work, but the proportions are of importance. To the extent the credit crunch is the main issue, the Fed and Treasury need to continue their effort to loosen up lending, and at the minimum reduce the likelihood of financial institution bankruptcies.

The last National Federation of Independent Business report did not indicate credit concerns were high; from the October report (pertaining to September):

Regular small business borrowers report that credit is increasingly more difficult to obtain. This has risen to 11 percent in September (12 percent said “harder”, 1 percent "easier") as the creditworthiness of potential borrowers does decline as the economy weakens and customers disappear. Because a slowdown in the economy changes the credit worthiness of potential borrowers as sales and profits decline, more "rejections" will occur even with no change in credit standards by lenders. And, many credit worthy borrowers don’t need credit in a period when business expansion makes no sense and inventories are being reduced, not increased. Thus, the aggregate amount of business loans will fall with no change in credit standards. Regular borrowing activity was reported by 32 percent of the owners (down 2 points), reflecting a reduced need for funds to support inventory accumulation or discretionary capital spending. Both inventory and capital investment plans have been declining as the economy has weakened. So, credit demand is down and fewer loans are being made, but not directly due to a lack of credit availability. Loan demand is lower for many firms. Thirty-three (33) percent reported all their borrowing needs met compared to 6 percent who reported problems obtaining desired financing. The net percent responding favorable was 2 points lower than August and 2 points better than July. Interestingly, 36 percent reported all credit needs met in the tumultuous second half of September, compared to 31 percent in the first few weeks of the month.

Since some of the survey results pertain to the period before the financial crisis, beginning in mid-September, it's of use to see assessments that are more recent. Here is one in contained in Congressional testimony from about a week ago; this statement is from the Chair of the Small Enterprise Committee of the Association of Equipment Manufacturers:

While Wall Street is on a financial roller coaster, I am here to tell you that many small businesses in America are in an economic freefall. AEM members, like the rest of the country, are experiencing challenges due to the credit and liquidity crisis.

....

I have heard from several colleagues on how they are experiencing problems with obtaining lines of credit. One of them, a small manufacturer in rural South Carolina, had an operating line of credit with Wachovia that was secured by a stock portfolio, but with the unraveling of the market their line was frozen. Attempts to restructure their line with Wachovia stopped before they started and inquiries into other banks were met with a "we are only engaging in lending with existing bank customers" type responses. Now my colleague is spending most of his time trying to resolve the issue when he should be working to secure orders in this down market. Still other colleagues of mine have capital to operate but find their orders disappearing, in part because their consumers cannot get credit to make the purchase.

I found this testimony of interest, even taking into account the fact that the representative has an interest in conveying the situation in the starkest terms, because it lays out the web of interconnections to areas which I would not have expected an impact. The testimony continues:

We are now seeing farmers delay the purchase of these inputs [fertilizer, seed, chemicals and fuel] from their "normal" pre-season purchasing patterns as they are having trouble accessing credit and are hesitant to pay such steep prices...

What the foregoing highlights is that for sure credit concerns are important, although the relative importance of decreasing demand is probably rising over time. So, the predictions I made in a post a month and half ago -- about how small businesses will likely be very impacted by this financial crisis -- have to some extent come to pass.

By the way, for those who doubted the reality of the financial crisis, see the Boston Fed's rejoinder (coauthored by Wisconsin PhD Ethan Cohen-Cole) to that Minneapolis Fed "myths" paper (h/t Mark Thoma).

Technorati Tags: small business, credit crunch, employment, Wall Street, and Main Street.

This from Taipan Publishing:

’Tis the season of too damn many cocktail parties. I simply don’t have the stamina for so much small talk and gossip, and don’t much care for finger food – or weak drinks.

But this time of year they are simply unavoidable (i.e., my wife makes me go). And so, all too often, I am forced to put…

This from Taipan Publishing:

’Tis the season of too damn many cocktail parties. I simply don’t have the stamina for so much small talk and gossip, and don’t much care for finger food – or weak drinks.

But this time of year they are simply unavoidable (i.e., my wife makes me go). And so, all too often, I am forced to put…

He says it is essential to guard against today’s downside risks with trailing stops, inverse ETFs, and put options.

And every investor should have a plan to re-engage with the markets when this financial storm passes.

This from Money Morning:

As the worst financial crisis in recorded market history rocks Wall Street, millions of investors on Main Street keep asking a single question.

When will this end?

The market volatility is unprecedented: Where professional traders once ranked a day as “wild”…

And it gets worse. That increase in borrowing costs will spread to other parts of the global debt market, representing an across-the board threat to corporate, institutional and sovereign borrowers. If interest rates remain high and interbank lending remains tight, the credit crisis is not likely to recede.

This raises two key questions. Are desperate times prompting desperate measures? Is LIBOR being manipulated by banks that are trying to make their financial positions appear better than they really are?

If that’s the case, it’s one more…

Bear in mind that each new economic report, earnings statement, news report or trading session represents a new opportunity for fear and uncertainty to reemerge.

Fortunately, next week’s economic calendar remains quite light, although retailers may just weigh in with “doom-and-gloom” holiday predictions.  Earnings season may be weak as well (with even more pessimistic outlooks), so investors should not overreact even if Texas Instruments Inc. (TXN), Halliburton Inc. (HAL), Amazon.com Inc. (AMZN) and others fail to meet expectations.  Volatility should continue and…

This from Taipain Daily:

For the last 25 years, Soros observes, the “motor of the world economy” has been the American consumer. And not only has the American consumer been aggressively consuming, he “has been spending more than he has been saving.”

“So that motor is now switched off,” says Soros. “It’s finished. It’s run out of — can’t continue. You need a new motor.”

The declines of that truly awful week when the…

This from Taipan Daily:

Treasury Secretary Hank Paulson didn’t want things to go this way.

As the ex-head of Goldman Sachs and a die-hard free-markets advocate, he didn’t want to become a de facto socialist (buying stakes in the banks) any more than George Bush did.

But he and Bush have no one none to blame but themselves (and maybe Greenspan) in being forced to swallow this bitter pill.

Commitment to principle is worthless without…

This from Money Morning:

Neither banks, nor corporations, nor any other commercial paper issuers are able to raise significant amounts of money in the CP marketplace.

Almost all of the commercial paper being sold is only one-day paper. Because of systemic fear, one day’s risk is all most buyers are willing to stomach.

However, all CP issuers have long-term obligations, or liabilities that they need to continue to fund – in short bursts – by borrowing in the commercial-paper market. But there are no buyers, because buyers don’t want to lend to anyone on just their creditworthiness, and they don’t want to lend to anyone who is willing to back their CP with assets.

Why?

Because no one knows what those assets might be worth tomorrow. As far as the banks are concerned, it’s even worse than you think.

Not only did banks lend long to borrowers, banks borrowed short-term CP money to buy collateralized residential and commercial mortgage-backed securities for their own inventories or balance sheets.

Banks paid for these toxic assets by issuing commercial paper: They thought it was a great borrow-short/lend-long spread play. But when these short-term loans come due, they can’t “roll” them over.

Where are they going to get the money to pay back the investors who bought their commercial paper when it comes due – in one day, 30 days, 60, days, or however long they borrowed for? If no one will buy any more paper, that’s a big problem.

In fact, that’s a game-ending problem.

Enter the Fed, investor of last resort.

Between commercial-paper borrowings and floating-rate notes (which are similarly short-term borrowings, but for typically up to two years) for just financial institutions – not including industrial corporations and others – it is estimated that more than $1 trillion will have to be paid off by the end of 2009.

Now you know why the Fed has to backstop the commercial paper market. All these desperate short-term borrowers trying to fund long-term assets (loans and securities) will have to find other funding sources; all of which will be devastatingly more expensive than what they paid in the CP market.

As we’ve repeatedly pointed out, this credit crisis is exposing every weakness.

Source: Credit Crisis Update: An Inside Look at the Commercial Paper Debacle

Looking at some of the components of the index, new orders plunged to 38.8 from 48.3, production fell to 40.8 from 52.1, and employment was down to 41.8 from 49.7.  From a GDP accounting perspective, there was a little bit of good news as the export index is still above the 50 neutral line at 52.0, but that is down from 57.0 in August.  The import index fell to 44.0 from 48.5.  This should help a bit on the net export side of GDP growth, but trade improvement from imports falling faster than exports (well exports still appear to be expanding but less rapidly than before, and rising exports have been just about the only bright spot in the economy lately) is not a healthy development.

Also today, the Mortgage Bankers Association reported that its index of total mortgage applications fell 23% last week, despite overall mortgage rates holding steady.  The refinance index collapsed by 34.7%, while the index for new purchases was down 10.7%.  Clearly we are nowhere close to being out of the woods on the housing front.  The takeover of Fannie FNM and Freddie fre does not seem to have done much to free up mortgage lending yet.  The longer the credit freeze goes on, the greater the damage will be.

I would still avoid the Financials in here.  The idea of abandoning mark-to-market accounting is just a desperate attempt to sweep the problems under the rug.  That is the mildest way I can put it.  We need more transparency in the financial statements of the banks, not less.  This is an attempt to repeal one of the most basic rules of accounting, namely that assets should be valued at the lower of either cost or market.  With this change, the books of every major financial institution will belong on the fiction shelf.  Fairy tales can make for enjoyable reading, but you don't want to rely on them for making investment decisions. 

Longer term, there will be some real winners among the banks.  I suspect that J.P. Morgan (JPM) and U.S. Banks (USB) will fall into that category, but I would wait at least a few months before getting into them.  Avoid the weaker banks like National City (NCC), Fifth Third (FITB), Key (KEY), Downey (DSL) and Regions Financial (RF) like the plague.  Sure, they may have days when they pop up by 20% or so, but they will also have days when they are down 20%, and there will be more of the latter than the former.  You would have more fun in Vegas, anyways.

Read the full analyst report on USB

Read the full analyst report on NCC

Read the full analyst report on FITB

Read the full analyst report on KEY

Read the full analyst report on RF

Justice Litle isn't fully sold of the bailout. But he says it isn't an option to let Mr. Market sort himself out this time: the US is too leveraged to follow Andrew Mellon's "liquidationist" approach during the Great Depression.

That's why the feds will do whatever it takes to prop up the system... and run the dollar into the ground. And that's why you should buy gold now.

This from Taipan Publishing:

The problem, in a word, is leverage. Rightly or wrongly, we all got leveraged up to the eyeballs these past few years. Not just the Wall Street banks (though they were the worst offenders) but everyone, including U.S. consumers.

As we all know by now the offending financial institutions - be they bought out or bankrupted or absorbed - were leveraged by as much as 30 or 40 to 1. That’s the equivalent of making a $100 bet with two or three bucks in your pocket, declaring yourself “good for it” if the bet goes bad.

So now, thanks to the laxity of Greenspan, Bernanke, the SEC, Congress and others, we’re saddled with “capitalism on the upside and socialism on the downside,” as some have aptly put it. Wall Street’s stupidly big bets have become everybody’s problem.

But you know what? Joe Sixpack got himself nicely leveraged, too.

Spengler of the Asia Times observes, “Leverage is the secret of American wealth. The average American family in 2004 had a net worth of US$448,000 on an income of $43,000, according to the Federal Reserve's survey.”

When Americans talk about their net worth, they are largely talking about two things: the value of their homes and the value of their investment portfolios. Both those numbers are greatly inflated by the built-in leverage of the system.

For example, what is a house worth? Whatever someone is willing to pay for it... the “multiple” of which depends greatly on a few key things. (Like functional credit markets, for one.)

And what is a stock worth? Whatever multiple someone is willing to pay for the company earnings stream... again based on a handful of key factors.

The upshot is that the average American is leveraged, too, by a factor of 10 to 1 or more. And we’re only talking about Americans with positive net worth here -- not to mention the trillions in pension funds.

If the financial house of cards comes crashing down, it doesn’t just crush Wall Street. It crushes Main Street, too. This is what the Cool Hand Lukes who want to say “screw the system” don’t understand: We as a country are too deep in the system to survive its sudden demise. When you’re in up to your neck, you can’t walk away.

The Mellon Plan: Not an Option

Andrew Mellon was the only Treasury secretary to have served under three U.S. presidents. He held office from 1921 to 1932.

After the crash of ’29, as the Great Depression got underway, Mellon made his position known as a “liquidationist.” Mellon’s famous advice in response to the budding ‘30s crisis: “Liquidate labor, liquidate stocks, liquidate farmers.” In short, liquidate everything in sight. Let the weak fail... and let God sort them out.

That’s simply not an option today. Our entire system is built on leverage. That is the Achilles’ heel of modern financial markets.

In normal times, it’s a good thing that a young couple with a promising future can buy a house on 20% down. In normal times, it’s a good thing that a single mother can get a low monthly payment on a car so she can drive to her new job. In normal times, it’s a good thing that an entrepreneur can get a loan to start up a small business.

But all those good things require debt and leverage... on at least one side of the equation, if not both.

Leverage, like debt, is not an inherently bad thing. It’s a tool that can be used or misused. The ability to use leverage efficiently has played a large part in our current prosperity. But as a result, the use of leverage has become too common and too widespread to just say, “liquidate.” We’re in too deep... we no longer have access to the “Mellon plan.”

The Nuclear Option

This is why I think the powers that be will go “nuclear” in a way we haven’t yet seen.

That is to say, when the depth of the danger really hits home... when it sinks in that the viability of the entire system is at stake, and that we are all at risk of being sucked into the deleveraging vortex... the public and political resistance to a full-blown, no-holds-barred rescue will evaporate.

We haven’t seen the full-blown response yet, only shades of it. But it is coming.

On Monday we got news that Wachovia (NYSE:WB), another major American banking institution, would disappear. The Fed took great pains to clarify it was “not a failure” like WaMu (NYSE:WM)... but another giant bites the dust nonetheless. We also got word that Fortis (EBR:FORB), a Belgian bank, is on the brink. (Welcome to the party, Europe.)

In response to all this, the Fed announced plans to pump $630 billion into the global financial system, according to Bloomberg. By the time you read this they may well have pumped a lot more. (Tell me again why $700 billion is supposed to a big number?)

The plumbing of our global financial system is rotten. Pipes are bursting left and right. A bunch of fat-cat bankers may be the ultimate culprits, but we all played a part... and it’s the only system we’ve got.

Really, what other option is there?

We cannot just “ride this out.” We cannot just “let it pass.” Full-on liquidation would be the equivalent of economic and political suicide. It is going to keep getting worse until the powers that be come up with the most dramatic response they can muster.

We haven’t gotten to that point yet. The “nuclear” option -- in terms of flooding the system with enough dollars to flood the Panama Canal, or even writing outright checks for U.S. equities a la Hong Kong in 1998 -- has not been tried.

It’s going to get worse from here. And so the government is going to do more. And they will keep doing more until things have been turned around, at least on paper.

“This Sucker Could Go Down”

“This sucker could go down,” as President Bush so eloquently put it last week.

The U.S. electorate and Congress did not really believe the Commander in Chief, seeing as how he has been so dead wrong on so many other things. They thought the crisis could be handled with a helping of provisos and quid pro quos -- a little urgency with a little temperance, too. They didn’t really believe that the entire global financial system as we know it was at stake.

But, like it or not, it is at stake. As much as I find it surprising to agree with Dubya, this “sucker” really could “go down.” I view this not as a moral assessment, but a structural assessment... like an engineer testing the joints on a suspension bridge and finding it in danger of collapse. It doesn’t matter whether the situation is fair or unfair, or who screwed up the bridge or built it poorly in the first place. It just is what it is.

When the truth sinks in, the powers that be will do all they can to prevent collapse from happening. The blame game will by sidelined by emergency the task at hand.

And how do I know Washington et al haven’t “done all they can” yet? Because the dollar, heading into its twilight days as the world’s reserve currency, has not yet been destroyed.

That’s the final outcome of the von Mises prophecy... the final reality of the Austrian Endgame. And it’s where we are headed. When the dust clears, it may be recognized that we had to pass through this panic point, to reach the height of realization of what’s at stake, before the true “nuclear” measures were implemented.

Gold Shines Here and Now

There are few areas where I’d be willing to buy with both hands right now. There are some incredible bargains out there to be sure. But as the market bleeds, they are just becoming even more incredible.

I still think the “stocks in the stratosphere” scenario as laid out last week is likely to play out, as the flipside of a U.S. dollar meltdown plus hyperinflationary stimulus.

I think that, with the Dow in full-blown crash territory, we are closer to that “nuclear” trigger point now than we were before. It’s a bit of a counterintuitive thing... before we get paper asset lift-off, things have to get bad enough to panic the powers that be into creating the inflationary conditions that fuel lift-off.

In other words, you don’t walk the path of Zimbabwe and Weimar Germany if you can avoid it. A big part of my thesis is that America’s path is predestined -- and we’re being forced onto that path now.

Being a trader at heart, I prefer to buy when the prices of things I like are going up, even when I’m buying for long-term investment purposes.

Today, what’s going up is gold.

Gold stocks aren’t following suit in the short term, but that’s because frightened hedge funds continue to dump assets left and right. We are witnessing a fire sale of epic proportions. I believe that hard on the heels of this we will see a stimulus injection of epic proportions, and that will push a lot of hard assets higher.

So you could do far worse now than to get your hands on gold: physical gold, gold ETFs, gold stocks. That’s the general ranking in order of safety vs. risk. I like them all now. Gold and gold stocks also make a compelling case for a trade from the technical side.

On the fundamental side, as the reality sinks in of what’s ahead of us, I believe gold will punch through its old highs and keep going (and going... and going... and going...).

Keep a cool head, and I’ll do my best to keep you informed.

Source: Why the “Nuclear” Response to the Crisis Is Still Coming... and What to Buy Now

The blue-chip Dow Jones Industrial Average Index plunged 777.68 points, or 6.98%, to close at 10,365.45. The tech-laden Nasdaq Composite Index plummeted 199.61 points, or 9.14%, to close at 1,983.73. And the broader Standard & Poor’s 500 Index plunged 106.59 points, or 8.79%, to finish the day at 1,106.42.

All sectors were gutted, but energy and financials were among the hardest hit, plummeting 11.02% and 10.55%, respectively.

"My outrage over this just continues to grow," Money Morning Investment Director Keith Fitz-Gerald said in an interview late yesterday. "This just didn’t have to happen."

U.S. share prices sold off sharply once it appeared the House measure would go down to defeat and continued to slump as the afternoon progressed when that appearance became a reality.

Financial markets worldwide had slumped even before the House voting began; Hong Kong’s blue-chip Hang Seng Index plunged 4.3%, while the Paris-based CAC40, London’s FTSE 100 and in Paris and London they were down 3 percent. Hong Kong’s blue-chip Hang Seng Index plunged 4.3%, nose-diving 801.41 points to close at 17,880.70.

By 3:15 p.m. EDT, the Dow had fallen more than 5%. House leaders backing the bailout deal kept the voting period open for more than 40 minutes past the allotted time, pointing to the damage being done to the U.S. stock indices in an effort to convert some of the "No" votes to votes of approval - to no avail, The New York Times reported.

There may have been some optimism - reflected by the close of markets on Friday - that that whatever deal might come out of the Congressional-compromise efforts being hammered out over the weekend would be better than what had previously been on the table, said R. Shah Gilani, a former hedge fund manager who is now a Money Morning contributing editor, and who last week crafted an alternate bailout plan that he presented to readers of this global investment news service. Then, when markets overseas saw what was actually forthcoming, the markets in Asia and Europe sold off as a way of effectively voting "No" to the bailout plan. When the U.S. markets fell at the open, it was as if investors were telegraphing that the deal was doomed, Gilani said.

"What the markets reflected was a ‘no-confidence’ vote in the rescue plan - period," Gilani said. "When the House [of Representatives] vote finally came in, the resulting deeper drop evidenced despair in the continuing politicization and shotgun to specific problems that, for all clear minds, can readily be neutralized by targeted action. Either way, this was never going to be a positive day for the markets."

The vote against the measure was 228 to 205, with 133 Republicans joining 95 Democrats in opposition to a legislative measure that President George W. Bush and Congressional leaders of both parties claim is crucial if the country is to avert a total meltdown of the U.S. financial system. The bill was backed by 140 Democrats and 65 Republicans, The New York Times reported. Proponents of the bailout bill promised to do their best to bring another rescue plan up for consideration in as short a period as possible - perhaps as soon as tomorrow (Wednesday) or Thursday, although there were no plans to do so as of yesterday evening.

"It’s pretty much a nightmare," Michael Nasto, the senior trader at U.S. Global Investors Inc. (GROW), told Bloomberg News. "This is the worst we’ve seen it since the credit mess started. Until we know exactly why they didn’t pass it, we’re going to be selling off for a while."

The CBOE Volatility Index, or VIX index, hit a record high of 46.72 yesterday. The VIX is a measure of "investor sentiment and market volatility." Using real time options prices, it is often used as a measure of fear in the market. The higher the VIX goes, the more fear in the market as investors utilize options to hedge positions.

Given the panic unfolding on Wall Street yesterday, a high VIX reading doesn’t seem that surprising. But what is surprising is that historically, the S&P 500 Index has performed well after such high fear-fueled days.

"Since 1990 there have been four other periods where the VIX closed above 40," Bespoke Investment Group said in a research report released yesterday. "Following each period, the S&P 500’s performance was mixed the next day and week, but over the following month and quarter, the S&P 500 has had consistently positive returns."

Commodity Markets

Commodity results were mixed as the equity crash had opposite effects on oil and gold.

Concern that the weakening economy would severely hamper demand sent oil futures diving. Crude oil for November delivery dropped $10.52, a decline of 9.8%, to close at $96.37 per barrel on the New York Mercantile Exchange. It was the second-largest one-day drop in dollar terms, according to FactSet Research data.

Meanwhile, investors seeking a safe place to invest went running for the yellow metal. Gold for December delivery gained $5.90, or 0.7%, to close at $894.40 per ounce on the Comex division of the New York Mercantile Exchange, MarketWatch reported.

"It would be hard to invent a scenario that could be more bullish for gold than right now," Mark O’Byrne, executive director at Gold and Silver Investment, told MarketWatch. "Bailout or no bailout, gold is going a lot higher due to a broad based flight to quality."

In the bond market, yields on both the 10-year and 2-year U.S. Treasury notes fell as investors poured funds into the safer Treasury Market in yet another example of the current flight to quality.

It may be a good bet or a bad bet, but it's a bet all-the-same. Let's not pretend otherwise.

We are in completely unchartered waters here.  We have no idea what the financial services industry will look like in six months. We cannot even be sure what it will look like in six days.

We've got the House Republicans playing political football with the bailout; Henry Paulson trying to appoint himself czar; Wall Street banks begging with one hand and lobbying with the other; and Presidential candidates who refuse to comment on the most pressing financial crisis in eighty years. 

There is a black hole of leadership in this country, and that's frightening.

The only reason there isn't panic on Main Street is that people don't understand the credit markets. The credit markets have stopped functioning. LIBOR spreads, money markets, CDS contracts, muni's ... the market is in chaos. This will hit Main Street in a very real way if it isn't corrected soon: companies will be unable to meet payroll, factories will be shuttered, etc.

A few points to remember:

• We don't know for sure that the bailout will go through (although it looks like it will).
• We don't know for sure that the bailout will work.
• We don't know for sure what regulations will be enacted next year by Congress to constrain the financial sector in the future.

That last point is a big one. Regulators are going to rewrite the financial laws next year. The days of 33-1 leverage are over, and that means that profit growth and P/E ratios will shrink in the Financial sector.

I'm as tempted as you are to call a bottom in Financials and pick up some bargains. I've almost bought XLF myself a few times over the past week or two. I may do it yet. Over the next few years, there's probably a good chance you make money on that trade.

But with all the uncertainty and poltical brinksmanship going on, no one ... no one ... has any real insight into how this will turn out.

In the best-case scenario, banks will not return to their 2006/2007 profit levels for many years to come.

In the worst case ...  well, our fearless President said it best:

"If money doesn't get loosened up, this sucker could go down."

---Sign of the Apocalypse---

According to Ali Velshi, senior business correspondent for CNN, reporters at the station are not allowed to use words like "meltdown" or "free fall" to describe the markets without prior approval.

A spokesman for the Wall Street Journal says the paper is "staying away from" words like "crash," "panic," "apocalypse" and "pandemonium."

I understand that this is the most reflexive market we've ever had; a big confidence game.  But when the media starts banning words, that doesn't exactly inspire confidence, does it?

Andrew Snyder says campaign managers, not economic advisers, are now shaping the bailout plan. This is bad news for US stocks. The Dow Jones Index (DJI) opened 100 points down from Thursday's close.

Andrew says investors need to go short to profit from this mess. Sportswear retailer Under Armour (NYSE:UA) is primed for a heavy fall. Andrew recommends buying the firm's January 30 Puts (UAMF.X) to profit from a weak holiday season for retailers.

This from Today's Financial News:

Wall Street is in a mess today. It is all thanks to our elected officials in Washington. Yesterday, we were close to a deal. Today, we have moved backwards and investors are paying for it.

The deal is dead. Here we are one week after Bernanke and Paulson ran to Washington to beg for nearly a trillion dollars and no progress has been made. In fact, our elected officials may have succeeded in moving the whole thing backwards, making one of the most dangerous, politically charge financial emergencies in the nation’s history.

Yesterday, the equities market celebrated rumors of a finalized package. All we needed, we thought, was for McCain and Obama to gather with the president, smile, and snap a few campaign photos. It was supposed to be a done deal.

Who knew a shouting match would erupt, proposed bills would be ripped apart, and Wall Street would be hanging on for its life?

As if this financial fiasco was not nasty enough, Washington’s political pandering has decreased the chances of success exponentially. Our legislators are not thinking about what is best for you and me on Main Street. They are merely working their political campaigns, and screwing us in the process.

Instead of economic advisors shaping the deal, campaign managers are calling the shots.

Thanks to this nation’s tendency to put politicians before citizens, Wall Street looks like it is gearing up for a plunge today. Money managers across the globe took yesterday’s bullish action to shrink their portfolios and bail out while they had a chance. There will not be any buyers today unless Washington makes a move.

If you are a savvy investor looking to make some money off this action, go short. Invest in the companies looking to make the biggest drops. My favorite short position right now is with Under Armour (NYSE:UA). Earlier this week I recommended readers buy its January 30 Puts (UAMF.X). Their value has risen by over 35% already. Much bigger gains are on the way.

Today is going to be a historic day on the Street. There is no doubt the bears will start off in charge. Hopefully, Washington pulls itself into high gear and gets us out of this politically corrupt mess before too much damage is done.

One thing is for sure, Washington is not looking out for you and me.

Source: The nation’s future: Campaign managers in charge

By midnight, it was hard to tell who had suffered a worse evening, Bush or McCain. McCain, eager to shore up his image as a leader who rises above partisanship, was undercut by a fierce political squabble within his own party's ranks.

The consequences could be worse for Bush, and for millions of Americans if the impasse sends financial markets tumbling, as some officials fear. Closed-door negotiations were to resume Friday, but it was unclear whether House Republicans would attend.

Now that all five big investment banks -- Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs and Morgan Stanley -- have disappeared or morphed into regular banks, a question arises.

Is this bailout still necessary?

The point of the bailout is to buy assets that are illiquid but not worthless. But regular banks hold assets like that all the time. They're called "loans."

With banks, runs occur only when depositors panic, because they fear the loan book is bad. Deposit insurance takes care of that. So why not eliminate the pointless $100,000 cap on federal deposit insurance and go take inventory? If a bank is solvent, money market funds would flow in, eliminating the need to insure those separately. If it isn't, the FDIC has the bridge bank facility to take care of that.

Next, put half a trillion dollars into the Federal Deposit Insurance Corp. fund -- a cosmetic gesture -- and as much money into that agency and the FBI as is needed for examiners, auditors and investigators. Keep $200 billion or more in reserve, so the Treasury can recapitalize banks by buying preferred shares if necessary -- as Warren Buffett did this week with Goldman Sachs. Review the situation in three months, when Congress comes back. Hedge funds should be left on their own. You can't save everyone, and those investors aren't poor.

...that of the House Republican Study Committee, seems to be a joke. It calls for a two-year suspension of the capital gains tax to "encourag[e] corporations to sell unwanted assets." But the toxic mortgage securities clogging up bank balance sheets are worth less now than when they were acquired. Meaning that no capital gains tax would be owed on them anyway. If you repealed the tax, banks would have even less incentive to sell them because they wouldn't be able use the losses to offset capital gains elsewhere. Seriously, where do these people come up with this stuff?

Eric Cantor, the Republican chief deputy whip, has a more reasonable-sounding if still pretty vague plan to insure more mortgages rather than buy mortgage securities. ....

I'm in agreement with Justin that guaranteeing even more mortgages won't be any better than the original Paulson plan.

My observation here is that the obstructionism of this group is either a manifestion of denial of reality, or a sheer indifference to the needs of their constituents -- to the extent that House Republicans purport to represent small business Main Street.

From CNBC:

Small Business Struggling As Credit Dries Up

Posted By:Kenneth Stier, Sep 25, 2008

While most of the nation's attention is focused on saving behemoth financial firms, small businesses are struggling to ride out a perfect storm of tougher credit conditions in a badly hobbled economy.

The result is that the finance sector's woes -- which has spawned new lending prudence -- is exacerbating, rather than relieving, economic weakness.

Even government programs designed to help small business are falling down on their mandate just when they are needed most, says small business advocates.

"It's always been difficult for small business but now it is become almost impossible" to survive, say Marilyn Landis, chairwoman of the National Small Business Association (NSBA). "Many factors are coming together to make this a perfect storm for small businesses."

Until recently most small business owners could go to their local banks and get unsecured loan of $100,000 or more but those days are long gone.

In the past, owners could put up buildings or equipment for loans needing collateral; similarly service companies could post solid track records of positive cash flow.

But under sharply tightened lending standards these are no longer any guarantee to get needed funding.

Besides, with so much manufacturing having migrated offshore there is less equipment to use as collateral, and property values have plummeted around the country.

As a consequence, small businesses are now using bank loans -- far preferable than relying on credit cards -- is at a 15 year low.

Sixty percent of domestic banks reported having tightened standards on commercial and industrial (C&I) loans to medium and large firms, according to the Federal Reserve Bank's July survey of senior loan officer's opinion on their lending practices.

But for small firms, terms tightened even more. Lending standards to small firms were raised on C&I loans at 65 percent of banks, up from 50 percent in April.

Some 32 percent of small business survey by the NSBA said they were experiencing worsening bank terms, forcing many to use credit cards more.

That's more convenient for banks—which can shift debt off their books to a handful of credit companies – but it subjects borrowers to higher rates and terms that can be changed at will.

In an August survey, 67 percent of small business owners reported worsening credit card terms—up from 57 percent in February.

All this has added to small business owners being "extremely anxious" about the prospect for recession, according to a recent NSBA survey, which found 79 percent anticipating a recession or flat growth at best.

"Even the perception of such limitations on small business sector translates into prolonging the recovery of the US economy," says the survey.

This is critical because small businesses are responsible for 93.5 percent of net new jobs created in the US since 1989, according to the NSBA.

The trade association's survey says near-term prospects for new net job is stagnant.

"It"s a tighter market, it means it takes a little longer, there is a more scrutiny, consumers have to jump through a few more hoops to get that loan," says Tracey Mills, a spokesperson for Consumer Banking Association. "And it's a good thing because banks just want to make sure that whoever gets the loan, will have the ability to repay."

Co-mingled credit histories

One of those new tighter hoops is tighter scrutiny of credit scores.

But that particularly complicates small businesses because many owners' personal and business credit histories are co-mingled, with the debt businesses normally have to carry pulling down overall scores.

...

Another indication of the freeze, from Thursday's FT:

... On Tuesday, the US Federal Reserve quietly admitted that it had been temporarily unable to calculate yield levels for non-financial commercial paper, issued by AA-rated companies for one to three months.

The problem, it seems, was a dire lack of activity; or, as Morgan Stanley says, "extreme levels of stress and illiquidity". More specifically, while investors are still purchasing ultra short-term notes -- say, for one or two days -- on a massive scale, they are reluctant to buy instruments that last longer than a few days. That may be temporary (yesterday yield prices were apparently returning to the AA sector again although they were unusually high). However, even a temporary freeze is remarkable. After all, these non-financial companies typically have nothing to do with Wall Street or toxic mortgage debt.

In other words, the spreads are not just rising; at some maturities in some instruments, markets have disappeared, albeit briefly (for now).

Returning to the CNBC article, I found most startling this statement (I never thought I'd agree with a statement from the US Chamber of Commerce, but these are unusual times):

"Main Street and Wall Street are inextricably connected," said Bruce Josten US Chamber of Commerce executive vice president, urging Congress in a letter Wednesday to act quickly on a bailout out package to stem further market damage. Failure to act, he warned, would make the harm already will in retrospect seem "only the tip of the iceberg because a lockup in credit markets will cripple Main Street's ability to operate and threaten taxpayer jobs and income."

See also this post, as well as

So if we end up delaying until households and small firms individually experience the credit crunch directly for the sake of ideology, well, we'll know where to locate the responsibility.

A large group of House Republicans oppose the government intervention and want a market solution instead. Their proposal, which lacked details last night, calls for the government to insure the bad debt. While I welcome alternative plans, I don't see how this version helps the crisis.

I don't like the modified Paulson plan either, but right now, it is the best proposal we have. The credit crunch is being driven by a lack of trust. Establishing an entity to purchase this bad debt will restore faith by removing the questionable assets from banks' balance sheets. The only question is how to fund the entity.

Unfortunately, taxpayer dollars seems to be the only source of adequate financing. It's far from ideal, but the alternative of doing nothing would be much more harmful.

(We have been providing special coverage of the proposal and the ongoing crisis on the home page of Zacks.com. If you haven't seen it, I recommend checking it out. Included in the coverage is a great post by our Director of Research, Dirk van Dijk, about what credit default swaps are.)

Meanwhile, on Main Street....

The economy continues to be sluggish, and even with a bailout, we probably won't see a recovery until next year. Economic conditions will improve - it's just the timing of the recovery that is uncertain.

Retailers are clearly scared right now. Over the weekend, I saw a decorated Christmas tree at a local shopping small. (Yes, September is way too early to put up Christmas decorations.)

The National Retail Federation said earlier this week that it expects the holiday shopping season to show just 2.2% growth this year. If this holds true, it would be the worse holiday shopping season since 2002.

I'm also starting to see reports about small businesses having difficulties getting loans. On balance, however, most people and businesses with good credit can still get loans. But the credit is getting harder to obtain and the cost of financing has increased. If you can wait until the bailout proposal is passed, I would recommend doing so.

Those of you who are trying to close on a house should call your mortgage broker daily to make sure everything is going fine. In addition, have an alternative broker lined up, just in case. A little prudence and a lot of communication right now will go a long way towards ensuring a successful closing.

Third-Quarter Earnings

I expected a mixed bag for third-quarter earnings.

At the index level, we should see a small decline in year-over-year profits for the S&P 500. The median company, however, should report growth in the upper single-digits; probably around 8% after positive surprises are factored in.

Keep in mind that the composition of the S&P 500 is changing quickly. Many financial firms are falling out of the index, with Washington Mutual (WM) being the latest shoe to drop. This actually helps earnings by removing the weakest links.

Our Strategy for the Focus List

We are trying to maintain a balance of seeking fundamentally sound stocks trading at attractive valuations, while avoiding unnecessary risks. I would like to increase the size of the portfolio, but not to the point where we are just adding and selling stocks to maintain a specific number in the portfolio.

This said, there are opportunities for long-term investors and we will continue to add selected stocks on a case-by-case basis.

Focus List Changes

We locked in a profit on Accenture (ACN) at the start of the week. Earnings estimates for 2008 and 2009 were being cut.

Tupperware (TUP) and Watson Wyatt (WW) both became Zacks #4 Rank ("sell") stocks and were subsequently removed from the portfolio. TUP was a bit of surprise given its global business and the simple fact that more Americans are brown bagging their lunch right now. But, analysts obviously saw reason to be concerned about the company's prospects.

A stop loss was executed on GameStop (GME). The company's fundamentals remain fantastic, but the market continues to ignore GME's positive business momentum.

As I stated in last week's commentary, we added ReneSola (SOL), Smith International (SII) and Sohu.com (SOHU) to the Focus List at the start of the week.

As a quick follow-up to CF Industries (CF), our timing on removing the stock proved to be correct. An analyst downgrade has sent many fertilizer stocks tumbling this morning. CF was trading around $90, $15 below the price we sold it at. Changes in earnings estimates can help to limit your risk, especially in volatile stocks like CF.

The Markets

Everyone is waiting to see what happens with the bailout, so neither technical analysis nor fundamental analysis is going to provide any help with judging near-term direction. Still, it's useful to see what's going on.

The S&P 500 mostly remains in its trading range. If the bailout falls apart, we could see new lows for the year. If it is approved, we could see an upside breakout from the current trading range. Fingers crossed....

The VIX remains above 30. Puts are being purchased as many traders seek protection for their portfolios. Often spikes like these signal a market bottom, but everything right now depends on the proposal.

Keep Looking At Stocks

I know today's commentary has not exactly been positive, but I'd rather give you the facts than provide false optimism.

This said, the economy will recover and stocks will find new highs. The economy goes through cycles, with recessions typically being considerably shorter than periods of expansion.

The best thing you can do is keep researching stocks. This is what successful investors do. We'll help get you through it by finding fundamentally sound stocks and giving you the tools necessary to do your own research.

Charles Rotblut, CFA, is the Senior Market Analyst for Zacks.com. He can be reached at crotblut@zacks.com.
"CF" Free Stock Analysis: Buy? Sell? Hold?
"TUP&" Free Stock Analysis: Buy? Sell? Hold?
"GME3" Free Stock Analysis: Buy? Sell? Hold?
"ACN2" Free Stock Analysis: Buy? Sell? Hold?
"SII" Free Stock Analysis: Buy? Sell? Hold?
"SOL3" Free Stock Analysis: Buy? Sell? Hold?
"SOHU" Free Stock Analysis: Buy? Sell? Hold?
"WW" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

Plunging prices didn’t get the housing merchandise moving either.  The average price of a new home fell by 11.8%, and the median by 5.5%...IN A MONTH!  The inventory situation is still very troublesome, as declining sales offset the decline in the number of new homes on the market. 

At the current sales pace, it would take 10.9 months to clear out the existing inventory.  That is down only slightly from the most recent peak of 11.2 months back in March of 2008 and not far below the all time record of 11.6 months in April of 1980.  A normal figure for months of supply is more like 4 to 5 months.  Given that credit markets were still relatively functional in August, at least compared to what we are seeing now, it is very likely that the September numbers will be much worse than August.

In the Manufacturing sector, total orders for Durable Goods fell 4.5% -- the biggest decline since January.  The January decline was mostly payback for a very big increase in the December number, but this time the July increase was very modest.  Orders for Capital goods -- excluding transportation equipment and defense, or core capital goods -- were down 2.0%.

On the employment front, the news was not much better.  Weekly unemployment claims rose by 32,000 to 493,000.  The four week moving average rose to 462,500.  Some of that increase was due to the recent hurricanes and the resulting severe gasoline shortages across the Southeast.  However, given the freeze-up in the credit markets, I would not expect the number to fall back anytime soon. This week’s number was the worst we have seen since the spike following 9/11.

The credit market remains frozen.  The spread between the rate on a three month T-Bill and what banks lend to each other for three months, known as the TED spread, is still at 3.00%.  Normal is about 0.40% and it had been running at about 1.0%.  In the previous waves of trouble over the last year (i.e. during the Bear Stearns bailout), the spread got to about 2.5%.  The spread between the yield on the very highest quality commercial paper, for example from General Electric (GE) and what mere mortal firms have to pay to borrow for a month, the A2/P2 spread, is off the charts at near 4.00%.  It has never before gone over 2.00% and is normally at about 0.30%.

Stay in the companies who have the strongest balance sheets and which either don’t have to use the commercial paper market, or if they have to can get the best rates.  Firms like Exxon (XOM) and Coca Cola (KO) would be examples of this. 

Read the full analyst report on XOM

Read the full analyst report on KO

"Over the past several weeks, the collapse of confidence in financial markets has become particularly severe. Short-term loans between financial institutions have fallen off sharply. Instead, the Treasury and the Federal Reserve have become the financial intermediaries for them. In other words, rather than financial institutions with excess money lending to institutions needing short-term funding, many institutions with excess short-term money have purchased Treasury securities, the Treasury has placed the proceeds on deposit at the Federal Reserve, and the Federal Reserve has then lent the money out to those institutions needing short-run funding."

The Central Bank has been forced to act like a regular bank.  This is not its normal function, but has stepped into the vacuum.

"Thus far, turmoil in the financial markets has had less impact on macroeconomic activity than may have been expected, and, indeed, economic growth was relatively strong in the second quarter of this year -- in part because of the stimulus package enacted earlier this year. A modern economy like the United StatesÂ’, however, depends crucially on the functioning of its financial markets to allocate capital, and history suggests that the real economy typically slows some time after a downturn in financial markets.

"Moreover, ominous signs about credit difficulties are accumulating. The issuance of corporate debt plummeted in the third quarter, and the short-term commercial paper market has also been hit hard. Bank lending, which has thus far remained relatively strong, will undoubtedly be severely curtailed by the difficulties that banks are facing in raising capital. Such a curtailment of credit means that businesses and individuals will find it increasingly difficult to borrow money to carry out their normal activities. In sum, the problems occurring in financial markets raise the possibility of a severe credit crunch, which could have devastating effects on the U.S. and world economies."

If you think things are bad on Main Street right now, you ain't seen nothing yet.  Soon it will be No Cash for Nobody.

"To mitigate the risks, the Department of the Treasury has proposed the Troubled Asset Relief Act of 2008, and similar proposals have also been put forward by the Chairman of the House Financial Services Committee and the Chairman of the Senate Banking Committee. In an analysis of these proposals, it is useful to identify two problems facing financial markets: illiquidity triggered by market panic and the potential insolvency of many financial institutions."

We have two basic problems: a deep underlying problem of insolvency of many major financial institutions and a liquidity problem on top of it.  With financial institutions, even solvent, well-capitalized firms can fail due to liquidity problems (classic "run-on-a-bank" scenario).  However, merely solving the liquidity problem will not get us out of the woods when the problem is insolvency.

"One problem is that the markets for some types of assets and transactions have essentially stopped functioning. To address that problem, the government could conceivably intervene as a 'market maker,' by offering to purchase assets through a competitive process and thereby provide a price signal to other market participants. (That type of intervention, if designed carefully to keep the government from overpaying, might not involve any significant subsidy from the government to financial institutions.)

"The second problem, though, involves the potential insolvency of specific financial institutions. By some estimates, global commercial banks and investment banks may need to raise a minimum of roughly $150 billion more to cover their losses. As of mid-September 2008, cumulative recognized losses stood at about $520 billion, while the institutions had raised $370 billion of additional capital...Restoring solvency to insolvent institutions requires additional capital injections, and one possible source of such capital is the federal government."

I would argue that the real sum needed to be raised is far bigger than the $150 billion he cites.  That figure might be the case if there were no more losses coming down the pike, and that is clearly not the case.

"Those two problems are related in the sense that it is difficult to know which institutions are insolvent without being able to value the assets they hold (which in turn is impeded by illiquid markets). Undisclosed losses are unlikely to be distributed uniformly throughout the financial system, and the inability to identify which institutions are carrying the largest losses has led to a breakdown of trust in the entire financial sector...

"That loss of trust has sharply increased the cost of raising capital and rolling over debt, which threatens the solvency of all financial institutions. Injecting more capital into financial institutions could help to restore liquidity to some financial markets, because, with larger cushions of capital to protect against default, the institutions would be more willing to lend to one another.

"Another linkage between these two problems could occur if some institutions are unwilling to sell assets at current market prices if that then triggered the recognition of accounting losses; such reluctance to sell can contribute to illiquid markets. With additional equity, those institutions may be more willing to sell at current market prices even if that required recognizing losses.

"Although the problems of illiquidity and insolvency are interrelated, they are at least conceptually distinct. Indeed, some policy proposals appear to be aimed primarily at the illiquidity of particular asset markets, and others appear to be aimed primarily at the potential insolvency of specific financial institutions."

While the two problems are inter-related, it is easier to understand if they are treated separately.

What about the 14 companies I highlighted as likely candidates for the Dow? What about my two favorites—Amgen and Wells Fargo?

I really thought Amgen would get the nod. Biotech represents an increasingly important part of the American economy, and picking Amgen would show that Dow Jones was embracing the future of American commerce and not just the well-established past.

And Wells Fargo? What a statement that would have been about the continued importance of the Financial sector in today's economy! Wells Fargo is a well-run bank, and probably deserves a place in the Dow 30. It would have been nice to look past the headlines and recognize that.

Still, now that the initial shock of being wrong has worn off, I have to admit: It is hard to argue with the selection of Kraft. "Food" is a pretty basic category—pretty important to our day-to-day lives—and there were no food companies in the Dow.

Why did I miss that? I didn't look far enough down the market capitalization tables. With a market cap of just $50 billion, Kraft is not even among the 100 largest companies in America. I thought Dow Jones would look bigger than that, but clearly, I was wrong. I should have known better: There are a half-dozen smaller companies already in the Dow, including GM, 3M and American Express.

In a way, the selection of Kraft is a reminder that the Dow Jones Industrial Average is closer to Rob Arnott's Fundamental Index family than it is to straight, market capitalization indexes. The Fundamental Indexes use a "Main Street" approach to selecting and weighting companies, rather than a "Wall Street" approach: practically speaking, that means they use measures like revenues and book value rather than market cap to choose components.

Consider Kraft and Amgen. Despite having a market cap of just $51 billion, Kraft has an enormous "Main Street" presence: It has revenues of $41 billion, 1 million employees and an important presence in the lives (and cupboards) of millions. Amgen, in contrast, has a market cap of $64 billion, but revenues of just $14 billion and employs just 17,400. Not surprisingly, Kraft is the 27^th-highest-weighted company in the FTSE RAFI 1000, while Amgen ranks 49^th.

The truth is, there is substantial overlap between the DJIA and the FTSE RAFI U.S. 1000: 19 of the top 30 components in the FTSE RAFI 1000 are also in the DJIA, including all of the top 10 components.

So what are the largest holdings in the FTSE RAFI 1000 that are NOT included in the Dow?

ConocoPhillips and Wells Fargo.

See: I knew WFC was a good guess. Maybe next time.