Look for U.S. Stocks to Shock the Markets in 2008

Today's comment is by Eric Roseman, our Investment Director and editor of Commodity Trend Alert.

Dear A-Letter Reader,

Just when investors thought it was safe to go back into the markets, a dose of bearish news poured cold water over Wall Street's sub-prime recovery. In fact, Wall Street just faced its worst daily loss since early August on October 19th.

In addition to horrible earnings, especially for the banks, brokers and homebuilders this quarter, US$90 oil is just too much for this market to digest.

High oil, poor corporate earnings and more sub-prime warnings from Greenspan helped spark a brutal sell-off in stocks recently.

Although the earnings picture definitely looks dicey at the moment, I would remain invested in stocks over the next 12 months. Why? You may ask.

I suspect other companies will report better figures over the next few weeks. I also see lower global interest rates in 2008. Also, a formidably competitive U.S. dollar will boost exports in 2008. That will all be bullish for stocks.

Banks and Homebuilders Trample the Bull

Thus far, 22% of companies in the S&P 500 Index reported a 14.8% decline in earnings for the third quarter, according to National City.

In addition to the big drop recorded by financials, homebuilders have fared even worse. They just suffered a dizzy 77% crash in corporate earnings.

And technology stocks have been the market's savior - that is until recently.

Last week, Sweden's Ericsson released a surprise earnings decline. Their poor earnings helped trash the stock 29% in a single week! That threw the entire consensus forecasts into question for this quarter. Indeed, prior to the sub-prime crisis, analysts had projected 7.1% earnings growth in Q3. That forecast has now been sharply reduced to -3.7% - the worst quarterly results since 2002.

Major Shocks Absorbed by Consumers, Markets

Commodity inflation has not stopped companies from growing their bottom line. High food prices have caused an earnings compression since 2006. But still most companies have successfully raised prices to offset input costs.

The continued headwind generated from soaring crude oil is even more impressive.

Oil selling at over US$90/barrel is a major barrier for any market. I've been incredibly impressed by the stock market's agility over the last several months when crude soared past US$80 and then US$85 per barrel. The consumer is absorbing the cost of high gas prices.

U.S. consumers are absorbing oil at US$90 per barrel. I see U.S. consumers continuing to absorb higher prices well into the future. As long as employment growth remains benign and wage growth exceeds inflation, consumers will keep buying.

The real concern for the economy is housing. When will we see this real estate bear market form a bottom? I'm guessing not until 2009, at the earliest.

Amazingly the market has held up quite well lately. That's impressive considering the high oil prices, disturbances in Iran, Turkey and the Kurds, more horrendous news on U.S. housing, the massive sub-prime write downs and a parade of earnings disappointments in the financial sector.

Over the next 12 months, I continue to believe that stocks will outpace bonds, real estate and most other asset classes. But stocks will do so at a much more modest pace compared to the spoiled returns we've grown accustomed to since 2003. In other words, the "easy money" is over.

The sub-prime fiasco will continue to keep the economy bogged down through most of 2008. I believe it will create more reasons for the Fed to cut interest rates in an election year. Though I'm expecting more sub-prime-related shocks next year, a cheap dollar and lower interest rates should act as the tonic supporting corporate earnings.

Lower Rates, Cheap Dollar will
Support Earnings in 2008

Financial services stocks, and to a lesser extent, the homebuilders, will continue to weigh down the stock market over the next year. And over the next year, the Federal Reserve will also shift from fighting inflation to thwarting deflation.

But even adjusting for sub-par earnings in financials and housing, stocks should produce at least an 8-10% total return, including dividends. I see that happening as the Federal Reserve continues to boost liquidity. Also, the European Central Bank and the Bank of England should eventually cut rates, too.

Emerging markets will continue to outpace major market stocks. Emerging markets will rule with their superior earnings growth, while the Fed lowers rates and earnings boom.

Stocks are embarking on a period of rising volatility after almost four years of exceptionally low risk-adjusted returns. Investors should remain invested in global stocks, especially U.S. large-caps, which will benefit from an extremely competitive currency and generally healthy balance sheets in the non-financial sector.

The bull market since 2003 is getting grayer by the day, but is not over yet. Continue to own stocks, commodities, gold, foreign currencies, international REITs and avoid most bonds, except ultra-safe Treasuries.

ERIC ROSEMAN, Investment Director

The Next Market Shock Meltdown on Wall Street:
A Tale of M-LECs and SIVs Part I

Two related news items rocked Wall Street last week. The first was key players in the financial sector announced mounting losses tied to the sub-prime credit crunch. The second was a Hail-Mary play drawn up by the U.S. Treasury and Wall Street banks. They're planning to create a "super-fund" to help jumpstart gridlocked credit markets.

It's clear to me that Wall Street is desperate. It's time to hit the panic button.

Third quarter profit reports took a turn for the worst last week. Of the S&P 500 financial firms that have reported so far, earnings are plunging 22% from a year ago, according to data from Zacks Investment Research. That's the largest decline in Wall Street profitability since Bloomberg began tracking the numbers in 1997!

So far, Wall Street firms have collectively written-off US$20 billon in sub-prime and other loan losses as a result of the credit crunch, and the hits will keep on coming. So they've asked the Treasury Department for what amounts to a bailout. The solution is to set up a new and suitably cryptic Wall Street acronym known as an "M-LEC" (Master Liquidity Enhancement Conduit). This will help bailout another obscure Wall Street acronym known as an "SIV" (Structured Investment Vehicle).

Just what are SIVs, you may ask, and why do they need to be rescued by an M-LEC?

That's a good question. But have no fear - Wall Street and Washington are diligently working on the answer, which is akin to a high-finance version of the old shell game.

Let me explain. Wall Street's biggest banks and brokers created SIVs for the sole purpose of hiding assets...legally of course. Some economists, including NYU's Nouriel Roubini have said that SIVs should be "forbidden." But still accounting regulations allow these special purpose vehicles. And SIVs have become big business in recent years.

Typically set up by banks and investment firms, SIVs issue short-term commercial paper (backed by the parent firm), then use the money to purchase long-term asset-backed debt securities. In recent years, this has included lots of sub-prime mortgage loans and many of these are now defaulting at alarming rates. That's the problem now impacting credit markets.

Here's how the operation usually works. A big bank, say Citigroup, sets up a SIV for the sole purpose of buying, let's say, mortgage-backed securities. The SIV is considered a separate operating company apart from Citigroup. Therefore the assets, and more important the liabilities, are NOT consolidated on Citigroup's own balance sheet.

And that's the key to SIVs. Banks and brokers are subject to strict reserve and net capital requirements that limits their ability to leverage up their balance sheet. After all, too much debt appearing on the balance sheet might lead to a credit-rating downgrade. And financial firms are very sensitive about their sterling credit ratings.

Banks like Citigroup are still ultimately still on the hook for the SIV's debts, but these are considered "contingent liabilities" that aren't typically counted in the credit-rating equation.

So the SIVs come in handy as a short of shell-company, keeping mountains of risky debt off the parent firm's balance sheet...that is until a credit crunch strikes as it did this past summer...

Tune in tomorrow to find out why the US$400 billion SIV market is teetering on the brink of collapse...and what it could do to your portfolio. Or read my blog right now to find out how this latest market shock could impact your portfolio.

MIKE BURNICK, Senior Editor & Global Markets Analyst

EDITOR'S NOTE: Wall Street creations like SIVs and M-LECs are just the latest in a dizzying array of derivatives floating around world financial markets. It's a largely unregulated market estimated to total more than US$400 TRILLION in size! The sub-prime crisis is already triggering massive losses on some of these derivatives, and we see many more aftershocks to come.

Our Director of Research, Mike Burnick has uncovered profitable ways to use these market shocks to your portfolio's advantage. Just last week, Mike recommended a way to play the troubled U.S. banking and financial sector for his Market Shock Trader subscribers. The next trade could be just around the corner. Click here to grab your share of the gains now.

Privacy & Rights

How to Buy a Second Passport...
and Why You Might Want to Have One

In last week's A-Letter, I described a sham program for "economic citizenship" from Lithuania. According to the Lithuanian embassy, this "economic citizenship" has no legal basis. For that reason, I recommend avoiding it.

However, two countries - the Commonwealth of Dominica and the Federation of St. Kitts & Nevis - have "citizenship by investment" programs fully authorized in law.

Dominica, sometimes called the "nature island of the Caribbean," is located approximately 300 miles southeast of Puerto Rico.

Not to be confused with the Dominican Republic, it's an amazing island with mountains rising nearly 5,000 feet out of the ocean, a boiling lake and the last original settlement ofnative Americans in the Caribbean. A former British colony, Dominica has been independent since 1978.

Dominica's gorgeous scenery, clean water, pure air, and a largely unspoiled environment have made it a popular ecotourism destination. But the country's rugged coastline, lack of sandy beaches, and the absence of a large international airport have hindered its growth.

Dominica also is periodically affected by hurricanes, although it's at the southern tip of the Caribbean hurricane belt. Last summer, it suffered a severe blow from Hurricane Dean, although damage was limited to its agricultural sector and didn't seriously affect business or tourism.

With a price starting at only US$75,000 for a single applicant (US$100,000 for a family), the cost of Dominican economic citizenship and passport is relatively low. Legal and due diligence fees add approximately US$25,000 to these costs. To qualify, you need to pass a background check, have a genuine interest in Dominica, and speak English fluently.

With a Dominican passport, you can travel visa-free to about 50 countries and enter another 40 or so by obtaining a visa upon entry or with minimal formalities.

The passport provides a substantially expanded ability to live or work in any of Caribbean Community (CARICOM) countries. In addition to Dominica, these are Antigua & Barbuda, The Bahamas, Barbados, Belize, Grenada, Guyana, Haiti, Jamaica, Montserrat, Saint Kitts & Nevis, Saint Lucia, Saint Vincent & the Grenadines, Suriname, and Trinidad & Tobago.

MARK NESTMANN, Privacy Expert & President
of The Nestmann Group
www.nestmann.com

P.S. The Nestmann Group, Ltd. can provide assistance to qualified individuals seeking second citizenship and alternative residence. Please contact us for more information at assetpro@nestmann.com. To learn more about securing a second passport, click here.