Question: I hear that upcoming earnings reports are worrying the market. If there are a number of really poor reports how do you think the market will be affected and what can the average investor do? — Greg (Philly, PA)
Jonathan Hoenig: There are a number of factors worrying the market right now. Since the beginning of October, stocks across the board have weakened, quickly slipping from the summer highs that saw the Dow near 10,700 and the S&P at 1,240. Year-to-date, all major indexes are now firmly in the red, with the S&P 500 down 2%, the Dow off 4.6%, and the Nasdaq 5% lower. Leading the way downward have been many widely held financial stocks, with JP Morgan Chase (JPM) and Bank of America (BAC) both lower more than 10%, and mortgage lender Fannie Mae (FNM) off by more than 35%. Dow 10,000, last nipped in mid-April, once again looks well within the market's immediate reach.
While stocks have been falling, interest rates, both short and longer term, have made demonstrable progress higher. The five-year Treasury now yields 4.3%, nearing levels not seen since 2002. The yield on the 10-year bond, stuck in a range between 4.0% and 4.5% for more than two years, now appears ready to challenge the upper ceiling of that range.
Bonds of the automakers, namely Ford Motor (F) and General Motors (GM), have been rocked in recent days, with the yield on their debt now well into the double digits usually reserved for risky banana republics or bankrupt debtors. Derivatives broker Refco (RFX) has imploded — it's market capitalization has evaporated in just a week's time.
Even with recent consolidation, energy prices are still sharply higher year-to-date, and the Reuters CRB index is resting near peaks not seen since the early 1980s. Gold, often cited as a "safe haven" during economic turmoil, isn't far from 18-year highs.
What's an average investor to do? I'd say now is a terrific time to get your financial house in order, paying off debts, reducing your spending and getting used to living beneath your means. I'd also suggest putting stop loss orders on all your positions and trimming any individual trades that account for more than 15% of your overall portfolio.
Question: I own shares in Krispy Kreme (KKD). They've been having some real trouble lately. What do you think of the stock and is it a good opportunity to buy more or should I just get out? — Thanks, Phil
Jonathan Hoenig: In the market, it is often the case that where there's smoke, there's fire. So when I'm long a stock that abruptly craters, you can bet that I'm one of the first ones running for the exit, no matter how encouraging the fundamental news might be. If a stock isn't acting right, that's all I need to know before kicking it to the curb. In my world, you sell first and ask questions later.
Let's be frank: Krispy Kreme hasn't been acting right since 2003, when the stock traded near $50 a share. Since then, it has followed a persistent downward trend. That's never an encouraging sign. It's my belief that markets aren't chaotic, but rather they move in trends that tend to persist over time. So while I can't precisely predict the future, I can observe the present and make calculated guesses about how securities are likely to respond.
After a drop from 35 to 20, you might have thought Krispy Kreme would have enjoyed a "dead-cat bounce", but that's not a trade worth sticking around for. In my experience, very rarely does an investment break 20% lower because it's intent on marching right back to previous highs.
I'm going to take a guess that you have a losing trade in Krispy Kreme. Here's how I would play it: with the stock at $4.50, I'd put a stop loss order in with my broker at $4.10. If the stock rallies, I'd slowly move my stop loss higher. If the stock drops, my stop loss order will be triggered and I'll sell my shares near $4.10 per share. My hedge fund has no position in Krispy Kreme at this time.
It doesn't matter why a stock moves, only how it moves. A good trader's responsibility isn't to explain a market drop but to be able to react to it in a calm and disciplined fashion. So when the air-raid siren sounds, don't hesitate to run for cover. More often than not, a stock's first big plummet signals the time to move on.
Question: Do you feel Berkshire Hathaway is overvalued, it has gone nowhere for some time now? — David (Leonardtown, MD)
Jonathan Hoenig: Warren Buffett is regarded as one of history's greatest investors. But lately, as was the case in the roaring 1990s when tech was hot, it seems as if the "Oracle of Omaha" might be on a cold streak. Berkshire's main business is reinsurance, which has been hurt by both the hurricanes as well as increased regulatory scrutiny.
His recent stock picks haven’t been that hot either. Shares of Budweiser, in which Berkshire holds an interest, are down about 8% over the past six months. Berkshire also holds a relatively new position in retailer Pier 1 (PIR), which has fallen nearly 30% since May.
We don't own shares of Berkshire in my hedge fund, and am not looking to add it at this time. If I owned the stock, I'd use a stop loss order near $2,700 per share.
The real reason to own Berkshire Hathaway is to be able to attend Buffett's annual meeting, held each hear in Omaha, Nebraska. It's referred to as the "Woodstock of Capitalism", and considering Buffet's age — he's 75 — the $2,800 it costs to buy a "baby" Berkshire share could be considered, simply, the price of admission to meet the legend in person.
Question: U.S. stocks leave a lot to be desired lately. Are there any foreign stocks that you recommend? — Janet (San Francisco, CA)
Jonathan Hoenig: For months, the U.S. market went nowhere while many foreign markets, such as those in Brazil, India, and South Korea, achieved strong gains. In recent weeks, however, that divergence has dissipated. Stocks have weakened across the board — even the international stocks that had previously been leading the pack.
If you want a real bargain, you might consider looking at Japan. The country’s benchmark Nikkei 225 index (their version of the Dow Jones Industrials) was recently quoted at 13,000, a far cry from the 39,000 level it stood at in the early 1990s. Japanese lawmakers continue to reform the country’s outdated postal savings system, which will prove to be a major boom to capital markets.
Mutual fund players should take a look at iShares S&P/TOPIX 150 Index (ITF), which holds positions in companies such as Canon, Honda Motor and Nippon Telegraph and Telephone. A similar option is iShares MSCI Japan Index Fund (EWJ), which counts Toyota, Mitsubishi Tokyo Financial and Sony among its top holdings. My hedge fund does not have a position in either fund at this time.
Question: Is it wise to invest in my company's stock as part of my 401k? I'm hesitant to do so because of what happened to people at Enron and WorldCom — if my company goes under I'd be out of luck. What are your thoughts? — Jack (Cincinnati, OH)
Jonathan Hoenig: I’m always reluctant to commit too much capital to a single position. Not because I don't believe in my flair for stock picking, but because sometimes the best way to manage risk is not to take it in the first place. In the markets, size kills.
A well-constructed portfolio should serve to diversify risk. But by owning too much of your employer’s stock, you are actually concentrating your risk. If business falters, you are not only exposed to a falling stock price, but the potential for losing your job as well. To that end, I’d be reluctant to hold more than 15% of my portfolio in my company’s stock.
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Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC and is a markets columnist for Smartmoney.com. He appears regularly on FNC's business program Cashin' In.