Like most investors, Harvard University’s billion-dollar endowment fund took a beating during the global financial crisis. Many investors cashed out, opting for the safety of the sidelines.

But Harvard called a new play.

During the first quarter, Harvard engineered a dramatic shift in its endowment-fund investment strategy – boosting its stakes in some of the most prominent emerging market exchange traded funds (ETFs). Indeed, its largest first-quarter investments included:

• $50.9 million in Vanguard Emerging Markets ETF (NYSE: VWO)
• $1.5 million more iShares MSCI Brazil Index ETF (NYSE: EWZ)
• $1.1 million more into in iShares FTSE/Xinhua China 25 Index ETF (NYSE: FXI)
• $877,700 into Van Eck’s Market Vector Russia ETF Trust (NYSE: RSX)
• $817,300 into iShares MSCI Mexico Index Index (NYSE: EWW)
• $390,400 more into iShares MSCI South Africa Index (NYSE: EZA)

Harvard’s fund also took a first-time, $45.5 million position in iShares MSCI South Korea Index ETF (NYSE: EWY), as well as two foreign titans – a $16.7 million stake in China Mobile Ltd. (NYSE ADR: CHL) and a $12.6 million stake in Israel’s Teva Pharmaceuticals Industries Ltd. (NASDAQ ADR: TEVA).

Obviously, an institution such as Harvard does its homework before making such an aggressive play call, and committing so much money to the emerging economies of the world – global regions whose stock markets took even bigger hits than the United States’ Standard & Poor’s 500 Index.

Since the market bottomed out at 676.53 on March 9, the S&P 500 has gained an impressive 34.2%.

During that same span, however, the ETFs that received Harvard endowment dollars have handily trounced the performance of that U.S. bellwether index. Just as an example: Vanguard Emerging Markets ETF is up 58.1% and iShares FTSE/Xinhua China 25 Index ETF has gained 51.2%. 

And the overall MSCI Emerging Markets Index ETF (NYSE: EEM) – which measures a 26-country-tracking index of the same name – is up 55.2% since the bottom.

Emerging Market Professors

One of the market professors Harvard is listening to is Robert G. Doll Jr., vice chairman and chief investment officer for private equity fund BlackRock Inc. (NYSE: BLK). Doll said earlier this week that the global economy has likely seen the worst of the worldwide financial crisis, and that developing economies are already emerging from recession.

“If, in fact, we have seen a bottom in markets and economies are going to recover, the emerging parts of the world will recover the most and the fastest,” Doll told Bloomberg News. “After all, their recessions were largely unwanted inventory build-up and not the credit bust in the Western world.”

Earlier this month, Doll said he believed the S&P 500 would fall from its current levels (which it had), and then rally to end the year at around 1,000 – for a gain of about 11%.

“Emerging markets, if they are going to do better than that, are going to do closer to 20%,” Doll said. “There are some that already have. Some have done better than that.”

A couple weeks before Doll’s vote of confidence, Mark Mobius, famed investor and head of Templeton Asset Management Ltd., said that emerging-market stocks are building a base to enter a bull market at the end of the year, Bloomberg reported.

“We are at the base-building period for the next bull market,” Mobius told Bloomberg while attending a conference in Indonesia. “What I see happening is perhaps this continuing till the end of the year, and then a breakout.”

Many of these emerging and developing economies are on the cusp of breaking out, but are being held back by the drought of others. The ultimate catalysts that set them loose will be falling interest rates and easing inflation, Mobius said. 

In the first week of May, about $4 billion was pumped into emerging-market equity funds. It was the largest weekly inflow since December and the eighth-largest on record, MarketWatch reported. Most of that went into ETFs, and long-term positions at that.

Not coincidentally, the specific countries seeing the largest inflows are represented in Harvard’s portfolio. Brazil posted its second-largest weekly inflow on record. China, India and Russia also saw huge gains, MarketWatch reported.

Those four markets – Brazil, Russia, India and China – comprise the so-called “BRIC” economies of the world.

Emerging Market ETF Plays 

How to capitalize on emerging markets reemergence from recession depends on your risk tolerance. And risk levels can vary by country and investment sector.

Carl Delfeld, head of global investment advisory firm Chartwell Partners, noted that while the U.S. financial sector is the chief culprit of the global financial crisis, some healthy-capital foreign banks are currently very nicely positioned because they didn’t get involved in the bad U.S. debt, and because they have the fastest-growing growing base of consumers in the fastest-growing markets. 

And a good way to play this trend could be the soon-to-be available Global Shares Dow Jones Emerging Markets Financial Titans ETF, Delfeld writes in the May 25 issue of Forbes magazine. Of the fund’s top-10 holdings, four are China-based, three Brazil and two India.

More speculative investors might be interested in another new ETF, the WisdomTree Dreyfus Emerging Currency Fund (NYSE: CEW), a basket of 11 equally weighted emerging market currencies that are rebalanced every quarter.

The currencies in the fund are the Brazilian real, Mexican peso, Chilean peso, Israel shekel, Turkish lira, Polish zloty, Chinese yuan, South Korean won, Taiwan dollar, Indian rupee and the South African rand.

For more general plays on specific countries, Harvard’s list of new investments could be a good starting point.

Money Morning Contributing EditorHoracio Marquez recommended iShares MSCI Brazil Index (EWZ) in his popular “Buy, Sell or Hold” column last October. It’s also one of the five emerging market ETFs that Money Morning’s Martin Hutchinson recommended earlier this year. Others included iShares MSCI Chile Investable Index (ECH), iShares MSCI Taiwan Index (EWT) and iShares MSCI Singapore Index (EWS). 

News and Related Story Links:

• Yahoo! News:
  Harvard Looks to ETFs, Emerging Markets to Fuel Turnaround

• Bloomberg:
  Emerging Markets Stocks May Rise 20% in 2009, BlackRock Says

• Bloomberg:
  Emerging Markets May Rally by Year-End, Mobius Says

• MarketWatch:
  Huge flows into emerging-market funds in past week: Merrill

• ETF Trends:
  It’s Here: An ETF That Bundles Emerging Market Currencies

• Money Morning:
  Buy, Sell or Hold: iShares MSCI Brazil Index

• Money Morning:
  The Five Most Promising Emerging Markets ETFs for 2009.

• Money Morning Special Investment Report (Part II of II):
  Special Report: Hit the BRICs for a Global-Investing Double Play.

• Money Morning Special Investment Report (Part I of II):
  Special Report: Hit the BRICs for a Global-Investing Double Play.

• Money Morning:
  As Problems in India and Russia Escalate, Let’s Drop the BRIC.

The results of the bank stress tests are in, but instead of releasing them today (Monday), the U.S. Federal Reserve is holding them close to its chest until after the markets close Thursday.

The amount of information awaiting disclosure seems to have grown, as have the reasons to postpone the potentially damaging data.

Not only will the government unveil which banks require more capital, it will also disclose potential loss estimates for certain loan categories and the banks’ ability to “absorb those losses” assuming economic conditions worsen through 2010, a government official told The Wall Street Journal.

Negative results could deal a huge blow to both the banks and government, as a sub-par grade may be viewed as an indictment not only of the failed management of the banks, but the government’s decision to loan them billions of taxpayer money. The banks also are concerned that anything but a tactful release of the results will cause internal and investor panic.

Government and banking industry officials told Bloomberg that both sides needed the extra time to debate preliminary results, as well as plans regarding how banks can recover capital.

On April 24, the government showed the tests’ preliminary results to the 19 U.S. firms it reviewed – from behemoth banks like Bank of America Corp. (NYSE: BAC) and Citigroup Inc. (NYSE: C) to the smaller GMAC LLC (NYSE: GMA) and MetLife Inc. (NYSE: MET). The banks involved in the stress tests hold more than half the loans in the U.S. banking system and two-thirds of the assets. 

“Everybody understands they’ve got a tiger by the tail here,” Mark Tenhundfeld, a senior vice president at the American Bankers’ Association in Washington, told Bloomberg. “If they don’t let him go gently, there will be a lot of mauling going on.”

Already, reports have leaked that two specific banks need more capital, and reaction hasn’t been pleasant.

After showing Bank of America and Citigroup test results, the government told the banks to raise more capital despite receiving a combined total of $95 billion in bailout loans.

At least three more banks need more capital, either from converting common shares to equity and/or receiving more government cash, sources told Bloomberg.

Sensing blowback from Congress, as well as the public, Federal Reserve chairman Ben S. Bernanke said that banks requiring more capital will have to attempt to raise it on their own before receiving another lifeline loan from the government.

Confusion On Evaluation’s Methodology

Debate over the results isn’t the only reason for the postponement. Disputes and confusion over the Fed’s methodology has also erupted.

According to a Fed’s test criterion, common shareholder equity should be the “dominant” portion of Tier 1 capital. Officials favor tangible common equity of about 4% of a bank’s assets and Tier 1 capital worth hovering around 6%.

But The Wall Street Journal reported last week that some bank executives got mixed signals during a meeting with regulators.

The regulators are asking “a million questions” and it’s “very unclear what they’re aiming at,” a senior executive told The Journal. “We can’t discern a pattern.”

Citigroup officials argued that regulators haven’t given the bank enough credit for its efforts to offload large asset chunks, such as Smith Barney and its Japanese brokerage arm Nikko Cordial Securities.

On Friday, Citigroup agreed to sell Nikko Cordial Securities, its Japanese brokerage arm to Sumitomo Mitsui Financial Group (OTC: SMFJY) for about $5.5 billion. The deal, which is to be completed by Oct. 1, also includes a transfer of about $2 billion in excess cash from Nikko Cordial to Citigroup.  

The deal will boost the bank’s Tier-1 capital ratio by approximately 27 basis points.

Individual Result Releases

One insider told Reuters that the government is leaning toward releasing individual results for each bank involved in the stress test – a move away from issuing a summary of results.

The source said the plan “is not very far along,” and that regulators also aim to disclose a lot of confidential supervisory information about the banks.

One analyst says that test results could be so specific to a bank’s portfolio that it’s not wise to use them as a litmus test for the overall health of the banking sector.

“Once you try to take that information and extrapolate it, it gets very complicated and it’s dangerous," Kevin Petrasic, who served at the Office of Thrift Supervision from 1989 to 2008 and is now an attorney at law firm Paul Hastings in Washington, told Reuters.

Whatever the results – or how they are disclosed – Money Morning’s Shah Gilani, a former Wall Street hedge fund manager, said the evaluation process has several flaws.

“What’s missing, unfortunately, is an assumption of how much additional capital would be necessary to facilitate credit expansion – which, in turn, would serve to fuel economic growth. That, after all, should be the ultimate stress-test objective,” he wrote.

And the end result is more stress added to an already stressed banking sector, as too much information and/or misinformation only makes a sound assessment more difficult.

Money Morning’s Stress Test

The government’s pushback of stress test results only made the public more hungry for the their release. But you don’t have to wait until Thursday to know which of the 13 biggest U.S. banks are diamonds or duds.

Last week in “Money Morning’s Bank Stress Test,” Martin Hutchinson highlighted the four secrets that will let you separate the winners from the losers in the U.S. banking system

• Banks that made profits in the very difficult fourth quarter of 2008 and first quarter of 2009 are probably in good shape, especially if their loan-loss provisions exceeded their charge-offs (the amount actually lost.)
• Banks that lost money in the fourth quarter and first quarter may or may not be in terminal trouble; it depends on the amount of those losses and whether the red ink is expected to continue to flow going forward.
• With the run-up in bank stocks in recent weeks, there’s been an accompanying rise in the ratio of share price to book value (stock price per share/book value per share). If that ratio is still below 30% – even after the recent price increases – the market lacks confidence in the bank’s ability to solve its own problems. Unfortunately, the market currently appears to be overly optimistic about some of the banks that still have considerable ongoing problems.
• Management’s dividend policy is less of an indicator than it was just a few short months ago; several banks have sharply cut their dividends in order to repay the Troubled Assets Relief Program (TARP) capital they got in late 2008. Reasonably, profitable banks don’t want the government meddling in their business or compensation structures

Hutchinson also gave an individual analysis of each bank, highlighting their strengths and pulling a curtain on their weaknesses. 

News and Related Story Links:

• The Wall Street Journal:
  U.S. to Release Stress-Test Results on May 7
• Bloomberg:
  U.S. Bank Stress Test Results Delayed as Conclusions Debated
• Money Morning:
  Bank of America’s Lewis Says Paulson, Bernanke Forced Merrill Takeover.
• Reuters:
  Individual "stress tests" may be unveiled
• Money Morning:
  Controversial Stress Tests Reveal Only One Bank Needs Capital, but Worries Remain.
• Money Morning:
  Money Morning’s Bank Stress Test Says These Three Banks Are the Strongest

Barring some dramatic – and unforeseen – news this week, expect investors to tread water until Thursday, when the government is expected to release the results of the bank stress tests it conducted on the 19 largest U.S. banks.

The stress-test results are expected to show that the 19 banks may have to raise between $100 billion to $150 billion – or even more – in new capital. Investors will cause the shares of the strong players to zoom northward, and will likely savage the shares of the weakest players.

"I can’t think of a time since I’ve been watching banks when there’s been so much uncertainty about the true value of a key set of assets," Douglas Elliott, a fellow at the Brookings Institution, a Washington think tank, told Reuters.

The U.S. bank stress tests have transfixed the world financial markets for weeks, exacerbating the ongoing financial crisis – worsening the U.S. recession and shaking economies around the world. That’s escalated the burden on the still-new Barack Obama administration and on the U.S. Congress.

The banks being tested include Citigroup Inc. (NYSE: C), Bank of America Corp. (NYSE: BAC), JPMorgan Chase & Co. (NYSE: JPM), Wells Fargo & Co. (NYSE: WFC), and Goldman Sachs Group Inc. (NYSE: GS). All told, the 19 banks hold two-thirds of total U.S. bank assets.

"Most banks will have to raise capital in some form," Friedman, Billings, Ramsey Group Capital Markets Group (NYSE: FBR) managing director Paul Miller told Reuters. "The capital raises will be much bigger than people think."

Miller said that uncertainty about what the tests might reveal has made banks stocks "uninvestable" in the near term.

The issue for investors is that “you just don’t know how the government is going to view it," Miller said.

Public release of the stress test results is set for Thursday. The government is scheduled to brief the top officials of the banks themselves tomorrow (Tuesday).

Although all but one of the 19 major U.S. banks the government has stress-tested reportedly passed, many skeptics believe the banks are still using all sorts of accounting dodges to keep from revealing just much they still hold in toxic assets and bad loans, National Public Radio reported.

Why wait for the U.S. Treasury Department’s bank stress test when Money Morning can highlight the four secrets that will let you separate the winners from the losers in the U.S. banking system?
Call it the “Money Morning Bank Stress Test.”

Money Morning Contributing Editor Martin Hutchinson last week evaluated the 13 largest U.S. banks and rated them as either “Zombies,” “Walking Wounded,” “Risky But Proud,” and “Hidden Gems,” and concluded that nine of the banks pose some degree of risk. But he also found that four of the financial institutions are “Hidden Gems” that might be worth a look for investors.
On Thursday, we’ll finally see how it all plays out.

Market Matters

Chrysler LLC filed for bankruptcy and then forged a potentially “game saving” partnership with mighty Fiat SpA (OTC ADR: FIATY), Italy’s largest car manufacturer.  General Motors Corp. (NYSE: GM) will be saying good bye to its Pontiac brand (any interest, Fiat?).  Bank of America’s Ken Lewis was stripped of his board chair, but will continue to put out fires from the chief executive office.   Earnings season moved forward and Exxon-Mobil Corp. (NYSE: XOM) did NOT set a new record for a change.  International Business Machines Corp. (NYSE: IBM) bucked the cost-cutting trend and actually raised its dividend.

With Treasury set to release the stress test results on Thursday, rumors are circulating that Bank of America and Citigroup may be in need of additional capital, though both are pleading their cases.  Meanwhile, Citi began lobbying for permission to pay retention bonuses to key employees [it worked for American International Group Inc. (NYSE: AIG) and Merrill Lynch (NYSE: SQD)], who may seek the greener pastures of other (ailing) financial institutions.

Telecommunications firms were in the spotlight early in the week as chipmaker Qualcomm Inc. (Nasdaq: QCOM) raised its revenue outlook and Verizon Communications Inc. (NYSE: VZ) actually announced increased earnings in the first quarter.  Verizon may be teaming up with Microsoft Corp. (Nasdaq: MSFT) to develop its own touch-screen cell phone to cut into Apple Inc.’s (Nasdaq: AAPL) iPhone market share.

Drugmakers Pfizer Inc. (NYSE: PFE) and Bristol-Myers Squibb Co. (NYSE: BMY) posted quarterly results that beat Wall Street expectations, as did The Dow Chemical Co. (NYSE: DOW) and Starbucks Corp. (Nasdaq: SBUX), though the latter’s major restructuring (store closures) prompted a 77% decline in profits.

MasterCard Inc. (NYSE: MA) confirmed that 2009 will be a challenging year, though rival Visa Inc. (NYSE: V) beat earnings estimates, as debit card usage increased, resulting in greater fee income.

The Procter & Gamble Co. (NYSE: PG) struggled last quarter, with weaker sales, as shoppers traded down to lower-priced consumer goods.  Exxon-Mobil, Chevron Corp. (NYSE: CVX), and Royal Dutch Shell PLC (NYSE ADR: RDS.A, RDS.B) were victims of the declining global demand for oil.  Still, Exxon’s long-term outlook remains strong as the company continues pouring money into development projects to be fully prepared once the recession ends.  In fact, management even boosted its stock dividend. 

Economically Speaking

While the U.S. Federal Reserve seemed to offer some “cautious optimism” about the overall direction of the economy, the policymakers avoided any sugarcoating and hedged their comments for fear of an unforeseen development (such as the “swine flu,” also known as the A/H1N1 flu).

While the virus quickly expanded across the globe, most of the worst cases have been limited to Mexico, where the already depressed economy will be further impacted from business closures and travel restrictions.

When SARS (Severe acute respiratory syndrome) hit in 2003, China’s gross domesic product (GDP) was estimated to have been hurt by about 1%; According to early projections by Moodys Corp.’s (NYSE: MCO) Economy.com, the Mexican economy will contract by 6.2% in 2009 (revised from the -4.5% estimate to account for the flu).

The Fed plans to leave rates at near 0.0% and stands prepared to purchase more Treasury and mortgage-related securities to keep the economy moving in the right direction.

The first quarter’s gross domestic product (GDP) highlighted a relatively hectic week on the economic front.  While the economy contracted from January through March at a worst-than-expected 6.1% clip, analysts found some positives deep within the release, as consumer activity actually picked up during the quarter.

The spending component rose by 2.2%, after falling by 4.3% in the fourth quarter.  Additionally, a decline in inventories hindered the release; however, economists point out that such a reduction indicates that manufacturers have scaled back production and will not be burdened with excessive supplies that may need to be deeply discounted to be sold. As demand slowly returns, they will be able to boost production once again.

Meanwhile, consumer confidence surprisingly soared to levels not seen since November 2008, which is especially good news, since the consumer accounts for about two-thirds to 70% of the activity in the economy.   

Weekly Economic Calendar

[Editor’s Note: For more insight into the bank stress tests, check out this related story, which appears elsewhere in today’s issue of Money Morning. The report is free of charge.]

News and Related Story Links:

• NPR:
  Will Bank Stress Tests Soothe Public Fears?
• Money Morning Banking Analysis:
  
  Money Morning’s Bank Stress Test Says These Three Banks Are the Strongest.
• Money Morning News Analysis:
  U.S. Auto Industry Spins Out of Control, as Chrysler Goes Bankrupt and GM Struggles to Reverse Course.
• Guardian Unlimited:
  Spain leads Europe in swine flu cases with 40.
• Wikipedia:
  Severe acute respiratory syndrome. 
• Money Morning News Analysis:
  Data Shows Unemployment, Consumer Spending Close to Turning a Corner.

Why wait for the U.S. Treasury Department’s bank stress test when Money Morning can highlight the four secrets that will let you separate the winners from the losers in the U.S. banking system?

Call it the “Money Morning Bank Stress Test.”

Back in February, I looked at the Top 12 U.S. banks, to determine whether it was really necessary – as U.S. Treasury Secretary Timothy Geithner was proposing at the time – to devote the enormous sum of $1.5 trillion of our money to bail them out. I came to the conclusion that such a huge bailout was unnecessary, and that only a few of the Top 12 banks seemed in any danger of collapse. Fortunately, policymakers and the market have now come to agree with me.

With banks’ first-quarter figures now out, it seems a good time to take another look. Since, at reader request, I had added Fifth Third Bancorp (Nasdaq: FITB) to the Top 12 (I have written on Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS), now technically banks, separately), meaning that we now, here, have a “Top 13″ list of banks – a bit smaller than the list of 19 the government has stress-tested.

[I'm aware of the hang-ups and superstitions involving the number "13." But I'll brave the bad luck, as I can't believe that number will stay at 13 for more than a few months; at the bottom end of the quality spectrum, there are clearly a few banks that need to be put out of their misery.]

All of the financial institutions discussed here have been subjected to Treasury Secretary Geithner’s “bank stress tests” and we are told they have all passed, with one exception (more information is due to be released Monday). That is hardly compatible with the government stance – of just two months ago – that another $1.5 trillion would be needed. I would suggest that the truth is somewhere in between the two extremes: Most of these banks are in reasonable shape and can be expected to recover on their own, but a few need to be put out of their misery.

For the U.S. Treasury Department to buy up “toxic assets” in alliance with hedge funds seems a very bad idea; these banks have been managing their toxic assets themselves and know their portfolios best. Banks that have accumulated toxic-asset portfolios too large to manage, or that are managing them ineptly, should be put out of their misery – and not rewarded with asset purchases at inflated prices. Capital needs to be invested in the most-efficiently run venture, not the least-efficiently run institution.

There is lots of information – about both the potential bailout needs and possible investment bargains – that can be gleaned from the banks’ first-quarter reports. But there are four key factors that investors can employ to separate the investment-worthy bank stocks from those that aren’t.

These four Money Morning bank-stress-test secrets will lead investors to conclude:

• Banks that made profits in the very difficult fourth quarter of 2008 and first quarter of 2009 are probably in good shape, especially if their loan-loss provisions exceeded their charge-offs (the amount actually lost.)
• Banks that lost money in the fourth quarter and first quarter may or may not be in terminal trouble; it depends on the amount of those losses and whether the red ink is expected to continue to flow going forward.
• With the run-up in bank stocks in recent weeks, there’s been an accompanying rise in the ratio of share price to book value (stock price per share/book value per share). If that ratio is still below 30% – even after the recent price increases – the market lacks confidence in the bank’s ability to solve its own problems. Unfortunately, the market currently appears to be overly optimistic about some of the banks that still have considerable ongoing problems.
• Management’s dividend policy is less of an indicator than it was just a few short months ago; several banks have sharply cut their dividends in order to repay the Troubled Assets Relief Program (TARP) capital they got in late 2008. Reasonably, profitable banks don’t want the government meddling in their business or compensation structures

Using those four Money Morning bank-stress-test indicators, we can assess the viability of the leading U.S. banks. We can then divide them into four categories, from weakest to strongest (Zombies, Walking Wounded, Risky-but-Proud, and Hidden Gems). Here are the four categories, and how we defined them:

• Zombies: Institutions kept alive only by TARP funding. These subtract value from the economy and should be put out of their misery through controlled liquidation, with the healthy parts being salvaged.
• Walking Wounded: These may well need some moderate additional help, but are operating reasonably well on their own, right now. Even so, there is a caveat: Should there be an intensification of the current U.S. economic downturn, one or more of the “Walking Wounded” could be pushed into “Zombie” status – or even bankruptcy.
• Risky-but-Proud: These banks have relatively high risks, either because of some ill advised past acquisitions, or because of their business mix. Even so, the “Risky-but-Proud” banks are operating at full blast and can hold their heads high for their success in dealing with enormous difficulties.
• Hidden Gems: These banks have conquered 2008’s difficulties, taken care of their bad-debt problems, and still managed to make a substantial profit. Short of a repeat of 1929-1933, they should continue to do so. Not all these “Gems” are still hidden, however, now that the market has experienced a substantial run-up from its bottom, with many bank stocks seeing even bigger gains.

Here are the Money Morning stress-test ratings of the 13 largest U.S. banks (by assets). The list that follows ignores foreign-owned banks, and also avoids Goldman Sachs and Morgan Stanley, for the reasons we cited earlier. We list the “Top 13″ here in reverse order (smallest banks listed first), because the status of the biggest banks is much easier to determine after you’ve studied comparable regional banks, which have simpler businesses:

13. Fifth Third Bancorp (Nasdaq: FITB). Zombie: With $120 billion in assets, and having received a $3.4 billion TARP investment, this Cincinnati-based regional bank grew by buying other banks in the Midwest and Florida. A recent share price of $3.71 meant Fifth Third was trading at 28% of book value. It lost $1.2 billion in 2008 (even after goodwill write-offs), and has lost another $26 million in the first quarter of this year – a bad result, since the 2008 disaster and the TARP investment should have allowed it to mark down its bad assets, taking “everything but the kitchen sink” into the 2008 loss. Without further federal assistance, Fifth Third’s survival as an independent entity would seem to be extremely doubtful; an orderly liquidation would seem the best alternative. Certainly it should not be subsidized further.

12. Regions Financial Corp. (NYSE: RF). Walking Wounded: With $146 billion in assets, and a $3.5 billion TARP investment, this Birmingham-based regional bank has operations primarily in the Southeast. A recent share price of $5.56 meant Regions Financial was trading at about 30% of book value. It has cut its dividend to a nominal 1 cent per share. It lost $5.6 billion in 2008, and its tangible net worth is only $10.5 billion. However, that loss was entirely an impairment of goodwill; on an operating basis, Regions made a profit of about $300 million. It notched a $77 million profit in the first quarter, although executives stated on the conference call that its Georgia and Florida markets were still a problem. Regions is a definite “Walking Wounded” bank, and is very close to “Zombie” status. However, it’s likely to need only modest additional funding, and looks to be significantly stronger than Fifth Third.

11. BB&T Corp. (NYSE: BBT). Hidden Gem: With $152 billion in assets, and a $3.1 billion TARP investment, this Winston-Salem, N.C.-based regional bank has its primary operations in the Mid-Atlantic region. A recent share price of $23.42 meant that BB&T was trading at about 94% of book value. BB&T was profitable in each quarter of 2008 and in the first quarter of 2009, making $1.5 billion for all of last year and $271 million in first quarter of 2009. It maintained its dividend of 47 cents a share for first quarter of 2009, the only bank to maintain its full payout. The question, of course, it whether management will be tempted to follow fashion and cut the dividend next quarter; otherwise, it looks very solid.

10. Capital One Financial Corp. (NYSE: COF). Zombie (was Walking Wounded): Primarily a credit-card company with some banking operations it acquired, this McLean, Va.-based company has $161 billion in assets, and accepted a $3.6 billion TARP investment. Capital One looks to me like the credit-card-market equivalent of mortgage lender Countrywide Financial Corp. Capital One’s recent share price of $18.97 meant that Capital One was trading at 28% of book value. It lost $1.4 billion in fourth quarter of 2008, and was just below breakeven for the full year, although it reported making $895 million from continuing operations. Capital One lost $112 million in first quarter of 2009, and cut its quarterly dividend from 37.5 cents per share to 5 cents a share. If credit card losses continue to deteriorate, as seems likely, Capital One is a “Zombie,” and only a sharp improvement in the credit-card market can save it.

9. State Street Corp. (NYSE: STT). Hidden Gem: With $174 billion in assets, and a $2 billion TARP investment, this Boston-based bank is focused chiefly on serving institutional investors worldwide. Its recent share price of $37 meant that State Street was trading at 146% of book value. Its 2008 earnings per share (EPS) of $3.89 represented a year-over-year increase of 13%. First quarter net income down 16%, but State Street still earned $445 million. It pays a quarterly dividend of 24 cents per share. With a global business, conservative leverage and Boston management, State Street is a great risk. But it’s somewhat of an unexciting investment currently as securities issues and trading volume have fallen.

8. SunTrust Banks Inc. (NYSE: STI). Walking Wounded (but in danger of Zombification): With $189 billion in assets, this Atlanta-based regional bank accepted a $4.9 billion TARP investment, and has operations in the Mid-Atlantic and Southeast regions, especially Florida. With a recent share of $15.96, SunTrust was trading at 31% of book value. It posted a fourth-quarter loss of $379 million, but its overall 2008 profit was $747 million. However, SunTrust posted a first quarter loss of $815 million, including $715 million of mortgage- and real-estate-loan losses. The bank reduced its quarterly dividend sharply to 10 cents per share in fourth quarter. SunTrust saw its financial position deteriorate in the first quarter, and is in severe danger of zombification, although there are now reasons to believe most of its problems may be out in the open.http://www.google.com/finance?q=bk

7. Bank of New York Mellon Corp. (NYSE: BK). Hidden Gem: With $237 billion in assets, and a $3 billion TARP investment this New York-based bank has its primary operations in New York and Pennsylvania, and has an institutional/corporate orientation. With its recent share price of $26.88, it is trading at 122% of book value. It reported 2008 net income of $1.39 billion, and first quarter profit of $322 million, after which the bank reduced its quarterly dividend from 24 cents to 9 cents a share. Looks solid to me.

6. U.S. Bancorp (NYSE: USB). Hidden Gem: It has $266 billion in assets, and a $6.6 billion TARP investment and is a regional bank headquartered in Minneapolis that operates primarily in the Midwest and Northwest. A recent share price $18.97 means it is trading at 176% of book value. It reported a 2008 profit of $2.94 billion, and a first quarter profit of $419 million. U.S. Bancorp cut its quarterly dividend from 42.5 cents per common share to 5 cents a share, as it wants to pay back its TARP investment. This bank is in good shape, but its capital base would become too thin if it repaid TARP; I’m not sure I want to pay 11-12 times earnings for this stock when the dividend’s so low and the uncertainties are so high, as there’s still some chance of dilution, should it raise capital.

5. PNC Financial Services Group (NYSE: PNC). Risky but Proud (but close to upgrading to Hidden Gem): With $291 billion in assets, and a $7.6 billion TARP investment, this Pittsburgh-based bank bought the slightly larger Cleveland-based National City Corp. in October. Its primary operations are in the Mid-Atlantic and Midwest regions. A recent share price of $43.22 meant it was trading at 104% of book value. PNC’s net income was $882 million for 2008, and $460 million for first quarter of 2009. It cut is quarterly dividend from 66 cents per common share to 10 cents per common share. PNC appears to be handling its National City acquisition well, but remains concerned about possible deteriorations in its credit quality. Nevertheless, PNC’s problems – particularly those derived from National City’s Ohio base – are not hidden, and its continuing profitability means PNC is close to an upgrade.

4. Wells Fargo & Co. (NYSE: WFC). Risky but Proud (but close to upgrading to Hidden Gem): With $1,309 billion in assets, and a $25 billion TARP investment, this San Francisco-based bank went national with its acquisition of Wachovia Corp. With a recent share price of $21.40, this stock is trading at 123% of book value. Wells incurred a fourth-quarter loss of $2.55 billion, not including $11 billion net loss at Wachovia; full-year 2008 earnings were $2.84 billion, and first quarter 2009 earnings came in at $2.38 billion. The stock pays a quarterly dividend of 34 cents per share, but may cut the payout (though this has yet to be announced). Like PNC, Wells is fairly high risk because of the acquisition and Wachovia’s own 2006 acquisition of the California mortgage bank Golden West Financial. But Wells, also like PNC, benefits here because most of its problems are in the open. Optimism may have pushed this stock up too high in the near-term, however.

3. Citigroup Inc. (NYSE: C). Zombie: With $1.945 trillion in assets and a $45 billion TARP investment, plus government guarantees on $301 billion of its assets, this is the big fish for federal regulators. I believe it should be liquidated, though maybe the regulators they want to practice on Fifth Third, first. A global financial conglomerate based in New York, Citi has been a serial flirter with bankruptcy over the last 30 years. A recent share price of $3.19 means the bank is trading at 25% of book value; it’s the only bank stock down since my February report. Citi lost $18.7 billion in 2008. It theoretically made money in the first quarter of 2009, but lost it again because it had to reset the terms of some preferred shares issued the previous year, further diluting common shareholders. It reduced its dividend to a nominal 1 cent per share. At the annual stockholder’s meeting, Citi Chairman Richard Parsons said that “shareholders want profits or flesh, either one.” If I were a Citi shareholder, I’d want both.

2. JPMorgan Chase & Co. (NYSE: JPM). Risky but Proud (close to upgrading to Hidden Gem): With $2.175 trillion in assets, and a $25 billion TARP investment, this New York-based international bank has a large investment-banking operation and bought The Bear Stearns Cos., in March 2008 and the housing-lender Washington Mutual in September – both with federal help. With a recent share price of $33.38, JPMorgan was trading at 92% of net asset value. It had 2008 net income $5.6 billion, and made $2.1 billion in the first quarter of 2009. JPMorgan reduced its quarterly dividend of 38 cents per share to 20 cents in this year’s first quarter. Again, very high-risk because of its acquisitions, JPMorgan nevertheless appears to be in excellent shape – and like PNC and Wells Fargo, may be overcoming the problems it does have.

1. Bank of America Corp. (NYSE: BAC). Zombie: With about $2.8 trillion in assets (including Merrill Lynch & Co., which was acquired after the 2008 year-end), and a $45 billion TARP investment (plus $118 billion in asset guarantees against Merrill Lynch assets), this Charlotte, N.C.-based retail bank is a nationwide player. It bought No. 1 housing lender Countrywide Financial Corp. and No. 3 investment bank Merrill Lynch in 2008. Its recent share price of $9.10 meant it was trading at 32% of book value. BofA reported a fourth-quarter net loss of $1.55 billion, plus the Merrill Lynch net loss of $15.3 billion. It reported a first-quarter profit of $2.8 billion after preferred share dividends, but that included $2.2 mark-to-market write-up of Merrill Lynch debt (the opposite of all those “mark-to-market” write-downs that banks are whining about). It reduced its quarterly dividend to a nominal 1cent per share. Judging by other banks’ results, if Bank of America had made no acquisitions in 2008, it would be in solid shape today. However, excluding special items, it’s barely ahead of break-even in the first quarter after a horrendous 2008, and seems decidedly accident-prone. As the revelations about former Treasury Secretary Hank Paulson strong-arming BofA Chief Executive Kenneth Lewis to push through the Merrill deal seem to show, the bank’s management is pretty anti-shareholder, too.

There are two types of conclusions to be drawn from this analysis, public policy conclusions and investment conclusions.

On the public policy side, it is becoming even clearer that buying up bank “toxic assets” is a very expensive way to attack the problem. The government provides taxpayer subsidies both to hedge funds doing the buying and to banks doing the selling, most of which don’t need the money. At the same time, for the “Zombies” like Fifth Third and Citigroup, taxpayers would have to buy a huge chunk of the balance sheet before the problem was solved.

Equally, there are some banks out there that are not going to recover on their own, and it’s getting close to time for some “tough love.” There’s a public policy case for further subsidies to the borderline cases – Regions and maybe SunTrust – but there is no good case for further subsidies to Fifth Third and the egregious Citigroup, or to Bank of America. As for Capital One, if the credit card business recovers very quickly, it may survive on its own. But if the market doesn’t improve, Capital One should be liquidated, since its business model is based on aggressive card marketing and controversial fee charging – practices which should both be discouraged in a well-run financial system.

For outside observers, the best sign that the crisis is really over will be when the Feds push one or other of the Zombies over the edge. That may not be for some months yet, however.

The investment picture for banks has deteriorated in three ways since my February report:

• First, some of the borderline cases, notably SunTrust and Capital One, have slid further towards Zombie status.
• Second, several banks that were paying juicy dividends have cut them sharply, in spite of continuing to earn enough to cover them. However, since many of the nation’s bank management teams want to get out from under the TARP bonus restrictions, those cuts were decidedly anti-shareholder in nature.
• Third, stock prices have shot up – in several cases by more than 50% – even for doubtful survivors like Capital One. Investor sentiment has swung from deeply negative to rather positive on the U.S. banking system, while the sector’s overall condition has somewhat deteriorated. Stock prices well above net asset value do not adequately account for the considerable continuing risks to the U.S. banking system, or of the feeble dividends that most banks currently pay.

Of the healthier banks, I like JPMorgan Chase, because it is still trading at less than book value, even though the investment banking part of its business is intrinsically unattractive. PNC, at just above book value, is also probably worth looking at; it appears to be well run. Finally, if BB&T avoids the dividend cut frenzy, and maintains its 47-cent dividend (the announcement will be made around May 24), its 8% yield makes it attractive.

News and Related Story Links:

• Money Morning Investigative Report on the Bank Bailouts (Part VIII):
  Obama Administration Must Revive “Shadow Financial System” to Revive U.S. Banks.
• Money Morning News Analysis:
  Controversial Stress Tests Reveal Only One Bank Needs Capital, but Worries Remain.
• TimesOnline:
  More than 100 funds want to buy toxic assets.
• Investopedia:
  Loan-Loss Provisions.
• Wikinvest:
  Troubled Asset Relief Program.
• Money Morning Market Analysis:
  The Top 12 U.S. Banks: From Zombies to Hidden Gems.
• Money Morning News:
  Bank of America’s Lewis Says Paulson, Bernanke Forced Merrill Takeover.

Only one of the 19 financial institutions that received a bank stress test would require additional capital, the controversial government initiative has reportedly concluded.

The identity of the bank that is alleged to have failed the bank stress test was not revealed.

The bank-stress-test findings were reported yesterday (Sunday) by CNBC.com, which said it obtained the information from a source that it did not identify. The source did not identify the company, CNBC.com reported.

“At least one firm – under the [bank] stress test assumptions – will require more capital,” the source said.

The bank-stress-test results were contained in a two-dozen-page report that the government released Friday. But the results had already been “conveyed” to the firms, meaning the bank in question is aware of the U.S. central bank’s assessment, according to the published report.
                                                                     
This round of bank stress tests was essentially a two-step process. The first step – outlining how the banks have been analyzed – was taken care of with the report released over the weekend.  The second step – releasing the results to the public – will be taken care of when the actual results are released May 4, which is one week from today (Monday).

Neither the U.S. Federal Reserve nor the U.S. Treasury Department would comment.

The bank stress tests have a very specific purpose. Financial institutions that are found to have inadequate capital will have six months to raise the money via the private sector. If that doesn’t work, the government has said the financial institutions will be eligible for an infusion of capital via the federal government’s so-called “Capital Access Program.”

U.S. Treasury Secretary Timothy F. Geithner said he would be open to banks repaying their Troubled Asset Relief Program (TARP) loans, as long as the availability of credit (borrowing) was not adversely affected.  As a Money Morning special report detailed last week, the credit markets don’t seem to be loosening up: Lending dropped by more than 20% from October 2008 to February 2009, despite initiatives to encourage such activity.

According to the conclusion of the report released over the weekend, “most banks currently have capital levels well in excess of the amounts needed to be well capitalized.”

However, as Money Morning has reported, the tests have become a “no-win” situation for the Obama administration.

“There are two things that are terribly wrong,” William M. Isaac, the Secura Group chairman who served as head of the Federal Deposit Insurance Corp. (FDIC) from 1981 to 1985, told CNBC.com. The first problem – and a big one – is the fact that the details were announced at all.

“I can’t imagine what Treasury was thinking when it made that move. It has been causing incredible angst in the markets,” said Isaac. “The second big problem is that the Treasury is directing the stress testing, apparently with direct involvement of the White House at the highest levels. Bank regulation by law is supposed to be carried out by the independent banking agencies without any political interference.”

Market Matters     

As Money Morning reported Friday – in a Wall Street version of the old “he said/(s)he said” drama, Bank of America Corp. (BAC) Chairman and Chief Executive Officer Kenneth Lewis claimed that ex-U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. and central bank Chairman Ben S. Bernanke threatened to remove him from office if he backed out of the Merrill Lynch & Co. Inc. (SQD)  merger or (publicly) discussed the mounting losses.

Paulson had previously testified that Lewis must have misinterpreted their comments, but then seemed to blame Bernanke for the threat (Translation: Paulson tried to throw Bernanke “under the bus.”).

New York Attorney General Andrew M. Cuomo has been investigating the activities surrounding the merger to determine why shareholders were kept in the dark about the financial “challenges.”

Shifting to autos, Italy’s Fiat SpA (OTC ADR FIATY) emerged as a potential major global player as it attempts to forge a partnership with (soon-to-be-bankrupt?) Chrysler LLC, and also has interest in buying General Motors Corp.’s (GM) Opel unit. Meanwhile, GM will be closing 13 production plants over the summer to trim inventory and seems likely to miss a $1 billion debt payment due June 1 as it too moves closer to bankruptcy protection.

How bad is GM’s plight: GM may close its Pontiac division after 82 years of operation, The Wall Street Journal and MarketWatch.com reported over the weekend.

While the earnings news of the week found plenty of winners and losers, ultimately analysts perceived a bit of “cautious optimism.”  Bank of America and Morgan Stanley (MS) failed to live up to the favorable showings by Wells Fargo & Co. (WFC) and other financials, though techs like Texas Instruments Inc. (TXN), Apple Inc. (AAPL) and International Business Machines Corp. (IBM), beat Wall Street expectations, and brought new hope that the downturn was nearing an end. (Watch for an updated “Hot Stocks” feature on IBM here in Money Morning later this week).

Unfortunately, Microsoft Corp. (MSFT) posted the first quarterly revenue decline in its 23-year history, though investors still cheered its ability to reduce costs during these challenging times for PC sales. McDonald’s Corp. (MCD), AT&T Inc. (T), and Ford Motor Co. (F) were among the diverse group of companies reporting better-than-expected results, while United Parcel Service Inc. (UPS), Caterpillar Inc. (CAT), and Continental Airlines Inc. (CAL) issued disappointing numbers.

Amazon.com Inc. (AMZN), the subject of a recent “Buy, Sell or Hold” feature here in Money Morning, bucked the negative trend facing many retailers and posted higher quarterly earnings and revenue.

Additionally, U.S. retailers J.C. Penney Co. Inc. (JCP) and Coach Inc. (COH) each expressed positive sentiment that sales activity seems to picking up.  Oracle Corp. (ORCL) snapped up Sun Microsystems Inc. (JAVA) for $7.4 billion after IBM chose to pass, and PepsiCo Inc. (PEP) is attempting to purchase two related bottling companies as corporate execs seek favorable deals in this environment.  Such merger-and-acquisition (M&A) transactions often signal boardroom confidence and also indicate that the “worst” part of a downturn may be over. 

Oil prices surged above the $51-a-barrel level late in the week as traders overlooked the higher inventory levels and instead focused on some favorable signs that the economy may be closing in on turnaround mode.

With a six-week winning streak on the line, investors offered their best “clutch hitting” late Friday, pushing all major indexes to higher levels. Early in the week, after investors digested negative news from the likes of Bank of America and GM, prognosticators said the weekly stock-market winning streak was all but over. However, some better-than-expected earnings and economic reports brought out the “bulls” for one final run.  The Nasdaq Composite Index ended the week in positive territory, and the other equity indexes were virtually flat from last week’s closing levels (with the Dow Jones Industrial Average suffering a slight decline). 

Economically Speaking

According to the International Monetary Fund (IMF), the global downturn will be far worse than previously expected.  For 2009, the IMF expects the world economy to contract by 1.3%, its first such decline in 60-years, with over 10 million employees losing their jobs.  Unfortunately, its projections for the United States are even more dire (-2.8% for the year), with domestic financial institutions suffering $2.7 trillion in losses, almost twice the IMF’s prior estimates from just six months ago.   

While much of the economic data of the week confirmed the IMF’s weak projection, analysts found a few positive signs that the downturn very well may have bottomed out.  While both new home sales and durable goods orders declined in March, the results beat the weaker Street expectations and came in the aftermath of some (relatively) strong February numbers.

In another promising sign of stability within the housing sector, the median price of an existing home sold in March actually rose for the second straight month.  Still, the record unemployment filings last week revealed the ongoing difficulties facing job seekers amid these tight labor conditions.  Likewise, leading economic indicators, a predictive report, dropped for the third consecutive month and many economists expect the recession to last at least until late third quarter. 

Weekly Economic Calendar

News and Related Story Links:

• CNBC.com:
  
  Stress Tests Show One Bank Would Need More Capital.
• Money Morning News Analysis:
  Stress Tests Put Obama Administration in “No-Win” Situation.
• Money Morning News:
  Bank of America’s Lewis Says Paulson, Bernanke Forced Merrill Takeover.
• Double-Tongued.com Definitions:
  Throw [Someone] Under the Bus.
• Wikipedia:
  Andrew M. Cuomo.
• Money Morning Special Report (Part II of II):
  A Look at Liquidity: The Real Reason Banks Aren’t Lending.
• Money Morning Special Report (Part II of II):
  A Look at Liquidity: Venture Funding Hits 12-Year Low Amid Cold IPO Market.
• The Washington Post:
  A Better Way to Aid Banks.
• RTT News:
  PepsiAmericas Board forms Transactions Committee to review PepsiCo’s offer – Quick Facts.
• MarketWatch.com:
  GM may close Pontiac division after 82 years.
• Money Morning:
  Buy, Sell or Hold: Amazon.com Inc. Looks Even Better Now Than it Did in February.
• Money Morning:
  Hot Stocks: IBM’s Diverse Business and Global Presence Should Boost First Quarter Earnings.
• Money Morning Outlook 2009 Series:
  The U.S. Market for Deals Remains in a Deep Freeze.

The Obama administration may have backed itself into a corner when it released the details of the "stress test" methodology being used to evaluate the health of the nation’s big banks. 

With final results not expected to be released until May 4, releasing the testing methods for Citigroup Inc. (C), JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), and 16 other banks is only likely to increase market speculation – the exact result Obama’s economic team is trying to avoid.

Releasing the formula may also lead analysts to compare the test criteria to public financial data and start to draw their own conclusions about which banks are likely to fail or will require massive infusions of additional capital.

"They’ve gotten themselves in a pickle on this thing," said Bert Ely, an independent banking analyst. "It’s clear they didn’t think through how this was going to play out."
The stress tests are based on two scenarios: One assumes current forecasts for the recession are correct and that the unemployment rate will remain at 8.8%, while the other projects conditions will deteriorate with unemployment climbing as high as 10.3%, according to documents released by the U.S. Federal Reserve.  The tests are being used to determine if banks have enough money reserved to withstand further losses under either scenario.

The administration has said no banks will fail the test, but if they fall short, regulators will force them to boost their capital. If they can’t raise the funds through private sources in six months, the government will step in with funds to shore up operations at the banks that are deemed too big to fail.

Part of the tests will focus on loan quality as a measure of health. Commercial loans in default or foreclosure soared to $65.9 billion in the first quarter, up 43% from $46 billion at year-end, according to New York-based research firm Real Capital Analytics Inc. Property values have fallen at least 30% since their 2007 peak.
U.S. banks have reported more than $550 billion in writedowns, losses and credit provisions since 2007, according to Bloomberg data. Banks have raised more than $400 billion from private investors and the government to guard against loan losses as mortgage defaults surged.

Federal Reserve officials disseminated preliminary results to representatives of the banks on Friday.   KBW Inc. (KBW) issued a report on April 23 that said lenders may need to raise $1 trillion in capital to cushion losses.

The fear is that speculation will only increase after the release of the testing criteria, which may cause a run on banks with capital needs.  That could make it harder for them to persuade investors to give them cash.

"We’re really hesitant to put money into financials," Douglas Ciocca, a managing director at Renaissance Financial Corp. in Leawood, Kansas, told Bloomberg News. 

"The ambiguity is still engulfing the opportunity."

Regulatory bank reviews are normally kept secret to avoid shaking up investors and customers who may race to withdraw their money.  The administration is trying to  maintain a delicate balance between revealing too much – which could destabilize weaker banks – or saying too little, leading the public to assume the government is whitewashing the results. 

The tests are at the center of the Obama administration’s plan to stabilize the financial system. Officials have been refusing to answer questions about the banking system for months saying they’re awaiting the test results.

Officials are trying to release enough information to give investors confidence. But they don’t want to give analysts so much detail that they can run their own tests on the banks before the official release of results.

The slow-motion rollout is intended to tame market reaction to the news but that might backfire as well.

"It’s a week plus until we find out, that’s where the danger is," said Anton Schutz, president of Mendon Capital Advisors Corp. in Rochester, New York, which manages $150 million of financial stocks, told Bloomberg. "You get market movement on what might be fact or fiction," he said.

Further complications may arise when the government releases final results on May 4 because the Obama administration may ask banks that need more capital to disclose how they plan to get additional funds.

In a report on the tests last week titled "Total Confusion," analyst Richard X. Bove of Rochdale Securities contended that the government is in a no-win situation because there was "no effective way to communicate the results of this test without causing greater stress than the test itself," the Times reported.

News and Related Story Links:

• Los Angeles Times:
  Bank bailout plan’s ’stress tests’ already causing stress

• Bloomberg:
  Stress-Tested Banks May Struggle as Bad Assets Triple

By Ron Brounes
Contributing Writer
Money Morning

Long-short investing strategies aren’t just for hedge funds anymore.

Many investors believed diversified “long-only” portfolios would always serve them well, regardless of the market conditions. They expected certain asset classes would perform well even as others were struggling.

After all, most mutual funds, exchange-traded funds (ETFs) and managed accounts offer long-only strategies. And why not? After all, the strategy is simple: These portfolio managers buy securities and hope to take advantage of price appreciation.

But the ongoing financial crisis proved those investors wrong – for several reasons. After all, what do you do in a trendless (sideways) market? And what about a declining market?

In either situation, the profit payoff from a purely long portfolio doesn’t figure to be very large. And that’s no surprise. After all, when bear markets arrive – as they periodically do – long-only money managers are typically limited to raising additional cash, or seeking conservative investments with limited downside, meaning the upside potential is also fairly small. And as investors have seen all too often during the current financial crisis, money managers who insist on “fighting the tape” can often generate big losses for their clients.

That’s where long-short investing strategies come into play.

“It’s only investing strategy with a built-in lifeline,” said Louis Basenese, editor of The Long and Short Alert. “If the markets head up or down, you’re positioned to profit. And given the wild volatility we’ve witnessed in the last year, any investor not playing both sides of the market, simultaneously, quite frankly, deserves it if they drown their portfolio.”

Unfortunately, many investors have learned their lessons the hard way for the past year and a half as virtually all classes have declined in value, resulting in sizable losses within their portfolios.

“This environment has exposed the flaws in traditional asset allocation theory, Capital Asset Pricing Model (CAPM), or whatever label you choose to put on it,” said Tom Samuels, managing partner of Houston-based Palantir Capital Management Ltd. and manager of the Palantir Fund, a global all-cap long-short mutual fund.  “While Markowitz (Harry) and Sharpe (William) still have their firm believers, sophisticated investors are realizing that they cannot achieve true diversification merely by being long a variety of asset classes.”

Samuels believes the majority of long-only returns are influenced by the direction of the overall markets and that long-short investing strategies provide one of the few ways to achieve true portfolio diversification and risk control.

“Long-short represents the only asset class that can effectively handle both sideways and bear markets,” Samuels said. “The asset class allows investors an opportunity to systematically approach the markets and individual risk parameters differently than being long-only.”

The Long and the Short of a Newly Popular Investing Strategy

A long-short money manager has the ability to both buy and sell stocks to help reduce risk during such less-than-optimal investment environments as a trendless market or even a bear market.

The long-short strategy often serves as a hedge from overly bearish markets by allowing investors to take advantage of upside potential (long positions), while also benefiting from downward movements of certain investments (short positions).  In choppy markets – like those of today – the strategy can help investors book some gains as they focus more on capital preservation, and not simply appreciation.

In reality, investors should consider incorporating some form of a long-short approach as part of the overall asset allocation of their portfolios, experts say.

Brian Lipton, founder of Gaithersburg, Md.-based YellowWood Financial Advisors Inc., seeks out investments that are not correlated with traditional stocks and bonds.  Lipton views long-short investment products as another piece to the portfolio construction puzzle, and has incorporated hedged equity mutual funds as part of a tactical allocation – a way of reducing exposure to the risk of a long-only securities position.

“We realized long ago that we cannot ‘time’ the markets,” said Lipton.  “We typically allocate about 20% to 30% of our equity portfolios in a tactical manner. Hedged equity represents a part of that allocation that helps satisfy certain risk elements and, of course, allocations that reduce long-only exposure in this environment have been beneficial.  We have found that hedged mutual funds have been a very good choice during periods of intense volatility and could work well during other times as well.

Lipton’s firm uses one fund that goes long on favored positions, short on out-of-favor positions, and another fund that buys equities and hedges them with short positions on various indexes.

“While the latter fund is 100% hedged today, that percentage could change based on their views of the market environment,” Lipton said. “Security selection is still important.”

Sign up below… and we’ll send you a new investment report for free: “Credit Crisis Report.”

Hedging Plays: Make Macro Calls, Dodge Market Falls

At Palantir, Samuels looks for opportunities to hedge long positions, while also seeking profits on the short side.  In managing his long-short fund, Samuels will make macro calls on the markets and the economy, micro calls on companies he believes to be either under- or overvalued, and also employs market-neutral arbitrage trades by pairing long and short positions in similar securities.

“Right now, we are short the dollar by owning the [PowerShares DB U.S. Dollar Bearish Fund (UDN)], an unlevered ETF that inversely mimics the movements of the U.S. currency,” said Samuels. “That position represents a macro call against the dollar and the ETF shot up dramatically when the Fed announced its intent to aggressively buy Treasuries to lower rates.  Additionally, we believe this short trade provides nice cover as some domestic companies may struggle relative to their international counterparts.”

Samuels’ fund is also betting against U.S. Treasuries through short positions in an ETF that tracks long-term government securities.

“Historically, central banks have had mixed records of holding rates down, particularly when their currencies begin to fade,” Samuels said. “Shorting Treasuries provides an opportunity to make money on that macro call, while also serving as a hedge against certain long industrial and consumer-related domestic equities that may struggle in a rising interest rate environment.”

Dave Walker, YellowWood’s director of operations, points out that his firm has begun using a long-short commodities-based fund as a way of employing this non-traditional investment strategy.

“We have been allocating a portion of certain clients’ portfolios into long-only commodities funds for years, but gains and losses have recently come so fast and furious that we chose to move into a hedged product,” Walker said.  “We realize we cannot time these markets on a daily basis by investing long or short.  But based upon the trends in the global economy and surrounding specific categories of commodities, a hedged commodities fund allows us to participate in this alternative asset with lower risk and volatility.  We will trail indices when there is a quick rebound but, more importantly, we expect to curb the downside.”

Market Neutral Pairs

Palantir’s Samuels explains the pairs trading concept through a hypothetical example.

“The market-neutral pair trades entail buying a company in a high-quality security as measured by free cash flow (FCF), low debt, and [solid] profitability, and simultaneously selling a security in the same sector that we perceive to be [of a] lower quality based on these same parameters,” Samuels said.  “Let’s say, we liked Intel (INTC) because of where the company is in its product cycle, its low debt position, and its positive cash flow.  Conversely, we recognized that [Advanced Micro Devices (AMD)] maintains considerable debt and its last product introduction was under whelming.  In this example, we may choose to go long Intel and short AMD.”

Samuels then discusses an environment that has the overall equity market declining by 30%, with Intel and AMD dropping 25% and 35% respectively.

“A properly executed paired trade would have returned 10% to the investor, even as the stock market as a whole lost 30%,” said Samuels.  “The long-short manager then has the opportunity to unwind the arbitrage, but only one side at a time, if desired.  We may believe AMD is more fairly valued after a drop of 35% and choose to cover our short, while still owning Intel, a high-quality stock that could appreciate should the market rebound.  The long-short approach provides us significant flexibility, while the long-only manager has to identify high-quality stocks and then hope that the overall market direction cooperates.”

Client Interaction

YellowWood’s Lipton had not seen sheer panic from his clients – at least not before the Dow Jones Industrial Average recently fell below the 7,000 level.

“For the most part, our clients understand their allocations and we received very few distress calls,” said Lipton.  “Nevertheless, we know the concern is there. When the Dow broke below 7,000, some became worried about further significant slides without any apparent market support.  We spoke with them more about increasing the hedged positions and they were happy to control the downside better, while giving up a bit of appreciation potential.  They were very interested in such investments, particularly given the uncertain environment we are in.”

And these days, a little peace of mind can go a long way.

[Editor's Note: Ron Brounes, CPA, is a regular contributor to Money Morning. A technical financial writer, Brounes, is president of Brounes & Associates, a Houston, Tex.-based consulting firm that provides writing, communications, and educational services for financial services professionals. Back in March, Brounes wrote about how the Obama stimulus package would affect your income taxes.
For more information about the long-short approach to investing, check out analyst Louis Basenese’s Long and Short Alert,which focuses specifically on thatstrategy.]

News and Related Story Links:

• Money Morning Financial Crisis Investing Series (Part VII):
  Financial Crisis Investing: How to Profit Even if the Current Bull Market Rally is Really a Bear Market Fake.
• Money Morning Financial Crisis Investing Series (Part VI):
  As Financial Scams Go Global, Here’s How to Avoid Being Stung.
• Money Morning Financial Crisis Investing Series (Part V):
  Seven Ways to Get an Income-Tax Boost From the Obama Recovery Plan.
• Money Morning Financial Crisis Investing Series (Part IV):
  For Dividend-Seekers, Financial Crisis Means it’s Time to Dip Into DRIPs.
• Money Morning Financial Crisis Investing Series (Part III):
  Mutual Funds With Low Minimums Can Put Investors Back on the Winning Path.
• Money Morning Financial Crisis Investing Series (Part II):
  Retirement Strategies: The Three Best Ways to Rescue Your 401(k).
• Money Morning Financial Crisis Investing Series (Part I):
  Retirement Blues: Financial Crisis Pulls Billions From Pension Plans, Crimping Consumers’ Dreams and Corporate Profits.
  
• Investopedia:
  Managed Accounts.
• FinancialDictionary.com:
  Don’t Fight the Tape.
• Wikipedia:
  Asset Allocation.
• Wikipedia:
  Capital Asset Pricing Model.
• Wikipedia:
  Long-Short Investing.
• Financial Guide:
  Non-Correlated Assets.
• Wikipedia:
  Market Timing.
• Wikipedia:
  Pairs Trading.
• Investopedia:
  Free Cash Flow.
• Money Morning Investment Research Report:
  In the Long Run, the Dow’s 40% Nosedive May Actually Turn Into a Safe Landing.

By Don Miller
Associate Editor
Money Morning 

Since the Obama administration took office almost 100 days ago, it has repeatedly said the key to an economic recovery is to unfreeze the credit markets and increase bank lending. 

So far, American taxpayers have shoveled out almost $600 billion in Troubled Asset Relief Program (TARP) funding to prime the economic pump and get the banks lending – and people spending – again.

Yet a report by The Wall Street Journal shows the banks are lending less money than they did five months ago. And further research shows no matter how much TARP money the government pumps into the U.S. banking system, American consumers may just not be ready to drink from the trough – a sobering reality that could doom the chances of a quick economic rebound.

Meanwhile, the banks’ perceived reluctance to lend – coupled with their lavish spending on bonuses and management perks, has the the Obama administration on the defensive, sensitive to skepticism about the government’s ability to revitalize the banking system.

Bank Lending Still Anemic

Despite government pronouncements to the contrary, pumping billions of dollars into the financial sector has not had the desired result, meaning lending hasn’t accelerated. In fact, according to the recent Wall Street Journal analysis, initial loans and refinancing outlays at the nation’s big banks dropped by 23% from October to February.

According to the data, 19 financial institutions made or refinanced a total of $226.3 billion worth of loans in October. That figure plummeted to $174.2 billion for February, The Journal reported.  In fact, the total dollar amount of new loans declined in three of the four months the U.S. government has reported the data, and all but three of the 19 largest TARP recipients originated fewer loans in February than they did in October.

For its part, government officials say the current situation could have been a whole lot worse without TARP funding. 

Just last week, the U.S. Treasury Department praised “the relatively steady overall lending levels.” Without those capital injections, “lending would have suffered a far smaller total volume of loan originations in February than January,” the Treasury Department said.

But bank executives defended their lending levels by saying the reason behind a decline in new loans, refinancing deals and modifications of troubled loans is the lack of demand from consumers and businesses – and not the banks’ willingness to lend.

JPMorgan Chase & Co. (JPM) showed one of the biggest lending declines, dropping from $61.2 billion in October to $39.7 billion in February – a drop of 35%.  But JP Morgan executives explained the bank made more than $151 million in loans in the first quarter, “despite the fact that loan demand has dropped dramatically.”

Commercial lending slid by about 40% and may have been depressed by a partial thawing of the bond markets, where some corporations raise money instead of borrowing it from banks. About $70 billion of corporate bonds were issued in February, up from $21.4 billion in October, according to Thomson Reuters.

The figures show that consumer loans, especially mortgage refinancings, account for a large portion of bank lending. Nearly half of February’s lending went to consumers, up from about one-quarter in October.

But excluding mortgage refinancings, consumer lending dropped by about one-third between October and February. And because the United States has accounted for one-third of total growth in global consumption since 1990, any change in U.S. consumer behavior has profound implications, not just for the United States, but for the worldwide economy. 

Increased Savings Rate Could Slow Rebound 

Consumer spending is the engine of the U.S. economy, accounting for about 70% of gross domestic product (GDP). And in the go-go days of the early 21st century, U.S. consumer spending was in full swing.

U.S. households nearly doubled their outstanding debt to $13.8 trillion between 2000 and 2007, according to the McKinsey Institute.  During that unprecedented period, personal consumption accounted for 77% of real U.S. GDP growth and personal liabilities reached an astounding 138% of disposable income.

But a shift occurred as the global financial crisis worsened at the end of 2008: U.S. households reduced their outstanding debt for the first time since World War II by curtailing spending and reducing borrowing.

In fact, recently released U.S. Federal Reserve data shows that outstanding consumer credit dropped from $2.95 trillion to $2.56 trillion in January.  

But as consumer spending and borrowing plunged in recent months, the saving rate has rebounded, reaching 5% in January. And each extra point in the savings rate means more than $100 billion less in spending a year, according to a recent McKinsey study.

In fact, the study found that if consumers continue to reduce debt, the increased savings rate would result in $535 billion less consumption a year, a potentially serious drag on a nascent economic recovery.

Banks and Obama Still Not Out of the Woods

Looming over all this is the possibility that banks may need more government assistance in the near future in order to keep lending – even at the current depressed levels.

JPMorgan analyst Matthew Jozoff predicts banks could suffer another $400 billion in losses as a result of continuing credit deterioration, which could force policymakers to deploy yet another round of capital infusions.

Obama administration officials acknowledge that they may still have to ask Congress for more money in the future. Beyond the 19 big banks, which are defined as those with more than $100 billion in assets, the Treasury has also injected capital into hundreds of regional and community banks.

The most immediate expense may come in the next several weeks, when federal bank regulators complete “stress tests” on the nation’s 19 largest banks.  The tests are expected to show that at least several major institutions will need to increase their capital cushions by billions of dollars.

That could include Bank of America Corp. (BAC), a bank that many experts say probably should have been liquidated long ago.

In order to avoid another capital infusion, the government might elect to take equity in return for previous loans.  Converting the loans into common stock would increase the capital of big banks by more than $100 billion and give the government a large equity stake in return.

Of course, converting those loans into common shares would turn the government into the bank’s biggest shareholder – a move some critics see as a back door to nationalization. The move would also serve to further dilute the holdings of existing shareholders.

While the option appears to be a quick and easy way to avoid a confrontation with congressional leaders who are wary of putting more money into the banks, the administration would no doubt be heavily criticized for displaying such “socialist” tendencies.

[Editor's Note: When Slate magazine recently set out to identify the stock-market guru who most correctly predicted the stock-market decline that accompanied the current financial crisis, the respected online publication concluded it was Martin Hutchinson, a veteran international investment banker who is one of Money Morning's top forecasters.

It was no surprise to our readers: After all, Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives did in insurer American International Group Inc. Then last fall, Hutchinson "called" the market bottom.

Now Hutchinson has developed a strategy for investors to invest their way to "Permanent Wealth" using high-yielding dividend stocks. Indeed, he's currently detailing a strategy that will enable investors to make $4,201 in cash in just 12 days. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]

News and Related Story Links:

• The Wall Street Journal:
  Bank Lending Keeps Dropping

• McKinsey Institute:
  Will U.S. Consumer Debt Reduction Cripple the Recovery?

• Federal Reserve Statistical Release:
  G.19 Consumer Credit

• Zero Hedge:
  JP Morgan Sees $400 Billion More In Bank Losses

• Money Morning:
  The Top 12 U.S. Banks: From Zombies to Hidden Gems

• Money Morning:
  Three Reasons Bank Nationalization Will Keep Investors Awake at Night.

• Money Morning Look at Liquidity Series (Part I of II):
  A Look at Liquidity: Venture Funding Hits 12-Year Low Amid Cold IPO Market.

By Mike Caggeso
Associate Editor
Money Morning

Capital venture firms in the Unites States invested only $3 billion in 549 deals in the first quarter – a 61% decline from the first quarter last year – hitting a low that dates back to before the dot-com bubble.

Investment activity was down 47% from the $5.7 billion invested in 866 deals in the fourth quarter last year, according to research by the non-profit National Venture Capital Association (NVCA) and PricewaterhouseCoopers LLP.

“Given the economic turmoil that began in the third quarter of 2008 and continued on into 2009, it’s not unexpected that the (venture capitalists) would pause to assess the impact on their portfolio companies before again looking forward to their next investment,” Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers, said in a news release.

Declines plagued nearly every sector – both in the total amount invested and the number of deals.

Software companies received the highest level of funding, with $614 million invested in 138 deals. But that was still a 42% drop in dollars invested and a 34% drop in total deals compared with the fourth quarter of 2008.

Clean-technology (alternative energy, pollution and recycling, power supplies and conversion) was the hardest hit sector, as investment fell 84% to $154 million in 33 deals from a record high of $971 million in 67 deals in the fourth quarter last year.

The financial services sector was the only one that saw an increase in dollars and deals – taking in $108 million from 17 deals, increases of 26% and 21%, respectively.

In addition to having considerably less money to invest, venture capital investors were also weary of investing in new companies and technologies that couldn’t promise a short-term return.

Instead, they spent their money on companies and sectors they already own, John Taylor, vice president of research at National Venture Capital Association, told Bloomberg.

“We are in a very difficult, stressed time,” Taylor said. “Everyone is trying to figure out what is going on.”

The investment drought in clean-tech could bottleneck the sector, as ready-for-market technologies can’t get out of the lab.

“We are continuing to see a lot of innovation coming out of universities and government labs, but the big challenge looming is how any of these will be scaled and who will pay for them to see the light of commercial day,” Noubar Afeyan, chief executive of Flagship Ventures, told The New York Times.

Mark Heesen, president of the NVCA, wasn’t entirely pessimistic over the figures. Venture firms with the ability to invest are pulling the trigger on capital-starved entrepreneurs with “game-changing” technologies, he said.

“While this drop in investment is significant, we are not forecasting levels to continue to fall further,” Heesen said. “We would expect a mild and steady increase in investment throughout the rest of the year, particularly if the exit pipeline is allowed to clear.”

Two recent deals gave hope to the static initial public offering (IPO) market.

Shares of language instruction software titan Rosetta Stone Inc. (RST) rose about 40% on its first day of trading, netting the company $112.5 million. And online college Bridgepoint Education, Inc. (BPI) rose 7% on its opening day of trading, reeling in $141.75 million from its initial stock sale.

Both companies’ shares continued making gains for the rest of the week after their IPOs.

[Editor's Note: When it comes to liquidity, capital, banking or global economics, there's literally no one better than Money Morning Contributing Editor Martin Hutchinson - a former investment banker with more than a 25 years experience. Hutchinson has proven himself to be a market maven and he is currently offering investors an opportunity to make $4,201 in cash in just 12 days. You can also subscribe to Martin's new investment service, The Permanent Wealth Investor, by clicking here.]

News and Related Story Links:

• National Venture Capital Association:
  VC Investments Q1 2009

• Bloomberg:
  Venture Capital Investments Plunge 61% Amid Frozen IPO Market

• The New York Times:
  Venture Capital Investment Sinks

By Mike Caggeso
Associate Editor
Money Morning

U.S. stocks just capped off their strongest two-week performance since 1938. The Standard & Poor’s 500 Index is surging toward its third straight week of gains, something it’s done only three times since the bear market in U.S. stocks started 78 weeks ago. And the Nasdaq Composite Index has erased its year-to-date losses and is now is up for the year.

The path of least resistance is now higher," Miller Tabak & Co. LLC equity strategist Peter Bookvar told MarketWatch.com, citing such factors as not-as-bad-as-feared economic reports, optimism over Obama administration economic fix-it plans, and a recent jump in commodity prices that “has done wonders for some of the emerging markets that depend on them, whether it was Russia or Brazil.”

As Money Morning has continued to report, U.S. stocks are smoking hot. But the question remains: Will they stay that way?

With an index, the S&P 500, that closed yesterday (Wednesday) at 832.86, most market bulls see an index that’s gained 167 points from its intra-day, bear-market low of 666, meaning it’s zoomed 25% in just three weeks. It also means that the closely watched U.S stock index is now only 13% below its intra-day high for the year of 943.85 – a mark set Jan. 6.

The journey from that low to that high would represent a move of 42%, but there are some experts – including Ed Yardeni, president of Yardeni Research, who believe that can happen.  And why not? After all, we’re watching the best monthly market gain since 1987.
“I wouldn’t be surprised to see this rally take the S&P [500 Index] up to 1,000,” Tom Wirth, senior investment officer at Chemung Canal Trust Co., which manages $1.5 billion in Elmira, NY, Bloomberg News. “It’s been one data point after another that’s come in better than expected.”

But the bears aren’t hibernating: Once you claw away the apparent good news, you’ll find some troubling numbers, they say. For instance, this is the fifth time the market has spiked more than 10% since peaking in 2007, and two of those spikes shot up more than than 21%. They also note that the S&P 500 Index is still down 8.0% this year after sinking 38% last year – the worst annual return since the Great Depression.

"We’re in a situation now where the market is a little ahead of itself, considering how murky the fundamentals still are," Chris Johnson, chief executive of trading and analysis firm Johnson Research Group, told The Wall Street Journal.

Pointing to the financial sector, which has been the rally’s chief catalyst, Johnson said: “It’s like a kid in school who went from getting an ‘F’ in class to a ‘D.’ People are happy, but only to a certain extent.”

There’s also the possibility that analysts, at this point, simply aren’t sure what to believe.

“Welcome to the club. Many investment managers are (paralyzed) too,” writes MarketWatch’s Mark Hulbert. “That’s because, on the one hand, they’re scared of the bear market continuing, making fools of those who flash  ‘Buy’ signals now …Yet, on the other hand, these advisers are afraid of missing out on a new bull market, if indeed one has begun.”

The question is: Where does that leave the typical investor?

The opinion emanating from the U.S. Federal Reserve is that the U.S. economy will turn around by the end of this year or the start of 2010. And the majority of both bulls and bears agree that the stock market – typically a “leading” economic indicator – will rebound before the economy does.

But before you make up your mind as to whether or not you want to join in on this rally there are several factors you should consider.

Easy-to-Read Market Indicators

Hundreds of economic and stock-market indicators exist, but many won’t be relevant – even if you could decipher them.  Here are a few stock market indicators that are both reliable and readable to everyday investors.

• Blue-chip earnings reports: Stock indices won’t begin to rebound in earnest until earnings expectations improve for the companies they list. When our financial fiasco started, companies were comparing their falling earnings to results the prior year, when business was markedly better. This was one of the factors that induced investors to sell their stocks, exacerbating a decline that was already under way. With the first quarter of the New Year coming to a close, and companies in most industries closing their books and getting ready to report their first-quarter earnings, two factors will be working in their favor: First, they will be reporting against the much-lower profit reports of last year, making improvements easier; and second, earnings expectations going forward are much lower, meaning that there’s a much-greater potential for stock-market-boosting upside earnings surprises. If expectations are met or exceeded, traders can see the company’s low stock price as a deal and buy.

• Advance/Decline Line (A/D line): The A/D line is one of the most popular tools for measuring the breadth of a market advance or decline – in other words, gauging its overall strength or weakness. For instance, when more stocks move up than move down, the A/D Line moves up, as well. It’s also useful to look for divergences between a major market index, such as the Dow Jones Industrial Average, and the A/D line, as a way of determining whether a market is really in a rising or falling trend. For instance, there’s an old Wall Street adage that holds that “trouble looms when the generals lead and the troops refuse to follow” – meaning that if the Dow advances and is making new highs, but the A/D fails to do so, expect the market’s apparent charge to fall apart. Yesterday, 441 S&P stocks advanced, 57 declined and two remain unchanged.

• Volatility Index (VIX): Fear and greed are the primary emotions that drive the market. And the Chicago Board Options Exchange Volatility Index indicates the direction of the market by tracking the price of options for S&P 500 stocks – investments driven by fear and greed. When the VIX is low, option traders believe that the market will rise and get greedy with their bets. When the VIX is high, they are worried the market is going to tumble.

Green, Yellow or Red Light?

No matter how you interpret the indicators above, it’s best not to view the current rally as a green light or red light, but instead as a flashing yellow. Slow down, approach with caution, and be cognizant of everything coming at you from every other direction.

Applying that to your money and investments means cherry picking from both sides of the aisle in order to form a plan.

If you are looking for long-term gains, the bulls are more in the right than the bears. Every market downturn has rebounded. So the fact that the S&P 500 is more than 47% off its high is more of a reassuring statistic than a disconcerting one.  

If you are trying to avoid short-term losses, the bears are more in the right than the bulls. This may be the most promising stock rally since the global financial world collapsed, but with unemployment high and suppressed consumer spending keeping the U.S. gross domestic product (GDP) in the red, it could also be the biggest “head-fake” rally in a continued bear market.

“Despite the fact many investors feel like they missed the boat to get in, it’s still not time to be cavalier,” says Money MorningInvestment Director Keith Fitz-Gerald.

But it’s also not the time to stand completely on the sidelines, either.

Should a bear market continue, there are still plenty of conservative investments out there – from those that pay hefty dividends to gold – that offer better potential returns than an antique Ball (BLL) Mason canning jar hidden in the bottom of your sock drawer.

“In a market as unpredictable as this one … I am less concerned with short-term rallies than I am with long-term investing success,” said Fitz-Gerald. “That’s why – if you’re thinking about getting in right now – I urge you to first carefully review both sides of the argument.”

[Editor's Note: The ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will quickly and painfully determine the winners and losers out in the global financial markets. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

In fact, Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." His key discovery: Despite the gloom brought about by the ongoing financial crisis, we may actually be standing on the precipice of the greatest investing opportunities we'll see in our lifetimes. To capitalize, today more than ever, investors need to employ the correct tool.

In his newly launched Geiger Index investing service, Fitz-Gerald feels that he's found that needed device. Geiger Index, developed after more than a decade of work, is a new, computerized trading model that's based on a mathematical concept known as "fractals." This system allows Fitz-Gerald to predict price movements of broad indexes, or of individual stocks, with a high degree of certainty. And it's particularly well suited to the "trendless" markets that are the norm today. Check out our latest insights on these new rules, this new market environment, and this new service, Geiger Index.]

News and Related Story Links:

• Bloomberg:
  U.S. Stocks Rise, Extend S&P 500’s Best Monthly Rally Since ‘87

• Wall Street Journal:
  US Stocks Higher As Market Overlooks Weak Data

• MarketWatch:
  An antidote to rigor mortis

• Money Morning:
  Are We Looking at a Stock Market Rebound, or Just Another Bear Market Head Fake?

• MarketWatch.com:
  
  S&P 500 heads to third straight week of gains

• MarketWatch.com:
  Nasdaq erases 2009 losses, turns positive for year.

• Money Morning:
  
  Will Last Week’s Rally Carry Over?

• Money Morning Financial Crisis Investing Series (Part VI):
  As Financial Scams Go Global, Here’s How to Avoid Being Stung.

•  Money Morning Financial Crisis Investing Series (Part V):
  Seven Ways to Get an Income-Tax Boost From the Obama Recovery Plan.

• Money Morning Financial Crisis Investing Series (Part IV):
  For Dividend-Seekers, Financial Crisis Means it’s Time to Dip Into DRIPs.

• Money Morning Financial Crisis Investing Series (Part III):
  Mutual Funds With Low Minimums Can Put Investors Back on the Winning Path.

• Money Morning Financial Crisis Investing Series (Part II):
  Retirement Strategies: The Three Best Ways to Rescue Your 401(k).

• Money Morning Financial Crisis Investing Series (Part I):
  Retirement Blues: Financial Crisis Pulls Billions From Pension Plans, Crimping Consumers’ Dreams and Corporate Profits.

• Money Morning Week Ahead:
  Super-Investor George Soros the Latest to Predict the Worst is Yet to Come.