By William Patalon III
Executive Editor
Money Morning/The Money Map Report

Just this week, a friend told me that he wanted to jump-start his long-neglected saving-and-investing efforts, but was worried it wouldn’t be possible on his current household budget.

I’d be willing to bet that a lot of folks are asking that very same question right now.

I mean, let’s face it: Everyone knows how important it is to save money. But in the middle of what may well be the worst U.S. financial crisis since the Great Depression, finding the cash to create an emergency fund – or to invest in a mutual fund that requires a $10,000 initial outlay – can appear so daunting that many investors decide to not even bother.

Don’t that same mistake.

There’s an option: Mutual funds with a low initial investment threshold. We all know, for example, that Vanguard Wellington (VWELX) is a great fund – indeed, it’s a favorite of Money Morning Investment Director Keith Fitz-Gerald – but here in the depths of a financial crisis, not everyone has the $10,000 in cash needed to become a new shareholder.

The upshot: Unfortunately, a lot of folks stop right there, and don’t bother to jump-start their saving-and-investing program.

Don’t that same mistake.

When a Small Start is a Good Start

One way around is to seek mutual funds that allow investors to start with either a very small initial investment – or with no initial investment at all (provided you’re willing to let the fund company take $50 or $100 a month directly out of your checking or savings account).

This approach has a couple of advantages, Money Morning’s Fitz-Gerald says:

• First, it induces you to keep investing, even in a bad market, which history shows is a key element of better long-term results.
• Second, by taking advantage of the electronic-investing option many fund companies offer, you’re investing consistently – for instance, investing the same amount of money on the same day each month.
• Third, for the ultra-cautious the lower investment thresholds can serve as a de facto risk-management tool, since it means that you’re putting less money at risk in the market at a time when the market is uncertain (although, at the same time, you’re still investing).

“It’s a way to insure that you continue to invest, even when the markets stink,” Fitz-Gerald says. “If you are gun-shy, and don’t really want to put a lot of cash at risk, this is a good way to continue your forward-investing momentum, to continue even when the markets aren’t optimum.”
Where do you look for funds like this?

One good place to start your search is with Morningstar, the noted financial-products researcher. For some help, we turned to Morningstar.com’s handy mutual fund screener. And here’s what we did. We looked for funds with an initial purchase of $500 or less. Not wanting big chunks of our capital to for sales commissions, we set the “load” status to “No-Load Funds Only.” And we opted for low-expense offerings, meaning we screened for funds featuring expense ratios of 1.00% or less.

Wanting to cull this further – and to hopefully end up with the “best-in-breed” funds – we limited our search to funds that were rated as “five-star” products by Morningstar. Lastly, since we’re looking chiefly as equity funds in this exercise, we ran one screen for domestic stock funds and another for international stock funds.

We ended up with 23 funds in the domestic-stock category and 16 funds in the international stock category.

What this demonstrates is “that there are quality funds out there,” even for investors who have smaller amounts to invest, Fitz-Gerald says.

Morningstar’s mutual fund screening program – which is free – allows for investors to include other parameters, too, including those for risk, returns, portfolio turnover, and management tenure. We were attempting to keep it simple to show what’s possible, and also figured you’d want to do some of your own research to find funds that match your personal financial needs. The program can also screen for bond funds. One task it does not perform is to identify which of the funds are close to new investors.

Go Global or Get Left Behind

The Money Morning graphic shows the results of our search for International stock funds – and for a good reason. As regular readers of Money Morning know, we believe a global investing strategy is key to any investor’s long-term success. Unfortunately, too many investors de-emphasize the international or global elements of their portfolio, believing that domestic investments are less risky.

There are many different kinds of risk, however – including the risk of getting left behind. Long-term, most of the growth that’s expected in the decades to come will be outside U.S. borders.

If you want proof, just ask the World Bank.

• Today, the United States and Asia each account for 28% of the worldwide economy. Combined, that’s a total of 56%.
• Twenty-five years from now, America’s share of the global economic pie will have slipped to 24%. But Asia’s will have soared to 55%.

In short, in slightly more than two decades, Asia will be twice the economic powerhouse that the United States is today.
It’s true that a number of overseas markets have been problem-plagued in recent months. But that’s just a short-term problem. And as the World Bank statistics demonstrate, the long-term outlook for growth outside the U.S. borders is exceptionally strong.

By focusing only on U.S. stocks, you’ll be looking at only a quarter of the world’s investment opportunities. You’ll miss out on some of the world’s fastest-growing markets. And you’ll get left behind.

The greatest growth will come from China, India and the newly capitalist economies of Eastern and Southern Asia. There may be some other growth areas, such as resource-rich Latin America.

Famed Wharton Business School Professor Jeremy Siegel recently pronounced that the long-held conventional wisdom on international investing should be thrown out the window. For decades, we’ve heard over and over how international investments should comprise 5%, 10% or at most 15% of our portfolio’s total value. Any more than that is foolhardy and risky, we were programmed to believe.

According to Siegel, however, the truly foolhardy act is to limit our international exposure that much. In other words, the biggest risk U.S. investors now face isn’t just the possibility of losses incurred when some foreign market plunges. The real risk now is the possibility that U.S. investors face – getting left behind financially because of all the growth that’s expected to be generated beyond U.S. borders.

Investment advisors who stick with the old asset-allocation model are actually doing their clients a huge disservice, Siegel says.

Siegel now believes that international investments should comprise about 40% of your total holdings. Most individual investors know Siegel for his best-selling book, Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies. The book first came out in 1994, and is considered one of a handful of “must-read’ titles in investing finance. The new edition, which appeared in November 2007, includes a long addition addressing the international arena, and how investors must adapt their strategies to the new realities of globalization.

The nation’s wealthy already really understand what’s at stake and are already profiting from these trends – and in a big way. According to a 2007 study by the Spectrem Group, 40% of affluent U.S. households are continuing to invest internationally, while a full one-third are actually planning to invest more. Their chief country of choice when it comes to investing abroad: China.

Other Options

For cash-challenged investors who want to capitalize on China’s growth, there is a solid option – the China Region Opportunities Fund (USCOX), which is operated by the San Antonio, Texas-based U.S. Global Investors Inc. (GROW). As it does with most of its funds, U.S. Global offers interested China fund investors its trademarked “ABC Investment Plan,” which permits investors to make a $100 initial investment and subsequent monthly investments of $30 a month, so long as the new shareholder consents to an automated electronic transfer. You can even tell the company which day of the month you want the money to be invested.

A number of other companies offer similar programs, which are known in the industry as “automated investment plans,” or AIPs. One other company known for operating quality funds is the Baltimore-based T. Rowe Price Group Inc. (TROW), a firm I covered during my time as a business journalist. With most of its funds, the minimum initial investment is waived as long as you agree to have at least $50 a month per fund automatically transferred from your checking account and invested. That arrangement must be maintained until you reach the specified minimums to avoid any extraneous fees.

(One point worthy of note: When my wife and I bought our house nearly nine years ago, the down payment came from two T. Rowe Price funds that I’d built up over a couple of years solely through AIP investments).

Here’s a list of T. Rowe Price funds of all types that are ranked four and five stars by Morningstar.

One final note about low-initial investment funds: This is a great way to get you started back on the savings pathway. At some point, however, you’ll likely want to either add funds or boost your regular investment total to start amassing capital.

“One thing that investors too often don’t understand: You never want to stop investing altogether,” says Money Morning’s Fitz-Gerald. “Even if it’s only a couple of bucks here and there. History shows that those who continue to invest through thick and thin are those who generate the best returns.”

At least, however, this strategy is a great way to get you started back on the savings pathway. At some point, however, you’ll likely want to either add funds or boost your regular investment total to start amassing capital.

[Editor’s Note: This new Money Morning series, "Financial Crisis Investing," will focus on ways investors can either side-step the ongoing uncertainty – or even use it to their advantage – in order to land market-beating profits, or simply to rebuild the personal wealth that was eviscerated as part of the estimated $6 trillion in shareholder wealth that’s been lost. In an upcoming issue, look for a story about a strategy American households can employ to bounce back from the effects of the recession. Money Morning is also offering a new report that details the additional dangers posed by the ongoing bailout payouts and the stimulus outlays that are to follow. The report is free of charge, and details ways that readers can obtain a complimentary copy of The New York Times best seller, "Crash Proof," whose author predicted the housing bubble and the crash of financial-asset prices long before they happened. And according to him, there are additional financial landmines still out there, continuing to pose danger to uninformed investors. He details those dangers, and outlines strategies for avoiding them. To read our free report, and to find out more about this offer, please click here.]

News and Related Story Links:

• Money Morning Special Investment Research Report:
  Global Investing: Has Wall Street Rigged the Game?

• Money Morning Special Investment Research Report:
  International Investing: Why U.S. Investors are “Boxed Out” of Big Global Profits.

• JeremySiegel.com:
  Jeremy Siegel

I have been much more positive about the Japanese economy than most other analysts in recent months, largely because I believed that many of the problems from the Japanese recession of 1990-2003 were finally in the country’s rearview mirror. In particular, I believed that the Japanese budget deficit – which, by 2003, had become quite acute – was well on the way to being solved through public spending restraint. That, in turn, would allow Japan to pay down its excessive public debt, giving its private sector room to expand.

But the surprise resignation of Japanese Prime Minister Yasuo Fukuda on Monday suggests I may have been wrong about the country’s near-term prospects.

Japan Gives Investors a Bubble Bath

The Japanese stock market and real estate bubble of the 1980s is now the stuff of stock-market legend, for it sent that country into a tailspin in 1990-91, after which came more than a decade of very slow growth.  There were a number of causes – one was the appalling quantity of rubbish loans that Japanese banks had put on their books during the bubble (sound familiar…. perhaps we are we seeing a reprise here in the U.S. market?), and the second was the inexorable expansion of the Japanese public sector.

Prime minister after prime minister would propose “stimulus packages” of public spending, mostly on roads and bridges in rural areas (always popular with politicians from those areas). The largest package – by Prime Minister Ryutaro Hashimoto in 1998  – was more than $400 billion, the equivalent of 10% of Japan’s gross domestic product (GDP).

Apart from covering Japan’s beautiful scenery with unsightly overpasses, these capital infusion packages had two very clear effects:

• They increased Japan’s public spending – from 31.5% of GDP in 1991 to 38.1% of GDP in 2002.
• And they created a huge public debt problem; Japan currently has public debt of 182% of GDP, the highest ratio in the world.

These stimulus packages had one very obvious shortcoming – they didn’t stimulate. And with good reason. These programs did nothing useful to revive the Japanese economy because the mostly useless public works projects they financed (in terms of GDP, these projects were more than twice as large as those of the next-most-profligate public-works spender – France) were using up all the domestic capital that should have been financing private-sector growth. In the parlance of economics, this is known as “crowding out,” and can be quite damaging, as Japan’s experience demonstrates.

Japan’s Prime Minister Troika

Since 2003, the key figure in Japan’s economic recovery is former Prime Minister Junichiro Koizumi (2001-06), who stopped building “bridges to nowhere” – prompting major protests from the Liberal Democratic Party (LDP) “old guard.” That stopped the growth in debt and then gradually brought the budget deficit down. As a result, Japan’s economic growth resumed in 2003.

Koizumi was succeeded briefly by Shinzo Abe, and then by Fukuda. Like Koizumi, Fukuda was a proponent of reducing public spending – he wanted to balance the Japanese budget by 2011. Indeed, Koizumi and Fukuda were actually quite close: Koizumi got his political start under the premiership of Fukuda’s father (also a tight-budget man) in the 1970s. So you can see why I was so confident that Japan’s public spending would be kept under control and that the Japanese economy would continue recovering.

Japan’s GDP showed a surprise dip in the second quarter, shrinking by 0.6%. As a result, public clamor arose for a “stimulus package” of public spending or tax cuts. The reality, however, is that Fukuda had been having a hard time since July 2007, because the upper house of the National Diet (which has considerable power) had been controlled by the opposition Democratic Party of Japan, blocking legislation.

Fukuda’s weakness was demonstrated by his Aug. 1 appointment of his political opponent, Taro Aso, as secretary general of the LDP. When Fukuda’s cautious Aug. 29 stimulus package of $18 billion – which consisted mostly of loans – was decried as inadequate, he realized that the clamor for extra spending would be unstoppable, and resigned.

Fukuda will likely be succeeded by Aso, a protégé of the big-spending barons of the rural constituencies.

Déjà vu all Over Again

The bottom line is that the public sector is likely to grow again, as it did in the 1990s, producing larger Japanese budget deficits, packing on more debt and stifling private sector development. Since Japan’s public debt is already so high, the chances are good that the country’s debt rating of AA (Standard & Poor’s) /Aa3 (Moody’s Investors Service (MCO)) will be downgraded. That would increase borrowing costs for all Japanese companies and damage the economy badly.

For more than a year, I had been positive on the Japanese economy, even as the market declined. But it’s finally time for a shift in outlook:

• In the near term – until the political situation can be sorted out – it’s better to underweight Japan in our portfolios.
• Long-term, however, we still believe that Japan is superbly positioned to capitalize on its proximity to China; indeed, as we’ve noted, the two countries are quietly forming what may one day well be the most powerful trading alliance on the planet.

In the meantime, until it becomes clear that this China-Japan connection can pump up the Japanese economy, there’s another Asian market – actually, one of the “Four Asian Tigers” – that’s clearly worth a look as an alternative.

And that market is Korea.

Korea’s Profit Promise

The Korean government recently improved with the election of president Lee Myung-bak and a pro-business party with a substantial majority. Korea’s economic growth is likely to accelerate, particularly if we have seen the worst of the commodity and energy bubble, since Korea is primarily an importer of commodities and energy goods.

The Korean stock market has been beaten down this year, dropping 20%, and currently trades at only 10 times earnings. But this low valuation is undeserved, since the Korean economy is expected to grow at better than a 4% clip for both this year and next, according to the respected global-economics magazine, The Economist.

Take a look, for example, at the Korean exchange-traded index fund (ETF), the iShares MSCI South Korea Index Fund (EWY), which tracks the Morgan Stanley Capital International Korea index. The ETF currently carries a Price/Earnings (P/E) ratio of 10.3 and features a dividend yield – after expenses – of about 1.9%.

[Editor’s Note: For additional insights on Korea, check out Money Morning’s investment research report: Why South Korea is set to Become the Biggest Economic Story of 2008. The report is free of charge. For broader investment insights on Asia in general, check out our research report on the once-in-a-lifetime profit plays being created by China’s emergence – and find out how you can get a free copy of investing guru Jim Rogers’ bestseller, “A Bull in China.” Money Morning recently ran a two-part story (Part I and Part II) detailing our most recent exclusive interview with the global-investing guru.]

News and Related Story Links:

• Wikipedia
  : Yasuo Fukuda.

• Money Morning Economic Analysis:
  
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it (Part I of II).

• Money Morning Economic Analysis:
  
  The Lost Decade: How the U.S. Financial Crisis Resembles Japan’s Ten Years of Misery – And How to Play it for Profit (Part II of II).

• Wikipedia:
  
  Ryutaro Hashimoto.

• Money Morning Economic Analysis:
  Two Ways to Profit as China and Japan Quietly Forge the Most Powerful Trading Alliance in the World.

• Wikipedia:
  
  Crowding Out.

• Wikipedia:
  
  Junichiro Koizumi.

• Wikipedia:
  Shinzo Abe.

• Money Morning News Analysis:
  
  Japan Plans Stimulus, but Economy Still Likely to Fall into Recession.

• Wikipedia:
  
  Japanese National Diet.

• Wikipedia:
  
  Democratic Party of Japan.

• Wikipedia:
  Lee Myung-bak.

• Money Morning Foreign Market Analysis:
  
  Six Ways to Capitalize on Korea’s Growing Global Muscle.

• Money Morning (Free) Investment Research Report:
  Why South Korea is set to Become the Biggest Economic Story of 2008.

• Wikipedia:
  
  Four Asian Tigers.

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part I):
  Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years.

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part II):
  Exclusive Interview: Jim Rogers Continues to View China as the World’s Best Long-Term Profit Play.

Unlike Dorothy in “The Wizard of Oz,” the brutalized U.S. banking system will never again return to that comfortable, cozy, and cushy capital place it once happily referred to as “home.” But its “Wicked Witch” was its own greed. The curtain has finally been pulled back on the machinery, and the hot air used to pump up the U.S. banking system’s version of the Emerald City in the Land of Oz.

For decades, American banks operated on a simple – and nicely profitable – business model: They took in deposits and lent out money.

In the simplest model, a bank might take in deposits of a million dollars and lend out a million dollars. In a perfect world, such a “matched book” is established if they know that the deposit will be left in the bank for a year and the loan they made has a maturity of one year. If the bank pays the depositor 3% and charges the loan borrower 5%, it can assume a profit for the year of 2% (the difference between the 5% loan rate and the 3% payout to depositors).

It Takes Money to Make Money – Disappear

In order to make more money, banks need more money to lend. In addition to taking in deposits, banks borrow money to make more loans, to buy assets to keep on their balance sheets, and to trade in the markets. They get this money by offering products such as certificates of deposits (CDs) to entice depositors to bank with them, they borrow overnight in the Feds Funds market (from other banks), they sell commercial paper backed by their balance sheets to investors, they get capital from profitable trades and investments, and they generate fees for their banking services.

The problem is that banks don’t just take in money in order to lend it out; they take in money to make more money with it by investing and, yes, speculating.

On the deposit-and-loan side of the equation, banks don’t even bother trying to run a matched book anymore. They borrow short and lend long. This works well if their short-term borrowing costs are substantially lower than their long-term lending rates.  But if short-term rates start to rise, banking profits in the borrow-and-lend game start to get squeezed. And if short-term rates shift so much that they’re actually higher than the interest rates the banks are charging on their long-term loans, banks actually start to lose money.

Banking-system executives are fully aware of these interest-rate dynamics. Indeed, they knowingly speculate on interest-rate movements by not running matched books, and trying to increase their spread profits by borrowing as short as they can and lending for as long as they can. The bottom line: Banks actually are speculating on interest-rate movements.

Speculating on the Health of the U.S. Banking System

If you didn’t already know that banks speculate, you’re about to be really surprised. All the money that is not lent out to borrowers floats around in what’s known as the bank’s “treasury.” The job of the people who work in the treasury is to make money with the cash that’s sitting around. To a banker, idle cash is no better than idle hands – both are regarded as the devil’s playthings.

There’s some merit to that argument. After all, no one actually makes money with idle cash: It has to be put to work, lent out, used as investment capital or, of course, used as trading capital in speculative deals.

Banks lend treasury funds overnight – and for short periods – to other banks, and to such non-banking institutions as insurance companies, corporate clients, securities broker-dealers, and investment banks (investment banks do not take in deposits and are therefore not the same as commercial banks, nor are they regulated by the same supervisory bodies that oversee commercial banking operations).

For banks, the problem in making these loans is one of “counterparty risk” – will the borrower be able to pay the funds back? Banks have become very wary of counterparty risk and have drastically cut back their lending to many traditional types of borrowers.

Instead, banks invest in assets, including government bonds, corporate bonds, mortgage bonds, currencies and derivatives. Some investments actually end up on banks’ books because they have deals to hold assets they are not able to syndicate (sell pieces of to other bank partners). And sometimes banks hold assets so that they can profit as these holdings appreciate in value. (Of course, stating that a bank is “holding assets as investments” is actually just a polite way of saying that it is speculating).

The Bottom Isn’t Yet Within Sight

Lately, banks have been holding mortgage bonds and similar financial instruments in so-called “off-balance-sheet” entities. By doing this, the bank essentially takes assets off its books (which are visible to investors and regulators) and places them inside a special holding company, where they now will be out of sight.

Why would a bank do this? Simple. Banks are hiding risky assets so that their “books” and balance sheets look better. Truth be told, there’s no reason for off-balance-sheet entities. Period. They’re nothing more than a means for a fraudulent conveyance.

Banks trade – a lot. They buy and sell government bonds, currencies, derivatives and whatever else their charter allows them to trade. Banks trade billions and billions of dollars every day. They are speculating.

Particularly in the U.S. banking system, what has happened is that banks have over-speculated across the board. And the losses that have resulted have severely reduced their available capital. This means that they have less money to lend and will be much more strict with prospective borrowers, exacting tougher loan terms and demanding higher creditworthiness before agreeing to make any loans.

As banks lose money – something I expect will continue for perhaps the next several quarters – their stock prices will continue to fall, reducing their equity capital (which is what regulators look at to determine their stability).

Banks keep raising capital via investments from sovereign wealth funds and through preferred and common rights offerings. And still their losses continue. They have to keep going back to the well. Sooner or later, this capital-markets well will have to run dry. There are going to be bank failures and we will see the doctrine of “too big to fail” tested yet again, as a major bank sinks into the abyss (the failure of The Bear Stearns Cos. Inc. (BSC) was a test and the subsequent central-bank-led bailout seems to have proved that it was too big to fail).

To understand this crisis is to first understand what’s wrong with banks. We cannot come out of this credit crisis if we do not repair the damage to the commercial lenders in the U.S. banking system. And by “repair,” I’m talking about fixing their credibility and integrity just as much as I am referring to the need to restore their capital base.

This country is the capitalist behemoth that it is because of our banking system. Where are the regulators? Where is Congress? Where are the outraged stockholders and borrowers? Will it take a banking-system collapse and a run by depositors to get these problems addressed and fixed?

Until the banks are fixed, avoid all financials – especially commercial banks and investment banks. Stay short on the dollar. Short the major stock indexes. If you have to remain long in equities, sell calls on a rolling basis.

The next stop on the Dow Jones Industrial Average is likely a test of 10,000.

[Editor’s Note: Contributing Editor R. Shah Gilani - and his column, "Inside Wall Street" - are brand-new additions to the Money Morning lineup. Gilani brings readers the ultimate insider’s view: He’s toiled in the trading pits in Chicago, run trading desks in New York, operated as a broker/dealer and managed everything from hedge funds to currency accounts. His self-professed goal is to take readers on a journey through the "shadowy back alleys" of the U.S. capital markets - and past the "velvet rope" that typically keeps the average investor from learning the secrets that sit beyond, just out of reach.]

News and Related Story Links:

• Money Morning Special Investment Report:
  Outlook 2008: Three Ways to Profit From Sovereign Wealth Funds – the “Next Wall Street”

• Wikipedia:
  “The Wizard of Oz.”

• Investopedia:
  Counterparty Risk.

• Investopedia:
  Off-Balance-Sheet Entities: The Good, The Bad And The Ugly.

• Wikipedia:
  Fraudulent Conveyance.

Can it be earnings season already?

It sure is, but don’t expect too much.

With its report tomorrow (Tuesday), Alcoa Inc. (AA) leads off what is expected to be a pretty dismal series of profit reports. Thomson Reuters now estimates that second-quarter earnings declined by 11.1%, which is significantly worse than the projected 2% decline that was made back in April.

Of course, financials will lead the charge in terms of these dire expectations, followed closely behind by consumer discretionary (which reflects the lagging confidence measures).  Technology is also expected to struggle; these days management must think long and hard about investing in any major systems upgrades.

But the real key to the stock market’s future may well lay with major multinationals. In recent quarters, many multinational companies – we often refer to them as "Global Titans" – have weathered the domestic storm. The reason: They’ve been able to generate substantial revenue and profits from continued growth in emerging markets and from the weak dollar (which increases demand for the "cheaper" U.S. goods). Unfortunately, this trend may be coming to an end as global inflation heats up and slower international growth means that multinationals may be losing their safety net.

Investors get a bit of a reprieve (and time to recover from second-quarter hangovers) as few economic releases of substance are on the calendar for the week ahead.

Market Matters

Good-bye and good riddance.  That general sentiment was shared by investors and traders alike, as the second-quarter came to a close (and none too quickly).  Many folks expected the market negativity to shift after a poor first quarter, since the U.S. Federal Reserve jumped in with both feet and attempted to end the credit crisis. Unfortunately, the past three months brought more of the same and the outlook for the remainder of the year does not look much stronger.

The Dow Jones Industrial Average suffered its worst 1st half of the year since 1970, while the bleak performances of the Standard & Poor’s 500 Index and the Nasdaq Composite Index brought back memories of the dot-com bubble collapse of 2001 and 2002.

Likewise, certain emerging markets (Shanghai and India) plunged in value, leaving equity investors few attractive options in the global marketplace. 

Thus far, the new quarter brings a continuation of those same "tired" themes: Financials and energy.  Lehman Brothers Holdings Inc. (LEH) actually moved to the backburner as investors focused on European competitor UBS AG (ADR: UBS) and a Justice Department investigation into the potential tax fraud of several key clients.  To date, the Swiss banking giant has reported more than $35 billion in asset write-downs, while reshuffling its board and revising certain governance policies to appease disgruntled shareholders.  Meanwhile, Standard & Poor’s downgraded much of the banking-and-financial services sectors, as losses become the norm and many firms search for significant capital infusions.

Story continues below…

Sign up right now, and we’ll send you an important new report for free: “The Three Best Investments in Asia.”

(Do sovereign wealth funds still have money to invest here?)

Bank of America Corp. (BAC) enhanced its leadership position in the mortgage origination and servicing markets (but is that really a good idea these days?), as it completed its acquisition of Countrywide Financial Corp. (CFC).  At closing, the transaction was estimated at $2.5 billion, down significantly from the initial $4 billion proposal due to BofA’s plunging stock price.

In non-financial-sector news, Starbucks Corp. (SBUX) is feeling the pain of a sluggish economy, given its customers’ inability to pay $5 for a "Cup of Joe," as the company announced the closing of 600 stores during the next year.  The General Motors Corp. (GM) liquidity struggles continued, as a key analyst even threw out the term "bankruptcy" in a recent report.  Microsoft Corp. (MSFT) still has interest in Yahoo! Inc. (YHOO) and opened discussions with News Corp. (NWS) and Time Warner Inc. (TWX) about potential partnerships in such a deal. 

The markets took their clues from surging crude oil prices yet again as supply concerns and tensions between Iran and Israel helped push prices to a new record near $146 per barrel.  Since the beginning if the year, oil has jumped by more than 50% and gas prices have followed, causing many Americans to alter their July 4 plans and stick closer to home because of record ($4.098) gasoline prices.

The Dow and Nasdaq have both tumbled into "bear" territory as the indexes have fallen in excess of 20% since the highs set last year.  On the international front, the markets have struggled in Britain, Germany, and Paris (among others), as escalating inflationary fears in Europe prompted a European Central Bank interest-rate increase (much to the chagrin of the Fed) [For a related story on the ECB rate increase in today's issue of Money Morning, please click here.]

Economically Speaking

While Fed Chief Ben S. Bernanke and friends fret over their "Mission: Impossible" task of guiding a struggling economy through a period of inflation, the European Central Bank increased its short rate by a quarter percentage point to counter its own price concerns.  That move just made Bernanke’s job even harder as the higher rate abroad puts new pressures on the dollar – and, subsequently, on the entire U.S. domestic economy.

On the economic front, all eyes and ears were on the Thursday morning release of unemployment and non-farm payroll additions as investors got a quick glance at the labor picture before heading out for the long weekend.  As expected, the jobless rate held steady at 5.5% and the economy lost more jobs for the sixth-consecutive month.  Clearly, all businesses and not just financial firms remain nervous about the immediate future. Many have issued pink slips or offered early retirement buyouts in an attempt to lower their expenses. Construction, manufacturing, and retail were among the sectors that reported payroll contraction in June. [For a related story on the job numbers in today's issue of Money Morning, please click here.]

The manufacturing sector got some good news in the form of a higher ISM survey release, though the euphoria was short-lived as a closer look inside the numbers revealed that higher prices contributed more to the increase than rising demand for U.S.-made products.

Likewise factory orders gained less than expected, another bad reflection on the state of manufacturing.  As has become the norm during the housing slowdown, construction activity declined again in May, the fifth time that’s happened in six months.

Additionally, the ISM Services (non-manufacturing) index revealed sector contraction in June, surprising analysts who were calling for a third straight month of growth. 

The week ahead doesn’t hold any big economic releases, giving investors a welcome break after last week’s disappointing round of reports.

Weekly Economic Calendar

News and Related Story Links:

• Money Morning News Analysis:
  Surging Demand, Weak Supply, and Dwindling Inventories, Drive Oil to Another Record High.

• Money Morning Analysis:
  A Bearish Dow Has its Worst June Since the Great Depression.

There’s an old adage in business that big contracts command big headlines.

But bigger isn’t always better.

All too often, companies that focus only on big contracts discover there are very lean stretches between contract awards. And that affects the predictability of their earnings.

That’s why here at Money Morning we’re more interested incompanies that can secure a lot of smaller contracts on a consistent basis – and that can transform those deals into predictable, double-digit growth.

We refer to these modest-contract specialists as the "Masters of the Small Bid."

Let me explain…

As we’ve stated, the companies we’re targeting aren’t characterized by headline-grabbing mega-contract wins, but by their proven ability to land smaller, more-stable deals. You see, by spreading their risk across many smaller deals rather than just swinging from the heels every time, the companies we follow are able to generate a consistent stream of earnings – despite a slowing economy, a wrenching credit-crisis and damaged investor confidence.

In short, our "masters" have kept themselves in front of paying customers at a time when other firms are simply worried about having customers.

Let’s look at several strong examples.

A Sample of Strong-Bid Masters

It’s no coincidence that our first example – defense-contractor and aerospace expert Lockheed Martin Corp. (LMT) – has been around for decades, and is a proven survivor. Remembered as the designer of the P-38 Lightning fighter of World War II fame – an aircraft so deadly that Nazi leaders ruefully dubbed the twin-boomed airplane "The Fork-Tailed Devil" – Lockheed Corp. went on to build the graceful Lockheed Constellation airliner in the 1950s and the cutting-edge F-117A Nighthawk Stealth Fighter in the 1980s.

A disastrous foray into commercial jetliners – in which only 250 airplanes were sold, even though the program lasted from 1968 until 1984 – would have likely bankrupted many companies. But Lockheed’s been a survivor. Indeed, back in the 1990s, to keep pace with a wave of defense-sector consolidations that created a smaller group of bigger players, Lockheed linked up with Martin Marietta Corp. to form Lockheed Martin.

Lockheed Martin re-established its fame with the so-called "Skunk Works" advanced-technology unit, and even today remains a defense-sector heavyweight. But it’s also a Master of the Small Bid. For proof, just look at some recent deals.

Lockheed roared into April, landing a $50 million contract for the U.S. Navy on April 1, and a $234 million Air Force contract on April 2. A week later, the company landed a deal a day for four straight days, in the process rolling up $725 million in total business from the U.S. Army, the Turkish military, and Japan’s Mitsubishi Heavy Industries Ltd.

The rest of the month saw still more action as the Navy signed on Lockheed for a one-year, $15.5-million contract for continued program management and engineering services for the United Kingdom’s Trident II D5 Fleet Ballistic Missile (FBM) program. The company closed the month in a decisive manner with two more major deals on April 30. The National Aeronautics and Space Administration (NASA) signed a $39.5 million contract modification with Lockheed Martin Space Systems to implement an employee-retention program, while the Navy supplied a contract boost worth up to $190 million to supply tooling and special test equipment for its new F-35 Joint Strike Fighter.

Not a bad month’s work. And it’s certainly representative of how Lockheed generates a predictable earnings stream. Because of deals such as these, the company’s share price rose nearly 8% in the month of April alone. In May we’ve been seeing even more deals, and the stock is advancing again.

Clearly, small deals can have a big impact on a company’s bottom line.

The Gamer That Doesn’t Play Games

At a time when other gamers are worrying about the next best thing, Japan-based Konami Corp. (ADR: KNM) retooled one of their most successful releases, Metal Gear Solid, adapted it for mobile phones, and then built up a lot of buzz as they pushed it out to customers of the Verizon Wireless unit of Verizon Communications Inc. (VZ).

Not only did Konami save a lot of money because it wasn’t developing a new platform from scratch, it also kept its audience smaller to produce bigger returns per person.

While the pumped-up adolescent males soak up this stealth shooter game, Konami hasn’t forgotten to take care of the over-moneyed and under-served teenage-girl market with its recent new game, "Diary Girl." The Nintendo Co. Ltd. (OTC ADR: NTDOY) Nintendo DS game provides girls of all ages the ability to interact with friends, while also organizing a calendar and address book in their own, password-protected electronic journal.

A month ago, Konami announced an agreement with Win Systems International Holdings Inc., to use Konami content in certain of Win’s pending lottery and gaming projects in Europe and Latin America.

Deals like this have caused Konami’s shares to seek higher ground. With a 19% gain over the past three months, the only thing that could help this company even more is if it had a highly awaited Sony Corp. (ADR: SNE) PlayStation 3 game coming in the near future – which just happens to be the case. Metal Gear Solid 4, the highly awaited PlayStation 3 game, will debut June 12.

The Other Kind of Gamer

MGM Mirage (MGM) is another great example of a company that is constantly finding ways to expand its customer base. When people consider MGM, they often think of the downtown Las Vegas strip, slot machines, neon signs and dealers waiting to take your money. MGM Mirage does very well in its dealings in Las Vegas and other casino resorts across the nation, but recently, MGM has made some moves that will give the company a new image, and help them to recognize profits in sectors that are so far untapped.

For instance, the company took steps to create non-gaming resorts so that consumers who want all the entertainment and the luxury of the MGM Mirage resort – but don’t want the gambling scene – could still be served. In other words, MGM Chief Executive Officer J. Terrence Lanni has realized that the MGM brand conveys an image and a value that transcends nickel slots, poker chips and a scotch on the rocks to take the edge off.
      
As Money Morning reported last year, most of these non-gambling facilities are being set up overseas, with a focus on markets in China. So not only does this provide classy places for wealthy Chinese consumers (and visiting business executives) to party, relax or even catch 40 winks, it also enables MGM to profit from China’s torrid growth. Increasingly, China’s emerging middle class is becoming very brand-conscious, and that holds true for their growing tourism forays: Consumers want the opportunity to stay in name-brand hotels and resorts. And MGM wants to make that happen; the result is that the company is going to dazzle them – with real neon lights.

The bottom line: MGM has become a high-profit play on China. And many other markets, too. It’s not just a gaming company anymore.

Mastering Bite-Sized Bids

Some companies aren’t mastering "small bids;" they’re mastering microscopic ones.

Global titan Yum! Brands Inc. (YUM) knows the importance of ultra-frequent, ultra-miniature deals. While the companies mentioned above are seeking out million-dollar contracts, Yum’s Taco Bell subsidiary is discovering ways to make hundreds of thousands of people say, "I’ll take the burrito supreme" – every day.

Yum’s latest focus? China, of course! The company is seeing a rising share of its profits coming from overseas in general, but the People’s Republic of China is developing into a frontrunner for sales growth. This comes as no surprise to us here at Money Morning. With all of the money flowing in, through and all around China lately and the looming Beijing Summer Olympics attracting attention from all corners of the globe, companies that depend upon disposable income are storming through the markets.

With full knowledge of this, Yum! has been adjusting to capture many more miniature bids. In 2007, Yum’s operating profit in China increased 30%.With only the KFC franchise alone they are expecting to have 3,000 stores in China by the end of the year.

Another company that is turning these micro-bids into huge profits is PepsiCo Inc. (PEP), – also a great example of a company that is recognizing its global potential. PepsiCo’s first-quarter profits were up 5% due to international growth, which left the company with a hefty net income of $1.15 billion.

In a quarter that was riddled with rough days in the U.S. economy, PepsiCo managed its way around the U.S. consumer malaise by capitalizing on overseas growth. Sales volumes were particularly strong in China, South Africa, the Middle East and India, while the Americas fared rather poorly, volumes falling slightly.

Companies like PepsiCo know where to focus their marketing when the time is right. Having a global presence during a downturn in its native U.S. market is an example of shrewd diversification.

And that makes PepsiCo – you guessed it – another Master of the Small Bid.

History shows that companies in this category generate consistent returns no matter how tough the markets get. And by moving forward at all times, these firms are positioned to really outperform their peers when the economy returns to normal.

And return to normal it will – when everyone least expects it.

News and Related Story Links:

• Money Morning Financial Analysis:
  Here’s Why MGM is a High-Profit Play on China.

• Wikipedia:
  Lockheed Tristar L-1011.

• AirForceTechnology.com Projects:
  F-117A Stealth Fighter.

• GlobalSecurity.org:
  Trident II D5 Fleet Ballistic Missile (FBM) program.

• Web Site:
  Joint Strike Fighter.

• Joystiq:
  Konami announces Metal Gear Solid for mobile phones.

• Gamespot.com:
  Diary Girl.

• Gamespot.com:
  Nintendo DS.

• IGamingSystems.com:
  Win Systems and Konami Execute Content Agreement.

• Gamespot.com:
  Playstation 3.

Consumer spending – the driving force behind the U.S. economy – slowed in April.

Soaring prices wiped out any benefit from the scant 0.2% increase in consumer spending in April, the Commerce Department announced. After adjustment for inflation, consumer spending was flat at 0.0%.

"Consumers are still spending, but just enough to keep up with price increases and nothing more," Joel Naroff, president and chief economist of Naroff Economic Advisors LLC, said in a note to clients the day the report was released.

The April rate of consumer spending represents a slow-down from March’s 0.4% increase.

Inflation was mild, if you disregard food and fuel. But anyone who has been feeling the pain at the pump or the grocery store checkout line knows that’s a pretty big if.

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Those painful prices are weighing heavy on the minds of consumers as a separate report released by the Reuters/University of Michigan Surveys of Consumers showed. Its consumer confidence index fell again in May, down to 59.8 from April’s reading of 62.6. The index is at its lowest level since June 1980, Reuters reported.

And while inflation is pushing up the cost of everyday staples, consumers aren’t getting much help from their employers.

"Income rose just at the inflation rate," Naroff said. "There was a troubling decline in wage and salary income and if that continues, consumers will not have the wherewithal to keep spending."

Overall, the two reports paint a bleak picture of the U.S. economy. Consumer spending provides the bulk of gross domestic product. If it continues to decline, a U.S. recession is inevitable.

It’s clear that the government’s economic stimulus checks have yet to make much of an impact on consumer spending. And the continued waning in consumer confidence is going to lead to more hoarding and less buying in the months to come as consumers prepare for even darker days ahead.

"As an indication of the growing conservative nature of households, lots of money is going to savings," Naroff said. "The rainy day is here."

News and Related Story Links:

• MarketWatch:
  Inflation wipes out income gains in April

• Bloomberg News:
  U.S. Economy: Consumer Spending Gains Slowed in April

• Reuters:
  Inflation turns U.S. consumers’ mood grim

• Money Morning:
  With Oil Speculators Blitzing, the Fed Needs to Call an Interest-Rate Reverse Play

Orders for durable goods, excluding transportation, rose 2.5% in April, an unexpected gain that underscores that a weak greenback and strong overseas demand for American-made goods are helping recharge the downtrodden U.S. economy.

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Total orders last month shrunk by 0.5% to a seasonally adjusted $214.42 billion, the Commerce Department reported. That was well below some forecasts of a 2.0% drop.

Durable goods – such as cars, appliances, electronics and toys – are manufactured items that are expected to last at least a few years. Together with sales of nondurable goods – more-ephemeral items such as paper and food – and sales in the service sector, durable goods are an important economic indicator.

"Here we really see that the effects of a weaker dollar are in fact giving us a lot more juice in this economy than we had expected," Anthony Chan, chief economist at JPMorgan Chase & Co.’s (JPM) Private Client Services Group, said in an interview with Bloomberg Radio. "When the economy weakens you tend to see the manufacturing sector also weaken, [though] this time around we’re not seeing that."

Among the sectors that posted gains, electrical equipment orders surged 27.8%. Orders for defense-related goods rose 4.8%

Among the sectors in which orders declined, aircraft orders plunged 24% and orders for transportation equipment fell 8%.

All told, the numbers caused trading to open higher yesterday (Wednesday), as the report doesn’t point to further declines in activity, said Joel L. Naroff, president and chief economist of Naroff Economic Advisors, Inc.

Naroff said the U.S. economy is still on the soft side, but as long as foreign demand for our products holds, we’ll dodge a sharp decline.

"Yes, housing is in the dumps and consumers are suffering from a massive case of food, energy and home-price depression," Naroff said. "But there is a real chance we escape with maybe only one negative quarter of growth.  And if the current quarter manages to eke out a gain, then there just may not be any negative quarter."

Past statistics, however, indicate a bleaker outlook.

In March, orders for durable goods decreased 0.3%, the third straight month of declines. The last time durable goods orders declined for three consecutive months, the United States was headed into the 2001 recession.

And with another net decline in April, it’d take a historic rebound to reverse this historical trend.

News and Related Story Links:

• Bloomberg:
  U.S. Durable Goods Orders Rise Excluding Transport

• Money Morning:
  Slight Decline in Durable Goods Could Be Good News for the U.S. Economy

The Conference Board’s index of leading economic indicators rose for the second straight month in April, but the National Association of Business Economists (NABE) isn’t convinced the United States can skirt recession.

The Leading Economic Indicators index rose 0.1% in April, just as it had it March. It was the first back-to-back increase since October 2006. 

"The message on the economy is that activity is soft but not moving down sharply," Michael Moran, chief economist at Daiwa Securities America Inc. who correctly predicted the index’s April gain, told Bloomberg News. "The economy is muddling along."

The news added to speculation on Wall Street that the housing slump and credit crunch will subside this year. The Dow Jones Industrial Average closed the day up 41.36 points, or .32%. It was trailed by the Standard & Poor’s 500 Index and which was up slight .09%.

While the latest survey by the NABE corroborated that belief, it also reflected an unshakable pessimism for the greater U.S. economy, with 56% of those surveyed saying a recession is imminent if not already here. That’s up from 46% in February.

"Although housing and credit markets will gradually loosen their grip, U.S. economic growth is expected to only slowly return to health," said Ellen Hughes-Cromwick, president of NABE and chief economist at Ford Motor Company (F).

Analysts anticipate employers will remain cautious in hiring, adding to a list of consumer woes that includes soaring food and energy costs.

According to the survey, unemployment is expected to climb to 5.3% this year and 5.6% next year. Those surveyed said consumer prices would rise 3.6% this year, before retreating in 2009.

Last Thursday, the Labor Department reported that the number of U.S. workers filing for initial jobless benefits increased slightly more than expected in the week ended May 10. First-time jobless claims rose to 371,000, up from 365,000 for the week prior. Economists surveyed by Reuters had forecast the number of new claims at 370,000.

That data was followed Friday by news that consumer sentiment was at a 28-year low. The U.S. consumer sentiment index, which is published by the University of Michigan and Reuters News Agency, fell to 59.5 in April, from 62.6 in March.

"The consumer is getting extremely grumpy," Brian Bethune, director of financial economics at Global Insight Inc., who had forecast a decline in the confidence index to 59.6, told Bloomberg News. "The economy is flirting with a recession. The only thing keeping it out is this huge amount of pump-priming going on," including aggressive interest-rate reductions by the U.S. Federal Reserve, the government’s stimulus package and deep discounting by retailers.

U.S. consumer prices rose less than forecast in the month of April, rising 0.2% after a 0.3% jump in March. However, soared 0.9% for the month, the biggest upsurge since January 1990. And gas prices are continuing their march towards $4 a gallon, with the national average of a gallon of regular unleaded gas hitting $3.794, yesterday (Monday). 

The AAA national average shows gas prices up 9.2% from a month ago and up 19.4% from year-ago levels. Gas prices have now risen for 13 straight days.

News and Related Story Links:

• Bloomberg:
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• Money Morning:
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• Money Morning:
  Consumer Prices Moderate in April but Soaring Food Prices Steal the Show

April was a strong month for retail sales, with Thomson Reuters data showing 68% of stores reported better-than-expected same-store sales.

It was the best showing for the retail industry since November, but don’t be quick to assume that means the sluggish U.S. economy is on the mend. Stores got a slight bump due to an extra sales day in April, as the Easter holiday fell in March this year. Also, large chain stores that sell consumer staples at discount prices performed the best.

"Discounters clearly stood head and shoulders above all comers," Ken Perkins, president of Retail Metrics Inc., told Reuters.

Wal-Mart Stores Inc. (WMT) beat analyst expectations of 2.1% same-store growth with a 3.2% sales growth rate in April. And Costco Wholesale Corp. (COST) did even better with an 8% jump in same-store sales, which again bested analyst expectations of 6% according to Reuters estimates.

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"If you didn’t have a sale, you didn’t have customers," Britt Beemer, founder of America’s Research Group, said in a Bloomberg News telephone interview. "Consumers are having a hard time dealing with inflation in both food and fuel."

With unemployment hovering around 5% and oil over $120 a barrel pushing up prices at the pump, U.S. consumers are seeking out cheaper prices on food staples. Not only do they save per unit by buying in bulk, but they also make fewer trips to the store, reducing gasoline consumption.

"The economy continues to get tougher and the ‘paycheck cycle’ is more pronounced for customers than in past months. As money gets tighter for them toward the end of the month, sales drop more than we have seen in the past," Eduardo Castro-Wright, Wal-Mart Stores U.S. president and chief executive officer said in a statement.

Soaring Costs Boost Sales

In addition to benefiting from bargain-hunting consumers, the same-store sales figures of the discount and warehouse chains enjoyed a boost from another source as well: inflation.

"We are, of course, benefiting from some inflation on the food side as a result of the recent run up in the cost of commodities and the continued run up in the price of oil and gasoline," Costco said in a statement.

The U.S. Federal Reserve’s aggressive rate-cutting campaign has weakened the greenback, which in turn has put upward pressure on the cost of commodities, many of which are priced in dollars.

Same-store sales figures are measured in total dollars sold, not by volume. Therefore, an increase in prices means an increase in total sales, even if the quantity sold remains the same.

It also doesn’t mean that the chain stores are necessarily profiting from the higher sales figures. Higher commodities costs mean higher supply prices for the retail outlets and customers alike. Stores such as Wal-Mart are forced to either raise prices or in some cases accept the slimmer profit margins.

However, the weak dollar is helping with international sales. At Costco, which has warehouses in Canada, Korea, Taiwan, Japan and others, sales outside the United States increased 14% in April. But if that figure is rendered on a local currency basis, the increase is only 6%.

News and Related Story Links:

• Reuters:
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• Bloomberg News:
  Wal-Mart, Costco Sales Gain as Shoppers Seek Bargains

• MarketWatch:
  Easter shift, discounts lift April sales; tough trends ahead

• Money Morning:
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The U.S. economy shed 20,000 in April, the Department of Labor announced in its monthly employment summary, bringing total unemployment up to 5% from 5.1% last month.

"We are in a recession, this report doesn’t change that," Ellen Zentner, an economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, told Bloomberg News. Zentner had forecast a payrolls cut of 25,000. "What it does is support the idea that the downturn will be mild. Consumer spending isn’t going to tank."

Compared to the 240,000 jobs the domestic labor market shed in the first three months of the year, 20,000 is a marked improvement. The continued slump in the housing market and waning consumer confidence affected sectors tied to the housing market and consumer goods.

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"Employment continued to decline in construction, manufacturing, and retail trade, while jobs were added in health care and in professional and technical services," the DOL statement read.

The report was universally better than expected, as many economists had expected a slight increase in the unemployment rate to 5.2%. Many saw the moderation in job losses as affirmation that the U.S. Federal Reserve should pause in its rate-cutting campaign.

"For now, this employment trend is validating signals sent by the [Federal Open Market Committee] earlier this week to take a pause in rate cuts," wrote Stephen Gallagher, economist for Societe Generale SA (OTC: SCGLY), MarketWatch reported. The report "lessens the fears of a deep, or prolonged downturn in the economy."

In an unrelated report, the Commerce Department announced that domestic factory orders increased 1.4% in March on the heels of a 0.9% decline in February due largely to strong international sales. The weak dollar is helping to boost exports and offset weakening demand at home.

"The cross currents of a weak domestic economy and a strong export sector continue to keep activity from faltering sharply," Jonathan Basile, an economist at Credit Suisse Holdings Inc. (CS) in New York, told Bloomberg.

Again, the report was better than anticipated, as economists’ had expected an increase of only 0.2%.

News and Related Story Links:

• Bloomberg News:
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• MarketWatch:
  U.S. job losses moderate in April

• Bloomberg News:
  U.S. Factory Orders Rose More Than Forecast in March