plain vanilla

I’ve been researaching food retailers for over 100 years and I’ve come to three conclusions:

1. They are inefficient.

So much for the January effect.

Three weeks into 2008 and the FTSE has sunk below 6,000. That makes it time to buy, right? It wasn’t last time, in August, and the macro picture isn’t much better this time.

Bad news is reputedly good news for brave contrarians. This argument, put across by financial experts and based on historical evidence, has tempted some investors back into the market and unfortunately lost them money over the last six months of supposed bottom fishing.

Now the FTSE-100 has again breached the “big number” is it be second time lucky, or is a bear market already upon us?

The value argument is airtight but this has been the case for half a year and the market has yet to find form. Sentiment is beating valuation hands down. Investors are skeptical and fearful, and will remain so for as long as asset managers are issuing profit warnings, banks are battling write offs and takeovers are being shelved.

When will the appetite return? When investors see some evidence of improving conditions. And, personally I am looking for more than a symbolically significant milestone to tempt me back in for the long-term.

Investment marketers will try and probably succeed in bringing some buyers back, even if only for the short-term, by attaching a significance to 6,000 and repeating the case for value.

However, in this volatile marketplace what significance does the “big number” really hold?

Bottom-up analysis is tunnel-vision investing. Looking at a company in isolation, not factoring in market, or economic performance - is this the best way to pick stocks?

Believers claim there will be opportunities whatever the weather, though some would call this risky.

It is popular among private investors that pay close attention to the fundamentas and little else. Mechanical investing take a bottom up view when using screening tools.

The Motley Fool gives the pros and cons.

It’s doing the trick for this fund manager, interviewed on Yahoo!

And this one, in the Independent.

Check out Digital Look’s supply of stock screens.

And, an extra special formula that I know will prove popular, based on Jim Slater’s Growth At a Reasonable Price (GARP) model.

A week ago a reader asked: “Should I buy shares in the LSE?”

While investigating the exchange market I stumbled upon this fabulous podcast from The Times Future of Business series.

Just shy of an hour, it isn’t short but it is clever and quite thought-provoking. In the broadcast, the exchanges valuations were evaluated. The point put across in the discussion was that value, measured by the P/E ratio, isn’t comparable with related sectors.

Also, as a natural monopoly, the LSE’s market position, ability to generate revenues whatever the weather (see latest Citigroup update), and perennial bid-target status make it seemingly a good addition to any portfolio.

Buy.

No this isn’t a long repressed childhood memory!

The Naked P/E (price-to-earnings) ratio is a proprietary measure that allows for comprehensive, apples-to-apples value comparisons. It does this by stripping out the elements of P/E influenced by the firm’s sector and market cap, which leaves just raw value.

As a strategy it has performed marvelously according to research by its creator, Dr Keith Anderson. A portfolio of the six best Naked P/E stocks, said to be mis-priced by the market, produced an average annual return of 39% from 1975 - 2003.

Lots more information on the theory can be found at the doctor’s website. A current list of stocks it has identified can be found at Interactive Investor.

Do you use this? It is a way to gauge the value of stocks to gilts - a UK government bond.

This ratio, based on income as opposed to capital gains, describes yield on gilts divided by the yield on equities. It helps to determine the more attractive investment option - bonds or stocks. It is said that when GEYR is high equities are expensive and, barring a fall in bond yields, should fall in price to resume equilibrium, and vice versa.

Thanks to Alun for the question, keep me on my toes.

Part 1 click here. Full unabridged version click here.

In 2008 I am looking for strong earnings from oil stocks, continued demand and possible consolidation for metals and for banks to stop the rot.

As oil and gas, mining and banking are the three largest sectors in the market these factors could keep the leaders from lagging. Valuations across the index are strong as are dividends with an average yield of 3.1%.

The professionals are also cautiously optimistic. Nearly two-thirds of fund managers and three-quarters of financial advisers are bullish according the Association of Investment Companies (AIC).

The credit crunch is not over. Even worse, it is very tough to measure its future effects therefore the FTSE would not be the first index an investor would look to buy.

The current climate is better suited to stock pickers than index holders. That said, and whilst I expect many false starts in the coming year, the UK market does have the infrastructure to finish the year higher. And, with Morgan Stanley et al suggesting capital preservation as opposed to capital growth just a year ago, that might be as good as it gets.

Hold.

1. Choose dividend paying stocks, guaranteeing a level of income away from capital gain.

Investors profit comes either from the price rising or a dividend payment. This is a percentage of the price that is given to stockholders, normally as cash. Dividend paying companies are normally those favoured by low-risk investors. The rationale is that only firms with a sound financial footing could afford the payouts. It is also a sign of maturity as the profit could be used to expand the business, though most firms do use profit dually to grow operationally and to pay dividends.

2. Ignore financial idiots.

OK. This is anecdotal evidence and I promise to provide more thorough reasoning later, but for now let’s look at the bear market we are apparently in.

According to my understanding of Dow theory, a bear market is a sustained period of lower highs and lower lows in stock prices.

In other words, a long-term down trend. One thing today’s market definitely lacks is a trend in either direction. The doom merchants confusing today’s market with a bear market should brush up on Dow theory. Charles Dow’s primary (bull / bear market) and secondary trends (correction / rally) clearly differentiate between a correction and a true bear market.

3. Don’t short sell.

A client borrows stock from a broker and sells, aiming to buy it back at a lower price. For example: A client borrows 1,000 shares of Superman PLC for £1 each, and SELLS for £1,000. The price falls to £0.90 and client BUYS 1,000 shares for £900, handing back to the broker. The profit is the change in price over the borrowing period as the client has only to return the amount of shares, not the worth.

Shorting is a risky strategy as the potential loss is infinite if the stocks rise instead of fall. Also, many investors believe that the influences that make stocks fall is simply the opposite of what makes them go up, which is a mistaken belief according to Henderson Global Investors.

For perma-bulls taking a worryingly optimistic view of my FTSE review, here’s a couple of ways to play the blue chip benchmark products.

1. ETF - A class of fund with all of their strengths but none of their weaknesses.

ETFs (Exchange Traded Funds) are passive funds allowing you to invest in indices, commodities, and various other baskets of securities like a regular stock. Unlike typical funds, the client is not tied to a lengthy holding period, management costs are at a minimum, and there are no joining fees. Its price reflects the performance of the underlying securities, i.e. When the FTSE-100 gains 10% that gain is mirrored in a UK large cap ETF.

For the private investors wanting cheap, diversified exposure to a market ETFs are hard to beat, window shop at Barclays stockbrokers.

2. Structured products - Tracking for the long-term.

These allow index tracking with a capital guarantee. Not only that but the upside is geared too, meaning if the value of the underlying investment (normally a sector or index) rises X%, your investment rises Xn% where n is the level of gearing. For example, Bob invests £10k in a FTSE-100 product offering 200% gearing and a 100% guarantee. If the index falls 50% Bob still gets his £10k back at maturity. If the FTSE climbs 50% Bob gets £20k back, an extra 5k because of the gearing.

The only catch is that investments must be held for several years for the effects of the guarantee and gearing to kick in.

Again, Barclays is a good provider.

Are British bluechips a good bet for your cash in 2008?

If relative performance, and fund manager sentiment is to be believed, the answer is yes. It’s not so much about what UK firms are tipped to do but what UK megacap stocks represent.

Big, defensive, high yield plays is something the FTSE-100 has in spades. There are more than 20 firms valued over $50bn in the index, many of which are among those most preferred by investment managers ahead of what is likely to be a volatile year for the domestic economy and the market.

The 100 also outperformed the mid-cap index, the FTSE-250, for the first time in over three years.

But facing facts, 2007 was a hard year for English equities that rose by just 4% over 12 months. Two major corrections, slowing takeovers, economic instability, plus the first run on a bank in over 100 years, have all taken their toll. The market ceased its four year trend and is now oscillating, wildly.

End of part one. For part two click here.