Small Cap Wisdom, Bernanke’s Forecasts, Gold Stocks, the Foreclosure Mess and More!

  “I think we can break the back of this thing,” said Ben Bernanke yesterday, as much of a Braveheart-style battle cry as he could muster. If the Fed and U.S. government take “strong and aggressive action,” he assured us, “we will begin to see improvements in 2009."

That was the height of Mr. Bernanke’s optimism yesterday… here are the forecast highlights from his speech at the National Press Club and the latest FOMC minutes.

• Unemployment will reach 9% by the end of the year, and will stay above 5% until 2012
• The economy will contract between 0.5-1.3% this year. That’s worse than the
• Fed’s previous forecast of a 0.2-1.1% decline
• FOMC participants “generally expected that strains in financial markets would ebb only slowly, and hence that the pace of recovery in 2010 would be damped"
• Inflation should remain tame, around 1.5-2% over the next couple years. (As you know, we think this is a gross underestimation… proof below.)

  The stock market reacted nervously to all the Federal Reserve hubbub . We showed you yesterday that the Dow was at a critical crossroads… well, it seems traders agreed, as the index crossed its break-even point 50 times Wednesday before coming to rest with a mere 3 point gain.

So we’re still at the precipice of new credit crisis lows. Today looks like we might step back from the cliff’s edge… with the help of better-than-expected earnings from CVS, Whole Foods and Sprint Nextel, the Dow opened up 50 points. Ironically, the only Dow component to report earnings was HP, which slashed its 2009 outlook after reporting a 13% drop in profits.

  “For individual investors with a small-cap focus,” notes our small cap analyst Greg Guenthner, with a helpful list in hand, “there are ways to play the recession and come out on top:  
  
“1) You need to think cheap. No, we’re not talking about fundamentals (although it’s always good to take a look at price to sales, debt and other important metrics before buying a stock). In this case, we mean cheap goods sold by discount retailers. When consumers are stretched thin, cheap stuff rules the roost. Don’t believe me? Just look at Tuesday’s drop. As of 4:00 p.m., only one Dow component had posted a gain: Wal-Mart. For the small-capper, screen for retailers with market caps less than $1.5 billion and you should find some interesting plays related to this idea. And for this screen, avoid specialty retailers and stores that primarily sell big-ticket items.
 
“2) During tough times, sin wins… Sin stocks are the comfort food of troubled times. A consumer who recently lost his job probably isn’t going to go out and buy a new car. But by the same logic, he isn’t going to give up his beer and cigarettes, either. In fact, the best-performing stocks during past recessions have been tobacco and alcoholic beverages.

“3) Find the necessities. We’ve already talked about the top two recession gainers from the chart above. But what about household products? Yes, families are cutting back. But we seriously doubt they’ll stop buying toilet paper and bleach just because they’re stretched thin. There are plenty of items every family can’t live without. Companies that make the goods should do just fine.”

If you want Gunner to do the legwork for you, check out Bulletin Board Elite.

  This week’s commodity trade seems to be on pause today. Gold remains near its recently lofty high, around $980 an ounce. And oil remains suppressed, at $35 barrel.

  “Lots of commodities look cheap these days,” notes Chris Mayer, “compared with what prices were before the meltdown started in full swing. Gold may not come to mind as a cheap commodity, because unlike oil or copper, it’s not wallowing near yearly lows.

“Yet on an inflation-adjusted basis, gold is nowhere near its all-time high of $850 per ounce reached on Jan. 21, 1980. To get there, gold would have to rise to $2,306 per ounce. All of which is to say we’ve got a long way to go in this bull market for gold.

“Perhaps the best chart I’ve seen on this is from Casey Research. The folks at Casey note: ‘Last month, the price for a single ounce of gold surpassed the S&P 500 index for the first time in 18 years. Following the last such inflection point that occurred in 1973, gold surged ahead over 600%.’

“There are other reasons for liking gold stocks in 2009,” Chris continues. “The first is the gold miners will enjoy a windfall from falling energy prices. Largely because of lower energy costs, mining costs will fall in 2009. Then there is the currency effect. In many gold-producing countries, the local currency collapsed against the dollar.”

Naturally, Chris found a gold stock for his Special Situations readers with both these assets. Get the ticker here.

  Here’s what our colleague Dan Denning says is “the most disturbing story of the day.” Credit spreads and bond pricing in Europe hint of looming defaults and credit downgrades for practically half the continent.

For starters, the market is currently betting on credit downgrades for Hungary, Poland and the Czech Republic. Investors are demanding higher yields for these countries than other nations with the same credit rating.

“Investors are getting nervous about governments in Spain, Ireland, Greece, Portugal and Italy, too,” says Dan. “The spread between 10-year government bonds in these countries and 10-year German bonds is widening.

“What’s more, the credit default swap markets now appear to be factoring in the possibility that certain national governments in Europe may simply default on their debt. Take, for example, Ireland. According to The Times of London, the pledges made by the Irish government to support its banking sector amount to 220% of the country’s GDP.

“The Irish government has promised to bail out its banks. But who’s going to bail out the Irish government? That’s what everyone’s starting to wonder. And that’s why — in addition to the billions in loans made by Western European banks to Eastern Europe — the euro is looking shakier by the day.”

  That’s also why “the mighty U.S. dollar is still rolling on!” proclaims our currency man Bill Jenkins. Do we detect… sarcasm?

“I’m looking for more dollar strength in the near term, not because the dollar is stronger, but only because of its relative strength against other major currencies. With the unthinkable drop in GDP by Tokyo, it looks like the USD is challenging all opponents! In the end, what will in the short run appear to be the cure for the dollar (short-term stimulus) will be its fatal death blow (longer-term massive inflation).”

The dollar index roared up as high as 88 yesterday, about half a point below its credit crisis high. Closer to 87 now, we’re seeing some profit taking this morning, especially after this number hit the tape:

  Wholesale inflation shot up 0.8% in January, beating the Street’s estimate nearly threefold. The government reports today that its producer price index broke its five-month losing streak last month, led by a 15% boom in gasoline price inflation. Even the core PPI — which the Fed used throughout early 2008 to quell inflation fears — popped up 0.4%.

But we suspect deflation will remain the fear du jour. The Labor Dept. reports wholesale inflation fell 0.9% in all of 2008, the first year of wholesale deflation since 2001.

  Elsewhere in the data patch, the number of Americans filing for unemployment benefits has attained a new record high. “Continuing claims” climbed to 4.98 million strong last week, the most since at least 1967, when the Labor Dept. started keeping track. Initial claims — people seeking unemployment benefits for the first time — matched last week’s count of 672,000. That’s just shy of a 26-year high.

But fear not, lowly American, Barack Obama is coming to the rescue. Mr. President unveiled the details of his new housing rescue package yesterday. What was described as a $50 billion program early this week has already morphed into a $275 billion beast.

Essentially, $75 billion goes toward “encouraging” lenders to lower monthly payments or extend the length of loan agreements. The other $200 billion goes straight to Fannie and Freddie, who will refinance loans on their books (also conveniently keeping the two GSEs on life-support).

The mission of the program will be to reduce all American monthly mortgage payments to no more that 31% of the owner’s monthly income. Those who are already in a home they can afford, well, they get reassurance of knowing they did the right thing… and the bill.

Aside from plenty of other concerns, we wonder… what happens five, 10, 20 years from now when the bailed-out homeowners sell their homes? If they’re worth more than the price today, who gets to keep the profits?

  And look at this… enterprising homeowners around the country are finding their own ways to stall foreclosure. Here’s our favorite: Just ask to see the original mortgage paperwork.

“During the real estate frenzy of the past decade,” explains the AP, “mortgages were sold and resold, bundled into securities and peddled to investors. In many cases, the original note signed by the homeowner was lost, stored away in a distant warehouse or destroyed.”

We can only imagine the paper trail cluster%*#$ emanating from boom-to-bust mortgage villains like Countrywide and IndyMac. Oy… sadly, this sounds like a decent strategy.

  “I guess it didn’t occur to Alan Greenspan and Lindsey Graham,” writes a reader referring to yesterday’s “nationalization” buzz , “that it would have been much less expensive to ‘assume temporary control’ over some banks by letting them go bankrupt, rather than bailing them out? Sheesh… our government at work.”

The 5: Ugh… don’t get us started.

  “Your reader slamming the comments about our way-too-expensive military budget sounds slightly insane,” writes another. “Nobody said the military should be abolished. Just that they get too much money and have too much influence. I don’t care how good it is at helping teach people to be leaders. Our economy simply can’t support the combined total of all other countries’ military spending, which is what our military budget represents. It’s a simple fact. That doesn’t mean we should get rid of the military all together, as your overly excited reader seems to think was proposed. I mean, after all, it was a former general, Eisenhower, who coined the term ‘military-industrial complex’ and warned of its power and influence. And I’m sure he knew the value of the system.”

  “If not for the military,” writes the last reader, “Uncle Sam wouldn’t be able to execute these stimulus programs and other wealth-redistribution programs. The military is the ‘teeth’ that the government needs to carry out all of its evil deeds, both foreign and domestic. As for speaking German and Japanese, get real! Common military doctrine teaches that to conquer an enemy the invaders need to outnumber the defenders 3-to-1. Let’s say only 100 million Americans owned a rifle. You’re talking about an invading force as large as the current population of the U.S. Sorry if I don’t get misty-eyed about you heroes splattering your guts for Leviathan. To defend a country, a volunteer militia is sufficient. Note the meaning ‘volunteer’ means it is done for free, without leeching off of the taxpayers.”

Thanks for reading,

Ian Mathias
The 5 Min. Forecast

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