Most people invest in them through a 401(k), yet they do not know the ins and outs of how to pick a quality fund.  Many investors simply use performance as a decision mechanism, but that is usually very faulty and fraught with danger.  Here are some other metrics to consider when picking a quality mutual fund:

* Alpha – This is a measurement that tells an investor whether the past returns are achieved with an acceptable amount of risk.  If the alpha is above 0 than the fund is achieving their returns without inappropriate volatility.  If the alpha is negative then their historical returns were achieved using excessive risk.
* Category Ranking – Compare funds to their peers in their specific investment category.  It is unfair to put an equity fund up against a bond fund.  This is on par with comparing apples to oranges.  In addition do not compare a domestic equity fund to an international fund, or a small cap to a large cap fund.  Compare relative performance to other funds that have the same investing style (Large vs. Small, Growth vs. Value).  Once you find a few great performing funds within the category adjust the return by considering some risk metrics.
* Standard Deviation – This is the simplest of statistical measures.  It is a straight measure of volatility.   The higher the SD, the more volatile the funds price performance will be.
* Expense Ratio – This measures how much the manager charges for their service of managing the mutual fund.  Expenses vary between types of mutual funds.  A bond mutual fund should not have an expense ratio above 0.75% per year, a domestic fund should not exceed 1.5% and a foreign fund shouldn’t go above 1.75%.  If a funds expense ratio is above these levels they are probably over charging.  This does not mean you shouldn’t buy those funds, it simply means look for  quality options within that space that are cheaper.

As usual however, never buy a mutual fund that charges you a load to buy (front-end loaded) or sell (back-end loaded).  There are plenty of no load mutual funds out there with good managers and a solid track record. A load is the word the industry uses for commission.

–Steve Peasley

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Greece is still a problem as the rest of the EU talks about a bailout without calling it a bailout. Greece itself seems to be walking around like a zombie telling anyone who will listen that they have no problem.

There are many issues that could upset the worldwide recovery as China deals with a budding inflation problem. So far they have tightened their money supply twice this year to hold down inflation.

Despite these headwinds there is a rather large tail wind for our economy. Only about a third of the stimulus package passed last year has been spent. As a result, this year and next will see massive spending in our country and at a time where economic stats are showing us the beginnings of a recovery already. That spending is a major push and should support continued growth.

Will that push stock prices higher? Earnings and growth are the key. The chances are good that both will do well this year.

Good Trading
Steve Peasley

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On the economic front, retail sales reported this week fell 11% from February to March, Industrial production fell to 69.3% down 1% from February, and new construction fell 10%. All bad news, so why didn’t the market fall this week? Obviously, this kind of news was expected. Fear is subsiding. We saw good news this week in the earnings reports for the banks, in inflation which is dead, in mortgage applications for homes which are up 45% for the week compared to a year ago and in mortgage interest rates which are down to 4.8% for a 30 year fixed.

The numbers are still very ugly but the stock market has been so beaten up that it is reacting to news that shows some hints that the worst is over. The stock market is still down for the year even with the strong up move in the last month. There was a stronger move downward for the first two months of the year and so far all the market has done is return to early February levels. Except for the NASDAQ.

The NASDAQ index, which is full of large tech companies, is flat for the year. Past bull markets have been led by tech and this one is no different. Banking stocks are coming off severe bottoms and no bull market in history has occurred without a rally in banking stocks. It appears that though the economy is still in a severe slump that the stock market, which is itself a leading economic indicator, is telling us that the fix is in. That ‘fix’ may be some months away as we deal with backward looking statistics but it certainly seems that the mood has changed.

As we at KPP Financial have been heavy in cash. We did not pick the bottom of this stock market, nor did anyone else. Because we were heavy in cash we did not go down with the market in January, February and the first part of March. What that means is that we are late in catching the rally as well. As our clients have seen we have been moving into the market for the last six weeks. We are now heavily invested but with some cash on the sidelines that we plan to put to work on any weakness in the market. This is a bear market rally so far, albeit a sharp one, forming a ‘V’ bottom which was unexpected. Any pullback will be an opportunity to buy.

Finally, history tells us that this is the first leg of a rally. If the ultimate bottom is in, which we have stated in previous newsletters that we think it is, then the rally should continue. It should rise at least 50% from the bottom. After the 1973-74 recession, which so far looks very similar to the current recession, the S&P 500 rallied 73% and the DOW 75.7% over 19 months. This kind of rally from a recession low is normal. Don’t think that this is uncommon. Therefore, missing part of the first leg because you were protecting your nest egg, as we were doing, is not a bad thing.

However, it is now time to invest. Do it carefully and in fact hope for some weakness so that you can take advantage of lower prices. Do not fear any correction. Fear is hovering over everything. To the degree it is keeping people out of the market it is a good thing. Stock market rallies climb a wall of worry. Be cautious but be buying.

We will continue to buy slowly. The plan is to take advantage of any weakness to buy more. That doesn’t mean we won’t sell if something is not working but overall we are on the buy side of the market not the sell side. That time is over.

Good Trading,

Steve Peasley

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This week was the start of earnings season as Alcoa posted over a billion dollars in losses on Tuesday. On Monday, anticipating that the report might be worse, the market sold off. It came in at about what was expected, so on Tuesday the market tried to hold up. Selling pressure intensified on Wednesday with 90% of the volume for 90% of the stocks on the down side. That was a very strong sell off as the market appeared to want to retest the lows. A retest is normal though tough to handle if you are the one who is experiencing the fall in your asset value. Still, it is normal and a successful retest is very positive. On Thursday the low was not broken and the market turned around in mid day ending on the up side after an intraday slide of almost 300 points on the DOW, a positive sign that maybe we have seen the low in this mini cycle.

The market this week was dealing with some tough economic reports. Though most of the news was expected, the retail sales report for December showed a fall of 2.7% which was more than expected. However, I think it was the news about the banks this week that pushed the market down. Citigroup is selling assets to try and improve its balance sheet and Bank of America announced that they are in negotiations with the Fed for more money and then got it early this morning. This uncertainty is not what the stock market wants to hear.

Economic news not so well reported as the retail sales this week, was inflation which has fallen off a cliff. On the producer level for December it came in at a -1.9%. No one is talking about ‘deflation’ which is what we have at this time. The reason no one is talking about deflation is because almost every expert expects inflation to come back at some point. That will depend on the FED and when it starts to raise rates again. That is not going to happen for a long time.

Foreclosures are up strongly, especially in California. This recent spike is nothing more than a result of government interference. The government forced banks to postpone notices of foreclosures to try and work out loan defaults and all that did was push back the time line. The good news is not in the foreclosure rate. That is going to continue to be a problem long after the housing market settles down. Any good news will be in mortgage applications which were up last week another 25%. That was on top of the 25% increase the week before. Annually, applications are up 50%. Of course 85% of those applications were for refinancing, but with 30 year fixed rates falling to below 5% this bodes well for future sales of properties. As I have said before, look for a recovery to start in refinancing and sales of homes. Don’t expect prices to rise or foreclosures to fall for a while but sales are the important aspect at this time. Without an increase in sales a recovery is not going to happen.

Import prices fell in December by 4.2% and that is on top of a 7% drop in November. I wonder what this means when you consider the retail sales report? Net of auto and gas, retail sales fell 1.5% not 2.7%, but what have lower prices on everything done to the sales report? Maybe it is not as bad as we all think. Still it is not good.

It appears the market is marking time. It has established a range and is testing the low of that range. There is no great urgency to buy stocks at these very low levels as fear makes investors worry about going lower while at the same time everyone is waiting for the new president to take office and see what his stimulus package is going to look like. A huge amount of money is sitting on the sidelines paying zero to 1% interest rates. Traders are waiting for something. They just don’t know what that something is.

Maybe they are waiting for more clarity in the economy. We shall have to wait and see. Meanwhile, stock prices are at historic low prices. The market will rally but maybe it’s one to sell not buy as we struggle in this trading range.

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At a final look at 2008, Fidelity Magellan, the largest and long established bellwhether mutual fund, lost 49% for the year. The CGM Focus Fund which was the best performing mutual fund in 2007 lost 48% in 2008. The average mutual fund loss for last year came in at 39%. There are a couple lessons to be learned. One is don’t blindly buy the largest mutual fund thinking it is safe and secondly don’t chase performance. Last year’s winner does not mean it is going to be this year’s winner.

But we have to look forward. What will 2009 bring us, both in the economy and the stock market? The big economic news this week was the jobs report out this morning which showed a loss of 524,000 jobs with an unemployment rate reaching 7.2% in December. Earlier in the week we had the ISM report, factory orders, construction spending and pending home sales. Most of these reports were for November and across the board they were weak. That was and is expected. It was October when the financial system collapsed and we are going to see several months or more of follow through of weakness before all the efforts to re-inflate the system start to show any result. Expect bad reports for a while.

However, the stock market has already priced in a very weak economy. It has started to rally from its depths and though many do not believe this is a sustainable rally, only a bear market rally that will weaken and roll over, a bottom has been put in. Of course it is a possibility that we could go lower. However, since very dire predictions for the economy have been built into the prices of most stocks it is normal to have at least a strong bounce in stock prices. A return to normalcy would suggest that a rally might last for several months before losing steam and give us some kind of retest of the lows. In October of 2002, in our last recession, the market bottomed and retested that bottom in March 2003. This market will not be the same as this economic slump is much deeper but so was the speed and depth of the market collapse. So the scale is sharply different in the two recessions but the pattern of the stock market lows and recovery so far is very similar.

The question that the experts are all asking themselves is will the Paulson and Bernanke efforts coupled with the Obama stimulus plan work? Will our politicians get it right? I have some serious doubts, but at the same time there is great hope.

I like the infrastructure improvement spending; the U.S. needs that and has needed it for some time. Also, tax breaks for individuals and small business are a good idea. These things will help as will cheaper gas and food prices. But then again- will it be enough?

No one can tell us. There are some hopeful signs that the economy is working its way through the problem; cheaper mortgage rates and interbank lending is starting to improve, but those are baby steps and the new rules the lenders are implementing appear to be very Draconian. Banks at some point are going to have to begin lending. That is the only way they can make money. Right now they are frightened thus they have tightened up standards to such a degree that loans are difficult to come by.

Looking past the current economic recession, inflation will likely return. It is a lot more familiar to deal with than the current deflation we are facing today. Inflation is an old friend, one which we know well, but if inflation gets out of control because of the liquidity we want and need today, then that excess liquidity can destroy the economy a year or two from now. I am referring to all the spending that is going on by our government. Printing money is inflationary and it could be ‘very’ inflationary if the government does not remove the excess liquidity at some point. As in all things it is the timing that is difficult.

Therefore, it is time to be invested not frightened. It will be a bumpy road but as the year unfolds it should be a good one. Keep your stops and be ready to exit at any time but on balance be in the market for 2009.

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As we enter Christmas week and then New Years, traders will be looking for the traditional end of the year rally. Both selling and buying that takes place during this time. Tax loss selling may be pronounced as there have been plenty of losses and traders may want to lock in those losses to apply to future gains. Buying may come in to try and take advantage of very inexpensive stock prices in an effort to benefit from a recovery to normal values of those stocks going into the new year.  

What might drive the market this week is the new and existing housing report for November which will be out Tuesday. Will inventory stabilize or sales increase? Everyone expects foreclosures to increase and prices to be weak but with the recent reduction of interest rates, which won’t help the November report, investors are paying closer attention to the home sector of our economy.  

At some point in 2009 cash, earning next to nothing in money market and short term treasuries, will not be desirable. That cash will find other places to go and some of the trillions of dollars that are avoiding the stock market will return. When that happens we will have a sustained rally. Until then the market is going to be choppy.

Good Trading
Steve Peasley 

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Monday saw one of the largest one day rallies in history. This is a continuation of unprecedented volatility that has gripped the market and is throwing all the norms out the window. The big one day rally was a result of the G7 countries coordinating an effort to reliquify the banking system around the world. This too is unprecedented and gave investors the sense that maybe the powers that be will succeed in their efforts to restore confidence in our financial system. It is that confidence that is sorely needed besides the cash that the banks require to add to their asset base, which includes their stock price. Banks won’t loan money to other banks at this point as evidence of the wildly overpriced LIBOR rate.

Earnings season is here and some large companies reported this week including Johnson and Johnson, Google and Coca Cola. They exceeded expectations and guided higher for the next quarter. Others did not fare as well but even those financials that reported this week were in line with the estimates which of course had been severely downgraded.

By mid week the big gain from Monday was given back. Economic numbers were poor at best. Retail sales fell sharply and though some of that was because of gasoline prices falling thus fewer sales reported for gas stations, but there was no getting around the fact that broadly the consumer reduced spending. The consumer is about 70% of our economy. Fear is gripping Wall Street and has spread to every part of the economy.

We are falling into a recession and the length will likely be short on an official numbers basis. If you are in the housing or financial industry you have been in a recession for over two years but officially it is two quarters or more in a row of shrinkage of our GDP. We have not had one as yet though I think it is likely this last quarter will be the first. We will know that next week or the week after when we get the report. The current quarter is certain to be negative. The future will depend on the success or failure of the governments everywhere in their efforts to reliquify the financial system. I think they will succeed. They have many tools to force it to happen. In fact if they want to they can ‘make’ companies make loans. They could dictate it. I don’t see that happening but rest assured they can and will if they have to.

By Friday after another week of extreme, historic volatility the market looks and feels a little better with LIBOR falling a little giving us a hint that maybe the efforts of the various governments are starting to work. However, it’s far too early to tell.

It is time to buy. Some of the strongest and largest stocks with no exposure to the financial crisis have been severely sold off. These stocks are at prices not seen in several generations compared to their earnings. There are many with single digit P/E ratios and paying 5% or higher dividends. Stocks are on sale and there is blood in the streets. You need to be buying when everyone else hates the market. On the other hand (there is always another hand), buy carefully and slowly. You only want to put your toe in the water not your whole foot, not yet. The sharks of the bear market are still out there. Let them bite your toe off not your whole foot. Then go ahead and put another toe in the water. I think those sharks have eaten enough. It’s time for them to take a nap and it is time for the Bull. Just be careful.

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With the credit markets this week becoming even more frozen the equity markets around the world have dived dramatically. Mutual fund redemptions are at record levels which causes selling regardless of fundamentals. The increased flight to treasury bills and away from risk have launched yield spreads to astronomical levels.

On Monday the market plummeted when the expectations that the TARP plan passed by Congress on Friday would spark a rally never materialized. The news on Monday was light, however concerns over AIG’s ability to repay their loan was in question and as it turns out they later revealed they had to borrow more money from the government to stay solvent. There were also additional downgrades of stocks by brokerage firms that added insult to injury.

Tuesday the Federal Reserve took the drastic step of entering the commercial paper market and lent money short term to sound companies that need cash for everyday operations. The Fed has never done this before and it goes to show how far the government is willing to go to free up the credit markets. The result of their action did not change our situation much but something should be said for how aggressive the Fed is being in their attempts to clear up our credit problems. None the less the market was down nearly 200 points, but unfortunately that was only just the beginning.

Wednesday came in with mixed news before the open of trading. IBM came out with earnings that beat estimates, but the retail sales report was weaker than expected as the entire country has felt the credit and housing mess. However the market did not react well as more panic selling met a lack of buying conviction that brought the market down nearly another 200 points.

If you thought that was about all you could take, then you were in for a real shocker on the back end of the week. Thursday was a light news day, but that just beget more selling pressure as the Dow plummeted at the end of the day to 8,579 down 679 points. Friday however could be argued to be a much wilder day. General Electric came out with earnings that met its previous pre-announcement and the market acted mixed. There was massive selling on the open and the market traded lower most of the day. However, the final hour was by far the brightest part of the dismal week. The market rallied over 700 points at one point from the bottom, but selling near the end of the day pushed the market to a close of only down 128 points.

Altogether the Dow Jones Industrial Average closed down 1,874 points or 18.15% for the week. We are witnessing history here. This is a market that we will not see for decades to come. The investing opportunities out there are many, but prudence is needed. The market is currently ignoring fundamentals on most companies and the time to be searching for them couldn’t be more enticing. Some stocks are trading at levels you might never see again, but there is still more work to do. The credit markets also pose immense investment potential because of the huge disruption. Yields in those markets must turn lower before equities can mount a comeback. The Fed and global central banks are taking very bold steps to clear the credit pipes, but it is obvious more needs to be done. The G7 meetings that are taking place this weekend will be solely focused on fixing our now Global credit crisis. LIBOR rates are sky high and must come down in order for the market to feel confident again. There is talk about the government’s guaranteeing the loans between banks, which would push the rate back down to normal levels. Will that happen? No one really knows, but it is obvious to all financial leaders that this has transformed from a U.S. housing bust into a problem that is affecting all corners of the globe. It may not seem like a time to be optimistic, but now is the time to get excited about the opportunity in front of all investors.

Was the brief market rally on Friday the sign of the bottom? Who knows, but I do know that the key to that answer lies behind the doors at the G7 meetings. The ideas they may formulate and how well they are received in the credit markets are the tools that will bring us back from the abyss. Look for these signs before getting too excited, but keep your head up. With history being made during such a bad time there will also surely be history being made when the sun is shining again. When that happens, remember this week! It was one for the record books!

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The big news this week on the economic front was this morning’s jobs report but on Monday we had construction spending which was a fall of .6% for July, after being up .3% in June, and an ISM report of 49.9% down from 50% for the manufacturing sector and another ISM report for nonmanufacturing with a reading of 50.3% when expectations were for 49.3%. Neither number told us much. On Wednesday factory orders for July were ‘OK’, and yesterday revised productively for the second quarter rose sharply, much more than expected. However, the jobs report this morning was the big story of the week showing us a weak job market. It wasn’t a surprise with a loss of a little over 80,000 jobs when the expectation was for a loss of 75,000 but there was a revision for the previous two months of more jobs lost, and this pushed up the unemployment rate to 6.1%. This data is telling us that we are in a weak economy but not a shrinking one. The economy is actually growing, just not with any gusto.

The dollar continued to strengthen slightly and oil collapsed after Gustov missed the production zone in the Gulf. Oil prices continued to fall all week sitting at about $105 per barrel this morning. Oil no longer controls the action of the stock market, that link has dissolved.

The assumption the traders are making is that the world economy is slowing but they are not sure if that is going to translate into a recession. I don’t think so. The World Bank is projecting a 4% plus growth rate for the world which is less growth than a year ago but still strong growth. Inflation has been conquered, at least in the current cycle, as oil and all commodities have fallen. But just as importantly, productivity has dramatically picked up meaning more downward pressure on inflation. Obviously, employers are not hiring yet; they are getting more work done with existing workers. How are they doing that? Much of it is technology upgrades and new technology that makes work more efficient.

As we said September is a tough month and this week has already proved that observation. That does not mean it will be negative. In election years September has been mixed, but in most years it is a down month. So cash held on the sidelines is prudent. However, it is also the month to start teasing into the market, just be very careful. Buy after any large down stroke in the market.

The stock market has always rallied strongly from the depths of negativism. The question is, are we at that point? Almost, universally the news on our economy is bent in a fashion to be negative. The consumer ‘feels’ poor with big hits to the value of his home and a painful reduction in the value of his 401K or other stock market assets. No wonder the consumer is down. At the same time it’s harder to find a job. It certainly feels like the news is all bad.

However, it is not all bad. Exports are still strong, finally the consumer is getting a break at the gas pump and we will see food prices start to come down. Salaries year over year are up 3%. Outside of financials and housing the economy is growing.

In our portfolios we are holding a huge amount of cash and we are shorting the market in certain areas. We also have tight stops in to take us out, producing more cash if need be. We will start to feel better about investing closer to the Presidential election when one uncertainty will be removed. The stock market hates uncertainty and in two months, with the elections over, I think we are going to look back and say things are starting to improve. Inflation’s fall will be showing up in the statistics by then. The financial crisis will be clearer and housing will be further into its weakness. Slight improvement is already happening but it is being ignored at this time. That’s normal.

One final point, the stock market has ‘always’ started to rally before you see any economic recovery. So, it is our job to anticipate that recovery. In this cycle we may not have seen the bottom but we are getting close.

The market is very likely to be higher by year end than it is today. The ride may be rough over the next six weeks leading up to the election but there is so much pessimism that chances are good the stock market is at or near its bottom, but the economy is not.

I see the stock market being much higher in 2009 and over the next few years returning not only double digit returns but high double digit returns. It is the journey getting there that is tough. It is never truer than in today’s market that you buy when there are sellers and sell when there are buyers. We have sellers; it’s time to buy, slowly.

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