THIS FEELS FAMILIAR AND LOUSY

The past 5 or 6 trading days have been miserable. If I was fully invested my nausea would resemble the swine flu. While I've taken my inoculation of holding cash, writing calls, and shorting a few names, the sick feeling still overwhelms me as I watch the equities that I own crater.

The sweaty brow, clammy hands, and ache in the pit of my stomach are symptomatic of my feelings last Spring as the market plummeted. Is this downward move just a minor, sideways adjustment or the onset of a major correction that will again test men's nerves?

We've only slid down to 9750 on the Dow and 1042 on the S&P so the bulk of the market's recovery is intact. Yet it feels as if we've fallen off a cliff. Rebounding equities have felt so good after the misery of the recession and credit crisis. Will investors panic and attempt to avoid a repeat of the March lows by selling out or will they view a 10-15% correction as a buying opportunity and start pushing prices upward again?

My guess, and it is obviously just a guess, is that the bias is still positive and after some of the gains are protected and taken off the table, the buying will resume. But the names will be different. The crappiest of stocks have done the best in the rally, and even the boldest investor should sense that it is time to become more cautious. Speculative names will be replaced with reasonable investments.

Over the next 6 months I still believe we will head lower, but not yet. So, use upcoming rallies to lighten up so that when the swine flu of investments hits us the nausea, chills, and aching won't become terminal.

Mister Market Is Laughing At Me

I will never be a great investor because I never follow my convictions and place all my marbles on my view of the future. My hedged bets tend to minimize being right and being wrong. That approach suits me as I sleep well and am still solvent. In the current rally, my stock positions have grown nicely and make me feel good. My cash position, on the other hand, makes me want to go sit in the corner.

As I stare into the corner I calculate how much I could have made had I put all my cash to work in equities. That bothers me. Then I remember how horrible it feels when stock prices tick downward and net worth sinks. An especially sick feeling if you are retired and no longer earn any replenishing investable cash. That's why I attempt to stay cautiously invested. Home runs aren't worth the risks involved.

Within the next six months I'll be happy that I'm not fully invested and I hope that I recognize an appropriate time to pull back from my long positions. I probably won't and that is why market timing is difficult.

JP Morgan is instructive. I should have bought it six months ago. Now it sells at almost its ALL TIME HIGH! Even after the dilution that came from issuing lots of new shares to repay TARP loans. You'd think that all the problems are finished. No, they remain. Now JPM is the best of the big banks, but they are still loaded down with non-performing consumer loans and accelerating losses. Loss Reserves have been built, but they will need further provisioning. The market has been celebrating the slowing of JPM's rate of losses. Losses are still growing, just not as fast! Is that worthy of a stock price that is very near its all time high? I don't think so, but I wish I had bought some six months ago. Now sure isn't the time to buy, but traders are.

Goldman Sachs is a similar story, as are the BRIC and commodity stocks. Their recent results have been astounding. They make me green with envy and feel like donning a dunce cap. Until I think about the likelihood of them remaining at current levels, then I regain some comfort in my liquidity.

A review of a DOW chart of the Great Depression depicts a strong bounce back before returning to lower levels. We've had our bounce back, and it may go higher, but I suggest preparing for a return to bleaker times. I will sleep peacefully, even though I will wish I had made some easy money when Mister Market taunts me.

An Unscientific Examination Of Our Financial Future

Economic and financial education, the financial press, and prayer have failed me. No matter how crusty and savvy I think I am, my results don't equal the image I have of my abilities. While far from prescient, thank God I tend to eke out better results than the professional investment sages. Still, I'm about ready to take up the Maharishi Yogi's Flying Yoga and look for enlightened answers to our investment future.

Where are we headed? Television's talking heads swear it is upward, even though they hedge their verbal bets with a few negatives that could pose problems. Sideline money that needs to be invested, a weak dollar and strong commodities, and momentum are forces that are too strong to stop. The market marches on. Or does it? That's where I wish prayer or Yogi flying would work. Where are we going, because Mama needs new shoes.

Did we overshoot by 50 percent at the nadir? Is cost cutting and an inventory correction worth a 50 percent retracement? Can decent growth in China, Brazil, and India compensate for anemic economic activity in the US and Eurozone? Is deleveraging over or the impact exaggerated? Who knows?

After bouncing up and down on my ass and attempting to fly into meditation, I've come to the following conclusions. We over indulged for too long and we're going to deleverage and suffer for a long time. Our 50% party is overblown and will not last. After a quarter or two of easy comparables fueled by inventory replenishment and cost cutting, we are going to flat line for quite some time. Select companies, in select industries, will do well but the "market" will struggle. Deleveraging is brutal and we haven't experienced brutal yet. Government may slow the process, but they can't stop it, especially since they are attempting to with DEBT!

So, I'm keeping lots of cash and only investing in select stocks that "may" do well despite the upcoming economy. I've kept some emerging markets ETFs and international mutual funds. I've added some short positions and will probably add more, but I scare easily. I'd like clarity, but I can't find any. OM, OM, OM. Off to Fairfield.

TAKE A HEALTHY BITE OF SMART BALANCE

I've owned SMBL on and off over the past several years. The story hasn't changed, but the share price is inching lower. An opportunity is at hand if you can wait five years. Regardless of the "markets" results, Smart Balance will reach $1 Billion, control a significant share of the dairy case, and sell out for a very nice price.

The "story" is one of smart management that has built brands successfully before. Steve Hughes, SMBL CEO, has been the architect of tremendous brand growth at ConAgra, Dean Foods, and Celestial Seasonings. His team has years of experience and the goal of building SMBL into a billion dollar foods concern. They are currently at the $250MM level after several years of business.

Smart Balance is a BRAND. It doesn't own manufacturing or research facilities. It is product, marketing, and people. It makes a little money and generates cash. Enough to paydown it's acquisition debt to $65MM. They should be debt free in a year or so. The lack of manufacturing is an advantage in our current tough times.

At its current share price of $5.90 the stock can be gathered in at a price that is significantly lower than the IPO price, employee options, and the entry points of some of their largest private equity investors. While it isn't at its 2 years low point, it is well off its highs and hasn't participated in the market's run up.

A reasonable plan is to buy some and tuck it away for 5 years. Forget about what the market price is and let Steve Hughes do his magic. Within that timeframe he'll sell the company and you'll end up with a boatload of ConAgra, Kraft, or Heinz shares. That's my bet anyhow.

Banks Require Zero Cost of Funds

It's well known that commercial banks have faced strong headwinds for the past several years. While banking commentators acknowledge that all of the problem mortgage loans haven't been foreclosed yet and commercial real estate problems loom, the industry has been saved by the combined action of the Fed and the Treasury. Share prices have moved dramatically upward off the fear induced bottom. Many seem inclined to believe that there is more upside to be had as long as the Fed keeps interest rates near zero.

Even with a very accommodative Federal Reserve, bank share prices will not stabilize at higher prices. Earnings power is becoming an issue. Where investors were once willing to celebrate the lack of failure and push shares up, they will shortly start to concentrate on what can banks earn with more capital, less leverage, a changed fee and expense structure, and examiners breathing down their backs. The answer is going to be that banks will earn substantially less than at their peak earnings.

Zero interest cost for overnight funds is necessary to offset the following:

1. Continued Loan Loss Reserve funding so mortgages can be foreclosed, HELOCs and credit cards can be written off, and commercial real estate loans restructured. Cummulative LLRs are not adequate to avoid future provisons on a grand scale.

2.Reflecting the above, the FDIC must be refunded and the two year advance premium payment the banks are now required to pay, even with the funny accounting treatment, will impact the banks ability to lend.

3.Regulatory changes in credit card rate changes will start to impact P&Ls.

4.The same will be true for Overdraft Fees, a major source of income for banks.

5.With quality loan demand slack, investment alternatives are not carrying high yields.

Treasuries and Agencies barely exceed overnight funding costs which has pushed bankers into GinnieMaes to find yield.

6.Finally, Regulators are behaving excessively tough on existing portfolios and requiring more reserves for a growing number of loans that are being classified as "substandard". Pressure is not inducive to extending new credit.

Earnings are apt to be "substandard" for banks for the next several years.

Vulcan Appears Vulnerable Again

Vulcan, and other similiar companies, has nearly doubled in the past several months as infrastructure rebuilding and stimulus mania has taken hold. The thesis holds that stimulus funding will fill the hole that developed in residential, commercial, and state road budgets. It won't. At best, it will halt the decline in volume, but it won't get the company on a fast growth track. The price surge reflects the beginning of good times being here again.

In 2007/2008/2009 I rode puts and shorts on both VMC and MLM. It's time to start nibbling at negative bets again as these companies are priced too richly.

AIRLINE SURVIVAL EQUALS DILUTION

Earlier posts have detailed my adventure in owning airline stock. I knew airlines were probably the worst industry to invest in, but Southwest, the best of the worst, was offered at a very attractive price. Rather than thinking, I bought and immediately started losing money. It took about six months of regret before the price returned to my basis. About 90 days after my exit, airline shares started moving upward. Have they ever. The airline ETF, FAA, is up over 100 percent in the last six months!

Does a 100% move mean the industry must be attractive? No, it means that the industry won't go bankrupt in the near term. New equity offerings and sale/leasebacks have raised cash for struggling carriers. Cheesey fees for bags, seat selection, and pets have juiced occupied seat revenue. But it is still a lousy industry. It requires too much capital, has unionized workforces, is subject to large fuel swings, and, mostly, faces pricing pressure from both leisure and business travelers. As usual, the optimists have gotten ahead of themselves and run prices up too fast.

I hope that I've got it right this time. Recently I borrowed some AMR shares and sold them short. American has enough money to continue to bleed for the next year and won't go toes up anytime soon. But it still must service a huge amount of debt, about 10Billion, with terrible operating margins. A difficult task. AMR recently sold equity and diluted the common shareholder, and issued debt at 10.5% for 3 years! They are staying alive, but at an expensive cost.

I think airline shares will go down; I know they won't go up another 100 percent. AMR is about as weak as they get. This time I picked the lousiest company in the lousiest industry and time is on my side.

THE 80/20 RULE MUST NO LONGER APPLY

Awhile back I wrote, in Crusty's How It Ought To Be blog, about two disruptive products that I was using to my advantage. One was a 4.01% checking account from a local credit union. Yes the rate is correct, 4.01% up to $25,000 and still 1% for excess balances. Virtually no difficult requirements attached. only one ACH and 12 debits monthly. My wife is easily up to that task.

My gameplan was to look for other credit unions to replicate the account and put more money to work at 4+%, government insured. I knew of a credit union in eastern Iowa using the same gambit, but paying 5%. But, I haven't gotten around to it yet. Now I won't have to as banking has changed in Omaha.

For the last twenty years most community commercial banks have followed the 80/20 Rule which shows that 2o% of the customers provide 80% of the profit, so raise prices on the 80% to increase their profitability. If they leave, so what as they were not as valuable as the important 20 percent. Bankers catered to the better off and sent the smaller balance accounts off to the savings & loans and credit unions.

The result was increased profitability and chest pounding. But now, twenty yeaars later, lobbies and drive thru lanes are empty and bankers have found customer numbers hard to increase. Not so at the financial institutions that enjoyed the customer traffic. Account balances were small and activity high, but they pay fees and take out loans. Bankers have started to take notice.

Proof of a changed approach is a new account from my local bank. IT'S THE SAME PACKAGE AS THE CREDIT UNION! Except that they are paying 4.05%. Other banks won't be far behind and I won't have to open an account in eastern Iowa. Since my wife is up to making sure we use our debit card enough times to keep the banks happy, we'll be opening accounts whenever the banks change their attitude. When we head to Florida for the winter I'm hopeful of finding a similiar banking climate.

4 percent, FDIC insured, is an attractive yield as it certainly beats by a large margin normal bank rates on money market savings and certificates of deposit. It also yields more than a 10 year Treasury and other bonds, plus you don't risk loss of face value due to rising rates. You can earn a 3% dividend on some solid common stocks, but not without the risk that the stock price will go lower with the next correction.

Moderation and balance is always the right plan and these accounts are attractive. Add them to dividend paying stocks along with some bonds and you have a good cushion for a stock portfolio.

Everybody Has A Coupon

Friday evening the wife and I ventured out for dinner, coupon in hand. Besides the usual question I pose, what do you feel like eating tonight, I now add another, what coupons do we have? We chose Olive Garden because the local Italian eateries didn't stick a coupon in front of us this week. As we finished ordering, my wife announced to the waiter "we have a coupon." "Everyone has a coupon tonight" was the response.

Americans are becoming their grandparents and it is about time! We are finally saving more and spending less. What is being spent is being spent wiser. This is a nationwide phenomenom. My Oliver Garden meal was in Omaha, Nebraska, an area minimally affected by the national real estate meltdown. But everyone needed a coupon to part with their cash. The prior weekend I was at our winter home in Florida and not only did all diners and shoppers carry coupons, there were not very many people in the restaurants and stores. Wal-Mart's parking lot was packed, but strip centers were empty. America is changing for the better, but it is going to be a miserable transition.

The transition from easy credit and spending future income to saving before you spend will be a difficult process as we won't need as much retail space or manufacturing facilities. Slower growth for our companies will mean lower valuations for stocks. Less spending means less sales tax revenue for the always voracious government entities. Goverments will attempt to tax away our frugality so they can continue their spending habits.

Just as our forefathers survived the Depression years, Americans will come through our current malaise. It has begun to sink in that good times are not just around the corner. Change in behavior is necessary and our society as starting to adapt and take personal responsibility. Our governments need to be forced to accept that same reality. Deficits need to be reduced through cost and program cutting, not tax increases. It is no longer business as usual in the American family and "tax and spend" cannot continue at any government level.

Our coupon society will lead to lower valuations as growth will be hard to come by. Cost cutting can't result in increased net income beyond an initial burst and flat earnings aren't worth much of a P/E. All companies will not fall victim to lackluster sales, but those with heavy debt loads will. Except for companies with exceptional niches, the only ones with growth potential will be the debt free that are still generating lots of free cashflow and can become larger through acquisitions. Now is the time to shed companies with debt. Not only will they not be able to participate in M&A, they will likely have difficulty rolling over maturities as bankers become more cautious.

The stock market has rebounded nicely over the past several months and may go higher as vacations end and investors return. But, the "new normal" would suggest that equity positions be trimmed in companies with diminished growth opportunity and significant debt levels. If an investor has an appetite to stay long, own the acquirers as they are the only ones with a chance of P/E stability.

K12 Could Become a Shortseller's Nightmare

I've thought that internet learning was destined to be a significant component of educational spending since 2000. That was the year that K12 was founded. That was also the year that I put money into a private placement of Class.com equity. The companies are very similiar as they deliver distance learning content over the internet, except that Class.com limits itself to grades 9-12. The similarity also departs in revenue production as K12 generates sales of $32oMM while Class.com is much smaller. After long gestation periods, both started making money several years ago.

In addition to my stake in the private company, I've put together a position in K12 as well. Like many stocks, it has made a nice recovery from its lows. I think it will continue to do well as it is in the sweetspot of education. It can save school boards brick and mortar expenses, enhance charter school curriculum, and remains popular with home schoolers. It works for remedial as well as advanced placement. Since a teacher is involved, even the teachers unions aren't adamant about killing the process.

With tight school budgets, shortsellers identified LRN as a candidate for decreased funding and resultant revenues. That hasn't happened, but the short interest is still present. And what a presence-it's huge! At mid month, there were over 7.5M shares borrowed and sold short. That is 39% of the float. At present volume levels it would take 63 days to cover those shorts. Take a look at the following table:

K12 Inc ( LRN) Short Interest

LRN K12 IncNYSE Settlement Date Short Interest Avg Daily Share Volume Days To Cover 8/14/2009 7,475,753 118,512 63.080135 7/31/2009 7,482,091 150,145 49.832435 7/15/2009 7,571,249 271,850 27.850833 6/30/2009 6,986,742 628,145 11.122817 6/15/2009 6,619,042 199,696 33.145591 5/29/2009 6,503,427 208,614 31.174451 5/15/2009 6,365,058 316,718 20.096925 4/30/2009 6,225,823 190,804 32.629416 4/15/2009 6,034,347 234,290 25.755888 3/31/2009 5,637,529 314,036 17.951856 3/13/2009 5,073,388 283,731 17.880979 2/27/2009 4,412,162 202,359 21.803636 2/13/2009 4,121,379 197,533 20.864256 1/30/2009 3,936,154 233,823 16.833904 1/15/2009 3,377,937 256,939 13.146844 12/31/2008 3,324,043 194,866 17.058096 Shares short has remained high while volume has lessened. Does that mean that everyone is on vacation? That shares are getting difficult to borrow? That shortsellers are biding their time until after the company reports quarterly results on September 9th? LRN's price has been creeping up which will cause one of two possibilities to happen. Either sellers will renew their attack on the company and be willing to borrow even a greater percentage of the float or decide that revenue isn't crashing and make a move for the exit. If the latter happens, with 63 days to cover, a significant squeeze could occur and the share price could move nicely higher. Would it stay high? It could as a squeeze would attrack notoriety and momentum investors, plus K12 is still growing, a rarity today, and in an insulated space. I'm keeping my position and hope that I see some nervous shortsellers in the next couple of weeks.