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Terrible Times Today... Mean Great Profits in Stocks

By Dr. Steve Sjuggerud
Tuesday, April 15, 2008

"Maybe the Sky IS Falling" it says on the cover of the current issue of Fortune.

"The Great American Slowdown" is on the cover of this week's Economist.

It is true. Times are bad.

But don't make the wrong assumption here... Don't think bad times for the economy mean bad times for stocks. The truth is quite the opposite actually. Let me explain...

Analysts believe earnings should fall 12% in the first quarter of 2008 (versus last year). That's pretty bad. But when you crunch the numbers, you see the truth...

Years ago, when I ran my own hedge fund, I was a client of a little-known research firm called Ned Davis Research. Ned Davis crunched Wall Street numbers in every way imaginable.

In his book Being Right or Making Money, Ned laid out four things he discovered successful investors do. He said they...

Use objective indicators.
Stick to their discipline, yet
Remain flexible enough to change when conditions warrant it.
And are always risk averse.

In the course of Ned's research, he found whenever "the crowd" believed strongly in one theme, we were close to a turning point. He even put together a book, The Triumph of Contrarian Investing: Crowds, Manias, and Beating the Market By Going Against the Grain, about this very topic.

One example he used was a poll by the American Association of Individual Investors... When individual investors are bearish according to this poll, stocks rise 21% a year. When individual investors are bullish, you don't make any money in stocks.

Ned recently updated his numbers on bad corporate earnings. The results are amazing...

Over the last 80 years, you'd have made the most money in stocks when corporate earnings were falling. It's true... When corporate earnings fell between 5% and 20% year over year, you'd have made an average annualized gain of 13.1% in stocks. But when corporate earnings rose between 5% and 20%, you'd have only made 6%.

In short, you make more money in stocks when companies are losing money than when they make money!

Here's another interesting result from the same study: When corporate earnings are soaring – growing more than 20% a year, stocks only manage a 2% annualized gain. Why is that? The answer is, after companies are growing their earnings at 20% or more, how can they get better? It's extremely difficult to keep that up.

The moral here is, you want to buy stocks when expectations are low... That's when companies can more easily exceed expectations, and their stocks can rise.

Right now, expectations are low.

The bar is way down, so companies can exceed expectations... And that's what causes their stock prices to rise.

Yes, we have plenty of economic "bad news"... but the stock market shouldn't go down because of it. The bad news is already priced in. Now the bar is low... It's the time when you make money in stocks.

Don't be scared of bad economic news. Instead, know when it's a great time to buy... and now is one of those times!

Good investing,


Market Notes


After a 40% price increase during the past seven months, most people wouldn't consider gold cheap anymore. The gold/oil ratio sees it differently...

We've covered the gold/oil ratio several times in DailyWealth. The two assets respond to inflationary pressures similarly... They usually move in the same direction at the same time. On average, one ounce of gold buys 15 barrels of oil. But from time to time, this ratio gets out of whack.

When the gold/oil ratio is over 20, gold is expensive and crude is cheap. A "buy oil, short gold" trade is a big winner in this situation. When the gold-to-oil ratio sinks below 8, gold is cheap and oil is expensive... so a "buy gold, short oil" trade works well. (Click here for the specific numbers.)

As you can see from today's chart, we're nearing the "buy gold, short oil" territory. While gold has done well over the past year, oil has nearly doubled. Gold isn't shout-it-from-the-rooftops-cheap versus oil, but it's getting darn close.

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