The Fed's Interest Rate Move Should Fuel a Bear Market Rally
(Stocks bottom when things look worst and top when there are no clouds in sight)
Most Likely Interest Rates Still Have a Long Way to Fall, and Bonds to Rise
Hold Stocks in strong companies selling at reasonable value
Keep more cash than you think you should
Beware of Buying Any More Stocks and Don't Get Sucked into a Rally

What we have been doing

For the most part our investments have been holding up well, notably our commitment to closed end bond funds, our surrogate long position in bond futures and, remarkably, our holding of Trans Canada Pipelines (TRP). The latter made a new 52 week high on Friday and it still looks capable of doing more.

The story on TRP is worth reviewing. The company carries natural gas from across Canada and from Canada to the US. Some years ago the company went on an extremely ill-fated acquisition binge. There was no apparent need to expand capacity and they thought they could buy businesses that would do better for their shareholders than paying dividends. It turned out that they bought a bunch of losers. New management cleaned out the crud, took some horrendous losses in the process, and cut the dividend. Needless to say the stock suffered severely before the cleansing, and its price even now is relatively depressed. However, a recent application for a 5 percent rate increase has been approved and almost all the proceeds will flow through to profits. This company will not grow spectatcularly like a dot.com, but it should increase profits steadily and restoration of the dividend to its former levels should not be long delayed. Meantime the current dividend pays enough to justify holding the stock. In our view the business of carrying natural gas should be a no-brainer for making money regardless what the price is for the gas going through the pipe.

Oil and Oil Service Stocks

Our oil stocks generally show a profit although last week they were pounded quite severely. There is a case, and indeed there was one early last week, to lighten up if you had a near-term view of their prospects. As expected, OPEC came through with a decision to have its members reduce production by a million barrels a day. Although oil stocks are now quite plentiful, we expect that the price will hang in more or less around current levels even if demand slows as a result of the slowing world economy. We could be wrong on this. It is conceivable that there will be cheating on production so that supply outweighs demand, and the price sets back down toward $20 per barrel. It is our understanding, however, that the amount of available production capacity in the world is limited and that widespread cheating is unlikely. Some OPEC members may even have difficulty in meeting their currently permitted production levels.

You will; note that for the most part we hold stocks in this sector which are focused on drilling and oil services, notably PDS and UDS. It is our string expectation that the Bush government will go a long way to favor oil and gas exploration and development in the US in order to lessen vulnerability to overseas disturbances. So, as with TRP, these companies should benefit even if the oil price sets back a bit. AOG sells at such a low price relative to its cash flow, perhaps 5 times, and its plentiful natural gas reserves, that the stock should pretty much hold up even if the general market continues falling. OXY should hold up on the basis of its low PE and its generous dividend yield.

We continue to nurse three high tech stocks. Symantech was hit hard this week but, remarkably, it is still up on our entry price. This company is involved in internet security, a niche which should prosper regardless of what happens in most of high tech and the economy generally. Texas Instruments has been a dog for us but, curiously, the stock is up from our last newsletter. This is one powerful niche player in the semiconductor industry, and there is no serious competition for its research and its specialized cutting edge products. Although it came out with the conventional lowering of sales and profits forecasts, which have become the norm, the company is certain to survive and it may come out of the downturn stronger than ever. We hold.

Our one real dog is 724 Solutions, but we hang in. We still like the story of its wireless connection between customers and their banks.

Interest Rates and the General Market

On Tuesday at 2:15pm ET, we get the Fed's interest rate announcement. A reduction in official rates of a half percentage point, as a minimum, looks to be a foregone conclusion. Our best guess is that there will in fact be a reduction of three quarters of a point, and a full point reduction is possible. Whatever they do, the probabilities strongly favor a major short-term rally, but almost certainly not a reversal of the bear market back to a new bull market. The very best scenario is for stocks to stop going down and to begin a long and laborious process of building a base in a sideways market designation.

The overall technical condition of the stock market right now is extremely serious. If the Dow and sectors like banking join in the decline started by NASDAQ, then the decline itself could lead to a serious recession. A reversal of the wealth effect could feed on itself and the downward spiral; could intensify. We don't have a strong opinion as to how far the general market might decline now that a bear market is in force. However, we do know that a serious contraction of consumer spending and of the housing industry could put the broad economy, and not just high tech, on the down escalator.

Another wild card for the world economy is the precarious condition of Japan. Their economy is now in serious recession but it could still implode a lot more. One risk to the world economy is that the Japanese Yen might start sliding out of control. There is no point in owning the Yen at a time when interest rates are barely perceptible and the currency is declining. You don't get any return on your money and what you do get doesn't begin to compensate for the loss on the exchange rate. It is our view that Japanese government debt is already at an unsustainable level even if they don't take over any more bankrupt banks. It is our strong view that the stage is set for a collapse in the Yen similar to what has happened several times to the Mexican peso. A collapse in the Yen would certainly cause more than ripples in world stock markets.

Given the risks in the economy and especially in Japan, it is our view that the risks related to a major reduction in interest rates is small, and that the risk of the Fed staying behind the curve is extremely high. A major lowering of interest rates would help to alleviate pressure on all sectors of the economy and also on the exchange rate for the yen versus all other currencies.

In present economic conditions, we can envision short term interest rates declining to the 3 percent level, for 5 now, and we can see the rate for the 20 year Treasury bond fall from just over 5 percent at present toward a level just over 4 percent.

Such a decline in interest rates would provide for very worthwhile capital gains from holding long-term quality bonds, but ideally Treasurys and not corporates.

A further major decline in the general stock market is possible even if interest rates are lowered, but we rate it more likely that a major decline in interest rates could arrest the collapse in stocks. We want to hold only very selected stocks, mostly very specifically targeted utilities, closed end bond funds and oil and gas stocks. In sum, pretty much what we now have.

We do not want to think about looking for so-called defensive stocks in other areas. Our best guess is that stocks previously regarded as defensive may not hold up if general weakness persists. Above all, we do not want to own stocks in the banking or brokerage industries. There is too much risk for all banks from loan defaults and we don't see the brokerage industry regaining for a long time the level of business it was doing at the top of the stock market.

Unfortunately, we have only one stock short, Coca-Cola, and it has not been conspicuously weak. We still expect it to go down more and we rate it a stock to hold short. We should have heeded the adage to sell already weak stocks rather than to guess at ones that might be expected to become weak. A characteristic of this bear market has been the relentless weakness in high tech, as presumably we hardly have to say.
.

New Recommendations: None

New Short Sales: None

Stock Positions to Sell/Exit: None

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action for our stock recommendations. The first is B, meaning the stock is timely to buy but the case for doing so right here is not overwhelming. Either the stock may have got ahead of itself and may be vulnerable to a retracement or else the stock has been performing disappointingly but may simply be regrouping. B+ and B++ indicate stocks for which there is a technical case to buy now, with plusses adding weight according to how many there are, up to a maximum of five. Stocks rated H are ones to hold, awaiting confirmation to buy more or to sell. SELL, of course, means what it says. It seldom pays to override this designation.

Stocks marked # are eligible for Canadian RSP funds. Otherwise there is a 20pc restriction on foreign stocks held in these accounts.

First bought Entry Last

1/4/01 724 Solutions (SVNX)# 18.72 12.81 H
2/1/01 Acm Government Income Fund (ACG) 8.07 8.32 B+
2/1/01 Acm Government Opportunity Fund (AOF) 7.99 8.42 B+
12/18/00 Alberta Energy Co. (AOG)# 42.63 42.55 H
12/18/00 Kinder Morgan(KMP) 50.00 58.80 B
12/18/00 Occidental Petroleum(OXY) 21.88 23.85 B
2/1/01 Pioneer Interest Shares (MUO) 11.95 11.69 H
12/18/00 Precision Drilling(PDS)# 33.19 36.72 H
1/4/01 Symantech (SYMC) 38.38 41.44 H
1/4/01 Texas Instruments (TXN) 50.19 31.10 H
12/18/00 Trans Canada Pipelines(TRP)# 11.19 12.42 B++
12/18/00 Ultramar Diamond Shamrock(UDS) 28.38 34.92 H

02/12/01 US Treasury 20 Year Bonds(USH) 104.21 106.17 B
Rolled from the March contract and price adjusted

Short Sales

12/18/00 Coca-Cola(KO) 54.00 48.51 Hold Short

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