Navellier Growth: your source for market-beating growth stocks

What a day on Wall Street!  If you look up the definition of "whipsawed," today's market should appear in the dictionary. At one point, the Dow was down 340 points before rallying and closing just 15 points down. So what the heck happened?  Well, in less than four weeks, the S&P 500 has lost $1.3 trillion. Today, we learned that U.S. housing starts are now at a 10-year low, and Countrywide Financial, the largest U.S. mortgage lender, is tapping an $11.5 billion emergency loan fund.  

I don't want you to get confused by all the frantic bits and pieces you're hearing in the media, so I'm dedicating this week's issue of "What's Working on Wall Street Now" to explaining clearly what this "credit crunch crisis" is all about. More importantly, I'll show you what investors should be doing right now.  Today's market bounce shows bargain-hunters were out buying…and you should be one of them!  I've got some great stock recommendations for you later in this issue.

First let's talk about the three letter trouble-makers which are causing so much mischief—CMOs or Collateralized Mortgage Obligations. These are pools of mortgages that are repackaged for fixed-income investors. CMOs have blown up like this before—first in the early 1980s, and then in the early 1990s.  In fact, I bet that this crisis will strike again in another decade or so, after a new generation of inexperienced fixed-income traders emerge.  The fact that hedge funds leveraged these CMOs to get higher yields and subsequently blew up is, well…too bad for those hedgies.  They obviously didn't assess the risks in their quest to get a higher yield.  However, now that the CMO credit crisis has hit big European banks too, the pain is obviously being felt by other investors as well.

Complicating matters this time around is a newer high-yield debt instrument, the Collateralized Debt Obligation (CDO). These are risky high-yield investments that were packaged to boost yields.  Structured CDO products totaled $3.3 trillion last year!  Hedge funds struggling with lower returns leveraged themselves deeply in these CDOs in an attempt to get higher returns.

Sadly though, the resale market for CDOs has now collapsed, since no one trusts any CDO until they break it apart to see what's inside.  The SEC is now investigating to see if major Wall Street brokerage firms are using consistent methods to calculate the value of their CMOs and CDOs, as well as the assets they hold for large customers, such as hedge funds.  If it turns out that some firms are valuing these assets differently, you can kiss the hedge fund industry goodbye! 

The SEC demands full disclosure and transparency, so if you can't properly price a security, chaos will reign, and that's exactly what's been happening.  Help may be on its way though. Goldman Sachs and other smart players are now nibbling at subprime and high-yield investments, looking for a big–enough discount.

Expect to see continued chaos for a few more weeks. Treasury Secretary Hank Paulsen (former head of Goldman) and Fed Chairman Ben Bernanke are mandated to protect our standard fixed-income investments, such as Treasuries and bank CDs. Now that the banking industry is at risk, the Fed has had to intervene in order to reassure everybody that it would be "providing liquidity to facilitate the orderly functioning of financial markets."

The situation got more complicated last week as the hedge fund meltdown continued to spread. Many equity hedge funds, especially those that short stocks, were squeezed on August 6, when the Dow Industrials staged their biggest one-day rally this year, led by the battered financial stocks.  This short-covering rally, combined with excessive stock market volatility (the Dow's swings averaged 400 points a day—much wider than usual), caused great confusion among some "market-neutral" hedge fund managers. Black Mesa Capital, for instance, has a hedge fund with about $1.9 billion in long positions and $1.9 billion sold short. But they told investors that market-neutral hedge funds had suffered losses of 5% to 15% so far in August.

Another hedge fund, the $29 billion Renaissance Institutional Equities Fund, led by a famous math professor, also reported significant losses in August as their computer models were overwhelmed by the wide stock price swings.  Many such "quant" funds analyze the historical relationships between related securities and trade when those relationships get out of alignment. Unfortunately, trading ranges have since widened, throwing their models off kilter.

This is what happens when Wall Street lets math professors play with the money instead of letting the finance guys run the show! 

I cannot tell you how many knock-down drag-out fights I have had with some pretty big players on Wall Street who no longer believe in fundamental analysis.  It's important to examine if a company has growing earnings, sales, margins and the like.  These math wizards are not trained in finance.  This is what happened to Long-Term Capital Management (LTCM) in 1998 when some Nobel Prize-winning mathematicians profited from the "normal" trading ranges. Then along came an abnormal move (devaluation) in the Russian ruble, and they had no idea how to stop the bleeding. 

Instead of constantly getting tossed around by the mistakes of others, my advice is to focus on investments that do well no matter what economic environment we're in. I actually like financial chaos because as a stock-picker I can go through the wreckage and find great values. During the last financial crisis in 1998, I had one of the best years ever—my Blue Chip Growth Buy List gained over 42% that year.

My secret then, is the same as my secret now--focusing on stocks with superior fundamentals. Again, by fundamentals, I mean the performance measures that separate good companies from bad ones—are they selling enough of their products (sales growth), do they maintain a good revenue stream versus the costs they incur (operating margins), etc.?  When money floods out of the market, it eventually floods right back in….and when it does, stocks with superior fundamentals benefit from the onslaught of buying pressure.

So let me share with you a few of my favorite picks, that will benefit when the buying begins again. At my stock-rating Web site, ProfolioGrader Pro, you can see how I rate thousands of stocks on the soundness of their fundamentals. I use simple letter grades to show you how stocks rate across eight fundamentals.

One of my favorite Blue Chip tech stocks right now is Oracle (ORCL). The company has stellar fundamentals. Earnings have grown over 20% for six straight quarters. Revenue hit a record $18 billion last year, and the company has spent $35 billion on 30 acquisitions since 2004. Thanks to the recent chaos, the stock has fallen below $20 even though the company's last earnings report was spectacular. The shares are now going for just 14 times next year's earnings. Plus, considering how ORCL keeps beating Wall Street's estimates, it could be a lot cheaper than that. I'm sure a lot of hedge funds are dumping shares of Oracle to meet redemptions. That's fine by me—it makes a good buy into an even better buy. The company is due to report earnings again in another month.

Another pick is Potash Corporation (POT). Right now Potash is seeing business skyrocket in the U.S. in order to meet the growing demand for ethanol.  During the past four quarters, the company has posted 34% sales growth and 21.6% earnings growth.  Second-quarter showed a 63% jump in earnings for Potash. The company declared this quarter as their best ever, with $285.7 million, or 88 cents per share in profits. For more on how I rate this stock across each of my eight fundamentals log in to PortfolioGrader Pro, it's free.

Ride Out the Storm

I'd say the current market situation is best described as "the blind leading the blind."  Too many hedge funds made the same bet and ended up on the wrong side of the trade.  With last week's actions by the Fed and other central banks, we may be in the process of repeating the 1998-style bailout. My advice is to ride out the storm in fundamentally superior stocks like Oracle and Potash. If this is a repeat of 1998, the buyers will come back to the markets over the next several months, and the patient investors will have the last laugh.

Sincerely,

Louis Navellier

P.S. I'm currently working on the September issue of Blue Chip Growth and I plan on having six new buys. To make sure you can the latest issue of Blue Chip Growth, sign up here.

Sincerely,

Louis Navellier