The Good news: It was a normal day in Sharon Springs Kansas, when a Union Pacific crew boarded a loaded coal train for the long trek to Salina.

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“Rules are Rules?!” (An email from Grandma)
September 27, 2010
The Good news:
It was a normal day in Sharon Springs Kansas, when a Union Pacific crew boarded a loaded
coal train for the long trek to Salina.
The Bad news:
Just a few miles into the trip a wheel bearing became overheated and melted, letting a metal
support drop down and grind on the rail, creating white hot molten metal droppings spewing
down to the rail.
The Good news:
A very alert crew noticed smoke about halfway back in the train and immediately stopped the
train in compliance with the rules.
The Bad news:
The train stopped with the hot wheel over a wooden bridge with creosote ties and trusses.
The crews tried to explain to higher-ups, but were instructed not to move the train!
They were instructed Rules prohibit moving the train when a part is defective!
REMEMBER, RULES are RULES!
(Don't ever let common sense get in the way of a good disaster!)

2. Click here to enlarge
Hard and fast “rules,” I have argued against them since entering this business some 40 years ago
because in the stock market you have to be flexible. The reason for flexibility is that markets
tend to be driven by, “fear, hope and greed only loosely connected to the business cycle.” I used
to get into arguments with finance professors about this point. While it‟s true over the long run
investing is all about earnings, many investors lose money in the short/intermediate term (even if
earnings are improving) adhering to that “it‟s all about earnings” rule because sometimes Mr.
Market decides “he” is unwilling to put a high price earnings multiple (PE) on those earnings.
For example, if you bought McDonalds stock (MCD/$75.10) in 1972, earnings increased for the
next 10 years. In fact, McDonalds never had a down sequential quarter over that timeframe, still
shareholders lost money for nearly a decade because Mr. Market was unwilling to capitalize that
improving earnings stream anywhere near the PE multiple he was willing to pay in the early
1970s. To be sure, in the short/intermediate term, the stock market is, “fear, hope and greed only
loosely connected to the business cycle!”
Most recently, rule-centric investors have been listening to far too many rants about double-dips,
death crosses, Hindenburg Omens, Roubini Revelations, Prechter Prognostications, et al.
Consequently, they have avoided my advice to buy blue-chip, dividend paying stocks, as well as
special situations. So far, that “shun equities” mindset has been wrong-footed. Granted, I have
underplayed the trading side of the current rally, however I have not underplayed the investing
side having recommended over 30 stocks in these missives during the past few months.
Additionally, I have been steadfast of the opinion that “it is a mistake to get too bearish here.” I
still feel that way. Indeed, I was on a conference call with some institutional accounts in Zurich
last week. Those portfolio managers (PMs) were quite concerned about being underinvested in
equities, particularly U.S. equities, which are a huge weighting in the EAFE Index. During that
call I suggested that with quarter‟s end approaching, performance risk, bonus risk and ultimately
job risk will drive stocks higher. Verily, I believe performance anxiety is going to cause PMs to
buy stocks right into quarter‟s end.

3. Meanwhile, as stocks rallied last week, the U.S. dollar dove. The result left the Dollar Index
below 80, a level not seen since January of this year. That action caused one Wall Street wag to
exclaim, “Are stocks rallying, or is the „measuring stick‟ declining?” Certainly a fair question,
yet it is consistent with my long-term belief one of the metrics needed to get us out of the “debt
box” we have painted ourselves into is the debasement of the dollar. If correct, you want to have
your investment dollars in vehicles that hopefully retain purchasing power and keep up with the
inflation that is most surely coming. I think quality stocks with dividends play to that theme, as
does my “stuff stock” theme. To that point, most commodities, as well as many commodity-
based “stuff stocks,” broke out to the upside in the charts last week concurrent with the dollar‟s
dive. I have been adamant on investing in “stuff” ever since 4Q01 when China joined the World
Trade Organization suggesting Chinese per capita incomes were going to rise with an attendant
rise in the price of “stuff” (energy, water, electricity, timber, cement, agriculture, metals, etc.). I
continue to feel that way because as per capita incomes rise people consume more “stuff.”
My more orthodox investment strategy is to buy a tranche of a distressed debt fund like Putnam‟s
Diversified Income Fund (PDINX/$8.01) and buy an equal amount of some equity income fund
that invests in blue-chip, dividend paying stocks. Then, purchase a tranche of an international
fund like MFS‟s International Diversification Fund (MDIDX/$12.54). Add to this portfolio a
“slice” of something like Raymond James‟ Asset Management Services “Alternative Completion
Portfolio,” which contains investment vehicles in Currencies, Managed Futures, Arbitrage,
Commodities, Real Estate, Long/Short Funds, etc. Finally, in an attempt to add Alpha to the
portfolio, I would judiciously purchase special situation stocks like cloud computing company
CA Incorporated, which has a Strong Buy rating from our fundamental analyst (CA/$21.15).
The call for this week: Last week most of the major stock market averages I follow broke out of
their May – September trading ranges to new recovery highs (small cap indices did not).
Confirmatorily, said break-out occurred on a 90% Upside Day (September 20th). According to
the invaluable Lowry‟s service, “There have been three consecutive confirmed 90% Upside Days
since the beginning of September. That‟s the first time there have been more than two
consecutive 90% Up Days since the March 2009 market bottom.” While I am not looking for a
repeat of the 2009 stock market rally, the S&P 500‟s (SPX/1148.67) April “highs” seem
achievable. Meanwhile, the bears continue to growl, “Where‟s the volume?” My reply to that
question is that the whole 2009 rally came on declining volume, as did this year‟s May mauling,
begging the question – does volume really matter? I think it does; yet, I can make the argument
that declining volume is actually bullish because it implies most participants just don‟t believe
the rally is for real. When volume finally arrives, it would suggest the naysayers have finally
capitulated, and bought stocks, which I would interpret bearishly as in – who‟s left to buy?!
P.S. – Speaking to “rules,” Rule #1: “Don‟t lose money.” Rule #2: “Don‟t forget rule number
1.” ... Warren Buffett