Investing in a Troubled Credit Market

This week’s email brought the following, from P.I. in Connecticut.

“I am very concerned about the credit markets and what havoc they could send around the U.S. and the World and I think it is a far greater problem than we realize. I just hope that we get out of this without a major meltdown that affects all facets of the economy here in the U.S. and the World. It could be very serious and it is far beyond me to understand how this circle of debt will be resolved.

I would appreciate your views on the subject.”


First, P.I. clearly wants to use rational thinking to divine the future of the economy and, by extension, the future of the stock market … and I appreciate that.

If I try to think rationally about this problem, here’s what I get. Debt is bad; equity is good. Consumers and businesses are already working to reduce their debt loads, and as they continue, they will develop stronger balance sheets and greater financial health, which is a good thing. (One aspect of this that is often forgotten is that this debt shrinkage is right on schedule for aging baby-boomers.)

Our Federal Government, on the other hand, continues to borrow heavily, and the result is a weakening dollar, which is a bad thing.

The shrinking dollar is one reason (though not the major one) that investments in foreign stocks have beaten investments in U.S. stocks in recent years. But I don’t believe anyone in the U.S. seriously wants that trend to continue.

And I don’t believe it will. I can’t identify what mechanisms will be responsible for the change, but I know that trends go to extremes, and that the point at which the majority of people identify a trend and expect that it will continue is the exact time the trend stops. Seems to me we’re approaching that point with the dollar.

Also, I look at the chart on my wall that shows the ebbs and flows over the past century of GNP, corporate earnings, the Dow and the Nasdaq, and I note that the long-term trend is up. We’ve come through wars, depressions, droughts, floods, waves of disease, massive corporate fraud, and equally massive government malfeasance. Yet the uptrend remains intact, giving me confidence that this credit problem will be surmounted as well.

Trouble is, none of this tells me where to invest!

Watch the Charts

Which is why we watch the charts. Remember, the stock market is VERY GOOD at anticipating the future. In fact, it’s better than any one of us, simply because it uses the combined wisdom of all of us. So the best way to predict the future is not to rationalize; the best way to predict the future is to watch the stock market.

And what is the market telling us today?

That the main trend is still down, but that we may have seen a bottom two weeks ago.

That homebuilders have definitely bottomed.

That financial stocks may have bottomed.

That coal stocks are a leading sector.

That certain pharmaceutical stocks are strong.

But that breadth is still very poor, and that most growth stocks remain in poor shape, factors indicative more of a bottom-building phase than anything else.

In short, it’s not a particularly good time to be an investor; the odds are not with you. Cash is preferred.

But this downturn won’t last forever, and when the new uptrend gets under way, I want you to be ready for it. I want you to accept it. And I want you to be buying the stocks that will lead the market to new heights.

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David Versus Goliath

In the news this week, though certainly not on the front page, was the announcement that Ben & Jerry’s was wading into battle against Monsanto (MON).

At first glance, this would appear to be a classic David versus Goliath story. Ben & Jerry’s, headquartered in Vermont, has an image as an earth-friendly, human-friendly little company.

But if you remember that Ben & Jerry’s was bought by Unilever (UN), the Dutch food conglomerate, back in 2000 for $326 million, and you know that Unilever saw $59 billion in revenue last year, you realize it’s giant against giant, and it’s all about money.

Monsanto, for the record, had $9 billion in revenue last year. It gets a third of its revenue from the corn business, a third from chemicals that are used by farmers, and the remainder from soybeans, vegetables, etc.

Bovine Growth Hormone

At the heart of this disagreement (behind the money) is Bovine Growth Hormone (BGH), or more specifically, recombinant (artificial) BGH, known as rBGH.

Monsanto, you see, sells a ton of it, because it helps cows produce, on average, 10% more milk. But Ben & Jerry’s doesn’t buy milk from cows that have been given the hormone, and they want their customers to know that.

Monsanto, however, claims that simply stating that on a package of ice cream would suggest there’s something wrong with rBGH!

Well, is there?

Perhaps. But there’s no proof.

On Monsanto’s side is the fact that rBGH was approved by the FDA in 1993, after 12 years of testing. Also behind it, or at least not against it, are NIH, WHO and a host of other official acronyms.

At least 25 percent of America’s dairy farmers use the hormone to get more milk from their cows, and they’re pretty happy about it. Because these farmers tend to be larger producers, it means about a third of the milk-producing cows in the U.S. are given the drug.

On the side of Ben & Jerry’s, and milk producers who want to identify their milk as hormone-free, is the fact that artificial hormones in cows increase the presence of another hormone, and that hormone promotes cancer in humans.

Furthermore, no other country has approved the use of rBGH as an aid to milk production.

The bottom line: The truth is not easily known. It appears there’s a chance rBGH is bad for you. Milk and ice cream made without it is probably better for you than those same products made with it.

But how much better? 5%? 0.5%? 0.000005%? I don’t know. No one does.

What we do know is that the higher yields due to rBGH lower the cost of our dairy products. The proper question, therefore, is whether the money we save is worth the added risk.

For deep-pocketed Americans, the answer is clear; pay up a little for hormone-free dairy products. But for the penny-pinching masses, the answer is not so clear.

And what should the government’s role be, given the lack of certainly in the matter?

In the end, I turn to principles. I’m always in favor of knowledge. I like to read food package labels, among other things. So I’m in favor of full disclosure in food packaging.

And I’m in favor of choice. So until a stronger link between rBGH and disease is made, I think it’s prudent to allow farmers to keep using the drug, and thus keep passing on the known benefit (lower milk costs) to consumers.

Ideally, the truth will eventually out, despite the large sums of corporate money spent by the parties on both sides of the issue.

Ten days ago I told you about Illumina (ILMN), the world leader in genetic analysis equipment.

I wrote “In my opinion, Illumina is shaping up to be a key player (perhaps THE key player) in the genetic medicine era, in much the same way that Microsoft became the linchpin of the desktop computer era.” And I concluded that the stock, at 64, was in “a decent buying zone.”

Soon after, management reported fourth quarter results, which were terrific. Following the news, the stock jumped up to 72, and it’s now pulled back below 70. It’s still attractive, though market risk should not be ignored.

And now here’s another high-potential growth stock in the genetic equipment sector.

It’s Cepheid (CPHD), a California company that makes genetic analysis systems that are used in the clinical market; for food, agricultural and biological testing markets; and in anti-bio-terrorism markets. But the biggest market by far is clinical, for detecting infective agents in hospitals.

Two weeks ago, in Cabot Top Ten Report, Mike Cintolo wrote the following:

“Today, patients have to fear hospitals as well as diseases. The Centers for Disease Control and Prevention has found that one in 10 hospital patients will get an infection, of which at least 5% are fatal. These infections cost the U.S. economy $6.7 billion in 2002, according to the CDC, and laboratories can take up to 72 hours to identify the infective agent. But Cepheid, a developer and marketer of diagnostic tests, makes a $25,000 fully-integrated genetic analysis system called GeneXpert that can, among other infections, identify Methicillin-resistant staph infections in about an hour. This state-of-the-art testing system has been adopted by the U.S. Postal Service for anthrax testing and the Department of Veterans Affairs is another potential customer.”

The company has not posted a profit yet, but I have little doubt that it will soon, as revenue growth is accelerating and the company’s equipment requires the use of disposable media, a source of recurring income.

Cepheid’s chart shows a stock in a steady uptrend (the major reason for its inclusion in Cabot Top Ten Report), but the market weakness of recent days has brought it back down to its 50-day moving average, on low volume, and to me, this looks like a decent buying zone.

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Yours in pursuit of wisdom and wealth,

Timothy Lutts
Publisher Cabot
Wealth Advisory


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