On Wednesday evening, Hewlett-Packard (HPQ) announced it was buying 3Com (COMS) for $2.7 billion in cash, a 35% premium over its closing price.  This will enable HP to sell just about everything for data centers, from servers, storage, management services and networking.  This deal is expected to close in the first half of 2010.  This deal is raising eyebrows for a number of reason.  First, it was all cash and a big premium over the closing price.  Second, this wasn’t the company many believed would be bought out.  Third, the options trading before this deal was announced has many believing somebody knew something that you & I weren’t privy to.  Something stinks.  I’m sure there will be an investigation.

The ball is now in IBM’s court whether they want to make an acquisition and there are rumors that Brocade is the company they may target.  But, investors need to focus on the bigger picture.  The M&A activity is heating up and it has been for some months.  The credit markets have been easing allowing more deals to get done and company’s are anticipating a slower growth environment.  Therefore, the bigger companies with lots of cash are using that cash to acquire growth.  I think this will continue into 2010.

Where you & I can benefit is by focusing on where the action might be for the next acquisition.  Sure, we could speculate on individual companies.  But, that’s exactly what that would be, speculation.  We know there are going to be more deals.  The easier way to benefit from the acquisitions is to buy a basket of companies that are prime.  The place I think that has the most potential is the midcap growth area.  These companies are big enough to matter to a big company, but small enough that the big companies can afford them.

Not only can we benefit from M&A activity by purchasing medium-sized growth companies, but these buyouts help the overall market.  It builds confidence that if big companies with lots of cash are finding values and pay big premiums for companies, then surely there are a lot of companies undervalued.  Hence, a higher market.  One more positive for the market.  Add it to the list.

On this 20th anniversary of the falling of the Berlin Wall, I thought it’d be appropriate to post what would Ronald Reagan think of socialized medicine given the passing in the House on Saturday.

Two weeks ago, investors were worried about the removal of stimulus (i.e. Australia, Norway, & India), rising U.S. rates, and a strengthening dollar.  On Monday, investors woke up to news that the IMF was quoted as saying the dollar was still overvalued, G20 finance ministers were saying they were committed to more stimulus, and the dollar was weakening.  In fact, all that talk about the dollar strengthening, the call buying, buying in the ETF UUP (bullish dollar ETF) all went away Monday.  In fact, you can see that as I mentioned in my video newsletter, unless the dollar index breaks above the 50-day moving average, there was nothing to worry about.  Well, it failed at the 50-day moving average once again last week and is headed down further.

Weak dollar, more stimulus, and low interest rates.  This is the recipe for owning pretty much anything.  Risk assets moved up once again.  Commodities, stocks, materials, emerging markets, U.S. stocks, etc. all moved up.  We may be entering the more selective phase in the rally where not everything goes up but if this reflation recipe is still being served, the coast is clear.  But, let’s watch for underlying weakness even though the indices are moving higher.
That’ll be a sign that this rally is getting tired.

The non farm payrolls report was just reported and came in with a report of 190,000 jobs lost last month.  The estimate was for 175,000.  However, last month’s number was revised from -263,000 to -219,000.  The unemployment rate finally went over 10.2%.  Below is a picture of the non farm payrolls from 2003 until now.  You can see even though these estimates are way off each month, the overall trend is improving which is correlated to the stock market.

Remember, this report is a lagging indicator.  Employers will make their current employees be more productive and work more before hiring.  Then, once they are convinced the economy is better, they start to hire.  The trend is still moving in the right direction.  Unfortunately, there are still a lot of people sitting at home who want a job.

The almost too predictable oversold rally has occurred.  We were so oversold according to many different oscillators that I watch.  They were at such low levels that we knew a rally would occur.  On my radio show the past few days, I told listeners if they wanted to sell, they would have higher prices to do so.  Now, we have those higher prices.  If you want to sell, go for it.  Here’s your chance.  Of course, when the Dow’s up 200 as it was on Thursday, nobody wants to sell.  But, the rationale person sells at higher prices if they wanted to sell a few days ago.  The question now is whether this was just another dip on the way higher or was the pullback a part of something substantial?

Two things happened when we got this sell off.  First, it created a deeply oversold condition that almost insures a snap back rally.  But, more importantly, some damage was done that is causing investors to reconsider holding stocks.  Now, we know the economy is still improving.  If you’ve been following this blog, that’s been a consistent theme for several months.  More surprises regarding the economy are in our future.  But, there will be a time when the stock market has fully discounted this.  I don’t believe we’ve reached that ultimate top yet.  But, in the short-term, I’m concerned about the market.  When the S&P reached 1100 & the Dow reached 10000, we churned around for a few days and then fell down to 1030.  But, we also fell below the 50-day moving average, we had a little bit heavier volume, and the uptrend that’s been in place since March was broken.  Investors haven’t forgotten that.  In addition, we’re getting late in the year and many managers want to make sure they lock in gains before they erode after last year’s results (hedge funds get paid purely based on performance).  This is all causing a lot of volatility and big swings.  We could get up to the 1075 level in the next day or so based on the picture below.

The market could be developing a head and shoulders pattern which could signal lower prices ahead.  As I said, I’m not suggesting the top has been reached in the market but a correction down to 1000 or so wouldn’t surprise me a bit, especially if the dollar breaks above its 50-day moving average.  This head & shoulders pattern is just something to watch for over the next few days.

Now that we’ve had this oversold rally, I’m very cautious right now and would not hesitate selling a lot of positions on the first signs of weakness.  Tomorrow’s jobs report could be that first sign.  You know this is a backward looking indicator and doesn’t mean anything regarding how the economy will look a few months from now.  In fact, rising unemployment into a recovery is perfectly normal.  But, any number could be spun to be bad news and cause some selling.  No time to fall asleep.

This post published at www.karleggerss.com

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For part 1 of the interview, click here.
For part 2 of the interview, click here.

Tuesday morning, we woke up in the United States staring at the Dow Jones futures down almost 100 points.  A big down day certainly would have fit the pattern of the last few days.  Up, down, up, down.  Then, we got the news that Berkshire Hathaway was purchasing Burlington Northern Santa Fe (BNI) for $100/share, or $26 billion.  This was a 31% premium over Monday’s closing price.  Buffett already owned 23% of BNI and now he owns the whole enchilada.

As soon as this news spread, the futures healed up and we finished with a stronger market than the futures were indicating.  The speculating began about why.  Why would Warren Buffett buy this company now and why at such a premium?

There are all kinds of reasons being tossed around why Warren Buffett purchased the rest of Burlington Northern.  He believes in the U.S. economy.  He had too much cash.  He wanted a business with plenty of cash flow.  Those all may be true but the real reason Warren Buffett purchased BNI is because he’s adjusting his portfolio to reflect the macroeconomic situation.  For years, he’s been known for purchasing insurance companies because they were such a great business.  Coincidentally, he’s owned insurance companies during a period where interest rates have fallen from the high teens to under 5%.  You see, insurance companies own lots of bonds.  Bonds do very well when interest rates fall.  Warren Buffett has basically been buying lots and lots of bonds for years enjoying capital gains from those purchases.

Now, he sees and worries about the same thing I worry about,  interest rates.  That means he needs to diversify away from bonds into businesses that will benefit from rising rates and inflation.  Burlington Northern is a company that transports lots of goods around the country, including commodities such as coal.  This is a play on the need for commodities around the world and inflation.  Pure & simple.

Mr. Buffett still has it.

On Tuesday morning, gold was up .5%, but so was the dollar.  When was the last time we saw these two moving in the same direction?  If you think the dollar is going down, should you necessarily go buy gold?

Below is a picture of the correlation of gold & the dollar.  When the chart is in the green, that means the two are correlated positively.  Most of the time since 2005, it has been a negative correlation.  But, there are times where the inverse correlation breaks down.  This breakdown can ruin your strategy at times.  So, be careful and don’t assume they are always negatively correlated.

Based on volume in some of the double short ETFs yesterday, it looks like the easy money is to short the stock market and ride that all the way to the bank.  But, before you hit the sell button and run out and buy some of these, let’s examine the market for a minute.  First, we’ve definitely had some technical damage.  The downtrend in the dollar has broken and that has caused many to run for the exits from commodities, stocks, emerging market, etc.  The uptrend since March has broken.  Countries are starting to raise interest rates.  There are some things to be concerned about.  But, I’ve said though on my radio show, there still aren’t signs of a long-term top….yet.  So, whipsaw risk is very high (buying high and selling low).

So, if you want to protect yourself even if it’s for the short-term, selling is always the best hedge.  Nothing will protect you as much as just selling.  But, there’s always tax consequences and other considerations so buying put options is another option (no pun intended).  The third option and one many of you use all the time is to buy an inverse ETF (1, 2, or 3 times the opposite of the market).  I use these all the time and they work.  But, they work better when the direction is smooth in one direction.  With the volatility in the last few days, we’ve had anything but a smooth move in one direction.  SDS & TWM had a great day on Friday and week but remember that if the market continues this seesaw pattern, the protection you think you’re getting will erode.  Use them at your own risk.