With all the fear that exists in the markets today, it seems all the world is waiting on what Mr. Bernanke decides to do with the Fed Fund Rates on Tuesday.

If the explanation for a rate cut is saving the housing market—think again; 25 or even 50 bps will have a minuscule effect on the mortgage and housing markets. It is a buyers market, but there is much more supply than demand, and housing will continue to falter regardless of Tuesday’s decision.

A rate cut could also send a message to the market that the Yen currency carry trade is winding up and could send the Yen appreciating versus the dollar and all major currencies once again. Let me rationalize that thought quickly: a rate cut, while it will have the obvious effect of lowering the interest rate differential between the Dollar and Yen, would allow Japanese investors, who have fled Japan in the hopes of generating additional returns abroad in the equity markets, to exit their positions. They will exit their positions because of the short-term run-up in US equity prices from a rate cut and transfer their money back to Japanese Yen, causing further appreciation of the Yen. Thus, another liquidity source would be drained.

No rate cut will be seen as a sign of an unwavering Ben Bernanke standing in the way of a thousand Red Coats—I mean Wall Street executives—looking for blood because they want their equity investments to shoot up in value before the end of the quarter from a rate cut. Expect equities and fixed income securities to take a beating if the rate stays the same, but you can expect foreigners to stay invested here in the United States.

Gauging the market’s activity over the past couple weeks, there will be a rate cut of 25 bps on Tuesday, although it might not in the best interest of a stable US economy. The 25 bps cut will instead have a negligible effect on the economy and will symbolize to the world that the United States is gearing up for a recession. However, it all rests on Bernanke’s shoulders, so we’ll all just have to wait and see what stance the Fed wants to take to combat the current conundrum.

“When there is blood in the streets, it’s time to buy.” Obviously, this saying could not be any truer than the situation that investors all over the world are experiencing at the time of writing this post. Fear and risk grip the global marketplace in a way that hasn’t been seen since 2003. Investors everywhere should soon be taking advantage of the readjusted asset prices in all areas of the market, and because of this, I believe there will be a re-emergence of the carry trade that has been driving the currency markets over the past few years.

The currency carry trade involves the buying of high yielding currency and the simultaneous selling of a low yielding currency. The idea behind this type of trade is that an investor looks to lend at the interest rate in the high yielding currency and finance or borrow at the low yielding rate of another currency. This is similar to the operations of domestic banks that “borrow” money from depositors, in the form of paying interest on a savings account, and then lend that money out to borrowers on higher-interest loans and profit from the spread between the two interest rates. The carry trade has been popular in the currency markets due to the amount of leverage available to traders who wish to exploit the spread between a high- and low-yielding currency pair.

Over the past few weeks, I have been bombarded through email, internet searches, newspapers, and TV media with articles proclaiming, “Unwinding of the Yen Carry Trade” and “Forex Carry Trade Unwinds Nearly 6 Percent, History Says it May Go Further.” The media obviously has done a great job at painting a gloom and doom picture into the minds of the majority of the investors in the world. The market has now taken out the weak hands as well as the hands that were overleveraged. Now, the selling pressure is looking to have leveled off, and the market appears poised for a rebound over the next few weeks.

All around, the market has been playing into the cycle of fear. The domestic market’s shortcomings are mirrored in that of currency markets, especially in the case of the Yen. However, it is nothing compared to what the internet news searches mentioned above claim. There is a certain inherent risk with currency, but as illustrated in Figure 1, this risk correlates with the risk involved with the S&P 500. The performance of the S&P 500 and the USD/JPY have had a strong correlation recently, which gives rise to the idea that a lot of the boom in the domestic equity markets is partly the result of the Yen carry trade. Figure 1 illustrates the correlation between the performance of the USD/JPY and the SPY (SPDR S&P 500 Tracking ETF).

There is some cause of fear for domestic Japanese investors who took their money offshore in the search for higher yields, investing in securities in countries such as New Zealand, Australia, Great Britain, and the United States. As with any investor who might have investments abroad, any negative currency movements would put strain on the ability to profit in those areas, because the idea is that one’s home currency should weaken against the currencies in the areas in which one’s investments are made. Everything is great when everything is sticking to the plan, but as investors have experienced over the past few weeks, all is not well in paradise; there has been a massive exodus of money from foreign markets back into Japan. This migration of money back to Japan is causing a substantial appreciation of the Yen, which exacerbates the problem for Japanese investors who still have money abroad. The Japanese investors then exit positions and bring the money back domestically. Figure 2 illustrates the performance of the NZD/JPY, which was the “ultimate” carry trade among the major currency pairs. Since July 21, 2007, the NZD/JPY pair has fallen almost 20% from its high, meaning the Japanese Yen has appreciated almost 20% against the New Zealand Dollar in less than a month. The performance of the pair is a prime example of how the carry trade can go wrong, because New Zealand was a country that Japanese investors flocked to in order to seek higher yields, and those investors were caught when the contagion hit.

Strength in the Yen has been a precursor to prior sell offs in the domestic equity markets, similar to what was experienced on February 27, 2007. The fear has always been, “when will the Bank of Japan raise interest rates that have been held at less than 1% for over a decade?” The question is pretty simple to answer; the odds that Yen interest rates will increase greatly is fairly small because Japan is a primarily export-driven economy. The fact is that Japan exports $134.59 billion to the United States each year, yet only imports $62.89 billion back from the United States. The rest of Japan’s exporting takes places with other Asian countries, such as China (14.3%), South Korea (7.8%), Taiwan (6.8%), and Hong Kong (5.6%) (See Source), which, when looking at the Purchasing Power Parity, are all undervalued currencies, by comparison terms to the USD, because of the exporting nature of their economies. Japan, like China, would essentially be shooting its own domestic economy in the foot if it allowed its currency to appreciate any further or any faster than it already has. Goods such as automobiles and technology would not be as competitive against United States rivals in a situation with massive appreciation.

At this time, Japan would not risk another domestic meltdown after what they went through to recover from the Asian Crisis and other market shocks, which means that in the near term there will be no drastic changes to the current monetary policy. While these near zero interest rates may not be in place forever, the fear and overreaction gripping the market should now be taken with a grain of salt. The panic selling has finally dissipated and the overleveraged have received their margin calls. The only question left to answer is, “Who will profit from the next upward carry trade wave?”

The intention of this article was not to incite an angry mob to short the Japanese Yen, but rather it is to inform the reader that there are many fear mongers in the market and their only goal is to get in at the very best price for themselves and their client. Wise investors have to look past all the media bologna and rely on their own analyses. Whether investing in the US market, international markets, or currency markets, if it seems like the news can’t get any worse, it probably won’t, and it is probably time to pick up some of those discounted assets.

Here are some ways to play the rebound in the Yen Carry Trade:

• Short CurrencyShares Japanese Yen Trust (FXY) – Bet that the Yen will depreciate versus the US Dollar
• Short iPath JPY/USD Exchange Rate ETN (JYN) – Bet that the Yen will depreciate versus the US Dollar
• Long PowerShares DB G10 Currency Harvest Fund (DBV) – Bet on going long the three highest yielding currencies and short the three lowest yielding currencies.
• Combination of one or more of the CurrencyShares ETFs (Euro FXE, British Pound FXB, Australian Dollar FXA, Canadian Dollar FXC, Mexican Peso FXM, Swedish Krona FXS, Swiss Franc FXF) and a corresponding short CurrencyShares Japanese Yen Trust (FXY), giving investors flexibility to use currencies other than the US Dollar.
• Long XXX/JPY pair in a retail Forex Account

Source: https://www.cia.gov/library/publications/the-world-factbook/geos/ja.html

Just when you thought the list of society’s outcast stocks couldn’t get any longer, I’ve found four stocks in the bunch that are poised for a bounce back to more rational levels. The market correction over the past two weeks has brought these stocks to the front of the pack, and it is time for investors to take a look at these companies for inclusion into their portfolios, which have taken a being of over 6% since July 19, 2007.

The first pick is a company that many people may never have heard of, even though they manufacture products that we use everyday. The company is Genlyte Group Incorporated (GLYT) and the industry is lighting. The company operates in a historically recession-proof industry and has recently come under pressure—falling 25% from its 52-week high of $87.80. The company is trading at a forward price to earnings ratio of 12.19and has a projected five-year growth rate of 16%. Genlyte Group has averaged a P/E ratio of 15 over the past 5 years. It appears that the stock has caught support the $66 level and is currently trading at $67.16. My 1 year target price for GLYT is $82.65 (Forward EPS of $5.51 times the average P/E ratio of 15), which represents a 23% return from the current level.

Next, allow me to examine the retail sector. I often wonder why would anyone want to be invested a company involved in this industry? Consumers are dealing with high gas prices, weather-related incidents, and a driving up of credit. Despite all the negative aspects of this sector, there is one company that has caught my attention, and it appears to be on the fast track to growth in handling these situations. In fact, if any of the above concerns improve, investors will see a nice jump in the stock price. The company I am describing is a department store called The Bon-Ton (BONT). A recent article that appeared in Stores magazine announced that The Bon-Ton was the #1 fastest growing retailer in their annual “Hot 100” list, which is a list of companies with the fastest-growing annual sales. A slight problem with the disbursement of earnings with BONT is that they have negative earnings three quarters of the year with a strong fourth quarter that effectively puts BONT into overall positive earnings for the year. They have since made a few acquisitions to help evenly disburse the earnings, but it is projected that this trend will continue. They are trading at a forward price to earnings ratio of 5.5, which—by itself—appears abnormally low. However, by looking at the historical high/low P/E ratios over the past 10 years, one will notice that this is within the range, and it is not unusual to find this company trading at this low of a P/E ratio. The company is projected to grow at 14.5% per annum over the next five years, which, when combined with a forward P/E ratio of 5.5, gives the investor a value and growth stock. The company is highly leveraged, which is the primary reason for the fall from over $50 a share to a price of a little over $21 in less than two months. This is more of a speculative play than Genlyte, but I am a buyer at this level, and from past filings, George Soros is an investor who believes as well.

What’s in your wallet? That’s right, it’s Capital One Financial (COF) that I am recommending as an addition to any portfolio. This company has been punished over the past couple months for diversifying away from its core credit card business into a more Citigroup-style company. They made two strategic acquisitions: Hibernia and North Folk Bankcorp. Subsequently, the market has scolded them because of the timing of those purchases. The sub-prime fear in the market has placed a cloud over the real growth experienced within this company. Capital One Financial is trading at a forward P/E ratio of 8.48 and is currently projected to grow at approximately 11.50% per annum over the next five years. The company has a stable management, which has been in place since its IPO in 1994, and has rewarded shareholders with a total return of 1400%. As of Wednesday, August 8, 2007, Capital One Financial has announced the acquisition of NetSpend, a marketer of prepaid debit cards; this acquisition is yet another example of diversification within in the company and an additional potential source of growth. The company has been beaten down to an irrational level and it is time for investors to act in order to give this company the price it deserves.

As I pointed out in my post about the fire sale prices of some stocks, the energy industry is full of bargains lately, especially with the continued growth of the area. Lufkin Industries (LUFK) is one of those companies that stand to profit from the continued exploration of natural resources by providing those companies with the equipment. The company currently has no debt on the books and recently announced a $30 million share buyback. The company has a forward price to earnings ratio of 9.76, which is at the lower end of its historical price to earnings ratio range. Furthermore, the company is projected to grow at 19% per year over the next five years. Along with the share buyback, the company has recently announced a 9.5% increase to its dividend, which currently yields 1.70%. If the price of oil continues to hover at its current level, more firms will enter into the exploration of natural resources, thus driving the demand for equipment that Lufkin Industries supply.

The companies that were mentioned in this article all exhibit the characteristics of being out-of-favor to Joe Investor but have a reasonable growth rate and a low price to earnings ratio. The key to smart investing in today’s market is trying to find companies that will give you the best bang for your buck. These companies have what it takes to give an investor’s portfolio a boost from improving fundamentals, especially those dealing with the macroeconomic environment. So, sit back and enjoy a return to rationality when these star stocks start to make their rise to fame again.

To view the performance of the stock picks mentioned in this article, as well as, my other stock picks from previous articles, please visit http://stockalicious.com/stock_journal/1208. The portfolio will be updated with changes and additions as they come along. Each stock in the fictitious portfolio is initially allocated a $10,000 investment.

My biggest pet peeve is the parrots on CNBC reciting news that the market has already digested. It seems as though they exist for instilling fear in investors to get ratings, and with any market shock, they sure definitely get an increase of viewers to scare. When Joe Investor goes home to check his IRA and notices a 7.5% drop in two weeks, of course he wants to find out why. Look at the Alexa reach for CNBC (Financial, Blue) and MSNBC (World News, Red) websites:

Even with a catastrophe occurring in Minneapolis, the World News site has declined in visitors, while the Financial site has increased tremendously from the gloom and doom journalism surrounding the recent decrease in markets. While these are only for website visitors, one can assume that the same trend is occurring in the TV journalism arena as well.

The name of the game is Ratings, and perhaps the only benefit of that game is that it provides “rational” investors the opportunity to take advantage of “irrational” stock prices. Currently, investors can find quality stocks that have strong growth rates trading at ridiculously low prices. This approximate 8% correction over the past two weeks, though instilling fear in the investing general public, is presenting an opportunity for sidelined investors to pick up stocks at bargain basement prices.

Take for instance, Citigroup (C), which is a diversified financial firm that is feeling the brunt of the drying up of liquidity in the debt markets. It is trading at a forward Price to Earnings ratio of 8.98. This price is at the very bottom of its historical P/E ratio over the past 10 years; the only other time it traded at this low level was in 2002-03, which marked the bottom of the bear market following the technology bubble crash. The risk to reward ratio seems balanced with Citigroup, as it pays a nice fat 4.72% dividend based on the closing price as of Friday, August 3, 2007 of $45.72. The dividend is comparable to the interest rate that an individual might receive putting their money into a money market account.

Another interesting pick up is a company known as Valero Energy Corporation (VLO), which is a vertically integrated oil company. Vertically integrated means that they not only refine the oil, but they are also expanding in the retail markets and selling directly to the consumer. A competitive advantage over other refiners and retailers is their ability to refine sour crude oil, which trades at a significant discount to the light sweet crude oil, thus opening up the margin for profit for Valero. This company is a projected 11% annual grower over the next 5 years, and it is trading at a Forward P/E ratio of 7.60. If oil hovers around its current level or if it increases, it will add to the top and bottom line of Valero and potentially make this stock even more attractive. This is just one of many stocks in the energy sector that have attracted my attention over the past few weeks; I thought it was priced attractively at $70, and I think it is a steal at $62.

Well, I have touched on two of the three despised sectors in the market—financial and energy—but what about the real estate market? I definitely have a pick in that arena, and that stock goes by the name of Cohen and Steers (CNS). They aren’t the typical real estate play; they are a company that manages closed-end and mutual funds invested in real estate. They make money through management and advisory fees, which have been skidding since the Net Asset Values of their funds have been dropping along with the broad domestic real estate market. Cohen and Steers have combated this through the introduction of new funds that deal in international real estate, which has remained strong, as well as new, broader funds to diversify away from its core real estate focus. Another nice feature is that the company is 64% owned by insiders, so it is beneficial for the managers to increase shareholder value. The company is trading at a 14.32 Forward P/E ratio and is projected to grow at approximately 13.25% per year over the next five years. Add to that a 2.53% dividend yield and CNS is one attractively priced stock that is positioned well for future growth and will benefit from any rebound in the domestic real estate market.

So those who can push back all of the gloom hanging over the broad market can easily position their portfolios to take advantage of the irrational stock prices of these three top-quality stocks. While there may be some short-term pain (because it is impossible to time a market bottom), in the long term, these stocks will benefit from a return back to rationality.

To view the performance of the stock picks mentioned in this article, please visit http://stockalicious.com/stock_journal/1208. The portfolio will be updated with changes and additions as they come along. Each stock in the fictitious portfolio is initially allocated a $10,000 investment.

The main premise of this site is to develop and communicate new trading strategies, but sometimes there is a shock that comes along that tests even the best disciplined investors.

Tuesday, February 27, started out with an approximate 10% drop in the Chinese A-shares stock market, which sparked a worldwide equity sell-off. While the 10% drop sounds like a lot, the Chinese stock market since February 5th has seen a non-stop 15% growth up until this drop. The problem is that there is so many risk-adverse investors right now that they weren’t valuing investments with appropriate risk premiums. The emerging markets do present some risks that are not an issue in developed markets, but investors were valuing those securities as if they were in a developed market environment.

Another issue was that of the massive selling and profit-taking that went on domestically and around the world. This little shock in a somewhat unrelated region of the world sparked this weak open and market performance. The problem with investing is that people trade with their emotions and the belief that the stock market can go up indefinitely without much of a pull back, which drives them to bid up prices in stocks and basically taking on too much risk for little return.

The problem is that stocks tend to overshoot their intrinsic values and a correction is needed to take those values back in line. Tuesday was one of those days, it was a breather that needed to be taken so that stocks can continue on their healthy uptrend.

You could tell that people were unhedged and were taking on risk because the VIX, the CBOE Volatility Index, was around 10-13 for the past couple months, which means that there was very little expectation of risk in the marketplace. After yesterday, the VIX reached a level 18, thus increasing the cost of becoming hedged in the market. I would expect for this value to come down, because people have a way of forgetting recent events and will continue on with their risky investing styles. Obviously the Chinese stock market has rebounded 5% today, so maybe people have forgotten yesterday already. The problem is in China, investors are mortgaging their homes, borrowing funds to invest in the market; if Americans can remember back to 1929 that is the exact reason why the Great Depression occurred.

It was unwarranted for the market to fall that much yesterday; panic selling and stop losses were the main culprit. Emotions are the biggest hindrance to a rational marketplace, and it is harder on one’s mind to lose 1% than it is to gain only 1%.  Options and other hedging instruments could have been used yesterday to protect against such a sudden market downturn. The Covered Call Put Option Dividend Strategy, which has been described on this site, would have provided the investors with a protected investment, where the 4% drop would not have been felt at all, because of its long term time frame. I will continue to provide updates on the strategy and will be looking more into testing this strategy in the real-world.