October, 2006 saw the S&P 500 climb through the mid-upper 1300s, on its way to the 1500s by mid-2007. 18 months later, the S&P 500 is again climbing through the mid-upper 1300s. Where does it end? Up. How long will it take to get there? That depends on the economy.....

In mid-2007, it wasn't the economy that began to fall apart and cause massive downturns and swings in stocks. Rather, if somebody poops in the pool, everybody has to clear out and so the lifeguards can shock the water. After ~1 hour, people are allowed back into the pool. The stock market is financial-centric, no two ways about it. All stocks swim in the pool, but if the financials are a mess, it's clear out time. I'm pretty sure you can figure out the players in my parable. I wish (really wish) I would have sat out most of the market for a while last fall and this past winter. Hindsight is always 20-20, but in the future, if I do see poop in the pool, I'll take some off the table and buy some market put options.

So here we are, still well below where the SP 500 started 2007 at 1418, well below last summer's 1550+, and ~10% below the MSCI World Index highs from last year. Money has been coming back into the market in the past month, which is nice. But, to me, the question still remains, is this a bear market rally? This past week, giddiness exuded from many areas, especially Friday with Cat, Citigroup and Google. How much poop is left in the pool?

While one can never be sure as to what is around the corner, examining what's left might be worthwhile. Let's assume home prices still have another ~15%-25% drop left. I firmly believe that. Home sales will revive when prices fall.....supply and demand, right? That's all it is....supply and demand. No question demand for homes has dried up across the nation (yes, I know there are a few pockets......), and supply has risen. Demand will not increase until prices decrease....or we allow an extra few million wealthy immigrants into the country. With credit conditions, fewer and fewer people will be able to afford/qualify for a house. Then, who in their right mind would want to buy one today when....odds are....they can get one cheaper next year. So, what would another ~20% drop in home prices do with financials? Then, how would it impact the market and the consumer?

I'd still say there's plenty of financial mess, just not sure about how that will play out. Most homeowners, granted, have lived in their homes for quite some time and have enough equity where a loss of 20% more wouldn't be too much of a big deal, especially if they didn't realize how much they could have gotten for their home a year or two ago. That being said, financials are looking/hoping/praying for the bottom, bouncing whenever they report news which isn't as bad as it could be.

So what to do? Two things. First, buy quality stocks of quality companies, especially if they're on sale. Apple was in the $120 range a month or two ago; today it's in the $160s. Google was in the low-mid $400s, now in the mid $500s. Pick any quality company, and more than likely its stock has improved vastly in the past month or two. Those are the stocks you want to buy; ones of quality companies.

Second, buy damaged (cheap) stocks of companies with little or no debt and "worst case" scenario priced. Three of these I like and own myself are Leapfrog, Arctic Cat and Hot Topic. Valuations on all three are very low (though LFs valuations have improved since it was on fire-sale near $5 per share). All three have (or had) the gloom and doom consumer priced. All three have no debt. Bankruptcy won't happen anytime soon (good), credit ratings don't matter (good), business will likely turn around sometime (good for long haul) and all three are easy takover targets. LF, ACAT and HOTT. Buy now; I see all three doubling by later in 2008.

Until next time.