True to my word, this year I have dedicated to giving Scottrade investors and traders helpful tools.  Velocity & Forces is something you might want to analyze and see if it is right for you when actively investing.  I have included my latest article in this innovative product and hope it brings value when dissecting the markets.

Hello fellow Scottrade Community members.  Watching the recent meltdown of our financial markets has been a painful and important reminder of the risks we all take with investments in our brokerage accounts.  I hope over the next few months to explore those risks and highlight opportunities within the market to help rebuild your confidence and trust within the capital market system and its investment vehicles.  In addition, I hope to add my thoughts and comments on particular products and trading techniques that are available here at Scottrade. 

I look forward to your comments and see you soon.

The Professor

As we gear up for the fall season, a typically busy part of the year for investing, I thought I might give a brief introduction/ refresher to you all about our Products & Services Landing Page. At Scottrade we have access to Stocks, Bonds, CD’s, ETFs, Mutual Funds, & Options. Also, the page highlights the many different accounts at Scottrade : Individual, Joint, Guardianship, Conservatorship, IRA(Retirement), Roth IRA(retirement), Coverdell ESA(education), Trust Account, Estate, Partnership, Investment Club, Sole Proprietorship, Corporate Accounts, LLC Account, Stock Broker-Assisted Account, 401k Plans, Defined Benefit, Money Purchase, Keogh DVP. In addition, we also highlight our services at Scottrade which include our 3 Trading Platforms (Scottrade.com, Scottrader, ScottradeElite), in-depth market research, our nationwide call center, your local brokers, and wireless trading. I urge you to become very familiar with this part of the website because of the valuable resource this page can be. Each category is carefully identified and extensively explained as to the benefits to you. Also, we provide you with additional information that may increase awareness in an area you weren’t currently familiar with. It may be easy to dismiss this part of the site because you may think that nothing new can be learned here, but I know that each time I visit them I learn something new myself.

Thank you,
The Professor

On July 15, 2008 the Securities and Exchange Commission enacted an emergency order for the execution of a short sale, this new rule is trying to curb the abusive powers of “naked” short selling.  Here is a copy of this emergency order:

“It is Ordered that, pursuant to our Section 12(k)(2) powers, in connection with transactions in the publicly traded securities of substantial financial firms, which entities are identified in Appendix A, no person may effect a short sale2 in these securities using the means or instrumentalities of interstate commerce unless such person or its agent has borrowed or arranged to borrow the security or otherwise has the security available to borrow in its inventory prior to effecting such short sale and delivers the security on settlement date.3

In order to allow market participants time to adjust their operations to implement the enhanced requirements, this Order shall take effect at 12:01 a.m. EDT on Monday, July 21, 2008. This Order shall terminate at 11:59 p.m. EDT on Tuesday, July 29, 2008 unless further extended by the Commission. “

¹ This finding of an “emergency” is solely for purposes of Section 12(k)(2) of the Exchange Act and is not intended to have any other effect or meaning or to confer any right or impose any obligation other than set forth in this Order.

² The definition of “short sale” shall be the same definition used in Rule 200(a) of Regulation SHO and the requirements for marking orders “long” or “short” shall be the same as provided in Regulation SHO.

³ Short sales to be effected as a result of a put options exercise are subject to this Order. In addition, we note that short sales used to hedge would also be subject to this Order.

Appendix A

Company Ticker Symbol(s)

BNP Paribas Securities Corp. BNPQF or BNPQY

Bank of America Corporation BAC

Barclays PLC BCS

Citigroup Inc. C

Credit Suisse Group CS

Daiwa Securities Group Inc. DSECY

Deutsche Bank Group AG DB

Allianz SE AZ

Goldman, Sachs Group Inc GS

Royal Bank ADS RBS

HSBC Holdings PLC ADS HBC and HSI

J. P. Morgan Chase & Co. JPM

Lehman Brothers Holdings Inc. LEH

Merrill Lynch & Co., Inc. MER

Mizuho Financial Group, Inc. MFG

Morgan StanleyMS

UBS AG UBS

Freddie Mac FRE

Fannie Mae FNM

Interesting, but what really has changed?  Nothing really on the surface :  “Regulation SHO, which became fully effective on January 3, 2005, sets forth the regulatory framework governing short sales. Among other things, Regulation SHO imposes a close-out requirement to address failures to deliver stock on trade settlement date² and to target potentially abusive ‘‘naked’’ short selling³ in certain equity securities. While the majority of trades settle on time, Regulation SHO is intended to address those situations where the level of fails to deliver for the particular stock is so substantial that it might impact the market for that security.”

2 Generally, investors must complete or settle their security transactions within three business days. This settlement cycle is known as T+3 (or ‘‘trade date plus three days’’). T+3 means that when the investor purchases a security, the purchaser’s payment must be received by its brokerage firm no later than three business days after the trade is executed. When the investor sells a security, the seller must deliver its securities, in certificated or electronic form, to its brokerage firm no later than three business days after the sale. The three-day settlement period applies to most security transactions, including stocks, bonds, municipal securities, mutual funds traded through a brokerage firm, and limited partnerships that trade on an exchange. Government securities and stock options settle on the next business day following the trade. Because the Commission recognized that there are many legitimate reasons why broker-dealers may not deliver securities on settlement date, it adopted Rule 15c6–1, which prohibits broker-dealers from effecting or entering into a contract for the purchase or sale of a security that provides for payment of funds and delivery of securities later than the third business day after the date of the contract unless otherwise expressly agreed to by the parties at the time of the transaction. 17 CFR 240.15c6–1.

However, failure to deliver securities on T+3 does not violate the rule.

3 We have previously noted that abusive ‘‘naked’’ short selling, while not defined in the federal securities laws generally refers to selling short without having stock available for delivery and intentionally failing to deliver stock within the standard three day settlement cycle. See Securities Exchange Act Release No. 54154 (July 14, 2006), 71 FR 41710 (July 21, 2006) (‘‘2006 Proposing Release’’).

But really there is a change, a change in the process at brokerage firms throughout the United States.  The process is subtle but important.  What the SEC now wants is for the Brokerage Firm to locate the specific shares and allocate them to the client shorting the security and decrease the amount available to short on their books.  So what?  Well this change requires a more stringent pre-borrow and allocate process.  Not only must you find the shares but then they must be allocated.  Below I have listed SEC Rule 203 for Locate and Delivery.  When stocks are deemed abundant “easy to borrow” a blanket assurance can be used.  Now these stocks must not only be treated as hard to borrow but the shares must be located and set aside.  This is the important aspect of the new rule change.  Essentially making a short sale in these securities more difficult to find in order to short and then placing a virtual headcount on the shares and reducing the number available for the next client looking to affect a short sale.  Quite powerful, it will be interesting to see if this has the impact that the SEC was hoping for. 

The Professor

http://www.sec.gov/rules/proposed/2007/34-56213fr.pdf

The Case Schiller Housing Index was created to accurately reflect the current single family housing environment. According to their website “The S&P/Case-Shiller Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. These indices use the repeat sales pricing technique to measure housing markets. First developed by Karl Case and Robert Shiller, this methodology collects data on single-family home re-sales, capturing re-sold sale prices to form sale pairs. This index family consists of 20 regional indices and two composite indices as aggregates of the regions. “

Great, but what does this mean? It’s a real time (monthly) dashboard of how your home value stacks up against previous year’s home values benchmarked to the year 2000. Let’s take a look at the index for March 2008: We see a composite reading of 172.16. What does this mean to the homeowner? Well, based on the year 2000, (100) we see that home prices across 20 metropolitan regions have increased over 72% and at their peak in July 2006 at over 107%. 100% increase in 6 years!! Even with the declines we have seen to date we still have a 72% increase in 8 years! Historically, homes on average increase after inflation at 0.7%. If we do a back of the napkin subtraction of inflation at 3%, we still see a rate of 6% year after year increase in the price of our homes.

So what now? Well, two things have to happen. Either home prices decrease substantially or salaries increase. Unfortunately, the first part of the last statement has already started to occur, we are seeing prices decline on our homes substantially. (see chart) But, the second part of the statement does give us some hope. The median household income for 2006 was $48,201.00. If we take a rule of thumb (three times your income for home mortgage and a 10% down payment) and multiply the average household income we come up with $159,063, this is what a median household could afford for a mortgage. What we see is that today’s median home price is $196,300. So, we can afford $159,063 but our median right now is $196,300 a $37,237 difference. So homes can fall another 19% OR wages can increase 23% to $59,500. A very depressing choice to be sure, neither is very accessible in the short term. However, I believe we will see a combination of the two. Since our median wages have not kept up with the dramatic increase in housing appreciation and other inflationary pressures we all may see an increase in the median wages. Also, increase in the real median household income makes some sense considering how stagnant our wages have been compared to inflation and housing over time. Figure1 shows how our wages have increased at a meager 1% over the last 30 years.

What now? If our median wages can show some acceleration say 2% year over year - without igniting inflation and home prices see a decline year over year of just shy of 5%, in 3 years we may reach our goal. Wages would have to reach $51,200 and median home prices approach $169,000. Exciting to think about a 3 year bottom and better yet, realistic.

The Finance Professor

Microsoft has decided to pull its bid for rival Yahoo. It appears as though the reasoning behind this bid was to plug a hole in Microsoft’s product offering and fight off Google.* It seems Google is doing such a good job at building a better web mouse trap that the “monopoly” Microsoft is trying to protect is in danger, they were even scared enough to buy a fading web brand. The question still remains, what now? If we follow the logic from the failed merger: Microsoft needed an established partner like Yahoo to hit the ground running and compete with Google. Others argued Microsoft should just build a more competitive web presence and forget about buying Yahoo; using the money saved to compete against Google. Who knows which argument is correct. I do know that if Microsoft were a true monopoly none of these questions would matter. A true market monopoly could just kill their competitors with price or not allow access to its customers.** I think for the many years that Microsoft has been arguing that it is not a monopoly (but secretly acting like it was) the company has made a terrific blunder by not recognizing sooner the danger of upstart rival Google. It now seems ironic they have been arguing that they weren’t a monopoly, and it turns out they really weren’t.***

Any specific securities, types of securities, or research tools mentioned or shown are for demonstrative or conversational purposes only. Investors should not construe such information as investment advice.

*http://searchitchannel.techtarget.com/news/article/0,289142,sid96_gci1303615,00.html

 **http://en.wikipedia.org/wiki/Monopoly

*** http://en.wikipedia.org/wiki/United_States_v._Microsoft

There is an old saying on Wall Street, “Don’t fight the trend.” What this means is that there are reasons behind a trend, fundamentally and technically. Oil has been in a bullish trend since the late 1990’s and T. Boone Pickens has been arguably the most bullish oil man in Texas during that time (which is saying something) He has been very successful staying with this trend and in 2006 made more than $1 billion by betting on the continuing rising oil prices. He stayed with this trend into 2007, he believed that oil would eclipse the $100 a barrel mark. Now, it seems Mr. Pickens thinks oil has found a top. After calling for $100 barrel oil for years he loudly proclaimed that oil was now to be sold. Funny thing about markets, they never seem to listen. But, like a true Texas oil man, he is bullish once again and back with the crowd. According to an article on Reuters, “Pickens said his fund is now looking for oil and natural gas prices to rise.”The position is long, not short," he told reporters. "I covered the short position - it was a mistake on my part."”

Where is Crude Oil headed?

Looking out onto the investing horizon, I wonder if every type of investment will be packaged and wrapped into an ETF structure.  Will you ever need to have anything but a brokerage account?  Want to own the U.S. stock market - buy an ETF. Like the looks of gold - buy an ETF. Need exposure in your portfolio to expanding markets of Africa and the Middle East - buy an ETF. 

Not only can you easily access broad markets like the S&P 500, but ETFs give the individual investor a chance to invest like a hedge fund.  Speaking of hedging, like to hedge some of your UK ETF with the British Pound Currency ETF? Well it could be as easy as buying the first and shorting the second. Another important feather in the cap of ETF investing is the relatively low expense fees. On average the ETF fees run at about .41% compared to a Mutual Fund average of 1.35%.  With a head start like this it seems ETFs have an unfair advantage.  Of course, there are no sure things and some Indexed Mutual Funds do have lower fees than their ETF counterpart, so it’s important when investing to do your own homework. 

I like to use Scottrade’s Quote and Research page and combine it with ETF Connect.com and Yahoo Finance.  I feel the information provided from these sites give an accurate picture of whatever ETF or Mutual Fund I am investing in. Which makes me think, some ETFs can be somewhat misleading of their holdings, take for example the ProShares Ultra Semiconductors Index ETF (USD); sounds pretty interesting if you are looking for exposure in the chip sector, but looking deeper I see that Intel (INTC) makes up over 30% of this fund.  30%!!  If you throw in Texas Instruments (TXN) and Applied Materials (AMAT) you can account for almost 50% of the fund in 3 stocks.  On top of all this, it has an expense ratio of .95% - pretty pricey for 3 stocks.  It just goes to show that doing your homework is so very important when you are investing and even ETFs have to be studied.  What research websites do you like to use?