How to make money from stock investment – Part 3

Sukumar raised an important question from last post, about when technical chart doesn’t work and pitfall. I explained by using Freddie Mac [FRE] example. I think i need to spend some time here about FRE and decision making process when technical and market conditions are not favorable to us.

The 5 year, 50 SMA [Simple Moving Average] charts for FRE is scary one for us. The chart just fell south from 60 to 7, over last 7-9 months. The investor who followed basic ‘double armor’ rule, that is, one limit order with 15% below buy price and other one with 50% above buy price, are not losers, in fact lot of people made good amount of money from FRE for long time.

Now it is million dollar question whether to buy or watch FRE, we don’t have favorable technical analysis and market condition. can we take risk? If yes, how much…

FRE is a government based enterprise and it will always take care by federal government, no matter what happens to it. Latest fall was obvious that US real estate melt down and foreclosures. So the fall would be well predicted by experienced investors a long ago, i would say last summer itself.

In these conditions, we have to use best case and worst case analysis, this is very good exercise before buying stocks.

Best Case Analysis
1. President Bush today signed Home mortgage relief law (http://news.yahoo.com/s/ap/20080730/ap_on_bi_ge/mortgage_relief_q_a_5), which is favorable to almost 400k home owners, who are in the blink of foreclosures.

2. FRE business depends on long term treasury bonds also, a long pause of interest rate cut by Feb reserve and strong dollar are good for FRE.

3. Continue sliding oil price and slightly improving labor market is also good for future home sales and FRE.

4. New government and both McCain and Obama are in favor of consumers and ready to make some more laws and relief’s.

5. Iraq war winding down and all factors are pointing to withdraw from Iraq slowly from next year, and budget deficit may improve next year, if Obama become president.

6. FRE can raise money by liquidity.

Worst Case Analysis
1. First home mortgage write off was estimated as 100 Billion and then 500 Billion and now 1 Trillion. Heck..it is lot of money. It is 8% of US GDP. At this point of time nobody knows whether we reached bottom or not.

2. All foreclosures will impact FRE directly or indirectly, because they are monopoly, market share is 70% of mortgage businesses in US, i mean they can’t share profit lose with anybody other than government. But point to remember is, US fundamental is capitalist, how long government provides this socialism support.

3, New government, new laws and war are long way to go to become fully take effort and time line is indefinable now.

Based on the above analysis, i would recommend wait and see for FRE. If we have say 3-5k or so, sitting in extra cushion, i think we can take some risk with FRE now.

Comments

sukumar said…
Thanks for responding to my request. I have read this a couple times, not sure i understood completely. I guess i need to do some more reading up.
Please let me know if i need to change anything to make it easy. Thanks
Subba

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