10 Rules Of Investment Classic

1. Markets tend to return to the mean over time
When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people's heads. It's easy to get caught up in the heat of the moment and lose perspective.

2. Excesses in one direction will lead to an opposite excess in the other direction
Think of the market baseline as attached to a rubber string. Any action to far in one direction
not only brings you back to the baseline, but leads to an overshoot in the opposite direction.

3. There are no new eras -- excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots.
Look at how far the emerging markets and BRIC nations ran over the past 6 years, only to get
cut in half.As the fever builds, a chorus of "this time it's different" will be heard, even if those exact words are never used. And of course, it -- Human Nature -- never is different.

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
Regardless of how hot a sector is, don't expect a plateau to work off the excesses. Profits are
locked in by selling, and that invariably leads to a significant correction -- eventually. comes.

5. The public buys the most at the top and the least at the bottom
That's why contrarian-minded investors can make good money if they follow the sentiment
indicators and have good timing.Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.

6. Fear and greed are stronger than long-term resolve
Investors can be their own worst enemy, particularly when emotions take hold. Gains "make
us exuberant; they enhance well-being and promote optimism," says Santa Clara University
finance professor Meir Statman. His studies of investor behavior show that "Losses bring
sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning
stocks."

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
Hence, why breadth and volume are so important. Think of it as strength in numbers. Broad
momentum is hard to stop, Farrell observes. Watch for when momentum channels into a
small number of stocks ("Nifty 50" stocks).

8. Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend
I would suggest that as of August 2008, we are on our third reflexive rebound -- the Januuary
rate cuts, the Bear Stearns low in March, and now the Fannie/Freddie rescue lows of July.
Even with these sporadic rallies end, we have yet to see the long drawn out fundamental
portion of the Bear Market.

9. When all the experts and forecasts agree -- something else is going to happen
As Stovall, the S&P investment strategist, puts it: "If everybody's optimistic, who is left to
buy? If everybody's pessimistic, who's left to sell?"
Going against the herd as Farrell repeatedly suggests can be very profitable, especially for
patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.
10. Bull markets are more fun than bear markets

Especially if you are long only or mandated to be full invested. Those with more flexible
charters might squeek out a smile or two here and there

High Valutaion

Last week, the S&P 500 Index ascended to a Shiller P/E in excess of 24 (this "cyclically-adjusted P/E" or CAPE represents the ratio of the S&P 500 to 10-year average earnings, adjusted for inflation)
Based on our standard methodology (elaborated in numerous prior weekly comments), we presently estimate that the S&P 500 is priced to achieve an average total return over the coming decade of just 3.15% annually. Again, we've seen weaker projected returns over the past decade. But then again, the S&P 500 lost about 5% annually in the decade following the 2000 peak, and even including the recent advance, has achieved an annual total return since 2000 of almost exactly zero. So despite periodic speculative runs, rich valuations have an annoying way of ruining the fun. Equally important, even during extended speculative periods as we observed in the late-1990's, those advances have tended to suffer deep and abrupt intermediate-term corrections once elevated valuations are joined by overbought conditions, over bullish sentiment, and rising interest rates, as we observe today.----John P. Hussman, Ph.D.

Paulson Latest Holdings

Full breakdown of holdings as of Dec. 31 (full green row highlight is new position).

Bull, Sideways and Bear Market

Japan Bear Market

Starting in the late 1980s, over a 14-year period, Japanese stocks declined 8.2 percent a year. This decline was driven by a complete collapse of both earnings – which declined 5.3 percent a year – and P/Es, which declined 3 percent a year. Japanese stocks were in a bear market because stocks were expensive, and earnings declined over a long period of time. In bear markets both P/Es and earnings decline.

The P/E journey from one extreme to the other is completely responsible for sideways and bull markets: P/E ascent from low to high causes bull markets, and P/E descent from high to low is responsible for the roller-coaster ride of sideways markets.

Bear markets happened when you had two conditions in place, a high starting P/E and prolonged economic distress; together they are a lethal combination. High P/Es reflect high investor expectations for the economy. Economic blues such as runaway inflation, severe deflation, declining or stagnating earnings, or a combination of these things sour these high expectations. Instead of an above-average economy, investors wake up to an economy that is below average. Presto, a bear market has started.

Let's examine the only secular bear market in the twentieth century in the United States: the period of the Great Depression. P/Es declined from 19 to 9, at a rate of about 12.5 percent a year, and earnings growth was not there to soften the blow, since earnings declined 28.1 percent a year. Thus stock prices declined by 37.5 percent a year!

Red Flags Commonly Used to Insinuate Fraud

A. Financial

1. SAIC documents do not match SEC.
2. SAT documents do not match SEC.
3. Low R&D expense, especially when company has unique technologies. BORN
4. Unusually low accounts payable position. ZSTN
5. High margins compared to competitors.
6. Allegations of low credit rating when SEC filings look pristine. CCME

B. Internal Controls/Corporate Governance

1. Ineffective internal controls, especially when issue exists for an extended period of time. SKBI
2. High CFO turnover. CSKI
3. Resignation of several members of the board of directors. BORN
4. High auditor turnover, especially if company goes back to old auditor.

C. Ownership Structure Issues

1. A significant delay in meeting registered capital requirements upon an RTO transaction. This could imply that original players were not comfortable infusing capital into a company. WKBT
2. Desire to switch ownership structure to a variable interest entity (VIE) from a foreign invested enterprise (FIE). ONP, CHGY. This could insinuate difficulties in securing capital from original players of the the RTO transaction.
3. Illegal corporate structure as defined by PRC law. CEU note

D. Share transactions

1. Several equity offerings within a tight time period.
2. Company raises money when it has excess capacity
3. IPO that priced well below desired price, yet company does not cancel or delay offering. BORN
4. Company raises money despite adequate cash balance. CBP note
5. Company raises money despite contradictory comments in filings and press releases. TSTC note
6. Equity offerings at low valuations when balance sheet is healthy and at least 30% EPS growth is expected. RTO stocks in general.

E. Miscellaneous

1. High land right use. LTUS
2. Company won’t disclose sellers related to certain transactions. CGA
3. Company won’t disclose address or names of retail locations, distributors and subsidiaries.
4. Lies about date of establishment of acquired business.
5. Negative commentary by media outlets in PRC. KGJI note
6. IPO rejected in the PRC if firm claims to be a leader. KGJI
7. Inadequate Website. CEU note
8. Low executive salary.
9. Regulatory interventions (SEC, PCAOB, etc).

Suggested Steps Companies Should Consider to Establish Credibility

A. Financial

1. Disclose SAT through an independent source. PRC law, as it relates to annual inspection process among several governmental bodies, implies that for FIE, SAIC should match SAT. However, a linear relationship for VIE between SAIC and SAT filings can not be assumed which is why SAT verification is particularly important for VIE company structures.
2. Reconcile SAT/SAIC filings with SEC fillings when they do no match.
3. Auditor should make a statement verifying they saw cash and SAT information and obtain this information independently. Access to documents should be made available at any time without company knowledge to avoid speculation that company has had time to employ fraudulent short-term measures.
4. Also consider giving an independent source random access to SAT filings and cash balances.
5. If you have engaged in tax avoidance schemes request a letter from PRC government forgiving past indiscretions and/or just settle the issue. ( we understand this may not be practical). Ideally, this should be done before going public.
6. Request a letter from the PRC that SAT filings are in line with SEC filings.

B. Internal Controls/Corporate Governance

1. Retain a Top 10 auditor (Top 4 is the most ideal)
2. Ideally, internal controls should be in check from day one. Even if a company can’t afford a top auditor on a full time basis one should at least be retained to implement effective internal controls such is the case with CBP. Internal control procedures should also be promptly reevaluated upon the completion of acquisitions.
3. Qualified Board of Directors should be in place upon going public.
4. Consider an independent advisory panel

C. Share Transactions

1. Do not issue equity at absurd valuations when you have (a) ample cash on hand, a healthy current ratio, a healthy cash ratio and (b) guidance or EPS estimates that imply at least 30% EPS growth.
   
   Additionally, make a statement that you will not have to issue equity in order to grow EPS and stand by these words, unlike TSTC and SPU. If you do issue equity, reduce the share raise by utilizing cash so that healthy EPS growth will still occur.
2. Consider the use of some debt over equity when possible

D. Establish Investor Confidence

1. Issue EPS guidance. NEWN FSIN ALN GFRE (Ideally, for upcoming quarter and year)
2. Implement buy back programs when valuations are low as a way to increase EPS growth. CHBT CFSG ZSTN FMCN
3. Release monthly reports on status of buy back program.
4. Management buys stock. CMFO CCME
5. Declare special or quarterly dividend. CCME
6. Issue annual reports with letter from Chairman of the Board
7. Pay proper taxes
8. At some point, dual list shares

Clues that an Equity Raise is on The Horizon

1. Be aware that boiler plate language insinuating that current capital is sufficient to maintain current operations can offer a false sense of security vs. explicit language in SEC documents inferring that a company does see a need for an equity raise.
2. Look for contradictions in press releases that infer no need for capital vs. opposite jargon in SEC documents.
3. Compare “liquidity” sections in SEC documents to “risk disclosure” sections for contradictions regarding a potential need for capital.
4. Look for changes in statements about the need for capital when the level of business has remained unchanged/increased, yet liquidity standing has not seen significant changes.
5. Company has never raised money since going public.
6. Sudden cancellation to attending investment conferences and not returning calls or emails. This could imply that a company is in a quiet period. YUII note
7. No Q&A section during earnings conference calls can also signify that a company is in a quiet period. SPU
8. The “Offering” document filed with the SEC includes the proposed share amount of a potential offering, the amount of funds to be raised and the expected offering price.
9. When a foreign invested enterprise (FIE) has not met its registered capital requirements. WKBT note
10. When a company plans to switch to FIE from a variable interest entity (VIE). VLOV note
11. A company that grows by acquisition.
12. A company is at full capacity. CHGY
13. Requesting the removal of anti dilution provisions TPI note
14. Company with liquidity issues AKRK note