October 2nd, 2008

SLV, GLD, FXE and FXB: A Costly Mystery and Mistake

If you’ve been a reader since the beginning of the year, you know that I’ve consistently been encouraging liquidating your positions and holding cash. I’ve also encouraged you to hedge the remainder of your holdings (or to capitalize on the market implosion) with positions in the various Index-linked PowerShares Ultrashort ETFs.

However, I have to apologize for one extremely disappointing and, for me, costly and unprofitable trade: the purchase of precious metals and foreign currency ETFs. What can I say other than to tell you that it’s cost me dearly, too.

Ever since around July 17, these have all been in a free fall. On that day, Ben Bernanke, the Chairman of the Federal Reserve, assured the United States House of Representatives Financial Services Committee that giant mortgage companies Fannie Mae and Freddie Mac were in “no danger of failing.” Is there a connection? I don’t know.

Look at these charts:

  • Silver
  • Gold
  • Euro
  • British Pound

It’s said that you can’t hope to bat a thousand when it comes to the market. And they say that if you cut your losses, you’ll survive to play another day. It’s been a suprising, bewildering and disastrous trade. I’ve learned some lessons that I hope never to have to use.

Every one of these securities is behaving contrary to every economics book and everyone’s expectations. Anyone have any explantions for this behavior? Any ideas of where it’s headed?

August 20th, 2008

Bottom or Consolidation Channel? What’s Your View

Some will call it a upward-sloping channel, some call it a wedge, some see it as the right-shoulder of a broad head-and-shoulder formation and the eternal optimist again sees it as a bottom. But I’d rather let the chart speak for itself.

Some show a short-term chart that zero’s in on the spurt that’s taken place since the July 15 Fed intervention in the Freddie and Fanny debacle and consider the 7.5% move a bottom:

But the recent action is cause for concern. The angle of the channel is too step for a bottom formation; it’s usually either a consolidation followed by a continuation in the same direction or the left-hand part of a larger pattern.

I’d rather take a longer-term view that takes into account all the events since the credit crises began over a year ago:

It seems obvious to me that the recent upward-sloping channel isn’t a “v-shaped” bottom – it rarely is, if ever. The recent movement may broaden out and morph into a true bottom formation but that wouldn’t happen until the Index returns and tests the resistance at 1200. If it passes, then the attempt to form a true bottom pattern will continue. If not, then the channel was a consolidation and the decline will continue.

On July 31 , I made a bet with Cramer in response to his “Bye, Bye Bear” call that “the market, as measured by the S&P 500 will see 1150 (10% down from 1278 as of 10:22 today) before it sees 1405 (10% up from current)”. Of course, I didn’t actually make it with him but I’m keeping score any way.

I’ve been consistent telling you that my MTI (Market Timing Indicator) continues to signal that an all-cash position position is still the best strategy. I’ve also been consistent in calling for a move to 1150 ever since the beginning of the year. It looks like the market is now heading lower so we’ll see if Cramer now tells his viewers “Boo, Hoo Bull”.

If you want to play the downside, I wrote a piece on June 28 entitled “How Do Ultrashort ETFs Work” that displays the relationship between the underlying index and the etf. You might want to take a look at it again.

July 14th, 2008

Freddie, Fannie and the Future

Futures show a big increase coming but let’s put those numbers into focus. The Dow futures are up around 120, S&P 500 up 16 and Nasdaq up 18. So the talking heads are painting these increases as a turn-around.

In reality, this could be nothing more than some short covering since these levels are no higher than the highs of the last trading day, Friday. Let the markets open, go through half the day and we’ll see their viability. If you’ve been reading here, you remember that last Wednesday I wrote about a bounce at around 1234. Friday’s low as 1227 and close at 1239; that’s pretty close to 1234.

Yes, there is a fundamental reason for a bounce — the US Government coming in and backstopping the Freddie and Fannie. But since 2005, this level has also been a pivot point several times, a point where it changes direction. But given those turns, the prevailing trend continued (back in 2005 it was a continuation of the bull market).

This time, we’re going to need more evidence before believing that the prevailing bear trend has reversed before significantly changing our investment philosophy. We’re going to continue investing in precious metals (in the belief that all this financial remediation is going to lead to even more inflation) and hedging the indexes through the DoubleShort etf’s.

July 3rd, 2008

Our "Worst Fear" Is Realized

Only a week ago, on June 24, I wrote in “What We Fear Most“:

“Even though I wrote yesterday that one shouldn’t fight the tape, the whole Oil & Gas sector seems greatly extended by most technical measures (for example, Bollinger Bands). I started closing out some positions today. Selling too early? I won’t know for a while but the Congressional Hearings are my “tell” that it’s time to lighten up. It also may be impetus for the S&P 500 to resume its decline to 1150 and, perhaps, beyond.”

What I didn’t expect was that the commodity soft spot was coal rather than oil; but perhaps oil’s going to follow soon.

The coal stocks imploded today and either coincidentally or as a result the market closed below the support level … just barely (the Index closed at yesterday’s intra-day low). Tomorrow could be an unbelievably chaotic trading day: labor report and EUB interest rate before the market opens and early closing before a long weekend). Going out a limb, I can only see the market dropping another 2% to approximately 1234, a trendline I inserted back in 2006 due to having been a pivot point frequently in 2005 and 2006:

It’s feasable to assume that:

  • the 2% decline could happen tomorrow
  • the trendline extending from 2006 could serve as a supportive lower boundary in a new horizontal channel with the upper boundary being the trendline that’s currently the lower boundary of the January-June channel
  • that support will be tested for several weeks, with a high likelihood that it will ultimately fail as the only strong stocks in this market, the oils, food, steel and other commodity stocks, follow coal’s lead and cascade down after the Olympics.

But this is getting way ahead of ourselves. First let’s see if the market bounces around 1234 or goes through that level, as one talking head recently said, “like a warm knife through butter.”

Fortunately for me and I hope for you, we’ve been anticipating this coming storm with our hedges through the gold and silver ETF’s, the double short ETF and cash positions that I’ve been recommending for the past several months.

June 28th, 2008

How Do UltraShort ETF’s Work?

A reader named Ram, wrote “Ultrashort ETF’s now? Aren’t we pretty close to an intermediate term low?” I never quite thought about what expectations I should have of UltraShort ETF’s. I just believed they go up when the market goes down.

But Ram’s questions got me thinking. What is the relationship between the ETF’s and their underlying indexes. I’ve went out on a limb projecting that the S&P 500 Index will drop but never examined what that meant for SDS, it’s associated Ultrashort ETF? And what about the Nasdaq Composite and its QID, or the Russell 2000 and TWM?

One way to understand the relationship (for stock chartists, that is) is graphically. So I went back to the data since the ETF’s launch dates and created the following charts and tables.

  • S&P 500 (SDS)
  • Nasdaq Composite (QID)

    • Russell 2000 (TWM)

    Granted, my “projections” are based on my the assumption that the S&P 500 will breach its lower boundary support and continue down to 1150. Should that happen, the other indexes indicate similar declines which, not so coincidentally, are in the same percentage ballpark range.

    I’ve tried several times to understand the mechanics of UltraShort ETF’s but the best I could do is infer that the issuer (State Street) makes a market in them, will make their income by someday redeeming them at markedly lower prices since they theoretically decrease in value by about 10%/yr. over the long-run and, perhaps, after the market has gone up considerably, the ETF’s will be subject to reverse splits to raise them back to tradable prices. While they do increase in value as the market declines, it is of no concern to the issuer since they have nothing to do except maintain the market. All that happens is that holders make profits by trading back and forth to eachother.

    There’s an underlying relationship between the Index and the ETF but the actual price might vary from it based on supply and demand (and augmented by State Street issuing more or redeeming some in their market making activity). The premium or discount moves something like the VIX. When the market increases, demand for the ETF’s decline; when the market declines, demand increases.

    So, thanks for asking the question, Ram It forced me to do some technical and charting research to arrive at some expectations of the profit opportunity in a market decline (or risk in a positive reversal) in these UltraShort ETF’s.

June 22nd, 2008

Investor or Trader? What are You?

I attended a wedding this weekend and, during the dinner afterwards, I was telling a friend about this blog and my upcoming book, “Running with the Herd” when he unexpectedly hit me with, “Are you an Investor or a trader?” He quickly followed up with a question that sounded like skepticism in his voice “How long do you own stocks, a year or less than a year?”

With what sounded now like derision, he quickly said that he “usually holds stocks for three years or more”, clearly implying that anyone who didn’t do the same was somehow a gambler and not truly worthy of any sort of objective consideration.

So what are the differences between investors and traders?

  • “Investors” put their money into stocks, real estate, etc., under the assumption that over time, the underlying investment will increase in value, and the investment will be profitable. Investing is normally a passive activity after the initial purchase of the stock or fund. Typically, investors anticipate declining markets with fear and anxiety, usually not planning ahead as to how they will respond. Instead, they hold onto the investment in declining (bear) markets and absorb the loses in the hope the investments will bounce back sometime in the future and they will again be winners.
  • “Traders” take a proactive approach to their investing and invest with one goal, to put their capital into the market to make “profits.” They “trade” with a plan that tells them what to do in any situation. When to enter and when to exit. They never allow large losses. Trader don’t necessarily move in and out of the markets frequently; this is a common misconception. Traders simply have plans for when they will enter and exit investments and/or the market. They know what to do if their trade goes against them, and they know what to do when their trade is profitable.

In short, 1) “investors” have no exit plans from either a stock or the market while “traders” do and 2) “investors” take a passive approach while “traders” are active investors.

So how will “investors” and “traders” actually have fared as the S&P 500 Index declines 10.4% since the beginning of the year and 15.8% since October 9. If I’m a “trader”, then I know what my strategy has been and will continue to be. Friday’s abysmal performance (down 1.85% with significantly higher volume due to quadruple-witching), only confirms my Market Timing Indicator and clearly continues to signal that the market should be avoided.

The strategy still includes taking only small opportunistic (trading) positions, closing out questionable or losing ones, taking some hedging positions (gold, silver, etf’s that short, puts or any combination) and maintaining significant cash positions. For frequent readers, the chart below is familiar and clearly indicates that there’s no prospect for any sustained upside movement for the market in the foreseeable future. I’ve been comparing this year’s market to the 1973-74 bear market crash since March 1 and seeing eerie similarities:

The next test will be at the lower boundary of the horizontal trading range made earlier this year or 1380, a further decline of 3.8%.

“Investors” remain clearly nervous and take dubious comfort in the thought that they’re “in it for the long-haul”, “own good companies”, or “own stocks paying good yields”. But how long might it take for them to recoup, through a combination of dividends and capital appreciation, the 15% or greater losses if the market goes to that support level? What if the support doesn’t hold and the market continues it’s decline into bear market territory?

Quite a while but if they had acted like “traders”, they would be able to sleep at night knowing they were protected by being in cash. They also would be in an excellent position to take advantage of the distressed prices offered whenever in the future that the market does finally make a bottom and begin to form a base. I’m confident that my Market Timing Indicator will signal a return to the market only when the opportunities significantly outweigh the market risks.

June 6th, 2008

Suckers’ Rally Arrives; SLV

The music stopped and the market fell on its ass. For the last several of days, I’ve written about how the index kissed the 60-day average and bounced. But today, as well know, it didn’t.

Its a perfect time to hit you with my favorite quote of Benjamin F. King: “50% of a stock’s price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own.”(Market and Industry Factors in Stock Price Behaviour, Journal of Business, January 1966).

I found this quote while research my Market Timing Indicator (MTI) for the book I’m writing. After today’s 3.09% decline, the Index finally fell below both the 60- and 90-day moving averages driving the MTI into an all-cash position. Will this move turn out to be a mirror image of the May 19 one-day move above the 180-day move?

It reminds me of when I warned on April 22 in “Beware Suckers’ Rally“, that the move above the upper boundary of the channel the market out of which the Market was attempting to breakout might in fact be a trap. The market is now just below the April 22 close. I repeated the cautionary note when I wrote “Dusting Off Bear Market Crash Call: Next 2% is Crucial” on June 2, just this past Monday. But the only think that counts is where we’re going from here and what should we do.

I’d immediately hedge (I finally did sell some new or poorly performing stocks and add 10% cash) put some hedges on. The vehicles I’ve been playing are:

  • SDS – ProShares UltraShort S&P 500
  • TWM – ProShares UltraShort Russell 2000

But the one that looks like it’s about to move higher is a left-behind commodity, silver. Here are two views:

Watch this channel develop and, if the price approaches 180, I’d jump in.