Category Archives: bear markets

Scaredy bears

Posted on
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Well, we’ve hit the first common Fibonacci retracement level (38.1%). We’ve now rallied 350 S&P points after a 904 point fall (1570 to 666). This is the best shorting opportunity since 12 months ago, IMO.

Source: Interactive Brokers

Nasdaq is nicely lagging, and the dollar is looking good. China could have topped already. The chatter on the boards is of scared bears and confident momentum chasers.

Next week could be nasty, maybe a drop to 950 before a rally to test 1000 again soon thereafter. Or maybe we slowly roll over and don’t break 950 til almost Labor Day (first week of Sept — when summer vacation ends in the US).

If this really is wave 3 down, it should be another 5 wave move, like wave 1. During the first wave, and even the second, most won’t believe the top is really in. Wave 1 could start from right here, since the momentum guys would be buying in on the decline and there would be few shorts to drive a squeeze to new highs. It would be seen as a “healthy correction.”

Reflation trade stumbling

Posted on
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Trends reverse asset class by asset class. Here’s where the reflation trade stands about two weeks past its possible peak:

Gold and silver: Nice, clear tops and solid sell-offs. I’m pretty confident about those tops holding, since sentiment readings got so high there. Decent profits are in hand, and I am out of this market as of yesterday, since a corrective rally wouldn’t surprise me here. I am waiting to put on my shorts again.

Treasury bonds: Firm-looking bottom off very negative sentiment and a nice rally so far. There is room to go, though I have sold my calls and now just own TLT. Recent auctions have been very successful, as these nice yields are drawing the highest bid-to-cover ratios since 2007.

The dollar: Back within almost a percent of its recent low, but I’m not worried about a collapse because most people are already positioned for fresh lows. Today’s mini panic looks like a potential set-up for the bulls, and I am very long versus the pound, euro and franc.

Oil: Sentiment here never got extreme, but the chart looks toppy and this trade is not independent from general dollar/reflation fears. I am short futures with a tight stop, since today’s bounce took us right up underneath a clear resistance level. Fundamentally, oil is way overpriced for this environment. I still think $20 awaits at some point in the future.

Copper: Very similar to oil’s situation. No extremes, but toppy. I’m short with a tight stop. I expect $1.00 again at some point once the S&P drops under 600.

Pork: Ok, this has nothing to do with the rest of this market, but pork bellies and hogs have been nice winners for me lately. I believe there is a good chance that they just made a lasting low. The flu panic has never been anything but hot air — just another boogeyman to drive people to love big brother. When the fears fade, demand is going to outstrip supply. China bulls ought to be all over this: the Chinese love pork — they even have a “strategic pork reserve”.

Stocks: The markets were pretty oversold after yesterday, but today we worked off that condition, so anything can happen tomorrow. Everyone is watching the 880 level on the S&P, though it feels like after the 40% rally we could see more nasty 90% down days in the coming days or weeks, which would take us closer to 800 and give the bulls a real gut-check. 880 wouldn’t do that.

If we do get down under 850, things are going to get tricky: we’ll have to look at internals and sentiment to divine whether we’re due for a big recovery and re-test of the highs, or if we’re on the express train to new bear market lows.

It is also possible that we never get a deep sell-off, but just chop around within a 50-100 point range for a few more months while fundamentals deteriorate until Pangloss just can’t justify hitting the offer anymore. Chopping around the 900s without ever breaking clean through 1000 would be nearly as exhaustive for the bulls as this rally has been for the bears. It would draw them all in until none were left and volume dried up. That would be an awesome set-up for bears who aren’t themselves worn out in the chop.

This is why I’m such a fan of long-term puts for playing a bear market: with them you don’t have to worry much about how the market gets to its destination, so long as it arrives and on time. Right now, you can buy 36 months of leeway with December 2011 puts. I bought December 2008 puts in Q2 2006 and 2009s in 2007 — there was drawdown from rallies and time decay, but in the end it didn’t matter.

Three months to go?

Posted on
8

I prefer to do the most basic charting imaginable. I just look at history and try to find times that resemble the present. In tonight’s browsing of the record of mankind’s opinion of its future, my eye zeroed in on September 2001 to March 2002. The dot marks the week of September 17, 2001:

This interim bear market bottom came 18 months after the all-time peak. Sound familiar? We had a dramatic sell-off into that bottom followed by a very sharp recovery, no doubt boosted by desperate short-covering. The bounce had covered most of its total ground within three months, but it was not until the VIX retreated to levels last seen at the top of the previous bounce that the indexes registered their final highs. This occurred after another three months of choppy trading, after which the VIX snapped right back to panic levels and stocks began to roll over into the final descent of the three-year bear market.

If this is our fate, perhaps the S&P chops its way to 1050 by September and the VIX touches 20. In that scenario, a lot of pain awaits holders of puts and inverse ETFs, and a lot of gain awaits patient buyers of the same.

I don’t feel like posting 10 charts here, but I couldn’t help but notice how many major market turns have come in September and March. These are the equinox months, and I believe we are primed to experience a collective shift at these times as a remnant of our past as farmers and hunter/gatherers whose livelihoods were very much tied to the seasons. If anyone has the time and know-how, it would be interesting to see if the numbers back up this hunch.

Of course confidence was up in May

Posted on
5

Since they both reflect prevailing social mood, the stock market and consumer confidence move together. Today’s CC figure (about as high as last summer), is another sign that the investing public’s opinion of our economic prospects is overly optimistic:

If this were a stock chart of a company with horrible fundamentals (a prospective short), I would wait a bit longer to see if it kissed the 2002-2003 bottom before going heavily short, though I might start to establish a position at these levels.

What is striking about this 9-year view is how closely CC tracks the stock market, and how much more lackluster the mood was in the dead-cat bounce from 2003-2007 than the true secular peak in the late 1990s to 2000.

The Global Dow needs to crash some more.

Posted on
57

Last fall, Dow Jones launched the Global Dow index, composed of 150 stocks from around the world. A quick glance at its 10-year chart shows that stock prices have only so far blown off the froth from 2006 and 2007:

Source: wsj.com

Stocks are driven by mood, and mood today seems to be highly coordinated around the globe, so rather than scrutinize the twists and turns in the Dow, DAX or Nikkei, perhaps this new index is the best reference.

What is most striking about this picture, as opposed to that of the S&P500, Eurostoxx 50, or Nikkei, is that stock prices are only 2/3 of the way back to the 2002 lows, as opposed to right upon them.

This says to me that even this first stage of the crash has further to run. Fundamentals are deteriorating with blazing speed, but market participants remain in secular bull market mode. Too many are still buying the dips, or at least ignoring their losses and hoping for a rebound. The stock market is still viewed by most Americans as the best way to save for retirement, and the myth persists that if only your time horizon is longer than a decade or so, stocks will always beat cash.

This wave off of the November lows is looking weaker and weaker. We had our chance for a strong bounce like the one after the crash of ’29 (the Dow was up about 45% from November ’29 to April ’30), and all we could muster was about 20%.

Today’s action is a pretty strong indication that panic has been lurking just below the surface. With the sell-off in bonds possibly having run its course, precious metals stalling out at resistance, and a very low put/call ratio indicating extreme trader optimism, the news of the Great Pork Package and latest bankers’ bailout may be just the catalyst we need for a sell-off. Hope is fading fast.

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Oh, and it is worth mentioning that John Mauldin reports that a contact at S&P told him that the latest quarter’s earnings are apparently coming in at a NEGATIVE $7 for the index. I have been saying all along, that if this is a depression (it is), PE’s should bottom out at well under 10 and even dividend yields should be in the double digits. Whatever figure you come up with as a final bottom target for the S&P, it should be a very low multiple of very low earnings.

Among financial planners, the equity culture lives on.

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Bloomberg columnist Jane Bryant Quinn reports that most financial planners still view stocks as the cornerstone of a retirement plan. An informal survey of planners showed overwhelming support for an equity allocation of 50-60%, although many have a new found respect for cash.

It still sounds as if most financial advisers are pretty worthless, just dishing up the same bad advice you could get from the New York Times:

Most of the planners are advising their clients to rebalance their portfolios, which effectively means putting money into stocks at current prices. They’re buying slowly, dollar-averaging into the market month by month. For taxable accounts, they’re also harvesting tax losses, to use against the capital gains that some mutual funds will be reporting, based on gains taken earlier this year. They also love municipal bonds.

Any adviser who had clients in more than a token amount of stocks by 2007 should be fired for incompetence. Same goes for those who still advise 50% or who like municipal bonds, which are an accident waiting to happen.

A good adviser doesn’t just deploy static formulas for asset allocation, but has the historical (100+ year) perspective required to identify periods of relative over- and under-valuation in various asset classes. Stocks were a time-bomb after about 1995. Commodities should have been avoided by early 2007. Real estate was on a crash course post-2004. Munis and corporates were also all risk an no reward after 2004.

This is pretty simple stuff, really. Just look at the relationships of various assets to one-another and to consumer prices, and don’t forget that metrics like PEs and yields can reflect overvaluations for so long that up begins to look like down.

As asset classes get way out of whack with historical averages, they should be sold or bought accordingly. People often forget that cash is an asset class, perhaps the most important one, and should be bought in spades when it is cheap and held until it is dear. It is still cheap.

Short-term trades: Don’t buy gold. Prepare to go long stocks.

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When everyone has run to one side of the boat, stroll over to the other.

GLD in blue, S&P 500 in green, Nikkei red. 2-year chart:

Source: Yahoo! Finance. Click image for sharper view.

I’m not calling a bottom in stocks (I think the Dow is going below 3500), but nothing moves in a straight line, and it looks like the market is setting up for a bit of a clearing rally, although it might take a plunge below 9000 to really capitulate first. It actually feels relatively calm to me today, despite the panic conditions, so another deep plunge to finish things off wouldn’t surprise me from here.

Along the same vein, look above at the inverse correlation that gold has had with stocks during this bear market. Markets are all about mood, and lately when fear is high, stocks are down and gold is up. We are nearing the point at which everyone is already on board the panic express. From there, you can expect temporary relief. When the relief comes, gold will resume its own unfinished business of working off the manic top from 2005-2008:

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Note: I’m not going long stocks. I’m still massively short with long-term puts, so short-term rally or not, it doesn’t matter to me. I’m also long gold, but holding a few puts on GLD right now.

Bailout deal? Whoop de do.

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Well, there you have it. Paulson got his 700 big ones (to start) but Congress is going to make him ask again for some of it (like they’ll say no). Executive compensation cuts? Well, deduction caps and no new golden parachutes for the biggest beggars. Equity? Well, warrants, and Paulson gets to say how many, what price, etc. Majority stakes only in some circumstances. Boy, Congress really fought this thing once it learned how its constituents felt.

Futures traders are just beside themselves (with apathy):

 

 

 

 

 

 

Source: Bloomberg

So, where do we go from here? As I have been saying, we still have a crash to take care of. Maybe it starts this week, maybe next week, maybe December, but a year from now the buy and hold crowd will be lucky if the Dow is closer to 10,000 than 5,000. This bill won’t do a thing to stimulate lending. We are just turning Japanese, without the exports or savings.

As a short, I won’t look this gift horse in the mouth. Paulson bought his buddies time to unload the remainder their personal securities, but the bailout also adds a few girders to bolster counterparties on the losing side of a crash. My biggest fear these days is that so many securities dealers could go broke at once that the Options Clearing Corporation can’t make up for bankrupt put sellers. That is my version of TEOTWAWKI.

So, are there no libertarians in financial crises? I railed against this thing, but the bankers make the rules in this new zero-sum game, or rather negative-sum game (wealth is going to money heaven). For those who stay in, it is every trader for himself.

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Here’s a pdf of the full draft of the bill at it stands tonight.

Out of the Woods? Treasury market isn’t buying it.

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30-year treasury yields in blue, S&P 500 in red:

Click image for sharper view. Source: Yahoo! Finance

Talk about a non-confirmation. Treasuries rallied on Monday when stocks tanked, but they have failed to sell off since then as stocks have rebounded. Treasuries remain solidly in their 26-year bull market, and I suspect that we will soon enter the crazy phase when a bull runs far outside of fundamentals (in this case the solvency of the creditor).

P/E’s are Nil on Dow and Russell 2000

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Click image for sharper view. Source: Wall Street Journal Online

Earnings have gone negative. How’s that for value? Remember, most bear markets end with P/Es below 12, sometimes 7. Even the value play in the group, the S&P 500, will have to fall by more than half to get there, without any further contraction in earnings.

And what kind of fools see value in equity yields under 3%, when earnings have grown above trend for years? Stocks are all risk with no reward. You can get these yields on 1-5 year treasuries right now.