Tag Archives: bear market rally

What a close. Down 473 points in 15 minutes.

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I have built up a position in DIA Nov. 08 puts on rallies over the past couple of weeks, and with the Dow up 300 at 3:30 today, I couldn’t resist adding a few more than I would ordinarily be comfortable with. I intended to part with the extra contracts maybe tomorrow or the next day in the inevitable correction after such an awesome rally (1,208 points, 14.8%). As it turned out, the Dow proceeded to drop 473 points in about 15 minutes, and I unloaded the contracts at the close for the fastest money I’ve ever made (as regular readers know, I’m more fond of buying LEAPs to capture the big, multi-month moves).

From Bigcharts.com, here’s the 1-day chart (1 minute):

Click image for sharper view.

As I count the Elliott Waves, this pattern has the A-B-C shape characteristic of a countertrend move, so it doesn’t change my expectation for new index lows in the coming days or couple of weeks. The mini-crash at the close looks like waves 1, 2, 3 and 4 of an impulse wave, which would resolve with another drop below the wave 4 low near the open tomorrow. Impulse waves move in the direction of the one-larger degree trend, as opposed to A-B-C moves.

Today’s chart also illustrates another textbook pattern: the contracting zig-zag from 2:40 to 3:15 resolved in the direction of the previous trend — up, way up. The 1-month pattern is still a very large contracting zig-zag, which, should it stay true to form, would resolve downwards, perhaps to Dow 7000, though a push above the October 14th high first is also possible:

Click for sharper view.

All of this near-term wave counting and trading is really just a hobby for me. I don’t use big money in it, but just enough to keep my attention so that I learn something. My real money is in T-bills, gold and still a boatload of 2010 puts that I accumulated over the last 15 months (see disclaimer), though I have been paring that position in the crash. If I hadn’t been selling, it would be about 85% of my portfolio by now.

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Sorry for the paucity of posts lately. I’m in the middle of a trans-oceanic move, ditching a ridiculous Latin American country for a central European one known for staying sane while the rest of the world goes nuts.

A massive rally is straight out of the 1929 playbook.

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Below is a table of highs, lows and closes from October 23rd to November 14th, 1929, courtesy of Yahoo!. (Unfortunately, their date function is stuck in 1969, so you have to count up from the bottom.)

Key dates:

  • September 2nd. Pre-crash high water mark: Dow 381.
  • October 25th, Black Thursday. From the previous close of 305, down 11% in early trading, a swing into the black, and a close down 2%. (eerily similar to last Friday).
  • October 28th, Black Monday. Down 14.7% intraday, 13.5% at the close.
  • October 29th, Black Tuesday. Down 18.5% intraday, 11.7% at the close.
  • October 30th and 31st: Huge two-day rally, 19%.
  • November 13th: Bottom for 1929: Dow closed at 198, down 48% in 10 weeks. It then rallied to 294 by late April, before declining to 41 by July 5, 1932.

Here’s a visual aid (wider time frame):

Source: sharelynx.com

Look at the rally from the 29th, Black Tuesday, to the 31st: 19% by closing values, and 33% intraday. So far in the Panic of ’08, we are up 11% from the close and 21% intraday from last (Black) Friday.

The rally in ’29 was a wave four bounce within wave three, and it failed spectacularly. I’m not saying this wave four of three bounce will end in exactly the same way, but I think we have yet to see the lows for this fall:

Careful shorts, don’t press your luck.

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This sell-off is nearly overextended. Sure, the odds of a real crash are as high now as they will ever be (markets crash from oversold), but all the same, those are extremely rare events. Bear markets of this magnitude last for years, and there will be lots more rallies to short on the way down. Be prepared for one heck of a dead cat bounce when this panic subsides. The Ministry of Truth is full of fools and knaves bearing advice about averaging down, and there are still lots of buy-and-holders out there whom the market hasn’t sufficiently demoralized.

I started to close out my near-term puts last week, and hope to take care of a bunch more in the coming days. There is nothing wrong with cash. It gives you ammo to do this all over again. And if you don’t want to abandon shorting/hedging altogether, consider switching to long-term puts, like SPY Dec 2010s. They will go down less in a bounce.

That said, I have never seen a more powerful decline than this one, and it could easily take us below 9000 on the Dow by Christmas. It is just that there is no need to swing for the fences when this game lasts your whole life.

Crash conditions still present: zero interbank lending.

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Last Friday, I wrote about the condition of the credit market and how it was ominous for stocks. Well, there is no relief yet. Things are worse, as banks are only willing to lend to one another at rates too high to justify borrowing. Overnight LIBOR hit 6.88% today, and 3-month LIBOR was a record 350 basis points higher than 3-month T-bill rates. Here is a graph of that difference, the TED Spread, which, in calmer times, used to stay well under 50 basis points:

Source: Bloomberg

Here’s an excerpt from a Bloomberg piece today:

“The money markets have completely broken down, with no trading taking place at all,” said Christoph Rieger, a fixed- income strategist at Dresdner Kleinwort in Frankfurt. “There is no market any more. Central banks are the only providers of cash to the market, no-one else is lending.”

Credit markets have seized up, tipping banks toward insolvency and forcing U.S. and European governments to rescue five banks in the past two days, including Dexia SA, the world’s biggest lender to local governments, and Wachovia Corp. Money- market rates climbed even after the Federal Reserve yesterday more than doubled the size of its dollar-swap line with foreign central banks to $620 billion. Banks borrowed dollars from the ECB at almost six times the Fed’s benchmark interest rate today.

Libor Rate

The two-month Libor rose to 5.13 percent today, also a record. Libor, set by 16 banks including Citigroup Inc. and UBS AG in a daily survey by the BBA, is used to calculate rates on $360 trillion of financial products worldwide, from home loans to credit derivatives.

After a massive sell-off in the equity markets, you would typically look for a powerful bounce, and while US futures are indicating an open of a couple of percentage points over yesterday’s close, I suspect that stocks won’t have much more steam than that, maybe a few percent in all.

While we dropped a lot in one day yesterday, the Dow only closed at 10,365, less than 500 points beneath its intraday July 14 low. I’m looking for another 1000 points on the downside within a few weeks before calling for a meaningful bear market rally. There is so much emotion out there that anything is possible, but that also means that whatever happens will happen soon.

Keep your eye on the bouncing commodities ball

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Here’s a five day chart of my favorite commodities stock shorts:

Click for sharper view. Source: Yahoo! Finance.

I nailed the commodities short at the peak in June, and sold a lot of my puts (GLD, GDX, TCK, NUE, X…) earlier this week as the sector made what may be the first of multiple panic bottoms in a bear market. I like shorting with longer-term puts, so I didn’t close all of my positions, but I built up a bit of cash. Lots of that went into retail and REIT shorts earlier this week, but some of it is waiting for this commodity bounce to get overextended.

This group fell 30-40% over the last ten to twelve weeks, so if this was indeed a meaningful way point, it could take up to eight weeks and a 25% rise for the countervailing bout of hope to play out. If the broader market is on the verge of a strong downdraft to beneath the July and March lows, which seems likely to me, commodities could get swept up in any waterfall and resume their decline sooner rather than later. This might not even be much of a bounce at all if broader market sentiment deteriorates quickly. Crashes do arise from oversold conditions – just ask Lehman shareholders.

The commodities markets are exhibiting a bit of negative correlation with the dollar, so I am also a bit short-term bearish on the currency. Any significant retracement would be another opportunity to get out of Euros, Pounds, Aussies, Loonies or precious metals (or short them again).

It’s a beautiful day for shorting. My picks: Wal-Mart & Costco

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I wouldn’t be surprised if the market ends down on the week (maybe even the day). This morning’s little bailout* blip just offers shorts another chance to set up some trades we may have missed in the bounce since July. (*For a dissection of the bailout, here’s Mish).

Why short leading discount big-box retailers? Although they sell stuff cheaply, they have come to rely on Americans buying lots of cheap stuff. American’s have a habit of viewing low prices as an opportunity** to buy more of something, not to buy the same amount and save the difference. The aisles of these stores are packed with discretionary goods: a myriad of toys, cosmetics, housewares, sporting equipment, and all kinds of footwear and clothing. People’s homes are overflowing with decades worth of junk: enough clothing for a couple of generations, and used toys, tools and appliances galore.

These stocks are priced for perfection, as if the consumer binge will continue in perpetuity and the companies will continue to open new stores in new exurbs. Unfortunately, many of those new developments will be ghost-towns before long, and the stores will be big, empty cleanup liabilities.

Let’s take a look at the numbers:

Wal-Mart: Price: $61; P/E: 18; Dividend yield: 1.6%; Earnings growth, 2005-2007: 6.5%

Costco: Price: $70; P/E: 24; Dividend yield: 0.9%; Earnings growth, 2005-2007: 0.94%

By any Graham and Dodd style evaluation, these two are massively overpriced, Costco more so than Wal-Mart. However, I like the short odds on Wal-Mart just as much because it is so overbought and near a 52-week high in a sort of nifty-fifty bubble (hence, I picked up some puts this morning — I’ve had long-term puts on COST for a while).

Yes, same store sales may be up, but that is largely on account of groceries and gas. The profits are in discretionary items. Over the next 12 months, watch for sales to go flat and margins to shrink, before sales drop outright.

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**People don’t apply this logic to investment purchases, hence the securities and real estate markets are inefficient.