Not the bottom

Most non-traders probably missed it, but the S&P 500 futures contracts tanked right after the close yesterday and touched 681 for a moment. We are bouncing a tad right now (futures trade around the clock during the week), but this is just another head fake. Lower lows await this month. However, I have now closed substantially all of my long-term short positions. I am not going to press my luck. If we make a nice washout low, I will even go long for a trade, but only from much lower levels than this.

Here is what we need before we can call a bottom:

1) The Russell 2000, Nasdaq, Nikkei and various stocks like Walmart, Home Depot, Apple, Amazon and Exxon Mobil need to make new 52 week lows.

2) The volatility index (VIX) needs to break AT LEAST 60 again, preferably 70. Look at how tame it still is:

3) Investors need to buy more puts and fewer calls. Everyone is gloomy, yes, but they are not worried enough about a major decline from here. When they give up on trying to time the bottom with calls and desperately try to short or protect themselves with puts, that will be the bottom.

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35 thoughts on “Not the bottom

  1. I’m surprised we didn’t get a bigger bounce today. Guess all the nervous shorts have already covered. Either that or they are getting cocky?

  2. Mike -

    What is your opinion on Treasuries right now? Looks like all the bailouts maybe taking a toll on the interest rates. TIA.

  3. They will, eventually, but the market isn’t really driven by news like that in a way you can profitably trade. I am not playing treasuries at the moment either way, because I think they could either rally back up a bit or fall a few more percent from here. I am leaning towards falling before rising again. The news has zero relevance — just look at charts and market sentiment.

  4. Mike,
    Congrats on the accurate analysis and hitting your SP680 goal. It has been a pleasure following your blog.

    1. How low do you think we can realistically go? ie. might we be looking at an 80%+ multi-year sell-off a la Nikkei 1990-2008 and the Dow 1929-1932.

    2. Since government spending as a % of GDP continues to increase and add inefficiency to the economy, is there any realistic hope for a long term increase in overall corporate profits driving the markets higher or do the markets just stay flat except for bear-market rallies?

  5. Hi Leonard. Thanks for the kind words. It has been quite ride, but it is not over by a long shot. I have a bunch of limit buy orders on SPY and various other things that look very compressed, but they will only be filled if we get down SP620 to SP525.

    To answer your questions, yes, we will be down over 80%, if not 90%, and the Nikkei should keep falling for a while too. The timing should be much more swift than Japan for obvious reasons — this is the BIG ONE for the whole world, not the bursting of a localized bubble.

    As for #2, you are absolutely right. Most people, even bears, have no idea how low SP earnings will go and how slowly they will recover. I think on a multi-decade scale, we will be looking at a flat market, with lots of cyclical bulls and bears.

    That is not to say that this coming rally won’t be intense — that’s why I’m preparing to go long. Bear market rallies from highly compressed conditions can give you 20 to 50 percent in a matter of weeks, but then then can take many months before succumbing to reality and rolling over again.

    So I assume we do something like this: SP goes under 600 by the end of the month if not next week, then we rally to 800 or higher by summer. The market peters out and we have a devastating crash later in the year or in 2010. This one will be like the last 18 months but swifter and things will really come apart — SP may reach 150, but things like futures and options may break down and shorting will be banned, so it will be wise to get out and get safe before then.

    Then we finally hit SP sub 100 after a bit of a rally, and after that, who knows? We’ll have to take it as it comes, but the market may be the farthest thing from our minds at that point.

  6. Andy is here Bridget. Hope ya folks din’t miss me :-)

    I am still a gold bull. Corrections happen in bull markets. So what? And I knew we were ready for one which is why I locked in my profits. You just HAVE to get your timing right (it takes time, but its possible) with Gold and keep a manageble amount of leverage to take care of the volatility. This correction in Gold may be over or it may go on for sometime more, but I am willing to go on record here that the next target for Gold is $1050 followed by $1200 – and that’s just for starters. We just might see $2000 gold this year.

    I also plan to short the crap out of the crash that is about to occur now (is occurring now). I have pyramided some puts starting in Feb, so I won’t lose much even if things don’t go as planned, but lots of profits if they do. I also intend to pyramid Gold all the way using leveraged positions, of course keeping leverage to manageable proportions.

  7. And for all you folks holding cash out there thinking its “safe”, I just want to tell you that the safest form of cash to be in is Gold, and not soon-to-be-worthless paper.

  8. I know a lot of the thinking on this blog is influenced by Robert Prechter, but with all due respect he didn’t and doesn’t “get it” about Gold. This from wikipedia:

    “Recently, Prechter has missed the latest portions of the rally in gold and oil. In July 2006 he asserted that gold had reached its peak and that oil, then around $70 bbl, also had peaked in price. His analysis was clearly flawed, as oil in late May 2008 reached $135 bbl and gold was at $925/ounce.”

    Mish claims to favor Gold, but his theory behind it can be considered wobbly at best.

    Both of them are deflationistas favoring a bull market in the dollar. What they ignore is that the dollar today is just another fiat currency, just like the rest of them including the Zimbabwean dollar. Today’s dollar is a different currency from the one before ’71. All they did was keep the name. They might as well have named it something else. Also, for those deflationistas pointing to the recent correction in Gold prices and saying “I told you so”, I would like to remind them that the correction wasn’t nearly as pronounced in other fiat currencies. I am not trying to diss anybody, just pointing at the facts as I see them.

    What’s happening now is plain and simple dollar deleveraging/short covering. And – this may seem blasphemous – but it doesn’t matter what the quantity of money in circulation is – all that matters is the quality. And we know what the quality of today’s fiat currencies is. This is why no matter how much money is destroyed in this deleveraging phase, Gold will keep on rising.

    I rest my case.

  9. Deflation is happening, but in terms of Gold, not the dollar or any other fiat currency. So you can say I am a “Gold deflationist”, while others are “dollar deflationists”.

  10. Tom, thanks for this chart. It is excellent. It is now undeniable that out of the last century only the 1930s provide a precedent for our current conditions, from economic indicators to the stock market.

  11. Yeah, that was something. I closed my short silver contracts at 12.11, then started to short the rally only to get stopped out.

    Kind of shocking to me that the Fed can still move the markets like that, but I guess we were primed for a short squeeze in the metals and bonds. Will be interesting to see if their downtrends are really broken or just set back.

    Equities are very tricky here. We now have to strongly consider that this rally has legs — maybe not the kind to take us anywhere near SP 1000 (we never got the washout I think would be necessary for that), but maybe the high 800s before rolling over. Or maybe we just chop around the 700-800 range for a while. Nasty stuff.

    Whatever the case, we’re pretty overbought on a short-term basis.

  12. Mike,

    “I am not playing treasuries at the moment either way, because I think they could either rally back up a bit or fall a few more percent from here. I am leaning towards falling before rising again.” Mike on March 5th.

    Any new thoughts on T-bonds now that Uncle Ben has made his move?

    I bought TBT over a several day period and averaged about $38 when you first recommended it a long time ago. I am thinking of adding to the position for no real sound reason other than I think most of the buyers of long-bonds are going to get spooked at some point by all of this nonsense.

    I don’t do in and out stuff, I just take positions and then hold them for a long time. I averaged into gold from 1996 to 2006. I don’t know what the average price was but I would guess about 400-425.

    I bought a position in GDX when Mish recommended it and averaged about $26. I just thought at the time that gold had not come down all that much and the cost of mining had come down a bunch. My gut tells me GDX will go irregularly higher for the next five years.

    Tom

  13. I’ve always suspected that the bottom was not in for yields, but whether this move takes us back there is up for debate. My gut says that today was a head-fake and that we see fresh lows for t-bonds first.

    TBT and other such inverse ETFs are not buy and hold vehicles. Your timing has to be just right, and you have to take profits on the first move in your direction. I held TBT for about 2 weeks as I remember.

    Take a look at the choppy but down-trending 12 month history in SRS and compare that to the devastation in IYR or the Dow Jones Real Estate Index, of which SRS is a derivative. Or compare QID to the Nasdaq 100 or TWM to the Russell 2000 or SDS to the S&P500. These things are trading instruments only, which is unfortunate since they are so attractive to regular traders who take them at face value.

    I’m still short GDX and the metals, based on techicals only. No problem with a very long term hold here, but for that I highly favor the actual metal.

  14. Mike,

    Thanks for the advice on TBT. I do remember you getting out of the trade after a short time. I just wanted to leave the position on for a longer term move.

    After going back and reading your post on the math, even though I did not completely understand it, I definitely want to move out of TBT and into a more appropriate vehicle. Are there leaps puts on 20 and 30 year bonds?

    Tom PS – I guess I am one of the knuckleheads mentioned in the comments section of the post on inverse ETF’s. :-)

  15. Anbody who’s short PM’s at this point has to be insane in my book. The dollar and treasuries are FINISHED. Game Over.

  16. “Anbody who’s short PM’s at this point has to be insane in my book. The dollar and treasuries are FINISHED. Game Over” … Tells me PM’s need a breather…

  17. To all the PM bears:

    Corrections don’t mean the end of a bull market. In fact, they are the sign of a healthy one. As a matter of fact, Gold has “corrected” all the way from $250 an ounce in 1999 to $952 as of today’s close. A bull likes to shake off as many riders as possible – but I guess you are already off. Thank you.

  18. And when I say “The dollar and treasuries are FINISHED. Game Over”, my horizon is at least 6 months to an year out, as opposed to the next minute.

  19. Andy, please don’t post here anymore. You’ve never contributed anything, and you’ve gone from annoying to just plain rude.

  20. I guess your definition of rude is someone who doesn’t agree with you all the time. Not a healthy attitude, IMHO. Surrounding yourself with sycophants to avoid facing the reality is a good recipe for failure. Sayonara.

  21. Nominally, I think the bottom would be around 350-500. (It could get lower, and I am not much of a bear that Mike is.) But, I do expect the general equity market to have higher dividend yields as this reflects increased discounting by the general population. I expect dividend yields for the general market to be at least 200 bp higher than 10 government year bonds as the market because less liquid as there would be less market participants (so stocks would also have a “liquidity premium”). I also expect the market should not price in economic growth too and the 200 bp number will also be applied to companies with solid cash flow and little debt too. Those companies might lose nominally in the future, but of course, they would outperform others. In addition, a sell-off of dollar denominated fixed income assets would also lower prices as this drives up yields and exacerbate deflation further. I do not expect a level of sub 100 because unlike the NASDAQ bubble, many of these companies do something for cash flow, and I do expect many of the companies removed by the Darwinian flush to be delisted and replaced with stronger companies.

    But the best answer for when the bottom would occur would be in the form of a rhetorical question without an immediately quantifiable answer, and as Mike pointed out, one has to consider game theory considerations. (He said look at the VIX and the put/call ratio which provide information about market participant’s sentiment.) The biggest question one has to answer is when the Darwinian flush of the equity markets would finish. This is not a question of valuation (as stocks are not solely valued on valuation, but on discount counted cash flow according to the standard Gordon mode), but again a large part is based on people’s time preferences. Since people do not save as much in the US, the discounting rates would be higher than in the Japanese deflation which would have a stronger short term effect on stock prices causing the decline to be quicker. Also, in Japan, these was less labor competition and securer jobs after the asset bubble burst which is another reason for increased discounting. The deflationist paradigm has help those who embraced it understand this crisis. Another way to ask is to question when would everyone realize that buy and hold many work for some people, but not work for everyone? When people start realizing that equities have downward volatility in long run as well as the short-run as evidenced by the Japanese equity market for the last two decades? When do people who are saving for education, housing, and retirement leave the equity market (in a way similar to a Darwinian flush) when they realize that “long beta” is a bad “investment” “strategy” as they start demanding liquidity? Even people who are currently bullish (in the long term, not technical people who go long in anticipation of a bear market rally) on equities argue that if you need liquidity, then do not put money in the stock market. (see this example of a bullish view on equities, and it is the best argument I see for being bullish on equities, but it hasn’t convinced me: http://www.huffingtonpost.com/james-berman/reports-of-the-death-of-e_b_173460.html)

  22. I have left-wing political views (I merely say this as a disclaimer as it might cloud my empirical views, but hopefully my political preferences should be separated by my empirical perspective), and I am not a gold bug, but I do love your bearish arguments for gold (in the short term). Here is an argument supporting your bearish case on gold.
    http://www.creditwritedowns.com/2009/03/drug-suspects-show-ben-bernanke-how-to-drop-helicopter-money.html

    Apparently, people risk their lives to pick up Federal Reserve Notes which reflect higher short-term discounting rates.

    However, I want to see your counterargument against my argument against your gold bearish thesis:

    “I do not know if there will be a massive sell-off in gold because the key question is who is buying it, and how leveraged they are. I doubt the people who are buying the gold now are likely to sell it in a few years, and these people, I speculate, are generally wealthy so they could take a “paper” loss if gold falls in “value.” It is unlikely that this would facilitate panic selling (you did not argue for this though.)

    I doubt those people would sell gold now due to a lack of liquidity, since they presumably have other assets with the necessary liquidity.

    The gold market would be illiquid, and its price would be decided by a few number of bidders and sellers as most of the people who are holding gold or rolling over the futures (they might pay a small premium if there is a contango) because they hold it for diversification reasons to hedge against certain non-trivial outcomes where gold would have more utility. Of course, those people probably have flatter discount curves so they are willing to hold the gold.

    Basically my argument against your hypothesis is that these people do not struggle to pay debt or bills so they do not have an immediate need to convert gold to cash. (Taxes might be somewhat different.)”

    In other words, I do not think a large portion of gold buying is speculative. These people will not demand liquidity in the gold market, so they would not put downward pressure on gold prices. I also want to know the discount rates of most of the gold buyers. Are they as Mike speculated high, but above, I think they might be lower than what Mike thought.

  23. d
    In addition, I also love this counterintuitive argument that gold would rise (since it is not used by many gold bugs). Essentially, the dollar would not collapse against gold, but evaporate. Traditionally, currencies collapse when the velocity of money increases (MV=PQ according to monetarist theory) and this causes hyperinflation, but the argument goes that the velocity of gold would increase, thus increasing its utility, while the velocity of FRN would fall as it would be used in less transactions.

    Sorry, Mike, I had to use the word discounting a lot. It is a very simple theory (more specially “hyperbolic discounting”) that few people understand (like Darwinian evolution in the biological sciences) that explains a large amount of information using a simple heuristic rule.

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