Monday, December 22, 2008

Potential bearish breakout

This chart of the S&P 500 index says it all. (The S&P has broken downwards through a bottom trend line.)


By the way, my second purchase of GRZZX was processed on Dec. 17th at a price of $8.67 per share, so my average purchase price was $9.02.

Tuesday, December 16, 2008

Do you see what I see?

The S&P 500 index closed at 913 today, which is the highest closing price since the November 20 low of 752. More importantly, the index climbed more than 5% in one day, erasing the gradual decline of the previous five trading days.

Just two weeks ago prices were forming a small bullish pattern of a gradual rise interrupted by a brief, steep correction. The past six days reversed this trend, sporting a gradual decline that ended with a big single-day rally. In other words, the charts are starting to look bearish again.

Tomorrow I will transfer another 25% of my Roth IRA funds to GRZZX.

Sunday, December 14, 2008

Too much optimism about stock prices

It's Grizzly Time.

In the last couple of weeks, short-term optimism about stock prices has become almost as great as it was back in May, when the S&P 500 briefly topped 1400 before swooning to new lows. In addition, the short interest ratio, which quantifies the fraction of investors who have made longer-term bear market bets, is at a multi-year low. When these factors are coupled with an S&P 500 forward P/E ratio of 21 for the 4th quarter of 2009, it just doesn't make sense to stay in cash any longer.

The positive money flow and breadth that I mentioned last week are still in play, but in my book sentiment trumps other factors in a tie. Besides, stock prices have been strangely flat despite the bullish internals.

On Monday I will direct 50% of my Roth IRA savings to the Leuthold Grizzly Short Fund (GRZZX), which means the purchase probably won't happen until Tuesday. In my taxable margin account, I will sell short the leveraged 2x bull fund SSO, instead of buying the 2x bear fund SDS. This way I will actually get a boost in my returns if the derivatives market implodes.

There's a good chance that world events will sabotage my timing, either by crashing the market on Monday before my purchase is made, or by an auto-bailout-Wednesday that rallies the market right after I've taken a bearish stance. These things happen - especially in a market as volatile as this one.


December 15 update: It's just occurred to me that I may need the cash from my taxable account in the next few months - both to fund my Roth IRA for 2009 and for other things - so I'm not going to short SSO this time around.


December 16 update: My opening position in GRZZX was priced at $9.23 per share.

Monday, December 08, 2008

A rally with legs

The S&P 500 closed at 909 today, which is a 21% gain from the closing low of 752 on November 20.

I'm not even suggesting that the bear market is over, but a few characteristics of this rally indicate that it will last a while longer. Money flow is more positive than it's been since September, and breadth has been solidly positive for multiple days in a row. Most importantly, the chart could almost be mistaken for a bull market rally, if not for the insanely high volatility. Instead of the bearish norm of a few big up days interrupting a gradual downward trend, the last two weeks have seen a series of relatively small up days with one big downward "correction" on December 1.

So, although there's been growing optimism about stock prices, I'm inclined to respect this bear market rally until I see more signs of weakness.

Wednesday, November 26, 2008

Cheering on the optimists

This week's rally has caused a short-term spike in optimism, and if this bullish sentiment can just hang on for several more trading days, then I will finally have an opportunity to buy into GRZZX and make low-risk money on the next market slump. So please - everybody stay cheery!

Monday, November 24, 2008

Two days instead of one

This time around the huge 13% gain in the S&P 500 took two days (Friday and today), which is a little slower than rising 11% in one day. I suppose that's slightly less bearish for the market.

Slightly.

Sunday, November 23, 2008

Downward Acceleration

The S&P 500 index has actually been accelerating downwards since late October.

At the same time, investors are becoming pessimistic again by more than one measure, and this can fuel an eventual short-to-medium-term rally. As I've said before, this is still a bear market, and I'm only interested in buying a bear fund (GRZZX) at the end of a sucker rally when optimism is high. So, for the time being I'm still sitting on the sidelines.

Thursday, November 20, 2008

April 14, 1997

... That's the last time the S&P 500 index closed lower (743) than today's close of 752.
  • The dot-com bubble and the crash that followed played out entirely at higher prices than today.
  • The 2002-2007 bull market has been completely erased.
  • The infamous market low on October 9, 2002 would be an improvement now.
If eleven-and-a-half years with no capital gains doesn't shake one's confidence in buy-and-hold investing, then nothing will.

Wednesday, November 19, 2008

Less than 4% to go

On October 9, 2002, the bear market that deflated the tech/dot-com bubble reached its all time low, with the S&P 500 index closing at 776. Five years later to the day, the S&P reached its highest ever closing price of 1565, amounting to a 101% gain. Today the S&P closed at 806, which is less than 4% away from completely erasing the gains of that five-year bull market.

Something has to eventually shake up the emotions of investors, either positively or negatively, to get the market to move in the same direction for more than 10 days, and passing below the 2002 bear market lows may be just the catalyst. Such a dispiriting event could trigger a new group of investors to give up on stocks, drive the market even lower, and create the conditions for a rally with legs. Granted, this is simply hopeful speculation, but without any solid forecast to pass along, the next best thing I can do is describe possible scenarios.

Monday, November 17, 2008

Tedious

We've been here before, and it's just as boring for me to write this as it is for you to read it.

The S&P 500 index is once again bouncing around inside of two converging trend lines. The chart below shows the closing price at the end of each trading day for the last two months.


The 850 price level has been a solid floor so far, and the neutrality of my market indicators turns out to have been prescient after all, because stocks have been without direction for more than a month.

So, in lieu of something more interesting to say, here's some entertainment courtesy of the late Donald O'Connor:

Thursday, November 13, 2008

Twofer Thursday

Today the S&P 500 index passed below 820 for the first time since October 2002 (a new low), and then rallied 11% in only 3 hours to close at 911 (an insane rally).

The bear market continues.



Wednesday, November 12, 2008

Back to the bottom ... again

Remember the +11% day on October 28? The S&P 500 is less than one half of one percent from erasing it completely.

It's also only 1.5% away from reaching the all-time intra-day bear market low of 840.

For the umpteenth time: I never make bull market investments in a bear market.

Tuesday, November 11, 2008

Neutrality

Just about everything is in neutral right now. Not only is the S&P 500 index lingering in the 840-1000 range, but the short-term market indicators that I watch are also at intermediate levels - neither bearish nor bullish. Sentiment indicators were moving into optimistic and bearish territory earlier, but the recent retreat of the market has pulled them back.

In the meantime, the long-term trend is still a bear market, and the odds favor the market falling further before reaching bottom.

Friday, November 07, 2008

Bouncing around and going nowhere

On October 7, the S&P 500 index closed below 1000 for the first time in this bear market. Ever since, the S&P closing price has rattled around between 840 and 1005. Anyone who has been in either stocks or bear funds for the past month has seen some wild swings in their investments, but no large gains or losses in the long run. Despite protests from both bearish and bullish readers of this blog, I've been in cash the whole time.

Tuesday, November 04, 2008

Narrow mini-trend

The S&P 500 index has been trading in a narrow rising wedge pattern for five trading days now, and has gained almost 20% since its intra-day low of 840 on October 10. Optimism is steadily increasing in the sentiment indicators as well, so I think this is setting up an opportunity to invest in GRZZX and make money on the next slump.

p.s.: I will let readers know here when I buy GRZZX.


Monday, November 03, 2008

Election eve

While tomorrow's outcome may affect stock prices on Wednesday, I doubt it will have an effect on the current bear market trend. On the other hand, the new President may very well affect long-term prices over the next several years, but I'll leave that for a later post.

Friday, October 31, 2008

Last days of the 401(k)?

A policy change being discussed by the political classes could affect the profitability of investing in stocks, and could therefore create long-term downward pressure on stock prices. Congress is considering eliminating the tax savings on 401(k) contributions and returns, and is discussing a plan to allow workers to replace current 401(k) holdings with a guaranteed retirement account composed solely of government bonds.

If these plans were put into effect, there would have to be another wave of sell-offs in the stock market as investors pulled out of their 401(k) stocks and mutual funds. There would also be reduced buying pressure in the stock market over the long haul since monthly deposits normally destined for 401(k) stock purchases would be going to the new guaranteed government plan instead.

With that potentially seismic change looming, I'm in no hurry to declare that the bear market is over.

Thursday, October 30, 2008

O.K. - It's a breakout.

The S&P 500 has officially broken above the declining tops line.

If this "rally" gets momentum behind it, then I will wait for it to top out and invest in the Leuthold Grizzly Fund (GRZZX) to make money on the next slump. I know some of you have already opened bull market positions to make money now, and I wish you luck.

Tuesday, October 28, 2008

Big up day #837

There are two reasons not to get too excited about today's nearly 11% gain in the S&P 500 index.

First, huge up days like this are not healthy for the market in the long run, as has been made painfully obvious several times earlier this year.

Second, the breakout above the declining tops line is tiny at best, and could be just another head-fake.

Saturday, October 25, 2008

Reader poll: Reduce government control

The poll on government controlled corporations has closed. Out of 43 respondents, 32 answered that the number of companies controlled by the government should be reduced. Perhaps there's still hope for free- market capitalism after all.

Friday, October 24, 2008

Running out of wiggle room

For the past two weeks, the S&P 500 index has wandered between a declining tops line and a (presumably) lower support line at 840.

One of these limits will be broken in the next week or so. If the index passes above the declining tops line, then that would signal that the 840 support line will last for a while. A dip below the 840 support line, however, would open the door to further losses.

In early August the chart pattern was the reverse of this, with a resistance line at 1292 over a rising bottoms line. The S&P 500 actually did a head fake in that case, as it rose through the resistance line on August 11 before turning around and beginning the plummet that we're still in today.

Thursday, October 23, 2008

First rule in a bear market: RELAX

IT'S UP!
IT'S SIDEWAYS!
IT'S DOWN!

WHAT DO I DO????

Relax. Keeping your head clear in these market conditions will give you a big contrarian advantage over all of the other investors who are pulling their hair out right now. When everyone else is complacent, like October of last year, that is a far better time to be on edge.

Because bear markets are relatively unpredictable, I only put my money in a bear fund when it's obvious that the next drop is coming, like it was on May 21st and August 19th.

Until the indicators align like that again, I will remain in cash.

"But what if the market goes down? You should be in GRZZX!"

"But what if the market goes up? You should be in SSO!"

No-no-no. That's a great way to get an ulcer and big doctor's bill. Here's how I see the future when I'm floating on my peaceful pile of cash (or short-term treasury fund):
  1. If the stock market goes up from here, then that will simply set up the next predictable drop, and I'll make money on the downside with GRZZX.
  2. If the market falls from here, then that will make the dividend yield of the S&P 500 even higher when I eventually get back in to stocks.
  3. If the market goes sideways like it has been recently, then who cares?
Sure, this means I'm in cash sometimes when the market makes a big move, but more importantly it means that I'm much less likely to suffer a big loss by going out on a limb when the indicators aren't in alignment.

Yes, I'm Baloo the Bear when it comes to timing a bear market. Day traders and risky-rally-riders will have to look elsewhere for advice.

Tuesday, October 21, 2008

Nothing decisive in the charts

I don't think the market has picked a short-term direction yet. If that's a breakout above the declining tops trend line then it's not a very convincing one.

Sentiment indicators are on the pessimistic side, which forecasts a rally, but that's been the case for the past few weeks. So much then for sentiment forecasts during a bear market!

Gasoline below $3

It happened so quietly I almost didn't notice it, but for the first time since February, the average price of gasoline in the U.S. has fallen below $3.00 per gallon. In an earlier poll on this blog, only five out of 54 respondents predicted that this would happen, so congratulations to those contrarians.

I don't usually try to predict prices based on future world events, but in this case I'm going to make an exception. Even with a slowdown in the economy, I don't think that these lower oil and gasoline prices will last any longer than a few months. The Middle East has been unusually quiet recently, and that reminds me of the optimistic/complacent conditions at stock market tops. The more complacent people feel now, the bigger the effect will be when panic returns.

Wednesday, October 15, 2008

Back to the low point

The stock market has returned to the bear market lows of last Thursday's and Friday's closing prices. Either this concludes a very quick sucker rally on the way to new lows, or the market is testing these levels again before a more significant bear market rally gets going.

Did I mention I'm staying in cash?

Monday, October 13, 2008

Huge bounce at 8500; Sucker rally begins; GRZZX awaits

I think we're at the bottom of the first waterfall.

The Dow Jones Industrial Average (Dow 30) closed at 8579 on Thursday and 8451 on Friday, and then rallied more than 11% today to close at 9387. This looks to me like the start of the next sucker rally in the bear market, and that puts the first big bounce less than 1% away from my bottom call (8500) made back in January.

I don't think that this is the bottom, and I don't think that the bear market is over. In fact, if my market indicators cooperate in the coming days and weeks, then my plan is to buy GRZZX at the next top (no higher than 11,000) and then ride the market down to the next low, which should be in the vicinity of 8500 or lower.

Pick up the pieces

Consider how much effort has been wasted by stock pickers and market experts over the past several years.

My early mentor Bob Brinker has held on to his Market Timer mutual funds for this entire drop in the stock market, and it has nearly wiped out all of his gains since the previous market bottom in 2002-2003. Month after month, for $185 per year, he's discussed inflation, money supply, unemployment rates, earnings forecasts - and he never once concluded that stocks were over-priced.

In the middle of the day on Friday I visited the Motley Fool website and was bowled over by what I saw. They have several monthly stock- picking news letters with multi-year track records, and as of Friday all but one had resulted in net lifetime losses for their subscribers. The only winning newsletter was sitting on a total gain of 3%.

Over the years the Fools have made hundreds of stock picks, written thousands of pages of analysis and earnings calculations, and conducted dozens of interviews, and yet they would have done their subscribers better to simply recommend cash or Money Market funds until stocks reached more reasonable valuations. Instead, the Motley Fools have been some of the most vocal proponents of stock buybacks, and have always managed to conclude that stocks were good investments -even at the tops of both the 2000 and 2007 bubbles.

The folks over at Bespoke published an eye-opening table on Friday showing the forecasts for the S&P 500 from the top investment strategists on Wall Street. In January, when I made my S&P 940 call, the "experts" were predicting anything from 1525 to 1700. Even on Friday the forecasts were still between 1300 and 1500.

I don't know if Bespoke is a proponent of Fibonacci grids or not, but they've also published a chart of the Dow 30 diving through Fibonacci support levels like the phantoms that they are.

It's strange that people cling to various fantasies about how the market works, but those of us who know better can take advantage of the bubbles and crashes that happen as a result.


Saturday, October 11, 2008

Election prediction: comfortable win for Obama

This is a follow-up to a previous post on the Presidential election polls, and will probably be my last word on the election. John McCain's poll numbers have fallen through the rising bottom trend that represented his last chance to keep the election close, and his next lower "support level" is around 41%. Barack Obama's poll averages meanwhile have reached the 50% threshold, and his lower support level is around 45%.

Assuming that the final election results fall in the middle of the long-term channels for both candidates, my prediction is a 3% margin of victory in the popular vote for Obama on November 4. There's a good chance then that, for the first time since 1996, we'll know who wins the election before midnight on Election Day. Imagine that!

Friday, October 10, 2008

Prediction comes to full fruition: Dow passes 8500

Who woulda thunk it? Maybe I should stop calling my long-term forecasting method "experimental" and move on to "working prototype."

Historic

This will be something to tell your grandkids about.

It's obvious now that our economy was propped up on a mortgage bubble that made people feel more wealthy than they actually were, and this probably affected the prices of all kinds of things beyond houses - including stocks. However, every stock market bubble also requires some kind of fake justification in order to form, because even rich people don't want to buy something that they think is worthless. The 2000 tech bubble was propelled by creative earnings calculations (Enron for example) and by an awe for all things dot-com, as if human enterprise would suddenly expand at breakneck speed because clicking had replaced the mail order catalog. The buyback bubble that's almost in our rear view mirror was justified by "experts" who assured us that higher stock prices - inflated by share repurchases - were just as good as the dividends we used to collect.

When it comes to investing, nothing beats simple cash payments from profitable corporations to stockholders. As the old saying goes: a bird in the hand (cash dividend) is worth two in the bush (expensive unsold stocks).

Thursday, October 09, 2008

The market will not be denied

Marvel at what we have witnessed:
  • A $700 billion bailout
  • Countless "liquidity injections"
  • Bans on short selling
  • Multiple interest rate cuts
  • Nationalizing mortgages (Freddie Mac and Fannie Mae)
  • Nationalizing insurance (AIG)
  • Nationalizing banks (potentially)
None of it made squat bit of difference when it came to the prices of stocks. Buyback-inflated prices are inflated prices no matter how much money gets passed around from the taxpayer to the Treasury to the Fed to a mortgage-strapped bank. I'm convinced that one reason I was able to foresee this huge stock market drop - even though I wasn't yet aware of the magnitude of the mortgage meltdown - was because I realized that stocks were overvalued relative to the good old boring dividend yield. The facades of buybacks, low yields, and P/E ratios over 15 are finally crumbling before our eyes. Good riddance!

I want to calculate the amount of money wasted on buybacks over the years, but the market keeps dropping and expanding the time range over which the wasted buybacks were made, so I'll just wait for the first bottom to form.

Right now the S&P 500 is lower than it was on July 3, 1997, and is also approaching the vicinity of the absolute bear market lows of 2002-2003. If the market keeps dropping, then average stock yields could rise to the historical upper range of 6%, or even the rare level of 10% not seen since the Great Depression. If that happens, then you won't need me or any other guru to tell you what to do; for the first time in 25 years, stocks will be good investments that you can buy and hold and forget. We're not there yet, however, so market-timing is still the way to go for now. I've been in bear funds and cash ever since my January forecast, so I've fared better than most so far this year.

One half of my long-term prediction comes true: S&P 500 index passes 940

It was all the way back on January 22nd that I made an experimental long-term forecast for the stock market. I predicted that the Dow would fall to 8500, and the S&P would reach 940.

The S&P 500 index has crossed the threshold today, and as I type the Dow isn't far behind at 8700.

I am not calling a market bottom today. For all I know the Dow could keep plunging to 5000 from here, and then my forecast would only be semi-prescient.

Tuesday, October 07, 2008

Groundhog Day

The S&P 500 index passed below 1000 today, closing at 996 and falling ever closer to my low prediction of S&P 940 made all the way back in January. The very first time that the S&P 500 closed above 1000 was . . . .

February 2, 1998.

The steepness of the stock market's fall - 20% in 12 trading days - is finally starting to resemble the action at a major low. However, even if a multi-week rally begins tomorrow, this low will not necessarily prove to be the low. I will remain in cash until the end of the next rally (whenever it occurs) at which point I will make my first investment in GRZZX, the derivatives-free bear market mutual fund. I don't know when that opportunity will come, so I'm not holding my breath.

The thing about being 100% in cash is that, no matter what other investors are going through, every day looks exactly the same to me.

Monday, October 06, 2008

One step closer to a bull market

One of the requirements for changing a bear market into a bull market is for large numbers of normally bullish investors to change their minds, give up on the stock market, and cash out of their stocks and funds. This event causes prices to plummet to more reasonable levels, and also creates a reservoir of reluctant sideline cash which will fuel future price gains.

This morning Jim Cramer, an influential stock picker on CNBC, officially declared himself long-term bearish. To the extent that his followers take his advice and cash out, this will help to accelerate the bear market to its conclusion, and start the next bull market that much sooner.

Is today a good day to get out of stocks?

Unfortunately there's no good answer to this question. At panicked times like this it is likely that (1) if you stay in stocks, the market will keep falling and you will lose more money; yet (2) if you cash out of stocks, the market will quickly turn around and have a short-term rally, and you'll be kicking yourself mercilessly. This is not evil karma, but is actually how the market works. It's why I've spent so much time in cash recently.

The best days to get out of stocks are the days when NOBODY is panicking, like May 21 (Dow 12,601) and August 19 (Dow 11,348) - two times when I went even further and bought or held an inverse/bear fund.

Please understand I am not trying to rub anyone's noses in anything. There are many market refugees checking in today, so it's a logical opportunity for me to explain to some new visitors how things work.

Another Big Monday

Here we go again. It's Monday morning, and we're waking up to huge stock market losses in Europe, Asia, and U.S. stock futures.

I don't wish investment losses on anyone. It reduces wealth, delays retirement, and generally disrupts life. However, these stock market losses are going to happen eventually - it's simply a question of who cashes out first and when. The sooner and steeper the plunge, the sooner stocks become good investments again, and the sooner the bear market comes to an end.

Remember that there are at least two bubbles being burst simultaneously in this bear market: the mortgage/financial bubble, and the buyback bubble. That's a lot of hot air to get rid of.

Friday, October 03, 2008

Bailout passes Congress - Market falls to new low

How about that? Congress passed the $700 billion bailout bill, the President signed it ... and the S&P 500 fell below 1100 to a new bear market low anyways.

It's time to repeat some talking points:
  • A bear market is a bear market is a bear market.
  • I never go long (I don't invest in stocks, SPY, etc.) during a bear market, even if short-term indicators say that a rally is on the way.
  • I never let big news items influence my investment decisions. The only information that matters comes from the stock market itself.
By the way, today's close of S&P 1099 is only a 14% drop away from my January prediction of S&P 940. The Dow meanwhile is 18% away from my prediction of 8500.

Thursday, October 02, 2008

Poll trends

This has nothing to do with the stock market, but I'm interested to see if trend lines can be as predictive in election polls as they are with stocks.

The 2008 Presidential election polls - as computed by the Real Clear Politics website - do indeed seem to be following trend channels. Barack Obama's average poll numbers (blue) have been rising about 3% per year, in a channel about 5% wide. John McCain's major trend channel (red) is almost 8% wide, and has also been rising at a rate of 3% per year.

On shorter time frames, McCain's average poll numbers have formed two sub-trends. (yellow) A declining tops pattern began in January and was broken just after the conventions. A second rising bottoms pattern began at the end of June, and McCain's latest poll average is now sitting right on that line.

If I can apply the same rules to these trends, then I think next week could decide how tight the election will be. If McCain's ratings bounce off of the new rising trend line then it would confirm that McCain and Obama are in the same neighborhood, and would make for a close outcome. However, if McCain's average numbers fall below the trend line at 43%, then that would bring the long-term 8%-wide channel back to life and give Obama the clear edge.

Maybe I'm crazy to even try this, but there's no denying that poll numbers and stock prices are both determined by news-driven decisions of millions of emotional people. We'll see in a month.

Wednesday, October 01, 2008

Temporary ban on short selling extended

The SEC's temporary ban on short selling of 800 stocks has been extended to "no later than October 17." So sleep tight, everyone. There's nothing to see here.

Typical turbulence

The bumpiest part of any trip over a waterfall is at the bottom, and the same is true for any large decline in the stock market. The current leg of the bear market began on August 11 at S&P 1305, and was as low as 1106 (-15%) after the market close on Monday. The big bounce on Tuesday (+5.2%) following Monday's historic plunge (-8.8%) dovetails with the theory that the market is near a short-term bottom.

Monday, September 29, 2008

Recap of a big day

The S&P 500 index fell 8.8% today. The Dow 30 index (which has a longer track record) fell 8% or more only eight other times in the last 80 years: twice in the 1987 crash, three times in the 1929 crash, and three times in the great depression that followed. The market rose on the next day in six out of those eight cases, but obviously that's little consolation in the long run.

By the way, financials fell 10.7% today despite the ban on short selling. Go figure!

One sentiment indicator reached an all-time record level of panic today, and volume was actually less than it was on three other down days this month, so there are signs that the bear market will pause to take a breath soon.

Serenity now!

One week ago today I was selling the last portion of my SDS position in a three-day sale that spanned September 18, 19 and 22. Congress announced the possible bailout plan on the afternoon of the 18th, causing the market to rally 10% and significantly cutting into my profits on the following two days.

Now the bailout has been rejected by the House of Representatives, and in response the market is falling to where it woulda- coulda- shoulda been on the 19th and 22nd. SDS rose 14% today, just 5 trading days after I cashed out.

Serenity Now!!!

New bear market low

The bear market just keeps plodding along. The S&P 500 index briefly touched an all-time bear market low of 1126 1112 after the House of Representative voted to reject the $700 billion financial bailout bill.

For some perspective, the index closed at the 1126 level on January 7, 2004.

It also closed at 1126 on April 21, 1998.

My next task is to calculate how much money was wasted on "price-enhancing" buybacks during these intervals...

Friday, September 26, 2008

Waiting...

I'm just sitting here with my cash, waiting for a resolution like everyone else is. You know something is up when Washington Mutual becomes the largest bank failure in U.S. history, and yet it isn't even the biggest financial news of the day. I have strong opinions about what the government should and shouldn't do, but that's not really the point of this blog. In the end, making money in the stock market means reacting to conditions as they are, rather than as we wish them to be.

Wednesday, September 24, 2008

Bears losing their shorts

1) Last Friday Rydex followed suit with Proshares and stopped purchases of new shares of its Inverse Financial ETF (ticker RFN).

2) According to Bespoke Investment Group, almost 20% of the stocks in the S&P 500 are now off limits to short sellers.

Volume trends forecast a rally

The market has fallen for three straight days, but trading volume has been relatively low and has grown gradually smaller each day this week. Conversely, the rallies on Thursday and Friday were accompanied by record high volume, so the last five trading days collectively are consistent with the start of a medium-term rally.

Before anyone asks, the answer is no!

ETFs still afloat

Several of Proshares' ETFs like SDS paid dividends today, which makes it appear in the charts as though investors lost several percentage points this morning. For a couple of minutes there I thought the major meltdown of derivatives had arrived, but all is well for now.

Monday, September 22, 2008

All cashed out

I'm 100% in cash now, waiting for the market to give me a sign. I might be waiting for a while.

My three sales of SDS on Thursday (81.63), Friday (64.05) and this morning (66.96) occurred at an average price of 70.88. Since I bought in at 66.72 last month, that's a 6.2% gain, or 3.1% for my entire account including the cash position.

Yes, it occurs to me that I would have done much better without the announcement Thursday afternoon that the government would absorb bad debt, and the short-selling stoppage on Friday morning. However, those events were simply unforeseeable, so I'm content to get out with any kind of gain.

Friday, September 19, 2008

It has begun

The first leak has sprung in the ETFs that use derivatives. Proshares' short and ultrashort financials ETFs (SEF and SKF) stopped trading for 2 hours this morning.

Proshares has made an ominous announcement about these two funds, saying that they are
not expected to accept orders from Authorized Participants to create shares until further notice. Unless notified otherwise, shares will be available for redemption by Authorized Participants as normal. The shares of these ProShares are expected to trade in the financial markets today, but may trade at prices that are not in line with their intraday indicative values.
This sounds to me like nobody will be able to buy any new shares, but that selling is still allowed. The important point is that this probably won't be the last Proshares stoppage.

That settles it for me. I'm selling the remainder of SDS (only 17% of my account) at my first opportunity on Monday. The Grizzly Short Fund (GRZZX) is my official bear market fund for the time being.

A real test

I've just woken up to the news that the SEC has temporarily banned all short selling on financial companies, and that S&P 500 futures are 10% above yesterday's low point. That would nearly bring SDS down to the price where I bought it last month, which is a bummer of a development in less than 24 hours. I'm going to stick to my plan of selling off the rest of SDS today and Monday - here's hoping Monday gives me another dip.

In the long run, this is one of those quick rallies which tend to be bearish for the market.

Thursday, September 18, 2008

The trend is still downward

Don't get too excited just yet folks. Sure, there have been some wild swings in the market this week, and today's biggest-gain-in-6-years is all the buzz. The big picture, however, is that the trading range of the S&P 500 index fell progressively lower in each of the last 5 trading days.

To top it all off, today's end-of-session rally was preceded by an all-time bear market low of 1133 on the S&P, so I'm not ready just yet to declare that the next rally has arrived.

Ca-Ching!

My market indicators are finally starting to choose sides, and one of them is pegged at maximum panic, so I've just cashed out of 1/3 of my SDS position, locking in a 21% gain for part of my investment. That means I'm left with about 1/3 in SDS and 2/3 in cash. Depending on what the indicators do, I anticipate selling off the remainder in equal pieces tomorrow and Monday.


Update: Sometimes it pays to be lucky. I sold my partial SDS position at exactly 1:00 PM today, very close to the market low (SDS high) of the day. Market bottoms, whether short-term or long-term, are impossible to time perfectly, and that's why I prefer spreading out my transactions over more than one day.

Corporate Bond Freefall

Here's a chart pattern you don't see very often. Let's call it "the cliff":

This is the iShares Investment Grade Corporate Bond ETF (LQD), which has fallen 15% in less than a week. Now, this only reflects a change in bond prices, and doesn't mean that corporations have reduced their interest payments to bond holders. However, it does mean that investors are worried that some interest payments are threatened.

This brings us one step closer to the derivative meltdown scenario. If and when corporations start to default on bond payments, then credit default swap obligations kick in, and cash-strapped bond insurers (like AIG) will be asked to pay up. What happens if insurers default? Nothing good, that's for sure.

Wednesday, September 17, 2008

Down. Definitely Down.

The S&P 500 index has set a new bear market low in each of the last three days. Or, in plain English: "The market is going down." That's really all I can say right now, because few of the other market indicators are giving me any guidance. I've got no trend lines to work with, no clear volume information, mostly neutral sentiment indicators ... I've got nothing! This means that I can't anticipate how much longer this downward leg will continue, and it will make it more difficult to identify the beginning of the next rally when it arrives.

Oh well. We're in a bear market, and for now my SDS position is very sparkly.

Tuesday, September 16, 2008

A bad dream in slow motion

Is this really happening? According to news reports, the Feds have essentially taken ownership of A.I.G., the nation's largest insurance company, in return for $85 billion of you-know-who's money. I'm sure the U.S. government will run a much tighter ship over there, since they have such a great track record of fiscal responsibility.

To sum up: Uncle Sam Big Brother cornered the market on mortgages last week, and is now the largest player in insurance. Viva la Revolucion!

Monday, September 15, 2008

A bear is a bear is a bear

The S&P 500 index has just closed at a new bear market low of 1192, which is a 24% loss from the October '07 peak. The SDS position that I bought last month is up 11% according to my online broker, meaning that I'm up 5.5% in one month when my cash position is included.

(Side note: The S&P 500 index is now lower than it was on December 13, 2004, when it closed at 1198!)

I'll re-iterate some important points here:
  • A bear market isn't over until the charts say it's over. No amount of hoping, justifying, or expert opinion on TV will change a bear into a bull.
  • News items like takeovers, bailouts and bankruptcies may create some big wiggles in the short term, but they have little influence on longer trends.
  • When in doubt, I go short (SDS, GRZZX) in a bear market, and go long (SSO, SPY) in a bull market.
  • For the love of God, don't go long in a bear market!
The bottom line is that a bear market is a bear market, and it doesn't make sense to treat it like anything else. Even though I've been getting no guidance from my short-term market indicators recently, I knew that my SDS position would eventually pay off.

Someone asked me why I didn't put my remaining cash into SDS today, and the answer is that there still isn't a bearish consensus among the indicators like there was, for instance, in May. I'm perfectly happy though, because right now I'm outperforming the Motley Fool newsletters, mutual fund buy-and-holders, Bob Brinker market-timers, and all-cash-wait-and-seers. My 50% cash reserve lets me sleep at night, as it turns any unexpected rally from a short-term loss into an opportunity.

Of course this is all predicated on my cashing out with a gain! That's what I have to work on now...

Sunday, September 14, 2008

Storm Watch

Will a major financial institution finally be allowed to go bankrupt? Sunday night headlines are suggesting that Lehman Brothers may have to be liquidated, despite weekend negotiations between the usual suspects to arrange for a rescue package. Given the recent string of bailouts and takeovers, a true bankruptcy of such a large firm may at long last spark some real panic.

In an earlier post I talked about keeping an eye out for unusual news that might herald a breakdown in the derivatives markets. In weekend articles about Lehman Brothers, I'm suddenly seeing words like "derivatives" and "swaps" that don't normally appear in every-day financial news. For instance, this appeared in Bloomberg.com:

Banks and brokers today held a session for netting derivatives transactions with Lehman, or canceling trades that offset each other, in case the New York-based firm files for bankruptcy before midnight.

"The purpose of this session is to reduce risk associated with a potential Lehman bankruptcy," the International Swaps and Derivatives Association [ISDA] said in a statement today.

Now, I have no idea what a "session for netting derivatives transactions" is, and this is the first time that I've ever heard of the ISDA, but it doesn't take a rocket scientist to see the big picture here. The bottom line is that a Lehman Brothers meltdown poses a risk to derivatives. Since leveraged ETFs like SDS and SSO use derivatives, their returns might be affected if a wave of defaults were to propagate across the market.

I don't think the full-blown emergency is here just yet, so I'm not dumping SDS. I would prefer to ride SDS to the end of the next decline, cash out, and then perhaps get into GRZZX at the end of the following rally, but that all depends on what the stock market does and on how quickly the derivative mess spreads.

Monday morning update:

Lehman Brothers, the 4th largest investment bank in the nation, has officially filed for bankruptcy. Its debt exceeds $600 billion. Wow.

European stocks are down between 3% and 5% today, and S&P 500 futures are down nearly 4%. The story was just the opposite last Monday after the Federalization of the mortgage industry. What a difference a week makes.

Friday, September 12, 2008

Earnings continue to slide

If future earnings have anything to say about the longevity of this bear market, then we're nowhere near the end.

Today the S&P 500 index is 20% below the October 2007 high, yet the projected P/E ratio for the end of 2009 (15 months from now) is 21, which is still highly over valued. That means the market would have to fall another 28% from here - down to 900 on the S&P - to reach the approximate historical average P/E of 15. This is assuming of course that future earnings aren't revised downwards even further. Would anyone care to place a bet on that?

Tuesday, September 09, 2008

Sometimes I wish I were wrong

I told you so. This just in from the Financial Times:
"It is the CBO [Congressional Budget Office] view that Fannie Mae and Freddie Mac should be directly incorporated into the federal budget."
More socialism. Yippee.

Monday, September 08, 2008

Socializing the mortgage industry

Normally I don't weigh in on the issues that cause large daily moves in the stock market, because they usually end up being irrelevant in the long run. But today is not a normal day. The anticipated Federal takeover of the U.S. mortgage industry, by way of Fannie Mae and Freddie Mac, has finally arrived. Stock markets in Asia and Europe are up between 3% and 5%, and the futures market anticipates similar gains in the U.S. (I'm writing this before the market open.)

My simplified version of the current mortgage/credit crisis goes like this: Banks and other lenders are no longer willing to give high-risk loans to home buyers because too many borrowers have been defaulting. In order to stay profitable, banks have had to raise interest rates on those mortgages that are still being paid. However, higher interest rates cause a new round of defaults, because people who could just barely afford their monthly payments now no longer can. Higher rates also discourage new buyers, which causes existing home prices to fall, which can create even more defaults when the amount owed on a mortgage exceeds the value of the house.

Fannie Mae and Freddie Mac are at the center of this crisis because they hold a significant fraction of all of the mortgages in the U.S. The mortgage payments made to these two companies are distributed to investors around the world who own Fannie Mae and Freddie Mac bonds. Needless to say, bond holders can't be paid if mortgage payments aren't being made. If discouraged investors stopped buying Fannie Mae and Freddie Mac bonds, then Fannie Mae and Freddie Mac wouldn't be able to buy new mortgages from lending banks, and that would make banks even more reluctant to give out loans in the first place.

The takeover means that you and I, Mr. and Mrs. taxpayer, will be making up the difference between defaulting mortgage payers and Fannie Mae and Freddie Mac bond holders until the crisis passes. I don't know whether or not this will fix the current problem, but I'm worried about the long-term effect. Programs like this, in which taxpayers are tapped to make things more affordable, usually end up just growing larger with time. Social Security, for example, makes up the difference for retirees, and Medicare and Medicaid make up the difference for health care costs. In total, Social Security, Medicare, Medicaid, Welfare and Unemployment have grown from 8% of the Federal budget in 1950 to 58% in 2007.

Today the taxpayer will make it easier for new home buyers to get low-interest home loans. If you think that home buyers five years from now will allow the taxpayer-subsidized lending program to come to an end, think again.

Thursday, August 28, 2008

Still no trend

The S&P 500 is well above the bear market low of 1214 that was reached on July 15. The only clear trend formation that has formed since then was broken on August 19th, producing a bearish signal. However, the market hasn't settled on a new trend yet, and most of the market indicators are neutral.

So far my prediction of a boring summer conclusion is panning out.

Friday, August 22, 2008

Which way will it go?

The market hasn't yet found a solid trend, but I think we'll know more early next week. The lower support line which was broken on Tuesday has intersected a potential declining tops line today.


If the S&P 500 rises through the declining tops line, then a medium-term rally will probably follow, with the old lower support line becoming an upper resistance line. Otherwise, if the new declining tops line holds next week, then that would confirm that a new downward trend has begun.

Regardless of which direction the market turns, I don't expect it to move very far one way or the other. With the exception of sentiment, which is mildly optimistic (bearish), most of the important market indicators are neutral right now. The last month of summer could be a boring one for the stock market.

Tuesday, August 19, 2008

Tangled Trend Lines

The S&P 500 is breaking trends almost as soon as it forms them. Earlier this month an ascending triangle formation resolved less than a week after I identified it. This morning I described a new wedge formation, and this afternoon it's already finished.

The lower July-August trend line was decisively broken today, which forecasts a decline from here. That means it's time to get back into SDS. Given the recent chaotic behavior and lackluster optimism in the market, I'm only going to purchase a 50% stake in SDS for now.

Monday, August 18, 2008

Return of the Wedge

The S&P 500 has formed the second ascending wedge formation of 2008. (The first one spanned in late March/early May.)

These formations usually end with the market breaking down through the lower trend line, so that places a pretty strict limit on the current rally at about 1350 on the S&P, the level at which the two trend lines meet. In all likelihood the next sell off will begin before that point, meaning the rally has less than a month to go.

Sunday, August 17, 2008

Bear Fund Comparison: SDS, BEARX and GRZZX

Thanks to some helpful pointers from readers following the earlier Armageddon Fund post, I've been able to compile a more complete set of data about the top bear-market alternatives to SDS, the ProShares Ultrashort S&P 500 ETF.

To review, SDS uses derivatives in order to make its price move in the opposite direction of the market, and at a magnified rate (2x). My concern is that a potential financial meltdown could undermine the derivatives market and hurt the returns of SDS (and every other leveraged and inverse ETF) during the darkest days of the bear market. The potential solution is to find a fund that uses actual short selling of stocks, and there are two funds that do this: BEARX, and GRZZX.

Unlike SDS, which is an exchange-traded fund (ETF), BEARX and GRZZX are mutual funds, so they are less flexible and more expensive. They require minimum initial investments, charge higher fees, and impose additional penalties for short-term buying and selling. In addition, whereas SDS is indexed to the S&P 500, these two mutual funds are operated by managers who only use a subset of U.S. stocks, meaning the managers might pick the wrong stocks and hurt the returns. For these reasons, I would only consider using the mutual funds for a one-time financial emergency; SDS is still the better choice for normal bear markets.


SDS BEARX GRZZX
Min. Invest None $2,000 $10,000
Min. IRA None $1,000 $1,000
Derivatives
Major part
Some
None
Expense 0.95% 1.73% 2.86%
Trading penalty None 1% (30 days) 2% (5 days)
Long stocks No Yes No
Selection
Indexed Managed Managed

Although the Prudent Bear Fund (BEARX) is cheaper than GRZZX, there are disadvantages that make it risker in a financial emergency. Long-time readers of this blog know that I've been keeping tabs on BEARX for over a year now. One of the things that attracted me to BEARX at the start was its ability to make money in a bull market, which is the result of having some long positions in selected stocks. In other words, BEARX is not a pure bear fund. The mix may work well for pre-correction defense in a bull market, but it just drags the fund down in a bear market. In addition, BEARX actually dabbles in the dreaded derivatives market, and since the whole point of this exercise is to find a derivative-free fund, that's a deal-breaker for BEARX.

As far as I can tell, the Leuthold Grizzly Short Fund (GRZZX) is the real deal. It only shorts stocks, and there appear to be no derivatives or long positions. Unfortunately GRZZX is the costliest of the funds, requiring the highest initial investment ($10,000 for non-retirement accounts) and charging the highest yearly fee (2.86%) and trading fee (2%). Even so, if I thought that there was going to be a crash and derivative meltdown on Tuesday, I would put everything into GRZZX on Monday. The extra costs might end up looking small compared to the slip that SDS would suffer.

The icing on the cake for GRZZX is obvious in the charts. Since the October 2007 peak, GRZZX (yellow) has actually outperformed SDS (blue) for buy-and-hold investors:

This should be impossible. SDS is leveraged so that it moves twice as fast as the S&P 500, yet GRZZX, which uses no leverage, has done slightly better during this bear market. Apparently the managers at Leuthold know how to select the best stocks for shorting! Meanwhile, BEARX (red) has been seriously lagging.

So GRZZX is now my choice for the Armageddon Fund. This doesn't necessarily mean that I'll use it - only that it's my choice if it looks like the derivatives market is about to collapse.

Update (February 1, 2011): There's an even better bear fund now, in the form of an ETF.