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.