Monday, March 30, 2009

Rolling over

Today's fall was the second time this month that the S&P 500 index broke through a rising bottoms trend line.

There will probably be more exhilarating one-day gains in the near future, but the bigger trend seems to be a rally that is running out of steam. It looked to me like the rally trend had ended on March 20th, and despite a huge gain on the next day, the S&P 500 hasn't made much progress since then.

Thursday, March 26, 2009

Rage, rage against the dying of the light

I'm a contrarian investor, meaning that when in doubt, I try to bet against the masses. However, the stock market isn't the only place where I apply this philosophy.

Global warming alarmists have established an Earth Hour this weekend as an opportunity for people to "vote" for saving the planet. They're asking people to turn off their lights from 8:30 to 9:30pm to demonstrate that they want to save energy and make the planet cooler.

The irony is that Earth Hour has it completely backwards. The Sun is just beginning a multi-decade quiet period which will probably cool the Earth substantially. If carbon dioxide really does have any effect on the Earth's climate, then we should work to increase it to maintain the relatively mild temperatures that we've been enjoying for the past several decades. The last time that solar activity waned (1600's-1800's) was no picnic - in fact, that period is now known as the "Little Ice Age."

There are also economic considerations. Corporate profits have been falling for some time, the economy has been shrinking, and unemployment is on the rise. It strikes me that using electricity helps anyone associated with coal mining, coal transportation, or nuclear power. I don't know about anyone else, but I'd like to help the economy recover as soon as possible.

At 8:30 pm this Saturday, I'm going to turn on every light bulb, television, computer, fan, air filter, air conditioner and heater in my home. It should be pretty cheap electricity anyways if everyone else is in the dark.

Monday, March 23, 2009

Putting my method to the test

After bouncing off of the declining tops trend line on Friday, the S&P 500 index plowed through 800 today on the way to a 7.1% rally.

This is the umpteenth example of a single-day large rally accompanied by optimism in this bear market, and after every previous example the market eventually reached a new low.

Obviously I couldn't predict the news events on Wednesday (the Fed buying Treasury bills: $300 billion) or today, (the Treasury buying bad bank assets: $1 trillion) and I'm pretty sure that these have sustained the rally up to this point against the headwind of market optimism.

I've wired some new money to my Roth IRA to take advantage of lower GRZZX prices, but I won't count this new purchase towards my track record here on this blog.

By the way, one of my end-of-bear-market signals would trip if the S&P 500 closed in the vicinity of 850, which is less than 4% higher than today's close of 823. I won't say anything more about that unless and until it happens.

Friday, March 20, 2009

Earnings and dividends in the doldrums

The dividend yield for the S&P 500 based on the most recent quarter is only 2.75%, which remains highly overvalued and outside of the normal range of 3%-6%. In order to return to an historically average yield of 4.5%, the S&P 500 index would have to fall to about 485, which is a 37% drop from here.

Meanwhile, earnings continue to deteriorate. The projected real P/E ratio of the S&P 500 for the summer quarter of 2009 is an other-worldly 243. The forecast for the end of 2010 sees a more reasonable but still overvalued P/E of 19, however I don't really trust any forecast at this point given the earnings crash that earlier forecasts missed.

Looks like a reversal

The S&P 500 index has broken below the lower trend line of its confined two-week rally. The declining tops trend line at 800 shown in the previous post has held for now. I think this is the end of the sucker rally, and the beginning of a retreat that will take the S&P below the previous low near 670.

Wednesday, March 18, 2009

Technicals

The S&P 500 index has rallied straight up from its bear market low, breaking through one potential resistance line and bumping into the next.

Market sentiment has become extremely optimistic during this rally, so I'm not too concerned about the first trend line violation. If the resistance line at 800 holds and the market turns down, then my GRZZX position could pay off pretty quickly. If the S&P manages to keep rallying, then I plan to sit tight as long as sentiment continues to climb, and might even consider adding funds to my Roth IRA for another GRZZX purchase.

The situation that would compel me to cash out of GRZZX with a loss would be if sentiment starts to turn pessimistic while the market continues to rally. Stay tuned.

The Fed will buy Treasury bills

Good news everybody! The left hand (Federal Reserve Bank) has agreed to loan money to the right hand (U.S. Treasury). This should make everyone feel better about the economy, and it has absolutely-positively nothing to do with any bond/debt bubble. Ha-ha! Really. Everything is just fine.

Tuesday, March 17, 2009

Inflation

I have no idea if we're going to suffer from high inflation in the near future or not, so I don't anticipate placing a large bet either for or against it. However, for those folks who are convinced that the value of the dollar is about to take a dive, I can suggest some relatively low-risk funds. Depending on one's certainty or fear level, these can either be a small part of a diversified portfolio, or a larger part of an anti-inflation strategy.

Treasury inflation-protected securities (TIPS) are Treasury bonds that are linked to the rate of inflation, meaning that both the underlying principal of the bond and the interest payments are adjusted up or down in proportion to the rate of inflation/deflation in the U.S. This is obviously a very attractive investment when inflation hits, because the holder will earn real interest when other fixed-income investments are effectively losing value. Of course the reverse is also true, as deflation in the U.S. will cause TIPS to actually lose value relative to other bonds.

Access to TIPS funds varies between accounts. For Roth IRAs and taxable accounts there is an exchange traded fund composed entirely of TIPS with an easy-to-remember symbol: TIP. (Right now TIP has an impressive dividend yield of 5.9%.) In the case of limited accounts, (401(k)s, 403(b)s) some institutions offer TIPS funds while others don't, so anyone in this category who's interested in TIPS should check with his provider.

I don't necessarily recommend TIPS as hedges against financial Armageddon, because the government's ability to increase payments to TIPS holders depends on whether or not it has sufficient funds in the first place. In addition, any general sell-off of U.S. Treasury bonds will affect TIPS prices. Nonetheless, I think TIPS may be the safest liquid hedges against inflation because they pay interest and don't involve derivatives. In the case of limited accounts they're usually the only hedge.

Now if only I knew how to predict inflation...

Monday, March 16, 2009

GRZZX update

The GRZZX purchase that I made with my 50% cash reserve was completed on Friday at a price of $9.32. Since the other half of my Freedom account was already in GRZZX at a purchase price of $9.03, the average purchase price of of my current position is $9.18. (I'll round up, which actually works against me.)

Now, the accounting is more complicated than that, because that 50% cash position came from two sales that resulted in an average gain of 9.1%, or 4.5% (rounded down) for my entire account. To make the math simpler from here on out, I will forget about the 4.5% profit and fold it into the purchase price of the current GRZZX position. Thus, it is as if I purchased GRZZX for $8.79 back in December and January with the original amount of money.

Whew.

Friday, March 13, 2009

The human side of bear markets

This bear market has been educational for me, and not because of anything I've learned about stocks. If timing the low points in a bear market is difficult, navigating the storm of human emotions that comes with a bear market is even more challenging. I often hear that economic downturns will cause people to focus on what's important in life, which sounds like it would work to improve human relations, but I don't think that's the whole story.

On the one hand, buy-and-hold investors who have been losing money in long-term stock positions understandably resent hearing that someone is making any money at all in a bear market. I learned early on not to volunteer investing advice or news of my success to anyone in person, when a professional colleague actually sniped at me with "F- y-." Even when someone asks me for advice today, I try to tread lightly. Someone who's lost 50% in the market isn't about to pat me on the back with a hearty "congratulations." Instead I'm usually met with skepticism or painful silence.

On the other hand, more recently I've been the object of criticism or outright ridicule by people who think I'm hurting my returns by being too timid with my timing or with my choice of funds. A couple of comments that I've actually allowed to appear on the blog can attest to this. On the stock-rating page of fool.com, called CAPS, the overall tone of the public blogs there has taken a somewhat darker turn, even among the successful players who are actively trading and profiting from the bear market.

Aside from the damned-if-you-do, damned-if-you-don't attitudes of others, there is something unseemly about making money in a bear market. Every profitable trade that I make comes with the knowledge that hundreds of millions of investors around the world just lost by the same percentage, and it feels like an ill-gotten gain. I'm not going to stop using bear funds, but I'm not enjoying the whole experience quite as much as I thought I would.

Can you please tell me...

Tell me how you compute short-term sentiment.

NO.

Tell me your secret to identifying a bull market top.

NO.

Tell me your secret to identifying a bear market bottom.

NO.

Tell me how you made your Dow 8500 forecast in January 2008.

NO.

Thursday, March 12, 2009

Let's start the insanity

This 3-day rally has returned optimism to near-record levels, and that's enough for me to go 100% bearish again. That's right: I'm putting the 50% cash position back into GRZZX, which is now at a lower price than at least one of the two previous 25% selling points. It helps that there's a potential resistance line around 775 or 800 on the S&P which will probably cap whatever momentum is left in this rally.

The last time the market was this optimistic was early February, when the S&P peaked near 870. Now that optimism is peaking at only 750, I expect the next downward leg to take the market to new bear market lows below 670.

Your retirement account owns stocks.

I think there are many people who don't understand this basic fact:

If you own a retirement account, and if you haven't specifically contacted the administrator to move your savings out of the stock market, then you are at least partly invested in the stock market.


"Funds," "mutual funds," "equity funds," "index funds," and "growth and income funds" are all fancy names for a group of stocks. If you own one or more funds, then you probably own stocks, and that portion of your savings will move more or less in lock-step with the S&P 500, plus or minus any theme variations like company size or foreign/domestic breakdown. Fund managers and retirement account sponsors (Fidelity, TIAA-CREF, etc.) are not allowed to time the stock market, and will never pull your money out of stocks in anticipation of a crash. If they did, they themselves would be instigating a selloff and a crash.

It's up to the individual investor to allocate his savings between various stock funds and debt market funds (bonds, money market), either by calling his investment company or by going online and using their website. It's unfortunate that most retirement accounts are limited to these two types of funds, beacause we may be in the middle of both a stock and bond bubble, but at the moment we have to make do with what we have. My "Limited" portfolio is in a U.S. Treasury money market fund, which is as close to simple cash as any fund can be.

Diversifying for Armageddon

A troubling mega-trend has me thinking about the worst-case scenario for the U.S. economy. The Federal government has been creating and borrowing money at a mind-boggling rate in a supposed attempt to revive the economy, and I fear that it will ultimately have the opposite effect. I've lost track of how much money we're on the hook for, as it's been a blur of a half-trillion dollars here, 3/4 trillion dollars there, seemingly repeating every week or two. Our capacity to borrow from ourselves and from other nations is limited, and it's possible that the limit has already been crossed, even though the fallout has yet to fully materialize. The real irony is that the subprime mortgage collapse has just provided a hard lesson in what happens when people take on too much debt. It's almost as though the folks in D.C. are living in a different universe.

The latest news is that the FDIC, the Federal Deposit Insurance Corporation, is low on funds, and has asked for a half-trillion dollar loan. The FDIC is the insurance program for our bank accounts, and with all of the recent bank failures, its cash reserves are running out. Without a loan to save the FDIC, it's possible that at some point in the near future a bank could fail and all of the savings accounts could go up in smoke along with it. I speculated earlier that foreign governments like China might not be willing to lend us money forever, so scrounging up another $500 billion at the last minute could prove difficult.

The bottom line is that something has to give eventually. The unraveling may begin with an uninsured bank failure, or with a sell-off of U.S. Treasuries by foreign governments, or by hyperinflation brought about by too many dollars being in circulation, or by outright bankruptcy of the federal government. I don't know where, when or how it will all come down, but I don't plan on being blindsided by it.

I'm spreading around my liquid savings/checking account funds to minimize the risk from any one institutional failure. I'm opening up an account with a second bank in my neighborhood, and I'm already transferring some of my savings to a third online account with yet another institution. In addition, I'm taking out a little extra cash every time I visit an ATM to stash away in case the entire banking system collapses. (That's mostly to make sure I have enough gas and food to drive to the Midwest and hook up with family.) I fully realize how insane and paranoid this sounds, but I see these as small measures which could make a big difference if things get really bad.

If it turns out that the financial system recovers without any major damage, then I'll be very happy to withstand the embarrassment of having gone overboard with my preparations. On the other hand, if a collapse is looming, then I only hope I can make sufficient preparation before it's too late.

Wednesday, March 11, 2009

Beating the Market vs. Making Money

Medium-term bottoms in bear markets are steep and brief, and it's basically guaranteed that I won't be cashing out of GRZZX on the right day or at the best price, so I'm happy to make any positive returns at all in this market. The thing to remember about bear markets is that cash outperforms stocks, and anyone who's been 100% in cash or money market funds has been doing better than just about every other stock-holding portfolio.


Making MoneyBeating the S&P
Bull MarketEasy: Index fund (SPY)Hard: Timing or stock picking
Bear MarketHard: Shorting+timingEasy: CASH!


Update: The sale of the 2nd GRZZX position today happened at a price of $10.00 on the nose, for a gain of 10.7%. Half of my original $9.03 purchase of GRZZX has now been cashed out, for an average gain of 9.1%.

Tuesday, March 10, 2009

Upper trend line breached - cashing out 25%

The S&P 500 closed at 720 today, which is above the upper channel line, but not decisively so.
Today's large 6% rally was also accompanied by yet another spike in optimism, which suggests this rally may be short lived. Since I'm not very impressed with this rally just yet, I'm going to cash out of only 1/3 of my GRZZX position, meaning 25% of my "Freedom Account" will be transferred from GRZZX to cash tomorrow. That will leave 50% in GRZZX and 50% in cash.

Friday, March 06, 2009

An orderly retreat

The past month's decline in the S&P 500 index has formed a narrow channel pattern, with a well-defined lower trend line and a not-so-well defined upper trend line.

This is a helpful development, because these close trend lines are like trip wires that will give an early warning signal when the overall market trend changes. Sentiment is neutral right now and not much help, so this formation showed up at just the right time.

Thursday, March 05, 2009

I don't give a damn about the Dow

I've written before about how the "experts" do their best to hide the most factual and useful data by promoting fanciful or useless data. For instance, it's easy to find P/E ratios for stocks using operating earnings, but not so easy to find the numbers with real as-reported earnings. Similarly, when the stock buyback craze swung into full gear in the middle of this decade, pundits suddenly started singing the praises of buybacks while ignoring the historically low (and worthless) dividend yields.

The talking heads do the same thing when it comes to stock market indexes. No matter whether you get your stock market news from TV, radio, the internet or the printed page, the first number you probably see or hear is the Dow (the Dow Jones Industrial Average), which has become the standard gauge for "how the market is doing." The Nasdaq is usually the second number reported, and if you're lucky you might get as an afterthought the value of the S&P 500 index. Not surprisingly, it is this last and least-followed number which actually matters.

The Dow Jones Industrial Average suffers from two fundamental flaws. First, the 30 companies whose stock prices are used to calculate the average are chosen somewhat arbitrarily. Sure, its 30 members are among the largest companies, but they are not the largest, and therefore are not as representative of corporate America as one might think. Among the top-30 companies which aren't in the Dow are Cisco, Apple, Google, PepsiCo, and Philip Morris. Conversely, several companies which are in the Dow 30 are quite small by comparison, like DuPont (87th largest), Caterpillar (98), American express (103), and Alcoa (243).

The second problem with the Dow is how the index average is computed. The stock prices of the 30 companies are weighted, not by the size of each company, but by the price of a single share of stock, which is a meaningless number. So IBM, the 7th largest corporation in America, has the greatest weight in the Dow 30 index (10% of the total) because its share price is $88. Meanwhile, AT&T and Microsoft, the 4th and 5th largest corporations in the U.S., are only ranked 16th and 22nd in the Dow, respectively, counting less than 3% each towards the total.

By comparison, the S&P 500 index is a far more logical, meaningful, and useful measure of the stock market. Not only is the S&P comprised of 500 companies instead of the paltry 30 in the Dow, but the contribution of each stock in the index is weighted by the size of the company. More specifically, each company in the S&P is weighted by its market capitalization, which is the total price of all of the shares of stock, or the amount of money required to buy the entire company at its current share price.

The membership of the S&P 500 is also more logical and relevant. With only a few exceptions, the 500 corporations in the S&P are the largest 500 stock-issuing companies in the country, accounting for approximately 78% of the entire net worth of all stocks traded in the U.S. markets. (The largest corporation not included in the index is Berkshire Hathaway, whose class-A shares are worth $72,000 each today, thus placing it in a very exclusive market that most investors can't participate in anyways.)

For these reasons, I use the S&P 500 index to follow the stock market instead of the Dow Jones Industrial Average. Sure, the Dow still has some use in historical studies (it's a few decades older than the S&P) and as a sentiment gauge, (more people pay attention to it) but it's simply inferior to the S&P 500 when it comes to tracking the overall U.S. stock market.

Monday, March 02, 2009

Optimism breaks the last support line

The S&P 500 index is trading around 705 as I write this, meaning it has decisively broken through the important barrier at 740. Many investors were convinced that 740 would be a firm support level off of which the next bull market would begin. In fact, so many were convinced of this that it was treated as received truth on several of the websites I visit. Being the contrarian that I am, this only made me more confident that 740 would not hold.

The bad news for stock prices (and good news for GRZZX) is that the market has essentially run out of support lines. The S&P 500 index is at its lowest point of this bear market, and is well below the previous bear market bottom that occurred in 2002. If a 1987-style crash were to occur now, the market might hit support around 500, but that's a long 30% drop from here.

With the Dow below 7000 and the S&P staring into a chasm, I expect the market-bottom optimists to give way to the "Oh my God we're doomed" pessimists in the near future. Time will tell. Until then I'm riding it out with my 75% GRZZX position.