I wish politicians didn’t feel the need to stick to their guns all the time. Politicians should be able to change what they say, and just admit that they changed their minds, or that as time passed, situations changed.
Stock market analysts and commentators and advisers do the same thing. They write something down on paper (or text) and they are too afraid people will look at them like they are crazy, dumb, or just unsure of what they say if they change their tune. They think people will not take what they say in the future seriously.
But I’m not like these market commentators, and I’m not a politician. The stock market isn’t the place for that sort of thing. “Sticking to your guns” is a rookie mistake. In fact, one of the most important principles of trading/investing is the ability and willingness to change your stance, even if you just changed it three days ago.
This market is a bucking bronco, but fortunately for us, the direction of the general market doesn’t necessarily dictate whether or not we are profitable. The market is changing very rapidly lately, and we have to adapt to that change rapidly.
Chaos and Fear
All weekend I have been reading and talking to some of the greatest minds on Wall Street. There is more chaos than you would believe and sentiment is incredibly fearful. Of course we see that at intermediate bottoms. This is a market that can certainly crash. But it’s likely if that happens, it will be after a fast bounce higher.
I think people will celebrate a government bailout package short-term. But longer term, we still have more adjustable-rate mortgages (ARMs) readjusting higher. So what will they do about that? How much ammo does the Fed and the Treasury have? How many tricks do they have up their sleeve and when will they be caught by surprise again?
Hearing Treasury Secretary Hank Paulson close his Fox News interview by saying, “I’m sorry we’re in this situation, and we’re gonna work through it” is definitely not comforting to me. But that doesn’t mean everyone else feels that way. In fact, nothing that’s happening here makes me feel any better. But that doesn’t mean the rest of the investment world won’t celebrate.
Anyway, I think in a market that can crash, we have to have bearish exposure constantly while we also make bullish plays.
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Are the Bulls Coming Home?
The NYSE Bullish Percent Index (BPI) has reversed sharply higher to a column of “Xs” again. That means the bulls are back on the field. The technical indicators tell me to lean back toward the bull side, but the charts don’t know the whole story. So we should definitely be cautious here.
Just so you don’t think I’m nuts here, check out the NYSE BPI chart below. You can see that while we’re still only in the third quarter of 2008, we have changed columns eight times. Typically, the NYSE changes columns only a few times per year. I thought 2007 was active with six column changes.
My Take On This Market
Obviously this is unlike any market I have ever seen and I’ve studied all markets, but that goes for everyone, I guess.
Everyone’s saying this is the largest restructuring we’ve seen since the Great Depression but this is very different than the Great Depression. Just as the savings and loan (S&L) crisis was different in early ’90s.
During the S&L crisis, the government, using the Resolution Trust Corp. (RTC), inherited and then liquidated mostly hard assets like real estate from the S&Ls to clean off their balance sheets. The similarity was the government, through the RTC, took all these illiquid assets off the S&L’s balance sheets so the system could decongest, the banks could start loaning businesses money again and the system could start working.
Today, the government would be taking questionable loans — subprime loans, many of which will default. This should be much more difficult.
I see the government panicking, and it’s not making me feel good. If they are successful, that could cause a market bottom here, but I think the best-case scenario here is the market has one bottom here, and another one or two bottoms at the same level.
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So if the market jumps higher here on some sort of celebration of a bailout package (which would be a hell of a rally if it happens), I have to believe we see a few more disasters that cause us to retest the lows at best. However, it’s more likely that the market makes another leg lower than the one we’ve already seen.
With what I’m seeing the government do to curb a stock market crash — such as ban short-selling on 799 financial stocks — I know that’s the wrong move because we need short sellers. This is because if the market falls through the floor and crashes, and financial stocks start dropping, who steps in to buy? Nobody! The only ones to buy are the short sellers when they close out their short position. They have to buy back the stock that they originally sold short to close the position and take the profit. That “short-covering” is always the first bottom — not made by bold people who buy long on the cheap.
But then again, I think the greatest minds of our economy MUST have thought about the reasons I’m thinking about why it’s stupid. But they did it anyway. So that gives me more reason to think they felt that the alternative was worse. The question is, what else do they see?
Drastic Times Call for Drastic Measures
There could very easily be a collapse of the market and economy. These guys are taking drastic measures. It’s like the movie scene where the guy is sitting with a bomb and trying to decide whether to cut the blue or green wire as the last three seconds tick away on the timer. One will stop the bomb; the other will blow it up. Then they just say, what the hell, I guess it’s the blue one — we have to take so action or the timer runs out and we blow up anyway.
The Fed recently had $800 billion in cash reserves. Now, after bailing out Fannie Mae (FNM) and Freddie Mac (FRE), Bear Stearns, AIG (AIG), etc, they have only $300 billion and $500 billion in high-risk subprime loans. That’s not good. The Fed’s job is to keep inflation low and employment full. It’s not to sell off parts of an insurance company’s distressed assets or to back Fannie and Freddie or guarantee Bear Sterns’ bad debt pools for J.P. Morgan (JPM).
At one point the other day, institutions were so scared that they were paying the government to hold their money (buying Treasuries at a premium when Treasuries paid nearly 0%, knowing they would come down again in price). That hasn’t happened since the Great Depression.
A $65 billion money market fund suspended redemptions and threatened to “break the buck” by redeeming at less than face value (97 cents on the dollar). So the Treasury said they’d insure money market funds.
AIG thought they had $20 billion in questionable illiquid assets, then within days it went to $40 billion and then to $80 billion. I have to believe while the Fed is saying it’s $85 billion, still, nobody knows the real number, yet the Fed will be the holders of the bad loans.
My point is the market can crash. Who knows what could happen here? That’s why we have to have bearish exposure. That said, market bottoms happen when fear is extremely high — like now. At every market bottom everyone is saying — “no, this time is different” — like now.
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Typically you see huge volume as stocks trade higher, and Friday, as the market traded about 4% higher, the NYSE saw the highest volume traded in history. However, it was stock market manipulation by the government.
Commodity prices are down, which will help corporate profits and consumer demand. The central banks are taking extraordinary measures cooperating globally to support the market. And global markets could help a lot. Valuations have improved dramatically. On Wednesday, Sept. 17 in Britain, the yield on the FTSE was higher than the 10-year gilts. That happened last in March 2003 (bear market bottom) and in the late 1950s — and both were followed by big long rallies.
Maybe this is more confusing than helpful. But I have to give you a complete picture. (within reason — because I really can’t type faster than the newest info is being printed).
So a big, long-term buyer may be buying at the best time possible, but they have to be very brave. (And that’s not my thing. There’s always money to be made out there and I’m not a long-term buy-and-holder typically, while I do have long-term holdings.)
Just know that you should be playing both sides of the market — not only the bull side, and not only the bear side. If we get a panic with people dumping 401(k)s and all their mutual funds, it will be a relief to own some puts. Better safe than sorry.
Below is a 10-year chart of the S&P 500. I know that one bear market has nothing to do with the other — in fact, they are completely different. But for the sake of illustrating what I’m thinking in terms of the chart and what could happen, I compare the last bear market to today’s market. This is what I think:
What Should We Expect Next?
My takeaway from the above commentary was we are in a market that can certainly crash. Sure, we will also likely get a big spike from the current levels. But the potential crash is somewhere in here.
So the best thing to do is to stay hedged with some bearish positions that will profit if the market does crash, while playing the bull side as well. If you don’t play the market that way, I would consider lightening up on stocks significantly on the next jolt higher, and then sitting on the sidelines for at least a few months.
Remember, you don’t have to sell all or none — you can sell half. The goal is to not worry about missing the bottom, and to not worry about selling at the bottom. The goal is to understand that you are in a market that can crash. Do you want to play that game, or wait till the rules change a bit?
On a big pop higher, you will have a great opportunity to make money by entering bearish trades. Everyone around you will probably be telling you we hit a bottom. But take another look at the 2002-2003 bottom in the chart above. Bottoms are tested once or twice. That would almost certainly happen here.
Chris Rowe is the Chief Investment Officer for Tycoon Publishing’s The Trend Rider. To learn more about him, click here to read his bio.
