Archive for March, 2009

Yesterday was not necessarily a good day for the bulls.  However, the market did rally towards the end of the day and finished with some strength.  We closed well below the key S&P 500 price level of 800.  So now we find ourselves in between the 741 and 800 price levels.  Remember above 800 is positive and below 741 is negative.

There are a few very tough dynamics the market will be facing.  First, we have been getting better than expected economic numbers over the last three weeks. This has really helped the market.  As I wrote yesterday, many of these numbers have been tinkered with and will probably change in the future.  In other words, the Government dressed up those numbers a bit.

In April, it will be tougher to pull that off.  So we should be getting more realistic numbers.  One key economic number coming out this Friday will be the unemployment number.  We have yet to get the real horrific number.  I think that it is coming.  Second, tomorrow starts the day that hedge fund investors can ask for their money back.  There are only a few periods of time during the year where this open window exists for hedge fund investors.  The last time this happened, hedge fund redemptions were huge, forcing hedge funds to sell stocks.  Of course, this had a tough effect on the overall market.  Hedge funds are extremely risky and I would imagine that investors will want out if given a chance.

Finally, investors are holding onto the smallest sliver of hope that the worst might be behind us.  If this market rally fails, the last bit of confidence will be trashed. 

So, April should be an interesting month.  Over the next few days, we should get a better idea as to whether the bear market rally is taking a break or there has been a real change in character.

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News that came out over the weekend underscores why you cannot trust anything that comes from companies or the Government.  Wasn’t it just a few weeks ago that everyone was getting giddy over GM’s then-CEO Rick Wagoner’s comments about not needing any money from the Government and that everything is going just fine? 

In a recent client newsletter, I wrote the following:

Then GM made a bold announcement that they didn’t need any taxpayer money.  The market loved that news.  I think that they should have added one little tagline to that statement…”at least not this week.” 

Can you imagine the conversation between Tim Geithner and GM’s CEO Rick Wagner?  Hey Rick, how are you doing on funds this week?  Tim, we are looking good.  Taxpayer money is holding up.  Check back with me next week.  After all, we have some big corporate events and parties that need funding.

The audacity of a CEO making a statement like that when there is no way that everything was OK.  Well, big brother has spoken.

Then there is this string of “encouraging” economic news over the past few weeks. Economic numbers have surprisingly come out better than expected.  How could that be when Rome appears to be burning?  Well, thanks to the economic funny number crunching group, good economic numbers can be manufactured at the drop of a hat.  Barron’s Alan Abelson wrote this over the weekend:

The misleading figures cut across a wide swath of the economy, encompassing housing, manufacturing, employment — you name it. The leading agent of deception, unintentional or otherwise, has been that old sly villain, seasonal adjustment. As it turns out, the seasons don’t need adjustment as much as the adjustors need seasoning.

As Merrill Lynch’s David Rosenberg (who, incidentally, is planning to do a bit of adjusting himself and moving back to his native Canada; our loss, Canada’s gain) points out in a recent commentary, the official keepers of the books have been unusually aggressive in constructing seasonal adjustments for February’s economic data.

To illustrate, the seasonal adjustment for new-home sales was the strongest since 1982; for durable-goods orders, the strongest since they were first released in 1992; the retail-sales figures for February were flat (or, as David says, flattering) after such adjustment, but unadjusted fell 3%, the biggest drop on record. He also notes dryly that the 40,000 raw non-seasonally adjusted housing-start total for February “all of a sudden becomes a headline-adjusted annual rate figure of 583,000.”

Which makes David think that come the inevitably sharp downward revisions of such distorted data, first-quarter real GDP is likely to suffer a 7.2% drop. Which, together with the 6.3% skid in the fourth quarter of 2008, would be the worst back-to-back contraction in the economy in 50 years.”

This is why Wall Street has been bullish in recent weeks.  I think that this underscores that this bear market is far from over and Wall Street/Government (the irony is that they might be one in the same before it is all over with) want you to think everything is just OK.

So, how long will this stock market rally last?

I have been getting questions about this recent bear market rally and how long I think that it will last.  Let’s take a look at what happened in 2000.  The best bear market rally was 21%.  There was another that was 18%.  Basically, those were the two biggest bear market rallies from the bear market.  It is way too tough to speculate number of days.  This bear market is much different and more like the 1929 bear market.  I would rather focus on total gain of the bear market rally rather than how long it has lasted.  The reality is that this bear market rally could already be over. 

Thus far, we had a 24% bear market rally that lasted from November 20, 2008 to January 6, 2009.  The current bear market rally has gone up as much as 23% before last Friday. This GM news is very significant.  There had to come a time where the Government allowed for nature to take its course. Unfortunately, they have waited too long to allow the process to occur.

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This is not to be taken as advice.  This is a discussion on price levels and for educational purposes only.  There is no sure fire way to manage risk.  It is a process.

You’ve given us 3 price levels to watch. What should an investor’s reaction be with their portfolios given this information? Perhaps you can give a few examples?

This is a great question. I appreciate all of the questions that I have received both through e-mail and on the blog.  This is how we can learn this information together as a community. 

I want to add another layer to the discussion of price levels.  Let’s think short-term, medium-term, and long-term.  In other words, what direction is the market going in these three time periods?  Is it going up, down, or is it just moving sideways? 

Always think of the direction of the market as the direction of the value of your account. For the past 17 months, most investors’ accounts have been moving down with the long-term direction of the market.

I am only going to answer this from the standpoint of when you increase stock exposure through a stock index fund or ETF and when you decrease it.   If you are fully invested in the stock market and the stock market continues to stay above the 800 to 825 price levels, then you watch carefully.  Remember, we are looking for the market to go above 825 for things to start looking positive in the short-term. 

If the stock market were to get above the price level of 825 and stay there, then you might start to either increase your exposure (gradually) to the stock market or simply maintain what you have already invested.  As we see this morning, the stock market is already back below the 825 price level on the S&P 500.  Thus, yesterday’s close at the end of the day above 825 was not yet the positive sign that we are looking for.  

If the stock market falls below the price level of 800, that is a warning and, given the nature of the environment, might be a signal to you that it makes sense to reduce the exposure (sell) to your stock investment.  If the stock market continues to fall and goes down to 741 and closes below that level, you are taking extreme risk.  Remember the next price level down is between 575 and 600. 

It is in the short-term that investing is the trickiest.  If the market is really going to go up in value over maybe the next few months, you would want to participate and stay invested.   However, we are still in a dangerous environment, making the risk level even greater.  It truly is high risk for high reward. 

Now, for most investors, you want to look at the medium-term time period.  When the market starts to look positive in the medium-term, the risk level for investing in stocks starts to really diminish.  What would I call the medium-term?  In my opinion, the S&P 500 would have to get all the way back up to between 1200 and 1300 for the medium-term period to look good. 

The ideal time to be fully invested in stocks is when the short-term, medium-term, and the long-term are all positive.  Right now, the short-term is slightly positive, and the medium-term and long-term are both negative.

I know that this gets confusing.  However, you have to remember the objective right now.  As an investor, you always want to know what the risk and reward looks like for stocks.  The overriding principle is that you don’t want to be taking a ton of risk if there is a big possibility of you losing a lot of money.


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After reading, please offer your comments!

Of everything that I am writing right now, this blog might be the most important.  At the same time, it is the most difficult project that I take on.  The challenge is trying to write this information where it is relevent and understandable.  To further the challenge, I need to spend a lot of time building this site to include side information that you can reference.  The bottom line is that you can be a much more successful investor when you can understand risk and how to invest for it.  My goal is to teach that to you.  So, please stick with this resource as I work to build it.

Let me give you a practical example of what I am talking about when referencing risk.  Traffic signs are placed in the streets to keep us safe.  They tell us what speed we should be driving based on the conditions.  Obviously, we all want to drive as fast as possible to get to our destination quickly.  However, it might not make sense to do so.  There might be an increasing amount of risk involved with higher speeds. 

The goal is to get to our destination without crashing our cars or getting a ticket.

Sometimes the road is clear, we are on the highway, and we can drive the faster speed limits.  Sometime we have to drive much slower on those roads because of the weather.  It is dangerous to even drive the speed limit when the roads are slick. 

While pumping gas one day, I was watching people on the tollroad driving faster than usual in rainy and almost icy conditions.  Next to me was a State Trooper.  I asked him, “Why do people drive so fast when the weather is so bad?”  He said, “People think that they can drive the speed limit regardless of the driving conditions simply because the speed limit is allowable by law.  However, that is the speed limit for normal driving conditions and does not apply when the risk is elevated because of the weather.”

There there are times when we come across road construction.  When faced with road construction, we have a decision.  Do we detour and take another route or do we stay on the road?  Which is going to be faster?  If you take the detour, it might end up being a diseaster.  It might be that what you interpreted as bad road construction and delays was nothing more than a 2 or 3 minute inconvenience.  However, it might be that it wasn’t road construction but a major road construction shutting down the road for hours.

You are always making decisions and there is a risk that you will be wrong with every decision that you make.  The same applies to investing.  For most of us, the goal is to get to our investing destination as fast as possible.  We want to avoid the loss of time.  There is a real balance between risk and how we invest.

Sometimes the road is clear and the weather is fine.  If that is the case, you have smooth sailing ahead and can confidently take stock market risk.  Sometimes the economic weather turns bad and forces you to slow down or reduce the amount of risk that you are taking.  Remember you reduce risk in your investments by reducing the amount that you have invested in stocks.

Sometimes it just pays to be cautious because of the driving conditions.  Sometimes you see road hazards like the building real estate bubble and have to decide whether this is going to be a real problem (get out of the market) or stay on the road (stay invested).

I want to teach you how to read the traffic signs of investing by teaching you how to understand price levels in the stock market.  If you can at least understand price levels, you will be so much further ahead than the majority of investors. 

Let’s talk about yesterday.  The stock market is in the process of trying to figure out which direction it wants to go.  Part of the day the market went up and part of the day it went down.  At the end, the market finished with a nice day.  So the price levels we have talked about still stand.

The price level that the S&P 500 finishes the day at is what we are watching.  Anything about 825 is positive.  Anything below 800 is neutral.  Anything below 741 is very bearish.

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I was debating current issues with a buddy of mine who manages a hedge fund.  Throughout all of last year, we had been in agreement on what ails this country and the problems that we face. Recently, my friend has taken a more bullish (positive) attitude. 

He pointed out that the latest economic news has been much more positive than expected. He went through some of the metrics he follows on individual companies stating that things aren’t as bad as they seem.  I could disagree with none of those statements.  Economic news will get better at times.  Bear markets or economic growth doesn’t fall in a straight line.  In other words, there are always periods of hope amongst the despair.

I summed up my feelings about it this way.  If we are in a real bad recession and that is the extent of it, then the worst might just be behind us.  We also might have seen the bottom of the bear market a few weeks ago.  However, if this is much worse than a recession and more along the lines of a depression, then gear up because the worst is ahead.

Depressions are highlighted by periods of very high unemployment and economic loss in excess of -10%.  No one can say for sure.  I just cannot see that any of the proposed solutions put in place do anything at all to really solve the unemployment problem as well as increase economic growth on a grand scale.  Then you still have these massive levels of debt to deal with.

So, if this is a real bad recession, then we should go forward without major setbacks.  Any major setbacks would suggest that the worst is still ahead of us.

Yesterday’s stock market saw a modest decline in price levels.  I was telling someone this morning that a few years ago a -2% daily loss in the stock market would have been bad.  Today, it is just another normal market day. 

A decline yesterday made complete sense following such an enormous positive day in the S&P 500 on Monday. Now we are back to watching those price levels again.  Anything above 825 is positive.  Anything below 800 is neutral (neither positive nor negative).  Anything below 741 is very bearish.

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Just like that the market in one single day went right up into the zone of the price levels that we have been talking about over the past few weeks.  The S&P 500 finished yesterday’s market at the price level of 822 (between the 800 and 825 price level).

No doubt about it…yesterday’s rally was extremely strong.  Yes, I will have to admit that yesterday’s enormous rally added more credence that we are in the midst of a significant bear market rally that could be with us for more than just a few days.  At the same time, there are a few caveats.  If that is the case, it is probably more than half of the way completed as far as percentages go.  With the exception of a powerful bear market rally in 1929, most major bear market rallies go up between 25% and 30%.  This bear market rally has gone up roughly 21% thus far.

The market took off on the news that the Obama administration has the solution to the banking crisis.  The problem is that all of the Government-based solutions are more illusions than solutions.  There are so many problems with this solution that will just create unintended consequences.  All of the bad debts that banks hold didn’t just all of the sudden disappear with the announcement of this plan.

In order for this plan to work, the banks will still have to realize these losses, which is something that they have avoided thus far.  The Bush administration tried this approach last fall.  They didn’t go through with it because they couldn’t figure out the details.  It appears that we are not much further down the road from that initial attempt to solve the banking crisis last fall.

The worst part of this program is that taxpayers will ultimately get stuck with the bill once these mortgage backed securities lose their value.  One other item of note is that there are roughly 2 trillion dollars of these bad or toxic investments that the banking system owns.  This program only covers 1 trillion dollars of those bad investments. 


It looks like to me that the Obama administration is nationalizing the banking system without calling it nationalization. 


So what are the price levels to watch now?  Anything over 840 to 850 is stock market positive, anything below 800 would be a concern, and anything below the S&P 500 price level of 741 would be very bearish. 


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In the book Manias, Panics, and Crashes:  A History of Financial Crises, Charles Kindleberger writes about the various financial panics that have occurred throughout the world over time.  There is one consistency that exists amongst all of the examples written about in the book.  There was always a lender of last resort.  The lender of last resort is the country that steps in and saves the country in crisis.  We have been the lender of last resort and we have needed a lender of last resort before.


Well, guess who the lender of last resort is in this financial crisis?  We are the lender of last resort for ourselves.  Yes, the Federal Reserve made it clear in their announcement last week that they were going to make available another trillion dollars or so to save the system.  That is just another trillion dollars on top of an estimated $14 trillion already committed.  We don’t talk in billions anymore.  Trillion is new billion.    


If no one else will step in to save us, we will just print our way out of this mess.  Bernanke is running a huge Ponzi scheme.


The Fed has just assured us that this problem will get even bigger.  Never in the history of mankind has this type of self prescribed bail-out EVER worked. Washington talks as if the economy will bottom out sometime early next year and we are off to the road to recovery.  Just like that – POOF – and the financial crisis and all of its trillions of dollars left in its wake will be just that OK.


For this reason, it is going to be dangerous being a buy and hold investor.  Although I do think that we have a very strong bear market rally that we may have already started or is on the horizon.  The primary market is a bear market where buy and hold investors will just give back anything that they made during the bear market rally.


You have 3 choices over the next however many years that we face this mess.  First, you can just go along with the ride and buy and hold.  This strategy will put you in harms way every time an irresponsible decision is made in Washington.  Second, you can just go to safety by placing the majority of your investments in safe investments.  I think that strategy is better than the first.  Third, you can learn to identify risk and develop a game plan for when to invest and when to be safe. 


Of course, that is the purpose of understanding price levels (which is the focus of the Prudent Money Outlook).  Last week the market failed to make it above a crucial price level and is obviously very leery of the politician’s game plan to be the lender of last resort.  I believe that the market is leery when President Obama goes on the tonight show where he just jokes and laughs while people are losing their jobs and homes.  Of course, he also has those weekly cocktail parties (Wednesday night Happy Hour) at the White House every week.  It is nice to throw weekly parties while the rest of the country is hurting.  Have you ever stopped to think that we are paying for those Wednesday night cocktail parties?


This morning, the market is opening up very favorably to the latest bail-out attempt announced by the US Treasury.  It will be important to see how the market holds up from here.   


So here we find ourselves watching these price levels again.  We are trying to figure out the following question – Is this the start of a meaningful bear market rally or is it a break in the selling and we are about to decline down to the S&P 500 price level of 600? 


The price levels to watch are 741 and 800 to 825.  Any price level below 741 is extremely bearish and would suggest a decline down to 600 and anything above 800 to 825 would indicate that we are in a very strong bear market rally that could stick around for a while. 

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