Posts Tagged ‘Risk’

What motivates the stock market to go up?  Well, lately it doesn’t take anything of real substance. A great consumer confidence number could be the reason (even though the consumer confidence report gets the consensus of only 5,000 households), a reduction in the loss of jobs for a month(even though the Government accounting method greatly distorts the actual loss of jobs),  positive earnings reports that surprise the analysts (even though most of those profits came as a result of extreme cost cutting)…Then there are the times that  Ben Bernanke speak.  Yes, his words can move a market.  He did so just last Friday.

Ben Bernanke said what investors wanted to hear – that the economy is indeed on the verge of recovery – and they responded with a rally that sent the major indexes to new highs for the year (yahoo.com). 

Did it sound something like the following?

“Our forecast is for moderate but positive growth going into next year. We think that by the spring, early next year, that as these credit problems resolve and, as we hope, the housing market begins to find a bottom, that the broader resiliency of the economy, which we are seeing in other areas outside of housing, will take control and will help the economy recover to a more reasonable growth pace.”

As John Hussman points out in his weekly writing, this was what Bernanke said in November 2007 right at the beginning of the bear market.  If you are stock market invested, these shallow reasons are why the market continues to go up. 

I know that my bearishness on the stock market is probably getting old by now.  In fact, I feel a lot like I did back in 2007 when it seemed like you couldn’t find anyone who is bearish.  The market welcomes any positive economic news as the worst is behind us and everything is great going forward.    The headlines are looking better.  However, the fundamentals behind the headlines are awful.  You might even get some positive economic growth numbers here in the near future.  Growth as a result from printing money and the Obama stimulus package is not real good health growth. 

The Bottom Line – As we continue to go up in the market, the risk continues to increase.  Caution is still warranted.

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Well, I took the wrong time to take a vacation. A great deal of very important things occurred last week in the stock market and investors should be extremely cautious.  This morning I will take some time to get you caught up on what is occurring with price levels as well as what I believe to be a fundamental shift in the stock market. The stock market has been in a stock market rally from the middle of March at least until June 11. Since June 11, the S&P 500 has declined -7 %.

One of the themes that I have written about since the low in the stock market in March is the overall future direction of the stock market. If you ask most people on Wall Street, they will say the worst is behind us and we have started a period of recovery. I have argued the opposite. I feel that we are in a long-term bear market that started in 2000 and could last as long as 18 to 20 years (based on history).  Concerning out current situation, my analysis would suggest we have been in a bear market rally. This is a period of time where the stock market stops declining and starts what looks like a period of prosperity and recovery for investors.

These are mean periods of time for investors because they fool the vast majority of people into believing that the worst is behind us. When you look at how far up the stock market went in a small amount of time, it certainly would appear that the worst is behind us. At the same time, it also looks just like a typical bear market rally and not the start of a period of recovery.

Since the March low in the stock market, the question has been how long and how far the stock market will go up. It is a little too early to declare that the stock market rally is over. However, the evidence is building. The problems are becoming much too loud to ignore. So, let’s start with the evidence. We always want to look at price levels of the stock market. Price levels are determined by where the stock market closes at the end of each day. They can tell us a great deal about the level of risk that we are facing.

If we manage to stay above certain price levels, then stock market investors should feel comfortable with taking risk by investing in stocks. However, if the market closes below certain price levels, then the probability increases that stock investors will lose substantial amounts of money. On June 11th, the S&P 500 reached its highest price level since the March low. That closing price level for June 11th was 944 on the S&P 500.

As of last Friday, we were at a price level of 879. The price level of 878 is the first level of risk for the stock market. Last week the S&P 500 fell below that level but has not closed below that level. Remember that the closing level is the most important one to watch. Once that level is broken, the next danger zone lies between 814 and 779. If you are heavily invested in stock, you do not want to see the S&P 500 fall below 779. In that event, I would think that the next price level down could be as low as 719 all the way down to 666.

The price level of 666 is extremely important because that was the March low of the stock market. In the event that would happen, that would be a considerable low and loss to stock market investors. For now, let’s not get ahead of ourselves. Keep in mind that investing in stocks is all about monitoring your risk. One of the best ways to do so is by monitoring price levels.

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One of the most important aspects of determining risk in the stock market is watching price levels.  A price level is where the stock market closes at the end of the day.  If the S&P 500 ends the day at 895, that is the price level that we want to analyze.  Think of price levels as road markers.  If you are making progress and passing up important road markers, then you are making progress.  If you are not able to pass up important road markers, then you are losing ground. 

899 on the S&P 500 is an important price level.  The stock market fell below that price level yesterday, which is a warning sign.  You don’t want to stay below that level.  Now, the stock market will struggle to end a day back over that price level.  If it fails to do so in the near future, we might be looking at a significant decline.  The longer we stay below that price level, the greater the risk that the stock market rally that started in March is over.  As I have written since that rally started, we are always trying to answer one question.  Is this a pause in the bear market or is the worst behind us?  I still feel that this is a pause.

The next days will give us some clues.  Today is somewhat of a waste because the Federal Reserve Board is giving their Fed statement.  The market behaves very erratically on Fed Day.  Tomorrow’s reaction to the events of today will probably be more telling.

For those of you that follow technical analysis, there are two different moving averages – the simple and the exponential.  The price level of 899 represents the 200 day simple moving average.  The EXP 200 day moving average is 941.  The S&P 500 failed miserably at trying to close above that level.  While traders where cheering that the S&P 500 rose above the simple 200 day MVA, I think that many missed that the 200 day EXP MVA was a failure and a huge warning sign.  

Incidentally, the 200 EXP MVA gave its first warning November 7, 2007, when the S&P 500 was over 1500.  These moving averages are great indicators of bear and bull markets.

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 As an investment manager, I am constantly looking into the future and evaluating indicators to determine which investments make the most sense.  Since originally warning of the risk in stocks back in 2007, my indicators have not given any signs that the risk for being in the stock market has changed.  As long as the bear market is around, investors really need to be careful regarding the amount of money that is invested in stocks and stock-based mutual funds.


What has to change for stocks to be a prudent choice again?  Although there is a laundry list of reasons for investors to be cautious, one risk remains at the top of the list.  It has been the driving factor for the credit crisis.  Until we get past the foreclosure crisis, I believe this bear market will remain in control.


In the simplest of explanations, the foreclosure problem can be explained this way.  For years, the mortgage industry gave loans to people who could not afford them.  For example, Joe wants to buy a home.  He goes to the mortgage company and finds out he can qualify for up to a $100,000 home.  The mortgage company determines that loan amount by looking at Joe’s income and expenses.  Joe can afford the $1,000 a month mortgage. 


The mortgage industry thought that it would be a good idea to come up with loans other than a 30-year or 15-year mortgage.  With these new loans, that $1,000 a month payment would purchase a much bigger house.  In fact, it is possible that the $1,000 a month payment could buy a house valued at as much as $400,000.


In order to accomplish that magic number, the mortgage company had to make a few adjustments to the traditional loan.  First, they arranged it to where Joe just paid the interest for that month versus interest and principle.  This one little change made a big reduction in the amount that he had to pay. 


Second, they were able to give him an adjustable rate feature.  This gives Joe a much lower payment the first 3 years or so.  However, that rate adjusts after the first 3 years and the $1,000 goes up to $2,500 a month.  By then, the mortgage company rationalizes with Joe that he can simply refinance the mortgage and get the payment more manageable.


So, imagine millions of people just like Joe taking out adjustable rate mortgages and facing a higher mortgage payment in the future.  This is what has happened.  Millions of adjustable rate mortgages had a payment change and the consumer couldn’t afford the mortgage anymore.  They couldn’t refinance the home because the home was now “under water” or worth less than the mortgage.  This is what led to the foreclosure crisis. 


So, if we had hundreds of thousands of people facing higher payments in the year ahead, would it be reasonable to assume that we could have a high number of foreclosures? 


Well, this is what I wrote to my clients in 2007.  I showed the following graph which pointed out the billions of dollars of mortgages that were about to have higher monthly payments. You can see by this graph that during the first quarter of last year, the largest number of mortgages changed.  As a result, we had the beginning of the worst of the foreclosure crisis last year. 



Unfortunately, that was round 1 of the foreclosure crisis.  That graph only represented sub-prime mortgages.  Now, we have all of the other types of mortgages whose monthly payments will change coming due this year and into next year.



This graph shows that we are at the beginning of payment changes for mortgages that will not peak until 2011.  It looks like we will not be out of this problem until 2012. 


When you have waves of foreclosures, you have problems with the banking system and everything that is tied to those mortgages.  It gets much more complicated.  To make the problem more challenging, a good percentage of these homeowners owe more than the house is worth.  Look at the following percentages of homeowners with the various types of mortgages:


73% homeowners with Option Adjustable Rate Mortgages owe more than the value of the house.

50% homeowners with Sub-prime Mortgages owe more than the value of the house.

45% homeowners with Alt-A Mortgages owe more than the value of the house.

25% of Prime Mortgages owe more than the value of the house. 


Contrary to what the Government and Wall Street want you to believe, the risk is still extremely high for the economy and the stock market.  What has plagued the stock market is still the problem. 


So what is the bottom line for investors?  There are two things to consider.  First, make sure you understand the amount of risk that you are taking in your company 401(k) plans.  Remember the easiest way to define risk is by looking at the overall percentage of your plan that is invested in stock-based mutual funds or individual stocks.  Second, if your money is with a financial advisor, find out what their strategy is in the event that the bear market is not over.  If they have no strategy and instruct you to just “ride it out,” move your money to an advisor that can manage money in a bear market. 


It has never been more important to understand risk than today.

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Well, the results of the stress tests were revealed this past week.  It turned out to be much ado about nothing.  In fact, most of the banking stocks went up on the news.  It does leave the question as to what the Obama Administration is really trying to accomplish through a process that didn’t make much sense.  For now, we will leave speculation for speculation’s sake.

I found it interesting as to the criteria that was used in stress testing the banks.  They were looking for how the banks would react to the worst case economic situation.  Over the weekend, Alan Abelson wrote about the criteria in his article in Barrons:

“The “worst-case scenario,” as the cliché goes, that the Fed crew was able to dream up was one in which the unemployment rate, already a hair under 9%, would rise to 10.3% next year, housing prices would fall another 22%, and the economy — which has been shrinking at more than a 6% annual rate the past two quarters — would contract at a 3.3% pace.”

Well, I think that we could easily see 10.3% in unemployment.  Of course, that is dependent on how aggressive the Government gets with their monthly job “estimate.”  A decline in growth of 3.3% is also not unlikely.  That scenario would produce 599 billion dollars of loss for the banking system.  Now can you imagine the armageddon outlook if you were to come up with a realistic worst case scenario?  

Then there were the unemployment numbers.  I wrote about the numbers in detail on the Prudent Money Blog this morning.  It is funny that no one is writing about the creation of the 226,000 jobs out of thin air estimated by the Government in the jobs report.  Can the Obama Administration really pull off this illusion making everyone think that everything really isn’t that bad?

Well, the stock market certainly thinks so.  The market continued the rally this past week.  Thus far, the S&P 500 is up 40% from the price level of 666.  This falls right in line with what happened in the 1929 bear market.  The major stock market rally in that bear market was up 46%.  Keep in mind that even with this stock market rally, we are still a little bit over -40% from the highs in October 2007. 

I put together a very detailed analysis in my recent letter to my clients.  After going through that process, I have some very strong technical evidence that this is nothing more than a bear market rally and its days are numbered. 

Keep in mind that everything gets exaggerated in this type of bear market.  The moves both up and down are much bigger.  Guard your risk very closely!

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As the news and analysis continues to flow from this stress testing of the banking system, I become more and more disturbed.  The Government decided it would be a good idea to run a simulated stress test on 19 of the largest banks in the  United States.  They want to make sure that they banking system can handle the worst situation.  The Government has the results of the test and have told the banking system.

The Government is basically telling the banking system whether or not the individual banks are weak or strong.  They are doing this based on their own system.  In other words, career politicians and in some cases, individuals who have never run a bank before, are telling bankers about their health based on a simulated experiment.  Those results were due to be released tomorrow.  Then it was changed to Thursday.  Now it has been changed to Friday.  Banks are up in arms about the results and don’t necessarily agree with the Government’s assessment.

The Government is now giving banks mandates and telling them that they have to raise capital.  Citibank is rumored to need 10 billion dollars in extra capital to meet the Government mandate.  For the weaker banks, they will be forced to give the Government more and more ownership through the use of common stock. 

So, go with this scenario with me for a while. There was a king who wanted to take over the entire country.  The king  knew that he had to control most of the country’s businesses in order to have complete control over the system.   So, the king had his servents assess the local businesses.  The servents reported back to the king that the businesses were weak.  The king said that they had to triple their sales in a week or he was going to take ownership.  The businesses knowing that this would be impossible had to give up control.  As a result the king controls the country.

The red flags are flying and the Government is taking a step-by-step approach to get ownership of the banking system and this seems to disturb only a small percentage of Americans.  For that, I have no answer.  Maybe I am completely off base and paraniod.  It woulnd’t be the first time.  I just know two things.  First, politicians have never proven that they can be trusted.  Second, the Government is seeking to control alot of our once capitalistic system and doing so at an alarming rate of speed.  Paranoid?  I don’t think so.

With stress testing and swine flu outbreaks (probably a little overrated) as the backdrop, the market continues to march higher.  At this point it looks like the S&P 500 has a date with destiny at the price level of 900.   Analyst Jeff Saut posted his weekly commentary this morning and wrote that he characterized the last 9 weeks as a buying stampede.  It is a period where investors stampede into the market and buy as much stock as possible.   His analysis shows that the longest buying stampede that he has on record is 41 days.  Currently, we are on day 39 of the buying stampede.  We are also at a point where the stock market (S&P 500) is almost positive for the year.  That would occur at a close above 903. 

If you are wanting to reduce risk by selling stock, there might not be a better time to do so. As this rally continues, the risk grows greater and greater.  If you were going to stay fully invested you would do so based on the notion that all of the worst is behind us.

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The bottom line:  As long as the ranks of the unemployed continue to increase, the damage to the economy will worsen.  As a result, risk for a continuing bear market remains high. 

Yesterday, I wrote about a discussion that I had with a friend of mine that manages money. 

My friend completely disagrees with me regarding my cautious outlook.  His argument is that there are a lot of risks in the stock market.  However, the market is comfortable with that risk.  In other words, we have seen the full extent of the risk.  If you think about it, it is the big surprises that cause the large declines in the market.

Although I agree with that opinion, I don’t agree that the worst is behind us.  We have to consider the problems that are brewing on the horizon that have yet to become a full blown problem. 

I wrote that the stock market can get comfortable with the risk that can be seen.  However, at the same time, there can be a category 5 financial storm brewing out in the distance that has yet to arrive.  So, I wanted to write about what I feel makes up that category 5 financial storm.  Today, I will talk about unemployment.

I really do feel that this is the biggest symptom of the financial crisis that can cause the greatest problem.  There are a few ways to look at unemployment.  We can look at the monthly report which shows us the unemployment report for the past month.   You have to be careful deriving to much from this report.  The monthly unemployment report is really telling you old news.  Those unemployment numbers are a result of weak economic conditions that have already occurred. In fact, an economy will start to recover well before the employment situation gets any better.

Then we can look at the weekly jobless claims.  This gives you real-time information showing how many people are receiving unemployment benefits from the Government as well as how many filed first time claims the week before.  This weekly number continues to climb and it seems that we continue to see weekly records.  Currently, over 6 million people are claiming unemployment benefits.

The Government gives their “version” of the unemployment number each month.  It is grossly understated.  It doesn’t give you an accurate look at unemployment.  It doesn’t account for so many people who have fallen out of the system.  Plus, they include an estimate of how many people that they think received jobs that the report didn’t cover. 

The real number according to the analysts who really follow the real statistics is closer to 19%.  Keep in mind that during the Great Depression the number was 25%. 

I believe that the unemployment situation in America has gone past the point that it can be easily fixed.  Thus this unemployment problem could be around a lot longer than anyone expects.  It is like cancer.  The longer the cancer is allowed to be a problem the more damage is done.  The bigger problem is that the Government is doing very little to fix the unemployment problem which just exacerbates the problem. 

The bottom line:  As long as the ranks of the unemployed continue to increase, the damage to the economy will worsen.  As a result, risk for a continuing bear market remains high.  Tomorrow, I will go over the second reason.

Market update – The stock market is grappling over the potential of a real problem with the swine flu.  It is way too early to determine how big of a problem this will become. However, experts say that timing-wise we are due to experience a pandemic.  It warrants keeping a close eye on this one.

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I had a debate with a fellow investment manager about his take on the market. He completely disagrees with me regarding my outlook.  His argument is that there are a lot of risks in the market.  However, the market is comfortable with that risk.  In other words, we have seen the full extent of the risk.  If you think about it, it is the big surprises that cause the large declines in the market.

Although I agree with that opinion, I don’t agree that the worst is behind us.  We have to consider the problems that are brewing on the horizon that have yet to become a full blown problem.  I remember writing in my client newsletters a few years ago about the category 5 financial hurricane that is sitting out in the distance.   I wrote that the market sees the risk of the housing bubble.  However, there is nothing that is ruining the party – so why worry?

Then the Bear Sterns collapse occurred and the market woke up to that category 5 financial hurricane that was heading for the United States financial markets.  Of course, Swine Flu was never on my radar of financial risks.  In fact, up until Saturday, I had never even heard of it.  So is a global epidemic of Swine Flu the new worry?  

Well, it is always tough to tell what is really going on and if this is a real problem.  The health “experts”, much like economists, are positively optimistic and downplaying the possibility of an epidemic forming.  President Obama addressed the scare this morning.  “This is obviously a cause for concern and requires a heightened state of alert,” Obama said, “but it’s not a cause for alarm.”   We are on a heightened state of alert and there is no cause for alarm?  What did he say?

Typically, these types of stories cause a negative reaction in the market.  However, it doesn’t develop into a full blown risk for investors.  However, if this were to become something much greater, then it would probably become a problem for investors.  For now, it is too early to tell.

Price Levels – Remember we always watch price levels in the S&P 500 to determine how much risk is out there for investors.  Friday, although a good ending to the week, the stock market was having a tough time getting above 875.  I would dare to say in the short-term it would be tough to be to optimistic until the S&P 500 can close a market day above 875.  This is a new week and let’s see what clues the market brings. 

TOMORROW:   What does my current Category 5 financial hurricane look like?  We will talk about it.


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Yesterday, the market struggled throughout the day until the Beige Report on economic activity was delivered early afternoon.  The news was that it looked like the economy might be stabilizing and the word out of Washington was that the recession might be over sooner than we think.


Well, that day of struggle for the stock market turned into a nice day with the market finishing with a strong return.  This is pretty typical for a bear market/recession.  If there is any glimmer of good news, the recession is declared to be ending. 


An economic decline does not fall in a straight line.  You will see really bad news, maybe some good news every once in a while, and then a period where the news might not be so bad.  It is tough to see the light at the end of the tunnel when analysts state that the economic news, although still very negative, is “not as bad” as months before.


So, we get on that roller coaster.  At the risk of being a “doom and gloomer”, I think that we need to take a look at the real estate markets and get a fresh dose of reality.  I don’t think that anything is going to recover until we take care of this foreclosure crisis. 


Even though the Obama Administration has rolled out an enormous homeowner bail-out program and banks such as JP Morgan, Morgan Stanley, Citigroup, and Bank of America have suspended foreclosure proceedings in some states, foreclosures were still up dramatically in February by 30%.  Approximately 291,000 homes were added to foreclosure ranks.  


The idea of the Government fixing the foreclosure problem remains nothing more than an illusion.   In addition, John Mauldin reported in his weekly newsletter that there are in the neighborhood of 600,000 properties that banks have repossessed but not even put on the market.  In other words, there are many foreclosures that are not even showing up in the numbers.


The foreclosure crisis is THE problem for the credit markets which is the problem for the banks which is the problem for the stock market which is the problem for the economy.  It all ties together.  This is a worldwide cancer that is still making the global economy sick. 


My concern is that because the market is up over the past 5 weeks and all of the economic cheerleaders are returning to the stage, that you will declare that you will not take risk seriously with your investments.  You need to know that risk is still very high in the markets.









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Part 1 of a series on how to use this daily stock market outlook

I won’t deny it, last week was a big week for the bulls.  Last week finished the best 4 week rally in the stock market since 1933.  Typically when markets go through these big rallies, the stock market will go through a period of selling.  The key is whether the rally will resume after investors take a break for a while.  At least in the short-term, this is the last chance for the bears to take back control of the stock market.  If the bears cannot send this market back into a decline, this market rally might be with us for a while.  The golden opportunity for the bears is earnings season.  Earnings season kicks off tomorrow morning. This is the time of the year where companies give the good and the bad news. It has been a rough time for the stock market lately.  If the bulls can get through this period, that would be a positive sign for the stock market.

This morning the market is declining after a big 4 weeks.  Nothing has changed in my overall assessment of the stock market.  I still think that we are in a long-term bear market and experiencing what is referred to as a bear market rally. 

The big question is how long will this rally last and how big will it be?  I could also be very wrong and the worst could be behind us, signaling the start of the next great bull market.  The answer to these questions is key, no matter what type of investor you are today.  Whether you are a 401(k) plan investor, have accounts with a financial advisor, or invest your own money, this is a key question.

Over the next few days I will be introducing a new way to use this daily market outlook.  Yes, it will be written in such a way that even the most novice investor can understand it.   The key is – You need to know when to increase or decrease risk in your investment.  You increase or decrease risk by increasing or decreasing the percentage of money that you have invested in stocks, stock based mutual funds, or investment accounts. 

Yes, stock market investing gets more complicated than just looking at risk as the percentage invested in stocks or stock funds.  However, just understanding some key strategies can make a HUGE difference in your success as an investor.  So, before tomorrow, determine which category describes you at the moment:

1)  Want to reduce or increase risk

2)  Want to invest new money

3)  Want to trade and time your investing



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“New Signs Emerge That the Worst is Over”

“Investors hope that the worst is behind us”

Give one good bear market rally and all of the problems in the world are fixed.  This morning highlights the risk that plagues this economy and the stock market.   Hope is what you have when you pull the handle on the slot machine.  You hope to hit the jackpot.  Investing in hope is dangerous.  Going with the opinions of Wall Street and politicians are even dangerous. 

The headlines are there to lead people to believe that the risk is gone and now you don’t have to think about it.  This morning’s unemployment numbers put an explanation point behind the problem in America.

Even most analysts believe that we are looking at these horrible numbers for the entire year.  We are losing in excess of 600,000 jobs a month right now.  This morning it was announced that we lost 663,000 jobs this past month.  There are an estimated 13.2 million people out of work (at least that the Government will acknowledge). The unemployment is sitting at 8.5%.  The real unemployment is around 15% when you add everybody in that is not being counted.

One service that tracks these economic numbers attempts to get the real number.  The last estimate I saw was an unemployment rate close to 19%.

The following is an excerpt from a letter I wrote to my clients yesterday:

I think that we will all agree that unemployment is the biggest problem that faces the economy.  In normal times, an employment rate that rises to 7 or 8% creates a recession.  Today the employment rate could go north of 10% (using the Government’s inaccurate data). 


So when unemployment starts to improve and the rate drops all the way down to 7 or 8%, does the economy really get any better? 


If the plan to fix the unemployment problem consists, for the most part, of a bunch of construction jobs, where the bulk of which don’t start until next year, what is going to fix the unemployment problem? Further, of those construction jobs that have to be filled, how many will really go to Americans when there are countless numbers of  illegal aliens ready to take them?  Remember, they are not checking government ID’s on these jobs.

This is the problem that is not being addressed.  I suggest it is the problem that will further plague this market and economy. 

The unemployment numbers were worse than the headline would suggest.  January’s unemployment was revised, adding another 100,000 plus people to the unemployment ranks.  Then you have the Government’s “estimated” job growth. This is my favorite.  Each month they apply a ratio called the birth/death ratio to the unemployment numbers. 

This number “estimates” the number of jobs created that the Department of Labor can’t get data for.  They are assuming these are created by small businesses.  This month they added 141,000 jobs to the total number.  So before that “estimated” number was added, the actual job loss was close to 800,000 jobs. You add in the downward revisions for January and you are getting close to 1,000,000 jobs. 

The Government “estimated” that 41,000 jobs were added in the Leisure sector.  Yes, that is realistic since so many people have a lot of money to spend on leisure activities. I can see where that sector would be booming.

There is no doubt about it.  Risk is still real in this economy and market.  Approach your investments cautiously.



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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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 Unbelievably, CNBC was on the air declaring the end of the bear market following a very strong day in the market. Just to think that people go to that station for credible information. There is a more important question to consider. Is this the start of the bear market rally we have been anticipating? Of course, only time will tell. We accomplished a big feat yesterday by closing above the S&P 500 price level of 700. That would be step 1. Now, step 2 would be for the S&P 500 to close above 741.

That is a critical price level for the S&P 500. The problem with this bear market is time. The markets are going to have a tough time putting an end to this bear market until there is a confidence that the risk is in the process of getting fixed. The reality is that only time is going to fix a debt crisis. No amount of government intervention will fix this problem. A debt crisis is corrected through time and loss. The debt problem has to be alleviated and someone has to lose.

Would it help if the Obama administration was perceived as actually helping “fix” the problem? That would be helpful. Unfortunately that is not occurring. Obama wants to fix the healthcare problem, education, stem cell research, the war in the middle east, world hunger, the problems in Africa, end poverty, fix global warming, and do something about this little economic problem we are facing. Obviously, I am exaggerating. He hasn’t mentioned the problems in Africa yet.

While on his way to being viewed as the savior of the world, he is missing one point. As Bill Clinton said to George Bush in 1992 – “It’s the economy, stupid.” Wow, never thought I would be quoting Bill Clinton and not to call President Obama stupid in any way. Just making a point that until he puts his own personal agenda aside (he made a comparison to his administration and Lincoln the other day) and focuses on the economy, we are going to stay in crisis mode.

Although the Government cannot ultimately fix the problem, the Government can still look as if they are trying to fix the problem. So, lets keep an eye on the market today and see where it ends up.

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The objective of this daily stock market outlook is to help educated you on how risk and stocks work.  Although it is not always easy to take something like investing and make it understandable, this is my objective.  So, please work with me to learn this information.  If you have not done so, please read this post about price levels and trends.  It will be helpful for you as you start to learn this information.  I always welcome any feedback. 

With yet another price decline today, it leaves you contemplating one question.  At what price level will the S&P 500 stop losing value?  Today, the S&P 500 lost another 1% finishing at a price level of 676.  We are 56.8% below the all time high of the S&P 500 set in October 2007.  That does seem like an eternity ago.

In looking at all of the analysis, I have come to the following conclusion.  The good news is that I do feel we are close to that bear market rally.  The bad news is that we might have to decline another -18% before we get there.  If you are a trader, that might be an excellent point to invest money for a 30% plus gain.  I do feel that this bear market rally that we are certainly due will be a scorcher. 

If you are wanting to reduce risk in your portfolio (reduce the amount of money invested in stocks), then this should provide an excellent opportunity to get back some of the loss and start selling stocks.  No, I don’t think that will be the bottom. This is why I still think that it will be important to reduce your risk down to a level that you are comfortable.  Remember, you can accomplish that by reducing the amount of money that you have exposed to stocks and stock-based funds.

This continues to be a very dangerous stock market like none we have seen since the 1929 to 1932 bear market.  Invest very carefully.

Update Tuesday Morning 3/10/09

Markets look good right out of the gate this morning with the S&P 500 on its way to test the price level of 700.  If the market can close above that price level (700), that would be a real positive.  Then we would want to see some more of the same over the next few days.

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