Digging in the Mud for Green Shoots - How Did We Get Here?
I’m digging for green shoots but you have to sift through a lot of manure to find them this week!
A few weeks ago I complained that the MSM was irrationally exuberant and I couldn’t find any negative articles (outside of PSW, of course, where people thought we were too negative calling for a correction) and now, less than a month later, you can hardly find anyone who doesn’t think we’re going back to the March lows. I stand by my statement to Members in yesterday morning’s Alert where I said: "It’s ridiculous for the Dow to go back to 7,500 and ridiculous for the S&P to go back to 800. While it’s easy to make squiggly lines on a chart show 10% drops ahead (which seems like a normal 50% retrace of the gains overall) I just think it’s dead wrong from a valuation perspective so I’m not inclined to play it, especially when those valuations are about to slap you in the face over the next few weeks. Maybe I’m wrong and maybe earnings will suck and Q2 will be a miss and guidance will be lower but right now I say - Show me the misses."
So I said Cramer was an idiot to be herding his sheeple into stocks when the Dow was at 9,000 and now I am saying Cramer is an idiot for stampeding the herd out of stocks at 8,000? Am I that fickle? Not really, I just believe we are in a fairly tight trading range. On June 17th I warned on June 24th, as the market "rallied" back to 8,500 I warned we were simply in the midst of a "dead cat bounce" - using the following, very descriptive graphic:
We played oil to top out at $70 for a whole month before it finally fell and I had warned people to stay out of the USO oil fund on June 6th (20% higher than here), but perhaps the last straw was when I pointed out that China was buying oil in bulk for $16 a barrel and even that was a ridiculously expensive price that more sensible buyers would not pay. Not long after that, Iraq had trouble with their own oil auction, again, no one in the industry had any real faith that $70 would hold and now, not even $60 is holding. They talk a very good game but don’t put their money where their mouths are! On Wednesday, June 17th, with oil already back to $70 from $73, I said in that morning post: "We’re looking for proper capitulation in the energy markets and follow-through from our indices to the 5% rule at least (we are hoping for 8% total pullback on this leg)." That leg bottomed out at $67 the next week, down 8.2% from $73 before doing it’s own dead cat bounce back to $72.50, where we shorted it again!
Keep in mind that our chief fundamental indicator, that allowed me to hit the June 15th market collapse right on the head, was copper prices falling back - an event I compared to George Foreman knocking out Joe Frazier in 1973. In that morning’s post (Dow 8,800) I said: "This morning copper has been knocked down and is leading commodities lower after coming off an earlier knockdown at $200 and another at $150 - having started its run way down at $125 back in December. Of course, after a 100% run to almost $250 we can certainly forgive them a 20% pullback to $225 per our 5% rule and we’re not going to call the fight just yet but Oil is also pulling back off a 100% run while gold has only moved 17.5% over the same time period, already double-topping at $1,007 and $989 in February and May respectively."
Copper is HOLDING that $225 line, finishing Friday at $221.15 despite a dollar that is holding up well (about the same as June 15th at the moment) so we are still not ready to call this fight as either copper or the dollar may come off the canvas and put in a couple of good rounds in July. Just a few days before our market view proved to be right on the money, I had to ask myself in the weekend wrap-up "Is Cramer Still Wrong?" as the relentless last-minute market saves were giving us all headaches as we sat on our bearish DIA and USO short positions and mainly sat out the June rally as it all seemed like one giant pump job to me. It turned out that, yes, Cramer was still a buffoon and I was only one day early with my top call of June 12th, which I termed: "Fall Down Friday."
So here we are, back at the bottom of the trading range I predicted back in March and even as far back as November, when I said that, based on the fundamentals the crash should settle out at Dow 8,650. 5% above 8,650 is 9,100 and 5% below 8,650 is 8,200 and that’s all within the bounds of what I see as the "right" level for the markets to consolidate. Can we still go 10% up or down from there? Of course we can - the question is where is the market going to get pulled back to. Other mid-points are S&P 900 (855-945), Nasdaq 1,750 (1,650 -1,850), NYSE 6,000 (5,700-6,300) and Russell 515 (490-540). We certainly obeyed the top of our range recently and now we’ll simply see if we can hold the bottom through earnings. At the moment, this "horrific" sell-off is nothing more than a long-expected trip back to the lower end of our range.
Is the current panic justified? What’s really changed in the last 30 days? Obviously, there were great attempts being made to push us up and over the top during the early part of June - the media pandering, the constant "stick saves," Cramer’s idiocy, Goldman Sach’s $85 oil call - all attempts to pull investor dollars off the sidelines and break out of our range. Failure to do so seems to have led to a sell-off, perhaps funds are giving up on the year or perhaps the sheeple who were herded in at the top have no appetite for a market that doesn’t go up and up and up.
We’ve been testing the lower end of our range, mostly doing buy/write plays that give us 15% discounts off the current entry price. Hopefully that’s enough cushion to ride out a panic dip but we are also scaling in with plenty of cash on the side, as we’re happy to buy more if the market does drop 20%, all the way back to 700 on the S&P, where we would happily load up the truck. Meanwhile, we’re picking up good stocks at what we HOPE are cheap prices, given the current market conditions. While we are not yet in what I like to call "monkey with a dart-board" territory, where almost any stock is a bargain, we certainly have some clearly good deals out there already.
Earnings will tell the tale in the upcoming weeks. Don’t forget we don’t buy stocks to bet on the economy, we buy stocks to bet on companies - some will do well and some will do poorly but the fundamental question is: will they provide a good return on your investment? After hanging onto our cash for more than a month, since Wednesday, as stocks started falling back near the bottom end of our range, we finally took the opportunity to give ourselves an additional discount, selling puts and calls (and sometimes just naked put selling) against entry positions on stocks that are already trading near their March lows. Our hedged entries provided us with the following net pricing:
- CAL at $7.36/8.18 (price if called away/price if put to us) - now $10, March (all non-spike) low $8
- CBS at $4.31/4.65 - now $5.97, March low $4
- COST at $43.35 - now $44.97, March low $40
- CVX at $58.20 - now $61.40, March low $58
- DIS at $20/20.50 - now $22.41, March low $16
- EXM at $4.02/4.51 - now $6.05, March low $4
- RT at $6.50 - now $7.12, March low $1
- SNDK at $11.54/12.77 - now $14.47, March low $9
- SPY at $85.95 - now $87.96, March low $70
- SPWRA at $19.90 - now $22.35, March low $22
- SUN at $19.06/19.53 - now $22.09, March low $27
- V at $55.30 - now $59.86, March low $50
- VLO at $13.49/14.24 and again at $13.30/14.15 - now $15.57, March low $16
- WFR at $12.83/13.91 - now $16.61, March low $13
- X at $25.30/$26.65 - now $30.77, March low $20
- XLF at $8.98/9.99 - now $11.10, March low $7
- XOM at $58.98 - now $65.12, March low $64
- ZION at $9.07/9.54 - now $11, March low $8
As you can see, most of our buy/write selections were for targets very near the March lows. If you wanted to smack yourself for not being brave enough to buy stocks when they crashed in March - what is your excuse now for not taking a hedged entry that effectively gives you the same price now? Of course, hedging our entries somewhat limits our upside, but that limit is 10-20% PER MONTH, not exactly a deal-breaker in the average portfolio. Combine this hedged entry strategy with portfolio management techniques (see Strategy section on "Scaling Into Positions," something I expanded on in this weekend’s Member comments) and you can get very comfortable with your bottom fishing.
We also do not make these selections in a 100% bullish portfolio. We have our long DIA covers, following our "Mattress Play" strategy and on Friday morning I also discussed setting up some long disaster hedges using the FXP on the assumption that, if our markets are going to fall back to the March lows, then China has a LOT of catching up to do and we can likely do better betting against the Shanghai composite, which is up over 100% since November, than we can betting the Dow or S&P down, which are up "just" 20% since November and 35% over the March lows.
We’ll see how earnings come out over the next few weeks. All the "green shoots" talk in May and June had the effect of raising expectations for Q2 and we are not going to get the easy victory we were handed in April as Q1s earnings were and upside surprise over something I had complained was a very low bar at the time. Now I think expectations are fair and I think we are also being given fair entries on certain stocks as investors engage in a little pre-earnings panic. Keep in mind this is round one of our scaling back into stocks, the same cycle we started during the March crash before we cashed out into the end of May, waiting for EXACTLY this to happen!
Hopefully all goes according to plan and we don’t head too much lower, the green shoots may have died on the vine in the summer sun but that doesn’t mean we’ll never have another good season. It comes down to the question - where are you going to put your money? Commodites have lost their luster and the emerging markets are looking iffy. Treasuries are still paying near all-time lows, TIPS don’t really keep you up with inflation and Europe and Japan are certainly not in better shape than we are and I don’t think we’re going to be racing back into housing anytime soon. Money has to go somewhere and there is less money now in US equities (especailly non-commodity equities) than there has been in the last decade - the situation is ripe for a rally, we just need a catalyst to move things forward and hopefully earnings will provide it.
If not, we’ll step back and reassess. We are not guaranteeing this is a bottom but we are willing to establish some well-hedged positions here, rather than miss a very good opportunity to make some new entries.
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