Well, this is why we don't get excited about rallies until we see our ranges properly broken.
The market has been, on the whole, pretty well behaved in a range between 8,200 and 9,200 with occasional breaks up and down of equal proportions and timing, which balance each other out quite neatly. That has to lead us to wonder if 8,500 is the new 12,500, which is about our mid-point of the past 18 months. Did stocks really lose 1/3 of their value this year or were they, perhaps, never worth 12,500 in the first place? I've said before, in November of 1929, I'm sure there were tons of people telling you what a great opportunity it was to get into stocks at 40% off the highs AND IT LOOKED GOOD FOR A WHILE – that was before they then fell from 240 to 40 just 2 years later…
While I'm not predicting another Great Depression, I have been telling members for a while now that I can believe we're possibly down to a high range of 10,500 – which was about the range we were in before the irrational exuberance of 2006, when the great con that is CNBC managed to convince America that $80 oil meant we had a strong economy rather than a runaway asset bubble. You can't blow bubbles without a lot of hot air and CNBC and much of the financial press was spewing it for years and had all of us convinced – that the market wizards were great and powerful and not just the same pathetic old stocks behind the curtain, all puffed up with smoke and mirrors.
Who could have seen this coming? Well I could. I did see it coming on March 19th 2007, when I was still cynical of the rally, and wrote the article "Get Ready for an Economic Tornado" in which I flat out stated that excessive oil prices had "created a storm that threatens to tear the global economy apart" but, as the rally persisted and we went back through 12,500, then 13,000 and 13,500 I lost my own perspective and started to believe 12,000 was a real number for the Dow along with 1,300 on the S&P. While I had overwhelming "evidence" that the rally was unsustainable, the fact that it kept sustaining caused me, along with most people unfortunately, to forget where we came from, as well as where we probably were going back to.
That caused us to look for a bottom where there wasn't one on the way down but, after taking a step back and reviewing the past couple of years, I've decided that it's more than just a housing bubble and a commodity bubble and a mortgage-backed securities bubble… we had a good, old-fashioned ASSET bubble, where everything pushed up everything else and now we have to worry about things going the other way, where the return to a "norm" may cause overcompensation to the downside.
A long time ago, we had looked at a chart of historic Dow prices from 1900 to 2004 along with average p/e ratios and that chart predicted a range of 7,200-11,750 for at least 4 more years (could be 15) before companies grew into a valuation that would justify a move up. Given the context of today's economy, it would not be surprising if we do have a "lost decade" in the markets – much like Japan did from the mid 90s. There is little politicians can do to "fix" the markets (Japan lowered their rates to 0.5%) and we have had to adjust our trading style accordingly.
Still you hear from the media about when it will be time to "jump back into the markets" but let's think of it more like a river where we swam until we got chewed up by piranhas. When it it time to jump back in there? OK – well, maybe never in that case so let's think of this more like swimming in Love Canal – you may dip your toe in on a dare after 3 years and maybe go for a swim after 10 years but at what point will you drink the Cool Aid made with Love Canal water? Mortgage backed securities have turned the financials into a toxic waste dump and it will be much more than a few months until it is safe to go swimming. Meanwhile, the market can trade wildly in a range from 8,000 to 11,000 and may possibly go 20% higher or (more realistically) lower than that given the right catalyst.
For a while we were picking up stocks that were bottoming out at their 2005 levels but now we're looking for 2003 (when the Dow was at 8,000) to give us a little more comfort in entering a position. We are buying less leaps while the VIX is so high and selling more premiums as that monthly income may be as good as it gets in this market. This is the Dow's second major pullback to 8,000 since it broke out in 1997 and 8,000 is a 50% retrace off the rally from 2,000 so a bounce back to 9,000 is not very impressive at all. I wish I had a better report but, at the moment, we are only holding those 50% retracements on the expectation that the government will "do something." I think they will but we still have a lot of very nasty data to work for and we need to continue to exercise caution and, more importantly – adjust our expectations.
So it is VERY important to keep in mind that, when we do pick stocks to play with, they are in the context of virtual portfolios that are always at least 30% bearish (currently we are 60/40 bearish but looking to hopefully rebalance as we retest 8,200). Our downside plays are often ultra-shorts like DXD and SKF, which do very well on the way down and I promised members a full article on virtual portfolio balancing and I will get to it this week as that is probably the one thing most people need to work on, especially in this crazy market!
Asia was not too crazy for a change this morning with the Hang Seng and the Nikkei relatively flat and the Shanghai gaining 2.5% on the session. The Shanghai continues to be our most hopeful indicator that there may actually be a bottom in Asia but, sadly, in the case of mainland China, we had to give up 70% to find it. Japan has officially been declared in recession joining pretty much everyone else at this point and Fitch put TM on credit watch, imperiling their AAA rating so now we may see where Toyota finds a bottom.
Europe is trading down about 2% ahead of the US open, which also looks weak as the G20 meeting came up with nothing of note other than a call to tighten regulations on banks – which we all knew was coming so it will be interesting to see how our financials take it, but it's financials that are leading the EU down. The UK had some awful economic projections indicating 3M unemployed by 2010 in a country with the population of California.
Our own unemployment figures should get quite a pop with C planning to lay off 50,000 workers while GS executives are keeping their jobs by giving up their bonuses altogether. Things are still very bad but are they 40% off bad? Of course, as I said above, 40% off the highs is an illusion as the highs were an illusion. When you blow a bubble and it pops is there a "right" size for the bubble or is it simply gone? Until we can make a determination, we will continue to hedge our bets. I do think that Dow 8,200 is a good point of entry on many stocks but we have been very selective and we've been hedging our entries for an additional 20% drop so we're certainly not overly confident here. In fact, as a rule of thumb, I've been telling members that we should be looking for stocks we don't mind holding for 10 years if they drop in half from their current prices – and even then we haven't had a reason to go more than 60% bullish yet!
