In a series of posts since October 24 (See "Getting It" of that date), I have presented several scenarios: one or two posts for the bearish notion that the correction from August to October was not sufficient, even though it was over. And later and most recently several posts outlining the bullish notion that most of 2004 and 2005 has been a sideways correction which would lead to a large rally akin to the 1935-37 and 1985-87 bull markets.
Having more than one outcome scenario may make it seem to others like I don't have the confidence of a real opinion, but in my personal experience it helps me enormously to analyze both the bullish and bearish chances and the opinions of others to see if they make sense. I see so many people get married to an outlook and stick with it when it's clearly wrong. And I have done that myself. So if I can see the rationales behind opposite market opinions and actually put them into words, I'm more than halfway home to a plausible market approach. For me. Naturally, this doesn't guarantee that my final decision is going to be correct, but I gave it my best thinking and analysis, given the resources and understanding that I have at my disposal.
In my Portfolio Ideas posts, and in other sections, I have explained what my porftolio approach has been since early 2003: basically long the stock market through stock pickers of various types and in various sectors. Then I used ETF's and stock index futures (and lately QQQQ) to augment returns on the upside during intermediate term moves and futures or inverse or 200% inverse mutuals to hedge the core long positions to a variable extent during declines. I sold out the long "augmentation" group in the past ten days and got to about one-third cash in the total portfolio.
The 1935-37 bullish scenario is very seductive, and it has kept me long until now in funds of excellent stock pickers who have handily beat their benchmarks during a sideways to up market. But sentiment and value measures are overcoming my "hope" that we are going up right away. Value and sentiment are not geared to a large rise as they were in 1935 and 1985, and the last two years really do appear to have been distribution. I can and will get into all the indicators and data and cycles for this another time. For now I will simply say I have decided we have more down ahead. It could go up into New Year's Day as it did last year and as the Dow and SPX seasonal says. Last year it did so when sentiment was similar to now. But I am starting to build a more hedged and possibly an eventual outright net short position as of today. I plan to leave my core longs alone as they showed an ability to weather previous bear phases remarkably well. Most of those I have identified in the Portfolio Ideas posts and charts from the beginning of this blogsite. What I want to do is keep the above average and sell short the average or worse.
That's my st0ry, and I'm going to try to stick to it unless I am very wrong. In fact I hope I'm a bit early, as I was in selling the "augmenters", so I don't have to sell on the way down.
Bythe way, these are just my personal thoughts. I work for myself and my family only, am not an advisor, and this blog should be considered a personal diary of market thinking which could be completely wrong.
Odds favor being near a short to intermediate term high in many stock indices. My 2CS bearish sentimeter and a lot of other measures are close to levels from whence selling has occurred in the past two years. SPX has risen 7% in a month.
But, general public sentiment remains churlish and negative, and politics has already turned brutal three years ahead of the next presidential election in the US. Sentiment is rarely so pessimistic and defeatist at major highs, quite the contrary
The economy looks pretty good to those who accept accredited economic statistics and professional analysis. Even France may be turning the economic corner at last, and the ECB could even raise rates. Partly this is "jawboning" in Europe to counter the recent nano-revolution's effects on the Euro, but it seems to have believability nonetheless.
The madness of full moon US negativism and congressional posturing cannot be completely written off, since panic and further self immolation can follow such amazing displays on a mass scale. They can overcome normal responses and become self-fulfilling.
I saw the same things happen in 1974 and for the same political reasons and by the same people in some cases. So one has to buy a "crazy put" of some kind which in a worst case raises the cost of doing business but provides insurance.
The "crazy put" of choice in 2005 has been gold. Gold is up nearly 15% in dollars which themselves are also up nearly 15% against the US trading partners' currencies. (China still trades in dollars with a small recent cut.) 90 day US T bills are now yielding almost 4%. So the shotgun, T Bills, and gold folks are having a banner year and haven't had to fire a shot.
The left wing crazies have been short bonds and US stocks and dollars, and the right wing crazies have been long gold and t bills. I don't own a shotgun and have never fired a gun (yet), but the right wing look smarter to date. However, good stock pickers have beat everyone. I have stock mutual funds most of which are up 15-30% this year in a rising dollar environment and during sentiment as bad as 2002 and 2003.
My educated guess is that things are a lot better than they seem to the public since they are not long the stock market on balance.
Despite my belief in stats which suggest a downturn in the market, I think I have to mantain an open eye to a big breakout to the upside on grounds like but opposite to those often used to predict crashes: major breakouts occur in the direction of a strong trend. I don't want to be very leveraged to the upside, but I want an exposure to it since it seems so unexpected.
I've come up with an Elliott Wave count for the first time since 2002 which I think fulfills all the criteria. I would never suggest that those who don 't know Elliott Wave spend the years needed to learn it, because it it is so subjective and controversial. The basic cookie cutter of 1-2-3-4-5-a-b-c can be grasped in an hour. The other, and essential, 5% takes about twenty years. You would do better studying trends and reversals in other ways. But here it is anyway:
The basic premise is that 2004-2005 have been a complex Elliott market correction sideways in three segments. 2004 had the choppy down segment into August plus the recovery segment to New Year's Day. 2005's segment had choppiness again. In some indexes like small caps and mid caps, the whole correction may have ended in May 2005, but in the SPX it is almost certainly true that October's "Homeland Securities New York Subway Leak" plunge was the end. A correction whose end is at a higher price than its beginning is a "running correction" or runner in Elliottese. It leads to an acceleration of the trend.
An average target for the next larger trend segment would be the old SPX highs of 2000 in the mid 1500's. I don't "know" that this will happen, but I can put together an economic and political scenario which would support this interpretation of the SPX chart
The folks who missed the Economic Long Wave inflation peak of the mid 1970's were still insisting we hadn't seen a contraction yet, the last I bothered to look. But the curve of Consumer inflation as measured by the PCE shows the classic shape of 25 year increases and decreases in inflation.
With all the talk this week of Greenspan's legacy and Bernanke's prospects, it is well to remember that FED heads do not produce the economic cycle. In fact they follow it as fast as they can, sometimes making its swings more violent.
I am posting this chart from Paul Kasriel, and the classic long economic schematic chart below, several hours before the Consumer Price Index comes out. My view is that hang-wringing, wishing, and fiddling do not make a lot of difference in the long run. For investing and living , a grasp of the long cycle is superior to reading the tea leaves of daily economic releases. The longer tem fact is that consumer prices, and much else, peaked in the 1970's and bottomed in the late 1990's. That's when gold and crude oil bottomed in price as well
"How do you square the possibility of a 1935-37 run with a short term top"? I'm glad you asked. :)
Normally when we have got to this sentiment level we have been or will soon be slithering up into tops with both implied volitility (VIX,VXO) and price volatility (ATR14, etc.) dropping modestly. If we do that, I feel we will have a normal top between now and Christmas or the New Year.
If instead we see continued sharp moves upward in prices, and if range shifting in 2CS, because of VXO "collapsing", causes 2CS to fall under 40, then it's a new ballgame as in 2003. So I would watch ATR14, currently at about 12 and VXO currently at about 11. If either or both drop under 10, we are off to the races as from1935-37.
Before 1999 I was mostly a short term bullish trader in futures on top a long term bullish stock and fund portfolio. Being long futures when also long stocks is sometimes called the "Texas cattle hedge" after those enthusiastic cattlemen who believe so much in their calling that they go long futures too. :)
It wasn't due to great enthusiasm for the bear side that I went largely to cash in early 1999. Basically I didn't understand the market. I never invested in the mo-mo stocks and saw "value" melting away from the stocks I did understand. Lucky me!
In late 2002 and especially the first quarter of 2003 I got re-interested in stocks, but from a different perspective. Look at some of the earlier articles under "Portfofio Ideas" for basics I learned (and adapted) from Merriman. Basically I decided to pick the stock pickers and perform sector balancing (in all asset classes) instead of buying the stocks.
The new program still retains a bit of the "Texas Hedge" of old. Twenty to twenty-five per cent of invested funds goes into favored sector exchange-traded funds (ETFs) when I have short to intermediate term buys. Currently I am long QQQQ. If my schedule permits I also buy stock index futures for part or all of these moves, currently SP futures. The rest stays in long term core funds plus a few age-old stock positions.
When I get close to a putative high I start scaling out of the ETFs and futures and into short funds and short futures. This is where I am today. These swing moves tend to last for a few weeks to a few months. The best way I know to focus in on identifying the change points is by using daily and weekly sentiment measures. There are scores of these indicators, and some good services which do much of the work. Two I subscribe to (and I hate to pay for anything!) are Rainsford Yang's
Good sentiment analysts, like Yang and Slezak, have to "think like a criminal", to use Don Wolanchuk's very apt phrase. What does the market have to do to get the most people long at the top and short at the bottom, and not just positioned but absolutely committed? The only way that the really huge size of big traders and hedgers can be accomodated is by getting you and me, alas, committed the wrong way.
Having become a small portfolio manager, I want to be able to do what the 150-200 largest global portfolio hedgers are doing, as best I can: hedging their long portfolios short near tops, and lifting (removing) short hedges near bottoms. This is measured by watching the official and legal (registered with CFTC and showing proof of true hedging) portfolio hedgers via their positions in stock index futures and futures options. These are the big boys, and with a slight time lag we can know what they are doing. It's also important to know what the little guys and the commodity and "hedge" funds are doing, and both Yang and Slezak help there as well.
At this time the very simple 2CS of bearish sentiment is edging into the area (40's) from whence sells have come this year. It is not a time prediction but more like a two week general weather forecast. One thing it took me a long time to appreciate is that terminal moves can go farther than one suspects based on indicators. By scaling out of those ETF"s I pay a bit more in commissions with multiple sales (not so in futures which are per contract commissions), but I don't commit everything at once, too early or too late. Likewise for the new short positions.
Click on the chart image for a larger version. I have not put the number for each day, only the actual turn days. Some turns occur very close to when the first low 50's or 40's day of 2CS occur. Other times, as in the run from early November of 2004 to New Years', the 2CS hung around this range for nearly two months while SPX went fr0m ~ 1165 to 1225 on a closing basis, so some judgement, guessing, and/or scaling is required.
Sometimes I have decent time lines or other timing indicators. There is a pretty good (logical) one for about November 28-29. This one comes up from the second low of late April 2005. And there is another rather more logically potent time line from the March 2003 coming due at about Christmas.
Also bear in mind that the Dow (from 1928) and SP futures (from 1982) seasonal charts show strong seasonal moves up from late October to the New Year. Even in the very bearish years of 2000, 2001, and 2002 these seasonals still managed a gain. I have heard some internet chat folks laughing at the seasonal this year since it has been mentioned by guests and employees on CNBC. "If everyone on CNBC knows and talks about the seasonal, it can't work this year", say these folks. I won't point out all the logical faults in this type of "contrarian" argument, but seasonals have never been a secret that has been suddenly released to the public by CNBC. You have to go back to the bear years of the 1960's and 70's to find years when there was little or no rally in November and/or December. Some external economic or political event could cause a crash this year, but barring that, the seasonal chart lends support to the idea of a judicious approach to exiting or reversing portfolio hedges into year end strength.
I've found some interesting relationships in the SP500 chart which fit together in a descriptive and predictive way. Some of them I've known about for several years, but I think I now see how they are related. More later, but here's the chart:
Four months ago I had never seen this comparison. Now it is seemingly everywhere this week. Is this the financial information equivalent of new fall fashions and fads? Is any new market insight instantly doomed once it gets into search engines and is regurgitated into rss feed bowls throughout the universe?
Probably I'm just tired and a bit peckish.
This one's from Russia:
As always, click on the image for a large pop-up version.