Monday, December 29, 2008


This morning, the markets got down to the hourly support levels for the recent trading ranges, so I sold the remainder of my SKF (-2x Short Financials) and all of my PSQ (Short NASDAQ).

I figure that they won't let things crack this week.

The NASDAQ (QQQQ) has been stuck in a trading range since early December. Here is the hourly chart of the QQQQ with volatility bands. The +/- 0.5 band (Black Lines) has defined this trading range.
I covered my shorts on the NASDAQ this morning, by selling my PSQ (Short NASDAQ).
The NASDAQ will break out of this trading range soon. I’m just don’t think it will occur this week.

Financials (XLF)
The Financial Index is now testing the low of its recent trading range at $11.50 (Orange Line). $11.50 is support, until proven otherwise. So I sold my SKF (2x Short Financials).

These trading ranges may break down tonight, or support may hold. I have no clue.
But I know that if support holds, yet again, then I would be really ticked at myself for not booking small profits.

I am now operating under the assumption that they do not want prices to fall hard in the last week of the year.

I will scan charts tonight to see if anything is setting up. From what I have seen so far, there may be a short set up in Gold and US Treasuries. We’ll see if big money shows up and the trades trigger.

Wednesday, December 24, 2008

2009 The Year of the Pork Barrel

I want to start off with my 2009 prediction...
My best guess is that 2009 is the Year of the Hog on the Chinese calendar, because that $1 trillion “Stimulus Package” will be the biggest pork barrel transfer of wealth from taxpayer to political cronies in the history of mankind.

I have been telling clients all year that Hedge Funds have a history of inflating their performance numbers and then fessing up by taking an artificially large loss early in the following year. The fact that any entity in the investment community has the capability to fudge performance numbers is a really by indication of how lax regulations are and how bad oversight is.

The implosion of the Madoff Hedge Fund is the canary in the coal mine for the Hedge Fund/Fund of Funds/Alternate Investment/Managed Futures industry. Either regulators will have to start taking the auditing of Hedge Fund performance numbers seriously, or investors will pull their money from that investment product.

The big question for me right now is – how much of the performance numbers for Hedge Fund and Managed Futures Indexes were the result of Madoff’s bogus numbers? The big argument for owning this asset class is that it performs well during times where stocks are down. This improves the overall performance of the portfolio during bad years.

But what if a significant amount of the outperformance for Hedge Funds during down years was actually generated by the bogus numbers of Madoff’s Fund? I am going to email some people about this topic and will relay their thoughts to you.

On to the Markets
I hear a lot of people on TV telling me that the markets have found their “bottom”, that stocks are “cheap” values” “bargains” and that their targets for 2009 are someplace well above where we are now. My crystal ball is cloudy… I have no clue where we end 2009, and neither do the guys on TV.

I just want to look at the charts of the sectors to gauge the health of the markets, as we enter 2009. I see two patterns right now. Indexes have either made narrow rallies into declining moving averages (wedges) or they are stuck in narrow trading ranges. Now, things can change very quickly, but neither pattern is very promising.

Here is the chart of the S&P 500 Index (SPY). I see a bounce up into the declining 50-day moving average (Black Line) after a crash, on declining volume (Red Line and Arrow). That is very bearish.

Basic Materials (XLB), Financials (XLF), Industrials (XLI), Technology (XLK), Retail (XRT), Housing (XHB) and Semiconductors (SMH) each have patterns similar to the S&P 500.

Healthcare (XLV) and Consumer Discretionary (XLY), have similar patterns, but have held up better, in relation to the October lows.

Couldn’t Even Bounce
These sectors could not bounce, while the markets were able to make sharp bounces from recent lows. That is not a good sign for these sectors – Energy (XLE), Consumer Products (XLP) and Utilities (XLU).

Individual Stocks
Here are some stocks that scare me as we enter into the new year.

Microsoft (MSFT) is still well below key resistance ($20.68). It can’t get even get to the 50-day and has appeared to have broken its recent uptrend. I just saw some guy on CNBC tell viewers that Microsoft is now a “utility” and is his low risk pick for 2009. Who are these clowns who run these TV shows…

American Express (AXP)
Here is another stock that can’t get anywhere near its 50-day. I consider AmEx to be an important company. I don’t think its performance is a good thing for the markets.

Apple (AAPL)
This former darling looks like it is setting up for another leg down.

Now, onto the leading names, with strong growth, breaking out of trading ranges on heavy volume.

There aren’t any…

Tuesday, December 23, 2008

Keep Your Losses Small

I wanted to follow up on my last post.

Small losses are a part of the business. Not all setup that trigger become profitable. I always assume that I will have more losing trades than winners (I am not sure if that is the case), so my losses per trade have to be smaller than my gains per trade.

Crude Oil
I got stopped into Oil (USO) and then got stopped out at $31.80 yesterday. USO has been as low at 29.13 this morning. I still expect a real strong bounce on Oil at some point. To give you example of the power of the potential bounce, Natural Gas (UNG) has rallied 9.5% intraday. So I will be looking for other setups in the future.

A few days ago, I added to my short positions on Financials via SKF at $109 or so. I took half of my SKF out this morning. That gives me about a 3% exposure to SKF.

I had stops in to buy QQQQ (Bullish NASDAQ) and PSQ (Bearish NASDAQ). PSQ triggered and I now hold it. PSQ did its annual distribution of dividends and capital gains today. The distributions were a total of $4.2547 per share. So I am up a few percent on PSQ. The distribution will hit my account on 12/30.

Thursday, December 18, 2008

Something's Got to Give

I think the markets are at a crossroads and need to make a decision very soon. That would mean volatility and the opportunity to make some money. I think it is a trading opportunity. If it is a rally, then I expect a really good shorting opportunity in the next few weeks. If it is a breakdown, then I expect the opportunity to buy a retest of the 11/21 lows.

I don’t even know what I am having for dinner tonight. That is how short term my expectations are on this set up. I have already closed out purchases of the last 2 days – XHB, XLK, JNK and MYC. My trading positions have been small and I have been quick to take profits.

I Like Exchange Traded Funds
This removes company-specific events which may compromise an individual stock, even though the group may work. When really leaders with high growth show up again, then I will look at stocks again.

I see two very good potential trades. These aren’t recommendations! I’m just showing you what I am seeing. Most of you will look at all the lines, roll your eyes and go back to ESPN or CNN… I want my thoughts archived for future analysis of what worked and what didn't.

The NASDAQ 100 Index (QQQQ)
QQQQ has been trading in a narrow range between $28.5 and $30.5 for the last 9 trading days. Hourly volatility is now at extremely low readings, so a new trend may not be far away.

The trading range is capped by the Blue Line. See how this line has proven to be support (Blue Arrows) and resistance (Red Arrows) since the 10/10 low? It is a critical price level and traders have been keying off of it. Since mid-November, all rallies into it have been sold.

The trendline off the 11/21 low (Citibank bailout) has proven to be substantial support (Green Line and Arrows). It has held on all attempted selloffs.

Something has to give. Either resistance is taken out and the markets rally sharply, or support is taken out and we fall sharply. I think we are still in a Bear Market, so I am not invested in stocks and don’t care which way we go. I can make money in either direction. I just want a strong trend!

If resistance is taken out, then I want to own QQQQ. I will put in Stop Orders to Buy above $30.50.
I expect the first move out of this range to be a headfake and would not be surprised to see the market start in one direction to trigger a bunch of trades and then reverse sharply to trigger a bunch of stop losses to accelerate the real move. Yes, Market Makers do such things.

The inverse of the NASDAQ 100 Index is PSQ. If the uptrend from the lows is broken on QQQQ, then I want to buy PSQ. I will have stop orders in above the PSQ Green Line.

One thing to watch out for is that if support is broken, then I would expect CNBC to float a rumor that the government is going to announce a bailout after the close on Friday. Gasparino will be the guy who does it, if it happens – “My sources are telling me (blah), (blah), blah)…”

Here is the hourly on QQQQ. QQQQ was extremely oversold on 11/21 (Pink Circle). It was 2.5 Standard Deviations from its hourly norm. This is a rare occurrence and a normal place at which to look for a reversal. QQQQ closed right on the norm today (Black Arrow).

QQQQ is actually pretty oversold on the hourly chart (Blue Box and Arrow) and could just sit around here for a few hours on Friday before breaking down. It could also just ramp and be at $32 before you can blink. We’ll see how it goes. In a week, I could be telling you that we are still stuck in the $29.5 range... I need to take what the markets give me.

Crude Oil (USO)
The other potential set up is a reversal in the price of Crude Oil. I use the ETF USO for investing in Crude Oil.

USO has traded from $119.17 to $32.10 in 5 months. The last 2 days have seen MASSIVE volume (Arrows). I always get interested when volume explodes, because it often occurs at the end of a move. So, I am looking for a potential reversal.

Here is the hourly chart on USO. The setup is there for a panic bottom. See how Momentum (bottom of chart) is putting in a higher low (Blue Line and Arrows), while price is putting in a lower low (Green Line).

On a panic bottom, big money stops selling on the first bottom (Green Arrow) and the little guy gets shaken out on the final panic bottom (potentially today’s bottom).

The setup I will be looking for is a reversal in price back above $33.25. That would give USO a chance to start a major short squeeze, where all the people who went short on the break of $33 are forced to cover, while others are buying USO.

See how the norm is at $44? There is not a lot of resistance until $40. I’d be happy with $35…

Friday and Monday could have some serious fireworks!
Now, off to yet another Holiday Party or recital or something festive...

Wednesday, December 17, 2008

Why Isn't Energy Rallying?

After a sharp, 6-day rally, Crude Oil fell 7% today. The excuse is that OPEC cuts to Oil production were below expectations. I wanted to take a look at Commodities and Commodity-related sectors. I wanted to do so, because I keep hearing people on TV talk about how great the likes of Dry Ships (DRYS) and Chesapeke Energy (CHK) look.

I keep hearing the same words they were throwing around when they talked about Financial stocks – “Value”, “Cheap”, “Oversold”, “Bottom”… Bottoms will form over time and there is no need to jump in until institutions prove that they are looking to buy as well.

Bubbles Cause Mal-Investment
My thesis is that there is a massive supply of Oil now sitting in Oil Storage Facilities and parked in Super Tankers off many major ports. This supply is now competing directly with OPEC for a presently-diminishing number of consumers. So it doesn't really matter how much OPEC cuts supply in the near term, because there is ample supply available, without having to take any more oil out of the ground. At some point, this dynamic will change and I will be interested in OIl when it does.

The last phase of the 2002-2007 Bull Market was the bubble in Commodities and Energy. This bubble popped in early- to mid-2008. Here is a chart of the Energy Stock ETF (IYE). Look at how many shares of IYE were traded in the 1st half of 2008 (Green Box).

That was massive speculation, with buyers stepping all over each other to load up on Energy holdings. I think a lot of this was the result of Hedge Funds being allowed to lever up 6:1 or 10:1 and ramp up energy prices. West Texas Crude Oil ($WTIC) and Natural Gas ($NATGAS) went straight up.

So did Agricultural Commodities ($DJAAGT).

This was a classic bubble, where people all tried to chase returns and in the end, there was nobody left to buy. Then, the inevitable Crash soon followed.

Futures Deliveries
Because Futures Contracts ultimately end in the delivery of the underlying commodity to the owner of the contract, somebody has to figure out how to store the commodities they buy. What ended up occurring in the Commodity Bubble, was that Hedge Funds and large Investment Banks bought storage facilities and oil tankers to store their oil.

This stuff never made it into the economy – it was sitting in the SS Harvard Endowment Supertanker in the South China Sea, waiting to be sold at some future date, at some higher price.
When the bubble popped, there were no more speculators to sell to and now massive excess supply existed. The owners then started selling to consumers. So you now had this fleet of Oil Tankers and Cargo Ships full of Raw Materials, sitting in the harbors of the World’s major cities.

This excess supply led to price implosions and also led to implosions in the business of companies who make their money shipping raw materials – Shippers ($BDI), Pipelines ($DJUSPL) and Railroads ($DJUSRR).

The moral to the story is this – don’t go buying these sectors because some guy on TV is telling you that they are cheap. Be patient. The bottoms will take time. But they will eventually bottom and may become leaders again.

Remember how they looked at the top, because the cheap money now being printed by Central Banks is going to set up a new series of bubbles. There will come a time to buy these and then another time to sell these. I will let you know when these times arrive.

For now, here is the Energy Index (IYE). It has been consolidating for 11 weeks on contracting volume. Remember, consolidations are followed by violent moves. I expect a big move soon. I am not sure in which direction it will move, but I think I can make money on it when it arrives.

Huge Losses at CalPERS

CalPERS (California Public Employees Retirement System)
I didn't plan on posting this morning, but I came across this and had to get the word out.

The pensions money managed by CalPRES has lost 25% of its value since July 1, 2008.
According to the Wall St Journal, CalPERS bought lots of residential real estate and raw land at the top of the bubble. Even worse, they levered up to by the land (20% down and 80% borrowed). CalPERS is now admitting to losing 103% on at least one of these investments.

Do you have a pension? Do any family members? Yikes! Clients who worked for General Motors have seen their benefits decline the last few years. I hope that the same does not happened to potential CalPERS pensioners. CalPERS covers 1.6 million people. I hope that CalSTRS did not do similar things with the money they oversee.
In 2006 and 2007, everybody was trying to mirror the investment strategies of the endowments run by Harvard and Stanford. They both had enormous holdings in "Private Equity". They owned a lot of individual investments and Hedge Funds. These investments worked great on the way up, but have proven to be illiquid (you can't sell them) on the way down.
The moral to this story is that YOU are responsible for financing your own lifestyle. Pensions may be there and Social Security may be there, but you need to know that a certain amount of money WILL be there - no matter what. That means avoid Limited Partnerships, Fund of Funds, Managed Futures and "Alternate Asset Classes". Only own holdings where you can put in a "Stop Order" to protect yourself if you are wrong and the market turns against you.
CalPERS is by no means a Ponzi Scheme like the one run by Mr Madoff. CalPERS has a big pile of money. But CalPERS may now be "under funded" - meaning they will have to go to the entities that employ the current workers who are paying into CalPERS each money (Municipalities) and force them to pony up some additional money to make up for the investment losses. Municipalities are in no shape to fork over a couple Billion Dollars to CalPERS right now.
Compare these two links and see which one you believe.
CalPERS is Resilient in Market Downturns
State public worker pension fund takes big hit

Tuesday, December 16, 2008

Today's Rate Cut

Did anybody really not see this Fed announcement coming today? Really?

Quantitative Easing started on November 21st, when the Fed bailed out Citigroup, not today at 11:20 am. The markets have been rallying since and may soon sell on the “news” announced today by the Fed.

Recap of the Keys of Quantitative Easing (QE) - per Ben Bernanke
I broke down Bernanke’s beliefs about QE in the following post (that post will end up being one of many on the topic of QE) –

“When your target interest rate approaches zero, you are forced to use other policy tools to impact economic activity. Bernanke sites three –

- Provide assurances to the financial system that short term rates will be lower in the future than is expected
- Shift the asset mix of the holdings on the Balance Sheet of the Federal Reserve
- Increase the size of the Federal Reserve’s Balance Sheet beyond the level needed to get short term interest rates to zero. This is Quantitative Easing.”

With that in mind, I want to review today’s rate cut press release from the Fed –

“(T)he committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the Federal Funds Rate for some time.” - Point #1 from above

“(O)ver the next few quarters the Federal Reserve will purchase large quantities of agency (Fannie Mae and Freddie Mac) debt and mortgage-backed securities ... it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.”

“Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.” - Point #2 from above

“(S)ustain the size of the Federal Reserve’s balance sheet at a high level.” – Point #3 from above

The Fed really didn’t announce anything new today. Moreover, the markets have been pricing in this new reality for almost a month.

Buy Mortgage Backed Securities
On 11/25, the Fed announced a $500 billion program to buy Mortgage-Backed Securities issued by the US Government Agencies, Freddie Mac and Fannie Mae. The Fed already started buying these securities, weeks before today’s announcement.

The purchase program has brought up a couple of concerns. The primary concern is that if these mortgages are written by US Agencies and carry the “implicit guarantee” of the US Government, then why does the Fed have to print $500 billion in new money to buy some of them?

The answer is two fold. First, if the government completely takes over Freddie and Fannie and issues an “explicit guarantee” for their paper, then the US Government has to move the debt of Freddie and Fannie onto the Balance Sheet of the US Treasury, forcing the US Government to add over $5 trillion to that year’s deficit and over $5 trillion to the US Government Debt total (off balance sheet accounting).

The other concern is that the move is designed to raise the prices on all $5 trillion of the bonds, while they are only threatening to buy $500 billion of them. This is the old “Fractional Banking System Game”, where you act like you have enough money to cover anybody who wants to sell today, but in fact you only have a fraction of the total amount on hand and are really just bluffing.

The concern is then what happens to the prices of mortgages when the Fed spends the $500 billion? About 80% of PIMCO’s flagship mutual fund is invested in US Agency mortgages. Don’t you think they will want to sell a bunch of that junk at a fat premium to the Fed? I know that Foreign Governments are unloading that stuff at a rate of over $20 billion a month. China alone has well in excess of $500 billion in Agency paper.

Buy Credit Card, Automobile and Student Loans
On 11/25, the Fed also pledged $200 billion to buy these loans.

There are two goals to these debt purchase programs of the Fed. The first goal is to take toxic debt off the books of banks at better prices than they would get if they had to sell them at market to decrease their leverage. The second goal is to get lending going again by either getting the banks healthy enough to make new loans, or by having the Fed actually make the loans. The Fed would do so by buying the loans as securities, created by the original lenders – example - General Motors writes a loan to sell a car and sells the loan to the Fed, because these days, nobody else can or wants to buy that loan.

Paul Volcker
Volcker is a former Fed Chairman, who once uttered something to the effect of – eventually you get to a point where you have to make the decision to either crater the currency or crater the economy. Volcker was forced to crater the economy to kill inflation. He did this by raising short to interest rates in excess of 22%. This will occur again in the next 10 years - mark my words.

Now, Bernanke is faces with “curing deflation”. To do so, he will print infinite money and “crater the currency”.

When the Fed’s rate cut was announced today, I heard one of the CNBC guys say “Oh my God, look at the Euro”. The Dollar got killed today (-2.75%). The Euro rallied +3.07% today. The Dollar topped on 11/21 (think Citigroup bailout) and is down -12.5% since. The Euro has rallied 16% over the same period. Silver is up +26.6%.

Remember, asset price appreciation is the primary economic goal of the Fed/Wall Street/US Government crowd, which now controls our country (you can debate me on this if you would like, but my intention is to remain apolitical). So if you have assets, then you should be able to survive the inevitable, massive future inflation wave and interest rate spike.

You will need to get comfortable owning assets like commodities and inflation-adjusted bonds, in addition to stocks. You will also need to be able to own short-term bonds and avoid long-term bonds, because long-term bonds will get trashed when inflation goes up.

So, today’s Fed announcement was more of a confession about the obvious, rather than the announcement of a new policy. The dramatic moves in stocks, commodities and currencies since 11/21 should be retested in the not-so-distant future. I had stops in to buy a few small holdings in Technology (XLK) and Real Estate (XHB) today and my sell them tomorrow. I want to keep my mind fresh for shorting whatever topping process starts to form on this rally from the 11/21 low.

Sunday, December 14, 2008

Hedge Fund Nation

No doubt, by now you have come across the news of the arrest of Bernard Madoff. Madoff’s Hedge Fund managed to lose $50 billion (effectively all) of the money people entrusted with him to invest. That number is staggering! Many people have lost literally everything and their lives are forever changed.

Where Were the Regulators?
Bernard Madoff was the former Vice Chairman of the National Association of Securities Dealers (NASD).
Let me describe for you what the NASD is and what its functions are –The NASD (now FINRA – Financial Industry Regulatory Agency) was established under the Securities Act of 1934 to oversee all securities firms and licensed individuals who do business with the public. The goal was to set up a regulatory system to protect the public from crooks.
“NASD regulates trading in equities, corporate bonds, securities futures, and options, with authority over the activities of more than 5,100 brokerage firms, approximately 173,000 branch offices, and more than 676,000 registered securities representatives. All firms dealing in securities that are not regulated by another SRO are required to be member firms of the NASD.
NASD licenses individuals and admits firms to the industry, writes rules to govern their behavior, examines them for regulatory compliance, and is sanctioned by the U.S. Securities and Exchange Commission ("SEC") to discipline registered representatives and member firms that fail to comply with federal securities laws and NASD's rules and regulations.”
At FINRA, Madoff or his company now sit or sat on at least the following “FINRA Advisory Committees –

Compliance Advisory Group
National Adjudicatory Council
NASD Mutual Fund Task Force
NASD Nominating Committee

So it turns out that Madoff was one of the regulators responsible for protecting the public from the criminals.

What Happened?
Madoff set up a classic “Ponzi Scheme” - which involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business.

His Hedge Fund had an exceptional track record of historical returns. Money goes where it is treated best, so investors plowed their money into Madoff’s fund. At some point you need to figure out that the definition of greed is chasing large returns after they already occurred.

It turns out that the scam was uncovered when a client wanted their $7 billion investment back and Madoff was unable to come up with the money. Even better, knowing he was under the gun, Madoff tried to pay bonuses early to employees such as his sons. The bonuses would have been from the excellent performance returns the fund had generated for clients. Un-freakin-believable. The criminals are unconscionable!

My Big Concern
There have been a lot of instances over the past two years where Hedge Funds and Money Market Funds have had to freeze their accounts and no allow investors to get access to their money.

My fear is that there are a lot of crooks cooking the books at Hedge Funds. What I am afraid of is that the Fund Managers have held assets that are difficult to price, and have been generously setting their values too high. This makes the price of the portfolio artificially high and allows those selling to get out at artificially inflated values. It also leaves the late sellers with the losses, amounting to the difference between the invented price and the actual price of the securities.

This occurred in Florida about a year ago. A Money Market Fund was set up to manage the cash of Florida Municipalities and Charities. Its returns were in excess of those of other funds. Some investors got spooked and wanted to cash out. When investors want their money, the fund has to sell holdings to cover the redemptions. They tried to prop up the price of the fund and paid out artificially high prices to the first group of redemptions.

Eventually, they stopped honoring all sell orders. It then became clear that they had bad investments and they were over pricing their holdings. Good people got hurt.

Money Market Funds
I think the Money Market Fund managers got bailed out when the Fed instituted the $540 billion Money Market Fund backstop on 10/21/2008 and the $1.3 trillion Commercial Paper backstop on 10/07/2008. So at least the vast majority of the investing public was spared harm and an effective run on the Money Market Industry was prevented.

When Bear Stearns went under (sorry, was married at gunpoint with JPMorgan), I read Prospectuses and Position Statements on 34 Money Market Funds. I wanted to make sure that the money I managed was not exposed to bad investments.

When Lehman went under, a $25 billion Money Market Fund lost money and investors saw their money market accounts trading at 97 Cents on the Dollar. That was the death of the Money Market Industry. I was positioned to avoid it, because I did my homework. Clearly others weren’t because 4 days later, the Fed set up FDIC style Insurance for the Money Market Industry.

People didn’t do their homework and could have lost everything. I was sitting in 1-month US Treasuries at 0% yields. I got berated for the poor yields, but we eventually proven right when it all hit the fan.

Hedge Fund Nation
Now the US Government is a $7 trillion Hedge Fund. The Government is printing money, leveraging up and hiding price discovery. They won’t tell us what they are buying, who they are buying it from and what these holdings are worth. You know that they will keep buying stuff on any future market weakness. Do you see how the only people getting screwed in this are the Taxpayers? We keep having to pay to clean up everybody else’s mess.

It’s your money. YOU are responsible for knowing what you own, or you are responsible for finding an advisor you trust who does the homework for you and is proactive in getting the information into your hands.

The regulators are nowhere to be found. The crooks are everywhere, and they are trying to steal your money each and every day. Be careful, and either work with a pro or hide your money under your mattress.

Auto Bailout

I was going to bed on Thursday night and the Senate had stated there were not enough votes to allow them to give $15 billion to the automobile makers to keep them in business for another month. The Dow was down 350 points (at about 8,250). I had two thoughts –

This was the single biggest policy blunder in my lifetime
The Whitehouse would use the TARP over the weekend to bail out the auto makers

I turned on the TV Friday morning and the Dow was down -25 points, and I knew that Paulson had at the least hinted that he would open his proprietary Hedge Fund (the TARP) and write a check to save Detroit. I assumed that he would have waited until the markets closed on Friday, but he could not wait and had to prop up the equities markets ahead of the weekend.

By now you know my belief that until somebody other than the US Government is willing to buy an investment for longer than a few days, I am not willing to buy anything. Until the US Government gets out of the stock market manipulation business, I am reluctant to short anything. So I took most of this week and spent it with my family and some clients and turned off the computer and the Blackberry.

Monday, December 8, 2008

2008 - A Busy Year

I week ago I wrote about the areas of weakness I saw in the markets.

These areas have not done well during this bounce. Oil Service companies (OIH), Natural Gas (UNG) and Agriculture (DBA) made new lows, while Energy Conglomerates (XLE), Silver (SLV), Utilities (XLU) and the Euro (FXE) are weak.

In the mean time, the hardest hit areas have been reverting back into declining moving averages. This is a classic Bear Market bounce. But in classic 2008 fashion, multi-percentage moves have been compressed into hours and minutes, instead of weeks.

Here is a chart of the S&P 500 in 2008. I listed all of the actions of the Government. You can see how they were geared towards holding up asset prices or at the very least slowing their decent. The name of the game in 2008 was “Deleveraging” by financial institutions. So each rally allowed the big banks to sell more stuff at better prices than they would have been able to, had the markets not rallied.

This has proven to be an expensive exercise. Take a look at this chart from The San Francisco Chronicle. Scroll to the right and see how the programs have accelerated the last few months –

So in my eyes, this rally is just another Government-induced bounce into resistance. In my opinion, if you are a buyer, then all you are doing is letting some hedge fund or banks sell what they need to unload at a better price than they should be getting. There will be a time to buy, but I don’t think it is now.

Wednesday, December 3, 2008

Bill Miller - The Fed "Should Buy Stocks"

Somebody finally said the obvious. That “somebody” was Bill Miller, manager of the Legg Mason Value Trust mutual fund (symbol LMVTX).

What he said was that the Fed “should buy stocks and junk bonds to avert a deeper financial crisis.”

I have been very clear that I will start buying stocks again when somebody other than the Fed decides to buy something and hold it for more than an hour. Now, Bill Miller is telling the World that the deep pockets of the Fed are needed to get the markets moving higher again. Because the simple fact is that there are no buyers of stocks right now, just traders and those looking to liquidate.

You know by now that my contention is that the Fed has been buying stock futures to prop up prices intra-day. It is also my contention that the reason we are having this massive volatility is because stock prices are being propped artificially high, at a level where no real buying will take place. I think the Fed is waiting (hoping) for fundamentals in the economy to improve enough, so that these current prices become fair values for stocks and real investors will eventually show up to buy stocks at these prices. If you have a better theory, I’d love to hear it.

First, a Little about Bill Miller
Mr. Miller is a classic “value investor”. He tries to buy stocks that are inefficiently pricing fundamentals. Think Warren Buffett.

Year to Date, the Legg Mason Value Trust fund is down -59.7%. He has spent 2008 telling investors that banks stocks were “cheap” and, unfortunately, put his (fund shareholders’, actually) money where his mouth is, buying huge holdings in the likes of Fannie Mae, Freddie Mac, Countrywide and Yahoo.

This is an individual who was paraded in the Financial Media the last few years as one of Wall Street’s top mutual fund managers. He had a tremendous long-term track record, but is showing that he has no clue how to protect capital.

Kiplinger – “Buy Bill Miller Now” 12/18/2007
“Legg Mason Value has been a stinker the past two years. But Bill Miller is a gifted manager. Bet on him to rebound.” -

Take a look at Bill Miller’s Fund. Do you think the accounts I manage look like this?
Value was the hot dot from 2002-2006, just as Growth was the hot dot from 1994-2000.
You need to know when to zig and when to zag. If you can’t, or don’t have time to figure it out, then pay somebody to help you.

Now, today in fact, Bill Miller said –

It "looks as if the bottom has been made" in U.S. stocks
the "bottom has been made" in U.S. equities

"I think we will do better from here on, and that by far the worst is behind us." (Wait, sorry. That quote was from this past April)

So which is it – is “The Bottom” in and investors can now buy with impunity, or does the Fed now have to start buying stocks to help hedge funds further delever to meet a new flood of redemptions?

I really want stocks to stop going down. I really just want to get fully invested for 18 – 24 months and hang out with clients and my family again. I am sick of the 18 hour days and working late on weekends. I am also anxious to travel and visit clients again.

But I have a responsibility to protect those who have entrusted their funds under my management and I have to stay where I can push the bottoms if I need to do something.

I’ll let you know when it seems safe enough to try something other than a trade.

Tuesday, December 2, 2008

Use the Right Tool for the Job – Quantitative Easing

In the past few days I have read approximately 15 speeches and books by various economists, Fed Officials, Bernanke and Japanese Officials, on what to do when facing Deflation in a Zero-Interest Rate Environment.

My goal has always been to take the studies of academia and the teachings of the chart technicians and turn what I see and read into a profit. I’m not here to learn all the Depression and the Gold Standard and things like Novation and Quantitative Easing, for the sake of being a walking encyclopedia. I read and learn and study and battle my emotions in an effort to figure out where the markets are going and when is a good time to commit capital. That’s what I do. And these days, it seems to be all I do…

First, What is Quantitative Easing (QE)
A Central Bank normally impacts economic activity by targeting a specific short-term interest rate. Every day, the Central Bank injects or withdraws enough money from the banking system to keep the target rate at the desired level. The US Federal Reserve focuses its effort on the Federal Funds Rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

When your target interest rate approaches zero, you are forced to use other policy tools to impact economic activity. Bernanke sites three –

- Provide assurances to the financial system that short term rates will be lower in the future than is expected

- Shift the asset mix of the holdings on the Balance Sheet of the Federal Reserve

- Increase the size of the Federal Reserve’s Balance Sheet beyond the level needed to get short term interest rates to zero. This is Quantitative Easing.

So QE is simply creating more money than the economy currently needs to keep rates at near zero %.

Japan is the only real experiment with QE. Experienced an economic malaise since late 1989, Japan found itself with an insolvent banking system, systemic deflation and a 0.15% Target Interest Rate.

“In 2001, Japanese banks were still in the process of reducing their large stock of nonperforming loans. In the months prior to the launch of Quantitative Easing, 19 Japanese banks experienced downgrades in their credit ratings.”

So the Japanese were faced with what we now faced – an insolvent banking system on the verge of massive downgrades, which would cause massive, system-wide deleveraging of bad assets. Remember what Bernanke just said the tools were to fight deflation when the Target Interest Rate is effectively 0% -

The Japanese Government assured investors that they would keep interest rates at 0%, until the country saw 12 months of stable or rising Consumer Prices.

The Japanese Central Bank began buying 400 Billion Yen per month in Long Term Japanese Government Securities

Excess Reserves held at the Japanese Central Bank by Japanese Banks went from 4 trillion Yen to 45 trillion Yen in five years.

Did it work? I don’t know. Japan is still around, but their stock market is at the same price it was at in 1981. Moreover, the bad banks were spared from having to restructure and become profitable. QE started at the Green Arrow and ended at the Black Arrow.

Where or not QE worked in Japan is apparently the subject of a roiling debate in economist circles. I couldn’t care less. I just want to know how to be prepared to protect myself and my clients.

After reading a lot of his work, I am convinced that he is not stupid and that he believes to his core that the main responsibility of the Federal Reserve is to offer a stable economy with maximum opportunity.

The great thing about Bernanke is that he tells you what tools he is going to use if he ever runs into a problem in the future. It’s like in the movie Patton, where George C Scott screams “Rommel… You magnificent ------, I READ YOUR BOOK!” I feel the same way when I read Bernanke’s speeches. Look at this beautiful speech he gave in 2004 entitled – Conducting Monetary Policy at Very Low Short-Term Interest Rates

In this speech he lays out the three tools I cited above. I want to focus on the last two –

#2 Altering the Composition of the Central Bank’s balance Sheet
All you have to do is look at this chart to see how much the Fed has changed its Balance Sheet in the last year.

What the Fed is now really keying on is purchasing Long Term US Treasury Bonds. Bernanke has always hinted at the possibility of capping Long Term Interest Rates. You do this by putting a floor on prices. If somebody wants to sell a bound, you buy it at a price that lowers the yield to the level you desire.

The bailout of Citigroup a few days ago was the Fed admitting that it had undertaken QE to try and save the economy from Deflation and Depression. Look at how the Yield on the 30-year US Treasury has imploded since the announcement of the Citigroup bailout ($TYX is the 30-year Yield times 10) –

Look at how low rates are! Even worse, the Yield Curve is INVERTED on the long end (longer maturity rates higher than shorter maturity rates)! Are you kidding me? The Yield Curve is now pricing in even WORSE economic activity. Here is how the Yield Curve looked in June 2002. This was right before the Stock Market had its final plunge, before started its 9-month bottoming process.

See why I do all of this homework? See why I am looking over my shoulder on every short I take and am scanning charts everynight for hints of new potential leadership? I will be there, money in hand, when the markets do their bottoming process and leadership shows up.

There is precedent for capping Interest Rates. The Fed did it from 1942 to 1951.
It ended with rising inflation.

#3 Expand the Size of the Central bank’s Balance Sheet
“Besides changing the composition of its balance sheet, the central bank can also alter policy by changing the size of its balance sheet; that is, by buying or selling securities to affect the overall supply of reserves and the money stock.”

“(R)eserves can be increased beyond the level required to hold the (Target Interest Rate) at zero--a policy sometimes referred to as "quantitative easing."

The TARP, the Commercial Paper Purchase Program, the Money Market Purchase Program, the Term Auction Facility and all the other programs have massively expanded the Balance Sheet of the Federal Reserve. The Fed now has a total of $8.2 Trillion on and off of its Balance Sheet (up from $850 billion last year). Obviously, that is unprecedented.

The primary goal of all this purchasing is to drive down the cost of debt and credit creation (Interest Rates). Secondary benefits include deleveraging the books of banks, and lowering the cost of borrowing for the Government.

Here is how looks graphically -

There is now over $300 billion in “excess capital” sitting idly at the Fed. The money was created to allow the Fed to buy bonds from these banks in their effort to drive down interest rates. Wait, it gets better. Do you remember a few weeks ago when Paulson and Bernanke told Congress that they need the power to pay banks a rate of interest on the “excess reserves” banks held with the Fed? So now we actually paying these banks money for the privilege of buying their bonds at artificially inflated prices –

Why Are We Doing All of This?
You need to read Bernanke’s thoughts on the Depression to get an idea of what he is thinking –

“(T)he experience of the Depression helped forge a consensus that the government bears the important responsibility of trying to stabilize the economy and the financial system, as well as of assisting people affected by economic downturns.”

Bernanke believes that the Great Depression was result of the Fed not keeping enough money in the banking system. There were several causes

Monday, December 1, 2008

Man Did We Shorts Ring the Register Today

The New York Stock Exchange was down -9.05%, the Russell 2000 (Small Cap) was -11.85% and the S&P Financial Index was -16.67%. That was just today!

I was short the Dow (via DXD, +14.77%) and Energy (DUG, +19.05%).
Clients also had various shorts in Utilities (SDP, +12.72%), Materials (SMN, +19.79%), Financials (SKF, +29.32% (CHA-CHING)) and Emerging Markets (EEV, +17.84%).

I only had about 30% net short going into today. I didn’t buy it all at the top at Friday’s close. But I made some good money and took a bunch of shorts out in the last hour of trading today. Moreover, I completely avoided a day when the average stock was down -10%.

Not a bad day. See why I do so much homework?
Shorting in this environment is very hard. I have to fight Central Banks from all over the World. My goal to just scratch out small gains on each leg down and preserve capital for what is the inevitable next Bull Market. If I can end 2008 +5% or +10% and the markets are down -40% or -50%, then I will be in very good shape to position money effectively when things eventually do turn up. As long as I am doing my homework, I will be able to see the turn forming.

I think people are getting tired. Those who have held stocks the entire way down are selling. I hear the stories. I can feel the pain. I see the selling volume in mutual funds. Even the perma-bulls and Mutual Fund commercials on television are starting to talk about protecting assets, instead of growing assets. When they start telling you how to short assets, the bottom will be here.

Potential New Breakdowns
I see several key areas on the brink of starting new legs down. Most are in commodities.

Energy (XLE)
These charts scare the heck out of me. Take a look at the Energy Index. It sure looks like a consolidation pattern failing at the 50-day (Black Line). This is about as Bearish as it gets. I may just allow the remaining half of my DUG to ride here and see how much I can make if the breakdown occurs.

Natural Gas (UNG)
See how price is now stuck between key support (Green Line) and the declining 50-day (Black Line)? Natural Gas has a big decision to make in the near term. It isn’t just going to sit here. If Big Money sells, then the stocks will fall with the commodity (CHK, APA et al). If you hold these stocks and you don’t have stops in place then you are at a severe disadvantage to the professional investor who knows how to protect capital.

Agriculture (DBA)
Agriculture looks a lot like Energy.

A big move in commodities is coming in the near term. Because these charts are all in down trends and the charts appear to merely be consolidations of trends after large selloffs, I think the odds are really high that the next big move is down. So be prepared if you own any of this stuff.

Half of investing is not losing your shirt to obviously failing setups. If you lack the discipline to execute obvious trades, then pay somebody to do it for you. There no ego in investing. The markets are right and you have to follow them. If commodities go vertical on huge volume then I may look to buy pullbacks. I’m here to make money, not be right 100% of the time.

I don’t really follow Gold any more, much as I am starting to not even look at the Dow anymore. Both just move so differently from any of other comparable Index or Commodity. They just don’t give me a reasonable understanding of what is going on in the market (more on this below). So for metal, I use Silver as the proxy.

Silver (SLV)
Look at how Silver nestled right up into the 50-day (Black Line) for a few days. It was unable to break above and then had a brutal day today, down -10.26%.

These have been a safe haven for mutual funds that have to stay invested and need to find someplace to hide while the markets are imploding. Utilities are on the brink of joining the rest of the markets in the tank – same story, failure at the 50-day (Black Line) after spending two months consolidating the September 2008 Crash. They may offer a great risk/reward short set up in the near term.

Remember what I have taught you – The markets make 80% of their returns over very short periods of time and then spend a long time sitting around in a narrow range (consolidating), before having their next big move. After a big move in price, the ensuing consolidation often carries price up into the key 50-day Moving Average (Black Line). After consolidating, the next big move is normally in the direction of the move preceding the consolidation.

The Euro looks like commodities. The Euro appears to be consolidating after a sharp move lower and is setting up for the next big move.

So for the Euro, a sharp move down has been followed by several weeks of trading between 124 and 132. The 50-day has now declined to 132.5 and is falling. A break of 124 would be very bad for you if you own the Euro.

US Dollar
The anti-Euro is the US Dollar, so it makes sense that a break in the Euro will lead to further rally in the US Dollar. I will be looking to buy the Dollar on more weakness in the Euro.

I will cover the US Dollar/Euro connection later this week when I discuss Quantitative Easing and a potential Dollar Carry Trade.

I want to review two key companies in Energy to show you how much of an impact being a component of the Dow can have on the performance of your stock over a short period of time.

The two companies are Chevron (CVX) and Total Fina (TOT). Both are enormous Energy Conglomerates, with Market Caps of over $100 billion, Revenue of over $175 billion and Earnings of over $16 billion. I consider them to be similar enough that their stocks should be performing in a very similar manner.

But look at the differences in the charts of Chevron and Total –

Chevron broke support in September and then snapped right back up into it over the last two months (Pink Line). But Total broke in August and had a very weak rally the last two months.

The reason this has occurred is pretty clear to me. Chevron is in the Dow and Total is not. I’m not going to go on some conspiracy rant. That is not my intention with this. I could have replaced Chevron with Exxon, the other large energy company in the Dow. And I could have used BP, Royal Dutch or ConocoPhillips instead of Total.

I think what happens is that mutual fund managers are forced to stay fully invested at all times and sometimes they all plow into a handful of companies with way too much money. This leaves shareholders vulnerable for the time when everybody wants out of the company all at once

My concern is that if Energy and Commodities crack in near term, then the crowds in Exxon and Chevron may all run for the exits at exactly the same time. So if you hold these things, be very, very cautious.

The Bottom Line
Until proven otherwise, the mantra for the markets remains – Buy Weakness and Sell Strength. But the pressure seems to be building for a break of key support in a number of significant areas.

Big Money showed up today and sold the markets hard. I covered some shorts and am looking to reload in a number of obvious setups. If the markets rally, then they may only do so for an hour or two, or they may retest Friday’s high. Who knows. But I will know how to play it and will be looking at the intra-day charts for topping patterns to short.

Let me know if you have any questions or comments.

Sunday, November 30, 2008

The Best 5 Days in 75 Years

I emailed a buddy of mine last Friday and wrote something like – “You know the boys will pull out all the stops to get the markets to rally soon. You can’t have all the shoppers wanting to slit their wrists going into Black Friday (The biggest shopping day of the year).”

So the powers that be did their job. There were big gap up opens, huge last hour rallies, the bailout of Citibank ($326 billion) and the government promising to finance $800 billion of credit card, automobile and mortgage debt. I think the NASDAQ rallies 2% in the last 15 minutes on Friday. Did I mention that we rallied into month-end again?

Same old games.

Who are the guys who actually buy these rallies? Every other Fed-induced rally has ended in a crash. Do you think this one will be any different?

Let’s take a look
I went through several thousand charts over the last few days. I wanted to see how indexes were trading relative to prior crashes. I wanted to see which sectors were acting well. I wanted to see which stocks were holding up to be potential leadership for the next Bull Market. I wanted to see how bonds and interest are trading and how well commodities are doing in the face of all this new money creation by the Fed and the Central Banks of Europe and Asia.

I have never before seen a time where every, and I mean every, domestic stock index and international stock index all crashed in unison. It’s extraordinary!

S&P 500
All I see is a spike rally on diminishing volume into massive resistance (900). Look at how the last spike up rally failed in early November. I could rally up to the 50-day (Black Line), but the 50-day has been sold hard since this Bear Market started.

It will all come down to what does big money want to do next week. If they show up selling, then we get yet another leg down. If they show up and buy on volume, the 960 is real possibility.

The charts of all the US Indexes look exactly the same. The rally felt great and no doubt bailed a bunch of investors out for the time being. But it feels like a classic Bear Market Rally – made you feel good, make you nervous about not being in, suck you in and then roll over. We’ll see how it plays out, but I have started to build short positions.

There are 192 different sectors of the economy, as measured by Standard & Poors. I look at the charts of each sector this weekend, because at some point this Bear Market will end and I want to see if any leadership is showing up yet.

Potential Bottoms
I saw 1 potential bottom – Airlines
I looked at the charts of the companies in the sector and they look horrible. I see lots of bounces into moving averages and lots of companies being outright crushed (Southwest was the worst).
So I’ll pass on airlines for the time being.

Still look horrible.

Are still avoiding risk.

So, outside of a 5-day moon shot, nothing has changed. I sound like a broken record. I am starting to get short again for the inevitable retest of the recent lows, or worse…

If (when) things charge, I will too. But for now, I need a lot more evidence to convince me that I can risk my money again.

Monday, November 24, 2008

852 Revisted ( This Time From Below)

The markets have had their best 2-day rally since the Crash of 1987. So you’d think that US Treasury Bonds would be sold off hard, as investors moved money out of areas of safety and into areas of risk. But that was not the case, as the 3-Month Treasury Yield ended today at 0.01%. People are in cash.

Longer Term Treasuries fell some, but not a lot (20-Year down -1.56% and 7-Year down -0.94%). In my opinion, US Treasury Bonds are merely pulling back into support.

Corporate Bonds had really poor rallies today. I would have expected much better bounces, with stock indexes having such sharp rallies. That needs to change immediately, if stocks are to continue this rally.

Last week, $19.5 billion was taken out of Stock Mutual Funds and $13 billion was taken out of Bond Mutual Funds. Those are really big numbers. I follow big money flows and big money is getting out and buying 3-month Treasuries.

The Crash is now about Alt-A Mortgage Defaults
The last few weeks, the FDIC and JPMorgan commited about $50 billion to renegotiate mortgages. Now Citigroup had to be bailed out. This is all the result of Alt-A mortgages starting default at alarming rates. The Alt-A holdings of banks (Level II) are on average 10 times the size of their Sub Prime holdings (Level III).

Citigroup’s Level II holdings are over $1 trillion. Take a look at this chart and you can see how much money they are losing on these holdings. Citigroup was bankrupt. Period. Don't let anybody tell you otherwise. It seems inevitable that JPMorgan and Bank of America will collapse and soon need Government bailouts of their own. The size of the rally in Citigroup tells me that the taxpayer got screwed today, bigtime!
On to the Markets
You know the drill by now. Each time the Dow rallies 1000 points in 2 hours, I take a look at market internals.

I covered all of my shorts on Thursday and Friday morning. I also sold my holdings in the 7-year Treasury (IEF). Things had sold off too far, too fast and were due for a bounce. Bounces today are of epic proportions and play themselves out in hours and not days or weeks.

All I wanted was a rally up into resistance that I could short, and I got my wish today. The charts below show how much volume has traded at each price. They register how much buying was done. So when you break below those prices, everybody who bought there is now under water. When you rally back up into it, that volume becomes people who are desperate to sell once they get back to breakeven (resistance).

See how the Dow (DIA) has rallied right up into massive resistance (volume Green Arrows)?

The S&P 500 (SPY), The NASDAQ (QQQQ) and the Russell 2000 (Small Caps - IWM) have also been able to rally up, and are now at massive resistance.

I like to look at sectors to see what is going on in all parts of the markets.

Basic Materials (XLB), Industrials (XLI), Technology (XLK), Healthcare (XLV) and Consumer Discretionary (XLY) have all rallied up into the teeth of strong resistance.

Financials (XLF) have bounces, but are not even close to the old breakdown point. This weakness is a red flag. Continue to avoid Financials if you haven’t figured this out yet.

Consumer Staples (XLP), Energy (XLE) and Utilities (XLU) were in wedges and broke down as the markets hit new lows. They have now bounced. After evaluating the daily and weekly charts, I think these offer the best short setups. I may be dead wrong on this, but we will see how it shakes out.

So we have had yet another Government-induced multi-hour moon shot, on low volume.
I have been asking the question “why sell at the lows, when you know that a futures-driven rally of 500 to 1,000 points is right around the corner and you can sell tomorrow at 5 to 10% above where you are today?”

The rally arrived and the Dow was up 850 points in 2 hours of trading. I have started building short positions again.