That Was a Nasty Day

On Monday the markets had enormous rallies and I wrote the following post –

http://nbcharts.blogspot.com/2008/10/i-cant-find-crash-without-retest.html

In the post I looked at the Crashes of 1929, 1946, 1987, 2001, 2001, 2002 and 2002 and came to this conclusion –

“The biggest rallies have come in Bear Markets. Bear Market rallies make you feel good, scare you about being in cash, suck you in and then crush you. Buyer Beware!! (Gary Kaltbaum taught me this)
I actually started shorting some this afternoon. I expect a retest of Friday's lows.
I can't find a crash that didn't have a retest!”

“I am not interested in buying a spike down, and I am not interested in buying a spike up. I want to wait for a decent entry point, with definite risk.”

“The most painful scenario right now is a sharp selloff to retrace some of the massive gains of the last few hours of trading.
That would be enough to scare some more people into selling their stock before a more meaningful rally. Remember, the average rally from these emotional extremes is 24% over 8 weeks.”

“History tells me that there will be a retest of the recent lows, or at least a decent retracement of the first rally off the lows. It is at that time that I will be able to determine if I should be buying and how much risk I may be taking.”

I covered my shorts today when the Dow was down about 550 points. I am no longer interested in shorting.

A two-day moonshot up into the 10-day moving average, followed by an implosion. That was the expected action and that is what occurred.

This is not rocket science. I simply looked at how the markets reacted at the last emotional extremes and stated that I expected the same to occur on this crash.

I am not brilliant. I JUST DID MY HOMEWORK!!

I am WAY ahead of the markets this year and that allows me to be patient and wait for the low-risk entry points.

I am now going to do a lot of homework and try and figure out how to participate in the rally that I feel is going to show up in the not too distant future.

Now let’s see if the markets give me a Follow Through Day

http://www.investors.com/yahoofinance/2006w24/storyC03.asp

I Can't Find a Crash without a Retest

For those of you who have been fully, or even partially invested the entire way down, I am sincerely happy that you were able to make back some serious money the last few days.

That said, there was plenty of evidence in 2007 and early 2008 to tell you that it was time to get out of stocks and protect the hard-earned gains of the 2003-2007 Bull Market.

The biggest rallies have come in Bear Markets. Bear Market rallies make you feel good, scare you about being in cash, suck you in and then crush you. Buyer Beware!!

I actually started shorting some this afternoon. I expect a retest of Friday's lows.

I can't find a crash that didn't have a retest!

Look at the 2-day rally following the Crash in 1929. See how the market sold off and actually undercut the initial low?

The same thing happened in 1946. The Dow crashed and then put in a series of sharp rallies and retests. September - November 1946 looked like a really frustrating and unproductive time to own anything.

The Crash of 1987 looks a whole lot like the Crash of 1929. The crash was followed by a sharp, 2-day rally. Then the index tested the lows over the next week or so.

In 2001, the S&P 500 had two major selloffs (crashes). In the first (Green Box), the S&P rallied sharply for a few days and then retested the low of the crash.

In the second (Black Box), the S&P rallied for a few days and then sat around for 3 days (Black Arrow). While sitting around, price corrected 30% of the first move up, and support was easily defined for a clear stop point on any buys.

I am not interested in buying a spike down, and I am not interested in buying a spike up. I want to wait for a decent entry point, with definite risk.

There were also two crashes in 2002. The first had a 1-day pullback (Red Arrow), which retraced about half of the first-day's gains. A few days later, there was a nasty 3-day selloff which retraced a big chunk of the first rally.

After several weeks of rallying, the market rolled over and ultimately undercut the lows of July (Black Arrow). This testing and retesting is a part of the bottoming process.

My brother once told me that the markets go to the most obvious place in the most painful manner possible.

The most painful scenario right now is a sharp selloff to retrace some of the massive gains of the last few hours of trading.

That would be enough to scare some more people into selling their stock before a more meaningful rally. Remember, the average rally from these emotional extremes is 24% over 8 weeks.

This is an emotional time. The more information you have about historical precedent, the better you should be able to navigate the current market.

I think we are in a Bear Market rally of unknown price and duration. History tells me that there will be a retest of the recent lows, or at least a decent retracement of the first rally off the lows. It is at that time that I will be able to determine if I should be buying and how much risk I may be taking.

Clients know that I have been heavy in cash the last 12 months and that affords me the ability to pick my spots.

970 Broke, Leading to Another Leg Down

I noted the following yesterday –

“The S&P tried to find support the last two days at 970. That level had better hold, or the markets will start yet another leg down”

Here is the chart from yesterday, updated for today’s action. 970 got taken out and the S&P 500 did a nosedive into the close, falling about 60 points (-6.2%) in the last 90 minutes of trading.


I also noted the following yesterday –

“Sellers continue to swamp buyers and the markets continue to sell off hard into the close each day as mutual funds sell to cover what are no doubt massive redemptions.”

This is classic Bear Market action. I think we are in the “capitulation” stage, where people wake up at night in cold sweats and sell because they just can’t take it any more. The last few days of selling are always nose dives. So it can be so very costly if you are even just a few days early. That is why I want to only buy on a low risk set up.

You will not want to buy at the end of a Bear Market or a selling panic. It is human nature. My goal with this blog is to get a continuous commentary going to let you know how the markets evolve and how those internal changes in the markets will tell you when it is time to be buying and not selling.

As the markets were topping last year, I went through the changes with clients in great detail and we were able to take defensive measures to protect capital. Some chose not to sell. I am sure that they will listen next time...

I can now buy the markets at a 37% discount to a year ago. Are you kidding me? Those who raised cash in late 2007 and the first half of 2008 are now years ahead of the game. Those who didn’t may have to delay retirement for a few years.

I think people grasp onto the “buy and hold” mantra because they have not found how to determine when it is time to be buying and time to be selling. Just as the markets gave a lot of clues as they topped, they will also give lots of clues as they bottom. My goal is to keep you informed, so that you are interested in buying what big money is buying, even though the idiots on TV are telling you to sell – just as they were telling you to buy the first 4,000 points down on the Dow! Remember, “Buy low and sell high”.

I did zero trades today. Then I went home and took a long nap. I am exhausted. Interpreting this intra-day volatility is hard work. Even with the hard work, I may still miss the low and not be able to trade whatever bounce we get. My concern now is that the next rally may only carry up to 970 on the S&P 500.

This Bear Market is of Epic Proportions

I figured that we had a decent chance of a crash on Monday, but this is getting ridiculous.

I only have reliable charts back to 1980, but I can tell you that since 1980, there are only 3 occasions where the markets got to this level of extreme selling – October 1987, July 2002 and this crash.

Today, the markets had an excuse to rally, with several Central Banks cutting interest rates over night and Wal-Mart being less bearish than expected, but the markets cut through support like it wasn’t even there. Sellers continue to swamp buyers and the markets continue to sell off hard into the close each day as mutual funds sell to cover what are no doubt massive redemptions.

Here is the market today

Here is The Crash of 1987

As you can see, The Crash stopped below the -25% band (Black Line). I have no clue where the market bottoms on this leg down. Anybody who tells you they know where things will bottom is making it up and you don’t need to bother listening to that nonsense.

But I can use past market moves to see how the market reacted once the selling stopped. In 1987, the S&P 500 fell below -25%, reversed for a few days, then retested the -25% band (2nd Black Arrow), then rallied back to the -15% band (Blue Arrow), then retested the -25% band again, before reverting back into the Mean (Green Arrow).

So the odds are high that after this selling panic stops, the markets will rally and then retest the lows for a while before they make their move back into the Green Line.

The same thing occurred in late 2002, as the S&P 500 spiked below -25%, then rallied, retested the Bear Market Low of July (Red Arrow), then tested the Green Line on several occasions, retested the July and October 2002 lows one more time in March 2003 (Red Arrow) and then started a new Bull Market.


The 1987 bottom took several weeks and the 2002 bottom took over 8 months to form. So I expect this market to see a bottom form over time. There might be a HUGE short term rally once the bottom is reached, but there will most likely be a retest of the lows after this rally.

The other issue I have noticed is that while the market was in these bottoming processes, the Green Line was falling. So when the market finally does revert back into the Mean, the Mean will be a lot lower than it is today. In 1987, the Mean fell 11.5% from the day the market bottomed, until the day the market finally touched the Green Line again.

Today, the Green Line is at 1300. 1300! While the S&P 500 is at 986…
It is just a guess, but my guess is that price and the Green Line end up meeting in the 1150 – 1200 range.

I expect the next rally to be highly shortable.

Today I moved some of my 401k money from cash into the S&P 500 Index Fund. I did not buy a share of anything for my clients. I did the 401k purchase, because I can only buy mutual funds at the close and it is more profitable to be a day early than it is to buy at the end of the day of the bottom.
The S&P tried to find support the last two days at 970. That level had better hold, or the markets will start yet another leg down. IF 970 holds, then I will consider buying it, because the first real resistance is at 1100. That is 14.4% from 970. If 970 fails, then I will wait for the market to try and build a bottom at some lower level and then look to buy a reliable set up.

Did I mention that 976 is the -25% band on the S&P 500 and 1103 is the -15% band? You can’t make this stuff up.


One of these bottoms is going to work. I’m just not sure which one. But I have to treat every attempt with the potential to be a bottom. I hope the bottom arrives soon, because I am exhausted.
The charts of the NASDAQ and the Dow Jones both have similar potential bottoms to the S&P 500. They will most likely all bottom in unison.

Bond Market Crash

Corporate bonds crashed the last two weeks. Here is the chart of the high quality stuff – The Investment Grade Corporate Bond Fund (LQD). This is the little old lady portfolio where you are supposed to be able to hide your money when all you want is income and little price volatility.
This index has fallen 24 percent this year. 24 PERCENT!!
Grandma is going to get her statement at then end of the month and keel over...

Compare the performance of Corporate Bond to the performance of short-term US Treasury Bills (SHY), which are at their highs for the year!

I have been hiding is short-term Treasuries and CDs for over a year. Sure, the yields have stunk. But I have been more concerned about return of my money, rather than return on my money. I appreciate the patients of clients during the last 12 months of low yields, but the hand writing was on the wall for this disaster since at least 2006.

I want to look at a couple of popular strategies for capturing higher yields. These strategies are Bull Market strategies that use leverage to build portfolios of bonds that benefit from rising short-term interest rates. The biggest of these is the
Van Kampen Senior Income Fund (VVR), with $2.3 billion in assets. VVR was only down --10.45%. TODAY!!

The PIMCO Corporate Opportunity Fund (PTY) also uses leverage to buy lower-quality bonds in order to get enormous yields. It only fell -9.02% this week, but is down -30.9% from its high for the year. I am now looking out my window a couple times a day to make sure that nobody from PIMCO has jumped from the building...

Again, these are Bull Market strategies that borrow money to buy Junk Bonds (now called “High Yield”) to try and generate big yields. High yield bonds get crushed during recessions as their default rates go from an average of 1% to 6% in a two year period. During recessions, Junk Bonds end up yielding 10% more than US Treasuries as investors sell them and their prices crater.

Even the bonds of other governments are not immune to the carnage in bond land this year. The debt issued by Emerging Market countries has fallen hard, as the Alliance World Dollar Government Fund II (AWF) illustrates.

If you think I am cherry picking bad charts to prove a point, then go to http://www.cefa.com/ and you will see that these charts are indicative of the performance of these asset classes.

My big concern is that bond prices are not just falling because of deteriorating economic fundaments and massive unwinding of leverage. My fear is that long term bonds are finally starting to price in the reality that interest rates are going to go through the roof as the government prints trillions of new dollars, resulting in massive inflation.

I know the numbers for inflation are relatively low in the US, but I think the numbers for our CPI are fake (a topic for future discussion). Here is a chart of the combined CPI for nine major industrialized countries. As you can see, their rate of inflation is twice what ours is. So either they are not buying the same stuff as us (exotic stuff like food and gas), or our numbers are artificially low compared to reality.

I am afraid that the pain in Bonds is just starting. Heed my warning, do not go out an buy a portfolio of long-term bonds because the yields are attractive relative to money market rates.

Yields on the 30-year US Treasury are at historic lows, and do not have far to go until they reach zero. They have been kept low by design to stimulate consumption. At some point they will need to be brought to extremely high levels to crush the inflation wave which is inevitable. That is where bond prices will get crushed and you will lose a lot of money if you hold a portfolio of long term bonds.

Here is the yield on the 30-year US Treasury Bond ($TYX = 30-year yield x 10).

Here is the price of the 30-year US Treasury Bond ($USB). Prices are approaching an unbreakable ceiling as rates approach zero.

To summarize, Corporate Bonds have been annihilated this year, while US Treasury Bonds and Bills have continued to new highs as people buy them up in a flight to quality.

There will be a time in the next 12 months where the Bond Markets begin to price in economic growth and the trend will reverse. At that point, I will be looking to buy Corporate Bonds and sell short-term US Treasury holdings. Moreover, I will be looking to abandon Long Term Bonds and buy inflation-adjusted short and intermediate term bonds to protect myself from the ravages of what seems to be certain, significant future inflation.