Friday, January 2, 2009

Bear Market Rally

Be careful--the equities market tanked 50%, already discounting all the bad news. It could test its lows again in the first quarter, but my long positions are doing quite well. Don't get caught up in the gloom and doom that's being reported. You should have been gloomy and doomy last year--before asset values plummeted thru the floor.

Again, employment and economic stats are retroactive--markets are forward-thinking. For instance, the government declared we were in a recession a year after the fact, when the markets clearly indicated we were already deep into one the year before. As usual, investing on what the government SAYS leads to disaster; it is more fruitful to invest on what the government DOES. And right now, they are printing our way towards inflation, due fears of deflation. The outrage is the pending inflation, dampening our savings and raising our cost of living (and killing our standard of living). Inflation is a "quiet" tax that the public ignores because it is slow and insiduous. But the Fed knows it can generally get away with it, especially if it creates jobs. So they drive us further into debt, when monetized debt was what goes us into trouble in the first place.

That's why oil and other commodities are soaring off their lows. And that's why T bond yields are bouncing off their bottom. As I mentioned last week, I shorted T bonds (I'm betting on interest rates rising), and it's paid off already. I've found a timing indicator which has proven uncanny, but my fundamental and subjective analysis has to be intact first. I won't just trade off of my technical charts, but I will use them to confirm my entry point into a trade.

Wall St. has an ongoing debate between the technicals (guys who strictly rely on reading price, volume and momentum charts) and guys who only do fundamental analysis (value guys like Buffett). I say do both. If my fundamental analysis tells me to either go long or short, I will read the charts before l pull the trigger. In general, the fundamental guys do better long-term, even if they mistime their entries. Buffett pulled the trigger too early, and hence is down 30% since his recent buys, but he can afford to wait it out 10 years.

Day traders try for incremental gains, which I find hard to achieve, because you have to repeat it many times. I swing trade, looking for reversals and big moves. I can be early too, but I am exercising more discipline and patience, waiting for my targets to hit their price points, and once they reverse their trend, I pile in. No one can capture the exact inflection points, but if you are close enough, you'll be able to catch the majority of the next big move up or down.

For instance, short term T bills are yielding 0%. I consider that situation unsustainable long-term. I don't know when or how hard rates will go up, but they will at some point. I'm not shorting them because the Fed can 100% influence short-term rates by setting the Fed funds rate.

The long end of the curve (30-year T Bonds) is a different animal. They also touched all-time highs, yielding an all-time low 2.5% recently. The Fed cannot control these rates--they are market-driven, and thus depend on market participants' forecast on inflation. When inflation goes up, long-term rates go up. Right now, the bet is that deflation will be upon us for the next dozen years, similar to the Great Depression. I say hogwash--because the Fed and Treasury are making sure that doesn't happen as they liquefy the markets with credit and tons of capital.

Once investors (mostly foreign) figure out tying up their money for 30 years at 2.5% is a poor investment, they will pour out of them en masse. Right now, everything else around them has collapsed, so they are fleeing INTO US Treasuries, but once they figure out other assets have a better chance of appreciating, they will vote with their dollars OUT of T Bonds, and into equities, commodities, and precious metals.

The bond (fixed-income) market is twice the size of equities, and dwarfs the commodities market. So any small change in asset allocation into equities and commodities has a levered effect on the latter--that's why you see such violent volatility in stocks and commodities (more so in commodities). Oil is up 30% from its lows already, while the prevailing public opinion is that filling up their tanks is still really cheap compared to last year. You ask the average person off the streets about the price of oil, and they'll tell you they're happy that gas prices are low. However, as a trader, if you were short oil, you would have been killed, due to the recent price spike and leverage.

That's why I ask people all the time what their opinions are on certain financial assets. I'll inevitably go against them. They are understandably bearish on stocks after the 50% haircut, while equities have started their bear market rally (the rally is unsustainable due to rotten earnings). As you know, and it's been documented, gold mining shares are up 100%, even as people consider golf a barbaric relic. I'm considering pulling some off the table to lock in profits, and have already purchased long-term call options to capture the next big move up later this year, in case gold stalls and consolidates, before resuming its incline.

But Treasuries are a screaming sell right now, assuming we don't go into Great Depression mode, resplendent with 25% unemployment. It could happen, but the probabilities are getting smaller with each printed dollar. Until then, the big move up is interest rates, commodities, and even some stocks (high cash, cash flow, market share monopoly, no debt, and a dividend if possible)...and the big move down is T-Bonds. Precious metals should resume their increase, but like I said, I've captured the big move, so I expect a pause.

So I've got the direction on certain assets down, but I am refining my market timing. These are understandably proprietary, because if everyone catches wind of it, it will arbitraged out, and I will have no longer have a competitive advantage. That's another reason why you want to be careful about bubbleheads on TV--they're not all idiots. If it's an economist or some "pundit", they probably really are stupid--or more accurately, smart, but wrong-way Corrigans. But if the guy has a stellar track record (ie he's a billionaire trader), and keeps a low profile, he may throw people off his tracks by design.

For instance, he may tell people he's selling wheat, hoping the wheat futures tank, all the while buying up the physical inventory at a lower price. That's one more reason why following CNBC of Fox business news is not only useless, it is potentially disastrous. Unless, of course, you use it as a confirming contrarian indicator.


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