Friday, November 8, 2002 (FSense Friday market wrap)
Couldn’t Resist Going Short
This week has been provocative to the extreme in the world of finance, politics, and investing. There was plenty of room for all the arm-chair quarterbacks to sit back and prognosticate the possible outcomes of the elections on Tuesday and what the Federal Reserve would do with interest rates on Wednesday. It was beautiful to watch all of the market forces at play. Money flows were triggered in all asset groups (stocks, bonds, sector and index funds, commodities, currencies, options, mortgages, et al.) as they jockeyed for position prior to the expected rate cut. The spin-masters on TV were painting pictures that the Fed would do their magic once again.
Those that are bullish on the stock market have been dancing in the street since early October with most of the averages up 20-30% in just a month. Monday morning was classic as the NASDAQ went ballistic from the opening bell. It gapped up and never looked back for the day with a gain of 36 points or 2.6%. I kept thinking that this is too good to be true. I took the Monday market move as the politicians saying, “Let’s make sure everybody has a nice warm-fuzzy before they go to the polls tomorrow.” The NASDAQ has gone from 1100 to 1400 in less than a month, then a 36 point blow-off on Monday. My conclusion at the time was that these types of gains are unsustainable with deteriorating economic conditions. I couldn’t resist going short the NASDAQ Composite Index – so I did, and there I remain. The fundamentals of the stock market haven’t really changed. The only big difference from a few months ago is that the dollar is weaker and money has gotten cheaper.
NASDAQ 3-Year Weekly Chart NASDAQ 1-Year Daily Chart
From a technical standpoint, stocks were already short-term overbought and the extra push early in the week just created some better entry points on the short side. Also, if you take a close look at the Stochastic Oscillator, there are two things to note. On the weekly chart the stochastics are red-lined at the top of the range. It would take extreme buying power to keep it above 80 for a sustained period of time. The shorts have already covered and the mutual funds are “all-in” with very little cash to buy more. Secondly, a close look at the daily stochastics reveals what is known as an upside stochastics non-confirmation. That is where you see a higher price high on the index, but a lower-high on the stochastics. The divergence in price and momentum usually portends lower prices in the very near future.
Combine the technical analysis, the political warm-fuzzy for election day, possible war or terrorist attack, and what the Fed taught us last year (buy the rumor and sell the news), and there you have it—a marvelous set-up for a new short position with limited risk and great potential reward. I also went short the S&P 500 at 920. On the upside we could see 950 or on a super long shot 990, but I doubt it. On the downside, we could see 700 with warning season in December, fourth quarter earnings in January, and the probability of war during the same time frame. I figure maybe 4-8% upside risk versus 25-30% downside reward. I’ll take those odds any time. This is clearly not a recommendation to buy or sell anything, just my own reasoning. Now we need the Republicans to take the capital gains tax to ZERO (retroactive), and I’ll be a very happy camper!
The Content Contrarian
This seems like a good time to interject a point that I’ve wanted to make for the last couple of weeks. I hate reporting on all of the negatives in the economy and markets, but there’s just an overwhelming amount of financial things going bad. It’s a natural part of the bust following the boom. In the big picture I’m highly optimistic. I just try to be pragmatic, see the whole picture and go with the flow to make good investments. I am not a bull or a bear. I’m simply a contrarian investor and money manager. I own and recommend stocks, commodities, put and call options, mutual funds, and more. It’s not easy to speak out against what the mainstream wants to hear, but it works better for the portfolio numbers. For this content contrarian, the glass is clearly half full. I’m also very grateful to Jim Puplava for giving me the opportunity to turn my twenty-five year hobby of investing into a professional career.
Super Squeeze of 2003
Throughout the week it has also been interesting to watch the action in the precious metals arena. Gold has been pounding away at the $320 mark all week and finally closed at $320.30 on Thursday. Likewise, silver has been pounding away at $4.50 and would not be denied with a close of $4.54. The gains held overseas with gold hitting $323 in London/Hong Kong and silver touching $4.59 before the take-down in New York. Gold closed the week at $321.00 with silver closing at $4.52. Let’s see if they can build a base at these levels.
There are some very powerful forces at work in these two metals. I boil it down to the “paper shorts” versus the physical market. I don’t plan on opening a big can of worms at this juncture. For now, suffice it to say that some of the big bullion banks became overzealous in the gold carry trade and are now stuck with enormous short positions in a rising market. They are trapped. I’m just patiently waiting for the BIG short squeeze!! The day the bullion banks are forced to cover their short positions, it should go down in the history books as the “Super Squeeze of 2003.” Should be a fun ride.
If you take some time to study the supply/demand fundamentals of both gold and silver and see all that is developing globally from a geopolitical perspective/monetary viewpoint, the fundamentals are “pound the table strong” in favor of rising prices. As it stands, I don’t think the metals will break out until the war begins in earnest. The powers that be will need a scapegoat when gold blows through the $330 barrier, silver blows through $5.00, and the dollar is down twenty percent. Someone or something will have to take the fall in the aftermath of the derivatives carnage. If my timing is correct, this would also leave enough room for another session of gold-bashing before the inevitable price explosion. There are a number of ways that this scenario can play itself out. I believe the fundamental market forces will eventually win; history says they always have. It’s just a matter of time.
Financial market systemic risk and scapegoats becomes an interesting conversation in light of the developments this week. With the Fed’s aggressive rate cut, they will wash their hands of any wrong-doing to say, “We did everything we could.” Then everyone will point the finger at President Bush and the Republicans across the board, who will then blame all of our problems on Saddam Al-Qaeda Bin Laden. Funny how it all works.
Little Drummer Boy or Pounding Drums of War
I’ve now mentioned the probable war a couple of times. I make that statement based on the persistent efforts of President Bush to change the regime in Iraq and the recent statements made by Britain’s Foreign Secretary, Jack Straw. To paraphrase Mr. Straw, he basically told the parliament that Britain and the U.S. are prepared to attack Iraq without a U.N. resolution on weapons inspections and disarmament. Now Friday is here along with the United Nations resolution demanding unrestricted arms inspection in Iraq. Also today, Ronald McDonald said he will be closing 175 restaurants and pulling out of countries in the Middle East....probably not a bad idea. Maybe Tenet Healthcare could buy their properties to open up some new hospitals that should be in heavy demand in a few months. Tenet shares have now gone from $50 to $15 in two weeks….Wow!
In light of the possible war, it seems odd that oil has fallen about five dollars per barrel since mid-September. Could this be the calm before the storm? Keep your eye on oil prices and look for energy companies with little or no exposure to the Middle East. In general, the uncertainty in the region will continue to put a drag on the markets. Your portfolio would probably do better this Holiday Season if we were hearing the Little Drummer Boy instead of the pounding drums of war.
Time-out for a Recap
The Fed cut rates to their lowest level in the last four decades, rising unemployment, deteriorating economic numbers, pressure building in precious metals, a resumption of the primary bear market in stocks, the government needs to borrow more money with lower revenues, U.S. current account deficit, trade deficit, business and consumer debt burdens, rising commodity prices and on and on and on……… We end up with a volatile cocktail that sends the U.S. dollar to lower levels.
Actually, our guys aren’t so dumb after all. Now that we have unloaded roughly half of our countries’ debt onto foreigners, we can pay them back in depreciating dollars. I am very grateful to be an American, but I can also see why there are others around the world that aren’t very happy with our global monetary dominance since the Bretton Woods Agreement in July of 1944. Bretton Woods basically set up the international money system that established fixed exchange rates for major currencies and later established the IMF. President Nixon subsequently changed the rules (to floating exchange rates) in 1971 when he removed the dollar’s final link to gold. (That was after Charles de Gaulle of France emptied half of Fort Knox at $35 per ounce of gold in the late sixties.)
In roughly three weeks the dollar has fallen from 109 to below 105 on the U.S. Dollar Index (today’s close 104.67). A four percent decline in the dollar for a three week period is significant. When President Clinton started pushing for the “Strong Dollar Policy” in 1995 the index hovered in the 80-85 range. If the dollar should fall back to those levels, we will see our purchasing power decline an additional 20%. Imports will become more expensive, but it will help to correct our massive trade deficits. For now, let’s just keep it simple and watch the strength of the dollar over the coming months to see how it will affect our investment strategies.
Just yesterday I was surprised to hear of retail warnings coming so soon in the holiday shopping season. Costco Wholesale, Sears, and Wal-Mart all said that October sales came in lower than expected and guided lower for the current quarter. On the grocery side, Safeway and Albertsons also reported softer than expected numbers. It looks as though consumers are pulling back from spending. It will be difficult for the economy and stock market to put in a sustained recovery until we can get people back to work, pay off some debts, and go beyond the war worries in the Middle East. We will also need to get all of the under-funded pension problems resolved (many billions of dollars), get the corporate accounting rules squared away so we can get some meaningful numbers, and see a return to reasonable price to earnings ratios for equities.
If there is such a thing as a safe bet in the financial markets, without a doubt in my mind, it would be as simple as a reversion to the mean. All you have to do is find the inter-market relationships that are out of whack or even better—at extremes, then place your bet that they will return to the averages and probably swing in excess to the opposite direction. Take your profits and move on to the next opportunity.
Closing Numbers for the Week
The Dow added 19.46 points to close at 8537.13, the NASDAQ lost 1.41 to 1359.29 and the S&P 500 dropped 6.22 to close at 894.74. It was sideways for the week, with a big up and down through the elections and Federal Reserve meeting. For the week ending November 6th, Trim Tabs estimated that all equity funds had inflows of $3 billion versus outflows of $800 million the prior week. Bond funds took in another $2.8 billion this week in addition to inflows of $2.1 billion the prior week. Well there you have it. I said I was contrarian, and in fact went short on Monday and Tuesday while at the same time $3 billion went into mutual funds. Let’s see what happens next week.
Overseas Markets
European stocks fell as companies including semiconductor maker Infineon Technologies and adhesives manufacturer Henkel KGaA said they don't expect demand to revive. Deutsche Lufthansa and Deutsche Telekom dropped after analysts lowered recommendations on the shares. The Dow Jones Stoxx 50 Index shed 1.1% to 2510.15. The Stoxx 50 has slipped 0.5% this week. Seven of eight major European markets were down during today’s trading.
Japanese stocks dropped, led by exporters such as Sony Corp. and TDK Corp., on concern the value of their overseas sales may decline after the yen climbed to an eight-week high against the dollar. The Nikkei 225 Stock Average dropped 2.6% to 8690.77.
Bond Market
Long-dated Treasury issues extended gains after a massive rally on Thursday. The fixed-income market observed an early 2 p.m. close on Friday and will be shuttered on Monday for Veterans Day. The 10-year Treasury note rallied 10/32 to yield 3.84% while the 30-year government bond surged 1 18/32 to yield 4.79%.
Copyright © Michael Hartman |
