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This newsletter represents my humble opinion on the market and in any case represents some advice or is aimed at enticing third parties to take positions. The author can not be held responsible for any loss resulting from a position supposedly inspired by it's writings.
This newsletter discuss the opportunities and strategies for the LONG TERM trader. Please bear with the approximative English as the author is French.
In my humble opinion, phase II of the bear market initiated in summer 2007 still have to finish it's job and take us to new heights. For clarification, what I consider to be phase I was the initial drop from the 2007 highs to 2009's lows, while phase II is the rally phase that started march 09. In order to fully fool investors that the bear market is over and to restore their confidence, the market has to overcome it's previous high. Remember: you are trying to beat the market, and the market is trying to beat you. Generally accepted by all is the idea that a phase II rally in a bear market can not retrace much more than 2 thirds of the loss that occurred during phase I drop. I do not think so, and I don't believe in Elliott or Fibonacci sets of rules. However i agree with Elliott on the fact that tendencies are divided in waves that can be explained by psychology and I think the general pattern of 5 wave he suggested is very close to what happens in real life. Is a fundamental explanation for the "power" of phase II really needed ? It is not the topic here, but just look at the trillions in stimuli packages of all kinds and the huge savings on spendings by companies in order to preserve - which they did - good earnings. All of this was set to create a incredible rally in the short run but is due to trigger mayhem in the future. I believe we are at the dawn of phase III, which will see indexes sinking much lower than there 2009 lows. I think the drop will be relatively fast and continuous. I will not discuss the reasons why I am so pessimistic. It would be way too long and would miss the point of this newsletter.
That being said, I am bullish short term, still. I you are out of the market, I don't believe it is wise to try to take advantage of the reminder of the rally that I envision. At those levels, the risk/reward ratio is far from being favorable and the outcome of bullish positions at those levels could be disastrous if phase III decided to kick in early. In the long term approach that we focus on here, what one wants to do is catching the next wave. As a surfer, I know this better than anyone else: when you miss a set of bigger waves, you don't run after them or sit on the inside trying to catch the smaller ones. That would probably get you a couple of fun ones but you are pretty much guaranteed to take the next set on the face. It is ok when you it is a day of small, fun waves but the phase III wave that already darkens the horizon is set to be devastating. At any price, you don't want to fight against it. What you want to do is benefit from the rare opportunity to make money it represents. So, how do we achieve this ?
Let's have a look at the weapons first. All stocks should be down sharply during phase III. Bidding on bearish ETF that performs when major indexes are down seems to me like a good idea. Among those ETF's, ProShares UltraShort S&P 500 Funds (SDS) is among the top players and has been reliable during the past year's. This ETF has a "2 times" leverage.
I also believe financial stocks will be among the losing leaders, and hit big time by the CDS time bomb. For those who like sports and who can cope with volatility, the Direxion Financial Bear 3X ETF (FAZ), with it's triple leverage, could provide incredible return. Just bear in mind that the risk is proportionally high and invest accordingly.
When it comes to the strategy, at this time I plan to buy my short ETF's once a new high is confirmed. I believe the right level will be 3-7% higher than the previous weekly high (1364 on S&P) but lower than the 2007 highs on both DOW and S&P indexes. Looking at international indexes, China's SSE could be seen rising close to 2700 and Europe's Eurostoxx 50 (Euro Price) seems set to rally to 2580 for the end of next month. Of course, stop-losses should be set above 2007 highs, something like 5% over but at the discretion of each.
It is very difficult to give timing in advance for the start of a new major movement (I find it harder than "predicting" the actual levels), but I would say the levels I am waiting for could be reached as soon as the end of February. The next movement could start then or a couple of months later if the market decided to double top, but the first option is retained for now.
Once the ETF's are into the portfolio, given the probable ferocity of the bear's revenge, I will sit on it until the US indexes reach their 2009 lows. I will not be preoccupied by the beta slippage, because if phase III is what I think it will be it would be foolish to try to make back and forth inside the core movement. Remember those -7% days of 2008 ? You don't want to be out of the market when they happen ! The idea here is to enter at the start of a strong, long lasting tendency, fasten you seat-belts and stick with the groove. Once you think you are in the right direction, and you have eliminated the risk with a "no-loss" stop at your buying price, you should stop worrying about the position and let the market do it's thing until your target - or your "no-loss" stop - is hit.
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