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Principles of the Stock Market

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Have You Seen This?

Have You Seen This?

 PRINCIPLES OF THE STOCK MARKETA learning, teaching, always evolving stock market letter and advisory serviceSeventeenth Consecutive Year of Publication; Letter #1; Sept 18, 1990
 
  

Monday, March 3rd, 2008:  Three people yesterday told me they were sick of winter.  They weren’t angry, just tired of fighting Mother Nature.  Today we’re supposed to get a touch of spring, high about 50º.  Yay!

 THE ECONOMY 

Boy, I feel bad for President Bush!  I like him but he sure has had bad karma and has made some poor decisions.  I won’t go through his whole record but his recent decision to push ethanol is sure backfiring!  First, ethanol doesn’t reduce our overall energy use, we use energy to produce ethanol, and it isn’t clean which starting early last year became my first/biggest concern, finding clean, green energy alternatives.  And look at what’s happened to food prices and thus global inflation.  It’s surely not all President Bush’s fault, but the sharply increased demand for corn to produce ethanol has sparked off food inflation, here and worldwide.  That’s all I see on CNBC now, how higher prices for all foodstuffs are starting to work their way through to consumer prices.  Tortillas in Mexico, bagels and Hershey Bars in the US, etc., etc., etc. with lots more to come.  According to long term value investor Jim Rogers, whose investment perspective was formed and weaned during the previous commodity bull market of the 1970s, agricultural commodities would have risen anyway, even if the sharp demand for corn hadn’t led to smaller plantings of other crops, since supply has dwindled for many years.  Add sharply rising inflation to the Fed’s other two big issues, battling the suddenly-emerged, global financial and credit breakdown, along with the slow motion US economic slowdown which seems to be accelerating and spreading worldwide now and the Fed, the economy and the stock market all have big problems. 

 

Bottom line, an unusual, if not classic, credit crunch now prevails with FEAR of further losses, call it a “growing risk aversion” dominating institutional investor’s thinking.  Banks are thus reducing lines of credit, adding new charges and fees, tightening lending standards and terms, thus causing secondary financing markets to dry up.  Even interest rates on consumer loans for cars and mortgages are refusing to follow the Fed’s rate cuts down point for point, moving grudgingly downward, more like one down for every five (basis points) the Fed cuts.  So net, net, the Fed is effectively now “pushing on a string” validating my long held theory that the stock market would only be in trouble when the Fed starting cutting rates.  The Fed not getting very far with its rate cuts is scary!  Jeepers, creepers! 

 

Schwartz View:  I just can’t see things getting better any time soon.  Worse more likely as we haven’t even seen all the problems emerge yet, although each week, something new crawls out of this now opened can of worms.  Last week, while we got some capital injection for the muni bond insurers struggling to keep their all-important AAA ratings so as not to spark a further muni meltdown – munis just had their worst month in memory! --  the muni market got blindsided by the suddenly inoperable auction-rate bond market.  Now that this credit vehicle has become unworkable, muni dealers are now bracing for an overwhelming  flood of new supply as municipalities all over America need to find a new way to finance.  Bottom line, I don’t think we’re even close to having all the problematic issues out on the table yet.

 THE STOCK MARKET 

Well, Friday was one of the worse days since January’s first two weeks of day-after-day big drops, with stocks down big right from the get go.  Wasn’t a major surprise although the last five weeks of sideways to slightly up action may have lulled some investors into believing the worst was over.  You know that old complacency which naturally builds after a big market drop and when stocks stop going down and we can all breathe once more.  I commented last week that if the stock market couldn’t rally now, what with:  (1) multiple Fed rate cuts, and (2) the emergency government fiscal stimulus plan, and (3) multiple Depression-style homeowner bail out plans, and now (4) Federal Reserve Chairman Ben Bernanke’s reassurance last week that the Fed would continue its rate cuts, we’d be set up for big, big trouble and coming sooner rather than later.  If all this monetary and fiscal help can’t support the market along with whatever rigging the government’s “Plunge Protection Team” is implementing as well, the stock market may indeed be ready for another leg down.  And remember to go along with the “head feint” sideway triangle patterns which first broke upwards, then reversed downwards, it’s always something fundamental popping up during a bear market.  Some quotes about the opaque-to-most-of-us muni market written about in THE ECONOMY above were:  “The municipal market in the last week and a half or so has been in a free fall” by one muni bond manager and “The damage has been unbelievable” by another. 

 

Schwartz View:  Slammed by this difficult nexus of negatives, even the time-tested Wall Street adage of “Don’t Fight the Fed!” isn’t working.  With the major indices having held up somewhat, if you want to call losses of -10% to -15% holding up, many, many stocks have already undergone big bear markets since the Fed starting cutting rates.  Bottom line, I expect further losses ahead, coming sooner rather than later after both the Nasdaq Composite and Dow Utilities closed below their previous late January bear market lows last Friday.  Though there’s still a chance we hold at January’s lows, the odds against have risen.

 

PORTFOLIO STRATEGY

 

Is there ‘blood in the streets’ yet?  No, I don’t think so.  Although what’s been going on in the stock market and economy is no fun.  Because of years of globalization, our economy is much more diverse, varied, deep and resilient today than in decades past.  If we had today’s housing crash and auto problems a couple decades past, employment and the US economy would have dropped precipitously by now and the stock market would have followed suit being down some -30% or -40%.  But today we are benefiting from the free world economy having become much larger and more integrated.  Still I have to figure the old January lows will eventually fall as well; they started breaking last Friday.  So for now, I still can’t take a ton of risk.  My strategy has been, and remains, to hold much less overall market exposure than normal, stay in those sectors which remain in uptrends like commodities, and where I can find ways to hedge, say in the ProFunds funds family, use some inverse (short) funds and keep closely on top of portfolio values and fight tooth and nail to keep them up.  First Rule; don’t lose money!  Sure there may be some bargains out there. For example, PIMCO’s Bill Gross, who manages the largest bond fund in existence, says he’s looking to scoop up some fire sale muni bonds which stressed financial companies, hoping to stave of bankruptcy, have to sell.  But I don’t have that capability.  Or the time necessary to allow these depressed assets to regain fair value.  Buy the Pimco Total Return Fund for that.  I’m still in protect our assets mode.

 Down the line some I’ll be delighted to look for capital gains on the upside.  But as long as I keep hearing positive reports from guest after guest on CNBC, I have to remain skeptical.  And watch for and take advantage of head fakes upward.  Lat week I read where we had five rallies during the 2000-2002 Mama Bear market of 10% or more and none was ultimately proven correct.  As I figure it, and history shows, bear markets don’t bottom until everyone turns bearish.  Not the case today. 

My current buy recommendations are listed below:

 

SCHWARTZ BUY RECOMMENDATIONS: Disclaimer:  I hold small positions in a number of my recommendations.                                                                                                                                                                                                                                                Buy         Current                                                                                                                                Price       Price                                                                                                                                                                Hedge your betsDecember 13, 2007:                BUY MYY ProShares Short MidCap 400             59.91       64.83BUY SBB ProShares Short SmallCap 600             70.87       76.64BUY SH ProShares Short S&P 500                       60.28       66.60BUY MZZ ProShares UltraShort MidCap           53.20       62.71BUY SDD ProShares UltraShort SmallCap         69.70       80.68BUY SDS ProShares UltraShort S&P 500          52.92       64.47BUY SHPIX ProFunds Short Small Cap               16.58       17.53BUY UCPIX ProFunds UltraShort Small Cap       13.65       16.16BUY BRPIX ProFunds Bear Fund                         25.94       28.10 Schwartz View:  Well, we got that market strength I wrote about last Monday as a good time to buy some of these “short” or inverse funds, last Monday thru Wednesday.  In a bear market a good time to short is late in the trading day, after two or three days up if the market isn’t following through.  Thus last Wednesday late would have been ideal as Thursday’s modest drop and Friday’s debacle decline left all the above inverse funds ahead on the week.  Looking at their charts this morning, I must say we could easily see further and steeper declines ahead.  Again, I’d have a couple shorts to hedge your long portfolios if you’re not into selling.  “Soft” Agricultural CommoditiesOctober 31,2007                     BUY RJA Elements -Agricultural Total Return     10.13       12.94August 31, 2007                     BUY DBA PowerShares DB Agriculture Fund      26.63       41.56 Schwartz View:  Somehow the commodities sector is holding up and RJA and DBA rose again last week.  I would recommend buying on weakness.  Sure, they will top out at some point as the US and global economy weakens further but my theory remains it may be later than most now believe.  One of the unique characteristics of this business cycle is that for the first time we’re really, truly in a global economy.  Thus it’s only natural for late cycle sectors like materials and industrials to hold up.  And with today’s new global competition by countries to secure for their long term futures enough minerals, foodstuffs, energy and all commodities, it makes sense.  I’d hold a couple soft commodity positions.   Foreign CurrenciesSeptember 27, 2007                BUY FXY CurrencyShares Japanese Yen Trust    86.50       96.13BUY FXF CurrencyShares Swiss Franc Trust       85.50       96.25 Schwartz View:  Major upside week for foreign currencies, especially the two carry-trade currencies recommended above.  Continue to hedge against a falling US dollar.  Same as for the general stock market, if the dollar can’t rally here with all the gloom and doom surrounding it, we could be on the precipice of an even worse decline. SCHWARTZ SUMMING UP.  Correct strategy is to hold much less market exposure than normal in any bear market, such as the one we’ve been in going on five months now.  Also go short with today’s new-fangled inverse ETFs and mutual funds, hold some inversely correlated commodities, the commodity positions themselves not the underlying companies where you can, and finally bet against the dollar.   All these strategies have been performing well as you can note above, while we wait out this grizzly bear.  The problem is I expect this bear market to be a Papa Bear and thus last for at least a couple of years and cause the key averages to give back half of the previous bull market’s gains.  Those approximate minimum downside targets are Dow Industrials 10,600 and S&P 500 1172.  Those would be total losses off last October’s five year bull market highs of about 25% for both, thus meaning we need to stay hunkered down. Have a great week!  Hang tough! SCHWARTZ SUMMING UP.  Correct strategy is to hold much less market exposure than normal in any bear market, such as the one we’ve been in going on five months now.  Also go short with today’s new-fangled inverse ETFs and mutual funds, hold some inversely correlated commodities, the commodity positions themselves not the underlying companies where you can, and finally bet against the dollar.   All these strategies have been performing well as you can note above, while we wait out this grizzly bear.  The problem is I expect this bear market to be a Papa Bear and thus last for at least a couple of years and cause the key averages to give back half of the previous bull market’s gains.  Those approximate minimum downside targets are Dow Industrials 10,600 and S&P 500 1172.  Those would be total losses off last October’s five year bull market highs of about 25% for both, thus meaning we need to stay hunkered down. Have a great week!  Hang tough!

 





Posted 03-03-2008 8:20 AM by Richard Schwartz