Stupid, stupid, stupid

Sure, I am long the stock, and know a higher price will occur soon. But leave apart the writer's and my dueling banjos perceptions of the same stock, and think on his imbecilic recommendation...

Short Heinz/HNZ at $55, with a stop loss at $61.73, or 12.23% Your profit objective is $51.63, or 6.12%... $6.73 of risk, $3.37 of possible profit. In essence, an abomination of the typical relationship between risk and reward.

Did I say stupid? I also mean misguided, irresponsible, and wrong. Horribly wrong.
-- David M Gordon / The Deipnosophist

Fascinating interview with Marc Andreessen

Marc Andreessen (he of Netscape fame) has lived the 'quiet' life since, as commentator on all topics technology and as venture capitalist.

In this interview, Andreessen pairs both passions into a unified whole...

"I think 2012 is the year that retail - retail stores - really starts to feel the pressure. And I don't say that because I don't like retail stores. I loved going to Borders. I thought it was a great consumer experience. And I was a huge fan of Tower Records. But the economic pressure is huge as e-commerce gets more and more viable and as these category killers emerge in the superverticals. If I own mall real estate or retail stores in cities, or if I own chains like electronics chains, I'd be concerned... I think electronics and clothes are going to be a real pressure point. Home furnishing is going to come under pressure. It's going to get harder and harder to justify the retail store model. The model has this fundamental problem where every store has to have its own inventory and every store is also a warehouse. The economic deadweight of that entire inventory in each store--that's what took down Borders..."

I agree with Andreessen's main and general points - that the increasing viability to purchase anything and everything online leads to the inevitable destruction of brick and mortar retailers' profit margins. This notion harkens back to Bill Gates's comment about friction and the Internet. It also contributes to the phenomenon of showrooming.

And yet I disagree re his specific remarks that 'explain' the case study that is Borders. Borders had its own problems; inventory issues only hastened its demise. If you understand the publishers' distribution model, then you also understand that inventory serves as both curse (inventory = money) and blessing (inventory = money). Borders used this odd model to stave off its ultimate demise several times during its final years. Borders, in the end, finally cried "Uncle!"

So, too, will other companies. The interview with Andreessen brings into stark relief some conceptual winners and losers. Or, for investors, longs and shorts.
-- David M Gordon / The Deipnosophist

The folly of price AND time

Hmmm, what happens if...
- Christmas comes, but not 1330?
- 1330 comes, but well before Christmas?
- 1330 comes, but well after Christmas?
- Insert here your favorite permutation

In other words, where are the contingency plans? You know, if this, then that; if not this, then this other.

Tom DeMark is a smart fellow - he knows and understands the markets well - so I suspect the journalist edited Tom's commentary to the headline-grabber.

Ahh, the folly of pronouncements. I prefer good old money management.
-- David M Gordon / The Deipnosophist

[Trend] Lines and measured moves

The article below is from my site dedicated to investments and markets, Investment Poetry, posted earlier this week...

Always helpful to circumscribe the market’s oscillations to keep those oscillations from surprising you. For example, the Nasdaq Composite/COMPX, in which I identify several items...

1) Support and resistance. Focus on the line at ~2600 – former resistance becomes support, and now, possibly, resistance again;
2) Measured moves. The distance in prices (~2600 to ~2875) is the same distance to 2325 (from ~2600), and the level from which the market bounced. (And should the COMPX break down beneath ~2325, the next measured move counts to ~2050, the lowest trend line drawn. NB: the points of support and resistance clustered at the price level.)

The takeaway is that measured moves, in tandem with support and resistance - and other technical studies not shown - identify turning points, however ephemeral. The second takeaway is that as price crosses the channel to seeming resistance at ~2600, risk increases. (“Seeming” means presumed resistance until proved otherwise, which would require a close well above 2600.)

Of course, unless you trade the indices, you do not buy the market; you invest in individual securities. Perform a similar analysis for your favored investment opportunities, and then overlay those charts with the market’s chart to identify the few opportunities that act stronger than the market. Many such investment opportunities exist today, as always.
-- David M Gordon / The Deipnosophist

How to select stocks for portfolio success

Migawd, but this Wall Street Journal op/ed essay is hilarious!

"... My point is that I hate Apple. I hate that I irrationally crave their products, I hate their emotional control over my entire family, I hate the time I waste trying to make iTunes work, I hate how they manipulate my desires, I hate their closed systems, I hate Steve Jobs's black turtlenecks, and I hate that they call their store employees Geniuses which, as far as I can tell, is actually true. My point is that I wish I had bought stock in Apple five years ago when I first started hating them. But I hate them more every day, which is a positive sign for investing, so I'll probably buy some shares."

Who knew Scott Adams (Dilbert) is so funny? :-)
-- David M Gordon / The Deipnosophist

Market branchings manifest decision points

Just now finished my review of the equity markets, an analysis I do each weekend when the lack of market activity provides me a clear mind and perspective. And while yesterday's decline was no surprise (with more decline to occur), I also expect typical seasonal strength to re-appear later in February that provides one last upside oomph into March/April. (The technical analyst's bane and lament: "One more rally!") Except...

Almost without exception, individual charts betray worsening technicals: most stocks begin to droop, many wilt, and a few have withered while still on the vine. Even Apple/AAPL, the portfolio darling for many investors, me included, likely has made its high trade for 2011 at $357. (After hours trade, post earnings report.) Perhaps the market rallies one final time into March/April, perhaps not. My unease comes from what might occur next for the markets.

Subscribers and regular readers know I have been raising cash for the past few weeks via liquidating my weakest holdings -- selling the comparatively illiquid stocks (bull market phenomena), the under-performing, those purchased as trades -- while maintaining my holdings in long term investments. But what does an investor do, what do I do, when the budding decline looks worse than I expected... worse than I prepared for. (30% cash at this moment.)

Please understand: I am no trader, but a long term investor. To quantify that difference, imagine a stock chart with price bars: you analyze intra-day price bars, if a day trader; you analyze daily price bars, if a swing trader. But as an investor with a time frame of 1 year and more, you analyze monthly price bars. Get the picture? Fewer bars = fewer signals. How much weight does an investor grant a given signal, irrespective of time frame? Combine that with my expectation that the high for 2011 would occur as an exclamation mark to the rally since the March 2009 low... and prefatory to a sizable decline, and you are up to speed with my dilemma: Buy, sell, or hold?

Well, okay, that dilemma is every investor's, not solely mine. And it prevails at all market inflection points. So I would like to clarify two more items:
1) While I often increase cash as a percent of my portfolio, I rarely increase it to 100%.
2) I raise cash as a method to swap over-valued for under-valued, risk for opportunity, not as a matter of attempting to time the market's oscillations. (Price = risk.)

But is this moment (the coming days and weeks) one of those moments? You know, like the summer of 2007 that led into the Crash of 2008? I look around and wonder, "What could go wrong (this time)...?"
● Perhaps another liquidity crisis?
● Another crisis of confidence (ala 2008) that rattled systemic confidence?
● The spreading unrest in the Middle East that demands systemic change? (The explanation provided by several market commentators for yesterday's market decline.)
● Renewed food riots, as commodity prices soar ever higher?
(Remember that, in a free market system, prices reflect the abundance or scarcity of an item; in this instance, a scarcity of food for the world's billions of people. And when do rising prices equal the canary in the coal mine?)
● Extreme weather conditions?
● Mass die-offs? (Already plaguing animals around the world.)
● You name the ill

My effort is not to hang the fabric of my concerns for the equity markets on the hook of geo-political problems (if this input, then that outcome); gosh, I am wrong too often (read: always) to claim any special insight. But I do wonder whether the coming decline (over the course of 2011) will be just another intermediate term correction, a speed bump on the road to higher highs... or of long(er) term proportions.

Which returns me to where I began. What portfolio decisions to make now? Especially for a person who transacts few buy decisions, and even fewer sells. I watch markets closely, trigger-finger ready to sell if markets and the world deteriorate and devolve anew. Which brings up one final question... What value is cash in a world gone haywire?

Your remarks welcomed.

Full Disclosure: Long Apple/AAPL
-- David M Gordon / The Deipnosophist

Separating rumor from news, opportunity from risk

Market professionals rely on the clues that other investors betray, knowingly or no. Positive and negative divergences -- that is divergent action between a stock and its group, a stock or group and the market, and markets themselves (metals vs currencies) are one clue. Another clue is how a stock trades on rumors.

Consider two stocks (labeled 1 and 2) below (click on each chart to enlarge)...

Company #1

~~~

Company #2

Okay, you will quickly notice that each chart:
1) Includes daily bars since mid-2009
2) Ends on 30 November
3) Mimics the other, eerily so.

It is that last item I call to your attention: Two near-identical trading patterns... that ends, rather abruptly, come 1 December 2010...

Company #1

Company #2

Of course it would help were you to know the two companies; #1 is AT&T/T and #2 is Verizon/VZ. "Ahh," you say, "Now I get it!"

You probably do. Rumors abound that AT&T will lose its contract with Apple/AAPL for exclusive rights to offer the iPhone in the USA. But that rumor has been around for a good long while; what's different now?

One rule investors keep in mind is, "Buy the rumor, sell the news." It will be interesting to learn the news from Apple, AT&T, and Verizon in coming days and weeks. And the effect that news will have on their respective stock prices, now that the rumor of something has been priced in; arguably adequately so.

Full Disclosure: Long Apple/AAPL and Verizon/VZ.
-- David M Gordon / The Deipnosophist

Of disposable leads, and new leaders

To invest, even to trade, requires a risk of loss (of capital). And of ego, "I was wrong. How horrible!" So we each identify some analytical tool (fundamental, technical, valuation, top down, bottom up, etc) to derive some measure of comfort -- er, on which to base our investment decisions. Most analyses of the market, of opportunities, is of the worst type: they seem to offer insight, but really do not.

One part of my investing methodology is to select  potential investment opportunities from among high growth, small cap companies. Not so easy to find small cap companies these days, even after the horrific bear market of 2007-2009: a low share price does not necessarily equal a small market cap. And news about companies disseminates more quickly to everyone at mostly the same time, which means largely that only from the gleanings can an investor discover a true small cap opportunity. A related part of my methodology, explicated previously, is not to invest in penny stocks; in fact, I stay away from stocks that sell under $15-20 threshold. And a second part of my investing methodology is to identify the stocks that perform the best within its group, its sector, and the market: the leaders.

My template is the high level consolidation (HLC), defined and described previously. Prices rise and fall, rise and fall, but remain bounded by the HLC. That pattern ultimately will give way in one direction or the other. The oddity is the expectation almost always is for the break to be down; what with the bearish news that typically prevails throughout the secular version of this pattern, the decline from the top of the range to its lower boundary, most people expect more of the same price action. The quirk, and our opportunity as investors, is that the break almost always is opposite the widely-held expectation.

Such as now. I have argued ad nauseum for 11 years now that the market is in a high level consolidation that would perdure for 15-20 years. Yes, things look perniciously ugly out there – as occurs during any secular HLC. I agree the news is horribly bearish. I agree fundamentals do not favor a sustained market rise. I admit I expect another damaging decline to occur sometime next year (2011). But, with the exception of the last item, this all is well-known. Markets factor into price future unknowns and uncertainties, not the knowns and certainties, which were priced-in long ago. Please explain Apple/AAPL's absolute and relative chasm of a valuation discount, if you disagree. Or explain the strength of the retailing sector, across all its constituent groups, for the past 18 months (since the March 2009 low) in the face of what we all knew was the most dire period for retailers in... well, forever. Even now, still; after all this out-performance.

We all, being human, are subject to all the fallibilities and foibles that reality engenders. The crucial recognition, to me, is to recognize that these sideways-trending periods come... and go. Sure, they could endure for weeks, months, years, even a decade or two, but it is our task to identify these periods and invest around their limitations. And the opportunities they create. So frustrated is okay, but never flustered. Assemble your list of possible investment candidates, and via the process of due diligence and market performance, which includes declines, continuously whittle the list to find those few opportunities that have potential to be long term investments.

So how odd is it that my new investment recommendation below violates one part of my investing methodology, share price? Not so odd when you consider it: the company is under the radar for most investors. Not for long, though. Only one reason I recommend this largely unknown company that offers excellent potential to be a successful, long term portfolio investment...

This post continues on InvestmentPoetry. See you there!
-- David M Gordon / The Deipnosophist

How Indices Work -- Excellent primer from David Blitzer

How Indices Work

David Blitzer is a managing director and the chairman of the S&P Index Committee with overall responsibility for security selection for S&P’s indices and index analysis and management. Dr. Blitzer is the author of Outpacing the Pros: Using Indices to Beat Wall Street’s Savviest Money Managers (McGraw-Hill, 2001) and What’s the Economy Trying to Tell You? Everyone’s Guide to Understanding and Profiting from the Economy (McGraw-Hill, 1997)

Q: Let's start by talking about how the S&P 500 is composed.

A: It is 500 companies. We occasionally get phone calls, believe it or not, about how many stocks in the S&P 500. It's overseen and maintained by a committee of nine people, all of whom work for Standard & Poor's and McGraw Hill, our parent company.

We have a series of published guidelines and requirements for a company to be added to the Index. It has to be a US company worth at least $3.5 billion dollars, trade with adequate liquidity, have at least half the stock available in public float.

We look at what sector or industry it belongs to, to keep the balance of sectors in the Index very close to the balance in the market. And last, but certainly not least, it has to have made money. It has to have four quarters of positive earning using generally accepted accounting principles (GAAP) net income.

Over the years that has proven to be surprisingly important to the whole process.

What happens when someone reads that the S&P is up 10 points or down 10 points. How is that calculated?

The Index is what we call a value-weighted index, or sometimes called market-cap or market capitalization-weighted index. You take the market value of each company in the Index, and you add it all together, and you will get a number that is probably about $9 trillion right now.

Well, $9 trillion is sort of a big number to report every 15 seconds. In fact, by the time you get to the end of the number you've used your 15 seconds.

We divide it by a scaling factor called the divisor, and that gives you the value of the Index, 1,142 or whatever it happens to be. When you say the index is up, you take the value of all those companies – some go up, some go down at any given moment – the ones that went up outweigh the ones that went down, and after you scale it to a number that’s easy to handle, you come out with say 10 points, and maybe the Index has moved from 1,140 to 1,150.

You say that the companies are market weighted. What would be the biggest company in the Index right now, the most important company today?

The biggest one is most likely Exxon Mobile which is a giant US or global oil company.

So you have a company like Exxon at the top of the list, and they are up 3% in a day, and then you have one at the bottom of the list not nearly as important, and they are down 3%. So you've got two members, one’s up, one’s down, but they are not of equal importance to the index as a whole?

That's right. Let's assume the other 498 stocks didn't move, just to make it simple. Exxon mobile goes up 3%, and the number 500th company goes down 3%. The Index overall will be up, because Exxon Mobil's weight in the Index is going to be much larger. Its weight is probably 3, 3.5, or maybe 4%. The one at the bottom we’re talking about is a very small fraction of a percentage point.

You mentioned the S&P is the most widely followed the Index, but probably not the best known. The best known would probably still be the Dow Jones. Can we talk a little bit about how the Dow Jones differs from the S&P 500?

There are two big ways. The obvious one is the Dow has 30 stocks. We have 500. Quantity is not the answer, but with 500 stocks one gets much broader coverage of the overall market. And you know, you cover more, you're more likely to include stocks that either went way up, or way down, or did something else somewhat unusual.

The other way is the calculation. The Dow uses the same calculation method that they started using in 1896 when they did this on the back of an envelope, probably with a pencil and paper. They take the prices of the 30 stocks – not the value, but just the price – and they add up the number, and then they divide by a scale factor which gets them to their number.

So you can have two companies in the Dow, one may be worth 10 times the other one, but a one point rise in either company will have the exact same impact on the Index.

The other thing about the Dow, just because the way the arithmetic works out, is the number they divide by turns out to be very small. It's actually a little less than 1/5. So a one point move in the Dow by a stock, any stock, will be a five point move in that Index.

Or maybe more to the point, if 10 of the Dow stocks do nothing, and the other 20 each go up say two points, those 40 points are going to echo into a 200 point move in the Dow Jones. And a 200 point move in almost any Index is going to hit the news wires in a big way, and get people probably more excited than they really should be.

The Dow is equally weighted, unlike the S&P which is weighted by the actual market value of the company. Let's suppose a stock in the Dow has a price of $150, and another one with a price of $15, and you have a two dollar movement in each of those, does that two dollars have a different impact on the Dow overall?

Yes. If the $150 stock went to $152 which is a tiny little fraction of a percentage, and the other stock at $15 went to $17, this is a big move in percentage terms. Those two moves have the exact same impact on the Dow. Two points on the stock would be about 10 points in the Dow.

So you're getting movements that just depend on whether a stock is priced at $15 or $150, which really has nothing to do with the underlying value of the company.

Whereas in the S&P 500, it’s how much the value of the company has moved that determines the impact on the Index, and that's one of the reasons why we believe that market weighting gives you a much better door to understanding what's going on in the stock market. A big reason to follow indices is to understand what's happening in the stock market overall.

Some of the media coverage you hear occasionally says that we should buy a company, because it might be added to the Index. So could we talk a little bit about the underlying thinking to that?

Look at the S&P 500 and the amount of money that’s managed to track the Index, in exchange trade of funds, Index funds, pension funds, and other institutions whose investment strategy is to replicate the Index.

If a stock is added to the Index or taken off it, do they have to replicate that change?

That's right. They have a commitment to replicate the Index. The totality of that money is something well over a trillion dollars. If you go through the arithmetic of what that means, then for any stock in the Index, about 10% of the outstanding shares are going to be held by this collection of Index replicators.

So if we add a stock to the Index, and let's assume for a moment it's not in any other Index we run at the present time, over a period of a week between when we announce it is going in and when it actually goes in (because we make announcements five trading days in advance), about 10% of the stock is going to get bought up.

It has to happen. This is a very large buyback program. To give you some frame of reference, a corporation running a buyback program buying back its own stock will buy back a half percent to 1% of the outstanding shares in a quarter of a year, 13 weeks.

So these replicators are doing 10% in a week versus 1% in 13 weeks. The stock goes up. Typically it will gain 5, 6 or 7% over a week maybe two-week period. It will gradually give that back over the next three to six months, so this is not a permanent all-time rise, although it is very exciting. If you knew in advance what we were going to do, and we play this very, very close to the vest for obvious reasons, and you traded options, it would be even more exciting, but it would probably be trading on inside information unless it was just a lucky guess.

That's the case when you add a stock to the Index, just buying pressure from institutions and ETFs forces the price up short-term. Does the same apply when you take a stock off the Index that the price gets pressed down?

It does, but it’s much harder to calculate. The data are much thinner for a couple reasons.

First of all, something like two thirds of the exits from the Index are caused by M&A activity. So the stock that's coming out and being acquired in a merger, the price is predetermined by the terms of that merger.

And has already been pushed up?

It's already had its run up at the very beginning of the transaction process. There are other cases where when we take it out because it has fallen on very, very hard times. It clearly no longer makes any sense in the Index, and the selling happened months ago, not right now.

So while there probably is a short-term decline in a stock when it comes out, it’s much, much harder to measure and gauge. There are much less data. There are a lot of special circumstances that would be very hard to disentangle.

If someone is online and they see that you've just announced that you are adding a stock to the Index, should they rush to their broker to buy it?

First of all, we make our announcements at 5:15 PM Eastern time so the markets are officially closed. These days you can trade anything, anytime, anywhere, but the markets are very thin when it comes to 5:30, 6:00, or 6:30 in the evening. So it would be a little bit dicey to do that. But more so, this is a short-term play, and if you are into fast and furious short-term trading, you place your bets and take your chances.

If you're a long-term investor, and if you look at the long-term history of the US stock market and indeed of most developed stock markets, they have sideways periods. They have sustained periods where they don't seem to advance, and we are unfortunately in one, though hopefully coming to the end of one.

But over the long haul, markets do very well. As a long-term investor, the strategy to replicate an Index turns out to be very successful, in large part because it’s incredibly cheap.

I want to talk about some of the sectors in the S&P, where they've been in the past, and where they are today. Let’s start with the financial sector. What's the average importance over time for the financial sector in the US stock market?

The average importance has probably grown over the long term over the last three or four decades. Currently it's in the high teens. At its peak it was probably 20 to 25%, in roughly 2007. Clearly it came down very sharply with the financial crisis, as a huge number of large banks cut their dividends and a couple of very large public companies literally disappeared.

But what surprises many people is that the past decade, from the market bottom in 2002 to the peak in 2007, while financials are very important, they weren't incredibly dominant. It was not a financial repeat of the Tech boom. It was a broad-based improvement in the market over those five or six years.

Talking about the Tech boom, where did the Tech sector peak in terms of its importance in the US stock market?

The Tech sector was almost a once in history event. If you go back to about 1994 when it started, technology was around 8% of the Index. At its peak it was probably a third, 30 to 35% of the Index.

Today it's down to 15 or 16%. It's been moving up lately, and doing somewhat better. Probably in the long-term it will have a strong position. I'm not sure it will get back to the one-third level though.

One of the debates when it comes to investing is value versus growth. Those tend to be the two alternative approaches. What does your track record show in terms of the investor experience using a value approach versus a growth approach over the long term?

Over the long term, value tends to outperform, not year-by-year by any means, but over the long sweep of time. Value builds and maintains what appears to be a sustainable lead on a totally long-term basis. Value stocks tend to have higher dividends and are more likely to have dividends than growth stocks, and that's a big part of their long-term benefit.

But really the only time that growth seemed to suddenly surge ahead briefly was at the very end of the 1990s. At the peak of the technology boom, growth stocks were heavily dominating technology and appeared to be unstoppable. We know as a result of what happened shortly after the beginning of 2000, they were stoppable.

You mentioned dividends just a moment ago. Can you point to long-term data in terms of the investor experience focusing on companies that pay dividends compared to those that don't?

Yes. We put together a list a number of years ago which we continue to maintain, and what we nicknamed Dividend Aristocrats. These are companies in the S&P 500 with a record of at least 25 years of increasing their cash payout to investors.

So not only were they paying dividends or maintaining their dividends year-by-year, they were actually increasing their payout. There are not too many of them, and we've lost a lot in the last few years to other issues, but over the long term on a total-return basis, these stocks do very nicely.

Last fall I had a chance to interview Jeremy Siegel at Wharton. In his most recent book, Why the Tried and the True Beats the Bold and the New, one of his suggestions was that new companies get added to the Index after they've had the best period of their run-up, and investors actually are often not served by buying companies after they are added to the Index. What is your perspective on that?

Two things stand out, one particularly regarding Jeremy Siegel and his research.

He did some work a few years back for which we provided a lot of the background data, looking at the companies that were in the S&P 500 in March of 1957. This was when the Index moved from being 90 stocks, as it had been in ancient days, to being 500 stocks as it is now.

He studied how those companies did. His argument was that the original 500 actually outperform some of the ones that went in and out of the Index. There were a lot of particular stories in that period of time. So I'm not sure it's a general result, but it was a fascinating piece of work.

More to the focus of investors today, the S&P 500 is the large-cap stocks at the top of the market. Below that in size is a mid-cap Index of 400 stocks, and below that is a small-cap Index of 600 stocks.

The small-caps tend to be very exciting. There are some wonderful stocks there. There are some less wonderful stocks. They’re a little more volatile, and because they are small they are a little bit riskier typically.

The 500, as Jeremy Siegel suggests, are solid long-term good ideas, but they may have passed some of their high-speed growth.

Sitting in the middle turns out to be the mid-cap Index, and while obviously the past is no indication of the future, over the long haul since the mid-cap Index was created in the early 1990s, it does seem to have this attractive balance between the more rapid growing, more exciting, more dynamic smaller stocks, and the more secure larger stocks. It seems to get the best of both worlds.

For an investor who listens to Professor Siegel and doesn't want to own just the biggest stocks there are, but wants a little more interest and excitement, I would poke around and look at the mid-cap 400 among other things.

That sounds like an interesting idea, and one I think that many people hadn't thought of. Is there a risk that of that the 400 mid-cap companies you'll get the 20 or so that excel, that really become home runs, and then they grow to the point that they move off the mid-cap Index onto the 500? So will investors lose the growth once they've met that threshold and are no longer in the mid-cap Index?

Looking at the three indices, a large proportion of the stocks going to the S&P 500 come out of the mid-cap.

The way we maintain the indices, a stock can only be in one Index of the three at a time. It can't be in multiple indices. A company that outperforms or grows faster than most other companies will move up in size, and if it continues to do so, it will move to the top of the mid-cap and it will become a reasonably good candidate to be moved to the 500.

There's certainly no guarantee. Number one in the mid-cap by size is no more likely than number five, or number 10, or number 15, to be moved into the 500, although clearly the top 50 to 100 are probably more likely than the bottom hundred.

The one aspect that makes it very intriguing is the following.

I mentioned earlier that a stock going in the S&P 500 gets a short-term bump up. So let's say we announced tonight at 5:15 that a stock is going to come out of the mid-cap and go into the 500 after the market closes a week from today, which is the typical time frame.

For this week, which is when it gets a lot of that bump, it is in the mid-cap Index. It is not in the 500. At the end of this week it will get moved into the 500. So if you were sitting on the mid-cap, you got the bump. It goes into the 500, and over the next two, three, or six months it gradually drifts down and gives back what we're calling an “artificial bump.” It's already in the S&P 500, which is another reason why the mid-cap might be an interesting thing to take a look at.

The Bears' Argument

Articulate, well-spoken, even makes sense...

Part 1:


Part 2:


But how well known is the argument for even Tony Robbins to propound it...?
-- David M Gordon / The Deipnosophist

Trends within trends

Are equity markets headed higher or lower? Either direction, what periodicity? Is that periodicity meaningful to your, and your portfolio's, time frame?

No question; confusion reigns. It is ever thus, however, when the market's primary direction is sideways. Sideways? Well, yes, if you step back far enough to see the market has traced a trading range for the past ~13 years, as it builds either a base or top. For the Dow Industrial Average, 7000 and 14,000 bound the range; for the S&P 500, 750 and 1500 are the boundaries. A 50% decline from 1500 to 750 or 14,000 to 7000 is painful, and qualifies easily as a bear market for most investors; for me, it is a high level consolidation (HLC). All the trading within the range can induce fright or elation, but amounts to noise and carries little significance. These high level consolidations appear quite regularly.

And every few decades, the equities market suffers through a secular variety of this pattern that typically endures for 15-20 years. (Single point: 16 years.) Many professional investors differ as to this pattern's inception; typically, from the high prefatory to the first 50% decline. I prefer to start counting from the breakout that is immediately tested subsequent to the breakout and then again during the 50% decline. Which dates the inception of this HLC since Q1 1997, and leaves ~3-5 years more work before a breakout or breakdown finally occurs. Too, the market trades (tags) the outer boundaries of the HLC only a handful of times during the HLC; all other trading occurs within the boundaries.

Rather than utilize pattern recognition, most investors, whether by choice or innocence, deal with news flow and pronouncements:
1) For every market move, the media must ascribe a meaning and a motive;
2) Market pundits pronounce the market's direction, rarely correctly but always willingly.

My interest is not to disabuse these pundits from making their predictions, only to encourage you to ask how those predictions and pronouncements effect your portfolio decisions. For example, Robert Prechter, an incredibly intelligent fellow whose notion of Socionomics is a direct descendant of Isaac Asimov's more interesting notion of Psychohistory, argues that the prevailing social mood today, ugly, paves the way for a materially lower market. Unfortunately for Prechter (and his followers), he has argued the same call for Armageddon -- and not just financial Armageddon, but societal Armageddon -- for the past 30+ years, while the market instead has climbed higher 15x rather than decline. Other investors point to their discrete data sets to argue for a bull market. I argue that until the market breaks out of its HLC, there can be no true bull or bear market. Careful, now, I care not at all for statistical analyses that state a decline of 10% is a correction, and 20% is a bear market; to me a bear market is a sequence of lower highs and lower lows, beneath a determinable break point. Until then, the boundaries form a base or top, its action expected. Yes, I know I have argued the HLC before (and repeatedly). Makes little difference, though, for the only other professional investor I know who shares this perception is David Rosenberg (Gluskin Sheff). Perhaps surprising, because most people view David to be a perma-bear. Their loss for not reading his commentaries carefully or diligently.

Oddly, perhaps paradoxically, but always profitably, during and throughout the market's secular high level consolidations, emerge new sector or group bull markets (as I denote the term): higher lows and higher highs to all time highs, and then some. This separate peace is where I live (invest). The trick, though, is to identify the leading groups and themes. And then time your investment purchases and sales to align with the general market's oscillations. So I slice the market into smaller epochal slices of one month, and base my expectations for the market on that thin sliver of time. Why one month? Because it equals one bar on a monthly basis chart.

Among market commentators, Tim Villano excels at recognizing the market's squiggles. Just this morning, Tim stated,

"Major sentiment surveys describe high levels of pessimism in the marketplace, and technical data continues to argue for an interim (intermediate term -- dmg) bottoming process. It would be unusual for the tape to break down or fall apart from the type of sentiment and technical readings currently seen. It would be difficult to sell the stock market short when the majority of participants, as described by the major sentiment surveys, are bearish. Under similar circumstances, I have seen the tape trade lower briefly or shake out more participants, but I cannot recall witnessing the beginning of a sustained declined from the type of sentiment readings present today."

Tim's comments always are more nuanced and balanced than the brief snippet above betrays, but the snippet above ably, if indirectly, argues my point: Do not fear the market; instead, trust yourself to make the right decision, the hard decision, when necessary. Which means pull your ear off the ground listening for the hoof-beats of history hurtling towards you. Listen, if you prefer, to your favorite market commentator -- but never forget to fit his or her predictions and pronouncements within your portfolio's needs.

50/50 that the market today builds an intermediate term base -- which grants equal odds the market instead could be building an intermediate term top. Increase the odds in your favor by buying the lower boundaries and selling the upper boundaries, until and when the market finishes its HLC and stakes a definitive, meaningful, and new trend. To my eyes, an intermediate term base within the market's secular HLC appears to build, and has the data to confirm such a likelihood. That said, demarcations of support must halt further declines beneath certain levels. Until proved otherwise, I seek to identify the new leaders, and invest at appropriate moments. (Never sufficient solely to identify the leader, and then purchase willy-nilly -- unless your time frame discounts wild swings in price.)

Full Disclosure: Specific investment opportunities, and their timing, discussed on Investment Poetry.
-- David M Gordon / The Deipnosophist

Google/GOOG: Predator or Prey?

This blog began 5 1/2 years ago amid my oft-repeated recommendations to invest in Google/GOOG... but even before those recommendations were my private entreaties elsewhere. Google went public in August of 2004, but investing in its shares at that time was neither layup nor a popular decision: The PLAYBOY interview with the company's co-founders published mere days in advance of the company's IPO angered the SEC for violating a few rules and the company's unusual IPO did not ingratiate the company with powerful Wall Street interests. Many people feared the shares would founder, if not sink, post-IPO.

But a good story never keeps a good stock down for long. And Google had a good story. They kept it quiet, hidden, enshrouded in secrecy and whispers for as long as they could but the IPO busted open just how profitable the company was. And because the company took another non-traditional step of no quarterly guidance to Wall Street, the combination proved profound: secrecy + powerful revenues growth = surprising earnings gains. The stock rose accordingly.

A few people questioned the company's torrid growth, centered on whether Google was and would remain a one trick pony. (Its one trick being search.) In the quest to increase and diversify its revenue stream, the company bought many other companies, both large and small, integrated those purchases sometimes well but more often poorly if at all, offered many new products to its users -- so many new products to so many users, in fact, that its product line became unwieldy with diffusion. (I have registered my own complaints; Google's products that I deem core to my life have become near intolerable with their unreliability to the point that I almost no longer use them.)

Google definitely suffers growth pains -- although most companies would love to suffer growth pains even remotely similar. At some point, though, Google must begin to monetize the many strands of spaghetti they have flung at the wall, and not rely on their one stupendous cash cow, search. Perhaps its new great success will be the Android operating system for mobile, which became a rapid and surprising success. Perhaps Google finally will calculate a method to capitalize on its massive purchase of YouTube. Or DoubleClick. Or AdMob. (This list of purchases could really lengthen the page, so I will stop here.) Not to neglect the home-grown opportunities: GMail, which was so startlingly fantastic when revealed, and now the company allows to whither on the vine. And so on.

Google's revenues have finally decelerated from their torrid pace of growth, as the critics argued, if for no better reason than the Law of Large Numbers, but the company's earnings now pay the price for lazy management, negative growth YoY, as reported last week. Such an event is a cardinal no-no for a growth company; it calls into question your nature as a growth company. Part of the problem at Google, I suspect, is management's utter trust that revenues and earnings would continue to out-pace CapEx and SGA into the knowable, and unknowable future. A difference exists between budgeting and hewing to a budget and spending willy-nilly with the expectation that a revenue stream will continue ad infinitum. Of course, I am not privy to executive level discussions at Google -- it is possible they have another trick up their sleeve.

I have been thinking about this all for the past few years, but it all came to a head this weekend when I read this brief report by Eric Savitz...

THE OTHER BIG EARNINGS REPORT last week came from Google. It modestly beat Street expectations at the top line, but missed by a few pennies at the bottom line, as expenses exceeded Street expectations—reflecting in part the fact that the company is bulking up again, adding nearly 1,200 people in the June quarter alone.

While Google (GOOG) has struggled to generate significant revenue outside the mainstream search-ad market, it nonetheless grew revenue 24% in the latest quarter, while ratcheting up its cash position to $30 billion. Google trades for 17 times expected 2010 profits, and 15 times 2011 estimates.

No question, there are tough issues for Google, but it remains one of the best plays on the continued growth of Web content and commerce. Concerns seem well-reflected in the stock; through Thursday, Google was down about 20% this year. For buy-and-holders, this looks like a nice entry point.

The crucial misunderstanding, and one shared widely, is Savitz's penultimate sentence in his final paragraph, "Concerns seem well-reflected in the stock; through Thursday, Google was down about 20% this year." My problem is
1) Friday's wild down day changed the calculation to 25% down for the year from 20% in one fell swoop, which effectively demolishes Savitz's argument that the "concerns are well reflected in the stock." Oops.

Also, and more important, is the notion that
2) Because a stock is lower since some artificial date (in this instance, 1 January), everything is somehow okay for investors to take the leap, and invest. But this confuses cause with effect; effect with cause.

Investing is rarely, if ever, a static endeavor; more typically, it is a dynamic process. Imagine the arcade game with the ducks moving by from left to right but now, they also move up to down, diagonally, and always randomly. And, who knows, perhaps you might move as well. It becomes more difficult to settle the cross-hairs on such a moving target, no? Welcome to the world of investing. Eric Savitz's perspective is... well, quite one-dimensional, though instructional.

You can see investors' indecision easily via the merest glance at Google's chart, especially its weekly basis (the better to capture all trading data since its IPO). An identifiable area pattern builds in that periodicity, a rather large area pattern that carries some measure of significance. A better, more valuable harbinger for investors might be obtained from incorporating such a birds-eye view, rather than one so artificially epochal as since 1 January.

This post continues on Investment Poetry.
-- David M Gordon / The Deipnosophist

Investment ideas

I often receive the question, "Whence come your investment ideas?" (Well, the question is phrased not precisely like that, but its objective is the same.)

Of course, all investors share the same well-spring, the public markets. (Private equity and venture capital, to name only two other investment markets, obviously have different characteristics.) Styles abound, but two predominate: value and growth. Value investors seek to purchase $1 of assets at a present day discount. Growth investors seek to purchase $2 of future value based on presumed continued growth for today's $1 present day price. (Simplistic definitions, these.)

From that starting point, the layers of complexity begin; for example, Warren Buffet melds growth and value into a unified whole, although he leans toward value. He ignores the technology sector altogether, partly because he claims not to understand it, but also, I believe, due to its tendency to have torrid growth... that does not endure beyond a few years, which does not comport with his time frame. (A crucial point.)

But the complexities become even more boggling for the investor: With so many possible investments, which to select? Rule out one style (for example, select growth, or vice versa), and then limit your universe only to growth stocks. Great, that leaves ~20,000 stocks. Now what? Penny stocks or institutional stocks? A bet on growth is a bet on the future, and because the future is unknowable, each asset class enjoys equal opportunity to succeed. (Well, perhaps in an egalitarian universe.) Filters would be of use: a minimum number of shares traded daily, a minimum share price, whatever. Or William O'Neill's CANSLIM.

Your objective is to:
1) Identify the leading theme for the market's next up leg;
2) Whittle the list to a manageable few;
3) Know, really know, those few companies that pass your filters;
4) Know, really know, the often subtle tells of each stock's trading action that are precursor to big moves in one direction or the other, which you could identify because you do not monitor a list 100s of names in length.

What you do not want to do:
5) Buy old names. A former growth leader that no longer grows is no longer a leader, and its shares certainly will be no leader; avoid it like the plague.
6) Buy yesterday's cycle's winners. Why purchase for your portfolio an investment that has a ceiling as to high it could rise? 
(These two items are similar, but not the same.)

Investing is difficult (enough); you, as investor, are presented with multiples of reasons why you should not buy, or not hold, your winning leader of an investment. So you do not buy, or you sell, or worse you trade out of it. ("I will re-purchase on the dip." A dip that never comes.) Why complicate matters? Find your core truths, simply expressed as your investment objectives and risk tolerances ("To make money!" is insufficient), and then the investment style and asset types you prefer, adjust the filters to your liking, and then enjoy some measure of success.

Slightly more to investing than this simple, simplistic bit, of course, but it is a good beginning.
-- David M Gordon / The Deipnosophist

A rocket-ride to Hell

To begin, a snippet from David Rosenberg (Gluskin Sheff)...

Is it the correction that is unusual, or is it the fact that in a matter of 12 months, the S&P 500 managed to shoot up 80% — and amidst the weakest recovery in real final sales in recorded history? The few times that the market had ever rallied so sharply off such a deep interim bottom were both in the 1930s, and we saw a pullback of around 40%. So, the reversal of the past three months very likely has further to go, and, sadly, many market participants are still not braced for it. The old buy-the-dip habits die hard.

The 12% slide in the market in Q2 wiped out $1.6 trillion of paper wealth off the books. In a particularly ominous sign, the 3.7% decline in the S&P 500 this past week stood in stark contrast to what we usually see this time of year because seasonally, the equity market rallies three-quarters of the time heading into the fourth of July festivities — the 4.6% decline so far this week stands in stark contrast too.

Taking the year as whole, with the S&P 500 off nearly 8%, this goes down as the worst first half to any year since 2002. That year, if you recall, was an aborted recovery as opposed to a classic double-dip; however, it didn’t really matter because a market priced for over 3% and got basically near zero growth in the second half of that year, did not bottom until October...

You cannot complain that I did not warn you, though; in fact, I bored you to tears with my frequent warnings throughout December 2009 and Q1 2010. Bottom line: The market built a top during Q1 2010, and broke down during Q2. I stated almost as often that the oil sector would be especially weak due to technical factors inherent in its own group and sector chart, and would lead the market lower because of its 15% weighting in the S&P. It has done just that, and then some -- but, even so, who could have known about the downside outlier that BP represents, which exacerbated the sector's and, by extension, the market's decline?

For equities, this moment, here now, is difficult, troublesome, perilous... and exhausting. I quote market analyst par excellence, Tim Villano:

The high-probability trade to new lows has occurred; ES 1020 hit easily, and the 1005 mark tested. These lows have the appearance of a daily, wave-5 movement.

As an investor who watches each tick, it is difficult not to apply some greater meaning from the market's one-way trajectories, especially now with the predominantly negative ticks. How could the market's rocket-ride to Hell not mean the economy sucks and that people will lose their jobs and thus be unable to pay their bills, which will cause a feedback loop that only worsens the downward death spiral in the markets and the economy, and back to the markets, feeding ever-deeper declines?

See what I mean? But often, market action has no greater meaning; its import is for the market and not the economy, although 2008 is an obvious and notable exception. The responsibility lies heavy on the investor, as always: Is a given moment one of (heightened) risk or (increased) opportunity? Is this moment one of (heightened) risk or (increased) opportunity?

Yes, good questions. And what about this one: What transpires next for the markets? Find out on Investment Poetry where this post continues and concludes.
-- David M Gordon / The Deipnosophist

You say potato, and I say...

So many methods to investment success, so little time. Simply, simplistically, an investor could view the investment landscape either as
a) top-down
b) bottom-up

The former (top-down), in essence, involves a prescriptive view that begins with geo-politics, filters down through national and local politics, economics (global and local), finance, companies, markets, sectors, groups, and stocks. The latter (bottom-up) is mostly similar, but in reverse order. The primary difference between the two, for me, is that the former makes pronouncements and attempts to fit the market's square peg into the investor's round perspective (or pronouncement), whereas bottom-up investors allow the markets to 'speak' to them, they 'listen' to the message the markets convey.

When I identify a company and its stock as possible leaders, I confirm that status via seeking similar strength in its group and sector. For example, after I identify xyz as a possible leader, I then attempt to identify whether other company's shares in the same group out-perform by a similar measure; if yes, I seek some measure of out-performance in its sector. (Please understand, the broader the group -- individual stock --> group --> sector --> market -- the less the out-performance, an argument in favor of concentrated positions: more risk = more reward.) This group and sector analysis confirms my thesis in favor of the winning investment opportunity, not vice-versa.

I never view the world and say, "Everything sucks, the world is going to hell, but it is a good time for ordnance makers. Buy their shares!" You willhear me say, and often, "He is smarter than anybody, but not smarter than everybody." This quote sums my view of investing. The consistently successful investor acknowledges the enduring power of the markets, which can and will grind him, his ego, and his portfolio to dust long before it acknowledges he was correct after all. Perhaps.

Which is why, correctly or no,  I choose to view the markets from the bottom-up; my view is clear, unclouded, rarely confused. And I can allow the profound power of the market to help guide me to enduring and consistent investment success

This post concludes on Investment Poetry.
-- David M Gordon / The Deipnosophist

A working thesis

The equity market's dynamics are always up to the investor to interpret, but its recent negative dynamics continue. Simply, simplistically, and solely: prices rise on diminishing volume, prices decline on increasing volume. The outcome from this particular dynamic, historically, has not been good or positive. To state it mildly.

So what's the problem...? This dynamic has been in force since the low and reversal of March 2009, it worsened off the low of early-November, and became truly ugly since the low of 5 February 2010... and yet the market shrugs off this dynamic, and proves itself resilient, if not also refuse to reassert its broad and wide decline. Of course, Friday's session, as broadly negative as we have seen of late, caused the market to breach finally ES 1080, which quite possibly changes its dynamics, although not yet its direction (as I stated in an earlier reply). At least, not necessarily and not yet; with its current placement after Friday's daily and weekly close, this next week should prove... fascinating; its arrival laden with ominous signs of imminent doom.

My investment methodology relies heavily on market action for insights as to which opportunities appear best situated at any given moment, so the past few months have proved personally damning. Readers and subscribers have abandoned this site because they seemingly prefer short term reward over the intermediate term's mounting risk. (Certainly it is not because I have been proved wrong!) But to invest now, and for the past several months, is, in essence, to play the momentum game (aka, the greater fool theory) -- and momentum with especially horrible dynamics. The decline that began in April might cause these investors to reassess risk, and should they and remove their buy orders, then flash crashes such as we saw on 6 May might become a recurring experience. To prepare you for this event(uality), I described in a previous post this phenomenon of a vacuum of balancing orders that foster the set of circumstances necessary to avoid these sudden air pockets.

The market's changes of trajectory help cause a shift in perception, of perspective; a new parallax view. So Apple/AAPL's chart action of the past 2 months transmogrifies to top from base, and suddenly you see that Google/GOOG began its decline on 4 January, fully 3 1/2 months prior to the market's peak. The question for many stocks now becomes whether the 200 day sma will stem deeper declines.

I took some heat last week for the chart above (updated through Friday's close) for having misidentified the right shoulder, or the neckline, etc; justifiable criticisms, if possibly incorrect. What the commentors do not know is I (attempt to) identify trends and their changes in anticipation of market action; the neckline I identify is nothing more than a working thesis. Although it also (increasingly) appears to be a correct thesis. Time will tell. But what will time tell us...?

This post continues on InvestmentPoetry. See you there!
-- David M Gordon / The Deipnosophist

The market today

From a letter to clients I wrote only 31 days ago...

"Moreover, the market's current position and posture argue for an intermediate term decline. Assuming forthcoming events prove correct my analysis (a decline to SPX 900-850), the possibility looms for a deeper decline based now on a weakening backdrop. But one step at a time. I would be remiss if I were not to mention my conviction that the leveraged short ETF, SPXU, will redeem your patience, and your portfolio, many times over. Markets never are mono-directional forever, oscillations against the prevailing trend do occur, and the current market has many reasons to decline, short and intermediate term..."

May 2010 proves to be the worst monthly decline since February 2009 and the worst month of May since 1962; SPXU, in turn, roared higher. The question now is, "What and where next...?" To that end, I study the chart of the SPX...

The ominous Head & Shoulders top identified previously -- and whose crucial trend line (the drawn neckline) the market stubbornly refuses to breach. At least to date. The pattern since March 2009 is not a pretty picture -- if you rely solely on its look; other factors come into play, though -- sentiment, market internals, money flows, geo-politics, etc -- that to rely on one item is folly. Nonetheless, many gauges and metrics align with a bearish tilt.

Easy to imagine many scenarios:
● Equity markets plummet now;
● Markets trade sideways for a few weeks or even a few months before breaching the neckline;
● The markets stabilize, and the feared correction is more time and shallow price than deep price.

So I exercise patience while I also search for signs of the true break. Easy to imagine my tactics whichever way the market breaks:
● Down -- buy more SPXU;
● Up -- immediately reverse course (cover SPXU and go long)

As of this moment, I still believe the market's intermediate term (the next ~4-6 months) trajectory is down to SPX 900-850, arguably lower. No matter the outcome, the onus remains upon me to identify now those stocks that manifest as excellent long term investment opportunities. Which is largely how I spend my market days: Identifying the new leaders and the true market direction.

I hope you are equally as happy as I am confident that the decision to increase cash to a dominant percentage of your portfolio was the correct choice. The market appears exceedingly treacherous right now, and for the next several weeks and months. Certainly, the systemic peril has never been greater, 2007/2008 included, the opportunities never fraught with more risk than now.

Full Disclosure: Long SPXU.
-- David M Gordon / The Deipnosophist

The markets' coming squiggles

Yes, I know all about the 'news' coming from Europe, England and Germany especially, that targets short-selling. (Really, the short sellers themselves.) No, none of it surprises me; please recall my comment from Monday's post, "... a future in which governments impose confiscatory taxes against ‘evil’ investors (of all types and time frames), which begets more selling to pay the tax" seems clearly in play. Unfortunately, and as I argued, the short-sellers represent not the problem, merely its symptom. (Short sellers do represent liquidity, something the markets scream for, so the Europeans efforts amount to shooting themselves in the foot.) The true problem is the spend spend spend philosophy of politicians, who effectively prove to be spenders, not managers. Whatever happened to the concept of thrift?

The markets follow, almost lockstep, the trajectory of the US$... although it thinks it follows the ongoing travails of the €. But that's okay, the net effects remain the same: Wild oscillations in all markets, especially during overnight sessions, with its lesser liquidity. But what of today, and the near future -- will the market crash here, now, as some market prognosticators suddenly believe?

This post continues on InvestmentPoetry. See you there!
-- David M Gordon / The Deipnosophist

Today's reality: Potential systemic failure or system failed?

Which came first, the chicken or the egg?

Apply that puzzle of philosophy as metaphor to global economics and financial markets, and we all wonder whether equities truly move in advance of economic fundamentals or react to them. Too many swings and oscillations occur to name this or that price swing as distinct from any large economic or financial news item.

In today's speed-of-light world, grave concerns increase re the sanctity of markets and economies, and markets react immediately, devastatingly. Or do markets' renewed declines anticipate follow-on weakness? The economic and financial problems the world faces are no secret; we all know them. What we do not not know, yet, is the fallout from all our past misguided policies and pursuits (by both business and government) and the maladroit attempt to control, top down, the consequences of past bad decisions and actions.

In The Lessons of '92, I alluded that bad decisions beget bad actions, which often create negative consequences. Market speculators smelled blood as a result of the bad policies and actions made by the Bank of England and the UK government, and dove in to the banquet. In The True Objective of All That Money I pointed out how welfare nations everywhere find themselves on a cliff's edge, with one foot dangling and the other sliding toward doom. And now the world finds itself on the cusp of a crack-up boom. (This article ably explains Ludwig von Mises' notion, and the terrifying nature of its consequences.) In essence, not good.

I, and other commentators, could argue (winningly) that the global financial system does not face possible systemic failure; in fact, the system already has failed. You need look no farther than last week's embrace by the EU of the detested nuclear option: the European Central Bank's (ECB) decision to purchase government bonds issued by euro zone members, thus abandoning their long-held resistance to such a move. And which action follows on our (the USA's) many bailouts of the past 2+ years, from which directives, policies, actions, and bailouts the Europeans recoiled with shuddering horror. "Welcome to the (debt) party, Europe! By the way, the hangover is a bitch."

What the Western world attempts today is as misguided as it is noble: to spend money it does not have, to create from thin air the paper necessary to 'cover' the new deficits, to paper over past errors with more paper, to issue more debt to fund existing debt. Oh, and to give to everyone everything he or she wants: jobs, holidays, health care, a car in every garage and a chicken in every pot. (NB: the protests in Greece will come soon enough to a piazza or square, or street, near you.)

For various reasons, parts of the world are immune to this outbreak of the debt contagion: the Middle East (for reasons cultural and religious) and South East Asia (because those nations endured their own version of this financial mess in 1997/1998, and came out for the better). China remains a question mark; the nation has gazillions of liquid reserves, but most of those reserves are in US$ denominated assets (Treasuries, the $ itself), which could wither to zero in an all-out financial storm. The Chinese know and fear this possibility, so the nation hastily diversifies into real assets -- which satisfies one step of Mises' crack up boom: "Everybody is anxious to swap his money against 'real' goods..." Pay attention to what China does with its excess reserves, continues to do, now and in the future.

Global markets reflect this concern, amid mounting doubts as to how governments regard their sovereign debt, and treat their debt-holders. (Servicing debt, especially with more debt, is a bitch!) China's markets peaked months ago, as did the European markets; they all are in the throes of their price corrections. The US markets... well, let's just say the rally since March 2009 is suspect. Chart below is of the S&P 500:

Note a trend that loses upside momentum; note, too, a possible head & shoulders top. (I ignored the integral component of volume, largely because volume has diminished throughout the recovery rally.) This particular, and potentially powerful, pattern remains a work-in-process, so its realization remains anticipatory; it requires a right shoulder (arguably complete) and a breach of the neckline (identified) to confirm. The double-arrowed line measures the potential for the pattern, ~160 S&P points from the breach, a potential decline to ~910-870. (The same level I pointed to for the past several months, well before this pattern showed up on the chart!) Several stair-steps lower must occur first, though, to validate the bearish scenario: 1125, 1110, 1100, the identified neckline, and the 6 May low of 1065.

What could go wrong with the bearish expectation...?
● No right shoulder forms;
● No breach of the neckline (~1070-1065);
● An accelerated rise from a pattern failure. (No pattern is as bullish as a failed H&S top!)

I could argue that the 6 May low represents a climactic low, which would put paid to the entire expected decline (albeit that expectation was for 900-870, not 1065); certainly the data reached oversold levels. Even were that the case, however, climactic lows typically are tested, sometimes repeatedly. Worse, US equity markets trade 'heavy' and a decline of one week, however seemingly climactic, is insufficient to erase all the technical divergences and negatives built up over the past 6 and 15 months. One possible scenario, of which I could limn many, is a sideways range between 1175 and 1075 that endures for several weeks or months -- before the breach beneath the neckline finally occurs in late-summer (August/September time frame). Only time, and the accumulation of new data, will tell the true tale.

Please recall again the post, The Lessons of '92: speculators will sell short an item they deem has a lesser value than its prevailing price. This means speculators could, would, and do sell short sovereign debt, sovereign currencies, even sovereign governments. (Oh, hello, Goldman Sachs -- arguably today's equivalent of Switzerland during WW2; purportedly neutral, but if they can make a buck, then Grandma also is for sale...) The intent of the new positions that occurred on Thursday and Friday of last week could be to test the EU's mettle and intentions. (viz, the EU's $1 trillion commitment of paper and jawboning.) I know not what actions governments will effect in the attempt to bind, or even banish, speculators. Not difficult, though, to imagine a future in which governments impose confiscatory taxes against 'evil' investors (of all types and time frames), which begets more selling to pay the tax. Until resolute action of some form occurs (best would be reining in our individual and collective expectations), currencies weaken, debt prices decline, and investors (even investors!) sell equities. Actions, reactions; sequences, consequences; selling... and more selling? Perhaps the sudden vacuum of no bids on 6 May will soon reoccur, regularly so. Caveat emptor. The game of musical chairs continues. Fun, eh?

The markets finally will break, up or down. What occurs today, before the break, is the usual comparative and relative swapping vs absolute sales (or buys): trading this weaker currency for that stronger currency one (say, the arguably devolving Euro for the strengthening US$), selling short this sovereign debt and going long that sovereign debt, selling short this or that equity or equity market and going long another equity or equity market. This all is the province of hedge funds in their original form (short this/long that), and bespeaks an ongoing process of correction, not bear market; nor the end of days. The bottom could drop out, though, at any moment; certainly the warning signs, economically and financially, begin to dot and dominate the landscape (charts).

I predict nothing. My role as portfolio manager and market commentator is to lessen risk and increase reward. So I seek the new investment themes and the new leaders: those sectors, groups, and companies that not only will ride out the (coming) storm but should succeed, if not excel. Of course, between then and now lies the Land of Uncertainty, and the possibility of lower share prices.

Fascinating topics (global economics / finances, and markets), to be sure; I could continue for a good while longer. Frankly, it all is rank speculation; at least, at this moment. Will the world muddle through (again)? Will markets stabilize, and rise? Will Charon still demand his fee for ferrying us to there from here? In what form will that coin be?

It pays to be ready for all contingencies:
1) Equity markets stabilize, and then rise anew
2) Equity markets plummet, but recover
3) The world (as we know it) ends

I prefer to focus my attention on items 1 and 2 for the obvious reason. I will do just that on InvestmentPoetry, with specific recommendations, in addition to a deeper discussion of the topics I presented above. As always, your comments and insights are welcomed and appreciated.
-- David M Gordon / The Deipnosophist

Fat Finger or Perfect Storm? You decide

I laugh easily these days (Hey, we must keep our wits about us!), but Jon Stewart really nails it with this clip...

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
A Nightmare on Wall Street
www.thedailyshow.com
Daily Show Full Episodes Political Humor Tea Party

Next time some person explains market moves, or anything for that matter, and that person resorts to cliches, ask yourself, "What insight did I really get...?"

Thanks for the laugh, Jon. I needed that!
-- David M Gordon / The Deipnosophist