Once, Twice, Three Times a Bottom…

October 30, 2008

Time for another chapter in the saga of capital destruction we call the stock market.

Just in time for the negative GDP number everyone has been waiting for, the market is finding a bottom.  It may not be the ultimate bear market bottom, but it’s probably the bottom for 2008.  As we noted in We’re sure scared now…bringing it all together, “Historically, a retest of the lows develops within a few months to verify the strength of the bottom.  Hitting the exact lows again is not a necessity, but a second significant down move usually at least comes close.  This offers a great time to pick up relative strength leaders as they separate from the pack.”

We have seen not only one, but two tests of the lows since that writing, in the broad market indices.  Neither one of those tests completely reached the initial low, but both were violent and low enough to be considered valid.  The updated chart of the Dow Jones Industrial Average shows pullbacks of 1,500 and 1,100 points respectively, with both lows about 300 points above the initial low of October 10.

What has developed now is a trading range.  Not exactly bullish, but much better than the ski slope drop of the last few months, October in particular.  Seasonality is also about to turn positive as the November through April time period is historically the best six months of the year for the markets.  November itself is one of the best single months to be invested.

So how do we decide what to do?

There are several options here really.  Trading range strategies are particularly profitable in times of high volatility.  Selling premium and initiating spreads are some preferred options trading strategies for this kind of market environment.  For long term investors, picking up relative strength leaders near the lows is a great strategy.  Many stocks have been unfairly punished and are now wildly undervalued.  For indexers or 401k investors that have protected their assets with bond funds and stable value funds and cash, start moving it back in on these bad days as long as the lows hold.  For aggressive traders, we know there are some serious mean reversion trades already started.

What we must all keep in mind is that we do not know if the lows will hold or not.  As long as they do, buy them but don’t commit all of your capital at once.  Take little bites and dollar cost average into positions, especially if you are not trading.  There are many great opportunities here, but there will be many in the future also.  Don’t let yourself get stopped or margined out (heaven forbid) when you should be buying more.  The amount of forced liquidation by hedge funds is not something that is knowable by anyone.  It is creating great prices, but it could carry much further if the selling continues to feed upon itself.  If the trading range is broken to the upside we would become more bullish and would start to look at the 50 day, 200 day and 80 week moving averages as resistance.  Another bullish clue we are looking for is for volatility to drop, specifically the $VIX needs to drop under the 20 day moving average which has provided support since the breakout in early September.


Statements from the Federal Reserve

October 29, 2008

Release Date: October 29, 2008

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.

The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.

Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

Release Date: October 29, 2008

For release at 3:30 p.m. EDT

Today, the Federal Reserve, the Banco Central do Brasil, the Banco de Mexico, the Bank of Korea, and the Monetary Authority of Singapore are announcing the establishment of temporary reciprocal currency arrangements (swap lines). These facilities, like those already established with other central banks, are designed to help improve liquidity conditions in global financial markets and to mitigate the spread of difficulties in obtaining U.S. dollar funding in fundamentally sound and well managed economies.

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Wall Street’s ‘Disaster Capitalism for Dummies’

October 20, 2008

14 reasons Main Street loses big while Wall Street sabotages democracy

By Paul B. Farrell, MarketWatch
Last update: 7:10 p.m. EDT Oct. 20, 2008

ARROYO GRANDE, Calif. (MarketWatch) — Yes, we’re dummies. You. Me. All 300 million of us. Clueless. We should be ashamed. We’re obsessed about the slogans and rituals of “democracy,” distracted by the campaign, polls, debates, rhetoric, half-truths and outright lies. McCain? Obama? Sorry to pop your bubble folks, but it no longer matters who’s president.

Why? The real “game changer” already happened. Democracy has been replaced by Wall Street’s new “disaster capitalism.” That’s the big game-changer historians will remember about 2008, masterminded by Wall Street’s ultimate “Trojan Horse,” Hank Paulson. Imagine: Greed, arrogance and incompetence create a massive bubble, cost trillions, and still Wall Street comes out smelling like roses, richer and more powerful!

Yes, we’re idiots: While distracted by the “illusion of democracy” in the endless campaign, Congress surrendered the powers we entrusted to it with very little fight. Congress simply handed over voting power and the keys to trillions in the Treasury to Wall Street’s new “Disaster Capitalists” who now control “democracy.”

Why did this happen? We’re in denial, clueless wimps, that’s why. We let it happen. In one generation America has been transformed from a democracy into a strange new form of government, “Disaster Capitalism.” Here’s how it happened:

*Three decades of influence peddling in Washington has built an army of 42,000 special-interest lobbyists representing corporations and the wealthy. Today these lobbyists manipulate America’s 537 elected officials with massive campaign contributions that fund candidates who vote their agenda.

*This historic buildup accelerated under Reaganomics and went into hyperspeed under Bushonomics, both totally committed to a new disaster capitalism run privately by Wall Street and Corporate America. No-bid contracts in wars and hurricanes. A housing-credit bubble — while secretly planning for a meltdown.

*Finally, the coup de grace: Along came the housing-credit crisis, as planned. Press and public saw a negative, a crisis. Disaster capitalists saw a huge opportunity. Yes, opportunity for big bucks and control of America. Millions of homeowners and marginal banks suffered huge losses. Taxpayers stuck with trillions in debt. But giant banks emerge intact, stronger, with virtual control over government and the power to use taxpayers’ funds. They’re laughing at us idiots!

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Buy American. I Am.

October 17, 2008

By WARREN E. BUFFETT
Omaha

The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So … I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

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A short history of modern finance

October 16, 2008

Link by link
Oct 16th 2008
From The Economist print edition

The crash has been blamed on cheap money, Asian savings and greedy bankers. For many people, deregulation is the prime suspect.

THE autumn of 2008 marks the end of an era. After a generation of standing ever further back from the business of finance, governments have been forced to step in to rescue banking systems and the markets. In America, the bulwark of free enterprise, and in Britain, the pioneer of privatisation, financial firms have had to accept rescue and part-ownership by the state. As well as partial nationalisation, the price will doubtless be stricter regulation of the financial industry. To invert Karl Marx, investment bankers may have nothing to gain but their chains.

The idea that the markets have ever been completely unregulated is a myth: just ask any firm that has to deal with the Securities and Exchange Commission (SEC) in America or its British equivalent, the Financial Services Authority (FSA). And cheap money and Asian savings also played a starring role in the credit boom. But the intellectual tide of the past 30 years has unquestionably been in favour of the primacy of markets and against regulation. Why was that so?

Each step on the long deregulatory road seemed wise at the time and was usually the answer to some flaw in the system. The Anglo-Saxon economies may have led the way but continental Europe and Japan eventually followed (after a lot of grumbling) in their path.

It all began with floating currencies. In 1971 Richard Nixon sought to solve the mounting crisis of a large trade deficit and a costly war in Vietnam by suspending the dollar’s convertibility into gold. In effect, that put an end to the Bretton Woods system of fixed exchange rates which had been created at the end of the second world war. Under Bretton Woods, capital could not flow freely from one country to another because of exchange controls. As one example, Britons heading abroad on their annual holidays in the late 1960s could take just £50 (then $120) with them. Investing abroad was expensive, so pension funds kept their money at home.

Once currencies could float, the world changed. Companies with costs in one currency and revenues in another needed to hedge exchange-rate risk. In 1972 a former lawyer named Leo Melamed was clever enough to see a business in this and launched currency futures on the Chicago Mercantile Exchange. Futures in commodities had existed for more than a century, enabling farmers to insure themselves against lower crop prices. But Mr Melamed saw that financial futures would one day be far larger than the commodities market. Today’s complex derivatives are direct descendants of those early currency trades.

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Bailout becomes buy-in as feds move into banking

October 14, 2008

Tuesday October 14, 9:43 pm ET
By Jeannine Aversa, AP Economics Writer

Government moves into banking — to the tune of $250 billion — as the bailout becomes a buy-in

WASHINGTON (AP) — Big banks started falling in line Tuesday behind a rejiggered bailout plan that will have the government forking over as much as $250 billion in exchange for partial ownership — putting the world’s bastion of capitalism and free markets squarely in the banking business.

Some early signs were hopeful for the latest in a flurry of radical efforts to save the nation’s financial system: Credit was a bit easier to come by. And stocks were down but not alarmingly so after Monday’s stratospheric leap.

The new plan, President Bush declared, is “not intended to take over the free market but to preserve it.”

It’s all about cash and confidence and convincing banks to lend money more freely again. Those are all critical ingredients to getting financial markets to function more normally and reviving the economy.

The big question: Will it work?

There was a mix of hope and skepticism on that front. Unprecedented steps recently taken — including hefty interest rate reductions by the Federal Reserve and other major central banks in a coordinated assault just last week — have failed to break through the credit clog and the panicky mind-set gripping investors on Wall Street and around the globe.

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We’re sure scared now…bringing it all together

October 14, 2008

A historic level of fear, even panic, has developed as forced liquidation is removing some players from the market completely. Another difficult lesson in leverage and risk management for some really bright folks. Brings to mind one of my favorite quotes, compliments of John Maynard Keynes, “The market can stay irrational longer than you can stay solvent”.

Irrational may be a mild description for what we’re seeing in the markets currently.  After a 1,000 point range on Friday from top to bottom, the Dow Jones Industrial Average added almost another 1,000 points Monday.  Clearly the selling was overdone on the downside and the market was drastically oversold after a 3,000 point decline from top to bottom in the previous eight trading sessions.  Thankfully, those nasty shorts decided to take some profits and get the rebound started Friday morning.

We wouldn’t consider this the all clear signal however.  Historically, a retest of the lows develops within a few months to verify the strength of the bottom.  Hitting the exact lows again is not a necessity, but a second significant down move usually at least comes close.  This offers a great time to pick up relative strength leaders as they separate from the pack.

The correlation noted in Here we are again? 2001 vs. 2008, Is it really 2001 again? and Back to the future again and it’s not pretty has finally culminated in the fear based washout we have been looking for.  Admittedly, it was at much lower levels than we expected, but the timing was almost perfect.  The rebound in 2001 started on the morning of Friday, September 21 at 944.75 on the Standard & Poor’s 500 (SPX).  The rally continued on Monday and Tuesday of the next week, covering a respectable 75.54 points or 8% from the lows.  Another 20 points were added by the close of the week after a brief rest on Wednesday and Thursday. By the end of the following week, another 30 points had been added (for a total of 126.63 points or 13.4%, from the lows).  Two weeks later, the net gain was flat after a brief run over 1,107.  Sideways trading then developed until a clear break over 1,100 in the first week of November.  Around Thanksgiving, the new high of 1,163 had brought the market back from the lows by over 23%.  The rest of the year saw a peak gain of only 10 more points in the first week of December.  A final 3.5 points was all that was left for the first week of the new year, as an intermediate top at 1,176.97 was found.  That top was tested again in late March of 2002, after a 100 point (8.7%) drop into late February.  That was all she wrote for that bounce however, as the SPX found new lows at 768 in October, finally the low for the entire bear market.  Patient buyers were rewarded as the final retest of the lows completed a massive head and shoulders bottom in March of 2003 at 789.

In 2008, the rebound started on the morning of Friday, October 10 at 839.80 on the SPX, almost three weeks behind schedule.  So far, the monster rally of Monday, October 13 has added 167.13 points or 19.9% from the lows.  A morning look at the futures market suggests another 20 or so points may be in the works for Tuesday.  In just three trading days, this bounce has covered almost the entire distance of the rebound in 2001-02, on a percentage basis.  The preceding decline was also much more violent as the SPX dropped from 1,300 to the lows at 839.80 (35.4%) in just six weeks.  In 2001, the fall drop was 28.2% over 16 weeks.

What Does it All Mean

If history holds, only a small portion of this bounce is behind us and there will be plenty of opportunities to get in at decent prices.  The first leg of this rally is past, but the second leg could be just as profitable.  At the very least, consolidation will develop following these monster gains.  This will give nimble traders the ability to buy the dips.  Long term investors are almost guaranteed to get another chance at prices near the lows in the coming months.  The key is to watch overhead resistance, and there is a ton of it.  Fibonacci retracements, moving averages and previous lows all will take their bite from the rally.  Don’t forget The Significance of the 400 day (80 week) moving average indicates we are still in a bear market.  No other long term indicators have given buy signals either.

One more market comparison to consider is the crash of 1987 which found its low on Tuesday, October 20.  This price action may actually be more appropriate considering the violence of the decline.  This October “crash” market dropped 35.9% in 8 weeks, bounced 19.8% in two days, then dropped back to within a few percentage points of the low in early December.  The market then totally recovered within two years.


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