Wednesday, April 28, 2010

Release the Hounds

Some current and former Goldman Sachs (GS) employees have a vexing problem right now - a Senate subcommittee panel. I tuned in yesterday and watched the investment bankers squirm and, for a moment, felt sorry for them, then remembered they are all multi-millionaires and get paid to take the heat. They were pretty cool customers, and I don't blame them. A slip of the lip and they could end up in stir somewhere down the road, especially when the SEC gets their mitts on them. One thing I got out of the grilling was that Goldman Sachs (GS) is probably not the only bank at fault, and there is plenty of blame to go around for other institutions too big to fail. These bankers will surely get cut down to size in other bare-knuckle brawls as the fraud unfolds. I also thought they should have put the senators on trial because the Senate is at fault also for repealing acts like Glass-Steagall and passing legislation that would allow people with no visible means of support to purchase homes.

The market sold off yesterday with a confluence of news in addition to the Goldman Sachs (GS) sideshow. Most notably is the ongoing story that some of the PIIGS (Portugal, Ireland, Italy, Greece, Spain) may default on their bonds. The main focus right now is on Greece, but Portugal may be the next to go causing a cascading of bad debts across Europe. I'd tell you that this will cause the correction I've been looking for, but my short theory has been shot full of holes so far. This market has got it going on, and although the shorts had a good day yesterday, it's been eight straight weeks up for the DOW and doesn't look like it is anywhere near winded. Although the DOW, NASDAQ and S&P 500 have had enormous gains since the lows of March 9th, 2009, it is the Russel 2,000 that has moved the highest on a percentage basis, more than doubling in 14 months, going from the low of 343 to reaching 741 last Friday.

I've got some skin in the game with the Russell 2,000 because I'm invested in the Direxion Small Cap Bear 3X Shares (TZA) which is leverages 300% to the downside of the Russell 2,000. If you have been following this blog, you are well aware my initial investment is down almost half since October of 2009. As foolish as it sounds, I'm still long this ETF because I firmly believe that we are in for more than a correction and the Direxion Small Cap Bear 3X Shares (TZA) will give me tongue wagging returns. This is because small cap stocks have a high beta and when the market goes up, you make a lot of money if you are long and lose a lot if you are short. The converse is true to the downside. When I say that I am long a short position, what I mean is that I am holding that stock or inverse ETF until I feel it is fully valued. Hopefully that will take longer than 12 months to take advantage of long-term capital gains. I lick my chops every time I look at the historical prices of the Direxion Small Cap Bear 3X Shares (TZA). At the market low on March 9th of 2009, the ETF was priced at $113.50. On April 23rd of this year, just a few days ago, it closed at $5.41. If we do get a double dip in the market, I can get close to a ten bagger if the market goes down in small increments.

The reason I need for the market to go down in smaller increments as opposed to crashing like we did in October of 1987 is because the ETF is priced on a daily basis and at roughly $5.50 a share, the Direxion Small Cap Bear 3X Shares (TZA) would only go up 100% to around $11/share if the Russell 2,000 would crater 33% in one day. A grinding correction, like the grinding rise we are currently experiencing, will give you a bigger bang for your buck. It's just plain old arithmetic. In the meantime while I'm waiting for the market to tank, I'll thank the SEC for putting Goldman Sachs (GS) in the spotlight. In the long run, this can't be good for stocks.

Sunday, April 18, 2010

Pandora's Box

It's not quite time to strike up the band if you are short the market, but Friday's SEC charges against Goldman Sachs (GS) for fraud may have put the brakes on the market's rapid rise the last two months, if not last year, especially if you take into consideration the cockroach theory. For those not initiated with the cockroach theory, our friends at Investopedia will give us a quick definition: "A market theory that suggests that when a company reveals bad news to the public, there may be many more related negative events that have yet to be revealed. The term comes from the common belief that seeing one cockroach is usually evidence that there are many more that remain hidden.". Goldman Sachs (GS) is probably not the only bad actor in the drama that has been unfolding since 2008. The SEC may very well have their sights set on other ne're-do-wells in the investment banking community which only causes more distrust and angst on Main Street. Retail investors reluctantly coming back into the market was a big reason the pundits thought the market could ratchet up another leg. That is now a dubious proposition. The genie is out of the bottle.

There is that famous line by Gordon Gekko played by Michael Douglas in the movie Wall Street that goes something like: "If you want a friend, get a dog.". It's too bad we have to stereotype investment bankers this way, but a few bad apples at white shoe firms like Goldman Sachs (GS) have done a lot of damage to the IRA's, 401(K)'s and pension plans of many middle class Americans. No matter how well-heeled these bankers are, they should be held accountable for the damage they've done. Just when the market is going gangbusters and people are recouping their losses, the SEC has a score to settle and this is going to take us back to square one. At least that's how I see it. It may not happen overnight. It may very well take a few more months of treading water, but this market is going down. I don't want to rain on anybody's parade or sound like a Dutch Uncle, I'm just examining the facts and, fundamentally, the market is extremely overvalued. It just needed an excuse to correct and this may be the catalyst I've been looking for.

We all know that Mother Nature can be a cruel mistress, and another wild card here to stop the levitation of the market is the volcano eruption in Iceland. Air travel over most of Europe has come to a standstill - no imports, no exports, at least by airplane for the foreseeable future. That can't be good for business. Our economic relationship with Europe is no shotgun wedding. The short squeeze that took place the last two months that goosed the price of stocks may well be over. The locomotive may very well have jumped the tracks and diverged from the predicted path of DOW 12,000 by early Summer as some pundits have projected. You don't feel like you've been had with the volcanic eruption like you do with the Goldman Sachs (GS) grift, but still, it could very well put the market in give back mode. We'll see what happens this week. There are still a lot of earnings to go through and the market is sound according to the technicians. It is fundamentally where the market is weak such as the high P/E ratio and low dividend yield that I've been writing about.

Friday, April 16, 2010

Down at the Heel

Weekly jobless claims were released yesterday morning and it wasn't a pretty picture. As summarized in the Carnegie Management Group Hotline Report: "Weekly jobless claims rose by 24,000 to 484,000, and higher than the consensus estimate 440,000. The four-week moving average climbed by 7,500 to 457,750. Jobless claims are reverting back to an upward trend. The unemployment rate of 9.7 percent will also revert back upward and back above 10 percent soon.". You need jobs to sustain a recovery because without jobs, people will stop buying things, especially discretionary items. Let's not forget that 70% of GDP is consumer spending. Now, you may be saying to yourself that retail sales were good for March and you'd be right. But don't forget that Easter came early this year and personal savings rates are decreasing at an alarming rate. According to the Bureau of Economic Analysis (a division of the Commerce Department), personal savings decreased from 3.4% in January to 3.1% in February. This is down from 5% in the second quarter of 2009 and 4% of the third and fourth quarters of that same year. People are taking from Peter to pay Paul.

We have a long way to go before we are out of the woods in regards to the employment rate. Check out this piece of information by Daniel Gross from an article entitled "America's Back! The Remarkable Tale of our Economic Turnaround" in the April 19th issue of Newsweek: "To recoup the 8.2 million jobs lost since December 2007, it'll take four years of growth at 170,000 jobs per month. And by definition, it's hard to identify the next transformative economic force - the next steam engine or interstate-highway system.". Granted, we do have growth in the clean energy or green tech sector, but it is more of an evolution than a revolution. The same holds true for mobile Internet technology, whether it be hardware, software, services or the build-out of the infrastructure. The iPad may be a thing of beauty, but it won't be the cause of massive hirings nationwide as some pundits claim. We have an economy that is being propped up by the government and once it exits the picture, there will be nothing to sustain the rebound of the stock market. We just don't have the jobs to support it. It's a sleight of hand, now you see it now you don't illusion that the economy is doing well. As soon as the little guy, or retail investor climbs back into the market to reap big gains, it's going to crash and burn. Those days are almost upon us.

Wednesday, April 14, 2010

Humble Pie

Manning the lifeboats to abandon ship would be ludicrous now, but it is easy to surmise that I was too early to the party. The rally from the March 2009 lows has been mind numbing, and the market gains speaks volumes for the bull camp. However, I believe we are topping despite the good earnings news posted by some companies this first week of earning's season. According to The Helicopter Economics Investing Guide in an April, 13th post: "Yale professor Robert Shiller has just released an updated version of his historical PE chart for the S&P500. The current level, just below 22, is around the long-term market peak in 1966 and is higher than the PE before the 1987 crash. It is well below the 30 level reached in 1929 and the 44 level reached in 2000 though. Investors should assume that the current 22 number understates the actual PE ratio. Changes in accounting rules during the Credit Crisis have made corporate earnings much higher than they would have been, especially for the financials.".

I took the liberty of locating Shiller's chart on the Internet and sure enough, the S&P 500 P/E ratio of 22 is right on the money. If you are interested in viewing the chart along with other charts for the S&P 500, then go to The data is courtesy of Standard and Poor's and Robert Shiller. Another chart they post is that of the S&P 500 Dividend Yield. I talked about the S&P 500 Dividend Yield in my April 2nd blog when Robert Prechter stated on CNBC that the dividend yield was 2.6, one of the lowest ever. Well, according to Shiller, the S&P 500 Dividend Yield is now 1.86, much lower than the 3 it registered on Black Tuesday in 1929 and Black Monday in 1987. The mean for the yield is 4.37% and the median is 4.3%. The lowest it ever registered is 1.11% in August of 2000. This is a bull market run that will end badly if history tells us anything. In fact, I still don't believe that this is a bull market run, but rather a bear market rally.

The facts speak for themselves and although it could be a rough April for the shorts because of year-over-year earnings comparisons, "sell in May and go away" is almost upon us if you adhere to that old Wall Street adage. I saw an interesting report by Bob Pisani on CNBC on Monday where he laid out the stated earnings and the estimated earnings for the S&P 500 from 2008 to 2011. In 2008 and 2009, the earnings for the S&P 500 were $49.51 and $56.86 respectively. In 2010 the estimated earnings for the same index is $78.12 and for 2011 is $93.55. That's a big leap in earnings from 2009 to 2010 - roughly a 30% increase. If we go by the P/E ratio of the S&P 500 using its current value of approximately 1,200, we get a figure of 15.3 if you go by the estimated earnings. That's in the ballpark when considering historical averages, but I don't think we are going to be growing 30% to 35% this year. I've seen some estimates for the S&P 500 for 2010 that are much, much higher than Pisani's figure of $78.12. So we'll have to see what shakes out.

Friday, April 9, 2010

Inside the Doomsday Machine

I thought I'd have something to crow about yesterday. Before the market opened, Christopher Rugaber of the Associated Press reported: "The Labor Department said Thursday that first-time claims increased by 18,000 in the week ending April 3rd, to a seasonally adjusted 460,000. That's worse than economists' estimates of a drop to 435,000, according to a survey by Thomson Reuters.". The market didn't like that news and the futures traded down. I thought I was on easy street for the day, especially when there are new worries that Greece may default on its debt, and if Greece defaults, there will be other sovereign nations to follow. Most specifically in Europe. After dropping down roughly 40 points the first two hours of trading, the market turned around at about noon with the news that the current currency crisis in China may be over.

The market just keeps going up and with earnings season on the horizon, there's no telling how much higher it can go. That's if we get good earnings reports. I'm a believer that the good news is already baked in the cake and we may get another correction as we did in January. For the mean time, I'll just watch the paint dry and not do any trading although it would be easy to cave under pressure. Once this market runs out of steam, all hell will break loose and it may fall faster than it ramped up. I'll just play the cards I've been dealt and stick to my long-term investing style. Being flexible and patient and not giving in to peer pressure are some of the themes covered in Michael Lewis' new book The Big Short: Inside the Doomsday Machine.

If you are not familiar with Lewis, he is probably the king of the jungle in nonfiction writing here in the US of A. Liar's Poker, MoneyBall and The Blind Side are some of his books you may be aware of. He's recently been featured on Bloomberg, CNBC and 60 Minutes touting The Big Short and rightfully so. He's a damned good writer and one of the bestselling ones in the past 20 years. If anybody is going to tell the story of the real-estate implosion, it might as well be Michael Lewis with the track record he has. I'd never read him before and was looking forward to his new book, but came away disappointed. Not because of the writing or the subject matter, but because much of The Big Short has been covered in other books. In essence, Mr. Lewis has been scooped by Gregory Zuckerman in The Greatest Trade Ever which was published back in 2009 and already reviewed on this blog.

Both The Big Short and The Greatest Trade Ever tell the stories of Greg Lippmann and Michael Burry among others, and, both books also give analysis as to how the real estate derivatives were created. I really related to Michael Burry. He shorted the real estate market for two years with his hedge fund Scion Capital and investors bailed on him because he was too early with the trade. Despite those that jumped ship, Burry was vindicated when the market finally turned down and pocketed 100 million dollars for himself. Seven hundred million dollars was made for the remaining investors at Scion, those that showed patience. Of the two chronicles, I liked The Greatest Trade Ever better. It was a more compelling story although you can not go wrong reading either book. They are tales that needed to be told and are probably defining points of the end of the decade. Both books make you angry at the system that Wall Street created with the help of Uncle Sam. If you want to point fingers, read either of these books and you'll know where to direct your angst. Or maybe you won't. It's a very tangled web we've weaved and I think we're not done yet.

Friday, April 2, 2010

The Big Kill

The employment report for March came out this morning while the markets were closed for Good Friday. It's a good thing for me because the futures were up after a gain of roughly 160,000 jobs. If the markets had been open, I would have taken more losses, at least at the opening bell. The unemployment rate is still 9.7%, the same as it was for February. Nothing to write home about, but the bulls have the momentum, and they liked what they saw. It's easy to second guess myself with the checkered returns I've experienced by siding with the doom and gloomers with their bearish scenarios, but they just make sense to me. Nobody is hanging me out to dry. My investments are decisions I've made based on probabilities. At first blush it would appear that I may have made the wrong choices, but my enthusiasm has not been dampened by my short investments. I still believe if I'm patient, the market will turn my way.

For instance, two weeks ago Robert Prechter was interviewed on CNBC and he went into some depth about the dividend yield for the market. If you are not familiar with the dividend yield, here is the definition supplied to us by our friends at Investopedia: "A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock." You can apply the dividend yield to an index in the exact same way you apply it to a security. To calculate this, just divide annual dividends per share by share price. According to Prechter, the dividend yield on the DOW a year ago was 4.7% and it is currently 2.6% - the third lowest reading in 100 years. The two lowest readings were in 2000 and 2007. I know that Prechter is predicting the DOW reaching 500 in the next few years in his book Conquer the Crash. Five hundred sounds a bit far fetched to me, but he gives some fairly sound statistics that we are in for a major correction.

Author Michael Panzner who writes the blog Financial Armageddon recently posted an article about the rate of change for the DOW. Now with a name like Financial Armageddon you know he's not a bull and has a bias to the dark side, but in the last two years, he's written a couple of good books When Giants Fail and Financial Armageddon. He's got some credibility. According to his recent article: "Based on data going back 90 years, whenever the 12-month rate of change in the Dow Jones Industrial Average has exceeded 40 percent, it has generally signaled trouble ahead. In three cases, a 12-month rate of change above that level has only marked a short-term pause, after which the market traded higher. But on 11 other occasions, similarly rapid advances have been followed by notable corrections, including the collapses that followed the 1929 and dot-com era peaks, as well as the 1987 crash.". According to Panzner right now the rate of change on the DOW is hovering above 40%. To me, the probabilities are in my favor of a correction coming soon, and if the market keeps climbing higher, it just means it will have further to fall.

Now what happens if we don't get the correction? Well, I'll be out a few bucks. However, the market cannot defy logic forever. If I were long, I'd get out while the getting is good. I'll stick with my modus operandi and wait for those jaw dropping valuations on stocks and reap big rewards. At least that's the plan for now. Nothing ventured, nothing gained.