Double Journey

The market probably reached its top last week and I expect the correction I’ve been predicting the last few weeks to finally happen now.  If I’m wrong on this one, and I’ve been wrong lately, the market rally will happen without me.  I have a lot of money sitting on the sidelines, but there is just no way I can put money into a market that has run 50+% in the last few months.  The market could continue to rally from here.  Heck it could go 20% up more from here no problem.  But if it does, it does so without me and I will have missed out on one of the best market opportunities of my lifetime.

Market went down today by over 2%.  While this is not the first big pull back for the market since this insane run up, it is starting to feel like we have hit a top in the market and we now are going to test some technical levels below.

I have slowly gotten out of some of my short positions but stayed in them for the most part waiting for this turn.  I got a little bit more short today, but overall I still lost a lot of money as I’m a little heavy weight in some commodity names and in China, two things that did not do well at all.  I wanted to get a little bit more short in a few sectors but ran into a small snag when Etrade would not let me short some ETFs.  Seems as if it is difficult to borrow some of these, probably because there are still lots of people short this market.

I checked the levels on all my accounts and much to my surprise, I have a lot more cash on the sidelines than I realized.  Most of this is due to the fact that I’ve not been doing very much buying in the last few months and I’ve been earning money in my day job in the meantime.  I’m looking to buy something if the correction I predict actually happens but to be perfectly honest, I’m really not attracted to anything unless we get a very serious correction, a correction back down to the March lows.  I just can not get very bullish about where we are as a country.  Yes, we may have averted disaster in the short term.  But does anyone really think that all that borrowing our government did is actually going to turn out well?  How did that work out for all those people who took out those home equity loans?

The market had a small sell off today.  Nothing to get too worked up about but perhaps the start of something bigger.

But as this market tries to find its equilibrium point, it got me thinking.  Are we just going to keep cycling through bubbles?  And if so, how badly is it going to end?  If we do indeed keep putting off our problems, like all financial mistakes it will just be that much worse when the bill comes due.

Right now, the market has rallied about 50% from its lows.  This run-up is in a matter of months.   Does that actually sound normal to anybody?  The market has gone up this much because the government is pumping out cash like there is no tomorrow.  This has already had some effect that should cause people’s eyebrows to rise.  The rally has been very broad based.  And I emphasize the broad part.  Some of the worse stocks are doing OK.  Stocks of companies that should not exist have actually gone up with the rest of the market. When junk is doing well, you know you have a bubble on your hands.

Just look at the other bubbles that we have had in the last decade.  The valuation of some of the dot coms were just ridiculous.  Billions in “value” for companies with no revenue.  The housing bubble was probably worse.  Run down shacks were selling for small fortunes in parts of the country.

Bubbles take longer to form than just a few months, but maybe this one actually has formed faster because we have had the others one that preceded this one.  Maybe we aren’t even in a bubble and I’m making too much of this.  But I just don’t see how we can have possibly gone up this much this fast.  The future does not look bright from here.  Granted, expectations were so low as to be ridiculous before but anyone who thinks that we are going to just bounce off the bottom is just not looking around.  There really is not much of an economic recovery happening.  People are still losing jobs and companies are still pulling back.  Is this really news to get excited over?

Today, I cut my short positions.  This just felt like the wrong thing to do here with the market continuing to rally.  I do expect a pullback relatively soon but I have left the money in these shorts far longer than I wanted to.  I tried to stay disciplined and say I would get out of the short position when I lost 10%, and I didn’t do that.  The trade kept falling behind and I kept waiting for the turn that never happened.  Rather than continue to lose money, even though I think the market will turn soon, I got out of the trade and cut my losses.

I still have smaller positions in this trade, but it is past the point where I think I can reasonably make more money than I already lost.  Had to do it.  There comes a point where you have to admit you were wrong and just move on.  I don’t think the market takes off from here, but I’m also not so sure we can come back down to retest the lows.  If you have shorts on at this point, just get out of the way of this market.  I know with my luck, this will exactly mark the turn, but I just could not continue to fight the market.

I made a bet several weeks ago against the real estate sector.  Specifically, I made a bet that we would see continued weakness in the Commercial real estate market.  I made this bet because I just looked around my neighborhood and the ones I drive by and I notice numerous empty store fronts without any real chance of all of them being occupied.  I actually did not realize how bad it is in certain areas of Southern California since my neighborhood is somewhat insulated from steep residential declines.  But if you go into areas where house prices have fallen more, and thus affected consumer spending more, you see a lot more empty buildings.  This is going to continue to be a drag on the economy and more importantly on the balance sheet of the those who own commercial real estate.

But right now, the market is just too good.  Everything is going up and it is a bad time to be short anything.  While my portfolio is up over the last several weeks, it would be even stronger if I wasn’t short here and short against the Dow Jones.  This does not really bother me since when the market looked weaker, I probably would not have gotten into some of my better positions if I did not short something against them.  So net, I have made more money than I have lost.

Is it time to take profits on that position.  If they were short term plays, absolutely.  The market rally is now right around the level where greed and fear is taking over.  There is no more reason to bid this market up yet it keeps going up.  Yes, the world is not falling apart.  But if you think a recovery is right around the corner, just take a peek there.  You will notice that the next street over looks pretty bare.

Surprisingly, the market was unchanged on Friday despite major misses by Microsoft and Amazon.  With the market showing some resiliency despite disappointing earnings from these bell-weather stocks, one has to believe that the market is indeed up from here.

But it quite honestly does not make any sense.  We are not in for any type of recovery any time soon.  I think a lot of people are looking at the housing bubble popping like the tech bubble popping.  People believe that recovery is just around the corner and that companies’ earnings will follow.  I just really don’t see that happening.

One just has to look deeper into the numbers to see what is happening.  Most companies are beating expectations because of the bottom line, not the top line.  That is, their revenues are not that strong.  They manage to meet earnings because they have controlled their costs effectively.  This should be a good sign because it will allow companies to use operating leverage if the economy recovers.  Sales will grow faster than the cost structure meaning that companies will be very profitable on their way out.

But this assumes the economy is going to recover soon.  Look at what happened last time.  We came out of the problems we had by creating another asset bubble.  Housing.  By keeping interest rates low and allowing questionable lending practices, the government was  able to paper over the previous problems with brand new problems.  Of course, it took a few years to play out but like all deferred problems, the new ones were much much worse.  Further, the jobs that disappeared with the tech bust never really came back, they just reallocated.  We had a “jobless” recovery last time.  Many of the high paying tech jobs never came back.  Some were replaced by good paying real estate jobs but by all accounts more good jobs were lost than were made.

That is not going to happen here.  I just do not see us able to paper over the problems that we have now created.  They are too big.  The housing bubble will not be re-inflated so what will take its place?  Health care? Another tech bubble?  I honestly don’t see anything even remotely resembling a recovery back to where we were. Companies are being very cautious when it comes to raising their cost.  For most companies, the biggest single cost is headcount and most will not be willing to increase this anytime soon.  Flat is the new up and I think more than a few companies will be willing to forgo higher revenues for a more predictable and low cost structure.

So we will see a long period of cautious companies.  Risk taking will be dampened.  This will mean that we will have an extended period of high unemployment.  This should have the effect of keeping any sort of earnings growth muted because most companies have cut to the bone at this point and will not see any more gains achieved from there.

How much more can it go from here?  Like all other market movements, I have no idea.  The market can stay stupid far longer than anyone can anticipate.

I was going through my computer the other day and found a spreadsheet I created almost exactly two years ago.  The spreadsheet contained the amount I held in various accounts at the time.  It was interesting to look back at how much I had and compare it to what I go today.

To give it a little bit of context, I’m going to compare it to the overall stock market.  It would be helpful if I could also throw in what has happened in housing since housing represents the vast majority of people’s net worth in this country.  But housing is very hard to make a comparison to get a raw number from in terms of what it has done over the last two years.  It has for certain dropped, but still not as easy as just looking at a stock graph.  Using the S&P 500 as a benchmark I would say that it could be expected that most people would probably have less wealth than they would have two years ago.  The S&P 500 is down about 39% since June of 2007.  This even with the recent rally in the market.

Compared to this, I’ve done quite well. I am up  about 18% over that period of time.  Now before you think I’m some sort of stock guru, it is important to understand how I came by this number.

Net worth is the total cumulative value of all ones assets minus any liabilities.  My assets include more than just my stock portfolio.  It also includes the cash I have in the bank.  My net worth can, and does, grow in ways other than stock market gains.  For the most part, since income from this site is quite small, my net worth grows because I have a job and it pays me.   This is why I’ve been able to do as well as I have.

In looking at my net worth, my stock accounts have done as poorly as the market, worse in some cases.  My Roth, which has had no contributions from myself in the last two years, is down 40%. My other retirement account, my 401k, is down about 4%.  But keep in mind, I’ve contributed a lot of money into it over the past two years, so this stat is very misleading. If I took out my own contributions over the last two years I still handily beat the market down only 20%.  Most of that was because I have had the foresight to be in cash for a long time.  More on that in a second.

But even given this, I’ve done quite well.  How is this possible.  Same way I got the money in the first place.  I’m a very, very good saver.  Keep in mind, my savings two years ago was quite substantial.  Despite the ugly markets, I’ve been able to grow a rather large nest egg even larger by good old fashioned saving.  The cash I have on hand is quite large now.  This is partially why I have done so well why the market is bad.  I have been mostly in cash for the last several years.  It was one of those things that did not look so smart up until 2007.  In fact, it looked downright stupid as the market rallied.  But I stuck to my belief that the market was way overpriced.  I just could not understand how housing could have the run it had without a correction very very soon.  Lucky for me, it came .

So overall, I’m doing quite well over the past two years.  I actually used the chart to map out how soon I could retire given a few assumptions.  I’m a little bit off my target numbers for my current age but I’m in really great position given what the market has give us over the last two years.   However, I’m not so optimistic I can reach my original goals since much of what I calculated assumed average market returns over the next twenty years.  Honestly, I don’t think that is going to happen.  I really think we are going to be in a very long economic downturn which will squash any sustained market rally.  Kind of gloomy huh?

Yay!  The Market is up 3% today!  Let’s celebrate.

On second thought, let’s not.  I’ve said it many times but it is worth repeating.  It is not a good thing when markets move this far in any direction this fast.  It means there is panic and fear on the street.  Panic and fear on the street mean there is going to be tremendous volatility.  So as nice as it is to see a 3% gain today, we could just as easily see a 5% loss tomorrow.  Now, I don’t think that is going to happen here.  I think the market is probably on a short term upswing.  Earnings season is underway and most of the people who have reported, and this is admittedly a very small sample size, have reported better than expected numbers.  If this continues, we could easily see the market rally.

On the other hand, if a few of the numbers come in soft, look out below!  I don’t think this is going to happen, but the danger is definitely there.  Now, I have not made any trades for the last several weeks.  This is partially because of the job and this is partially because I’ve been waiting for the market to do a bigger correction.  This correction has yet to materialize and I’m in no particular hurry to rush in.  Some of my trades like TBT have been particularly weak lately so I may jump back in.  I also really do like my China trade, FXI, which is rallying nicely after taking a small break.  If I make a trade in the next few days I think it is going further long these positions.

I’m not thrilled the market has not pulled back, giving me another opportunity to buy, but these two trades have great long term value in them.  China is doing very well comparatively to the U.S.  Not great mind  you, just better than the U.S. I also really just do not like being in the dollar, which is of course why I want to short U.S. Treasuries.

The market had its second triple-digit-down day.  After a 40% up move, the natural question is if the market is headed down from here.

I’ve been waiting for the market to start a correction for a while now and have thus far been wrong.  So I am hesitant to say that the next moves will be significantly down from here.  I have thought the market ran too far up 10% ago and have been consistently wrong so no reason to listen to me here.  But for me, the market just didn’t make any sense where it had gotten to.  We hid the mid 600’s at the market low and then bounced back up to 950.  If the market had only come back part of that way, say 800, then I would feel much better about the whole thing.  But oh how we soon forget.  Seems everybody is talking about the economic recovery.  Most of that commentary points to the market running up so much in so short of time.

But oh how people forget.  At the end of last year, we ran up from the November lows to a pretty nice “recovery” in December and January.  No sooner did everybody think the market had recovered did we turn around and hit the March lows.  Not sure we will go back to the March lows, but I definitely think we could see the 700’s again and see it very quickly.   If the market opens up lower from here, under 900, I think there is a good chance that this little bear market rally is over and the next leg is down.  That doesn’t mean I think you should short everything in sight.  In fact, you might want to take the time to eye a few stocks and start picking out the things you hvae wanted but didn’t buy the last time we hit the market lows.

The market was down significantly today, almost 2%.  Despite this my portfolio was up about 1%.  Now you might think that is because I am short the market but that would not be the whole story.  I made money yesterday when the market was up by almost 2%.  Now I did not make as much money as the market but I also did not give anything back today.  One of the secrets that Warren Buffet always uses is to not lose money.  In a market like this one, it can be hard to do because of how it is whip-sawing back and forth.

I am achieving this through a very specific strategy.  I am pairs-trading.  This strategy is relatively simple.  You go long of one thing and short of another.  For example.  Say you are bullish on Broadcom.  You would like to buy it but it has had a pretty good run the last three months running up more than 50% in that time period.  To do a pairs trade you can buy Broadcom and go short of a broader index like the Nasdaq or the Semi-conductor index (SMH)  Why would you do this?  You are taking the market risk out of your stock purchase.  Stocks move up and down for any number of reasons.  Only half of a stock’s price has anything to do with the actual company itself.  The other half is related to the broader market and the sector.  You are betting that the thing that you buy will outperform its peers but hedging yourself in case the market does crazy things.

I am short of the Dow, the real estate sector, and U.S. Treasuries while being long China, Materials, and a bunch of individual stocks.  This on a whole has performed quite well.  I’ve lost some money on my short positions since the market has continued to rally, but my long positions have more than carried me up.  Could I have made more money if I wasn’t short?  Sure.  But the hedges have kept me sane by limiting my gains and more importantly limiting my losses.

I continue to use this strategy to great effect.  I think we are about to have another leg lower from here, there is weakness in the market right now and that is pretty evident.  I would like to get more short of the  market but won’t get too crazy right now as I can easily be wrong.