After a major market pullback the natural reaction might be to just hang in their for the follow up rally, but not so fast. Market bottoms are a process not a point in time. What I mean is that we may have made a bottom in equities on Monday but the odds are very high that we’re going to have a period of at least a few months to finally exhaust all the sellers. Markets will likely be whipped around like a puppy’s chew toy and I’d rather keep volatility to a minimum.
In the meantime scenes we’re likely to see:
Failure of a major European bank – Its not like they’re going to give a heads up notice. When you start banning short selling you know you’re in a losing battle.
2012 US earnings estimates: They haven’t budged at all. They stand now at $111 for 2012. Despite a plethora of weak economic stats the numbers haven’t moved down at all. They must come down to reality before they can be trusted. The downward revision process will likely be painful if you’re heavily invested in equities.
Commencement of QE3: So far the QE process has been a complete bust. But thats about the only arrow the Fed has in its quiver to aid the economy and its a loser……unless you own precious metals and then its manna from heaven.
While risk at the moment may not be very large, the prospects for Intermediate term gains in equities isn’t rosy either. This is not the time to be excessively bullish or bearish for equities. In the meantime we have lots of cash on hand and in many accounts the long equities are balanced by Gold, Silver, Swiss Franc’s and the SDS.
Gold and Swiss Franc’s still too hot for new money and needs to cool off. Silver is frustrating but could rally.
Long SDS, GLD, SLV, FXF
Stocks are trading down heavily this morning with the Dow currently down 330. Despite this we’re not having a bad day as our hedges remain in parabolic mode with rumors of a potential European bank failure.
GLD a new all time high of $174 corresponding to $1800 Gold. Laggard hedge SLV trading higher up $1.65 to $38 and the Swiss Franc ETF FXF trading dow $1.21 to $135 after hitting $140 yesterday.
We remain steadfast in holding a great deal of cash as I used yesterday’s bounce to trim more equity holdings. I have yet to deploy cash in any meaningful way towards equities, the timing just isn’t right yet.
If we had seen a strong opening in the US I likely would have added Inverse Exchanged Traded Funds “SDS”, but the weak opening does not make that a smart trade. Hence a better opportunity to play the downside will present itself eventually.
Market bottoms tend to be a process, not a specific point in time. Stocks will fall to a meaningful low then stage a significant bounce that could recapture 30% or 40% of the decline before selling off once more to retest the previous low. This process can repeat itself several times, in successful bottoming action each selloff has less and less intensity.
Buying the retest is a much better option than trying to be the hero and pick the bottom. Early rallies fail almost every time and its devastating to the psyche to think you may have bought the low only to find that a month or two later you’re right back where you started. In 2008 the climactic low was in November but the best investable low came months later in March 2009.
Long GLD, SLV and FXF
In my opinion, the downgrade was both well deserved and telegraphed far enough in advance that the actual downgrade can hardly be a shock. It took a great deal of cajones from S&P to pull the trigger on the rating but they had the courage where other ratings services were blind or cowards.
Is there a silver lining, that this could finally be the wake up call to Congress to disregard politics and do whats best for the country? I would hope so but I’m not that optimistic. In my opinion, for across the aisle cooperation to occur the Tea Party would have to dilute their flawed dogmatic view on tax income which would allow Boehner greater flexibility in negotiations.
In the meantime: Equity markets are extremely stretched on the downside. According to Sentiment Trader.com the only two similar examples are the market crash of 1987 and the German invasion of France in 1940. 30 days later the S&P 500 was up 8.4% and 9.1%.
Our Gold, Silver and Swiss Franc hedges: They have worked remarkably well and while I still believe they’ll continue to work well longer term, the market for these commodities is too hot to handle right now. But I’m not a seller. The Swiss government has been stating their currency is wildly overvalued, but in turn it likely represents the most solid balance sheet currency. Considering the plight of the Dollar and Euro I don’t see any reason to reduce our SF holding.
This morning JP Morgan estimated gold could reach $2500 by year end, we’re at roughly $1700. This bulletin has the air of a buying panic which may indicate an intermediate term top. Should the S&P rally as previously stretched markets are capable of, our hedges will be a source of funds and likely decline. Keep in mind they have been in bull mode for several years and are likely to remain so, hence any pullback is an opportunity to add to holdings.
This is not the end of the world, this is not even 2008. Very soon we will likely make a volatile market bottom that will market the low water mark for equities. I don’t intend to increase equity exposure at this point, regardless of the selloff and the potential for a rebound. I believe the low water market will represent a market bottom that will be retested at least one more time, possibly more. Hence, the rebound which will likely be dramatic will be viewed as a chance to reposition our equity holdings into strong growth companies from cyclical stocks and add further hedges.
Long GLD, SLV, FXF