This is Thanksgiving week so let’s try to keep things positive here. However, let’s also try to be realistic and face up to a few uncomfortable facts. For example, we can state with certainty that at some point the stock market will stop “plummeting.” On the other hand, once that happens, the market may only be upgraded to “declining steadily” for a period of up to several years. Or perhaps we’ll get really lucky and the market will chop in a large trading range rather than decline over that time.
While that might not be quite as “cheerful” as some might like, the fact remains that since the bottom in August of 1982, an entire generation of investors has come to believe that the stock market “always goes up,” or at the very least that it “always comes back.” However, as I pointed out a couple of weeks ago, the stock market topped out in 1929 and did not make a new all-time high until 1954. Between 1966 and 1982, the Dow gained no ground. And in the past decade the market has lost about 12%.
So the uncomfortable fact appears to be that the time has come for most individuals to disabuse themselves of the notion that they can just put their money into any old mutual fund and wait for the profits to accumulate by the time retirement rolls around. While this may not be what you wanted to hear, once you open up your mind to that reality you also open yourself up to a whole host of opportunities that you may never have considered and which can still lead you to the investment success you are hoping for. It just won’t necessarily be as simple as watching the Dow march higher year in and year out.
On the negative side, it is obviously quite possible to make a pretty gloomy forecast for the economy of the world going forward. Still, it is important to remember that the great values and investments of tomorrow are forming today. When one peruses the devastation out there it is hard not to come away thinking that there must be some great values out there. The only real problem now is determining “how cheap is cheap” and mustering up the gumption to try to take advantage of the opportunities available.
The purpose of this column as always is not to give investment advice. The primary purpose is to help you look at things in a useful light and perhaps thereby figure a few things out on your own. Basically, the way most people look at the market today depends on whether or not they are fully invested. If you are not fully invested you may see the current environment as offering opportunity. If you are fully invested you may be seeing the curent environment as Armageddon.
So here are a few random thoughts that might help.
If you ARE NOT presently fully invested:
If you have some cash sitting on the sidelines, let me first say “congratulations!” Because cash is most certainly king at the moment. If you have cash to invest, there are two primary temptations to beware of:
1) The desire to get back in too soon,
2) The temptation to wait too long.
It is normal, and prudent, to want to wait to see some sign of the market “bottoming out” before taking the plunge. Nevertheless, bear market rallies have a way of taking off out of nowhere and leaving would-be participants in the dust. So one approach that might make sense is to peruse the market for things that look like they are reasonably valued and then “nibble.” In other words, consider putting a certain portion of your cash into investments that seem to have overshot on the downside.
Let’s talk about a few possibilities. First and foremost is:
The Financial Sector
Quick, cue the shower scene music from “Psycho!” Now on one hand there is no question in my own mind that a sharp rally off of an oversold low is in the offing for financial stocks. So anyone who is comfortable trading and/or speculating should keep a very close eye open for this possibility. Nevertheless, the vast amount of uncertainty and unanswered questions swirling around the financial industry (like for instance, “will any of them still be in business or not operated by the government a couple of months from now?”) means you need to take one of two approaches in this sector.
You need to either:
- Take the plunge with a reasonable portion of your capital and resolve to hold on tightly until the value is finally recognized once the panic is over, or;
- Prepare to trade in and out with an especially keen eye on risk management.
Chart 1 - Financial Sector ETF (Ticker: XLF)
If you decide to get into the financial sector and choose one of these courses of action, the most important piece of advice I can give you is this: The one thing you must guard against is changing from A to B, or vice versa, midstream. In other words if you buy a basket of financial stocks to hold for the long haul, don’t suddenly decide to start trading in and out. Likewise, if you decide to actively trade in this sector, do not decide down the road (mostly likely after you find yourself sitting with a loss) that all of a sudden you are just going to “ride ‘em.” Choose your strategy, determine your buy criteria and profit-taking criteria, and decide when you will cut a loss if need be. Then stick to the plan.
Junk Bonds
Recessions (not to mention Depressions) are a bad thing for the corporate bond market because they greatly increase the likelihood of bond defaults. This is especially true among the lower rated credits like companies that issue junk bonds. But, did you know that junk bonds presently offer a yield of about 20%?! Sounds amazing, yet the first instinct for most is the “if it sounds to good to be true, it probably is” instinct. Clearly the market is suggesting tough times ahead in the corporate world. Still, one also can’t help but to wonder how much of the apparent looming disaster is already priced into the market.
The investment world has pretty much flushed junk bonds down the drain in recent months on the assumption of the worst case scenario. Among the arcane world of closed-end funds there are presently several dozen “high income” funds with trading at discounts to net asset value of at least 30% or more and sporting current yields in excess of 18%. You would clearly need to do some research before buying these funds to determine just exactly how junky the junk is that they are holding. Nevertheless, buying an 18% yield at 70 cents on the dollar? In the immortal words of whoever said it first, “I’ve seen woyse.”
The fundamentals for junk bonds – which are essentially a play on the overall economy – are extremely weak. With most forecasts for 2009 at their most dire levels and with yields in the “it seems to good to be true” area, the junk bond market looks like a sucker's play at the moment. Nevertheless, an aggressive investor with a willingness to put a small portion of capital to work might well look back on this as a great buying opportunity.
Chart 2 - iShares High Yield ETF (HYG)
Commodities
As has been well documented, speculative buying of commodities – primarily by commodity index funds – propelled commodity prices higher sharply higher between early 2007 and mid-2008. Like all buying manias, when this one ended the results were not pretty. As a result, many commodities are now back below where they were when the 2007-2008 rally began. Here too one has to wonder if the world has suddenly stopped using commodities or if perhaps things have been overdone on the downside. Picking the exact bottom in crude oil, or silver or steel or corn, etc. is pretty much impossible. Likewise, as with junk bonds, commodity prices are often (but not always) a proxy on world economic growth. Given the weakening worldwide economic fundamentals it seems safe to assume that commodity prices will not be revisiting their 2008 highs anytime. Nevertheless, investors and traders should at least be looking for oversold opportunities among any number of commodities and can use exchange-traded funds rather than commodity futures in order to establish a position once they are comfortable that the present sell off has abated.
Chart 3 - iShares Commodity Index ETF (GSG)
Gold Stocks
I’ve been eyeballing gold stocks for a while now. The K-Ratio (the price of Barron’s Gold mining Index divided by the price of gold bullion) recently reached a new all-time low, strongly suggesting that gold stock should rally (if they could ever stop going down). After the close on 11/14, a model developed by Nelson Freeburg of Formula Research based on the K-Ratio gave a buy signal. On Monday 11/17, the ProFunds leveraged gold stock fund closed at 11.18. By the close on Monday 11/24 PMPIX was up to 15.37. This represents a gain of 37% in just one week’s time. This clearly illustrates the potential for finding great opportunities among the ruins of today’s financial markets.
Chart 4 - ProFunds Ultra Precious Metals (PMPIX)
If you ARE fully invested at the present time:
My sympathies. It is a painful shock to the system when, after a long period of watching your money more or less grow on a fairly steady basis (as most investors have done over the past quarter century), you suddenly watch a sizeable chunk of your net worth vanish in a very short period of time. My frank advice: get over it and start making plans for what to do from here.
What most people “want” to do is to hold tight and simply ride the “next up wave” back to where they once were. And perhaps that may come to pass. But more than likely individuals are going to have to adjust to the “new reality” and accept the fact that things may not be like they have been since 1982 for a long, long time to come. To wit, please see Charts 5 and 6. These slides are from Ian McAvity, the very insightful editor of “Deliberations: The Ian McAvity Newsletter.” Ian has been in the markets for over 40 years and definitely has developed the ability to see the “forest for the trees.”
Anyway, the first shows the action of the S&P 500 since 1900. Please note the rectangular boxes indicating multiple-year periods where the market essentially went nowhere.
Chart 5 - S&P 1900 to Present; Note long consolidations (Source: Ian McAvity)
The second chart overlays the market performance of the past decade with the 1929 into 1942 performance. You can see the similarities. If this proves to be an accurate guide then there are two key things to note. First, a strong bear market rally may be in the offing in the not too distant future. Secondly, if the current market follows suit then this bear market may not conclude until December of 2012. Not what most people want to hear.
Chart 6 - Present market and 1929 to 1942 market (Source: Ian McAvity)
The upshot is that if you are fully invested now you might consider using the next major rally as an opportunity to lighten up and rethink your overall investment strategy. Because as far as I can tell, buy and hold “ain’t where it's at.” More so than at any time in most of our lifetimes, now is the time to think about taking control of your own financial future.
For the future (like a rising stock market) is promised to no one.
Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site
