Well that was an easy one to call!
We expected a 50% retrace but not all in one session – this market is just like a regular market only time compressed so all the technical moves happen almost instantly. Literally retracements that used to take weeks to resolve are daily and sometimes intra-day events. We are still obeying the S&P priced in Euros 50 dma and that very much makes it look like we do have another bottom test (10% down) in our future.
Fundamentally, we have a situation in which the banks have had $2Tn in losses and the government has said: "Here's $8Tn – see if that helps and, if not, we've got another $8Tn for you." How can we trade lower and lower, completely ignoring the FACT of the new money coming into the system? Today the automakers get their bailout and it's easy to imagine that yesterday's frenzied sell-off was a warning to Congress from the true powers that be that they'd better be writing a big, fat check no matter how stupid the Big 3's plan is.
This market is being driven by fear, not logic. I heard there was a poll in which 40% of New Yorkers are worried they will lose their job and 80% have cut spending accordingly. At the height of the Great Depression, 25% of the people were out of work so it is very, very, VERY, likely that 1/2 the people who are worried about their jobs actually have nothing to worry about – even if the economy gets much, much worse.
There are many analysts saying corporate profits will be down 30% in 2009 but corporate valuations are down 50% and you don't value a company year to year – you value it over a 3 to 5-year outlook at least. This is another example of the market on speed (or crack), ANY slip in performance in any quarter leads to an extrapolation of the worst-case as if the downturn will go on forever. So BA has a 3 month strike and is priced like they will never make a plane again, Builders are priced like the last new home in America was built in 2007, Title Inurance companies are priced as if the last mortgage in America was written in the spring and the entire XLF is priced as if the concept of banking is dead and we will be getting through the next decade without any borrowing.
Still, tempting though it may be to grab the XLF naked and just take a 3-year cruise (they do pay a 5% dividend – assuming you believe they will keep up), as I said in the morning post, there is no bottom to the people who hold a pessimistic outlook. You can draw up a perfectly reasonable case for how this crisis will snowball and cost many Trillions of additional dollars – even all the money in the world, as Roubini and Whitney are speculating. If that's the case, as we often joke, then the only sensible things to buy are Bullets, Beans and Bullion because it is literally the end of the world as we know it. We do have gold as a hedge already and we are hedged to the downside but I simply don't believe things will go that far.
If the world doesn't implode, if we are not back to living in caves by the second decade of the 21st century – then we'd better own a few stocks don't you think? We discussed the aftermath of the Great Depression in the weekend wrap-up of the 21st and the two charts at the bottom say it all. Life will go on, some companies (even if you are a major pessimist) will survive and some of those will actually thrive (TSN is looking good now that PPC is BK) and shame on you if you ever kicked yourself for not buying Chrysler at $2 iin the 80s yet you stand here now and ignore Ford at the same price. And I'm not saying buy the autos but BA for $39.88, AXP for $19.64, INTC for $12.50, MSFT for $18.65 (who is going to fund a rival to take them out in the foreseeable future now?), TXN at $14.15, M at $6.41, CEG at $23 (Berkshire has an offer in at $26.50 and CEG pays a 7.8% dividend with a forward p/e below 5 anyway), TIE at $7.28, X at $25.40, GLW at 8.45, IR at $14.50, TXT $13.90, TEX $11.71, DE $30.40, CMI $22.50, CI $11.16, UNH $20.12, PFE $15.28, GNW $1.15, GE $15.50, NYX $19.79, VLO $16.23, BTU $19.55, KO $44.33, PEP $53.65, NKE $48, AVP $19.78, HAR $13.25, CBS $5.83, GCI $8.18, HOG $14.71, GOOG $265, AAPL $89, BBY $19, WMT $53…
All of these companies are industry leaders, brand names we will remember the way our grandparents remembered American Can, Nash Motors, Victor Talking Machines and Wright Aeronautical – which didn't survive the depression but they also had the opportunity to buy GE, SHLD, XOM and X at the same kind of discounts we are being offered on this century's greatest corporate names. Our strategy is simple, buy the above companies – scale in and hedge our entries by selling calls and puts against them and become long-term investors. We all have heard stories of relatives who had 100 original certificates of IBM or something and had no idea they had split 5 times and were worth $100K. I talk about buying some things and putting them under your pillow and forgetting about them like YRCW when they dipped below $2 and GNW, which is again down at $1 and SIRI at .17. I'm not saying these should be major investments but if you have $100K invested, it doesn't hurt to take $1,000 and put it into 5 of these kind of companies and you too, in 30 years, may become that crazy old relative who didn't realize how rich they were…
Our downside bets are easy. If the doomsayers are correct, the Dow will fall to 5,000 or less and our puts will more than triple so a 30% or better hedge to the downside keeps us out of the poorhouse. Even if the market goes nowhere, as long as we can collect 10% a month or better selling calls and puts, our virtual portfolios can post a small gain for the year. Stock ownership is different than options. If I have $60,000 worth of the above stocks and $40,000 worth of index puts and I sell $10,000 a month in puts and calls – I collect $120,000 a year and whatever value remains in the $70,000 worth of stocks is a bonus (assuming the puts expire worthless). By sticking to a good mix of companies as above we can be reasonable sure that they will only lose 30% of their value if the Dow loses 30% of it's value (2,400 points) and, obviously, our index puts would go through the roof if that happens – that's our hedge! It's almost more profitable for us if the market does make a massive drop as we can triple our short side while not losing 100% of the long side.
The trick to making a good hedged entry is to try to pick an entry on the upswing and buy the common and sell the calls. When the upside momentum slows, then it's time to sell the puts. You can also initiate the play in a down market by selling the naked puts on the way down, buying the stock as the momentum slows and waiting for a bounce to sell the calls. You need to set very tight targets to do this, you don't want to turn these plays into gambles but you can improve your positions nicely by timing it with our level tests.
Happy hunting!
