Finally Friday – In progress

I wish I was good at Photoshop.

This is a picture I put up on Thursday, May 17th to illustrate where I thought we were in the market.  At the time I said:

"Was I paranoid yesterday or is this really the top?"

"We won’t really know until the end of next week but we’ve had far too good of a year so far to take chances up at this level and I doubt many hedge fund managers will disagree with me.  My comment on the subject yesterday was: "While we could drop 150-200 points by Friday I think that’s what most fund managers are expecting and NOT dropping 100 points by Friday will but me (as a fund manager) heading into the holiday weekend on the wrong side of the market. That will cause me to put money into things that seem like they will rally but should be safe like MSFT, GOOG, MRVL, UPS… solid names that haven’t rallied with the markets."

If you were to reverse this picture and overlay the daily movement of the Dow since that day, it pretty much follows the exact profile of that mountain – a little dip, back up to a slightly higher plateau and then – Uh oh!

To keep things in perspective, we still have about 150 points left where we can grab onto that little outcropping but, if we can’t grab hold of it by 13,100, then we will have just our bungee cord at 13,000 for a bounce.  If that breaks, it will be a long and bumpy ride back to 12,500.

President Bush is having a bumpy ride at the G-8 conference, becoming ill after having a meeting with Putin (uh-oh!) in which the Soviet Premier turned the tables on him and offered to base the European missile defense system in Azerbaijan – something the President will have a very difficult time objecting to after all that talk about how the program was in EVERYONE’S interest.  Perhaps Bush was already feeling the heat as the other G-8 leaders decided to ignore him and move on with a global warming treaty without US input – flatly stating they will deal with his successor.  This is a very poor political turn for Bush and his party as it puts the Democrats in the position of being able to meet with World leaders to tackle the issue while the Republican candidates are forced to toe the party line and pretend it isn’t happening.

Another thing we need to ignore is Asia’s continued drop.  The Nikkei gave up another 274 points last night and the Hang Seng fell 291 points while both sides of the Shanghai held fairly flat.  The WSJ chooses to sum this up by saying: "Asian Stocks Ended Mostly Lower Friday."  Gosh I sure hope they never have a bad day!

European indices are in full retreat as well, giving up about a half point to a point across the board but tamer than yesterday’s 1.5% drop in the CAC (so far).   Brent crude is down $1 in morning trading and a steep drop in energy prices is one of the only ways I can see us doing a quick reverse in the markets – it’s what the falling climber would call a hand-hold that we can grab onto…

In the US markets we’ve got our SOX and Transport leadership, only not in the direction we were hoping for:

Oil MUST fall below $65 and the Transports MUST reverse or you’d better hope our 13,000 bungee cord holds up.  Until that, or some spectacular reversal in interest rates occurs, we will be mainly ignoring the analysts who are telling us to buy on the dips.  We will be turning around and doing some upside hedging as we are now so far ahead on the downside that a big gain would be annoying!  Our virtual portfolio stands about 1/2 cash and will probably drift more so by the close of the day.

The SOX are looking terribly hopeless which bodes ill for the Nasdaq so Happy Trading and I are keeping a close watch on the 2,525 mark, which would be the end of the bungee zone for that index.  Expect strong goosing of various index leaders (Cramer’s "4 Horesemen", for example) and silly "BUYBUYBUY" talk from Wall Street pimps analysts because they need SOMEONE to take these shares of their hands before they fall any further:

Fed Pres. Michael Moskow is on CNBC this morning telling us to keep "a longer term perspective" about this week’s dip, which is good advice but we can’t let the past cloud our future judgment.  That would be as dangerous as signing a 45-year old pitcher (August 4th) to a $28M one-year deal based on past performance – it might work but it’s a major risk!

So let’s try to make a realistic assessment of where the market is now, not where it was or where we’d like it to be.  Another thing that is not where we want it to be is END (Endeavor International), my one positive oil play!  That’ll teach me…  Actually their well in the North Sea came up dry and the stock will probably test our $1.75 downside target but I’ll be back in if they hold it as a long-term buyer but not a stock to stay in if you’re looking for a quick reward.  See Zman’s comments this morning.

Our trade deficit came in lower than expected ($58Bn vs $63Bn expected), which should give a boost to the dollar, lower rates and give us a small boost in the morning but until we get more than a 20% retrace of this week’s losses, there will be not much to read into.  Unfortunately we know that Chinese export prices are UP so it means we are paying more money for less goods and that brings us right back to inflation (and a slowdown in China’s exports to the US) so take it with a huge grain of salt when the analysts tell you that this number signals a turnaround.

Let’s remember that 25% ($1.2Bn) of that drop in imports is reflected in the 19M barrels of oil the energy crooks are parking offshore in order to create an artificial shortage, and drive up the prices so they can deliver them for a hefty profit.  They can’t pull that trick every month – at some point they run out of tankers!

Also, a very important note to members:

Keep in mind that the sudden increase in market volatility has the net effect of driving up the prices of your option contracts.  That means the reason your longer calls seem "bulletproof" is not because they are but because the implied volatility has increased more than the underlying stock has dropped.  Once we settle down to consolidate at a lower level, those contracts will quickly deflate.  One of the main reasons we’ve been buying options with such abandon this quarter was because they were priced too cheap relative to potential volatility – that situation is now changing fast and we will be much slower to enter new positions for a while!

• Rule #1 – Always sell into the initial excitement
• Rule #2 – When in doubt, sell half
• Rule #3 – Why are you even bothering reading this one if you didn’t listen to the first 2 rules?

Warren Buffet’s Rule #1 is: "Don’t lose money" and his Rule #2 is: "Don’t forget Rule #1" so please try to keep these five simple rules in mind today as my call for mainly cash includes lightening up on any leaps you would be sad to lose money on.  As I said yesterday, the gains we made this week were silly and lucky and the best way to protect them is to turn them into some cash – I’m sure we’ll find something else to trade next week.

I’ll be doing an LTP review over the weekend but a quick list of my UNcovered leaps (all virtual portfolios) is as follows:

• VIX Nov $13s – expecting more V
• ABX Oct $32.50s – will DD
• ESLR Jan $7.50 – not worth selling against
• EWJ Sept $15s – should have sold
• FIZ Oct $12.50 (STP, $10KP is covered) – hoping for a bounce
• GFI Jan $17.50s – also will DD
• IMAX Sept $5 – hoping for a miracle
• PG Oct $65s – didn’t want to cap it
• SIRI Jan ’09 $2.50s – not worth selling against
• TINY Dec $15s – waiting for Happy to call a turn on BTK (TINY is nano but it’s all science speculative)
• TIVO Aug $5s – not worth selling
• WTR Dec $22.50 – waiting to accumulate
• EWZ Sept $55 puts – new
• SU Sept $75 puts
• TSO Aug $55 puts
• BSX Jan $17.50s – not a good spot to sell against
• CC Jan $22.50s and $17.50s – thinking about dumping
• MTU Jan $12.50s – missed my sell window
• SCI Jan $7.50 – stock proxy
• TASR Jan $10s – still looks too good to sell against.
• LVS $80 puts – waiting for drop to stop
• XOM Jan ’08 & ’09 $75 puts – woo hoo!
• DNDN Jan 5s – sort of covered by other plays

Other than that pretty much everything is covered by as close to at the money calls as I could get, mostly erring on the side of caution (selling more in the money).  My risk is very much to the upside but I’d rather pay a bunch of callers $1 or so and have leaps in good shape on 7/20 than risk the alternative – a virtual portfolio full of way out of the money losing leaps!

Be careful out there today!