Troubling Tuesday – Bears and Bears and Bears, Oh My!

That is the Bene Gesserit incantation for bravery from Frank Herbert’s "Dune," one of my favorite books.  When the markets turn nasty on us it is time to get analytical, not emotional and we need to let our fear pass over us as we step back and evaluate the situation with fresh eyes, and a calm mind. 

Above is a chart of our major indexes and their year-to-date performance.  As we tested our -5% lines last week, we added a fresh round of Disaster Hedges, a series of trade ideas that can make 500% or more if the market falls further and in an afternoon Alert to Members yesterday, we added another SDS hedge with a 400% upside.  Having some high-reward hedges in your virtual portfolio allows you to set aside just 2% to protect your entire virtual portfolio against a 10% drop in the markets.  10% is A LOT for the markets to fall and, of course, now that they have brakes on the market, we can always add more hedges along the way down.  Should the market fall "just" 5%, we STILL make 10% on our hedges and that nets our virtual portfolio (in this example) UP 5% on a 5% drop in the market.  If our bullish plays were also hedged with covers – then so much the better! 

Most importantly, having a balanced virtual portfolio with hedges allows you to play the market WITHOUT FEAR.  Warren Buffett famously advises investors to "Be greedy when others are fearful" and our own PSW Rule #1 is "Always sell into the initial excitement," which doesn’t mean always buy but we look for opportunities to sell fear (naked puts) on a dip, the same way we sell our own positions into spikes up that we consider overdone. 

In last week’s "Disaster" article, I wondered if we were in the panic/capitulation part of the above chart and, if we are, then THIS should be the blow-off bottom.  It is possible that I’ve been wrong and that I am in DENIAL and we have a long, long way further to fall, which is why we love our disaster hedges – it lets us take a bullish chance at these inflection points, knowing that we are well-protected to the downside.  Yesterday we took a couple of bullish stabs on the premise the S&P would hold 1,155 but no luck there, now we are not likely to do anything until we see a break over our levels. 

It does seem kind of silly to freak out that the markets are down 5% for the year and, if you go to Yahoo Finance and change the chart to a 1-year view, you’ll find that we’re UP 5% in the past 12 months but down close to 20% over 2 years and down about 10% over 5 years.  Hardly the end of the World, is it?  You would think investors would have more backbone considering we were down 40% (on the 5-year chart) in March of 2009, which was down 70% from the top – now THAT’S panic! 

Investors tend get very caught up in the day-to-day market moves and forget about the big picture.  Our Q2 Buy List and our 9 Fabulous Dow Plays are generally 2012 trades that we initiated about 5% lower than we are now and we built in 20% protection using our "How to Buy a Stock for a 15-20% Discount" strategy and we have remained 65% cash BECAUSE we were not sure our range would hold up but, for new Members – this is an opportunity to initiate some of these trades at the entry prices we were lucky enough to get earlier this year.  We even have a nice, cooperative VIX that’s giving us good put and call prices to sell  into. 

If we are buying at 10,000 on the Dow and taking 20% downside hedges on our purchases then we are good to Dow 8,000.  Add a little disaster hedging and we’re good to Dow 7,000.  If you are more bearish than that, here is the web site of the Survival Warehouse – you probably already have the guns and ammo…  While I generally hate to argue with people who have stockpiles of weapons, on June 6th I did write "The Worst-Case Scenario:  Getting Real With Global GDP!" where I pointed out that things are just simply not bad enough to sit on our hands with a big pile of cash (or gold).

The Dow and the NYSE are up slightly from that spot but the S&P is down 4%, the Nasdaq is off 6% and the Russell has fallen 9% since then (3-month view).  So how do we play this?  We play the Russell to go up and we play the Dow to go down.  In a perfect world, they both move to the down 4% line and we gain 4% on each side.  If the market turns up, the Russell will hopefully climb faster than the Dow, which is already "up" and if we go down, we can hope for the Dow to catch up spectacularly to the other indexes with a huge fall.  This is how you can be market neutral but still do quite well on either side of your bets.  By taking plays where we SELL premium, we lock in an additional profit generator as the decay of premiums is one of the very few sure things we get in the markets.  NOW is the time to take advantage of the fear and greed of others!

Today is certainly fear day in the markets.  The news cycle has been getting more and more bearish and I noted to Members in yesterday’s chat at 3:20 that we were getting relentlessly bad news led off by our favorite bond pimp, Mohamed El-Erain, who predicts a "lost decade" for America with no hope for the unemployed who are "frozen" in bad communities due to a dead housing market.  Hugh Hendry was even worse on British TV last night, telling the EU viewers "I expect bad things are going to happen – further bad things. I think the most productive use for speculators today is to conceive of what are the worst possible economic outcomes." 

This morning we are getting even more (if that’s possible) doom and gloom as we wait for Retail Sales Data, NY ISM, Case-Shiller Home Prices, Chicago PMI (9:45), Consumer Confidence (10:00), Investor Confidence (10:00), Fed Minutes (2pm – dissent on the Fed is scary and there’s lots of it – as I reported last week), Farm Prices (3:00) and ABC Consumer Confidence at 5pm..  Yesterday was our 2nd lowest-volume day of the year, with Yahoo showing just 2.9Bn shares traded on the NYSE vs 4.1Bn on Friday.  The NYSE finished the day 1% over Friday’s low but you sure wouldn’t know it from listening to the MSM, where they are selling the end of the World as we know it.

White House Advisor Austan Goolsbsee made the mistake of not bitch-slapping Wolf Blitzer last night when Wolf said "How worried are you about a double dip recession" and the fact that he said "I don’t think we will have a double dip recession – but we should keep an eye on that" translates into the headline (and I’m not joking): "And Now Even the Administration is Talking About a Double Dip."  Let me ask you a question – do you resent being manipulated or are you so used to it that you now get a sort of empty feeling when the media doesn’t jam their hand up your ass and pull your strings? 

I almost get tired of pointing this BS out but then I remember that corporations like GE and NWS have entire television stations with multi-Billion Dollar budgets and they PAY people to say this stuff over and over and over again 24 hours a day, 7 days a week and they never, ever stop hitting people with their message.  So it is up to me and other "small voices" to do what we can to balance the scales – to at least keep some small semblance of balance in the system that would otherwise allow Corporate America swallow this country whole. 

The relentless negativity is doing its job as even hedge fund managers are heading for the exits with a 50% increase in bearish sentiment in the past 30 days!  47% of 104 hedge fund managers polled by TrimTabs said they were now bearish on the S&P with just 17% bullish, down 50% from the month before.  "The developments hedge fund managers are telegraphing bode ill for equities," BarclayHedge Chief Executive Sol Waksman said in a statement.  Hedge Fund manager Daniel Loeb turned negative on Friday and came out blasting the Administration (which he once supported), a trend among hedge fund managers as the administration seeks to tax their fees as ordinary income (35%) rather than the 15% they now pay – a loophole that baffles pretty much everybody since the money is not long-term, nor is it a capital gain.

Last month, Steve Schwarzman likened the administration’s plan for taxes on private equity to “when Hitler invaded Poland in 1939.” Mr. Schwarzman later apologized for the “inappropriate analogy.”  In addition to very angry hedge fund managers, we have people like INTC’s Paul Otellini telling us how awful things are.  Last week, at a dinner at the Aspen Forum of the Technology Policy Institute that “the next big thing will not be invented here. Jobs will not be created here.”  Then, after his comments tanked the market, he went out and spent $7.7Bn for McAfee and $1.4Bn for a division of IFX – it’s so much easier to get a good seat in a theater if you shout "FIRE" on the way in, isn’t it?

We’ve been discussing why the Administration would let things get this bad but, as I noted above – THIS IS NOT SO BAD.  Down 5% for the year is not exactly a reason to break open the piggy bank, even if they wanted to (and even if we had a piggy bank that didn’t already have a $15Tn IOU in it).  It’s that $15Tn IOU we keep forgetting along with the hundreds of Billions in state debt.  All this fear is allowing the Federal and State Governments to borrow money at record lows.  In fact, the Bond Buyer 20 General Obligation Bond Index fell to 3.88% last week, the lowest level in 43 years.  And, don’t forget that you used to be able to get tax-free Municipal Bonds – not anymore…

That’s down from 4.4% in June – an 11.8% drop in less than 3 months!  That kind of drop helps States balance their budget and shaves $45Bn a year off what the Federal Government must pay in interest to service their own debts – why should they fight that?  If people want to panic into bonds – let them I suppose.  I pointed out in yesterday’s post that the 10-year was also flirting with record lows but they have been lower – after WWII, when the government was also scrambling to refinance war debt and International uncertainty was driving money from all over the World into US Treasuries.  This also keeps the dollar strong (money flowing into dollar-denominated assets) and THAT’s where we run the danger of a Japan-like lost decade.  

The Nikkei fell 3.5% this morning as government action failed to do anything to get the Yen off it’s 15-year highs.  Japan also has zero interest rates and has had it for years and 10-year Yen notes fetch just over 1% BUT PEOPLE BUY THEM.  That keeps the Yen very strong and is a nightmare for exporters as TM, for example, prices a Camry in the US at $20,000, which they hope will be 1.8M Yen but the Yen falls to 85 and now Toyota only gets 1.7M Yen – possibly their entire profit wiped out by currency exchanges.  Things have now gotten so bad in Japan that 1/3 of the manufacturers surveyed are considering moving production out of country and the PMI growth was the slowest in 14 months (but at least it’s growing). 

The Hang Seng lost 1% following the Nikkei south and the Shanghai was off half a point.  India fell 0.34% and blew the 18,000 line at 17,971 despite putting up an impressive 8.8% growth in GDP, which is not something you hear discussed on CNBC, nor will you hear that auto sales in India rose 38% in July – because it doesn’t fit in with the parade of bearish analysts they march on screen one after the other.  Like China, India is talking about reigning in their economy – not stimulating it.  China’s GDP report comes out tonight and, so far, China has FAILED to stop their HUGE GROWTH.  They have taken some pretty drastic measures too and, if they do manage to succeed in today’s data – you can expect the bears to latch onto it like it’s proof that the whole world is coming to an end by Friday.  

Euope is no better and is trading down about 1% ahead of the US open as Euro-Zone Unemployment remains at 10% for the fifth straight month.  French retail giant, Carrefour posted a profit the way all International corporations are doing these days – with growth in emerging markets offsetting slowness at home.  This is my base case on the Global GDP (see link above) and it’s very hard for me to get bearish when I still see reports like this. 

I still think it’s all BS.  I’m still more in favor of buying off these levels than selling but I am getting VERY lonely over here and I have to face the fact that it may be Denial (back to the above chart) and that my Hope is coming too early in the cycle.  Of course, that’s why they call it the "Point of Maximum Financial Risk" at both the top and the bottom of our channels – fortune may favor the bold but only fools rush in where angels fear to tread.

Let’s watch our levels and be careful out there!