Things seem to be moving much more quickly recently. I had originally titled this post "Bad News Everywhere" on March 22, but in just a week, things don't look so bad anymore.
The big news since my last update is that the SPX successfully tested its January high of 1150 and broke the resistance level to set new highs. Unfortunately for stocks, things don't look so good. But in contrast to last week, things have gotten better for the stock market. Last week, there seemed to be a good possibility that the SPX would face a significant reversal; now, while it's likely the SPX will fall back to 1150, it is likely to find support there. In other words, this bull market still(!) has legs. The market had a key reversal day on Thursday, which lends to the short-term bearishness. More disturbingly, sentiment is near record levels of bullishness, which bodes ill for the short-to-intermediate term. Thus, while the intermediate trend is currently bullish (after having broken above resistance at 1150), there are plenty of caution flags that reinforce the belief that this stock market is not for buy-and-hold investors.
And yet plenty of people will be deceived to think that good times are back. The economy appears to be recovering, and people are eager to spend money -- even if the fundamentals are as bad as, if not worse than, 2008, and even if consumers are simply giving themselves more rope to be hanged with. So it may surprise some people that I predict the S&P will rise by another 60 points, to 1233 to be exact, which is based both on an inverse head and shoulders pattern that I mentioned sometime ago from a source I follow, as well as a 61.8% Fibonacci retracement of the S&P's 2007 high. I think this is the absolute ("absolute" being a relative term in this game) highest it will go. If the SPX manages to blow past this number, then the bull market will turn out to be far more powerful than any of us thought -- and it's already shown itself to be a force to be reckoned with. But I think 1233 will prove itself to be a worthy contender at stopping the advance. When might the stock market reach this level? My guess would be within the next two months or so, but when it reaches it is sort of irrelevant; when it gets there, we'll consider our options. In the meantime, we can continue to expect the same slow, relentless drive upwards, punctuated by a minor correction. Close trailing stops on SPY should work pretty well; just remember that the long-term trend is still down.
The dollar actually reached my target of 82, but just barely. With the target reached, the dollar has since declined. It now seems more likely that the dollar will continue to decline from here, at least for the short term. In this case, the intermediate trend is up, but we should expect to see some consolidation from the dollar. In particular, we should pay attention to two numbers. The first is 80, which is approximately where the 50-day moving average is. The second and more important number is 78.25 or thereabouts, as that is both the 200-day moving average and a 50% retracement. I still believe that the dollar will continue to surprise people, but at the moment it seems a decline is in order.
As I mentioned earlier, the situation in gold has cleared up quite a bit recently, and the declining dollar is another piece of good news for gold. The PM sector was formerly quite correlated with the stock market and not as much with the dollar, but lately gold has returned to its usual pattern of being highly negatively correlated with the USD. Since the dollar is likely to fall, this is very good news for gold. RSI and Stochastics are in favorable alignment, and the 50-day moving average is providing support. In addition, the big move last Friday likely marked the bottom. Strong price action in silver also suggests the end of the consolidation is near or has already occurred. Silver and gold stocks have both shown some vigor, and based on their tendency to lead gold, this portends well for gold prices in the near future. Gold has been very quiet lately, but I would not be surprised to see a quick move back to the $1200 level.
Finally, I'd like to comment on something I don't usually mention, US Treasuries. The 10-year Treasury has begun breaking down, as has the 30-year Treasury, which is bad news on several fronts. Falling prices mean rising interest rates, since bond prices and interest rates move opposite of each other. What do rising rates mean? First, rising interest rates will quickly kill any economic recovery. If consumers can't afford 3-4% mortgages and credit cards, there's no way they'll be able to afford a 5% or 6% or even higher interest rate. Second, rising rates are disastrous for the US government. The deficit is already at gigantic proportions, and this is at record-low interest rates. If rates continue to rise, the government will find it impossible to service all that debt. Interest payments will quickly devour the federal budget. Finally, rising rates portend the specter of inflation has returned. Is the deflation/inflation debate about to be resolved? Stay tuned.
Showing posts with label stocks. Show all posts
Showing posts with label stocks. Show all posts
Wednesday, March 31, 2010
Thursday, March 11, 2010
Signs of a Golden Spring
So much has changed in only two weeks. I first started writing this update on February 26, when things were looking good for the precious metals market, hence the optimistic title. I put off writing some more until March 6, when I wrote, "Since then, things have deteriorated quite a bit." And indeed, since then, things have deteriorated quite a bit, which was proven this week with gold falling by thirty dollars since I wrote that line. But I'm getting ahead of myself here. Let's start at the beginning.
Since my last update, things have more or less gone as I predicted. Stocks continued falling and actually did reach my target of 1037 before reversing in a bullish hammer candlestick pattern on February 5. However, the correction in the stock market was strong enough that according to almost all of the sources I follow, the intermediate trend has turned bearish. While that doesn't mean the stock market can't keep rising (and in fact, it's been rising for several weeks now), that does mean it has to prove itself before we can say the stock market will post new highs. That being said, the S&P is now inches away from its January 19 high of 1150.45 and is ready to test that high.
Tomorrow is going to be a big day. As I said above, the intermediate trend is bearish. In order to turn that trend bullish, the SPX must break above that high and stay above it for three consecutive days. If it does that, then we can say with a fair amount of confidence that the bull market is alive and well and will continue to rise. (Even though from a fundamental standpoint the stock market is outrageously overextended....) Although volume has been declining -- a bearish sign -- the past few days, volume has been increasing with the new highs, which is a bullish sign. In addition, the Dow is about a hundred points from its January high, meaning it needs to catch up, although it's possible we could have a scenario where the Dow catches up and the S&P posts a new high but fails to hold it for the requisite three consecutive days.
If the SPX does not break the January high (i.e., tests and fails), then it is likely that today's high marks a double top, which is very bearish. The most important support level to look at is around 1115, as that is both the 61% Fibonacci retracement level and the 50-day moving average. Using retracements, the next support would be around 1105, then around 1090. The 1090 level also marks an old resistance/support line. I expect the 1115 level to be relatively strong -- if it breaks easily, then stock bulls better be careful. In any case, no matter how you look at it, it's best to be cautious and see what happens before taking positions on either side of the market.
The PMs also did what I expected, though they did fall a bit more than I had thought. However, in keeping with the title of this post, it's not all bad, as things are looking more positive for gold than they have compared to December or January. Unfortunately, as I said at the beginning of my post, the situation has deteriorated quite a bit. The biggest sticking point is that sentiment is excessively frothy considering the rather lackluster price action we've seen in gold. While it's most likely February 5 did mark the beginning of the next bull leg (and hence likely marked the bottom), gold is going to have to take a breather. The nearest support is $1110, which is where gold is at right now, then $1102, then $1093, then $1080. My feeling is that gold will fall below $1100, as sentiment has not improved even though gold has fallen by over thirty dollars. Fortunately, RSI is neutral, and Stochastics are falling rapidly, suggesting the bottom is not too far way, perhaps a week or two from now.
The situation in silver is similar to gold, but the most interesting thing is that silver has shown relative strength. The PM sector has been highly correlated with the stock market lately, more so than with the USD, which is both good and bad, as I will explain in further detail when I talk about the dollar. However, silver has been particularly tightly correlated with stocks. Stocks have been strong, and so silver has been strong. If the SPX breaks out to new highs, then we should continue to see continued strength in silver. If it bounces off resistance, then we could see a rapid decline in silver to match gold's decline. One worrying aspect is that while RSI is neutral, Stochastics are overbought. Thus, I think there's currently more downside risk than upside risk with silver. With that said, my feeling, though, is that we will continue to see silver leading gold. (As an aside, typically silver underperforms gold at the beginning of a bull wave, then outperforms towards the end. Is silver's current outperformance a sign that we can see a strong bull leg in the future?)
Gold stocks are generally mirroring silver's price action, showing relative strength compared to gold. Similar to silver, Stochastics for HUI are also overbought, and thus the near-term downside risk is greater than upside risk. However, as with silver, I think the strength in HUI/GDX is a good sign for the intermediate and longer terms; during the bull run we saw last fall, gold stocks were weaker than gold, which is the opposite of what we normally expect, and an overall negative sign. If they continue to lead gold, then we should see a powerful bull run in the coming months.
Finally, we come to the USD. The dollar reached the upper bound of my target and since then has been consolidating in a flag-like pattern. Both RSI and Stochastics are neutral. I have a feeling that the dollar will continue consolidating for at least a few more days, but my next target is 82. I'm bearish on the dollar over the long term, of course, but I think for the intermediate term things aren't looking so bad. The intermediate trend is bullish, and a bullish golden cross has appeared on the chart. Interestingly, it's possible that a rising dollar will not have much of an effect on gold. One major issue lately is that it's been unclear whether gold would follow stocks or the dollar. We've gotten some clarity lately, as gold and stocks have been rising in concert in spite of the rising dollar. Of course, correlations can change, as we've seen these past few days, as stocks have kept rising while gold has fallen. Nevertheless, barring a euro currency crisis with Greece in the next few weeks (note that I called out Greece as a "looming problem" before the crisis broke!), I don't expect a strong impact from the dollar on gold.
Since this is a longer post than usual, I'll summarize: stocks are at a critical juncture, gold needs to fall some more but is otherwise building a nice foundation for the next bull run, and the dollar might continue to surprise a few people. The overall theme is to be cautious and let things play themselves out before committing to being long or short the market. After all, in this game, you can always catch the next ride.
Since my last update, things have more or less gone as I predicted. Stocks continued falling and actually did reach my target of 1037 before reversing in a bullish hammer candlestick pattern on February 5. However, the correction in the stock market was strong enough that according to almost all of the sources I follow, the intermediate trend has turned bearish. While that doesn't mean the stock market can't keep rising (and in fact, it's been rising for several weeks now), that does mean it has to prove itself before we can say the stock market will post new highs. That being said, the S&P is now inches away from its January 19 high of 1150.45 and is ready to test that high.
Tomorrow is going to be a big day. As I said above, the intermediate trend is bearish. In order to turn that trend bullish, the SPX must break above that high and stay above it for three consecutive days. If it does that, then we can say with a fair amount of confidence that the bull market is alive and well and will continue to rise. (Even though from a fundamental standpoint the stock market is outrageously overextended....) Although volume has been declining -- a bearish sign -- the past few days, volume has been increasing with the new highs, which is a bullish sign. In addition, the Dow is about a hundred points from its January high, meaning it needs to catch up, although it's possible we could have a scenario where the Dow catches up and the S&P posts a new high but fails to hold it for the requisite three consecutive days.
If the SPX does not break the January high (i.e., tests and fails), then it is likely that today's high marks a double top, which is very bearish. The most important support level to look at is around 1115, as that is both the 61% Fibonacci retracement level and the 50-day moving average. Using retracements, the next support would be around 1105, then around 1090. The 1090 level also marks an old resistance/support line. I expect the 1115 level to be relatively strong -- if it breaks easily, then stock bulls better be careful. In any case, no matter how you look at it, it's best to be cautious and see what happens before taking positions on either side of the market.
The PMs also did what I expected, though they did fall a bit more than I had thought. However, in keeping with the title of this post, it's not all bad, as things are looking more positive for gold than they have compared to December or January. Unfortunately, as I said at the beginning of my post, the situation has deteriorated quite a bit. The biggest sticking point is that sentiment is excessively frothy considering the rather lackluster price action we've seen in gold. While it's most likely February 5 did mark the beginning of the next bull leg (and hence likely marked the bottom), gold is going to have to take a breather. The nearest support is $1110, which is where gold is at right now, then $1102, then $1093, then $1080. My feeling is that gold will fall below $1100, as sentiment has not improved even though gold has fallen by over thirty dollars. Fortunately, RSI is neutral, and Stochastics are falling rapidly, suggesting the bottom is not too far way, perhaps a week or two from now.
The situation in silver is similar to gold, but the most interesting thing is that silver has shown relative strength. The PM sector has been highly correlated with the stock market lately, more so than with the USD, which is both good and bad, as I will explain in further detail when I talk about the dollar. However, silver has been particularly tightly correlated with stocks. Stocks have been strong, and so silver has been strong. If the SPX breaks out to new highs, then we should continue to see continued strength in silver. If it bounces off resistance, then we could see a rapid decline in silver to match gold's decline. One worrying aspect is that while RSI is neutral, Stochastics are overbought. Thus, I think there's currently more downside risk than upside risk with silver. With that said, my feeling, though, is that we will continue to see silver leading gold. (As an aside, typically silver underperforms gold at the beginning of a bull wave, then outperforms towards the end. Is silver's current outperformance a sign that we can see a strong bull leg in the future?)
Gold stocks are generally mirroring silver's price action, showing relative strength compared to gold. Similar to silver, Stochastics for HUI are also overbought, and thus the near-term downside risk is greater than upside risk. However, as with silver, I think the strength in HUI/GDX is a good sign for the intermediate and longer terms; during the bull run we saw last fall, gold stocks were weaker than gold, which is the opposite of what we normally expect, and an overall negative sign. If they continue to lead gold, then we should see a powerful bull run in the coming months.
Finally, we come to the USD. The dollar reached the upper bound of my target and since then has been consolidating in a flag-like pattern. Both RSI and Stochastics are neutral. I have a feeling that the dollar will continue consolidating for at least a few more days, but my next target is 82. I'm bearish on the dollar over the long term, of course, but I think for the intermediate term things aren't looking so bad. The intermediate trend is bullish, and a bullish golden cross has appeared on the chart. Interestingly, it's possible that a rising dollar will not have much of an effect on gold. One major issue lately is that it's been unclear whether gold would follow stocks or the dollar. We've gotten some clarity lately, as gold and stocks have been rising in concert in spite of the rising dollar. Of course, correlations can change, as we've seen these past few days, as stocks have kept rising while gold has fallen. Nevertheless, barring a euro currency crisis with Greece in the next few weeks (note that I called out Greece as a "looming problem" before the crisis broke!), I don't expect a strong impact from the dollar on gold.
Since this is a longer post than usual, I'll summarize: stocks are at a critical juncture, gold needs to fall some more but is otherwise building a nice foundation for the next bull run, and the dollar might continue to surprise a few people. The overall theme is to be cautious and let things play themselves out before committing to being long or short the market. After all, in this game, you can always catch the next ride.
Saturday, January 23, 2010
Memories of the Panic of '08
For investors grown complacent by the steady grind upwards in stocks, the dramatic fall these past few days has certainly been a wake-up call. In the past three days, the Dow has fallen over 500 points. Gold is down $40, and the US dollar is surging. The impact in the news that these declines have been generating is somewhat reminiscent of September and October 2008. Is this going to be the beginning of the big fall? While I've been saying for a long time now that the stock market will eventually test and fail the March low of 666 in the S&P, until we see a decisive break downwards, I'm not holding my breath.
I've been bearish on the stock market for a long time now, even though the stock market hasn't been willing to oblige. At the very least, however, it did need a breather; the last correction was back in October. The SPX is down a little over 5% from its high, but a healthy correction often sees a 10% decline. In that case, we could see the market decline to around 1035. More realistically, I would look at 1070 first, which would match better with the previous decline, which was 6.5%, and forms a support level based on a trendline from the two previous lows.
Suppose the market bounces off 1070 and begins yet another rise. What could we expect then? One source claims a long-term reverse head and shoulders target of around 1200-1230, around 15% higher from 1070. I'm slightly skeptical of the justification used for this target (mostly because the volume doesn't really confirm), but we should keep an open mind. And if support at 1070 fails? Frankly, this market has been so (suspiciously) powerful that I won't become bearish until something dramatic happens. If the market breaks through the 200-day moving average, currently at 1007, then I'll reconsider, but until then, I'm begrudgingly bullish on the stock market, at least for the medium term.
Though commentators have been concentrating on everything from disappointing earnings to uncertainty surrounding Ben Bernanke's reappointment as the cause of the recent decline, perhaps the driving factor in my mind is the US dollar, which recently broke out of a flag formation and is surging upwards towards a target of 80-81. This has triggered a sell-off in commodities such as oil and gold, and consequently led to the stock market decline. Considering that we are only about halfway to the target (the dollar is currently at 78.23), I expect more pain ahead.
The recent dollar rise has certainly been the major factor in gold's decline, but gold has been consolidating since its peak of $1225 in early December. Gold is now down about 10% and is likely close to the bottom. However, there's still some room for it to fall, as both RSI and Stochastics are not yet into oversold territory, and it may be another week or two before gold finishes its correction. Bear in mind that though gold has entered into a seasonally weak period, winter overall is gold's strongest season. By the end of its run, gold should post an intermediate top much higher than the recent high of $1225.
Like gold, silver has been consolidating since its early December peak, though its movements of course have been more volatile. Currently at $17, I expect silver to fall a bit more from here, perhaps down to $16.50 or $16 before beginning its ascent. By the end of its run, possibly in April or so, it should easily take out its December high of $19 and perhaps even take out its 2008 high of $21.
Finally, gold stocks, as represented by the Market Vectors Gold Miners ETF (GDX), which is very similar to the AMEX Gold Bugs Index or HUI, have so far suffered a 23% correction from the December high. Stochastics have just entered oversold territory, and RSI at 34 is close to oversold as well. One source claims that the PM sector will likely take a breather of at least a few days before declining some more, and personally, it seems like GDX is serving as a leading indicator. Today, while GLD and SLV both fell, GDX actually slightly rose. GDX is currently at $43.79, but it might need to fall to around $42 or so before it can begin the next bull run.
Gold sentiment got a little too frothy in the past few weeks, but the current correction (which is merely the second part of the larger overall correction) should serve to bleed out bullishness. Gold stocks seem to be slightly ahead of the pack, leading the decline, so we should pay attention to GDX to see when the PM sector will renew its ascent. Silver is lagging gold both financially and temporally and has more to fall, but towards the end of the next bull run, it should begin to outperform gold, as it usually does before intermediate tops.
As noted above, the target for the dollar is 80-81, but I'm still bearish on the dollar over the long run. In the intermediate term, though, we should not discount the fact that the US dollar is still the world's reserve currency. If there is another financial crisis (and there are many looming problems to choose from: Greece, Japan, the UK, Spain, to name a few potential currency crises), we could see a repeat of the Panic of 2008, with a flood of money into the "safe haven" of the USD, causing a surge in the dollar index and Treasury prices and a collapse in stocks and commodities. If that should happen, and it will again one day, all bets are off.
I've been bearish on the stock market for a long time now, even though the stock market hasn't been willing to oblige. At the very least, however, it did need a breather; the last correction was back in October. The SPX is down a little over 5% from its high, but a healthy correction often sees a 10% decline. In that case, we could see the market decline to around 1035. More realistically, I would look at 1070 first, which would match better with the previous decline, which was 6.5%, and forms a support level based on a trendline from the two previous lows.
Suppose the market bounces off 1070 and begins yet another rise. What could we expect then? One source claims a long-term reverse head and shoulders target of around 1200-1230, around 15% higher from 1070. I'm slightly skeptical of the justification used for this target (mostly because the volume doesn't really confirm), but we should keep an open mind. And if support at 1070 fails? Frankly, this market has been so (suspiciously) powerful that I won't become bearish until something dramatic happens. If the market breaks through the 200-day moving average, currently at 1007, then I'll reconsider, but until then, I'm begrudgingly bullish on the stock market, at least for the medium term.
Though commentators have been concentrating on everything from disappointing earnings to uncertainty surrounding Ben Bernanke's reappointment as the cause of the recent decline, perhaps the driving factor in my mind is the US dollar, which recently broke out of a flag formation and is surging upwards towards a target of 80-81. This has triggered a sell-off in commodities such as oil and gold, and consequently led to the stock market decline. Considering that we are only about halfway to the target (the dollar is currently at 78.23), I expect more pain ahead.
The recent dollar rise has certainly been the major factor in gold's decline, but gold has been consolidating since its peak of $1225 in early December. Gold is now down about 10% and is likely close to the bottom. However, there's still some room for it to fall, as both RSI and Stochastics are not yet into oversold territory, and it may be another week or two before gold finishes its correction. Bear in mind that though gold has entered into a seasonally weak period, winter overall is gold's strongest season. By the end of its run, gold should post an intermediate top much higher than the recent high of $1225.
Like gold, silver has been consolidating since its early December peak, though its movements of course have been more volatile. Currently at $17, I expect silver to fall a bit more from here, perhaps down to $16.50 or $16 before beginning its ascent. By the end of its run, possibly in April or so, it should easily take out its December high of $19 and perhaps even take out its 2008 high of $21.
Finally, gold stocks, as represented by the Market Vectors Gold Miners ETF (GDX), which is very similar to the AMEX Gold Bugs Index or HUI, have so far suffered a 23% correction from the December high. Stochastics have just entered oversold territory, and RSI at 34 is close to oversold as well. One source claims that the PM sector will likely take a breather of at least a few days before declining some more, and personally, it seems like GDX is serving as a leading indicator. Today, while GLD and SLV both fell, GDX actually slightly rose. GDX is currently at $43.79, but it might need to fall to around $42 or so before it can begin the next bull run.
Gold sentiment got a little too frothy in the past few weeks, but the current correction (which is merely the second part of the larger overall correction) should serve to bleed out bullishness. Gold stocks seem to be slightly ahead of the pack, leading the decline, so we should pay attention to GDX to see when the PM sector will renew its ascent. Silver is lagging gold both financially and temporally and has more to fall, but towards the end of the next bull run, it should begin to outperform gold, as it usually does before intermediate tops.
As noted above, the target for the dollar is 80-81, but I'm still bearish on the dollar over the long run. In the intermediate term, though, we should not discount the fact that the US dollar is still the world's reserve currency. If there is another financial crisis (and there are many looming problems to choose from: Greece, Japan, the UK, Spain, to name a few potential currency crises), we could see a repeat of the Panic of 2008, with a flood of money into the "safe haven" of the USD, causing a surge in the dollar index and Treasury prices and a collapse in stocks and commodities. If that should happen, and it will again one day, all bets are off.
Monday, August 3, 2009
The Bull's Still Climbing Those Stairs
Is the stock market ever going to fall? I keep on thinking it could be like 1930, but no amount of wishing from me is going to make that happen. It could be like 1968, which would be especially fitting since the S&P crossed 1000 today.
I've done some more reading and thinking, and I could be wrong about the stock market over the medium and even long term, at least in nominal terms. I've been thinking we could see a major decline, but there's no reason why it couldn't meander for years like it did in the 70s. And in fact, that might be the likelier case, what with the government very interested in propping up the market. If the Dow stays around 10,000 for years, it'll seem like investors haven't "lost" money, though in fact inflation and currency depreciation will belie that. The market could even rise to new highs but still be in a bear market after taking into account real-/currency-adjusted values. So I'm still bearish on the market long term, but this would have different implications on how to trade it.
If shorting the market isn't going to work, we need to look at other asset classes. Besides gold and silver, which I think are the best ways to make money in the coming years, there are commodities, bonds, and the dollar. Considering that the inflation/deflation debate hasn't been resolved yet and probably won't be for at least another one to three years, I'm not as enthusiastic on commodities; you would also need to consider the demand and supply data for them, which aren't as relevant for a semi-currency like gold. Treasuries seem to be a sure bet -- interest rates can only go up from here -- but my worry is that the government will intervene to keep them down. If the government is successful, you'll make no money in nominal terms but lose money in PPP-adjusted terms due to the necessary depreciation of the dollar. If the government is not successful, you'll make money in nominal terms, but you could still lose out in real terms if the market loses confidence in the dollar as a result. Consequently, I think shorting the dollar would be a better bet, since your downside risk should be lower than if you were shorting Treasuries.
Any way you cut it, the future doesn't look very bright for the US, or for the world for that matter. If you can't save the world from disaster, you should still at least try to save yourself.
I've done some more reading and thinking, and I could be wrong about the stock market over the medium and even long term, at least in nominal terms. I've been thinking we could see a major decline, but there's no reason why it couldn't meander for years like it did in the 70s. And in fact, that might be the likelier case, what with the government very interested in propping up the market. If the Dow stays around 10,000 for years, it'll seem like investors haven't "lost" money, though in fact inflation and currency depreciation will belie that. The market could even rise to new highs but still be in a bear market after taking into account real-/currency-adjusted values. So I'm still bearish on the market long term, but this would have different implications on how to trade it.
If shorting the market isn't going to work, we need to look at other asset classes. Besides gold and silver, which I think are the best ways to make money in the coming years, there are commodities, bonds, and the dollar. Considering that the inflation/deflation debate hasn't been resolved yet and probably won't be for at least another one to three years, I'm not as enthusiastic on commodities; you would also need to consider the demand and supply data for them, which aren't as relevant for a semi-currency like gold. Treasuries seem to be a sure bet -- interest rates can only go up from here -- but my worry is that the government will intervene to keep them down. If the government is successful, you'll make no money in nominal terms but lose money in PPP-adjusted terms due to the necessary depreciation of the dollar. If the government is not successful, you'll make money in nominal terms, but you could still lose out in real terms if the market loses confidence in the dollar as a result. Consequently, I think shorting the dollar would be a better bet, since your downside risk should be lower than if you were shorting Treasuries.
Any way you cut it, the future doesn't look very bright for the US, or for the world for that matter. If you can't save the world from disaster, you should still at least try to save yourself.
Saturday, April 4, 2009
All Attempts to Cheat Death Will End Poorly
Business cycles are natural. To interfere with them is unnatural. Yet there is a fixation by economists searching for a magical explanation of business cycles that will enable us to banish them to the ash heap of history. Why don't we also try getting rid of winter? All the arguments made in favor of ending business cycles can be used to argue equally for the end of seasons. But the attempt to find a "solution" to business cycles will end in failure, just as it will should we ever try to ban winter. Fortunately, we've matured enough to realize that winter arrives every year and there's not much we can do about the seasons. Why can't we see the same thing with the economy? It's ridiculous to try to find a "solution" to winter; the same goes for recessions.
In all business cycles, we have booms and busts. Typically a bust is called a recession; very bad busts are called depressions. When times are good, businesses expand and jobs are easy to find. The stock market consistently rises. At the extreme end of this, at the very top of the economic boom, people start talking about how "it's different this time," or how we are "entering into a new economy." Inefficiencies and misallocations accumulate as businesses expand and invest. Businesses might end up hiring too many people, for example, or they might decide to invest in a project that realistically will never return a profit -- they invest in it because nobody wants to be left out. It might be somewhat unsafe, maybe not a very good idea, but if those people are doing it, then we can and should do it too. Eventually, somebody realizes that no, this doesn't make sense, these businesses can't actually turn a profit on these projects. Costs are too high, sales are too low, we can't afford this. The money that flowed so freely to fund every single hot idea -- regardless of whether it was a good idea or not -- suddenly dries up. Businesses lay off workers, consumers cut back spending, and the economy falls into a recession. The mismanaged businesses and the ones that made bad mistakes shut their doors. All the fluff is blown away. The shrewd investors and businessmen will see the new opportunities that start popping up everywhere -- and they will lay the groundwork for the next expansion.
When left alone, the business cycle clears out the rot and allows the economy to become even stronger. To make another analogy, think of a forest fire. Nature ensures a forest fire every so often in order to clear all out the dead brush. When humans interfere, the dead brush accumulates to such an extent that when the next fire starts -- and it always will -- the resulting forest fire will be completely devastating.
Forest fires and recessions are a painful thing to go through, but they are every bit necessary. The problem, of course, is that it is a painful process. Politicians want to be to be reelected, and doing nothing during a recession appears makes one appear indifferent to the suffering of the people. Constituents want to avoid pain, and they too want action during a recession. The irony is that in their quest to avoid pain today, people end up having to endure a deeper and longer lasting pain tomorrow.
It's quite clear what I believe we should do during a recession: nothing. Unfortunately, this is completely unrealistic in the world we live in; we will just have to accept that people will meddle in things they should not.
In all business cycles, we have booms and busts. Typically a bust is called a recession; very bad busts are called depressions. When times are good, businesses expand and jobs are easy to find. The stock market consistently rises. At the extreme end of this, at the very top of the economic boom, people start talking about how "it's different this time," or how we are "entering into a new economy." Inefficiencies and misallocations accumulate as businesses expand and invest. Businesses might end up hiring too many people, for example, or they might decide to invest in a project that realistically will never return a profit -- they invest in it because nobody wants to be left out. It might be somewhat unsafe, maybe not a very good idea, but if those people are doing it, then we can and should do it too. Eventually, somebody realizes that no, this doesn't make sense, these businesses can't actually turn a profit on these projects. Costs are too high, sales are too low, we can't afford this. The money that flowed so freely to fund every single hot idea -- regardless of whether it was a good idea or not -- suddenly dries up. Businesses lay off workers, consumers cut back spending, and the economy falls into a recession. The mismanaged businesses and the ones that made bad mistakes shut their doors. All the fluff is blown away. The shrewd investors and businessmen will see the new opportunities that start popping up everywhere -- and they will lay the groundwork for the next expansion.
When left alone, the business cycle clears out the rot and allows the economy to become even stronger. To make another analogy, think of a forest fire. Nature ensures a forest fire every so often in order to clear all out the dead brush. When humans interfere, the dead brush accumulates to such an extent that when the next fire starts -- and it always will -- the resulting forest fire will be completely devastating.
Forest fires and recessions are a painful thing to go through, but they are every bit necessary. The problem, of course, is that it is a painful process. Politicians want to be to be reelected, and doing nothing during a recession appears makes one appear indifferent to the suffering of the people. Constituents want to avoid pain, and they too want action during a recession. The irony is that in their quest to avoid pain today, people end up having to endure a deeper and longer lasting pain tomorrow.
It's quite clear what I believe we should do during a recession: nothing. Unfortunately, this is completely unrealistic in the world we live in; we will just have to accept that people will meddle in things they should not.
Sunday, March 22, 2009
The Way of Investing
One of my favorite hobbies is investing. It's a little like gambling, but with an air of respectability. Besides the legitimacy of investing versus gambling, the other major difference is the outcome of your decisions. In gambling, the odds are fixed and known beforehand by both parties, that is, the player and the house. When you put money on, say, 12 in roulette, you and the house know that the probability of the ball landing on 12 is 1 in 38. Nothing you can do will change the probabilities. Investing, on the other hand, has unknown probabilities and unknown outcomes. This doesn't mean, though, that it's impossible to make money. What makes investing unique is that essentially you can stack the odds in your favor.
Suppose you wanted to invest $100 in a stock. If you did no research and simply bought a few shares of a randomly chosen stock, what is the likelihood that the stock will increase five years from now? If you have no knowledge of the company behind the stock and no knowledge of the economy that the company is a part of, it's probably fair to say that it is as likely that the stock will increase as it will decrease. But suppose you know that generally speaking, stocks go up over the long run. What are the chances that your randomly chosen stock will be higher five years from now? Perhaps the odds are now in your favor, say 75% of it going up versus 25% of it going down. Note that nothing actually changed; the only thing that changed was that you had some extra information about the stock. The more you move from a state of no information to a state of perfect information, the more the probabilities will move to 100% (and correspondingly, 0%). I described above the state of no information, where you knew nothing about the stock (or stocks in general) and simply picked one at random. At the other extreme, if you know for a fact that ABC Corp.'s first quarter earnings will be higher than the consensus forecast, then, all else being equal, there is a 100% chance that the stock will be higher. Assuming nobody else knows this (if they did, this information would already be priced in), you could make money on this news. At this extreme end, we call it insider information, and trading based on that news is illegal, and for good reason. After all, we believe in a level playing field for everyone, and insider trading goes against that idea.
But even when you use only publicly available information, it's still possible to make money beyond the market return. The key lies within the probabilities. Let's start with the micro level with individual stocks. Suppose the consensus is that there is a 50% chance that ABC Corp. will announce earnings of $1.00, a 25% chance that it will announce earnings below $1.00, and a 25% chance that it will announce earnings above $1.00. Accordingly, the market prices ABC stock at $10. You, on the other hand, believe that there is a 50-20-30 chance, respectively, meaning that you value the stock more than $10. Because you are a price taker (you're buying 100 shares when on average 10 million shares are traded a day, so your buying has virtually no effect on the price), you can enter the market without affecting the price. The next day, ABC Corp. announces earnings of $1.10. The market prices in this new information, and now ABC stock is worth $10.50. You've made money.
The issue, of course, is that you need to be consistently right, and for the individual investor, that's extremely difficult. After all, how did you know that the correct probabilities were 50-20-30, and not 50-25-25 like the market consensus? Was it pure luck? Fortune is fleeting. Was it a superior analysis? There are hundreds of stock analysts with Level 2 data, access to dozens of newsletters and commentaries, even fellow coworkers on the trading floor who spend hours every day following ABC Corp. The likelihood that you will be able to consistently outperform the market is extremely small. At the micro level, it's nearly impossible to make more than the market return without simultaneously increasing the amount of risk you're taking because markets are mostly efficient. (I'm not claiming the Efficient Market Hypothesis or EMH, however, which states that markets are totally efficient; there is a world of difference between "mostly efficient" and "totally efficient").
I should point out, however, that even if the EMH is true, that doesn't mean it's impossible to make money; it only says that it's highly improbable that you will make more than the market. If the market has a return of 30%, that's a pretty good return regardless.
As you start moving from the micro level to the macro level, though, you start gaining the upper hand. The Efficient Market Hypothesis does a good job of explaining why a stock might rise and fall, but it can't explain why there are bubbles in the stock market. At the macro level, there's more room for error, both in your judgment and in other people's judgment. Personally, I believe that even if on an individual level the Efficient Market Hypothesis applies, it doesn't necessarily follow that it should apply on an aggregate level. In other words, a stock might be priced so that it reflects all available information, but a stock market might be mispriced. I have to admit that this seems like a contradiction (a well-known example where the macro does not necessarily follow from the micro is Arrow's Impossibility Theorem; an example of its implications can be found here), and I haven't done any sort of research on it, but it is a compelling explanation, I think.
The other nice thing about working with markets is diversification. (I could write a whole post about how the word "diversification" is misused, but for now just think of it the way as we usually think of it: the more securities, the higher the risk-adjusted return.) Diversification allows us the ability to focus on the big picture rather than worrying about individual securities. If we take a hit on a particular stock, it won't affect our overall portfolio too much because it's such a small portion of it. But because overall the stocks will tend to move together, the movement of the overall market will outweigh the anomalous movements of individual stocks.
Working on the two ideas that markets as a whole can be mispriced and that diversification allows us to look at the overall picture, we can develop strategies that can take advantage of these mispricings. These strategies will require us to be able and willing to go long or short on a security. It's this ability and willingness to go short that separates the professional investor from the average investor. The typical investor is only long stocks. He buys an investment and hopes that it will go up. Because things go up and things go down, the amateur can make money only half the time. Not only is the professional investor is more knowledgeable than the average, amateur investor, but he also has more tools available. The professional investor buys an investment and knows that it will go up. But the professional investor also shorts an investment and knows that it will go down. He makes money regardless of the direction of the market because he knows the direction of the market. This applies no matter what particular strategy he's using, whether he's buying and selling individual stocks or buying and selling entire markets. I want to emphasize again that the difference between a professional investor and your neighbor who calls himself an "investor" is a mindset, a philosophy if you will.
I'll save further details on how to invest and what to invest in for a later post, and I'll end this post with my favorite investing quote:
"What's your advice for the average investor?"
"Don't be average."
Suppose you wanted to invest $100 in a stock. If you did no research and simply bought a few shares of a randomly chosen stock, what is the likelihood that the stock will increase five years from now? If you have no knowledge of the company behind the stock and no knowledge of the economy that the company is a part of, it's probably fair to say that it is as likely that the stock will increase as it will decrease. But suppose you know that generally speaking, stocks go up over the long run. What are the chances that your randomly chosen stock will be higher five years from now? Perhaps the odds are now in your favor, say 75% of it going up versus 25% of it going down. Note that nothing actually changed; the only thing that changed was that you had some extra information about the stock. The more you move from a state of no information to a state of perfect information, the more the probabilities will move to 100% (and correspondingly, 0%). I described above the state of no information, where you knew nothing about the stock (or stocks in general) and simply picked one at random. At the other extreme, if you know for a fact that ABC Corp.'s first quarter earnings will be higher than the consensus forecast, then, all else being equal, there is a 100% chance that the stock will be higher. Assuming nobody else knows this (if they did, this information would already be priced in), you could make money on this news. At this extreme end, we call it insider information, and trading based on that news is illegal, and for good reason. After all, we believe in a level playing field for everyone, and insider trading goes against that idea.
But even when you use only publicly available information, it's still possible to make money beyond the market return. The key lies within the probabilities. Let's start with the micro level with individual stocks. Suppose the consensus is that there is a 50% chance that ABC Corp. will announce earnings of $1.00, a 25% chance that it will announce earnings below $1.00, and a 25% chance that it will announce earnings above $1.00. Accordingly, the market prices ABC stock at $10. You, on the other hand, believe that there is a 50-20-30 chance, respectively, meaning that you value the stock more than $10. Because you are a price taker (you're buying 100 shares when on average 10 million shares are traded a day, so your buying has virtually no effect on the price), you can enter the market without affecting the price. The next day, ABC Corp. announces earnings of $1.10. The market prices in this new information, and now ABC stock is worth $10.50. You've made money.
The issue, of course, is that you need to be consistently right, and for the individual investor, that's extremely difficult. After all, how did you know that the correct probabilities were 50-20-30, and not 50-25-25 like the market consensus? Was it pure luck? Fortune is fleeting. Was it a superior analysis? There are hundreds of stock analysts with Level 2 data, access to dozens of newsletters and commentaries, even fellow coworkers on the trading floor who spend hours every day following ABC Corp. The likelihood that you will be able to consistently outperform the market is extremely small. At the micro level, it's nearly impossible to make more than the market return without simultaneously increasing the amount of risk you're taking because markets are mostly efficient. (I'm not claiming the Efficient Market Hypothesis or EMH, however, which states that markets are totally efficient; there is a world of difference between "mostly efficient" and "totally efficient").
I should point out, however, that even if the EMH is true, that doesn't mean it's impossible to make money; it only says that it's highly improbable that you will make more than the market. If the market has a return of 30%, that's a pretty good return regardless.
As you start moving from the micro level to the macro level, though, you start gaining the upper hand. The Efficient Market Hypothesis does a good job of explaining why a stock might rise and fall, but it can't explain why there are bubbles in the stock market. At the macro level, there's more room for error, both in your judgment and in other people's judgment. Personally, I believe that even if on an individual level the Efficient Market Hypothesis applies, it doesn't necessarily follow that it should apply on an aggregate level. In other words, a stock might be priced so that it reflects all available information, but a stock market might be mispriced. I have to admit that this seems like a contradiction (a well-known example where the macro does not necessarily follow from the micro is Arrow's Impossibility Theorem; an example of its implications can be found here), and I haven't done any sort of research on it, but it is a compelling explanation, I think.
The other nice thing about working with markets is diversification. (I could write a whole post about how the word "diversification" is misused, but for now just think of it the way as we usually think of it: the more securities, the higher the risk-adjusted return.) Diversification allows us the ability to focus on the big picture rather than worrying about individual securities. If we take a hit on a particular stock, it won't affect our overall portfolio too much because it's such a small portion of it. But because overall the stocks will tend to move together, the movement of the overall market will outweigh the anomalous movements of individual stocks.
Working on the two ideas that markets as a whole can be mispriced and that diversification allows us to look at the overall picture, we can develop strategies that can take advantage of these mispricings. These strategies will require us to be able and willing to go long or short on a security. It's this ability and willingness to go short that separates the professional investor from the average investor. The typical investor is only long stocks. He buys an investment and hopes that it will go up. Because things go up and things go down, the amateur can make money only half the time. Not only is the professional investor is more knowledgeable than the average, amateur investor, but he also has more tools available. The professional investor buys an investment and knows that it will go up. But the professional investor also shorts an investment and knows that it will go down. He makes money regardless of the direction of the market because he knows the direction of the market. This applies no matter what particular strategy he's using, whether he's buying and selling individual stocks or buying and selling entire markets. I want to emphasize again that the difference between a professional investor and your neighbor who calls himself an "investor" is a mindset, a philosophy if you will.
I'll save further details on how to invest and what to invest in for a later post, and I'll end this post with my favorite investing quote:
"What's your advice for the average investor?"
"Don't be average."
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