Strategies, December 2008—January2009
December 21, 2008
We have laughed at the foolishness of analysts who are rushing to make forecasts as to the likely next phase of the market. Now it is time to put our own faces into the van Allen belt of flying eggs – but in an entirely different way. (Please don’t laugh. We take this seriously.)
At this moment in the market as we have said contrarians and bottom fishers are struggling with bear market trend traders for control of the market. By no means is the market at a historic low valuation, judging by the dividend yield of the S&P. This is fundamental. Technically to expect the market to mount a sustained and meaningful rally, or to change the trend would appear to be unlikely at this point. Too much time is involved in bottom formation. It took about a year to put a bottom under the 2000 bubble. And that was back in “normal” times.
If we got another plunge here we might be looking at a Kilroy Bottom. (See 9th ed.)
The present rally of 20% (m/l) has been pretty healthy and is wending sideways the last 14 days. We are seeing analysts and advisors we respect plunging into the market and making substantial portfolio commitments. This is a little much for us. We believe in tiptoeing into water whose depth is unknown.
Lately we have been cautiously dipping a toe in. We have bought some “lottery tickets” (explained in a previous letter), discussed some utilities, taken some flyers on Ford and remarked that Citi might be a doable speculation. In the case of lottery tickets we treat those trades as exactly that – a 100% risk. In the case of the speculations we think the risks from market prices in this environment must be regarded as in the range of 10-12%. Our flyers on Ford, though, for example we treat like a lottery ticket. Probably you the reader should set stops closer based on the size of the capital you commit.
Here is the analysis behind this kind of thinking. FNM and FRE can’t go much lower, and if they do what do you lose? 30 cents? (Think of this a financial comedy writing.) By the same token You might pick some depressed utilities or energy or commodity stocks here and take a ride. If they rise and we see that the trend has changed you step into some more of it. If they fall you bail out at your stop point. If you have trouble or uncertainty in calculating a stop for an issue drop us an email.
Our unvarying tactic is as implied here – scale in, scale out. We always divide the capital we want to allocate to a market into tranches or units – anywhere from 3 to 7. And we scale in when entering and scale out when taking profits.
For our personal accounts we have shorted the long t bonds. This is an extremely speculative trade we will explore in a letter very shortly.
In short, a further rally would not surprise us, given the liquidity flooding the system. It might change the trend. But we expect this rally to expire and test the bottom again. Why? Because of the truly desperate condition of the economy. Potentially 7 million mortgages in trouble. Disemployment of 2,000,000 people this year. Utter incompetence on the part of the Bush Administration in dealing with the problem. And the failure of the Administration to attack the roots of the problem – mortgage foreclosures and job loss. Our contempt for the President and the Senate is boundless. We recommend that you do as we did. We mailed Bush a shoe. And are preparing another shoe to mail to Mitch McConnell, who blocked the auto bailout in the Senate with a filibuster.