Bull Run Falls Short

Bull Run Falls Short

End of Month Report - Part 1

Major Stock markets staged a remarkable comeback in March with the Dow Jones Industrial Average rising to 7,608, up 545 points or 7.7%. The S&P 500 rallied 8.5% to 797.87. While the gains were impressive, the S&P’s failure to close above 800 and the Dow’s inability to break above a major resistance level of 7,676 leaves doubt that the downtrend has come to an end.

I mentioned in previous writings this month that Volatility Levels are starting to drop. This is generally my first signal to anticipate a potential stock turnaround. The second step would be to look for a basing pattern in the charts.

With the Dow at least rallying this month, I will look for one of the following two scenarios to play out in April. Either the market will drift, potentially setting up for the three month test of the February lows, or the market will bounce down from the 4-month moving average and make new lows.

The following graph illustrates Scenario #1 …




SCENARIO 1: The three-month test of the low scenario might be the best possible outcome. Should the average remain stable, closing next month little changed, the price could rest right on the four month moving average. Then in May, we would be closely watching to see if the Dow could hold the February closing low of 7.062. Should we hold the 7,062 low, look for a long-term rally to begin.

Again, with the volatility indicator reversing, it’s very possible that price will drift sideways. While the above scenario could be the best scenario a variation of this is that the market will continue to drift sideways until it meets the ten month moving average (the red line). It could take another six months of sideways action to meet the 10-month moving average.








SCENARIO 2 is not as friendly and more probable considering the uncertainty that surrounds the banking system, auto industry and other sectors of the economy. As I have mentioned several times in the past month, markets almost always try to come back and test key areas of support and resistance. By not being able to maintain above the 7,600+ support level, chances are that the market will sell off in April, making new lows.


The battle for supremacy was fast and furious as expected. Like a battle between two prize fighters, the Bears were getting beat badly as the Bulls pushed the Dow towards 8,000 last week. The Bears though were not giving up and staged an attack starting on Friday, pushing the Dow down into the 7,400 area! The Bulls came back today, pushing the Dow up 200 points, above the support level.






In the end, the Bears again took charge, driving it index down below 7,600 at the market and end of the month close. Only last minute settlements brought the Dow above 7,600. There truly was a monumental battle here between the Bulls and the Bears. The Bulls could not hold their ground in the end. I'm sure that we will quickly learn whether the Bears will remain in control. As I write around 8:50 pm, already Dow Stock Index Futures are trading down to the 7,500 level.

GROWING CONCERNS

Believe me, I would love to be a fundamental analyst. But accounting data seems to be so manipulated, numbers massaged, footnotes everwhere. Who can tell what is going on? And if you wish to analyze various segments of most corporations, that data does not exist in public information. I fear that fundamental analysis will take another hit with the proposed Mark-to-Market (MTM) changes. What is MTM all about?

MTM is commonly used in the futures and other derivatives markets. At the end of each trading day, gains and losses are settled up. If you have a position that gained in the day, money from the loser would flow to your account. If you were the loser for the day, money would flow out of your account. If you don’t have the money, then you will get worried calls from your broker asking you to please, at your earliest convenience (by the end of the day) to add funds to your account or the position will be closed out.

The big reason that MTM is causing so much concern now is because many of the mortgage based instruments cannot be valued because the housing market is so volatile. If you can’t value the assets on your books then how can you determine what the bank is worth and how much cash they need to protect themselves and their depositors. What the banks are proposing is that changes be made in the accounting standards to allow them to value these “value-less” assets at face value instead of the current market value (which is very low). This would allow banks with very risky positions to look great on paper. Another blow to those who really want to understand the fundamentals. Without real transparency, is it worth it to buy bank stocks in the future?


THE US DOLLAR AND MTM

The government could be supporting the MTM accounting changes for other reasons as well. Recently, the Federal Reserve Bank announced that they would be aggressively buying long-term treasury notes and bonds in an effort to lower interest rates, helping to bring mortgage and other credit rates lower. The problem with this action is that the Fed is buying Treasury securities at very high prices and reporting them on their balance sheet to support the integrity of the US dollar. What would happen though if interest rates do advance sharply? Bond prices move inversely to interest rates so if rates advance, bond prices would fall. And the longer the maturies are, the more volatile the price movement would be.

It’s not inconceivable that bond prices could fall 25%! Imagine what impact that could have on the dollar from an integrity standpoint. If the assets backing the greenback decline in value (or become worthless as could be the case for some “toxic assets” they are holding), foreign investors could exit their positions in the dollar en masse! BUT WAIT! No no no! We don’t use the mark-to-market any longer. Our devalued investments can still be valued at face value since someday, we expect that they will reach maturity and we will get all of our money back. Will investors continue to be deceived? Or perhaps there is just no place else to go with money.

Dow Surges - BULL MARKET?

Dow Surges – New Bull Market?

The Dow Jones Industrial Average surged from a March 9 low of 6,440 to a high of 7,969 before falling back on Friday to close at 7,776, up nearly 500 points for the week and up nearly 1,100 points over the past three weeks! Virtually every sector of the market rose this past week with the exception of bonds and gold. Many commentators began stating that with the Dow’s upthrust of over 20%, “we are now in a BULL MARKET!”





In an effort to keep things in perspective, notice how the Dow average has rallied to the four-month moving average. A review of my universe of stocks reveals that many stocks are following this pattern. Will this be a level of resistance?

As I mentioned in my last post, it appeared that volatility levels were finally reversing indicating that the market could be starting to moderate. Be careful however not to get sucked into the euphoria that dramatic market moves instill. Be patient and wait for solid chart foundations to appear before making a move. Also consider that the 7,600 level on the Dow had previously been a strong support area. Before any sustained move can develop, the Dow will probably have to come back and successfully test this level.



TECH STOCKS ROCK

While many stocks and market averages appear to have risen only to a falling trendline, many TECH STOCKS are showing different patterns.





PowerShares QQQ Trust (QQQQ – 30.82). Notice how the QQQQ, an exchange traded fund that represents the top NASDAQ stocks, has tested its previous price lows and is now rallying. Notice also that it has risen well above it’s four month moving average, indicating strength. A review of technology stocks shows that quite a few have not only tested lows and established a base, but are at or above RISING four month moving averages.



Qualcom (QCOM – 38.94) is a prime example of a stock that made a three month test of the lows. The stock price has surged 16.5% so far this month. Strong base, rising trendline, I would expect this stock to continue rising.




Research in Motion (RIMM – 45.01) has jumped 12.7% this month after successfully testing the December lows. Even a move back to its recent high of 60 would generate a 33% return.


RETAIL STRONG

In our March 1 posting, we said that there were opportunities in Retail as well as Technology and recommended Kohls Department Store. As the chart shows, we were right on with our pick. Kohls (KSS – 43.14) has surged 22.8% this month. Other retail stocks have also done well: Gap (GPS – 13.05, +21%) and Best Buy (BBY – 38.04, +32%) were also on our client pick list.





WHAT’S TO COME?

Next week offers more excitement as President Barack Obama is expected to release details of a new $22 billion bailout package for General Motors and Chrysler. How the market will react to this and other news is anyone’s guess at this point. With the Dow just 100 points or so above the important 7,600 support level, my guess is that the Bears aren’t done yet and will try to drive prices back down.

With the end of the month falling on Tuesday, look for my end of the month blog that will include not only the US stock market, but also the Mexican market and the Mexican Peso.

Investment Picture May Improve

The Showdown!!

Stock market averages staged impressive rallies so far this week and with just one week left to go before the month ends, expect that the market action will be fast and furious. The bulls and bears will be battling it out over the market's current level - Bulls trying to take it higher and Bears trying to take it lower. As I had mentioned before, it's normal for a market to come back and test the former support level (red line). What had previously been strong support can now be expected to be strong resistance.



There are some signs (in this moment) that the market may be beginning to stabilize. First of all, the Volatility indicator that I have discussed in previous blogs appears to finally be reversing. This shows me that the downside momentum is finally slowing for the first time in seven months. Usually, when this happens, price will either go sideways until it meets a trendline or rapidly move to the opposite extreme which currently is at Dow 12,700!



INTEREST RATES PROVIDE A CLUE


Another thing to consider is that in normal times, stocks and interest rates tend to move in the same direction.

As I have been pointing out (as early as 2005 http://marketreality.blogspot.com/) normally interest rates and stock market movements are highly correlated. This allows us to be diversified among asset classes and help us receive moderate returns year after year. Starting in 2004 however, interest rates and the stock market prices began diverging. This resulted in both stocks and bonds rallying sharply. (Remember, bond price rise when interest rates decline.) The chart above shows the divergence with stock prices rising and interest rates falling. Finally, the stocks dropped and came right to the level of the 10 year interest rate! It's possible that once again, markets will start acting somewhat predictably with stock prices and interest rates again being correlated. With the massive amount of government intervention in the markets though, who can say what might happen.


BUT, if stocks and bond rates begin to act as they should, moving in correlation, then there could be good news for stocks and here is why. In December, we saw interest rates plummet as the Federal Reserve threatened to manipulate the bond market to meet its objectives. The 10 Year Rate fell to below 2.25%. But we can see that even as the Fed outright stated that they would buy $300 BILLION of long term treasuries, rates did not yet fall below December's lows! If you have been reading some of my other posts, you might recognize one of my most favorite patterns, the Three Month Test of the Low.

If this pattern holds, then we can expect rates (at least in the 7-10 year sector) to rally. Stocks should follow suit.

Rising rates would not be good news to US Treasury Secretary Geithner nor Federal Reserve Chairman Bernanke as their goal now is to bring long term interest rates to as low a level as possible. And while the government may be bigger than many billionaire investors who prefer to stand back and let the government do their thing, the government IS NOT BIGGER than the global market for US Treasuries.

Wag the Dog Redeux

WAG THE DOG

One of my favorite, thought provoking films from the past, is "Wag The Dog," featuring Dustin Hoffman and Robert DeNiro as the master of political subversion. The then current president, up for reelection, was caught in a sexual misdeed. In an effort to minimize or eliminate the fallout from the scandal, DeNiro created a fictitious war with Albania, dominating the news for an extended period of time while the president moved on, unscathed by the scandal.

I can't stop thinking that somehow, the fury over the AIG bonuses is somehow an attempt to shift our attentions to something that in the end is pretty much irrelevant. What is going on that we are not seeing? Can it be true that are government officials were so incompetent to allow the Executive Branch of the government to remove bonus provisions from the AIG bailout bill because of potential lawsuits? Hey, our government is run by and for lawyers. Why would they want to reduce lawsuits??

Are we to believe that the President and the Treasury Secretary had no knowledge of the bonus provisions? And the Congress! It seems that everyone has said that he or she did not read the bill. One congressman stated that on his right was an 800 page document and on his left, an 1,100 page document and he had to vote on it in hours. It's really nice to know that our elected representatives take their responsibilities to us so seriously. Across the board, both the executive and legislative branches of government are admitting incompetence! And then the ensuing legislation to tax bonuses at 90% - where is this intense concern regarding lawsuits now? Somehow, someway, this doesn't at all add up. I thought that Obama was a bright guy. I was pleased to see that he was appointing highly educated and seemingly qualified people to run the government. My fear is, perhaps they are too smart and again, the American people are being deceived.

What might we be missing?? If you have any ideas, please contact me at gary@assetdesigncenter.com.


FED TO BUY GOVERNMENT DEBT

The announcement that the Fed would spend more than a trillion dollars to buy mortgage backed securities as well as long-term treasury securities caused bond prices to skyrocket on Wednesday. While it appeared to many to be a surprise, I had mentioned the possibility only last week. The bond and note options market was also reflecting something this week as call prices (options to buy a security at a given price in the future) were very expensive on Tuesday and Wednesday. Many were betting that something big was going to come out of the Federal Reserve's meeting. Sure enough, the announcement rattled the markets.

Stocks surged BUT COULD NOT GET TO 7,600! We mentioned in our last communication that the rally should be used to adjust portfolios as a move to 7,500-7,600 was an expected scenario. In our short-term portfolios, we sold certain bank stocks such as Regions Financial (RF - bought below $3.50 and sold above $5), General Electric (GE), ProShares Ultra S&P 500 (SSO) and bought Dow Industrial Ultra Shorts (DXD). We also lighted up on positions of ProShares 20 Year Bond UltraShort (TBT) (but only in trading accounts). Our only activity in our core portfolio was the addition of Power Shares short Dollar Fund (UDN) (our trading accounts already have been positioned in this as well as Power Shares Agriculture Fund (DBA). Our core portfolio is up 2.81% year to day with still more than 40% cash on hand.

Despite the Fed's move, the surge in stocks and bonds was short lived. Stocks could not get above the resistance level of 7.600 and bonds began retreating. We need to wait however to see how this will be resolved. The next assault on our senses is expected to come next week when Treasury Secretary Geitner reveals the “long-awaited” Toxic Assets plan. The plan is expected to be a government and private joint venture to take the bad assets off of the books of banks and other government supported financial institutions. At this point though, why would any private organization want to participate? What will be the incentive to reap gains? Salaries of those in companies participating in the plan might be capped and any bonuses could wind up being subject to the 90% tax provisions Congress is now trying to get through.

What a mess.

IN THE END

While there are sure to be many great trades in the market, long term investors need to be hunkering down for what is to come. The government is spending too much money and the Federal Reserve is printing too much money. The government and Fed are still trying to manage the economy. For those with risk-averse profiles, Treasury Inflation Protected Securities (TIPS) might be the place for you to look. Unlike other types of fixed income instruments, TIPS gain in value in inflationary times, increasing in value as the inflation rate increases (increasing your interest payouts). While the government and Fed try to assure us that they will take measures to keep inflation down once the economy heats up again, keep in mind that the Federal Reserve’s move to dampen a heated economy by raising interest rates several years ago seemed to be the impetus behind the mortgage meltdowns. The Fed raised rates from 1% to 5% in a very short time, causing credit card rates and adjustable mortgage rates to soar. This was the beginning of the meltdown. They propose to do it again. President Obama declared that there will be no more boom and bust cycles. If he truly wishes to get rid of boom and bust, he must eliminate the federal reserve system.

For more information or to share your thoughts on these comments, please post an opinion or contact gary@assetdesigncenter.com

FED to buy Treasuries

As mentioned previously, the possibility that the Federal Reserve Bank would enter the treasury market to drive down rates and increase liquidity in the system was a strong possibility. IT HAPPENED!

Today, B. Bernanke, Federal Reserve Chairman, announced that the Fed would go on a spending spree, buying $300 billion on long term treasuries as well as purchasing mortgage backed securites.

Treasury securities rallied sharply. 10 year government rates fell below 2.5% and 30 year rates fell below 3.375%!


It's not a fair market! While we were positioned for this and recommended to be long in the interest rate instruments short term, the long term damage that the fed is doing will only drive the US into ashes.

Accompanying the bond move, the Dollar fell sharply against major currencies.

The basic investment premise put forth at the beginning of the year still holds true. While bonds look like they will continue to rally as the government is going to buy buy buy, look for opportunities to take positions in the TBT (Double Short long term bond ETF), currently at 44 (we entered into this initially at 37 so we are still not adding to our position here). But you should take a position in the Short Dollar Exchange Traded Fund (ETF) (Symbol UDN) currently 25.45.

AIG bailout vs bankruptcy

Asset Design Center Reviws AIG

WASHINGTON – Leaders of the White House economic team and the Senate's top Republican bellowed about bonuses at a bailed-out insurance giant and pledged to prevent such payments in the future.
From one Sunday talk show to the next, they tore into the contracts that American International Group asserted had to be honored, to the tune of about $165 million and payable to executives by Sunday — part of a larger total payout reportedly valued at $450 million. The company has benefited from more than $170 billion in a federal rescue.


Unfortunately, Government action caused this to happen. Why do we allow our representatives to act on impulse without knowing what they are doing???

We are fools for letting these people stay in office.

AIG Merrill Bonuses Rattle Regulators

AIG, whose fourth-quarter loss was the worst in corporate history, earmarked $1 billion in retention pay for about 4,600 of the company’s 116,000 employees so they won’t leave the crippled insurer. Liddy has vowed AIG will repay “every penny” to the U.S. for its bailout package by selling subsidiaries, and said the retention pay for talented people helps taxpayers by making the units attractive to buyers. (By Hugh Son and Robert Schmidt)


Reactionary tactics are killing the US Government. Bail out first, see the results later. Just like with GM, personnel costs are killing companies. Bankruptcy seems to be the best method to sort things out, under court supervision. The rush to bail out these companies is surely the wrong approach. Circumventing the laws were a part of the Bush administration. Let's move on.

China Worries

Fool Me Once, Shame on You, Fool Me Twice… China Worries

“I’m a little worried…,” Wen Jiaboa, Chinese Premier.

This week, much attention has been directed to the fate of Bernie Madoff, the former NASDAQ exchange director who pulled off the biggest Ponzi scheme in history, defrauding investors of at least $50 billion. But let’s face it, there is still a bigger ponzi scheme in the making and China is now fearful that it will be left holding the bag! As US President Barack Obama continues to spend trying to stimulate the economy and implement his social welfare programs, major investors are only now starting to worry about the “credit worthiness” of the US.

China has reportedly already lost more than $5 billion in other US investments and as of the end of 2008, had become the largest lender to the US owning more than $696 billion in US Treasury securities. Reportedly, China’s investment in US Treasuries is losing 2.7% this year and even the mention of their concern impacted the bond market this week. China wants “guarantees” of their investments and pressed US authorities to manage their financial affairs appropriately.

But as a heavy supply of debt continues to flow into the market, how can high bond prices be sustained? How can we circumvent the basic laws of supply and demand? President Obama tried to assure the Chinese by pledging that the US deficit will be cut in half in four years…

China is stuck. It cannot sell the bonds as even the mere thought of this idea will surely send the bond market plunging (resulting in losses to them). They have no choice but to continue to invest heavily in bonds to keep the market afloat. What else supports the US bonds? Only the government’s ability to tax. Ouch.


At the Heart of Financial Planning

Recently, when asked what I do and I responded that I am a financial planner, the response was, “oh, one of those!” But the truth is, a real financial planner can be more valuable to you now, more than ever. I chuckle each time I see the typical “scare tactics” emerging from the right on how small businesses are going to get hurt due to President Obama’s new tax ideas. People who believe this have obviously never worked with a competent financial planner.

A true, fee-only, financial planner is not going to be selling you investments, insurance or other products, the financial planner is going to review you situation to see if your other advisers are providing competent service that is appropriate to your needs. And most importantly, a good financial planner is going to have a strong command of the tax laws so that you can find ways to manage your taxes more efficiently. Let me make it clear, most financial planners are not CPAs and do not provide tax advice per se. But they should have the expertise to be able to review your taxes and point out strategies that will enable you to reduce and/or defer taxes and possibly eliminate future taxes.

Republican Criticisms
Grassley said Obama's budget proposal to raise taxes, starting in 2011, on individuals earning more than $200,000 and on households earning more than $250,000 will hurt small businesses.
"These small businesses happen to create 74 percent of all new private sector jobs in the United States," Grassley said. "Tell these business owners their taxes will go up. Odds are, they'll cut spending. They'll cancel orders for new equipment, cut health insurance for their employees, stop hiring, and lay people off."
1.
They’ll cut spending. Why??? Seems that all of the business owners that I know spend lavishly on entertainment, travel and other business-related activites so that they won’t have to pay taxes. Being a business owner is a lifestyle, at least being a successful, tax-efficient business owner is.
2. Cancel orders for new equipment. I admit that I don’t know if the rules for depreciation and amortization have been repealed, but business owners and rental property owners strive to take maximum use of such deductions. In 2008, business owners were allowed to immediately expense certain pieces of equipment up to $250,000 (higher limits apply in some cases). You can even write off up to $25,000 on your new SUV! I doubt seriously if such deductions will be changed.
3. How sad that a small business owner who has net income in excess of $250,000 would lay off people and/or cut their health insurance. At some point, business owners need to understand that they have a social responsibility. If you are clearing $500K a year and not taking care of your employees, then you probably should be paying higher taxes. Why should the rest of society be picking up the tab for healthcare for these people when you fully have the resources to provide for them?
4. Tax deferrals through Retirement Plans, Welfare Benefit Plans, Profit Sharing Plans, Volutary Employee Benefit Plans,… on and on and on. The tax planning strategies for business owners go on and on. If you are paying too much tax, then you absolutely need to work with a financial planner. While you may balk at the fee you need to pay, a good financial planner should be able to immediately look at your situation and show you many ways to save money. These savings should far exceed the fee you are paying.
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My Last Concern

The stock market bounced nicely from oversold conditions this week. The market was due for a bounce. Whenever a stock price breaks above or below a major level of support or resistance, it will normally try to come back to that level. I had identified the 7,500-7,600 level on the Dow average as a major support level so for the market to rally back to this level would not be a surprise. Be aware of this market level and be prepared to either improve your current portfolio here (closing out unwanted longs, adding diversification to protect you against any future downside, etc.).

What concerns me the most here is the news that appears to be driving this market move. First of all, as I mentioned previously, I do believe that the market wants to see a resolution to all of the wrong-doing that has been going on. No doubt, Bernie Madoff going to jail was a happy moment for many. Hopefully many more crooks will be identified and jailed but we here at Trendsetter won’t hold our breath.

Other news that sparked the markets was key banks reporting that the are operating profitably. But what does this really mean? Certainly with the billions of dollars that the government has provided them and considering that they aren’t lending out this money, only the biggest spendthrifts would not be profitable. We already caught one spending millions redecorating his office. So lavious expenses are being held in check.

At the end of the quarter though, when banks come out with earnings, sure, they will say that operating expenses were low and that they would be profitable without the massive writeoffs that they may need to take. It’s not that the banks have not been able to run the day-to-day business profitably, the problem is that they made huge, risky bets and shifted lots of it off of their balance sheets. Still, we don’t know how to value these bets since there is no market for it. Well, let me clarify, there is a market but the banks are not willing to recognize the losses.

AND OUR GOVERNMENT…

In their infinite wisdom is again trying to tinker with the market.
Mark-To-Market
Banks want to get rid of mark-to-market while investors and regulators want to keep it. How else can we have any clue what a company is worth? Already investor information is scarce. Public information is reported on a consolidated basis and true fundamental analysis is impossible. Plus, financial information is managed and accounting gimmicks prevent investors from seeing reality. If this were not true, how did we ever get to our current situation? How can investment analysts continue to earn their millions on Wall Street and have missed what was happening?

Already, the government allowed the banks to leverage up to levels way beyond their capacity for risk management. They further extended their exposure by creating derivative products that even the chairman of the Federal Reserve admitted he can’t figure out. And now the banks want us to value these items at full value?????? Avoid bank stocks unless you just like the action.

ON THE BRIGHT SIDE

Our diversified 2009, $100,000 portfolio closed the week with a value of $102,475. Our cash reserve still remains at a little more than $43,000 Our most recent recommenation of Kohls Department Store closed at 38.22 on Friday. We purchased it at the open on the Monday, March 2, following our recommendation at $34.80.

10-Year Note Futures Options


Our Treasury Note option trading won more than 3% on each $10,000 unit this week. Note that the April 124 call position is still open and marked-to-market at Friday’s close.



As the stock market increases, bond and note rates have been rising. We expect volatility however to remain confined between the two trend lines noted on the chart above. The high point is 3.38% and the low point is 2.76%. While volatility diminishes, selling options enables one to reap generous short-term gains.

Bernie Walks

Bernie Walks, Shoe Thrower Gets 3 Yrs

Bernie Madoff, the former US equity exchange director, pleaded guilty to defrauding clients of more than $50 billion dollars. The judge, citing investor incompetence, dismissed the charges. Meanwhile, in Iraq, a journalist who threw a shoe at former US president George W. Bush, was sentenced to three years in prision.

While it’s not true that Bernie is free, he remains in “house arrest” in his $7 million penthouse while investors, charities and other organizations lose their money. Seems that people who have a deep conviction about their civil liberties get punished harder than those of destroy the lives of hundreds, thousands or millions due to capitalist fraud and deceit. And Bernie is not talking. He transferred billions to family, friends and businesses and there is no doubt that his heirs will live richly at the expense of others, whos lives are destroyed by his criminal activity.

Bernie is just one of these who have totally destroyed the integrity of the capitalist system. Until there is CAPITAL PUNISHMENT FOR CAPITAL CRIMES, there is no reason to support the capital system. Consider taking your money from investment accounts and transferring money to gold or other tangible assets that may have value in the future.

Beware of false profits

Beware of False “Profits”

The Dow Jones Industrial Average surged more than 5% today rallying to 6,926, up nearly 380 points after Citigroup reported that it had “operated” at a profit for the first two months of the year. What is even more disturbing is that many noteworthy stock market experts have been coming on the stock market channels this afternoon claiming that we have made a bottom in the stock market.

At the end of February, I had been anticipating that the stock market could bottom. I had been looking for support on the Dow average at the 7,500 level along with support for a large number of stocks that I watch in every industry. But the Dow broke through this important level of support and the majority of stocks followed. While “doom and gloom” continues to be pervasive on Wall Street and in the minds of most investors, this positive comment sparked a surge in the market.

But what does it mean???? Do you really believe what bank executives say? I can cite dozens of examples where corporate executives and government officials as well have reported to us that all is well. But then a month later, company stock prices and even economies collapse. It’s clearly evident that CEOs of major corporations and key US government officials don’t really have a clue….

And what does this mean? They are “operating” profitably. I don’t think that the problem is that we have too many unproductive employees making salaries that exceed corporate revenues. There is no doubt that these corporations can function profitably. It is the massive writedowns and inability to price toxic assets that have been driving the financials down.

DON’T GET SUCKED IN

Bear market rallies are short and swift. Look at the weekly chart above. The Dow has only rallied to a trendline that is declining substantially. Don’t react to massive market moves emotionally. Here at the Trendsetter, we analyze our data and look for a number of factors to consider before making investment decisions. One important factor is Volatility. As mentioned before, when the volatility levels continue to expand, you must stay with the trend.

On a monthly basis, Size or my indicator of volatility, continues to gain strength despite today’s rally. For long term investors, be careful about entering markets that still have increasing downsize momentum.

In addition to watching this indicator, I like to see a test of the low. When we see such a test, especially with monthly data, we have some confidence that we have seen a bottom. I never trust a bottom that has not been tested. If we rally hard from existing stock market levels without having a three or four month test of the lows, I will always be looking for “shorting” opportunities, opportunities to play a stock or index to go down.

In our last issue, I recommended Kohls and mentioned that a number of retail stocks appeared to be ready to accumulate. A key reason for making the recommendation was that Kohls in fact made a three month test of the lows.



As can be seen in this chart, Kohls appears to have bottomed and is now headed upwards. While it may meet resistance at trendlines above, my experience has shown that when a stock establishes such a base (or topping formation), the ensuing move will be substantial and sustainable.

After hearing so many market gurus claiming that the bottom of the market is in, I reviewed my stock market data base, looking at monthly data. Perhaps IBM and one or two other stocks appear to be setting up to be buys in my end of the month newsletter. But as seen a month ago with I did a mid-month review, more than 100 stocks looked like potential buys but in the end, the market collapsed and I had very little to offer to recommend in the previous newsletter.

WHAT ARE WE WAITING FOR??

I heard it well put the other day what we are waiting for. I don’t believe that the problem with the stock market is valuation. There is no doubt that many companies are strong and are going to do well in the future, but the stock prices are not reflecting it. The problem is a lack of confidence in the capitalist system. We want to know, what happened? Who is responsible for this disaster. Will there be any accountability? Let’s face it, if heads don’t roll over this market meltdown, why would anyone ever again want to invest in the stock market?

It wasn’t that long ago that accounting fraud seemed to be a little pervasive in the US corporate world. Arther Anderson and other key accounting firms no longer exist because of funny accounting. I seem to remember that corporate CEOs and members of the Boards of Directors could be imprisoned if their financial reporting was wrong. But I haven’t heard anything about this now. Were the US laws and regulations so lax that no one can be held accountable for this? Then for sure, the regulators who were charged with ensuring that our financial and capitalist system remains viable should be prosecuted to the fullest extent. The grief that this financial meltdown has caused is so much more severe than any mass murderer has ever caused. The number of people affected by this terrible situations is much more harmful, in my opinion, than even 9/11. Millions and millions of people are now without jobs and families throughout the country, throughout the world, are suffering, while those who caused this problem are living their millionaire lifestyle, probably unaware or uncaring of the harm they have caused to the world’s societies.

If these people can go unpunished and no one held accountable for the problems that we are facing now, how can anyone ever have confidence in this system ever again? While my job is to provide financial planning and give investment ideas, how can I ever explain fraud, corruption or other evils that wipe out our savings and destroy our future? I can’t.

One thing that I know for sure, the market will do everything it can to take your money. Please be careful and don’t get sucked in to these bear market rallies.

Dow and Other Indices Tumble to New Lows

Dow Tumbles to New Lows

The Dow Jones Industrial Average plummeted 938 points in February, falling 11.7% from January’s close. Breaking below the long-term neckline around 7,600 was a wake-up call for myself. I had high hopes that the average would hold this line and had identified dozens of other stocks that appeared to be testing low levels.

As discussed in previous writings, one must stick with the trend as long as Size, my volatility indicator, continues to rise.

Size, or volatility, as a percentage of the current Dow average is nearly 25%. This, by far, is the most volatile time in the stock market at least since 1979, the beginning of my market information database. Even the great crash of 1987 saw volatility increase to 15% and during the 2002 decline, volatility levels reached 11%. For some investors, high levels of volatility is bad. But for others, volatility is good. Higher volatility offers the possibility of higher return for those willing to participate and invest in such a market. A case in point, the 10 month average for the Dow Industrial Average is currently above the 10,000 level. As in most “normal” observations, one can reasonably expect prices to revert to the “mean” or average once some certainty is restored to the market. Such a move now could result in a 40% gain!

One way to exploit high volatility is by selling options. An important component of an option price is volatility. As such, premium payments received for selling options now can be quite high. In our initial portfolio for the year, we bought some stocks but also sold stock options expiring in January 2010 to add some protection against possible downside. Despite huge moves in our stock and option positions, our base $100,000 porfolio stands up about $1,800 on the year or +1.8%.


The model portfolio held up well despite the current market volatility. Most of the individual stock issues were hedged with offsetting long term call options designed to enable us to weather a 30% or more drop in the stock price without us losing in the position. Despite our hedging attempts, the severe drops in BB&T, a Southeastern banking concern and AMR, the American Airline holding company, both dropped significantly. Our breakeven prices for BB&T is 21.46 and AMR is 6.47. The Kroger position is unhedged and is down from the $26 level.

The bright spots in our strategy was selecting the Dow Industrial ProShares Ultra Short instrument which rises 2% in value for each 1% the average declines. Our second best position was a similar position for the bond market.

As the monthly chart above illustrates, bond rates jumped sharply from the panic lows set in December. Bond prices fall when rates rise. Rates may continue to increase a bit more, perhaps reaching the 4% level on the 30 year index. Expect rates then to fall back in March and perhaps April as the market tries to test the rate lows of 2.69%. Successful support here would prompt me to add to my position both using Exchange Traded Funds as well as shorting bond futures and calls on the futures. While I am standing pat in the long term core portfolios and continuing to hold the Ultra Short Bond positions, in our high performance managed accounts, I am shifting our short term bias to be bullish on bonds.

I expect that rates will not go below the previous low of 2.69% but I also did not expect that the Dow Average would break below 7,500. As mentioned before, once momentum begins, there is no telling where it will end. We also face the possibility of government intervention in the bond market. While the Federal Reserve did not actually enter the bond market in December or January, the discussion of this possibility to reduce interest rates and increase the availability of low-cost credit caused the rates to drop precipitously as seen in the chart. Should the markets continue to move lower, as all evidence indicates that they will, expect the Federal Reserve to at least begin discussing their intentions to do everything they can to bring down interest rates in the hopes of stimulating the economy. As one famous investor commented when asked why he is not currently shorting the bond market, “the Fed has more money than me.” Such a move by the government can reduce rates to any level they wish as traders will have no recourse but to step aside. But in my mind, this type of action is one of the key reasons why the markets are falling as they are. They are no longer free markets.

ON THE BUBBLE



Getting stronger by the day is the US Dollar. I regret that I did not become an Economist as I fail to understand the logic behind the increasing value in the dollar. In my training, I learned that there were principals of supply and demand. The more supply that is available the lower prices should be and demand should not consume the higher supply. This concept does not hold true for the US Dollar nor for US Government debt. The US Treasury continues to auction off more debt but interest rates remain low. The Federal Reserve continues to print trillions more dollars and the value of the dollar goes up. While most of us probably are not going to review the Federal Reserve’s balance sheet to see exactly what kind of assets are backing the integrity of the US Dollar, I can attest that some of the collateral is so-called “Toxic Assets” named Maiden Lane. This is the toxic debt of AIG. The majority of the balance sheet, providing the backing of the dollar is Treasury securities. Imagine the incentive that the Federal Reserve has in keeping the value of Treasury securites high. Falling bond and note prices would undermine the integrity of the dollar! I believe that it is just a matter of time, no matter what the government does, before the US Dollar will collapse.

At some point in time, ESPECIALLY if the economic downturn continues, we are going to see China start selling treasury securities. We will see Saudi Arabia and other countries dollar rich through oil sales needing to raise capital. Will we let them continue to hold their treasury securities and offer them financing? I imagine that the US Government and Federal Reserve will go to great lenths to preserve the value of bonds and the dollar, but it can’t last. When bonds and the dollar collapse, where will one be able to find some investment security?

Thus far, I have had success with our prime hedges in the core portfolio: the short dollar and short bond positions. Also, I have been accumulating positions in OIL, an exchange traded security that moves similarly the the oil futures market. While I have made two OIL purchases thus far in the core portfolio, in other accounts, I have purchased shares incrementally down to the $14 range. I will continue to add as prices warrant. I have also established positions in a Gold exchange traded fund, ticker symbol GLD. Hard assets such as oil and gold should rise when the dollar declines.

In addition to gold and oil, other defensive exchange-traded vehicles to consider are the PowerShares US Dollar Bearish fund (UDN) and the PowerShares Agricultural Fund (DBA). As I discussed, I believe that the underlying assets supporting the dollar will eventually decline perhaps resulting in a mass exodus in the Dollar. Investing in hard assets that have some tangible value will prosper. While I have not gotten technical buy signals on UDN or DBA yet, I have begun to establish pilot positions in certain managed accounts and recommend that pilot positions be established in most portfolios.

The theme here is to be defensive in your positions. A big reason why so many lost so much money could have been because although portfolios might have been diversified, the assets were too correlated, meaning that they all moved up or down together. It’s important to have a good variety of uncorrelated assets even including put options against an existing stock or portfolio, short calls, exchange traded short position funds and other instruments that will move up when the stock market moves down.

When selecting your money manager, make sure that he or she is competent in all available instruments to help you design a portfolio providing the return that you require at the least amount of risk.

STRENGTH IN RETAIL


Surpringly, a number of retail stocks appear to be in a good position for accumulation. Consider adding Kohls to your portfolio but as with all other stock purchases at this point in time, I also recommend that you sell a January 2010 call option to protect yourself in the event of further decline. Currently Kohls sells at $35.40. The January 2010 $35 call is currently fetching $7.20. Buying the stock and selling the call would result in a cash price of $2,820 per 100 shares with the potential maximum gain of $3,500 or more than 20%. If you are even more risk averse, consider selling the $30 call against the position. With the call fetching $9.80, your cost would be $2,560 with a potential payout of $3,000, still a strong return given our current market – while receiving 30% downside protection.

While the buy list this month is limited as most stocks made new lows along with the indices, there appear to be some opportunities not only in retail but technology as well. We will be adding the Kohls buy/write position to the core portfolio at the market open on Monday morning.
WHERE DO I START?

So many people are confused now. What do I do? Whom do I trust? The problem is though, most people don’t know what their financial position is now nor what they need to do to achieve their goals. I always strongly recommend that you engage in a comprehensive financial plan to first, establish what your goals are and to see what condition you are in today. You need to visit not only your investment holdings, but also your cash reserves, your tax situation, your insurance and other important areas of your financial life. Only then can you even begin to understand what you need to achieve financial success.

Too many people are only interested in making as much money as they can. We have been told over and over again that we need to be patient and diversified but our current situation shows that perhaps the conventional wisdom just doesn’t hold true anymore. While the classic Brinson & Associates study showed that 91% of wealth was gained through asset allocation, ask anyone who invested in the last 10 years and they will tell you that this ain’t necessarily so! So what is the solution? What do we do? How should we invest?

Being diversified in line with modern portfolio theory appears to work in some years but not others. I remember, years ago, as a mutual fund salesman, I was impressed with a certain fund that returned 10% every year. When compared, over time, with the high tech funds that returned 80% in some years but down 40% in others, the slow and steady 10% outperformed the rockin high tech fnd! How hard is it to earn 8% to 10% annually with a low amount of risk and a high level of probability??? Not as hard as you might imagine. Just look at our example with Kohls Department Store. We can develop risk management strategies using options sold against our stock position to reduce our risk and define our return. A well rounded investment professional with experience in stocks, bonds, derivatives and other investment tools can design a portfolio providing you with a high probability of receiving the return you require with a reduced level of risk. If you knew that you could achieve your goals by being conservative, why would you not do it? Achieiving financial security in your lifetime should be your key financial goal.

Who would go to the doctor and learn that they had a serious ailment and ask the doctor for a more risky remedy than they needed? It could be suicide! Why risk financial suicide? You need to understand what your required rate of return is and achieve this goal with the least amount of risk possible. If you have additional funds outside of your goal setting savings, only then should you consider riskier investments.

INVESTING IN MEXICO OR U.S.?

Many in Mexico have been reluctant to invest now in the US as the US Dollar is too expensive. But despite Mexico’s very strong balance sheet. the value of the peso has continued to plummet against the US Dollar. As the next chart shows, the momentum continues to be strong (in favor of the US Dollar). At the end of January, one dollar bought 14.34 pesos, up sharply from the steady state between 10 and 11, that the peso enjoyed for so long. At the close on Friday, the dollar bought 15.25 pesos, an increase of 6.3% in February. While the Mexican government has tried intervening to defend the peso, at some point in time, they will have to abandon their defensive posture. Until the US economy shows signs of improvement and oil prices begin rising, the outlook for the peso is not good.

Owners of Mexican Pesos would do well to hold at least a portion of their cash holdings in US Dollars or even better – gold or silver coins. Another important reason to hold some investments in the US is the availability of products that you can use to truly diversify your portfolio.
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Trendsetter is produced by Gary Lewis, CFP®, ChFC, MBA and is intended to be of an informational nature only. Recommendations mentioned in this writing should be implemented only after reviewing your specific situation with your investment adviser or financial planner. Also, prices used in this publication change and could be very different than reflected here. Gary Lewis and his clients may own investments mentioned in this newsletter.

Gary Lewis’ portfolios take advantage of his almost 20 years experience working as a specialist in the deriviatives industry and over 30 years working with investments. He specializes in designing portfolios that meet the client’s required rate of return with a minimum of volatility. Using a comprehensive financial plan as a starting point, Gary helps you to determine your action plan. If you wish, Gary can help you implement the plan so that you can achieve your future financial goals.

In addition to holding the Certified Financial Planner (CFP®) certification, he also holds the Chartered Financial Consultant certification (ChFC) and has earned an MBA in Finance from Northwestern University. Gary currently resides in Mexico City.

For more information including a pdf containing illustrations, contact Gary at gary@assetdesigncenter.com.
More blogs available at: http://assetdesigncenter.blogspot.com/ and http://marketreality.blogspot.com/