Is the Market Rally Done?

Facts:

The market has just made its first foray below the 20dma (twenty day moving average - a commonly used technical indicator) since the breakout in early March - been below for the last 2 trading sessions - note that all graphs below depict the Nasdaq Composite...

In 2003, the market made its first foray below the 20dma around the same timeframe and stayed there for 3 trading sessions, during which time the market sold down about 2 1/2%. It did not step below the 20dma again till another month had passed...it stayed there for about 2 weeks, in which time the market fell no more than 2% OVER THE ENTIRE PERIOD...it did so again just a week later and stayed there for 3 weeks...the market fell a maximum of 3 1/2 % during this time frame - we then had a six week rally...
In 1995, the market made its first foray below the 20dma 3 months into the rally...and stayed there for 3 trading sessions, during which time the market sold down 1/2% - the market was far less volatile during this time frame...the market then rallied 15% over the next 5 months before falling below the 20dma again...remember, we were far less volatile...a 15% move in under half a year was unheard of at that time...
The question is...are we in 1995, 2003 or 1929/1930? Without a shred of doubt, and buoyed by the 14 new stocks on my radar from Friday's activities...I say we are in 1995...do your diligence...

The Dilemma of Discipline

So, it's been a while since I've posted here and this is simply because time has been difficult to find. I hope to not disappear for this extensive a stretch again. The market's storm higher since the March 9th lows has been dramatic and powerful...six weeks of some impressive individual as well as index gains...establishing a new bull market, albeit only technically.

Many in the analyst community are understandably skeptical after the collapse in both equity markets and the economy that began back in July 2007. Most bear markets stage these powerful rallies that fall apart all too surprisingly for the bulls that jumped in, afraid to miss the party. This run up has been referred to more often than not as simply a bear-market rally, by many of these skeptics.

As I argued back on March 12, my strong opinion is that we have put in a generational bottom. When coming off a generational bottom, almost everyone can make money in the first leg up, as this first move is often powerful and undiscerning...every index, every stock gets a boost. It is the truly disciplined at this time that pick not just the followers, but the leaders in this rally and grab the massive returns. Now, here's where I make an important point - in this blog, I cannot and thus, will not, identify individual stocks, but I will try and guide my readership on general observed market trends and industries where the investment opportunities are high.

The market today staged a strong powerful reversal

• Many skeptics will point to the high volume selloff today (ignoring the fact that one stock made up the entire increase in volume and then some). These skeptics will say the market has run enough - six weeks is enough for a bear market rally - these are the bullish doubters who expect us to make new lows, so that they can buy as they likely missed out on the first run.


• Other skeptics will point to the fundamentals and say that there is still lots of bad news to come - these are the lifetime bears who believe that every downturn is simply a stage for a further downturn. They believe that unemployment soaring from 4.7% to 8.5% is just the start, that the collapse of some our most powerful institutions in barely a year is not a sign of a healthy capitalist economy, but an indication that every great company in this country should fail. These are the bears and to allow them to drown out the positives is to give in to the fear.

But, a reversal like this is not a time to run to the exits nor is it a time to load up the truck...it is a time for discipline...and discipline means evaluating the markets without the noise of pundits. It means evaluating all the news without listening to simply today's news. And it means evaluating each holding to determine what to do with each share in your portfolio - some may need to be sold, others may be added to and the remainder may be holds...but each holding in one's portfolio needs to be re-evaluated.

The easy response in any reversal after a powerful rally is to be happy with one's profits and run into the nearest cave. The naive response is to think that every pullback is a buying opportunity. The difficult response is to be disciplined. The dilemma of discipline is that discipline is often hardest to find at times like this ... when the easy or the naive response are the first responses we gravitate to. But without applying discipline at this time, one will either regret selling too early or buying too soon. I think, overall, the trend will follow very close to the 2003 rally that begin March 10, shown here, and that the rally will storm higher, after a maximum of a 3-day pullback. But as I said earlier, the easy money has been made. The rewards now will go only to the most disciplined. Everyone else should just buy index funds.

Free Market Maxims II: Greed is Good

Or alternatively, “Altruism is Great…but is unsustainable…”

Although twisted in its ultimate objectives, Gordon Gekko’s memorable speech in the 1980’s thriller Wall Street resonated with this key Free Market Maxim.



Recent proposed tax hikes on the rich recommended by the Obama administration and the Pelosi-controlled Congress has been greeted with cheers – the Robin Hood mentality of society is starting to run amok.

Listen up America: we do not solve our economic problems by taxing the very people who are the engine to our economy. People who make over $250,000 are not evil wealth-hoarders – they are hard-working, thoughtful, innovative and self-motivated individuals just like each and every one of us - they have just have decided to take on a little initiative and a ton of risk. By taking on this risk, for mainly their own reward, they create employment for millions, tax revenues in the billions and grease the engine of this economy. All of a sudden, it has now become popular to vilify these individuals and these corporations.

So what if, every once in a while, these individuals decide to spend their hard-earned wealth and take a vacation. We should be delirious if they choose to fly first class, stay in fancy hotels, eat expensive food and drive nice cars. This may possibly irk us (who secretly wish we could do the same) but certainly the companies which receive these revenues and the employees earning their daily wage from these same companies are probably very thankful for this group's willingness to take on this risk and willingness to happily spend their profits! But now "our protectors", the Barney Franks and Harry Reids of the world, want to tell us that this is bad, that earning too much and spending money is a bad thing and thus, the wealthy are our enemy!

No one bothers to note that, when these "enemies of the state" are finished with their infrequent vacations, these risk-takers are often back in their offices (or steel mills or restaurants), working hard to identify and satisfy society's NEEDS and WANTS, continuing to give employment to many millions, and gladly paying a far greater percentage of tax dollars than most Americans. For this, our government rewards them by asking them to pay even more taxes.

One of the proposed tax hikes is a ceiling on deductions for charitable contributions. The proponents say that people will give regardless of the tax break they receive…an interesting theory - possible but highly unlikely. Without arguing with the proponents, just tell me this - wouldn't people give MORE if they get a tax break?

Oh no – the altruists say – people should give more without needing a tax break…well newsflash, these people have worked hard for their wealth and maybe a little encouragement doesn’t hurt. Don’t we want to encourage this greedy behavior which encourages larger charitable giving? Because the alternative – the belief that altruism is perpetually self-sustaining is simply naïve and has led to plenty of failed projects in the past, including Cuba, Eastern Europe and, of course, Russia.

Milton Friedman, hailed by the Economist magazine as “the most influential economist of the second half of the 20th century…possibly of all of it,” said it best in this interview from almost 30 years ago…

A Generational Bottom

It's never possible to perfectly time the bottom, so many investors likely missed picking up shares at the lows from last week. Actually, MOST investors likely did not buy last week - more probably sold into the downturn. This is evident from the level of pessimism that was prevalent 1-2 weeks ago - it was hard to find a bull even on Larry Kudlow's show on CNBC, despite Kudlow's best efforts to find one. The S&P McClellan Oscillator (to be detailed in a future post) also pointed to incredible bearish sentiment.

This level of pessimism often marks signficant bottoms. Evidencing this pessimism is the fact that after falling 40% over an 16-month period, the S&P collapsed another 30% in just 2 months - THIS level of pessimism is found at significant bottoms...markets move on investor perceptions...at the end of last week, the prevailing perception and expectation was that

• the DOW could potentially breach 5000
• unemployment would rise to double-digit levels by the end of the year
• every bank in the US would be closing their doors, despite only a handful of bank failures thus far, a very different state than we were looking at during the S&L debacle of the early 90's

That's where we were late last week...now, it is certainly possible that the economy will get worse, but the PERCEIVED disaster level cannot get any worse that it was 2 weeks ago...and as mentioned above, the stock market moves based on PERCEPTION.

Unless Vikram Pandit, Jamie Dimon and Ken Lewis all made bold-faced lies this week (and if they did, then guaranteed that each of them will see the inside of a cellblock), then you can take it to the bank (sorry for the pun) that the bottom has come and gone.

The markets will be volatile on the way up, but we have undoubtedly established a bottom - one that will likely last a generation, if not more...

DIMON indicates that JPM profitable through February 2009

Searching for a Bottom - the Disappointed Investor

I recently analyzed both the S&P 500 and the Dow Jones Industrial Average (DJIA), two broad market indices that most investors look to as their pulse of market health. I wanted to test the buy-and-hold theory on these broad indices which many of us invest in through indexed mutual funds, such as the Vanguard 500 (VFINX).

Taking an investor, say Investor A, who purchased $100,000 every month in each index, I tracked how that Investor A's annual return would look had he invested every month for the past 10 years. I then looked at how another investor, say Investor B, performed had he begun to invest just one month prior to Investor A and looked at his returns over a 10-year period. I then went back every month and retested this investment strategy, back to January 1960 for the S&P 500 (this investor was invested for the 10-year period starting January 1950) and back to January 1939 for the DJIA Investor (this investor was invested for the 10-year period starting January 1929).

The results of this analysis provides a perspective on an investor's "happiness" or "disappointment" with the performance of their buy-and-hold strategy when evaluated over a 10-year period going back over the past 70 years. The results are startling.

First, the S&P (note that red line indicates average 10-year return):

Next, the DJIA:
Notice anything interesting?? Just as people were ready to throw the theory of buy-and-hold out the window, as they likely wanted to do in 1942 as their annual returns looking back 10 years were almost -2% (DISAPPOINTMENT) or in mid-1974, as their annual returns looking back 10 years was almost at -4% (DISAPPOINTMENT), the trailing returns began to sharply recover. In 1942, it was the war effort that re-ignited the economy and in mid-1974, Nixon had just resigned and the DOW (and S&P) staged a horrific collapse over 2 months of over 25%. Newsweek, in one famous call, quipped "Is there no bottom?"

Well, we are at about that same place now on the charts above. In terms of market bearishness and annual returns for investors looking back 10 years...this is worse than it's ever been. An investor who began investing monthly in the S&P 500 10 years ago, is down 5% annually...an incredibly depressing figure and one that has the buy-and-hold bashers dancing in their bomb shelters. Shockingly, the S&P is down 27% over the last two months (echo, echo, echo...)

So what happens next...this is anyone's guess...it could get a lot worse (as everyone will quickly tell you)....or this is just the time when you should NOT be looking to get out, but actually looking to get invested and Quick! One minor note for those DEBATING whether to get in now...or wait...investors who jumped in at this same low point in 1974, saw returns over the next 10 months (as the market rebounded sharply) of 31% annualized...those who jumped in 1 month early, saw returns of 28% annualized.

Free Market Maxims I: An Obese Government is not the Answer

As the current economic crisis has sunk in and many of us have begun to accept that recovery from this massive downturn will not be as quick as any of us would like, we have begun to question the most basic of economic principles, what I call Free Market Maxims. As the current crisis is dealt with, let us recognize that the responses are those that are most appropriate during a crisis – not to replace basic economic norms, but simply to deal with a massive economic downturn of a magnitude not seen in three generations.

I have great respect for the intelligent strategies and suggestions put forth by our current administration. President Obama is clearly well-educated and articulate and his team seems to be of similar caliber. They have come into the Office of the Presidency under a great cloud of fear and destruction, where the failures of many, on both sides of the aisle – LEFT and RIGHT, as well as the complicit inaction of all of us have led to a dire economic climate. And they are responding as vigorously and as thoughtfully as they are able.

Short-term, I believe they cannot help but re-invigorate what has become an economy-in-retreat, and a consumer in hibernation. But I cannot imagine how successful their actions will be if, as they respond, they build rhetoric that continues to convince the American public and the world that the answer to our problems and our challenges is a permanently obese Government with all the answers and all the solutions.

Democrats have been and remain the worst violators, but the Bush administration exacerbated this nonsense with a ballooning deficit over the last eight years and ultra-orthodox policies that intruded in our private lives but ignored the public crimes that have led to our current crisis.

Government is not the answer – it is responsible to protect people’s rights, and provide safety nets (not safety hammocks) when people stumble. People are the answer, and providing the right incentives, the right infrastructure and the right access to resources and tools is the best way for governments to enable a climate of self-sustaining growth.

This is not a partisan issue. This is an issue about basic economic principles and not allowing ourselves to throw the baby out with the bathwater. I will be posting four more parts to the Free Market Maxims’ series over the next few days, in an effort to remind us why we embrace these as basic economic principles.

Buy and Hold - an antiquated theory?

Well, we finally did it - we've sold off 50% from the S&P highs, held just 9 months ago and there is still widespread fear all around that lower is the next stop..."ZERO" is the new mantra of the many hundreds of thousands that have seen their investments and retirement savings cut off at the waist. The joke around the water cooler is not how your 401k is doing, but whether you've liquidated your "201k."

Sadly, this is not a joke - many retirees are in a shell-shocked state, seeing their lifetime of savings halved in the blink of an eye. Unfortunately, these retirees were given incredibly inappropriate financial advice or believed (as did many of us) that the party on Wall Street would never end and they wanted their cake too. Those close to retirement should have been primarily in bonds over 10 years ago and out of the market completely over 5 years ago. Although this is a recommended asset allocation which serves to protect you from a nasty downturn, in fact, because Treasuries outperformed equities over the last 10 years, this asset allocation would have been better for all of us, not just retirees.

So what's next? Do we all go an cower in the corner til the sky falls and then rebuild? Should we all be going to cash - selling our holdings in investment and retirement accounts, here at S&P 700?

This is what many so-called experts will tell you - that Buy and Hold has ended and been a laughable strategy invented in the 80's as the boom market took off...that no one in their right mind holds a stock forever.

Well, they are right...partially. No one holds a stock forever - no one should. Companies have their own life cycle, and while they are growing or even in saturation stage (some companies stay at the saturation stage for a long time - see MSFT), they are absolutely worth owning. When business starts going south, then it is probably time to sell.

But how many of our 401ks are in individual stocks? How many of our investments are? The answer here is pretty clear - almost none. By and large, most investors, even today, continue to invest in mutual funds, which certainly explains how this multi-trillion dollars industry thrives, even today.

Mutual funds are managed holdings of a diverse basket of stocks. The key word here is "managed." Mutual fund managers buy and sell all the time ... so that WE DON'T HAVE TO. If we buy and hold, we continue to allow mutual fund managers to continue their good work, which is identify and buying great companies, while selling underperforming ones.

It is amazing to me that the opponents of "buy-and-hold" are attached to such a limited view of how stocks are bought and sold...as most of them are "experts," they clearly ignore the fact that a huge majority of investors DO NOT hold individual stocks and instead hold "managed" mutual funds.