Is risk lower now?

I have been warning for some time that winter was coming in the stock market and warning that that risk is high even as recently as this week.

Now that we got a big rally on Tuesday and the Canadian dollar soared today, has risk been lowered?

I am not sure yet. The ability of the S&P and Dow in recent days to stay above the October 10th lows (S&P 839) must be respected. Normally, if the market is truly going lower, it will fall right through the key level. The bears tried for about 2 1/2 weeks and it did not. I was actually quite short at the start of the day Tuesday, but I covered almost all of those positions around 2pm when I saw the S&P rally through a key level 882. I was fortunate as once the market got through that level, it was one of the biggest up days ever as the S&P finished at 940 (up 11%). I also switched a lot of US cash to Canadian cash late Tuesday and a little this morning as the dollar rallied about 5 cents from 77 to 82.

Now what happens? It could go either way, in my opinion.

Longer term, I remain confident that we are still in a bear market. That does not preclude a multi-week or multi-month 15-20% rally (half in one day?) especially since we were at record oversold levels prior to yesterday's rally.

Shorter term, I still believe that there is risk. As mentioned, there is risk here until well in to November. Also, to make me bullish, the market first needs to close above today's high (970), then above a bunch of levels in the upper 900s/low 1000s. If we get to those levels, and the internals look good, I will be on board for at least a bear market rally. I acknowledge that I will have forfeited some nice gains from yesterday's low, but that will be a small price to pay for preserving capital in one of the worst bear markets of all-time (thus far).

I also suspect that if the market can hold these gains for two more days, then it will be November. Then the bulls will be able to claim that a classic October bottom was made and the central bankers were able to preserve the system. And that bullish may lead to a risk of at least another retest of 840. If said retest fails, look out below (S&P 777 or 738 or gasp 662?).

I will keep you posted on my thinking. For now, I am mostly in Canadian dollar cash and I did a little nibbling on some gold stocks today. I could change my mind at any time and if I feel that this rally will peter out like the ones from mid October, then I may go heavily short again.

The Fed to cut this week (yawn)

The Fed is going to cut again on Wednesday.

1) How much?: I think 50 is likely but the market is hoping for 75. If we crash between now and Wednesday, clearly the Fed will cut more than 50.

2) Is there a joint cut this time? I don't think so. I talked about it a lot last time, but I don't think so since it didn't seem to have a big impact and since it would seem a little overdone doing it twice in a month. If we crash between now and Wednesday, then I would expect a joint cut.

3) Does anyone still believe that after going from 5.25% to 1.50%, that a 0.75% or 1.00% Fed funds is going to really make a difference? Sadly, there are probably some uberbulls out there who do, but I think the "Fed will save us thing" is so March 2008...

Risk remains very, very high, especially if we decisively break S&P 839....

Addendum (Oct 29th): Answers 1) 50 was right. 2) No joint cut was right 3) Still too early but market rallied then sold off post 2:15 rate cut announcement.

Back in the Bear Camp

Last Tuesday I wrote the following:

For the time being, I will wait and see. My gut tells me that the lows of this bear have not been made yet, but I are trying to remain open minded here. There is still a lot of near-term risk here and a retest of Friday's low is likely over the next few weeks or months. Any substantial take out of those lows would likely lead to a test of the 2002 lows. If those lows are taken out, another crash (THE crash?) would likely ensue...

After I wrote that (at S&P 998), we basically sold off like crazy (S&P 865) and then rallied (S&P 985) and now we are at S&P 897, below where we were at the close of that horrible Friday Oct 10th (intraday low was 840).

I have become bearish once again late last week and have acted accordingly over the past few days. Today's declaration of a currency crunch is only adding fuel to the fire. I have bought SPY puts and am putting a few shorts on again. I did not like most of the "bullish" action of late (with the exception of Thursday, Oct 16). Given the 45% drop in the S&P thus far, I would have expected more than the crummy volume on the rallies.

The strength in the US dollar and Japanese Yen (I hold both), the lack of consistent up days and other indicators that I look at (Lowry's technical service among others) are not yet showing a convincing bull case.

For some "voodoo", we are currently smack dab in the middle of WD Gann's 49 to 55 day death zone (look it up ; 1987 and 1929 saw 55 calendar day crashes) until Monday, October 27th. In addition, there are a variety of important dates after that that go well in to mid-November that give any of my bullish impulses pause here. (I give thanks to legendary trader Jeff Cooper at Minyanville.com for educating me about the importance of time and price).

I am loath to give a downside targets here as the volatility and the crosscurrents are enormous. However, I will say that it appears that we are heading for a test of that 840 Oct 10th level and if that doesn't hold the 777 level from 2002 comes back in to focus.

As I stated in the post from Oct 14:

If those lows are taken out, another crash (THE crash?) would likely ensue...

THE crash may not have been the early October version. We may be in a series of crashes or heading for THE crash. The good news? The time for this to likely happen is between now and mid November. Therefore, a bottom (perhaps but not necessarily THE bottom) is near in time.
The bad news? We are dealing with systemic risk where sellers simply swamp buyers and stocks can fall to unfathomable levels. The bottom in terms of price may not be near.

The most likely scenario is a test/undercut of either 777 or 840, but even the late 1994 levels of 450 are a possibility if systemic risk rears its ugly head via a 1987 style 1 day crash.

We are trying to deleverage 18-25 years of credit excesses in 18-25 months. As I have been preaching, this is not a garden variety bear market, as we all now know. This has been the fastest -45% fall in the S&P in the post WWII era. While most severe bears end at around -49%, the speed of the -45% decline (1 year) is possible proof that this one will be even worse. In addition, the unprecedented credit boom/housing bubble/derivative bubble and now a global intervention bubble make this very difficult to forecast.

In summary, we are at a very, very difficult juncture in economic and political history that our children and grandchildren will read about. Risk remains very, very high here.

It's official: Currency Crunch 2008

I warned 2 weeks ago that a currency crisis could happen. It is now official! The loonie dropped below 80 cents this morning, and most currencies except the US dollar and Yen are sinking.

On September 25th, I was furiously buying US dollars at 96 cents and warning that the loonie could fall to 85 cents. I thought that I was being pessimistic!

Then on October 9th, as we broke below 85 cents, I warned that the loonie could go to 80 cents. I hate getting more bearish as things go lower, but one must adjust his/her views to take into account market realities.

I sold most of my US dollars in mid October (at 84-87), but I have been buying them back at around 83-84 as I saw the 80 cent target coming back in to play.

Now, if the market crashes, I think the loonie is going to go a lot lower. There are some support levels around 78.5 and then a bunch between 72 and 76. Any of these are fair game in a panic.

Does this currency crisis morph into something like in 1997/98? No idea, as this is beyond my comfort zone. Only thing I know is that in this environment, anything is possible. As Mohamed El-Erian of PIMCO said in September: The unthinkable is now thinkable.

Risk remains very high here despite the 40% bear to date.

Harper and deficits

I tried to warn readers a long time ago about a Tory government and the return of deficits.

First of all, I was wrong about some things in that post. I speculated that the return of deficits could spell the end of PM Harper. Clearly, that wasn't the case and while the possible return of deficits was discussed in the campaign, it was not a big factor in this election. Instead, a related issue, the financial turmoil, was a big factor and the Liberals were not able to capitalize. The financial turmoil will lead to deficits but that is an issue for the next election, not this past one.

Second of all, it appears that a deficit is not in the cards for 2008/09, at least based on Harper's recent statement. There is a likely a lag on revenues from the recession and it appears that there were enough buffers and one-time gains to keep us in surplus for 2008/09.

However, barring major changes to spending, it appears that Canada is headed for a deficit in 2009/10. While the financial turmoil and recession are partly to blame, the Liberals and Tories are also partly to blame.

A little history

The Liberals, especially in the later Chretien years and under PM Martin, ramped up spending like crazy. Some of the spending was due to needs neglected in the belt-tightening 90s. The Martin PM years were mostly runaway spending years with relatively small income and corporate tax cuts. Then, along came PM Harper with big GST cuts, more corporate tax cuts, targeted income tax credits and more runaway spending.

I believe that the income tax and corporate tax cuts were smart but that the GST cuts were a huge mistake. I also think that both Martin and Harper overspent. The GST cuts totalled $12B and were the wrong type of stimulus (encouraging spending when the consumer was already overspending) at the wrong time (the economy was already hot). If Harper had avoided the GST cuts and held spending down, we may have had a $20 billion buffer.

2000 Buffer
In 2000, Canada had a huge buffer ($20 billion plus). Finance Minister Martin's massive (and well timed as luck would have it) 2000 tax cuts helped keep Canada out of a recession. Martin was probably lucky because he cut them in a special election budget that was called just as the economy was starting to sink, and in response to an aggressive tax cut proposed by the Canadian Alliance platform. Super shrewd PM Chretien probably saw tougher economic times coming in calling for an election in October 2000, but few saw a recession back in October 2000.

2009 No buffer
Instead, Harper now has to either cut spending (a sound long term decision) or raise taxes (unlikely) at precisely the wrong time as it may further hurt the economy in the short term. If Harper had a buffer, he could have cut income taxes to stimulate the economy. Harper also has to do this in a minority government.


Conclusion
At this point, big deficits are coming due to the fact that we are entering a severe recession. In such a recession, given our current budgetary situation, I would choose to run a deficit as cutting spending severely would likely make things worse. I would wait until the recovery (as the Liberals did in 1995- again lucky as they only got elected in 1993) to make huge spending cuts.

Notice how the Big Bank economists only starting talking about issues like recessions and deficits this past month, when this blog has been talking about this since last winter!

More CREA spin and new numbers

So what does CREA now say:

"Informed buyers and informed sellers look at the facts. And the facts right now indicate the real estate resale market is stabilizing in many markets," says Calvin Lindberg, the President of The Canadian Real Estate Association.

Hmmm, I guess sinking is the NEW stabilizing...

It gets better according to CREA per a recent Toronto Star article

"With the sales activity now beginning to slow from its breakneck pace last year, it's taking homes much longer to sell and since people are under no distress to sell, they'll take it off the market and put it on the market on a better day," Klump said in an interview.

"With fewer sales and fewer listings, it's a built-in stabilizer as far as the extent to which you can expect to see prices to decline."

1) So now they are pointing to the slight decrease in new listings in recent months as a sign that the market is stabilizing. This could be transient as sellers do what Klump describes above (take it off the market for a better day). What happens when they realize that the better day is not coming? New listings are going to pick up as the economy tanks and all those foreclosures kick in. And even if new listings don't pick up, I would expect sales to dry up as buyers become more selective and more patient and financing becomes much, much tougher.

2) A better day: When would that be? Houses have doubled or tripled already. It is possible that on an inflation adjusted basis, that houses may never get this high again?

What should they really say if they were forced to adopt a Jim Carrey Liar, Liar tone: "If you have a house to sell, sell it soon before prices plummet! If you want to buy, just wait as there will be bargains in the coming years, assuming that you can get financing. The end of 2008 and 2009 will be a disaster for home prices!".

CREA also trots out a new data series that shows that the weighted average price was -0.6% if you use existing private housing stock to weight the data. This is because activity in the hottest markets (Calgary, Edmonton and Vancouver) are bringing the reported number down to -6.2%. This new number has the same trend (down) and while it may lag for now, I'm sure it will catch up eventually as all markets are going to be going a lot lower. I would guess that Toronto, Montreal and Ottawa have a higher weighting in the new number and since they have held up relatively well vs the Western big cities, this leads to a lower number.

Expect CREA to emphasize the new numbers as it tries its spin. Hey CREA, what happened to the average price will be up 5% in 2009 that you put out a few months ago. Notice that they have not updated their number? Maybe they will try to use their new number to say that they met their forecast. I asked back then if they were just making this stuff up. They just made up a new way of reporting their number.

Answering an excellent comment

I receive many excellent comments which I always enjoy reading. An excellent comment by Chris, in response to my recent posting on recent mistakes, required a response in a post:

Just a thought here: Perhaps a narrower focus on fewer trading vehicles would benefit you.

I am not currently a trader, but did try a couple years ago at swing trading while trying to maintain a day job during market hours. I found it impossible to do because I hyper analysed every facet of an index/etf etc. trying to maximize my profit while cutting risk. The point you make about imperfect hedging reminds me a lot about of techniques I tried.

Anyway, if I was going to take a stab at it again, which I hope to do some day, I would want to focus on three vehicles: outright index futures, sectoral ETF paired trades, and reasonably straight forward option spread strategies.

It just seemed to me from reading the post that you maybe were losing sight of the goal which is to make money, rather than be perfectly right on how things move.

I hope you interpret this more as empathising rather than criticizing. Thanks for the blog.

Chris
Vancouver

Chris, thank you so much for the post and I do not take it as criticism.

Thankfully, I am up quite nicely in this vicious bear market, albeit not as much as I should be.

My first goal (and easily the most important) in a bear market is: Capital preservation

My second goal in a bear market is to make some money. Goal #2 can sometimes conflict with Goal #1 and therefore, it is important for me to follow the motto "Discipline over conviction" that I have learned from supertrader Todd Harrison over at Minyanville.com.

(By the way, these goals were developed in reaction to my experience in the 2000/02 bear market, but that is another story for another time that I will try to share one day. Suffice to say, I believe I have learned my lesson.)

This second goal has caused the mistakes mentioned but more importantly, it has also kept me from getting killed in the bull stampedes that result in a bear market (such as Monday's 11% gain on the Dow; TSX 18% gain Tuesday morning). I try to not allow positions to go against me double digits, although I do allow a little more risk tolerance for deeply held convinctions for long term positions (such as shorting financials in Sept 2007- I was early by a month or so and watched the position go against me by about 20% as Bernanke cut rates).

In this post, I illustrated these mistakes partly for therapeutic reasons as this market is tough with 9-10% intraday swings. Many pros that are leagues ahead of me in trading skills are finding this market the toughest of their lives. The other reason was that I wanted the reader to understand that I am not always right. I have many posts where I "brag" about a good prediction. This year, my predictions have been fairly accurate but that has not and will not always be the case.

I do agree with Chris that especially if this is not your full-time vocation, that a narrower focus on fewer trading vehicles is good, and I have been and will continue to try to keep this focus. The only problem with too narrow a focus is the lack of diversification and potentially greater risk. I have tried to cut the number of positions, but as you can probably tell from my blog, I have many ideas/predictions and it hurts me to see things go according to plan without being on board (case in point: Oil is now at $70). He also makes smart mention of imperfect hedging and I will try to heed the lessons of my HGD "mistake", which has been recently compounded by selling HGD on Wednesday ahead of its 20% rise on Thursday-Friday.

I made mistakes as mentioned in the post. I did not mention the successes which have been holding some of my cash in US dollars and some timely puts on C, MBI, MER and AIG back in August.