"Water shapes its course according to the nature of the ground over which it flows; the soldier works out his victory in relation to the foe whom he is facing. Therefore, just as water retains no constant shape, so in warfare there are no constant conditions."
Sun Tzu

Monday, January 12, 2009

Game Plan Week of Jan 12: Watch the Key Sectors

It's inaugauration week and I'm looking for signs that this could be a "sell the news" event.
Anyways, everyone was expecting a pull back and we got it last week. Since the market always surprises us, we should NOT go higher from here, right?

Check the charts of some key sectors. Key, because these industries are the benchmark for economic recovery: the charts of the Financials (IYF), Real Estate (IYR), China (FXI) look weak and are lingering around important support levels.

We are SHORT Financials already, but are holding a LONG postion of FXI. Should China show more weakness, we'll SHORT that immediatly. Speculators are betting on a quick recovery in China, but I believe any numbers from Bejing could be extremly filtered from the government.

On the other side, there some areas, which show decent relative strength, such as shipping (also a key sector), some tech plays and agriculture.

Be careful...

Tuesday, January 6, 2009

Oil Stocks: a Chart I Like

My favorite chart these days is the following one, the plot of Oil & Gas stocks with the Oil price:

Since October, we can see some very interesting developments: 1) Oil keeps droping, but Oil & Gas stocks seem to have found a bottom 2) Massive volume in the DIG ETF, around four times the average level of the prior period. Conclusion: someone is buying big time since last quarter. This trade offers a great risk/reward ratio, since the downside is limited to $25, but the upside has potential to go to $60, once the we break out of the trading range. Also note that the recent upside move has been accompanied by increasing volume the last days. Yet, I would just buy 50% of the position at this point and wait for a pullback.

Monday, January 5, 2009

Playing the Hope Rally

The market is insane, but that's nothing new. Of course we keep seeing deteriorating fundamentals, such as declining home prices or rising unemployment. Yet, the market seems to be in a bullish mood and keep rising on negative news. Reason for the current rally (and we will see if this holds true in frist *real* trading week of 2009) is simply HOPE for improving conditions later on. The new president plays the market very well. Headline in the WSJ today: "Obama plans $300 Billion Tax cut".

If markets keep rising this week, optimism can turn into mania very quick: market participants could be surprised by the rally and keep chasing the market, thus pushing prices higher. In any case, should the S&P reach the 1000-level in the next two weeks, I'm looking to reverse positions and become go net SHORT. But first, we have to see how the market will react on horrible employment numbers and upcoming earning reports.

Until then, I like Tech, Commodities, Infrastructure, China and (Alternative) Energy

Welcome to 2009!

Thursday, January 1, 2009

2008 Review and 2009 "Predictions"

Despite 2008 being a challenging year for many investors, the last 12 months offered a lot of opportunities for short term oriented speculators who love volatility. We ended up 2008 with a gain of 17.1% in our trading account after fees (which BTW took out 5% of trading performance due to over 250 trades in 2008). For the record: the S&P 500 lost 39% that year.

It is interesting to compare monthly returns with the S&P 500 performance:
Standard deviation of our monthly results was 5.7%, compared to 6.1% of the S&P. So technically, we achieved our returns with slightly lower risk compared to the US stock market. Especially in the months of January, October and November we greatly benefited from our massive SHORT positions. In December, though, we underestimated the bullishness of the market and went into the month with just 50% LONG, which obviously was the reason for the poor performance. Nevertheless, we outperformed the S&P 500 in 9 of 12 months. The chart also shows very clearly that the higher market volatility, the higher our returns, independent of market direction. That doesn't mean that we generally under perform during low volatility periods. We just adjust our trading style to benefit from longer trend moves. An example is our current LONG position in the Biotech sector (PBE), which was opened beginning of December.

You might have noticed the quotation marks in the headline of this post. The ordinary investor likes to read predictions, but I believe that any long term prediction of stock market behavior is a waste of time, due to the high degree of non-linearity and amount of influencing variables. I rather like to think in terms of possible trading themes for 2009:

- Unemployment: will get to 10% unemployment rate in 2009? Is that already priced into the market?

- Homebuilders: some of them have to pay back a decent amount of debt in 2009. Could that force some of them into bankruptcy?

- GM, Chrysler: it doesn't matter if they'll go out of business or not. They will scale down
dramatically. How will that influence the economy/unemployment?

- China: will the Chinese policy of floating the market with money be successful and prevent a major economic downturn? What if the Chinese stop buying American debt because they need the money for their infrastructure spending?

- American consumer: 70% of the US economy is consumer spending, so what if they stop buying stuff? I call this the "collapse of the American consumer" theme.

- Deflation/Inflation: we are in a deflationary environment, which can be quite dangerous. We already
see the effects in housing. If buyers wait with their purchase because they think prices will come down further, demand stalls.

- Cash: there is 9 trillion in cash on the sidelines waiting to get invested. Where will investors put that money?

- US: economic recovery in the second half of 2009 seems to be priced into the market. What if we don't recover before 2010?

We'll see how these themes will play out in 2009 and trade short term accordingly.

A final thought: a lot of commentators and analysts are forecasting the following scenario: we will see a "Obama rally" at the beginning of 2009, followed by a test of the November lows. If investors are positioned according to that scenario, how can a rally ever develop? Market participants would sell into a rally attempt and significant move actually wouldn't happen. We saw a similar pattern in December: everyone was expecting a "Santa rally", which actually didn't happen. I'm actually tempted to SHORT the entire market based on the current public expectation.

The only positive pattern these days is the markets tendency to ignore negative news. In order to get a sustainable rally, we need to see economic data at least flattening out. Currently, they get worse with every release.