Archive for March, 2008

Will The Rally Continue? Let's Look At The Technicals

Wednesday, March 26th, 2008

I had a question from a client relative to the technical picture of the market and how we were reading it. I explained that we watch the Oscillators (a momentum indicator) to give us a picture of the short-term direction of the market and to help guide our investment decisions. What we like to look for is that the movement in the Oscillator is confirming the movement in the market itself. If they are moving in tangent, then the current direction of the market (whether it is a rally or a correction) will likely continue. If they stop moving in tangent then we have a negative divergence, or a possible turning point in the direction of the market.

Given that the Oscillator is a bit of a mystery to most people, I thought that it would be a good exercise to demonstrate how it works in action. The discussion in the following paragraphs was adapted from Helene Meisler’s current article on the use of the Oscillator to make it clearer for the readers of this blog.

To demonstrate the use of the Oscillator, let’s look at the Oscillator for Nasdaq, and compare it to the Nasdaq Composite graph above to explain things visually.

Point A is mid-October, when Nasdaq had a high, as did the Oscillator. We then corrected and the Nasdaq went on to a higher high, Point B on both charts, yet the Oscillator went to a lower high. That was a negative divergence in momentum.

Point C in early December is the high following the November correction. We then corrected and rallied again to point D. Note that point D on the Oscillator chart is a lower high. Once again a negative divergence.

Now notice the move the Oscillator has made in the last several days — it’s quite sharp to the upside.

Generally, the window for a rally is open for three to six weeks (from a technical standpoint). The initial two weeks are typically when we see that big rise in the Oscillator like you see from March 9th through yesterday.

We then typically get some sort of pullback or correction, followed by another rally. If that follow-up rally finds the Oscillator (and other indicators we follow) making higher highs, then we know the rally has staying power and enters another three to six week cycle; if it makes a lower high, we start to get cautious on the market and book some profits, place some stop losses, enter some good ‘till cancelled sales with target prices, etc.

The market will likely reach a maximum overbought reading on the Oscillator next week, which conveniently turns out to be just after the end of the quarter and at the beginning of the new quarter. A correction from that point would then set us up for yet another rally in mid- to late April.

It is that follow-up rally where we will be watching for divergences, such as a lower high in the Oscillator, weakening RSI, falling VIX, etc..

For now, though, we haven’t even had the first correction, so the same theme we’ve had for two weeks now is still in place: We continue to have a rally window open and are opportunistically making purchases in high conviction themes (e.g., we added incrementally to our holdings of Monsanto the other day at $95 per share and its now trading at $114).

Has The Market Turned The Corner?

Wednesday, March 19th, 2008

Below is an article I’ve cut/paste from Jordan Kahn that discusses his view on why Monday marked the turning point in the market.

His reasoning makes a lot of sense so I thought I’d share it with you.


Four Reasons to Believe in a Bottom

By Jordan Kahn

3/19/2008 3:46 PM EDT

When I originally penned this piece on Monday night, after informally polling most of my contacts and asking them if they thought Monday was the bottom, the response was almost universally “no.” (65% of the respondents to a “Fast Money” poll on CNBC said the same thing.) I wrote on my blog ( on Monday that I thought it was likely we had seen the lows. Still, I wanted to see how the market fared on Tuesday, so I held off submitting my column. I never thought Tuesday would see such a huge rally, but it just reinforces my view.

Technical Evidence

Doug Kass had a good piece on Tuesday about his lunch with “Greg from Mega“. The points he raised resonated with me, but they were almost all of the valuation variety. They speak to how cheap the market is on a host of measures of both relative and absolute valuation. I follow many of these valuation models, and they have been flashing undervaluation for some time now. But they are not great timing tools. And when the markets get this bad, many fundamentalists go to the charts. The technicals often do a better job of highlighting bottoms, even though you never truly know without hindsight. That said, I think that the odds are high that Monday marked the lows for this bear market. I had been looking for the S&P 500 Index to test 1250 as a reasonable area to bottom, and Monday saw the SPX touch 1256. This is close enough for government work. Also, last Tuesday we saw a 90% up day (90% advancing stocks & 90% upside volume). Along with the 3% rally in the S&P that day, this was only the fourth time in the last 28 years that we saw this combination. And the last three occurrences were all significant market bottoms, including August 1982 and October 1987 (according to Merrill Lynch). Last, although the SPX breached its January lows, we saw the number of new lows on the NYSE contract meaningfully — a positive divergence. So the technical setup looks solid to me, but do we have enough extreme bearish sentiment to solidify a bottom?

Sentiment Evidence

Again, as a timing tool, sentiment does a pretty decent job, but it’s not great. This is because negative sentiment takes a while to build, but if you look back at any major market bottom in financial history, you will see that bearish sentiment always hits extreme levels. I saw that Monday. The 10-day CBOE put/call ratio hit 1.27, the third-highest reading since 1995 (as far back as my data goes). The 10-day ISE Sentiment Index hit 80 (put/call equivalent of 1.25), its lowest reading since the inception of this index. So bearish investors have been loading up on put options as the market bottomed, and these negative bets could provide upside fuel for the market as they get unwound. The investor surveys show even more bearishness. The Investors Intelligence survey showed the most bears (43%) since 1998, more than at any time during the bear market of 2000-02. And that low in 1998 was so bad that even our own Jim Cramer penned a piece that said “Get Out!” For its part, the AAII survey showed the most bears (59%) since 1990. That’s pretty incredible. And the volatility index (VIX) also showed its usual pattern. The VIX nearly reached 36 on Monday and closed at one of its highest levels since 2002. Then on Tuesday’s rally, it plunged 20%. This action looks like a peak in volatility, which would coincide well with a bottom in the overall market. So I think sentiment is lined up well to support the technical action, as well as the notion of a bottom here.

Anecdotal Evidence

I heard a lot of people saying that Monday’s action didn’t represent the type of capitulation lows that often mark significant bottoms. But the flip side of this argument is that when investors are braced for a cataclysmic session, and the market acts in the opposite fashion to expectations, maybe it is speaking just as loudly. Heck, on Sunday night, Hong Kong was down 1,000 points and CNBC changed its schedule to cover the Asian markets (and U.S. futures) for three hours Sunday night. Talk about getting everyone worked up into a frenzy. So the collapse of Bear Stearns (BSC) over the weekend should have resulted in a horrendous session on Monday. Instead, the market bottomed early, and the Dow actually reversed and finished in positive territory. If the collapse of the fifth-largest investment bank can’t take the SPX below 1250, I think it is unlikely that future events will be able to do so, even though there may be more negative headlines to unfold. Bear markets are often punctuated by a major financial crisis that occurs right at the lows. I thought that Countrywide (CFC) being taken under for roughly $7 might be the example this time around, but the Bear Stearns saga fits the bill even better. History will likely dump this event of market lore into the same category as Penn Central in 1970, Continental Illinois in 1984, Citibank in 1990, and LTCM in 1998. And all of those events marked significant bottoms. According to Merrill Lynch, the average return for the SPX in the 12 months following these events was +17.3%. Not bad.

Monetary Evidence

The mantra “Don’t Fight the Fed” exists for a reason, and I think it has now kicked in. The Fed has injected huge liquidity into the market and put in place ample loan programs to provide a backstop for financial institutions to prevent further bank runs. This is huge, and when the Fed says, “I’ve got your back,” you should probably cover your short positions. I am not advocating a “V” bottom here, because I don’t think the market will run away on the upside. There is lots of overhead resistance ahead of us, and it will take time for the market to work its way out of this morass. We could be in a multimonth trading-range market, which would still be preferable to the last five months. But I think we will look back at the “Bear Stearns Bottom” as the lows for this period, even if they are tested soon.

Portfolio Management in an Inflationary Environment

Tuesday, March 11th, 2008

Below I’ve cut/paste a great article from Gary Dvorchak discussing inflation, its cause, and how he manages client money given the current environment. The three areas of the market in which he believes we should be invested are exactly the areas we also emphasize in our investment strategies.

He does get a bit callous about the impact on the people impacted by the real estate crash, but maybe a dose of reality is called for in this momentous shift in the world economy. Please don’t be offended if you think that no one cares about the people who are losing their homes and jobs. That is not his point at all – his point is that in a capitalistic society, you have freedom to choose your occupation and investments, but you also have to accept responsibility if those choices don’t pan out.

I really enjoyed his writing and I hope you do, too. If you are managing your own money, you could do worse than accept his advice. You’ll have to determine your own timing and develop your own investment strategy – or hire us to do it for you.


The Disciplined Investor: Cover Your Assets

By Gary Dvorchak

Sometimes the complexity of developments in the economy and on Wall Street get the best of my simple mind, and I need to find a base to really understand what is happening — and how to position for the implications. I find the best way to analyze the economy is sometimes to simply look out the window.

As I gaze from my vertigo-inducing perch in downtown Los Angeles, I first see a number of large office buildings. Some were owned by Equity Office, some by Maguire, some may soon be owned by the lenders. But the buildings will be there tomorrow and the day after, and someone will show up to work in them.

I gaze farther toward the San Gabriel mountains and the famed Inland Empire, where large swaths of shiny new homes sit gathering dust at the edge of the desert. They aren’t going away now that they exist, and they will all eventually be occupied by someone — most likely at a price lower than the builders hoped.

We paper-shufflers on Wall Street tend to overfocus on the flickering pixels on our screen and ink shapes on our monthly statements, and sometimes forget to better contemplate the real economy going on out there while we fight over who gets what. The seminal truth is this: Our economy underwent a massive overbuilding in the housing sector, and no amount of paper-shuffling, TAFs, interest rate cuts, etc. can undo this massive misallocation of real resources.

The only cure for the economy is to have the contractors, the mortgage brokers, the lenders and all the other participants in the boom move on and find something new to do. This process is well under way. Thousands of square feet of office space in Orange County now sit empty since the New Centurys of the world shut down. (And thankfully, I now get one or two refi offers a day in the mail, instead of 10-15.)

Mortgage brokers are learning the new upsell: “Would you like fries with that?” Contractors call desperately looking for remodel projects, completely ignoring the do-not-call list laws. The homebuilders are cutting staff as fast as they can be shown the door. The process is well under way, but it will not be complete until all these laid off people are productively redeployed in new and different industries. That means a sharp recession at worst and a “rolling recession” at best, in which slow to no economic growth ensues while a succession of industries adjust to the new reality. I used a quote in the Jan. 29 The Edge, which is worth repeating:

“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed into hopelessly unproductive works.” — John Stuart Mill, 1867

Massive amounts of capital were destroyed over the last four years, and the process on Wall Street and in the banking sector is now about assigning the losses. What is important to the investment strategies of readers of this site is this: There are only two ways to assign the losses, either to those responsible or to society at large.

The fact that the Fed and other central banks are injecting hundreds of billions of liquidity into the system indicates that we’ve chosen the latter course. (By the way, I don’t criticize the effort. Money does matter to the real economy, and the threat of a complete meltdown of the financial system, with Depression-era implications, is very real.)

Every investor must recognize and embrace the reality that the Federal Reserve is choosing to use inflation to distribute the losses as widely and thinly as possible. Furthermore, you must embrace how to position yourself in inflation plays in order to assign your share of the losses to some other sucker who isn’t paying attention. The Fed and other banks are creating massive amounts of money now, and, as sure as night follows day, that money supply growth — in the absence of accompanying economic growth — will translate into higher prices.

The dollar is screaming this to you right now. Oil is screaming this at you. (Oil is already up nearly 10% since breaking the once-unthinkable $100 mark.) Gold is screaming this to you. Commodities are screaming this to you. If you really don’t believe it, ask your spouse what she (or he) spent at Safeway last week. Those “Ingredients for Life” now include inflation. To cover your assets and offload your share of the pain, investors need to be positioned in inflation plays, weak dollar plays and pricing power plays.

  • Inflation plays benefit directly from rising prices, and include commodity names — and companies levered to commodity price changes. Examples include agriculture names, oil exploration and production, the drillers and miners.
  • Weak dollar plays are any company that benefits from the falling dollar, either from greater overseas demand, lower domestic costs, or foreign exchange translation gains. Most tech names benefit, as most sales are overseas. Other large exporters, such as a Caterpillar (CAT) , will benefit as well.
  • Finally, pricing power plays are names that can pass through inflation-driven price increases quickly. The tobaccos are classic, as the demand curve is nearly inelastic. Big pharma can price in all environments. Some consumer names with strong brands can price aggressively, too. McDonald’s (MCD) strong comps yesterday show the fast food giant’s ability to both price and benefit from overseas business. (And it benefits from the tradedown effect in a weak economy.) Long McDonald’s/short McCormick & Schmick’s Seafood Restaurants (MSSR) would be a good example of a pair trade to capture the deflating hopes and dreams of the aspiring restaurant-goer.

Here are some of the inflation/dollar/pricing names I own in the fund my firm sub-advises, the Landmark Capital Disciplined Growth Fund (LCDGX):

  • Pure in
    flation plays include Mosaic (MOS) , EOG Resources (EOG) , Occidental Petroleum (OXY) , Deere (DE) , Exxon Mobil (XOM) , Flowserve (FLS) , Archer-Daniels-Midland (ADM) , Barrick Gold (ABX) and National Oilwell Varco (NOV) .
  • Weak dollar plays include Oracle (ORCL) , Microsoft (MSFT) , Research In Motion (RIMM) and Hewlett-Packard (HPQ)
  • Pricing power plays include UST Incorporated (UST) , Loews Carolina Group (CG) and McDonald’s.

Equity Put Call Ratio – An Up Indicator

Friday, March 7th, 2008

The chart above (courtesy of Helene Meisler) shows the Equity Put Call Ratio. You’ll see that the graph’s highs in August and January (coincident with the market turning points at those times) have been circled and that the current high is even higher.

The Equity Put Call Ratio shows the ratio of puts bought against a market correction to calls bought in anticipation of a market rally. The more puts bought means that market participants have been sufficiently scared to the point where they think the market can’t go up. This is generally the turning point in the market as this is a contrary indicator.

If you have cash to invest, I’d say that now is a good time to buy something, like an ag stock that may have been unfairly beaten down but which will jump back with more strength than the market in general. Unfortunately, this market is in turmoil and once it goes up, it will likely come back down. That means, you need to be nimble and buy strong sectors when markets get ready to go up, then sell weaker sectors when markets get ready to go down again. It is the only way to stay ahead in a market like this and it gives you an opportunity to reposition your portfolio for the coming resumption of the bull market. Use it to get overweight in the strong sectors that will outperform on a sustained basis: ag, energy, infrastructure, defense (unless Obama wins the Presidency – McCain and Clinton will maintain a strong military so they are not a determining factor in this sector), biotech, and precious metals.

In August and January, the market put in a bottom and rallied double digits (in the strong sectors noted above, but not necessarily in the broader averages) within a few market sessions, so you likely have a day or three to make changes in your portfolios. You should use them wisely – we are.


Oscillator Says Market Direction Is Up

Wednesday, March 5th, 2008

The above shows a graph of the Oscillator I follow. It doesn’t have dates at the bottom, but the big dips on the graph are the August and January lows. The current reading below the red line is definitely showing that the market is in oversold territory. This means that we are in for a short-term rally in the market.

We used Tuesday’s big selloff to buy shares in some of the strongest areas of the market: ag, natural gas, metals and gold. As the market turned around mid-day Tuesday and continued strong today those purchases gained nicely.

This short term rally gives us another opportunity to sell companies that are weaker fundamentally as the oscillator moves above the red line.

Market like this are very difficult to make money. You need to be nimble and make changes, selling weaker positions and adding to stronger ones. There are very few fundamentally strong areas within the equity market. As we work our way through this recession ( or economic slowdown if it turns out that there is no recession ) other areas of opportunity will present themselves – specifically I think that we will see a return of infrastructure, biotech, and defense – but for now ag, natural gas, metals and gold are the safe havens in which we are investing.