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Monday, July 12, 2010

Market Update - June 16, 2010 - Investor X

June 16, 2010
Investor X 

The DOW is getting close to the target I cited in yesterday's Market Update. The advance so far has been anemic with extremely low volume. This indicates that the bears are sitting on the sidelines for now and there is not much enthusiasm among the bulls to plow more money into this rally. So, the best way to describe the markets action so far this week is that it has been drifting slowly higher. Before I discuss my strategy to deal with this market, I would first like to take this opportunity to bring some perspective to the current situation in the markets.

What makes bear markets so difficult for most investors is the fact that upward corrections are typically slow and the topping and reversal process is time consuming. By contrast declines are powerful and fast. Wave bottoms, rather than being a slow process, tend to be a quick event. What this means is that during a bear market, in terms of time watching the markets, most of the time is spent watching the markets go up. Yet, overall the markets are declining. Another way of putting it is for the bears, the majority of the time is spent watching the markets advance and listening to the commentators explain why the markets have bottomed and why a new bull market has begun. Most investors cannot handle the cognitive dissonance this entails. It all seems too confusing and so it becomes much easier to simply follow the crowd while the crowd gets fleeced. Most investors simply do not have the tenacity necessary to stay the course in the face of the majority consensus hammering them with constant messages that they are wrong. Unfortunately, that’s the rules of the game, I didn’t make them but I do understand them.

That is why I mentioned in earlier updates that I instituted a core position of single short ETF’s that I plan to hold for a year or more and that I do not intend to trade these positions. In order to win the game this is the reality: In terms of time, one will be wrong 80% of the Time in exchange for ending up with a winning score. In my opinion, those who do not have time to follow the markets or those who find it difficult to psychologically deal with the above reality, it would be much better to buy in a core short position and then walk away from the markets for about a year. That will help to eliminate most of the confusion. Those who want to attempt to augment their returns and who enjoy playing the game can do so by adding to their core positions a few trading positions as well. The best advice I can give on this point is “To thine own self be true”. In other words make an honest assessment of your temperament and your comfort with risk and then invest accordingly.

As you know I have some trading positions in my conservative portfolio, that are double short ETF’s. I enjoy the game and so attempt to use them to augment my overall returns but I use them sparingly knowing that I am trading at a disadvantage. This is because, as I mentioned above, when a wave is topping it can be a long, slow, drawn out process but when a wave bottoms out, it is usually an event that may last for as little as a few minutes. For example on May 6th, the day of the so called flash crash, if an investor wanted to sell his short positions within 250 points of the bottom of the 1,000 point plunge, he had about 2-3 minutes to do so. If he sold just an hour or so late, the market would have advanced 650 points above the lows and he would have missed his opportunity. On the other hand, if a bull wanted to sell his stock within 250 points from when the market topped on April 26th, he could have done so anytime between April 5th and May 4th. So the bullish investor had about a month to sell out in order to have made “The right call” whereas the bear had only a few minutes. Additionally, that assumes he could have gotten his order executed at all during a period when most of the trading desks were frozen up.

If however one was not trading this market and was simply holding core positions, he would have found that three weeks later the market had dropped below the lows experienced by the flash crash. This is why for many investors it’s better to simply buy in a core position and forget trying to trade and time this market. This especially holds true for those who beat themselves up if they do not short at the exact high and sell their shorts at the exact lows. This is akin to a golfer getting depressed, upset and angry every time he doesn’t shoot a perfect 18. No one, not even Tiger Woods, expects to go out and shoot 18 consecutive holes in one. A more realistic goal is to do better than your competition and at the end of the game, when the final scores are tallied, to end up with a winning score.

This “game” we call the “Bear Market” began in late 2007 and will probably not hit its final lows for another five to seven years. So, it’s important to keep in mind that the score will not be tallied until the game is over. By then, many investors will have lost most of their assets and those who actually end up with a positive score, over that decade, will be rare. The media likes to cut the game into small pieces and act as if each small piece is a separate game and unrelated to the other pieces. I don’t know if that is because they are really that stupid or if it is because they try to keep their viewers confused and dependent upon their “sage” advice. As an example, we hear a lot these days about the risk of a “double dip recession” as if it were totally unrelated to the 2008 recession. Here’s a news flash, it’s going to happen and its not unrelated to 2008, rather it’s a continuation of the decline that began in 2007. So, don’t be surprised when you hear such things as “The economy has entered a Double Dip Recession” and “No one could have seen this coming”. Wasting time “hoping” that a “double dip recession” doesn’t occur is not a good use of ones time. Rather, knowing that the process that began in 2007 will continue until all the excess debt has been wiped clean, recognizing that their will be up phases as well as down phases during the process and actively preparing strategies to not be devastated by the declines when they do arrive is a much more valuable and productive use of ones time.

With the above perspective in mind, I’d like to discuss the current market in relation to my trading positions, which by the way, are only about 20% of the value of my core positions (which are single short ETF's being held long term and not being traded). As I mentioned above, this week’s rally has been anemic and unimpressive and therefore could stall out at any time. On the other hand, it could muster enough “Animal Spirits” to perhaps advance another couple of hundred points from current levels. Either way, it really doesn’t matter in my opinion because the probabilities are that a month from now the markets are going to be significantly lower than current levels. Therefore I am holding my double short trading positions through whatever short term advances the market may make from here. The reason is that if I sell to avoid any short term pain, if the market does advance a couple of hundred points, I will then have to buy them back in again when the rally is over. So, if I do nothing I don’t have to make any decisions but if I decide to sell, that will force me into making two decisions correctly, that is, 1) decide the best level to sell and then 2) decide the best level to buy back in. If I am wrong on either of those two decisions, I can end up much worse off than if I simply do nothing and let this short term rally do its slow and boring process of making a top.

That’s my thoughts on the current market. Have a nice day,


Investor X

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