Bad News is Good News? An October Reckoning

October is always the scariest months for investors. After all, the years 1929 and 1987 are ones the stock market would love to forget. Despite October's bad reputation, it still isn't as bad on average as September is when all is averaged out. This September has been another to buck the historical mean. However, this is a year that October might not fall within the averages.

Fear October.

That may be a bit strong, but when we analyze how the economic reports and financial news affect the market, we see an interesting phenomenon. Any bad news coming out now is spun into good news, referring to the foresight of the FED and its justification for a rate cut. Just read the Wall Street Journal or watch any number of financial news programs and they will echo the same. I have even read that all the bad numbers are good because it increases the chance for another rate cut. This has been rallying the market as of late, and we may even push ever further to break 14,000 once again, that is, until we reach what I call, "the scariest 3 days of October".

The 3 days spanning October 17th 18th, and 19th are ones to watch with increased scrutiny, critical to any trading strategy. This time period can act as a divining rod into what is to come in the next 18 months. It also has much more impact than the news today because there will be no excuses and no twisting the bad into good. The rate cut party will be long since over.

On October 17thh, being in the midst of earnings season, the market will have a vague idea how the economy is faring. Starting on the 17th, we will have earnings reports coming in from the Big Three . . . no, not the auto companies, the banks. Chase, Bank of America, and Citigroup, all report on the 17th,18th and 19th. If the big three miss their EPS estimates (1.02, 1.16, and 1.09 respectively), then it could prove to be a crushing blow to any bulls in the market. Why? These reports will let us gauge the continuing damage of the credit crisis and could either fuel a sustained rally or fuel a retreat. Banks can benefit from rate cuts, but it usually takes several months, far longer than the patience of a short term trader. If the big banks weather the credit storm and report less damage than expected, we could be looking good. If the Big Three miss projections, expect fear to rise. Fifth Third, Wachovia, and Wells Fargo are also reporting in this window, so there will be more than enough information available for us to analyze. If the numbers don't look good on the 19th, don't expect them to improve any time soon. If you tack those on to unfavorable unemployment or inflation numbers, it may be time to head for the exit.

There's nothing more fun than a really great party, but the hangover afterwards is directly proportional to the amount of fun you had. Cheers everyone.

Comments: View Comments |  Friday September 28, 2007

Congrats Bulls, you won this round.

With my portfolio taking a hit after the FED decision, one would think I would reverse my pessimistic view of the market and get on the bandwagon. After all, the market is now cured of any problems and we will soon be breaking Dow 15,000, right?

Wrong.

After the FED decision, I was caught in what is called a "bear trap", that is, I was heavy on short ETFs believing in a downward trend and the market started rising, hitting me with paper losses. I was a bear trapped in the uptrend. Once the decision came down, there is no doubt that the big players that were on the short side of the market desperately covered their short plays, adding fuel to the rally fire. What really surprised me is that the market didn't gain 1% - 1.5% more than it did. Seemingly caught in the bear trap, it looks like it is time for me to throw in the towel.

Not so fast, trader Joe.

The underlying problems in the economy do not get erased by a FED cut.

The traditional market inflation indicators, gold and oil, are on the rise. We all know what high energy prices mean to businesses that rely on transportation of goods--which is every business directly or indirectly. Commercial paper isn't out of the woods yet. Regardless of the cut, there are still many people that will lose their homes because they took a teaser rate that has reset on them. (If it only could have reset back to 1% maybe?). Employment is slowing down. Record dollar amounts of stock were bought on margin during the summer. The list can go on and on. For each of the above negatives, there are ways to see how each do not present a problem when studied on an individual basis.

I see the classic markings of a bull trap.

A bull trap is the exact inverse of the bear trap. Those that are buying today are betting on an overall market uptrend, and if the market takes a tumble downward, they are stuck with losses when buying high. What happens when more numbers come in showing many companies missing earnings projections? What happens when the unemployment rate ticks up just one tenth of one percent? What happens when the CPI and the PPI don't give us favorable bull market numbers?

Is this market a bear trap or a bull trap? Only time will tell, of course, but in the meantime I tip my hat the bulls on the win and await October, my pre-planned time to drop my 15% cash holding into more short ETF positions.

October surprise, anyone?

Comments: View Comments |  Thursday September 20, 2007

Upticks? Downticks? What to make of it all?

Back on July 6, the SEC abolished the Uptick Rule, and the smart money waited to see the deluge of volatility hit the market. Well, here we are 8 weeks later and volatility is the name of the game. Do we blame the abolishment of the Uptick Rule?

For those that know the ins and outs of shorting the market, you probably know the Uptick Rule well. For those that don't, that's ok.

Shorting is an easy concept to grasp and the Uptick Rule along with it. Quite simply, shorting a stock is betting that it will go down. If you short a stock at $50.00 per share and it falls to $40.00 per share, you now have a $10.00 per share profit on paper. Think of it as one of Newton's laws of motion in the market: Every force has an equal and opposite force. Shorting a stock is the 180 degree equivalent of buying a stock in the the way we all know how, that is, long. I won't go into the specifics of how it works, but there are several online resources to get you locked on to the mechanics of shorting.

The Uptick Rule came about after the crash in 1929. The uptick rule stated that in order for you to short a stock, you could only do it only after that stock had gained in price, an uptick as it is called. It was felt that traders shorting the market in 1929 accelerated the crash, and the Uptick Rule was put into place to protect the market from those "bear raiders" looking to short a company's stock into the ground.

This rule, of course, did not protect us from the crash in 1987.

On July 6th, the Uptick rule was abolished, and with it, shorting became incredibly easier. It didn't take long for the blame game to begin when volatility hit the markets. In fact, I just read an article this morning regarding about this entire debate. Click the link below if you are interested.

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20070910/FREE/70910009

Short sellers have been long been the scapegoats of so called problems in the markets. This current market is no different. Despite all the things exerting a downward pressure on today's market (problems that won't go away with FED action), the last thing the bulls have to worry about is the Uptick Rule or the lack thereof. In fact, an argument can be made that all of these big gain days for the markets are because of short sellers since they engage in "profit taking" just like long buyers. When long buyers "profit take", the market goes down and when short sellers "profit take" the market goes up. The difference is that you will never hear a talking head thank a short seller for the market rally. Short sellers are portrayed as the Lex Luthors, Wile E. Coyotes, and Darth Vaders all wrapped into one. If the market has several weeks of losses, bet money that short sellers and the abolishment of the Uptick rule will be blamed.

While many SLO open players are betting that Tobin Smith was right about the market bottom on August 15th and 16th, I wholeheartedly disagree. My portfolio is loaded on the short side because I believe the market top has passed and the downward pressure will be realized in the next 12-24 months. September traditionally is a tough month, but I believe the long term trend is down and I will continue to stick to my plan of holding about 15% in cash until October. Once the post FED party is over and the downward force starts to take hold, I will look for the sectors damaged least by the overall downward trend, and plow the rest of my cash into them looking for those sectors to follow the overall market down.

For all of you bulls out there, here's a sobering thought. John Heine, a spokesman for the SEC said regarding the Uptick Rule, "We note that while we believe that current price-test restrictions are no longer effective or necessary . . ." If he only could have said "new economy", "the old rules don't apply here" or "new paradigm".

Comments: View Comments |  Wednesday September 12, 2007

"Stocks skyrocket on word of economic depression"

I have yet to read that headline, but many have been close.

For those of us that get our daily dose of MSN money, CNBC, the Wall Street Journal, Forbes, and the like, we are constantly bombarded with news. A company's management team will be chided for serious blunders on one day, and the next day that same company will be touted as a possible "Buffett buy". What to make of it all?

Nothing.

That's right, there is nothing to make of it. As traders we need to learn to separate our emotions from the latest headlines and concentrate on sticking with our trading strategy through the thick and thin. How many times have we seen a favorable news article about a stock we own and get that silent elation causing us to do mental fist pumps? What about when we read a bad news article about one of our stocks and we start to sink into the depths of depression? Who wants to wager that those SLO players with Apple in their portfolios are feeling the latter since the news of the iphone price slash is out and commentators aren't as bullish about Apple anymore? Be patient . . . those commentators will be back on the Apple cart in no time.

News stories abound about September being the worst month on average for stock market returns, although you need to search to find that it hasn't been the case for the past 3 years. Some news stories will tell you the subprime problem isn't that bad, while others continually cite the subprime problem as a drag on stocks. The FED will cut rates, and now they won't. Don't bet the farm on a favorable news story, just stick to the strategy.

Emotions are a difficult thing to control, after all, I foresee a downturn in the market that I expect to run at least 12-24 months, but so far, it really hasn't materialized. My strategy has been to profit from the market downturn, and though I have been hurt in the short term, I will stay the course. I still have about $125k in cash that I will divide among my 4 lowest performing short ETFs on October 15th. In any market downturn, there will be sectors that stay afloat longer before the trend pulls them down. I am diversified across all sectors, so the sectors that have been beat up the least is where my money will go, and then ride the market down until the finish in December.

The tide turns quickly in this monster we call the market. Anyone selling any Apple stock?

Comments: View Comments |  Thursday September 6, 2007