The Stock Surfer

Bailout Noise And Crazy Volatility

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CREDIT CRISIS CONTINUES

I was traveling the day the Dow plunged 777 points, and was shocked when I heard about it even though I've had in mind for a while that a stock market crash is a real possibility. That was a glimpse of what could happen to the stock market if the credit markets don't stabilize. If most people are like me, there is a general lack of public understanding as to why the credit market is so important.

Simply put, many businesses rely on credit for common activities. Retail companies, for example, need to buy a lot of inventory in September and October to stock the shelves for the increased demand of the holiday season. They often use credit to do that, knowing they'll be able to pay back the loan after they sell the products. That's one example. Another would be a business that wants to expand operations to another part of the country or even overseas. Typically, they would borrow money to do so and plan to pay the loan back after their new opportunities pay off. When credit markets freeze up or become cost prohibitive, businesses suffer. Some businesses may even struggle to stay afloat. Credit is that important.

I could go into more detail, but this is a stock blog and not the Wall Street Journal. So what does this mean for stocks? The market is trying to price in whether or not the credit crisis gets solved. On Monday, the reaction to no government plan was a 777 point drop. Yesterday, the reaction to renewed hope for a plan was a 500 point pop. We're not looking at constructive buying and selling at this point, we're looking at emotion (emotion is always in the market, but more so now than usual). Volatility as measured by the VIX is now firmly above 40 and staying there. The market is oversold by most measures, but that doesn't mean we can't go down even more. Also, one could argue that even after a government plan is enacted, it may not work and it may not prevent a recession.

It's an extremely difficult investing environment because if you have any discipline in cutting losses, you are probably getting stopped out after a day or so. For this reason, I've tried to minimize risk by cutting all positions except those that I have confidence in longer term. Most of these are video game names that continue to sell off, despite solid fundamentals. I could be wrong, but I still like the prospects for companies like Activision (ATVI), Nintendo (NTDOY), and Take Two (TTWO). I'm not recommending those to anyone, but I will say this: if you are losing sleep over the stocks you're holding, you still have too much risk on the table.

GAMESTOP AND A FAT PITCH

Last week on my personal blog I mentioned that Gamestop (GME) is looking very cheap. I'm usually not one to buy extreme weakness, but I think the drop in GME is overdone and I bought a partial investment position today. I plan to lay out a more detailed case soon, but for now let me just say it's a value play.

Last week I also mentioned my Fat Pitch Account in which I'm testing out my day trading skills. A friend of mine said it should be the 3-1 Account since I'm looking for consistent base hits rather than home runs, and he has a point there but not a catchy name, so I'm sticking with Fat Pitch. Today, GME was my stock of choice, and here are the results.

DAYTRADE JOURNAL

Stock: Gamestop (GME)

Buy Details: Bought GME at 34.96. The overall market was down, but GME was up--a "green bean in a red sea", as Todd Harrison likes to say. That's a sign of demand for the stock. I had found it curious that during yesterday's big rally GME was not up. I also found it curious that GME was up despite acquiring a French video game retailer today (usually stocks are down when acquisitions are announced). All of that, including GME's ability to make an acquisition in this environment, struck me as bullish for today.

Sell Details: Sold all my GME at 35.55. There were ups and downs, but GME remained strong. I resisted the urge to get greedy and took the gain.

Profit/Loss on trade: +1.46%

Profit/Loss on account: +1.02%

Overall Profit/Loss on account (all trades): +1.53%

Note: Profit/Loss is calculated to include commissions. Since I don't always trade the entire account at once, the account P/L is different from the trade P/L. Also, there may be rounding issues.

Please visit www.thestocksurfer.blogspot.com for further stock banter, with charts, pictures, and sometimes videos!

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Extreme Caution Required

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In my last post, I wrote about taking a calculated risk to the long side. But I wrote this as well: "I also think there continues to be the risk of a major dislocation in stocks (read: crash)."

I don't mean to sound alarmist, but I think the risk of a crash has increased. The market's reaction to the bailout bill was certainly not encouraging. More importantly, the credit markets have not improved. The situation is serious, and even though I have been expecting some themes to play out intellectually (bear market, deflation, etc.), it's quite different to see them up close. We should all be prepared to lose money in the market, and we should all ask ourselves: What if the government's interventions don't work?

Of course, something like a crash would be a "black swan" type event, rare by definition. However, we have seen events in the past few weeks that I'm sure we never thought we'd see. These are all rare events.

Perhaps buyers of stocks now will cash in on a great trade next week or next month or next year. In oversold conditions, the odds sometimes point that way. The government will do everything it can to try to calm the crisis (perhaps a surprise interest rate cut?). But after trying to get bullish for a trade, I just don't like what I'm seeing. I will use any bounce to lighten up my already limited risk. One of the benefits of being an individual investor is that I can change my mind and my portfolio very quickly. And I will take trading opportunities as they present themselves. But this is no time to be a buy and holder.

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Teetering Between Crash And Capitulation

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Fear is very high, every position is getting clobbered, and at times like this I'm willing to contradict myself every few minutes or so.

This morning, my contradictions included selling a portion of the positions I've been holding, even though I think they are at good values. Even at good values, nothing is safe at this point, so I'm happy to flatten out. This is simply crash insurance. I also bought some short ETFs with tight stops.

On the other hand, the risk/reward favors capitulation and a rally. When sellers become exhausted, a vicious rally can ensue. My vehicle of choice is the Ultra QQQ (QLD). This is for my fat pitch account, which is very short term (hours, not days).

This is not an easy game, and if I weren't able to watch every tick I wouldn't be playing.

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Congratulations, You've Lived Through A Crash

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I've spoken on and off about the possibility of a stock market crash, but it's quite different to live through one. I've also learned a lesson about how humbling and sneaky the market can be, because this was not the crash I expected, a big one day event. It was a crash that happened over a series of days. And I shouldn't even be using the past tense. The crash is still taking place.

There is no easy advice to give at this point. As with all financial moves, what you do will be based on your own risk tolerance and time horizon. There are many different theories on how to manage money, and we each need to follow the one that suits us.

I've been singed but not burned by the crash. Last weekend, I was talking to my wife about how I had a bad feeling about the market. (This was after the bailout bill passed and stocks failed to rally.) I usually don't say things like that to her, and we agreed to move some more of our money to cash on Monday. I didn't do it. Why? Well, stupidity comes to mind. But actually it was the thought that when Monday came around, with the market down 800 points, we were near capitulation and I'd be selling the bottom. In hindsight I can see that we weren't and in fact we still aren't. I can also see that I should trust my instincts, and my wife.

Every book I've read on the market has a story about a gaffe. Monday's decisions will be in my future book.

Aside from that slice of humble pie, if I'm objective about it I was merely singed by the crash rather than burned because since early 2008 the majority of my long term money has been in cash. I've held a few stocks through it all, but sold significant portions on the way down. My remaining shares are at prices I would buy, so I'm keeping them. My short term trading account has been reserved for day trading for a several weeks now, so the damage there has been minimal.

I think it's important to assess the damage to your portfolio in a time like this. Closing your eyes will do nothing to change reality. However, once you survey the landscape, there is no reason to hang onto regrets about what you could have or should have done--we all wish we would've sold everything at this time last year and gone short. Too bad. The best thing you can do is plant yourself in the present and start taking control of your portfolio today.

There are certainly some tempting prices out there. I recently bought a little ERTS and CELG, and on my radar are stocks like RIMM, RIG, and FCX. I'd post some charts, but they all look the same--like a ski slope! This is a great time to look at stocks you've always wanted--chances are they are at prices you never thought you'd see. But for now, it's porbably best to do more window shopping than buying. There are plenty of hedge funds and mutual funds that will need to sell as people pull money out of the market, and this will continue to pressure stocks. The bottom will be a process, so be patient. If you buy anything now, hedge it with a short ETF like SDS or TWM (I've done that as well).

There will be a bounce at some point, and it should be unmistakeable (a big reversal day that begins down and finishes up on heavy volume). Those with cash on that day will have some great opportunities. Longer term, anything can happen, so I'll be trading more than investing.

Finally, a word about mutual funds. If you have mutual funds in your taxable account, be aware that you may face a big tax hit as they sell shares. Mutual funds may have gains this year on stocks they bought years ago, and even though funds have been going down, you will be taxed on those gains no matter how long you've been in the fund. This happened after the tech bubble, and people got hit by a double whammy of depreciating funds and taxable gains. I don't use mutual funds at all, but if you do, consider if ETFs may be a better way to go.

Good luck out there, and remember to relax. The stock market has crashed, and we're all still here.

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The Post-Crash Picture

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There certainly are plenty of issues to talk about, so forgive me in advance if this post gets long, or muddled, or both.

WORKING ON A TRADER'S BOTTOM

Most traders I follow are now building long positions following last week's prolonged crash. Why? Because Friday appeared to be a classic capitulation day. People were getting out of the market at all costs, and buyers on Friday were rewarded with a huge jump on Monday. Therefore, Friday's lows will act as a trader's bottom until further notice. A pullback or even a retest of the lows is expected, and a "higher low" or successful retest will be viewed as positive.

SHORT AND LONG TERM CONCERNS

Short Term Concerns: There are 4 short term concerns on my radar.

Capitulation Suckers: Last week was hard on many traders and investors, myself included. The toughest part was that Monday looked like a capitulation day as the Dow was down 800 points and rallied to finish down 300. Instead, the market just continued lower. So people who bought on Monday, (or Tuesday or Wednesday) may still be looking to unload shares.

Hedge Fund, Pension Fund, and Mutual Fund Selling: Even as traders may be ready for a rally, other investors may be ready to cash out. Hedge funds still need to get rid of leverage, and many will be facing redemptions and margin calls. This type of forced selling has been going on for a while, but there's no way to know how much more is out there. Also, many hedge funds and pension funds are still stuck in energy names that are waaayyy down. As far as mutual funds go, many retail investors undoubtedly prayed last week for any bounce whatsoever to sell their mutual funds, and you can bet they'll be selling by the end of the year for the tax benefits.

Another Crash Still Possible: Last week can be considered a crash, but if credit markets don't improve we need to be aware of the "Black Swan" possibility of another, more surprising and truly evil crash. Nassim Taleb said the current crisis is a "White Swan'', not a Black Swan, because it was something bound to happen. A Black Swan would be a market crash when everyone thinks it has already happened.

Earnings Season: Are expectations low enough, or will stocks get whacked as companies miss estimates?

Long Term Concerns: There are 50 long term concerns on my radar, but I'll keep it to 4.

Credit Bubble (Housing Bubble, Energy Bubble): We saw the market carnage following a tech bubble, but today we're facing 3 bubbles simultaneously. You could say they are all related, but either way these bubbles will take time to correct. Credit was so easy for so long that it led to the housing bubble and, through the weak dollar, to the energy bubble. By throwing more dollars around the globe, the powers that be are attempting to get credit moving again. But what if it doesn't work? Are we looking at a Japan situation for the U.S. and Europe--low rates that don't spur growth? Deflation on a global scale?

Global Recession: Even if the bubbles are addressed, we are still technically at the beginning of a recession in the US and probably elsewhere. Many thought it would be mild, but now many think it will be severe.

Socialism: Government actions have effectively remade the entire financial system. There are tons of unknowns and unintended consequences ahead of us. Perhaps it will lay the foundation for a better free market system in the future. Or perhaps these policies will make things worse in the long run.

Time: The S&P 500 went down more than 40% from its highs of last year, a decent decline in terms of price. But in terms of time, it has only been one year. Why would we expect the market decline to be finished that quickly?

TRADING STRATEGIES

So we have 2 competing realities to consider as we trade. We have the short and long term concerns that should make us cautious if not completely freaked out. On the other hand, we have the post-capitulation trading bottom that can provide us with trading opportunities.

Many strategies could work at this point, so I share mine not as a guide but simply as one way to skin a cat.

Short term, I'm looking to start or add to long positions as the market pulls back this week. Stops can be set at recent lows. For example, here's Electronic Arts over the past 5 days. 26.21, or just below, would be an appropriate stop. If you buy in the 27s, you risk about a buck but have the potential to rally to at least 32 or 33, which is where ERTS was yesterday. That'd be a move of more than 15%.

Medium term, I'm looking for a bear market rally that could last a few weeks or a couple months. The longest rally of the year followed the Bear Stearns bottom, and it was around 11% on the S&P 500 and lasted approximately 2 months. Keep in mind that we had such a huge day on Monday that we could be looking at a trading range with support at Friday's low and resistance at...I'm not sure. But I will be looking to sell any extended rally. Here's a 3-month chart.

Longer term, I don't think we've hit our ultimate lows. Predictions are impossible to make, but I'll be looking initially at the tech bubble lows of 2002 (around 775ish on the S&P). After that, I have no idea but it'd be back to the 1990s for support. A retest of the 2002 lows seems likely to me (click for chart), but after that I really have no idea and would need to do more work if the time comes.

Update: The huge drop today (-9% on the S&P 500) may put many stops into play tomorrow. If the S&P breaks through the Friday lows to the downside, all bets are off and any trading positions should be sold.

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Rally Possible, But (Bearish) Skepticism Has Been Rewarded

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Plenty of themes out there, so I'll just start going through them in no particular order. For context, check out The Post-Crash Picture, where I laid out some short and long term concerns along with some trading strategies. In a nutshell, I think we're in a bear market rally, but I think eventually we go lower as deflation and a global slowdown sets in. Just a best guess, and as always I remain flexible. Big picture thoughts, for me, are just an atlas (not a GPS system). It helps to look at the atlas before I start or when I'm lost, but while driving (trading), I'm looking out the window with my hands on the wheel.

STILL LOOKING FOR A RALLY

The action continues to be volatile, but many professionals I follow are cautiously looking for a rally off the October 10 low. I don't want to speak for others, but I encourage you to discover for yourself the views of Todd Harrison at Minyanville, Jeff Saut at Raymond James, Carter Worth at Oppenheimer, and last but not least, Warren Buffett. They all have different approaches and time horizons, but what they have in common is a belief that it's not a bad time to buy stocks (with differing caveats for each of them).

The upside of this is that there are smart folks looking to add to positions going forward. Any decent rally could spur buying from slower moving folks like mutual funds, resulting in a "meltup" of sorts. The downside is that the "smart money" on the street is also flexible money, and if the market breaks the lows, these guys will get out and live to play another day. That would result in another "meltdown".

As usual, I'm somewhere in between. I have long, medium, and short term accounts. The long term account is very high in cash because I think deflation / recession lows are not yet in. The medium term account holds some core positions and trading positions that I'm adding to at decent prices (but I'll lighten up if we see the meltdown). The short term account is reserved for quick trades only, and enters most nights at 100% cash.

BE SKEPTICAL

If there's one thing that the 2008 stock market should teach us, it's to be skeptical. I could pull out an example a day for the next year, but today I'll walk down memory lane to the dry bulk shippers. In the fall of 2007, I remember reading the transcript of an analyst forum, and every analyst was bullish on the sector. They had believable arguments and declared that it was simple supply and demand--not enough ships to do the job and shipping rates at all-time highs with no end in sight. These comments, it turns out, came near the absolute top of the stock prices. Take a look at Dryships (DRYS) (click for chart).

What is the lesson here? The lesson has to be skepticism. I'm not going to say these analysts didn't know what they were doing--I'm sure they are smart professionals who know more about the shipping industry than I ever will. But when it comes to making money in stocks, we certainly need to take everything with a grain of salt and respect price action in order to protect our money. No matter how good the news sounds, it makes sense to ask the question, "At what point will I sell?"

Of course I'm not saying that one should panic at the first sign of a drop, but there is a balance between confidence and skepticism that must be struck to make sound investment decisions. This year, the skeptical have had the upperhand, and those who have panicked early (like back in January) have actually saved money.

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Reviewing Gartman's Rules, And Today's Mercenary Trade

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I've found that the hardest part about trading isn't knowing the rules, it's following the rules. The first step to any endeavor is to have a game plan, but as my Minnesota Vikings will tell you, executing the game plan isn't easy (hint: giving up 2 special teams touchdowns to Da Bears was not in the game plan).

Last night on Fast Money, Dennis Gartman was asked how he could switch from being bullish to bearish with relative ease. Here's a link to the video, and his response is near the end, around the 7 minute mark:

http://www.cnbc.com/id/15840232?video=900139502

His response was basically that he has no problem changing his mind. This corresponds to his trading rule #2: Trade like a mercenary guerrilla. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.

Gartman also mentioned that he was up on the year, so his rules have evidently served him well. Here are some other rules that are worth reviewing in this very difficult market:

--Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.

--In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many.

--Bear markets are more violent than are bull markets and so also are their retracements.

Gartman's method of trading is not for everyone, but it's worth considering if you are actively managing your portfolio. Don't let past mistakes stop you from making better decisions going forward. This market is the most challenging that many of us have ever witnessed, and the goal is to stay sane and preserve capital above all else.

TODAY'S MERCENARY TRADE

Following Gartman's Rule #2, the bears are on the winning side until proven otherwise and the benefit of the doubt must be given to the downside. Today is no exception.

With a bearish bent, today I was looking to employ Gartman's Rule #7: Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. All day, Real Estate and the Russell 2000 have been very weak, so when the rally didn't hold I jumped into SRS and TWM.

With volatility so high the trend could turn on a dime, so even short positions (perhaps especially short positions) must be handled with care. But if the bulls don't start running by 2:30pm or so, it could get very ugly out there. The pattern over the past 5 days is that momentum speeds up late in the day (click for chart of S&P 500).

Sure enough, while writing this post we've moved aggressively lower and I will ride SRS and TWM until the end of the day (with a trailing stop, to protect against a snap up). I'm not comfortable holding overnight, as anything could happen before 9:30am tomorrow (another global rate cut? a ban on all shorting?). I can't claim any special insight today other than trying to play the trend and follow a wise set of rules that have been tested by a professional. For a few weeks I've been stubbornly trying to play countertrend moves, much to my own chagrin (and the chagrin of my P/L). In this environment, it seems better to wait until the market moves decisively, and follow along in that direction.

Is there any doubt now that we will test the intraday low of 839 on the S&P? The test could come as soon as tomorrow. If it doesn't hold, look out below. It's time to start thinking about what to do if that happens...

FINAL UPDATE

There was a snap up, and the trailing stop protected the gains in the short ETFs. What happens tomorrow is anyone's guess.]

[Also posted on my personal blog, with charts, at www.thestocksurfer.blogspot.com]

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Investing, Saving, and Deflation

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Today, as I enjoy yet another way to absorb caffeine (we just got a french press), I'd like to take a step back from the usual blog topic of trading and think about saving and investing. [Note: This article is posted also on my personal blog, www.thestocksurfer.blogspot.com, with charts and other content.]

I had been thinking about the overlap of saving and investing for a while but was unsure how to articulate my thoughts. Kevin Depew of Minyanville somehow got in my head and put it to paper (into a podcast, actually). Here's a highlight and I encourage you to read the whole thing if you have the time.

Kevin Depew: The blurring of the distinction between savings and investing goes back a long way. Probably you can trace it back to the death of pension plans and defined benefit plans...But the transference of the ability to control your own retirement destiny is the way it was sold and through investing in 401(k) plans. Well, what that did was that it sent the message, whether intentional or not, that the place to save your money is in the stock market. Well, the stock market is not a savings vehicle by any stretch of the imagination. When you invest in stocks, you're taking ownership in the company and, hopefully, as an owner in that company you're going to benefit from the dividend stream and the future earnings that that company accumulates. Savings is different. Savings is money that you can't afford to lose, by definition, and that's why you save it. And so somehow it became, you know, nobody really has savings anymore. They have some investments that have lost money over the past year or things of that nature, but they don't have really savings.

SAVING AND INVESTING

As Depew said, with the advent of 401k plans, many people now consider investing as synonymous with saving. I would add that the modern myth of mutual funds and index funds has also played a part. What is that myth? It's the conventional wisdom that stocks over the long run will go up 7-8% per year, simply buy and hold and then retire courtesy of an all-knowing online calculator. The reality is that stocks do not behave in ways that can be easily modeled, nor do bonds nor mortgage backed securities nor credit default swaps. For a further debunking of this myth, please read Fooled By Randomness by Taleb or When Genius Failed by Lowenstein.

The blurring of investing and saving hit me the other day while watching CNBC, and someone commented about how people are worried about their savings because the stock market has gone down. That comment should sound strange--one doesn't save money in stocks, one invests money in stocks. But it doesn't sound strange because we've been blurring the distinction for as long as I've received a paycheck. In this blog I usually write about trading, but I hope that doesn't lead anyone to think there's not more to the money picture.

THE CHALLENGE OF DEFLATION

The current economic environment is difficult to say the least. Talk of another global rate cut is everywhere, but we're increasingly faced with a situation where rate cuts are not having an effect (or, the desired effect) on stocks. As I've written about in this space previously (first way back on February 29th and several times since), what happens when the usual inflation-inducing tools don't work anymore? Deflation. (Depew, again, has been all over this theme.)

Despite the government's best efforts, credit is contracting and will continue to contract as both institutions and consumers delever their balance sheets. In layman's terms, we're shifting our focus to saving and paying off debt rather than taking on debt to spend. This trend becomes a feedback loop: We spend less, so the economy slows down, which means more businesses struggle, unemployment rises, which leads us to spend less, and so on.

I'm not saying it's gloomy for everyone, but the psychology of a slowing economy can affect everyone. My wife and I recently decided against making a somewhat frivolous purchase. She noted to me that even though our personal financial situation has not become gloomy, making a frivolous purchase seemed irresponsible because of what's going on in the economy. That is exactly how the psychology of deflation works. Even those who can spend the money are less likely to do so. It just feels right to save.

INDIVIDUAL STOCKS AS INVESTMENTS AND TRADES

Now back to stocks. As people wake up to deflation and a sliding market, the desire (or ability) to own stocks takes a big hit in general. Sure there's cash on the sidelines but no one wants to risk it. Valuations that once seemed reasonable (like a P/E of 20) no longer seem reasonable no matter how solid the company. People are not confident that the "E" (earnings) are going to be good enough. Furthermore, our idea of a good "P" has been shattered.

I remember setting up alerts to tell me when stocks like Electronic Arts (ERTS) or THQ (THQI) reached prices that would make them great buys. All of those alerts have been triggered, but the prices don't look so compelling anymore. For 5 years ERTS was a good buy near 40, but ERTS said goodbye to 40 and now 20 looks as a better entry. It's an example of the "anchoring bias" to consider 40 an appropriate price. It will take a while to determine new "appropriate prices" because all our anchors have been cut loose. This is price discovery, and it's disorienting. Click here for a chart.

When it comes to individual stocks, I usually lean toward trading rather than investing because history is riddled with stocks that have nice runs and then fall flat, like ERTS or Starbucks (SBUX) or Whole Foods (WFMI). These are decent companies but have been indecent stocks for a while now. Here are SBUX and WFMI over the past 5 years, compared to a stock I still like for an investment, Activision (ATVI). Notice the relative strength (click for chart).

Now of course ATVI could have a similar fall from grace, so I need to think ahead of time about conditions under which I would sell the stock. But if it is an investment (rather than a trade), I could see a time like this as an opportunity to build a position based on solid fundamental prospects.

The stage is being set for trading opportunities on the long side, with the huge caveat that it'd be best to wait for a general turn in the market and even then hedge your bets. Friday was not the capitulation day that traders look for, nor was there a meaningful reversal to the upside. That's a probable recipe for more pain this week. Good luck out there.

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Friday Video Game Update: Buying Activision On EA's Miss

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I'm starting a new weekly article today, the Friday Video Game Update. Hopefully I'll come up with a better title at some point, but for now I'll go with clarity over cutesy. I follow the video game sector more closely than most others, so I'd like to provide consistent analysis that you, the reader (hi mom!), can look for every week. Today's topic: Electronic Arts' earnings disappointment as an opportunity to buy Activision. (also found at www.thestocksurfer.blogspot.com.

WHY I BOUGHT ACTIVISION (ATVI) AFTER ELECTRONIC ARTS (ERTS) DISAPPOINTED THE STREET

Electronic Arts, long considered the king of video game publishing, reported earnings Thursday that met estimates to the penny. However, EA's guidance was less than stellar, and as I write this (3:20pm, Halloween Friday) the stock is getting punished to the tune of -17%. Where it will close is anyone's guess in this volatility. But the bigger question for video game investors is this: Should we be worried about the video game industry, or just about EA in particular?

There is plenty to worry about in consumer-land, but as I've written in the past, a growing video game cycle can cause gaming stocks to overcome a recession. Here's a chart showing how ATVI, ERTS, and THQ (THQI) held up from 2000-2004 while the S&P 500 lost ground.

In this case, I consider EA's stock to be a victim of EA itself. Expenses were high, catalog sales were weak, and a game (Tiberium) was killed due to quality issues. The sports games are great (I have Madden 09 in my Xbox 360 right now, literally), but appear to have reached something of a saturation point and can no longer drive growth. Some of the new titles are decent, but I don't see anything on the holiday slate that gets me excited to shop. I read the earnings call transcript on Seeking Alpha, and nothing in it gets me excited to own the stock either. The only reason I'd have to own the stock right now is that EA could become a takeover target, as reported by the Wall Street Journal. But I'd rather own it under $20.

So, as ERTS sold off today, I bought some more Activision. ATVI was down more than -7% in sympathy with ERTS at the beginning of the day--a gift, in my opinion. (ATVI finished the day down -2%.) Activision, unlike EA, is executing well. And it shows in the stock comparison--here's the past 6 months, with the S&P 500 thrown in for comparison.

>

Guitar Hero and Call of Duty are still growing, and the new James Bond title is buzzworthy. But the real kicker is Blizzard. With the addition of Blizzard, ATVI will benefit not only from millions of World of Warcraft addicts, but also from StarCraft enthusiasts who are finally getting the sequel they've been waiting for. If you don't think StarCraft is big, just check out this video of a televised StarCraft tournament in South Korea. I especially recommend jumping to the 5:00 minute mark to hear the crowd shrieking and play-by-play announcers yelling as one player wipes out the other.

I'm not fluent, but I think at the end there I heard the Korean for "Do you believe in miracles?!"

No one knows how the combination of Activision and Blizzard will perform, but I think this company has the biggest upside of any video game play because of the Blizzard factor. According to Gamespot, there are rumors of a next-generation Massively Muliplayer Online Game for video game consoles (as opposed to PC), and that could be a huge development, albeit probably a few years out for the next game cycle.

There are risks in the short term. Broadly speaking, the stock market is one big risk with the current volatility. The widely-reported "most difficult holiday season ever" for the consumer is also a risk. The biggest risk in my view is ATVI's earnings report on November 5th. I expect Activision to beat, but the reaction to the news can be unpredictable. Therefore, I'll be looking to to manage my risk heading into the number.

Video game investors and players: See you and your calloused thumbs back here next week!

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