Friday, July 10, 2009

Head and Shoulders Pattern in the S&P500

Ahh, the famous Head and Shoulders pattern. Precursor to extra-earthbound movement.

It looks like the next down-leg for the broad market might be starting its launch. Just in time for 2Q earnings, where I suspect we will have some nasty surprises.

A fairly clear head-and-shoulders patter has been formed and the market has closed below the neckline. Now is a good point to start lining up your short positions. Also note the EMA's, which look to be soon lining up for downtrend order and should offer some strong resistance on the way down.

Remember from one of my earlier posts that the good place to put your stop-loss on a head and shoulders is at the top of the right shoulder. If the market is able to get to that point there is a decent chance of a strong upswing.

Do I think this is one of those cases? Honestly, no. There is a lot of rot on the economic vine that is being sprayed with Febreeze by the governments and central banks around the world. It is not and has not been cut off. Just like a plant with dead husks still attached will not grow properly no matter how much fertilizer you dump on it, the same goes for a broad economy.

I personally am trading with the following in mind: We will continue to see lower lows in the broad market until either something massively positive happens or until the (currently) inevitable worst-case plays out.

That positive thing: Government needs to GET OUT of economics entirely as 1000 guys centrally planning the daily decisions and well-being of 300 million people just does not make sense. Government continues to siphon off resources to be used UNproductively, while the market is attempting to work its creative destructive magic.

If the government gets out - we will probably see one large and violent crash as the hugely insolvent banks' assets are liquidated and the market reallocates the tidal wave of malinvestment currently locked away from productive uses by the Federal Reserve and Government.

However I am certain that our 25 year stint of growing government intervention is not about to decelerate as most people are not educated in how free markets function and will only learn the perils of government intervention by watching what will unfold.

But the stock market can still go up! Long term Helicopter Ben seems willing to dump as much paper on these problems as he can print. Eventually this will create a tsunami of inflation which will cause all asset prices to rise, just not as quickly as basic necessities will rise in price.

But anyway, the chart you've all been waiting for :)

Also to note, Silver Prices are down around $12.50 right now, which is RIDICULOUSLY CHEAP on a historical basis. I am accumulating continuous physical silver bullion at any price under $15.00 / oz - this just makes me smile!

Anyway, folks, enjoy!

Wednesday, July 8, 2009

The New Subprime, Treasuries gain Short Term, and Get your Shorts in Line

I recently read a pretty good article over at The Motley Fool called "the new subprime". Even though I think that and its founders have gotten big enough that they are one-foot-in and one-foot-out of the "dumb money" category, the still do put out some decent articles on the macro state of things.

Yes, default rates across the board are up up up. Yes, commercial properties have over 50% higher vacancy rates than the majority of purchases in the last 5 years were financed for. Yes, the government created a legal/regulatory structure that FORCED banks to make loans to highly under-qualified buyers. Yes, they have TRILLIONS in off-balance-sheet assets that stink so bad I can smell them from here in Canada.

So what does this mean for you?

As I have been writing for some time, I think we are in the onset of a massive paradigm social shift. One that similarly took place during the Great Depression. What are the similarities up to this point?

  • At least a decade of very easy credit, huge money supply expansion, and reckless lending purported by government intervention in the markets
  • Massive over-expansion of housing sectors and the financial sector far beyond the ratio normally seen in a healthy, productive economy
  • A huge deflation of the asset bubble everyone was high on
  • A drop of about 40% in the market in a short period of time, followed by big government intervention
  • A sucker's rally of over 35%
  • An election of a Democratic president in the middle of all this
  • Government intervention the scope of which did not historically exist in the US until the moment the president signed the stimuli into effect
  • Huge government meddling into the banking system

Okay, so we've got what is similar. Actually eerily mirroring.

We are about at the point of massive government intervention in the banking system and at the top of a massive sucker's rally. What happened after this in the 1930's?

  • A crushing decline over 2 years that wiped out 86% of the market's value
  • Nationwide bank closures as undercapitalization withered away the financial system
  • So much government "stimuli" (including paying farmers to NOT grow crops to keep prices up - do you think that helped unemployment???) that over 6 more years followed in which the economy was smothered and stifled until it was gasping for life
  • A massive war which America's president decided to capitalize on
  • finally the end...... after so much government-induced pain.

Is this what we have in store? Possibly.

I personally think it is going to be a lot worse. And I'm not peddling pessimism porn or anything like that. It's just that we don't have a gold standard today to limit the government's abilities to print/spend as much money as they damned well please. And we don't have a political structure that even slightly realizes how much long term DAMAGE government involvement in economics does. (Other than Ron Paul, who I honestly believe is the last hope for America).

And finally, America is not an emerging market anymore. It was an emerging market in the 1930s. After the war it was the world's largest creditor nation, having much of Europe sending interest payments across the Pond. It also had huge agriculture and manufacturing sectors as a percentage of GDP, making it extremely productive and causing the purchasing power of the dollar to remain strong (a surplus of goods and services versus the amount of currency - locked to a gold standard I might add - caused low prices and high prosperity).

But we don't have that today. America's government budget on average has increased multiple times as a percentage of GDP, meaning that less and less money is going to the host (private sector that actually PRODUCES stuff for profit) and more is going to the parasite (non-productive).

China is the America of today, in terms of global positioning. The new emerging superpower. I would suggest buying gold and silver, of course, but having some spare Yuan kicking around might not hurt either.

So how does one play this situation?

Well, I am waiting for another opportunity to short US treasuries by buying long-term Call Options on PST and TBT. I am also currently short the following companies:

Capital One Financial. September 2009 Put Options $20 Strike. 5 Contracts @ $1.85

Bank of America. November 2009 Put Options $11 Strike. 10 Contracts @ $1.45

Tessera Technologies. July 2009 Put Options $25.00 Strike. 5 Contracts @ $1.65

JP Morgan Chase. September 2009 Put Options $33.00 Strike. 5 Contracts @ 3.35

I am waiting for TBT to hit at least the mid-40's and PST to his around $47.00 - once they are at this point I will look strictly to the technicals for my entry point. I am also planning on buying Baffinland Iron mines at hopefully around $.40 - purchased them at $.17 last year and sold out at $.50 a few months back, if you remember.

Finally I think Neo Materials is a good long-term buy once they hit at least a 30% discount to NAV (They are trading at around 20% over currently). And of course Migao Corporation is another on my buy list when the technicals are looking good.

Happy trading all!

Monday, July 6, 2009

Earnings, the S&P 500, Analysts and their Wacky Ways.

So over the last few days I have had a few arguments with folks on various message boards about what the fair value of the S&P 500 is. Some say 450, others say 700, still others say it's worth a negative amount.

It's pretty tough to pinpoint and if you wanted to make a really really accurate valuation you'd have to methodically go through each company listed on the index and dissect their books and add the weighted values together to find your perfect number. Plus or minus market sentiment of course ;)

Then you can use the broad valuation numbers like Price to Book and Price to Earnings. But even there you might come across a little snag. If you are talking about earnings, typically the most paid-attention-to number of all the financials of any corporation, most investors go by forecasts.

There are some good forecasters out there and there are some really bad forecasters out there. Typically I have found that the bigger the analyst or firm, the later they are to the party, and the more they follow the same school of thought as the great percentage of the market participants (dumb money) and the guys that read the teleprompter on the tv.

A few people have messaged me about earnings and asked a question about "bottom up" verus "top down" forecasting, as well as "reported earnings" and "operating earnings". Here are the differences (very basically) between these things.


Your typical top-down analyst is a macro-economics type of guy. Top down is a look at the big picture that this particular company is a part of. Top down analysts that are good usually are better at picking earnings in high-growth sectors and emerging business models because they look for new trends influenced by other factors.

Looking at things like demographics, broad social lending and credit or savings, broad investment allocation, broad-based demand for a new product or service, etc etc, are all things that a Top-Down analyst will take into context.

Once he has see the "big picture", he applies that situation to this particular company. By doing so he can venture a guess (which is, after all what analysts do - albeit it's supposed to be an educated one..... sometimes I wonder...) as to how much money this business will make, what their assets will be worth (i.e. are they in higher demand across the market or sector), and their future growth levels.


A bottom-up analyst is usually a by-the-numbers look. It is generally very specific to the company being studied, maybe including some competition or closely related industry players. Bottom-up is more backward looking analysis as it takes previous sets of numbers and applies a growth pattern to them in order to formulate the new estimates for the future.

Good bottom up analysts are usually pretty dead on when dealing with steady-growth companies and blue-chips. They often undershoot earnings in high-growth industries and in the mist of large social trend changes.

Bottom up analysis is a better system of comparison for value-investors while top-down analyst projections are more growth-investor oriented.

Earnings Themselves

So the million dollar questions. Sometimes the multi-million dollar question, actually. What is the difference between "Reported Earnings" and "Operating Earnings"

Reported Earnings

Reported Earnings is the number used in Earnings Per Share, Net Earnings, etc. This is the number used in P/E ratios. Reported earnings adds in any accounting changes that have been made that affect assets - for example the banks took massive writedowns (marked down the value of their loan to more realistic - if still far to high, in my humble opinion) which caused their reported earnings to be negative. If you lose a Billion $ of value in the first quarter, even though you actually made a profit through business activity, that $ Billion loss of value still gets bundled in to reported earnings.

Operating Earnings

Operating Earnings is basically a straight look at how much money the business made by doing it's day-to-day thing. It does NOT take into account any accounting adjustment that have been made and is the number usually posted before Net Earnings or Reported Earnings on an income statement.

It looks kind of like this:

Operating Earnings $1,000,000
plus or (minus) adjustments (474,000)
Net Earnings $526,000

So Operating earnings would be $1,000,000 and Reported Earnings would be $526,000

Hope this clears that up for those with questions. Happy investing all!

I wonder what this week will bring......