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 January
4, 2009 Commentary (weekend edition)-
Happy New
Year! And what a year it was. I was watching a few of those specials on
television about the year, and seeing it all there, as it unfolded, it really
was something. It made me think of '98 on steroids and HGH. This is the type of
thing you won't see that often. Now, even though I've started to really enjoy
the much higher levels of volatility, I hope this year is a lot quieter. My
thinking, though, is that the most likely case scenario is either a lot quieter
of a year, or another really wild one. I think the least likely scenario is
something in between.
I am not going to spend a lot of time
pointing out all the factors that still remain, or that still justify the
bearish case, as we now have plenty of television shows to cover that. I will
make one quick point, tell a little story on another topic, and then we'll get
right to work. I just saw that the P/E for the S&P was just a fraction
under 22 now. It was just about 19 before this last run up. It didn't say what
version of the P/E this was, but it comes from one of the most reliable sources
out there. Now, even worse than the last time I commented on this, every last
analyst is super-bullish on 2009, citing outstanding valuation by any measure
conceivable (I guess they don't consider P/E a valuation tool, it must be a new
paradigm nowadays...).
The 'low-end' range of estimates I saw was 15%-30% for
the year. Not a single analyst was under 15%, no less any flat or negative on
the year. As I have mentioned so many times, I'm always a little nervous when
everyone is on one side of the boat. But here's something else to think about.
Generally when a big bear market ends the P/E tends to swing too far to the low
end, the old pendulum overshooting concept. I hear lots of references to 7, but
lets say to be more conservative only 10 on the downside. Now, the last I saw,
most analysts are looking for $65-$75 in 2009 earnings. I think $45 is more
realistic. Let's see what all those numbers might imply.
If the
S&P is around say 900 right now, and the P/E did drop to 10, and the
earnings estimates were too optimistic and they did turn out to be $45, that
would price the S&P just under 300. 300! An approximate 2/3 haircut from
here! Now, to me, that's compelling valuation. I'd personally be looking to
'load the boat' in the retirement account for the longer-term at that
valuation. Yet that would not be that unusual for the end of a big bear market.
Keep in mind, I am basing this on numbers I have heard, and also given I'm not
exactly sure how the P/E of 22 was calculated (we've all heard lower numbers
for the current P/E), so at best this is a very rough 'back of the envelope,
down and dirty' calculation, so take it as nothing more than that, and do your
own research and due diligence on this.
My point is, I'm just not as convinced as
everyone else that we are at compelling, once in a lifetime valuations here.
That being said, is the bottom in? Well, as I always say, I make no
predictions, and don't need to in order to find trade setups, but if the bottom
is in, I think it would have to do with manipulation and loss of free market
economics and not great valuations. None of that matters as far as the
spendability of the money people may make if their stock/retirement portfolios
go up, but it may make a difference down the road in terms of the 'side
effects', the unintended consequences we all may have to deal with, and pay
for, down the line. But, for now, no one much cares about what a mess we make
down the line, as long as we deal with 'now'.
Sound familiar? So, what I'm saying
is, although it is possible we are done going down (recall what I said about
everyone on one side of the boat, though), no one will ever convince me the
market is grossly undervalued here, and I simply can't stand listening to those
who endlessly try to push their own agendas saying so, or are simply just so
naive as to think so. Tell me the market is moving up and you are capitalizing
on that and I'm 100% behind what you have to say, but just don't go on and on
about the reason it is going up is because it is so undervalued. We all know
why it is going up... Enough said.
Let's jump to my story, then it's work time.
I was hoping some day to do an article on some of the psychological aspects of
trading, as I get asked a lot about this topic. I've been asked many times if I
could write a book on the mental aspect of the game. If it wasn't for the fact
that I've hung my pen up, that would probably be the next book I'd write, just
based on requests. Although I truly believe I have enough new and unpublished
material for another ten books, there is only so much technical information one
can write, given that, in my opinion, the average trader starts to get to the
point of diminishing returns due to his or her own mental aspects. What I mean
is, the average aspiring trader, I think, has trouble utilizing more tools
because they are struggling to utilize the tools they already have due to the
mental aspects of the game.
For whatever reasons, it seems human nature (in any
arena) to be unable to create a plan and then stick with it. This is the mental
aspect I speak of. I recall a big boxing match once where the world champ
wasn't sticking with his plan. The other guy studied him and saw what would get
him off his plan, and once he got him off his plan, despite his corner yelling
at him constantly, he simply 'did something else', and it didn't serve him
well. In interviews I later heard with his trainer, he said that his biggest
downfall is that he simply won't stick with his plan at certain times. And this
was one of the greatest boxers in history. If he can't stay with his plan, what
chance does the average guy have?
I got to thinking about the little upcoming
story as I talked to one student of mine. He mentioned to me, as many others
have, that he was struggling with sitting most of the day watching the mini's
(his chosen vehicle), waiting for a setup to form. Sometimes he'd wait hours,
and it was boring. I have said in the past that I see, on average, maybe one to
three setups per day in the mini's that meet the criteria for my methodology.
Some days there are none (this is uncommon), and some days there are more. So,
the real challenge is to sit and watch every tick, waiting patiently. I think
very few can do this, it seems. Most mini traders I have known have been
'scalpers' to some extent, for no other reason than they keep themselves from
boredom that way.
I don't want to get too far off track here, and this is why I could
write a whole book just discussing my thoughts on various aspects of the mental
game there is so much to say, but let's look at this quickly in more detail. I
am always saying that the setups, the PTA, is only 10%-20% of my comprehensive
'Trading Plan', whereas for most, especially 'vendors', it seems to be 90%,
95%, sometimes even 99% of their plan. But in reality, I see many people that I
have known over the years, just traders I have come to know, and they have a
plan that seems decent, but they just can't stick to it. They are not
addressing things like boredom, emotions, overtrading, undertrading, deviating
from their plan, and on and on. They are focused on their setups, even though
it seems the main reason they are not making money is because of all the trades
they take between their setups.
Have you ever noticed how you make some money
working hard doing your plan, and then in a blink you give it all back, and
sometimes more? It seems very hard, a lot of work, to make some, and you give
it back effortlessly in a very short time. I noticed that it seemed to me when
I made some 'grinding it out' I was working my 'Trading Plan', and when I was
giving it back fast it almost always seemed to be from trades that had nothing
to do with my plan. I suspect this may be the case with many traders. So, the
issue isn't the plan, it's the trader not executing the plan. Deviating from
the plan. The mental aspect. I coined the phrase awhile back 'fix your head'. I
mean, why bother working on refining or improving a winning technique (assuming
the trader has a winning technique) if the reason the trading is net negative
outcome is because the plan isn't being followed.
So, back to the story. I told this
student about a dog I used to have, and how he reminded me of many traders I
have talked to, especially mini traders. This dog was quite cool, except for
one thing he did, which was just plain nuts. He would go absolutely psychotic
when he saw any animal he could chase. We had a patio door where we would let
our dogs out into a small fenced area. He would see say a rabbit out there,
inside or outside the fence, and he would go nuts. We might think he had to go
out, so we'd open the door, and he would charge out, running left and right
like a madman. He would chase and chase and chase. The really crazy part is, if
there was more than one animal, like sometimes there might be three rabbits in
the general vicinity, he would stop chasing one to chase another, then another,
in a grand game of tag. It didn't matter the animal, either, cats, birds, even
toads, he would just got nuts. Otherwise, he was the most normal dog in the
world.
I really got to thinking how much he reminded me of many of the
traders I have encountered who are struggling with intraday mini trading. I
can't tell you how many I have had tell me they are just sitting around waiting
for that setup to come together when they get bored, and see a little something
on a very low level tick chart, and they just go for it. Or they see something
else they like. Sometimes they just give back their previous profits, sometimes
they tell me they dig into a hole and then they get determined to dig
themselves out. Regardless, they are totally off their plan. Many or most of
the setups they are trading 'in between' they readily admit they haven't even
tested to see if they are 'net positive outcome' setups i.e. 'they work'. And
worst of all, they don't even seem to see that the reason they are not making
money, or are making some and giving it all back, is because they are so far
off their plan.
In this regard they remind me of my dog. They are running all over
the place, chasing this and that as fast as things move left or right, no
thinking, just reacting. There is little self-control, just a 'chasing of the
action'. And if I point this out, they sometimes become aware, but struggle to
do anything to change their behavior. I don't think anything could have been
done to change our dog, he was just programmed that way. And I'm not comparing
a person to a dog, surely, but I am saying that most people seem somewhat
programmed to act the way they do, and I feel that if they weren't we wouldn't
have a market. It would be too easy to 'do the right thing' all the time, and
gain an edge.
The market works, it can exist, in my opinion, not because it is
too hard to beat, but because most people simply can't stick with a plan and do
what it takes to just execute the plan. That why so many try 'system trading',
to take the emotion and lack of discipline out of the equation (and this gets
into another area we have no time for, which is that I believe nothing, or
little, can perform better right now that a human mind working at full
capacity). I think everyone should study themselves, and see how much they are
deviating from their plan, and how much of their winning and losing is when
they are on plan, and when they are not. It may be surprising.
Lastly, let
me say that not every timeframe or vehicle is for everyone. Not everyone is
well-meshed with a plan that requires sitting for hours on end concentrating
and doing nothing. Most people can't hold their attention that long without
doing something, and even if they could, they wouldn't enjoy it day after day.
There are many approaches to a 'Trading Plan', and many approaches to mini
trading, as well as the trading of other vehicles. Traders should try to find
approaches that suit their personalities, a plan that they will be able to
stick to. A plan is next to useless if a trader won't actually execute the
plan. Don't be like my dog. Stick to your plan and ignore everything else, or
stop until you can figure out how to stick to your plan, or you can find a plan
you can stick to. (Yes, I guess I probably do have enough for a book on my
thoughts on the mental aspects of trading...)
Okay, let's get to work. Today's
commentary will be a bit different, in that I am not going to do as much with
intense line and Fib work, and more on some food for thought concepts. I
thought this would be good for the start of the new year, since this is a good
time to think about what may lie ahead, as the bulls talk more bullish than
ever. I will be a bit of a mish-mash, with a few themes popping out as we
progress.
I'll start with last month's chart of the month, moved forward in
time to where it stands as of this writing, to get that out of the way, and
then we'll move on.
The chart, when posted as highlighted on
12/6/08, was a few bars up from the C point. It did go to the next arrow area
and overshoot that a bit before rolling over. I thought it may just keep going
up to one of the other two areas highlighted with the upper arrows, but it
didn't. It also didn't continue down, moving up off that one division line. It
basically range traded up and down from there, until finally 'breaking out'
right into this area with many lines converging together, where it stands right
now. It did tend to turn at or near lines in each case, but it didn't hit
either of the areas I really liked above.
That's the way it goes, and why
'before-the-fact' is so hard in a commentary like this. It did react, albeit
with a bit of an overshoot, to the first area, and that did give a potential
trade there, but after that, once that area produced a reaction, I'm pretty
much done with the other highlighted areas, and I'm looking at what patterns it
is forming, and what lines and areas it is reacting to, to form the next spots
to watch. So, the low it reacted off of before the final ramp up was a pattern
at a key area, but that is not clear from this chart, as it doesn't show any of
the work that came together from the price action that unfolded.
Sometimes I
can take a good shot at posting a chart, but many won't go near the area, but
will instead do something else that, as it unfolds, I can do work on and find
another area. The market is very dynamic, and charts, and potential premises,
have to be updated constantly. I won't comment on this chart any more, but if
this 'breakout' is going to play out further to the upside, I suggest everyone
look back at last month's commentary for my potential scenario outlines for
areas I am watching. There is also some information in previous commentaries
about the overhead areas I am watching
Let's move on. I will start with a chart
simply showing another look at something I mentioned awhile back, which I
called 'the power of the .886'.
Here's the NASDAQ Composite Index, showing
the .886 for the entire bull market off the '02/'03 low. (I tend to say '02/'03
low because I see that entire head and shoulders that was put in as a complex
bottoming process, as opposed to the ultimate low being 'the bottom'.) So, as I
mentioned before, although I think the market could possibly still trade lower,
I think it would be very cool indeed if the bottom was in, and we rocket off
into a new bull market from here, and I can show charts like this, with the
bottom forming right off my .886. If nothing more, it sure produced some big
reactions. Ah, the 'power of the .886'.
While we are on the NASDAQ Composite, let me
start with that to begin my theme for today 'the anatomy of a bubble'.
Here's a good example of what a bubble looks
like. The ultimate '02/'03 low is actually lower than what we see on the right
hand side of the chart, but in order to not scrunch (I like highly technical
terms) the chart up too much, I just showed this much. The idea is that it is
not uncommon for an issue to give up a lot, most, or even all or more of the
gain from the run up into the bubble.
Let's look at a more current bubble, in
oil.
I can't get continuous contract data for the
commentary charts (although that may change), so I showed the oil tracking
stock, USO here. The pattern is about the same as for the NASDAQ. I wanted to
show some other examples, but data and chart space required that I leave it
here. Take a look at grains as just one example, or even the CRB Index. So, now
you have a fresh idea in your mind what a bubble looks like, and what can
happen. Granted, not every big run up is a bubble, you have to use some
'context', but the idea is clear.
Now, I was recently talking to a fund manager
I friend I know, and as we discussed the market, I mentioned that I felt we
just keep going from one bubble to the next. I said I thought it was an aspect
of the system we have. He asked what I thought the next bubble was, and I
quickly said 'treasuries'. In some ways I think treasuries are the biggest
bubble we have seen in this whole mess.
Let's look at a weekly TLT chart.
I chose the TLT here because I can't get the
continuous data right now for a chart in here for say the 10-year. As I
mentioned, I'm working to remedy that at some point. As we all know, they have
been moving into treasuries with reckless abandon. The 30-year was trading
about 142! This has rates on the short end of the curve at just about zero. In
other words, people are lining up with tons of money, begging our government to
take it from them for essentially zero rate of return. If you are buying
treasuries here you are buying somewhere on the curve up to the bubble top, if
this is indeed a bubble. Where the top is I have no idea, but this sure looks
like a bubble to me.
Let's drop to a daily chart and see what has happened
recently, especially this last Friday.
Treasuries began to sell off aggressively.
The 30-year dropped, at one point, over three full points on the day. That is
some monster selling, in my opinion. Is the bubble bursting, or do they come
right back in, in a 'flight to safety'? Will the Fed start buying heavily, as
they have so publicly stated they may? Will mounting war tension with this
weekend's events bring back buyers? I don't know, but if this keeps selling
here it may create the burst bubble scenario just like the other examples we
looked at. Now, why is this so important?
Recall way back when I was doing
the 10-year rate chart every commentary? I said some day I'd come back to that.
Well, I'm back to it. Let's look at the very same exact monthly 10-year rate
chart from way, way back, current as of now.
There is a lot to cover here, so I'll try to
be succinct. The main thing I got from this chart was the big rollover shown by
the time factor in June '07, right at the key line area (shown by the upper
arrow). If you recall, this line can be extended back decades, to the old
inflation days. I suggest readers try to get a longer-term historic chart and
look that over. If I get the continuous data I'll likely show it in here at
some point. The three lower arrows showed areas I was watching, that were shown
in here in advance if I recall correctly. The first arrow area produced a tiny
bounce, which gave me a good clue, and that clue was further reinforced by the
bigger, but still anemic, bounce at the second (the lowest) arrow. That's about
where we left off, I think.
One of the key thing I was also pointing out was the
time factor, how a key reversal time for the 10-year seemed to be in the June
time period. I added the last time factor on there, the uppermost one, showing
the recent swing high again in that June time period. I also have noticed some
key reversal times are in the December to January time period. I added those to
the lower part of the chart. Now, notice what rates have done. They have moved
essentially all the way down to the lower end of this set, trying to actually
go under 2%. If my information is correct, the 10-year has never traded under
2%.
The key thing to note here is that this is in a place, and in that
place at a time, where a bounce may take place. Recall that as rates go up, the
10-year goes down. If a bubble is bursting, rates go up as the treasuries sell
off. That fits perfectly with what the rate chart shows. Now, could this drop a
bit lower and fully hit that line with a 'retest', and still be within the time
factor range? Sure, or it could go straight up from here, or it could go down
way more, or just chop sideways for a couple years. It could do anything. On
the other hand, am I giving this area a lot of respect? You bet I am. Am I
thinking up here may be the highest probability scenario? Well, I am surely
considering that.
You should be able to see a similar thing if you use the continuous
contract on the 10-year. I suggest everyone do their own work on this. For the
most part this is a multi-decade channel, and after rolling off the top of the
channel, we have now hit the bottom, once again at a new low for rates. The
really interesting part, and why I am bringing all this up now, is that
if this does turn rates up, if the bubble in treasuries does
burst (or even if they just come back down in price to a more usual level),
what will that do to the economy? Mortgage rates will sore, the cost of debt to
the government will soar, the market will be 'flooded' with supply, and so on.
The government is going to outrageous lengths to push rates way down. If market
forces overcome this, it may be catastrophic.
I was asked if I thought money
might flow into stocks like crazy if the treasury bubble (assuming it is
a bubble) bursts. A lot of times money flows from treasuries to stocks and vice
versa, but in this case I am not sure. If the market is going up here with any
sustain, it would likely be on the idea that the economy will recover next
year, and so the market is pricing that in ahead of time. If the rates really
rise, and treasuries are out of favor (with all the other implications of
that), the economic recovery scenario may greatly change, and the market may
realize it priced in something that perhaps isn't going to happen.
If so, it may
reprice itself (and into this mix the VIX has a big ABCD completing in here at
the old range top that it started to react to Friday that I suggest everyone do
a workup on, since the potential implications are great). Money may flow like
crazy into the stock market as treasuries come down, but once the greater
implications are clear from this, the market may not like the levels it finds
itself at. So, where the money goes is not as clear in here as everyone seems
to think it may be.
Ultimately, I have no idea how this may play out. I just
wanted to lay out what I see, so the reader can study this and be aware of it.
I think there are still some serious issues with the economy, and I, for one,
am very worried. And I'm worried because everyone seems to think we are kind of
'all set' now. I just heard a big call on housing, saying for sure a bottom
will be in this year, I think they said mid-year. If housing does bottom this
year, especially as early as say six months from now, it will defy everything
logical I know about supply, demand, bubbles, and so on.
It may, but
if it does, it will blow my mind the power of manipulation, that's all. And all
the unintended consequences of the near complete loss, in my opinion, of the
free market, well, those consequences either won't happen, or will be mild, or
will be way down the road (this may be somewhat true), since we are on the path
to prosperity now, right? I'm sorry I'm just not that optimistic that you can
wreck a system this bad, then print a bunch of phony dollars and 'fix' the
problem, it all goes away, and we are back on the road to great times. Up goes
the market, because companies are great to own.
To me that sounds like something
for nothing, a perpetual motion machine. The laws of physics and mathematics
can't be repealed because the government says so. Sorry. We got to pay the dues
now for this horrendous abomination, or we can push it off and pay way more
later. And the really sad part is that if they did just push it off and we have
to pay more later, everyone will just get all bullish and positive and call Jim
a negative pessimist as things 'improve'. And even I'll start to wonder if I am
wrong, and they did 'fix' it, and we did repeal the laws of physics and
mathematics and get something for nothing. And therein lies the problem. Yes,
the Emperor has a splendid new set of clothes...
The next commentary will be next
month's edition, posted by Sunday evening, February 1, 2009.
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