Options Trader: Monday Outlook

Well, this is why we don’t get excited about rallies until we see our ranges properly broken.

The market has been, on the whole, pretty well behaved in a range between 8,200 and 9,200 with occasional breaks up and down of equal proportions and time, which balance each other out quite neatly.  That has to lead us to wonder if 8,500 is the new 12,500, which is about our mid-point of the past 18 months.  Did stocks really lose 1/3 of their value this year or were they, perhaps, never worth 12,500 in the first place?  I’ve said before, in November of 1929, I’m sure there were tons of people telling you what a great opportunity it was to get into stocks at 40% off the highs AND IT LOOKED GOOD FOR A WHILE - that was before they then fell from 240 to 40 just 2 years later…

While I’m not predicting another Great Depression, I have been telling members for a while now that I can believe we’re possibly down to a high range of 10,500 - which was about the range we were in before the irrational exuberance of 2006, when the great con that is CNBC managed to convince America that $80 oil meant we had a strong economy rather than a runaway asset bubble.  You can’t blow bubbles without a lot of hot air, and CNBC and much of the financial press was spewing it for years and had all of us convinced - that the market wizards were great and powerful and not just the same pathetic old stocks behind the curtain, all puffed up with smoke and mirrors. 

Who could have seen this coming?  Well I could.  I did see it coming on March 19th 2007, when I was still cynical of the rally, and wrote the article "Get Ready for an Economic Tornado" in which I flat out stated that excessive oil prices had "created a storm that threatens to tear the global economy apart" but, as the rally persisted and we went back through 12,500, then 13,000 and 13,500 I lost my own perspective and started to believe 12,000 was a real number for the Dow along with 1,300 on the S&P.  While I had overwhelming "evidence" that the rally was unsustainable, the fact that it kept sustaining caused me, along with most people, unfortunately, to forget where we came from, as well as where we probably were going back to.

That caused us to look for a bottom where there wasn’t one on the way down but, after taking a step back and reviewing the past couple of years, I’ve decided that it’s more than just a housing bubble and a commodity bubble and a mortgage-backed securities bubble… we had a good, old-fashioned ASSET bubble, where everything pushed up everything else. Now we have to worry about things going the other way, where the return to a "norm" may cause overcompensation to the downside.

A long time ago, we had looked at a chart of historic Dow prices from 1900 to 2004 along with average p/e ratios, and that chart predicted a range of 7,200-11,750 for at least 4 more years (could be 15) before companies grew into a valuation that would justify a move up.  Given the context of today’s economy, it would not be surprising if we do have a "lost decade" in the markets - much like Japan did from the mid 90s.  There is little politicians can do to "fix" the markets (Japan lowered their rates to 0.5%) and we have had to adjust our trading style accordingly.

Still you hear from the media about when it will be time to "jump back into the markets," but let’s think of it more like a river where we swam until we got chewed up by piranhas.  When is it time to jump back in there?  OK - well, maybe never in that case, so let’s think of this more like swimming in Love Canal - you may dip your toe in on a dare after 3 years and maybe go for a swim after 10 years, but at what point will you drink the KoolAid made with Love Canal water?  Mortgage backed securities have turned the financials into a toxic waste dump and it will be much more than a few months until it is safe to go swimming.  Meanwhile, the market can trade wildly in a range from 8,000 to 11,000 and may possibly go 20% higher or (more realistically) lower than that given the right catalyst.

For a while we were picking up stocks that were bottoming out at their 2005 levels but now we’re looking for 2003 (when the Dow was at 8,000) to give us a little more comfort in entering a position.  We are buying less leaps while the VIX is so high, and selling more premiums, as that monthly income may be as good as it gets in this market.  This is the Dow’s second major pullback to 8,000 since it broke out in 1997, and 8,000 is a 50% retrace off the rally from 2,000, so a bounce back to 9,000 is not very impressive at all.  I wish I had a better report but, at the moment, we are only holding those 50% retracements on the expectation that the government will "do something."  I think it wlll, but we still have a lot of very nasty data to look for and we need to continue to exercise caution and, more importantly - adjust our expectations.

So it is VERY important to keep in mind that, when we do pick stocks to play with, they are in the context of portfolios that are always at least 30% bearish (currently we are 60/40 bearish but looking to hopefully rebalance as we retest 8,200).  Our downside plays are often ultra-shorts like DXD and SKF, which do very well on the way down. I promised members a full article on portfolio balancing, and I will get to it this week as that is probably the one thing most people need to work on, especially in this crazy market!

Asia was not too crazy for a change this morning with the Hang Seng and the Nikkei relatively flat and the Shanghai gaining 2.5% on the session.  The Shanghai continues to be our most hopeful indicator that there may actually be a bottom in Asia but, sadly, in the case of mainland China, we had to give up 70% to find it.  Japan has officially been declared in recession, joining pretty much everyone else at this point, and Fitch put TM on credit watch, imperiling their AAA rating, so now we may see where Toyota finds a bottom.

Europe is trading down about 2% ahead of the US open, which also looks weak as the G20 meeting came up with nothing of note other than a call to tighten regulations on banks - which we all knew was coming, so it will be interesting to see how our financials take it, but it’s financials that are leading the EU down.  The UK had some awful economic projections indicating 3M unemployed by 2010 in a country with the population of California.

Our own unemployment figures should get quite a pop with Citi (C) planning to lay off 50,000 workers while GS executives are keeping their jobs by giving up their bonuses altogether.

Comments

[David White:]

Looking at this morning's news: 50,000 Citi job cuts to come and a 24% decrease in profit from Target and Loewes, you would think the markets would have gone through the floor. They have not!!! This makes me think the bounce from $82 on the SPY is intact. The market is anticipating good news from the PPI and the CPI. The market is anticipating good news from some solar companies (LDK, SOL, and TSL have all raised 2008 profit outlooks recently). Oil has been going down, but it is due for a slight rally. The retail sector is in retreat, but Christmas is the busy season. We won't know the real state of retail until after the Thanksgiving weekend. I think the market is anticipating that it may want to move down then. It looks like it believes it can move up until then. Then it will likely move based on the actual news. I think there is likely a lot of upside in the next 1-2 weeks. Further Fund selling for the end of the year should b

2008 Nov 17 09:54 AM

[David White:]

Further fund selling for the end of the year should be taking a rest during this time also. Funds generally start adjusting their portfolios in early December. Further the manufacturing news was better than expected this morning

2008 Nov 17 09:57 AM

[David White:]

I meant to mention that SOL, TSL, LDK, STP, and CSIQ all report this week. They should provide generally upbeat news relative to the "bad news" from JASO and the know economic and "strong U.S. Dollar negative effect on soalr profits bad news".

2008 Nov 17 10:02 AM

[David White:]

The 10am EST Philadelphia Fed Survey news was relatively bad today. It predicted Q4-2008 and Q1-2009 GDP growth to be negative for both quarters 2.9% and 1.1% respectively. However, this shouldn't be really surprising news to anyone at this point. It also predicted moderate inflation for 2009 and 2010. This was relatively
good news. It shoudl be somewhat confirmed by the PPI and CPI data in the next two days.

A possible reason for an oil rally may be that the recent OPEC cuts may start to take effect soon. Plus people are anticipating that OPEC may cut again at its next meeting on Dec. 17. A rally in oil would be good for solar and oil service stocks too.

2008 Nov 17 10:11 AM

[David White:]

The nice rally in USO today may be a hint that this sector may rally for the next couple of weeks. Also techinically it is probably time for a rally.

2008 Nov 17 10:13 AM

[David White:]

I should point out that the news from FSLR could only be called great. It staged a huge rally afterwards as oil rallied briefly too. The more reasonably priced top performers are reporting this week. The non-module level solars should have more solid results and outlooks. LDK for instance, has lots of long term contracts at fixed prices (at least for 2009). These should allow it to have a great outlook even in the face of these relatively trying times. Further if its news about its new polysilicon plants is favorable, that would allow a little more optimism on the margin front. The recent price decline in high purity polysilicon costs should help with guidance going forward too, especially for LDK, which has long term contracts. Plus LDK and CSIQ (TSL has recently started also) produce some UMG wafers. This should also help them with margins (and allow them to lower some prices).

2008 Nov 17 10:27 AM

[David White:]

The fact that FSLR has fallen back to close to where it was before its relatively good earnings announcement also indicates that the timing for a rally in solar may be soon. FSLR (although trading at a huge premium to most of the other solars) seems likely to rally also. It seems due just from a technical standpoint. It should benefit from good news from the likes of SOL and LDK.

2008 Nov 17 10:46 AM