How to Trade in a Crisis

by: Fritz Hottinger

Dear Fellow Investor,

Shopping for a crisis to trade? Take your pick, we’ve had some dandies: family real estate; local restaurants and retail stores; commercial real estate; auto industry; banks; and every corporation with a lobbyist strong enough to get itself a TBTF (too big to fail) award from Congress.

But don’t worry if you missed these opportunities - - - there are more crises to come. They will be much larger, and they will not be restricted to our shores.

In the 4th quarter of 2008, Gross Domestic Product numbers, the thermometer of a country’s health, proved this economic crisis/disease/plague had truly spread world-wide:

  • UK down by 5.9%
  • Germany down by 8.2%
  • Japan down by 12.7%
  • South Korea down by 20.8%
  • Compare these to our own drop of 6.2%

(all numbers based on an annual rate), source WSJ, 3/1/2009, page W1

If history gives us any clue (and we should all be reading some now), such drops in GDP create unemployment, which lessens purchasing power, which lessens sales, which lessens investment in capital goods and inventories, which creates more unemployment - and this negative feed-back loop continues until Government steps in to reverse the trend.

Since national economies cannot “turn on a dime”, Governments will do whatever it takes for as long as it takes. This is where the pages of history become a bit chilling. It took the government spending on World Wars I and II to lift us out of major recessions; and the recoveries did not come overnight or without severe cost.

Years later Congress, with the Gulf of Tonkin resolution, gave LBJ the wherewithal for his “guns and butter” economy. Now that President Obama has outlined his program* for restoring our economy and Congress is set to dole out trillions to its supportive constituents, prudent investors will remove their rose-colored glasses to view the horizon.

Following those negative 4th quarter numbers listed above, since the first of the year the S&P 500 has lost 18.6% and the Dow has dropped another 19.5%. While most of the world’s markets have tracked a similar downward path, some countries have fared much better (see chart below).

click to enlarge

This ought to tell us that some portfolio global sectoring might be in order, if only for diversification of risk. The US market has further to fall, as do most others. But due to the enormity of our problems, and the piecemeal, timetabled recovery being set in place, we see the Dow testing 6,500 before any recovery begins. And we do not foresee any stalwart move in an upward direction until sometime in 2010.

Yes, there will be the occasional blips to the high side, some due to the green eyeshades in the PPT (Plunge Protection Team). This is when astute traders will be taking their positions in contra ETFs like these:

We continue to like the SDS as a swing-trading vehicle, due to its high volume and beta. Careful analysis of the chart below will show ample opportunities where price was in an Entry Zone and soon moved into, or above the daily Exit Zone. Such moves offer the ability to restore lost capital to a declining portfolio.

We began issuing some dire warnings mid-2007, and truly wish there were better news to offer right now. However, in our eyes honesty remains the best policy, though our President and Congress seem to have given themselves an exception - do they really believe the coming inflation will not be a form of taxation? We urge you to avoid a buy-and-hold mentality, which in many instances is simply an abdication of responsibility. Put the coming market gyrations to use - improve your portfolios with some positive trading.

*Had a typo here, “pogrom”, and only on second thought corrected it.

Disclosure: Long positions in SDS, GLD