How to Trade in a Crisis

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 4^th 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 4^th 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

Comments

[Mad Hedge F...:]

Certainly these are the "best of times and the worst of times." The US is turning into Europe. Think high taxes, high unemployment, more government involvement in everything, and much lower growth. That is the message the markets are telling us by retreating to the 6,000 handle, levels not seen since 1996, and down 54% from the peak only 17 months ago. Equity prices are shrinking to multiples in line with a permanently lower long term growth rate of maybe 2%, a shadow of the 5% rate seen for much of this decade. Maybe this is what mature economies are supposed to look like. If you do buy American stocks, only buy the ones that are really foreign stocks with American sounding names. Microsoft (MSFT), Intel (INTC), Oracle, (ORCL), Cisco (CSCO) all get 60%-70% of their profits from overseas where high growth rates have migrated. I think I’ll move to Tahiti and live off of coconuts and freshly speared fish, wearing only a loin cloth.

Mar 02 12:06 PM

[Fred Voetsch:]

Agreed. This is my basic position and it has worked well for well over a year now.

One should be wary of all ETF's, especially the leveraged ones but the SDS has performed much as expected, with little of the inefficiencies of other leveraged, more focused Exchange Traded Funds.

However it is not recommended that you hold SDS for a long period of time as it will deteriorate and it tends to outperform in short bursts of market turmoil. In short, if you have a great run with the SDS take your profits and wait for it to come back to a better price level. History tells us that even a rapidly declining market with additional downside potential will not move straight down but will consolidate and rally along the way; BUY SDS INTO THESE RALLIES!

I also agree with holding GLD. Given the possibilty of a total financial meltdown growing out of Eastern Europe, holding 10% of your portfolio in GLD is a wise move.

Mar 02 12:22 PM

[User 161034:]

Fred, Your comments are well-taken, re trading the SDS. Check out the Trader Results on my website. Buying SDS when the market rallies has worked for us with this caveat: It has to be in or below its Entry Zone.
We use limit orders,not market orders, and adjust the price according to the next day's Entry Zone.

We have been inclined to just hold the GLD, again buying on dips when price is inside the Entry Zone.

GLTA

On Mar 02 12:22 PM freddyv wrote:

> Agreed. This is my basic position and it has worked well for well
> over a year now.
>
> One should be wary of all ETF's, especially the leveraged ones but
> the SDS has performed much as expected, with little of the inefficiencies
> of other leveraged, more focused Exchange Traded Funds.
>
> However it is not recommended that you hold SDS for a long period
> of time as it will deteriorate and it tends to outperform in short
> bursts of market turmoil. In short, if you have a great run with
> the SDS take your profits and wait for it to come back to a better
> price level. History tells us that even a rapidly declining market
> with additional downside potential will not move straight down but
> will consolidate and rally along the way; BUY SDS INTO THESE RALLIES!
>
>
> I also agree with holding GLD. Given the possibilty of a total financial
> meltdown growing out of Eastern Europe, holding 10% of your portfolio
> in GLD is a wise move.
>

Mar 02 04:16 PM