Hunkering Down for a Big Correction

Doug Kass recently predicted the S&P500 stock index will finish the year at 920. It is currently right at 1000 (on September 2, 2009). I agree with the prediction of 920 sometime in the next couple of months. I think 900 may be possible and even lower to 875 based on the bottom set in July. But unlike Kass, I think the market will rebound by year end. I will wait for signs of a possible rebound once this current drop (begun last week) is further along. The signs of the bottom to this dip will be a stall in the decline just as the recent market top was shown by a stall or resistance around 1040. The rebound will happen when the market goes up on bad news. I think that may happen during the Q3 earnings season the middle of October into early November. I am still thinking that 1200 is a possibility by year end. This would completely retrace the panic selloff starting from the Lehman collapse on September 15, 2008. So if we wait until 900 to redeploy our cash raised the past few weeks that could provide a nice 33% finish to the year.

Where Kass is probably wrong, along with many others on Wall Street, is that there are just too many people with a bearish market view. There is virtually no one on the financial networks (CNBC, Fox Biz, etc) today saying that the selling should be ignored and the market will go much higher. There are just no Bulls as far as I can tell. The market always confounds the consensus position. It has to in order to work. If there are a majority of bears, then by definition, there is hardly anyone left to sell. Once all of us who had our finger on the trigger pull the trigger there isn't anyone left to sell. So I think the decline will be shallow and the market will rebound in 6-8 weeks. This can't be like the panic last year because all the retail investors that bailed out in the fall and winter are still on the sidelines. People who sold everything in January and February never got back in.

There are a lot of factors to a panic that are missing right now (as they usually are, fortunately). To get a true financial panic first everyone must be euphoric and unaware of or discounting trouble. Then when the decline starts because the market just can't go any higher (everyone who is going to buy has bought), investment holders must be forced to sell at any price by margin calls or other financial misfortune. Last year there was a cascading of events that are no longer in play. Most importantly, the leveraged, collateralized securitization market, the core of the trouble, is almost completely unwound (except CMBS, which is where there is still concern).

The leverage in 2007-08 was in the carry trade, which is what caused the dollar to soar and interest rates to drop when foreign currencies were sold and dollars bought to cover margin calls. The securitized loans are mostly back inside the big banks now with backing by government guarantees or in private hands where they have been de-levered which allows them to be held to maturity, if needed. So, there are no large institutions needing to dump stock or other financial instruments into an illiquid market to raise money to stay afloat. That is a big and significant change.

On the way down, I am using portfolio hedges to protect my positions. I like the SP500 Double Inverse fund by Proshares, with ticker SDS.

View the full SDS chart at Wikinvest

I like this ETF because it is a double short of the SP500, which is a pretty basic / broad index of the market and includes all the big financials, techs and energy companies. I also hold another hedge, the Proshares product called DUG. DUG is basically the double inverse of the energy market, something like IYE but with a little Materials exposure too.

View the full DUG chart at Wikinvest

I use it to hedge all my Materials and Energy exposure, although I also use covered calls for this on stocks like Suncor (SU) that have good premiums. I also have used covered call options on the Canroys, but the premiums are not very good because of the large dividends. It is just an alternative to outright selling them.

Even though it has become popular, I don't do those Direxion 3X ETFs. They are just too wild for my taste. Even the doubles are a little scary and I am careful to keep my exposure balanced with opposite long positions. I don't bet naked short, even now when I am pretty convinced the market is going lower. The market always goes up in the long run, so being short should be very tactical and short term. I don't want to get caught on the wrong side of that trade.

Disclosure: The author holds hedges in DUG and SDS

Comments

[Larry House:]

I don't know all that you listen to, but there is plenty of bullish sentiment out there. I also very much doubt if the market gives us what we expect. You speak with such precision--S&P at 900--buy--sell at such and such--35%. I can't trust anyone who thinks things are so predictable.

Sep 03 11:57 AM

[Neil459:]

From the article, "There are a lot of factors to a panic that are missing right now (as they usually are, fortunately). To get a true financial panic first everyone must be euphoric and unaware of or discounting trouble."

Or as is today everyone outside of Wall Street is on pins and needles with regard to their 401k. The ones that stuck with their investment now are up 50% from the lows. None of them want to see that increase go away. Obama has lost any confidence that existed during the first low. Everyone knows the economy will get worse with the tax and spend Democrats. So if/when it starts down this time, people will be more inclined to dump and keep what they have made. It could still trend down and not cause a panic, but the risk of a panic is very present based on this administration's total lack of financial honesty, transparency, and fascist trends.

With that said, if we have another market downturn in the next 6-9 months the Administration/Congress is doomed for the 2010 elections. So they will have to keep the market pumped up for the election.

So there are strong forces pushing up (Obama's Administration/Congress) and strong forces pushing down (economy). Which will win and in what time frame is anyones guess.

Sep 03 12:07 PM

[jeffgroove:]

If the bush tax cuts do not stand(expires in 2011), and the cap and trade stuff goes through(which I am not sure if it has, and don't thoroughly understand it), then I am sure there will be many democrats taken out. You cannot bail out an economy by imposing new taxes, ignoring the little people, supporting the unions, enriching the financial community, and tackling health care when it is the economy that is bad.


On Sep 03 12:07 PM Neil459 wrote:

> From the article, "There are a lot of factors to a panic that are
> missing right now (as they usually are, fortunately). To get a true
> financial panic first everyone must be euphoric and unaware of or
> discounting trouble."
>
> Or as is today everyone outside of Wall Street is on pins and needles
> with regard to their 401k. The ones that stuck with their investment
> now are up 50% from the lows. None of them want to see that increase
> go away. Obama has lost any confidence that existed during the first
> low. Everyone knows the economy will get worse with the tax and spend
> Democrats. So if/when it starts down this time, people will be more
> inclined to dump and keep what they have made. It could still trend
> down and not cause a panic, but the risk of a panic is very present
> based on this administration's total lack of financial honesty, transparency,
> and fascist trends.
>
> With that said, if we have another market downturn in the next 6-9
> months the Administration/Congress is doomed for the 2010 elections.
> So they will have to keep the market pumped up for the election.
>
>
> So there are strong forces pushing up (Obama's Administration/Congress)
> and strong forces pushing down (economy). Which will win and in what
> time frame is anyones guess.

Sep 03 12:20 PM

[market ace:]

You are probably right that a small correetion with a year end rebound may be in order as all of the stim and bailout money hits the economy and wasteful gov't spending spurs the GDP, but in the long run this can never be sustained.

There are just too many negative factors out there that can still cause total panic and collapse in a heartbeat. Less worse can only sustain a market so long and real growth has to enter to show any type of "recovery", but this too will take a very long time and never a return to the 'good old days".

I think right now most traders and investors are on a hair pin trigger with one foot out the exit door as seen on Monsay when just a rumor of a major bank failure sent the market tumbling. The gov't now restricting speculative commodities trading will also have very negative effects in the short term and in case you have not noticed a lot of investors are fleeing to gold again, which is a clear sign of major worry.

Anyone not using stops in this market is crazy.

Sep 03 12:25 PM

[Baboon:]

>>The market always confounds the consensus position.
What does this make the market then? The market is a consensus.

Sep 03 01:51 PM

[veeblefetzer:]

Your extreme political views are clouding your financial judgement.


On Sep 03 12:07 PM Neil459 wrote:

> From the article, "There are a lot of factors to a panic that are
> missing right now (as they usually are, fortunately). To get a true
> financial panic first everyone must be euphoric and unaware of or
> discounting trouble."
>
> Or as is today everyone outside of Wall Street is on pins and needles
> with regard to their 401k. The ones that stuck with their investment
> now are up 50% from the lows. None of them want to see that increase
> go away. Obama has lost any confidence that existed during the first
> low. Everyone knows the economy will get worse with the tax and
> spend Democrats. So if/when it starts down this time, people will
> be more inclined to dump and keep what they have made. It could
> still trend down and not cause a panic, but the risk of a panic is
> very present based on this administration's total lack of financial
> honesty, transparency, and fascist trends.
>
> With that said, if we have another market downturn in the next 6-9
> months the Administration/Congress is doomed for the 2010 elections.
> So they will have to keep the market pumped up for the election.
>
>
> So there are strong forces pushing up (Obama's Administration/Congress)
> and strong forces pushing down (economy). Which will win and in
> what time frame is anyones guess.

Sep 03 02:32 PM

[SanDiego:]

So you're saying that the US economy has been getting worse since Obama took over in January? As far as I can tell, the economy is in fact doing better. Of course Obama will be forced to raise taxes in the end. After all, George W left him with $9.5 Trillion in debt, two wars and the worst recession in generations. Regarding lack of financial honesty, transparency and fascist trends: aren't you talking about the previous administration? Perhaps Obama will be no better, but at least I'm prepared to give him a couple years to prove himself. Evidently, you have made up your mind in advance.


On Sep 03 12:07 PM Neil459 wrote:


> Obama has lost any confidence that existed during the first
> low. Everyone knows the economy will get worse with the tax and spend
> Democrats. So if/when it starts down this time, people will be more
> inclined to dump and keep what they have made. It could still trend
> down and not cause a panic, but the risk of a panic is very present
> based on this administration's total lack of financial honesty, transparency,
> and fascist trends.

Sep 03 02:40 PM

[The Economi...:]

All of this isn't even worth talking about. Our debt is going to bury this country. I suggest you prepare for the REAL crisis that is looming.

Sep 03 03:04 PM

[Neil459:]

On Sep 03 02:32 PM veeblefetzer wrote:
> Your extreme political views are clouding your financial judgement.

Well, I am not depending on any handouts to support my family, so you must be right.

Sep 03 03:25 PM

[Neil459:]

On Sep 03 02:40 PM SanDiego wrote:
> Of course Obama will be forced to raise taxes
> in the end.

No its a choice. Obama could have reduced taxes, improved employment, reduced government and it would have saved the economy. But instead he chose to consolidate power, strip freedoms, enhance the unions, lie to the American people, increase taxes on everyone, and put our children in significant debt. By the end of Obama's first year he will have racked up 3 times the Bush deficit while cutting back on national security, outing the CIA to foreign countries, and destroying the auto industry. He will have committed us to electric cars that require batteries with Lithium, of which the only know sources will run out in 5 to 10 years.

You need to look past the lies, sound bites, good feelings, rhetoric, propaganda and realize what is really happening before its too late.

Sep 03 03:36 PM

[enigmaman:]

You said " Where Kass is probably wrong, along with many others on Wall Street, is that there are just too many people with a bearish market view. There is virtually no one on the financial networks (CNBC, Fox Biz, etc) today saying that the selling should be ignored and the market will go much higher"

So your using the media as a Contrarian indicator, show me any time when the media wasnt going with the market trend, cheering when it was up and crying when it was down, I have never had the privilege to know anytime when the media fought the trend, To me your argument lacks any credibility

Sep 03 03:59 PM

[Jan Paul:]

From the reports the economy is not getting better, the market is.

Still, more layoffs, more drops in retail sales, higher fuel prices, lower dollar value, more foreclosures, more defaults on loans, more problems in commercial real estate.

It is like jumping out of a plane with a chute, but not opening it for a while. Free fall and then you pull the chute and slow the fall but, depending on where you opened it up, you could fall a long way before you actually hit the bottom.

That doesn't mean the global economy won't recover without us. It doesn't mean the stock market with hundreds of international companies won't stay up or even rise more. It doesn't mean that we won't see some exports rise.

It does mean that the economy isn't improving. It will get worse, even if we have a little bump because we haven't changed the monetary, economic and tax policies in a meaningful way.

The U.S. economy has been going down for decades. All the "bull markets" have been build on debt. While investors walked away at peaks with huge gain, the economy, the workers, the tax revenues were all falling behind in real terms if you used real CPI data.

How do we know that? Simple, buying power continued down where workers had to cut corners to maintain parts of their standard of living. They bought higher deductibles for car and health insurance. They bought cheaper health care plans from insurance companies that were higher risk companies. They even dropped coverage because wages weren't keeping up with real CPI.

Hospitals, Dr's and clinics have to pay real world prices, not substitution prices or hedonically adjusted prices. They pay real energy prices, not tossed out energy prices from the inflation core.

But, the worker, getting that "cost of living increase" that was 4% lower than real prices was falling further behind and thus, buying less of the discretionary items he bought before.

Another sign was the infrastructure. The Society of engineers has ranked all of our infrastructure at "C" or worse with an overall rank of "D." We build new stuff but can't maintain it. That is a sign of a decaying economy.

We hid the decay with inflation. Prices were going up, wages were going up, speculation was rising that things were getting better when since 1950's mfg. dropped from 30.4% of GDP to nearly 10% or so. That sector provided the middle class jobs we needed for our lower skilled employees and by shipping those jobs overseas we were subtly and slowly eroding our economy in the dust bin of empires that rose, peaked and fell.

Another sign. For social security recipients to have the same buying power as in the 80's they would have to get checks that were 70% higher. Again, they can buy less and that was eroding the economy slowly and quietly.

Another sign? How about the weakening dollar?

Another sign? How about tax revenues not keeping up with entitlements with constant warnings for over 30 years that it was getting worse, not better in keeping up with entitlement outlays. In a healthy economy, rising wages and productivity and less spending on welfare, food programs, etc., tax revenues rise faster than outlays.

We have not had a single year of Positive GDP for over 8 years if you use CPI data calculated the very same way we always did which always worked for over 100 years. Take a look at this chart from 1800 on CPI and you can see where the economy really started to get hit.

wealthmotor.com/wp/200.../

An illusion of growth created by debt and inflation that is destined to collapse at some point. We have passed the point of no return. We can't grow or tax out of this and Congress has been warned by its own accounting office of this risk before this crisis even hit. We can only delay, not avoid the eventual collapse of this Ponzi scheme "growth."

Sep 03 07:07 PM

[growser7:]

Jan Paul---bravo.

Sep 03 08:53 PM

[Brian McMorris:]

Larry: I never asked you or anyone to trust me. I do this for fun. The numbers I throw out are general areas of support or resistance, not some hard and fast rule.

Market Ace: I agree with you almost entirely. But I disagree that there can be another "panic". If the market goes lower from here, it drifts lower driven by traders, not retail investors.

Baboon: Mr. Market is ALWAYS opposite the consensus. He is the one taking the trade. (Who else was there to buy during the panic?). Go back and read your Benjamin Graham again.

Enigmaman: I don't understand your point. "So your using the media as a Contrarian indicator, show me any time when the media wasnt going with the market trend, cheering when it was up and crying when it was down"
Yes, I contend that the financial media (made up of investment analysts) is a contrary indicator. The talking heads represent the consensus opinion and the consensus is always wrong. You say I have no credibility and then prove my point for me. Thanks!

Sep 03 08:54 PM

[Carl Spackler:]

Playing the stock market is like fighting a war - you may go in with one plan, but keep your gameplan fluid. Seldom do things go as planned. The scenario above is so in detail, I fully expected the author to tell us what color socks he will be wearing when the market turns.

Sep 03 11:02 PM