What Goes Around Comes Around in the Equity Market

Home-owners in 2004 would not have been pushed into selling during those high-flying years just because they were alarmed at the expanding debt bubble that was hoisting real-estate prices to the moon. Neither should traders in 2Q08 want to sell stocks just because they worry that central bankers are out of control.

You may think this is a capitulation of sorts on my part, but it is not. A trader's level of concern may rise and fall, but that may not be a sufficient call to action. You see, we must trade prices, even when bankers manufacture them and manipulate them, and render them temporarily useless as a measure of economic value.

Regrettably, we are all now forced to be day-traders, and the new “Dow Theory Buy Signal” for many international markets, pointed out by Twiggs and I presume others, cannot be ignored. Smart traders take into consideration everything they can, and Dow Theory is one of the most important of the thousand points of light.

What does this introduction mean? It means simply that, due to the massive credit expansion that started with the JP Morgan (JPM) take-over of Bear Stearns (BSC), followed by the continued efforts by the Fed to flood new money into the banks, and by the Treasury Secretary to pander to Joe Public with 1-800-HELP telephone lines and instant tax rebates or money giveaways, that I anticipate seeing share prices rise for a bit longer, and the bullish Dow Theory signal will bring more bids to the market. Traders should not ignore that evidence.

But that does not mean you should assume the underlying value of the equity is rising; it is not. In fact, every argument that says new wealth is being created by governments, banks and, for the most part, the service sector, is flat-out wrong. Value creation through construction and manufacturing is clearly on a steep decline in America, and, to be frank, in too many other countries to ignore.

The sad reality is that all the free money being thrown around today is being done to save bankers from their own bankruptcy, a fact that will in time be recognized by your young children and their children.

The fact is that a price of a blue chip stock can be financially engineered just the same as a crooked stock promoter can do for a penny stock.

Do you recall the time I told you when a promoter from Vancouver came to see me when I was working for Canada’s 800-pound broker-dealer gorilla in the early 1980’s in Toronto? He was pushing penny stocks and I was one of the few who worked for a white-shoes firm in the city who would listen. I did ok by that practice, but that’s another story.

Anyway, this young man had been a practicing physician in Ontario who had been captured by the lure of record high prices of gold in 1980-81, so he quit his practice and moved to Vancouver to apprentice for a man who later became a friend of mine, a real scoundrel in the eyes of securities regulators but a person who in running the promotion for a stable of about 100 public companies raised incredible capital for natural resources company exploration.

So this ex-practicing physician and newly minted stock promoter came into my office with a story he wanted me to hear. “My stock is $1.00 today, but it’s going to be $1.50 on Monday. You need to jump in now.” So why, I asked. “Oh, do you want it to be $1.75?” he said.

…Absolutely a true story. I have seen it all.

Bernanke to Paulson, “So, Hank, when do you need the Dow at 14000?”

I cannot say the latter is a true story, but only because I wasn’t in the room. However, I am not an idiot; I don’t have to be in the room. The market tells me what’s going on.

I can see the desperation in the eyes of the Talking Heads on Financial Entertainment Television. There is no soul behind the words. These people are hurting. They have families who are in tears having lost their homes in the Hamptons. They are being ordered, under pressure of dismissal, to smile for the cameras.

For all I care, these people can do whatever they have to do to make a living, as long as it’s legal. They have careers and families to take care of. I cannot sit in moral judgment.

But I also don’t take the advice of desperate people, particularly sales people who, if they were in real estate, would be offering me swampland for beachfront property, or expensive Miami Brickell Avenue condos for what is really the unstated need to take over condo management costs since many of the buildings are empty.

What goes around comes around, and it will in the equity market too, especially when in too many cases the equity in stocks (like banks for example) is implied and not real.

So here we are, ready to buy stock prices higher just because they are going higher. The game of musical chairs has begun, with one difference: when the music stops, the Humungous Bankers and Brokers [HB&B] will have been tipped in advance and their chairs will have been assured by Prof. Bernanke… paid for in advance by our children and our children’s children.

To be practical, if you want to join the rush into stocks, and I hope not because RSI and Stochastics are too high at this point, why not look at the recent Accumulation Zone stocks of the Cara 100. At least these have some upside potential because they have been recently oversold. Starbucks (SBUX) for one is not a broken company. Their offering is not a place for discretionary purchases of over-priced coffee; it’s a lifestyle-oriented Internet café, which in a high-pressure world is, in my eyes, a staple. If the $USD continues to rally, the cost of coffee beans is likely to come down, as will oil prices, and so the customers are more likely to have a couple extra bucks to pay for that $4 peach- or double-chocko flavored latte.

Just remember that, in my view, this “rush into stocks” is merely a Bear market rally, but one that (with good timing) maybe should not be missed on account of the central bankers of the world being ready, willing and able to work with a lame-duck Treasury Secretary who just might be intent to take the DJIA to 18,000, even if he has to bankrupt America to get it there.

If you do consider following a prices-chasing strategy, for whatever your reasoning, please don’t think your stop loss orders will help much. The reason is simple: your broker-dealer is part of the central bank-HB&B network. They know your orders, they know your financial resources; they know your trading style; and, sadly, they – your trusted advisors – trade against you. They continuously create bursts of volatility to shake out stop positions. They do it to take your money to put into their pockets.

Is this knowledge such a bad thing? Well, we have to deal with reality, so let’s start creating mental stops, or paper stops, followed by market orders when those levels have been violated. There is no reason to hand the time float to the enemy. That’s like going into battle with cap guns and baseball caps. Little Jane and Johnny will get obliterated, real quick. You have to smart – the enemy is using your Assets Under Administration/Management to finance the recruitment of the smartest financial minds in the world to work for them, not you. So deal with it.

The enemy does not like Market Orders – trust me – particularly if they get hit with many at once.

There are times – like this – where day trading and Market Orders are necessary. I wish it were not so.

One final point is that I have not yet recommended (for intermediate- or long-term oriented traders) buying gold because that is a USD hedge play, and the Fed needs the $USD to stay as strong as possible while they buy time (time is their enemy) while they feed short-term money to commercial and investment bankers, hoping to stave a major recession/depression while long-term credit market excesses are corrected.

The Fed needs foreign currencies to flow into the US to buy stocks and bonds, or else the Fed is in trouble. Prof. Bernanke doesn’t have much of a balance sheet left to deal with for monetary policy purposes, and the banks that own him are sick, having too much trouble these days recapitalizing their own balance sheets. But, if bond prices, stock prices and the $USD don’t move up here (as they are), then interest rates will soar because inflation is soaring, and that will force more damage in the housing market crisis, which will cause the credit markets to seize up again. As I say, the Fed is at the end of their rope. The commercial and investment banks need time to raise more capital before we get hit with the next round of the credit market fiasco.

So, as long as I see the $USD strong, and oil and other commodity prices falling, I must believe that the Fed and other central bankers will do what they can to knock down the price of gold. How long and how far they can is the issue. I suspect the answer has a lot to do with how high the bond market goes before supposedly smart long-term oriented fixed income (bond) investors decide to say “no mas, no mas!!” That point will be reached when Americans admit they cannot or will not take any more inflation, and pull out of the stores and shopping malls. So, the Consumer Discretionary sector (XLY) and in particular the US Retailer industry [$RLX] is going to be a bellwether.

Here’s my recommendation. Insert the following string of ticker symbols into a new portfolio monitor using Google Finance -- the best free stuff available to traders. It is an outstanding tool.

Here is the link to the Google Finance, followed by the string of symbols you need to insert into the window that facilitates setting up a new portfolio. For your information, I glance at this page every day.

Link to Google Finance Portfolio.

56 US-based Retailers:
AMZN,ANF,ANN,BBBY,BBY,BEBE,BJ,BKE,BKS,BONT,CACH,CC,COST,CVS,
CWTR,DBRN,DDS,DLTR,EBAY,ETH,FDO,FRED,GES,GPS,HD,HOTT,IBI,JCP,
JWN,KR,KSS,LOW,LTD,M,NDN,PIR,PSS,PSUN,RAD,ROST,RSH,SBUX,
SHLD,SKS,SWY,TGT,TIF,TJX,TLB,TWB,URBN,WAG,WFMI,WMAR,WMT,WSM

Enjoy.

At the point I think the “Trade of the Generation” is ready to enter – sometime in the next two quarters – I will advise you. That trade (when it comes) will be to sell US Treasury Bonds and to buy Gold in the spot and futures markets.

Comments

[bluesmoke]

OK Bill, you got my interest. I went ahead and entered all the symbols in Google Finance. (I only own a couple of them, but I'm sure my mutual funds and ETF's own them as well). So now I wait, and you will let us know, right? Thanks.

[Alpha Seeker]

This author resides offshore and is selling you his portfolio- buy me, because my stocks need to go up. While there might be a little merit to his ideas here, he is what they call "overanalyzer&quo... - somebody that concerns himself with understanding all markets all around - we know that this is impossible and if you are all-around-doctor - you are weak-doctor. So, you can either waste time trying to shuffle through his complex thoughts or read another article.

[curious cat]

ok, bill, that's one theory. another is that people who saw that particular conspiracy cloud gathering ran into people who thought that oil had reached peak oil and they ran into people who believed that ethanol laws were misguided and counter productive and they ran into gold bugs. they all began buying commodities and easily bid the prices higher because the markets there were much smaller than in other markets. they caused spikes in the prices of those commodities which summoned the demon herds of traders who follow spikes.

this inflation you fear is nonexistent. if buyers do not go to stores, stores drop prices. that's the way it works in my area of the country. the only places they have pricing power is food and gas, because people have to eat and take their fat asses to the grocery stores. the power to price homes, cars, clothing, appliances, etc is gone (see wal-mart prices). we have been importing deflationary forces for some time now.

what bernanke and the talking heads do to encourage a rational market is provide liquidity. if there is no liquidity, that means no one is sure that the price the sellers want is fair. that means no bidders and no bidders means no pricing power. wow, no inflation!

now, the dollar may become weaker, as the pound became weaker when the u.s. took over the top dog role in the financial world. so, what became of the pound after that? did it disappear? did it become worthless? no, the brits simply stopped buying stuff until it became stronger. they paid the queen, james bond and their dentists fewer pounds, until they all started working harder. that's my theory and i'm sticking to it.

let me know when that penny pushing doctor comes back though. maybe we can all get together then. lol

[User 162922]

Curious cat;

Inflation is defined as too many dollars chasing too few goods, yes? The housing bubble came about because too many dollars were available to easily to too many people that couldn't afford it, yes? The question is, has the money supply increased? If so, that is more money in the system chasing the same amount of goods? Is that inflationary? I think so. So yes housing has become deflationary, but the world money supply, by all accounts, has become inflationary.

A bit further on inflation: Inflation measurements have changed twice since the 80s-shortly after Volcker was shown the door, and then during the Clinton administration. So, whereas inflation is 4.2% today, pre Clinton change it would be almost 8%, and pre-Reagan, almost 12%. So then, is there inflation or not? Depends on which measurement you trust.

Not sure about your pricing analysis either: In general, that works all things being equal. Having said that, nothing is equal over the last few years. I have so much money per paycheck. If I have to dedicate more of my money to food and gas/oil. It's less I have to spend on those products. Now those products have costs to produce them. If the vendor can't sell them for a profit, he doesn't, and they disappear from the market-he can't just keep dropping his price below cost of production.

Of course, this brings us back to inflation, or at least cost of living. The cost of living (food gas/oil/electricity/na... gas) have increased significantly. Perhaps that big screen tv has gotten cheaper along with that nice suit or fancy dress, but I can't afford them now that I have to pay so much in food and gas. Oh, but they're not included.

If the energy/food situation is real, then many "non-discretionar... items may actually disappear as the terms become redefined according to people's pocketbooks.

[bds231]

Wow, paranoid much?

"They [our broker-dealers] continuously create bursts of volatility to shake out stop positions. They do it to take your money to put into their pockets."

Where's the data to support that allegation??

[globalmacro]

The author probably also knows who killed JFK.

[whidbey]

"I am not an idiot; I don’t have to be in the room. The market tells me what’s going on."

Danger of overstatement here? You are an idiot and you should be in a room, rubber more than likely. Your attempts to incite readers is the mark of a chicanery intended to manipulate the USA market. Your analysis is aimed at your stocks and against any else. Shame.

[locke]

It was the central bank, on the grassy knoll, with the candlestick.

[Paul Price]

Whatever happened to valuing individual stocks on a bottoms-up basis and buying when they're just too cheap to stay there.

[fatcat]

alright ,young guys, this is a stock pickers market...don't listen to all the bs.Pick em right and you make money..simple.

[punk_ash]

exceptional insight into markets, too bad, these people who are posting, fail to grasp what the author is talking about.

[tradersystemguru]

Interesting take Bill. You may be right and we may be in a bear market or bull trap rally (take your pick of terminologies). The sad truth is that even though the asset bubbles are breaking and the market is in dire need of a correction to clean out the excesses, that probably won't happen for a few months until after the U.S. election based on historic performance. If the market crashes before November, it will mean the wheels have come off the government election priming bus.

Any study of markets will tell you that governments shamelessly manipulate economies and markets leading into elections and that governments and their minions are getting better at it. A simple system of buying the mid-term election year low 25 months before each election and selling at the end of November each election year would have captured 93% of all Dow gains between 1902 and 2006. In other words, the investor or trader would have made 13 times more money by being invested in the two years leading up to each election compared to the two years after.

In the Canadian TSX, where you got your training, the ratio is an astounding 97:3 - 97% of all TSX gains from 1950 to 2006 were made in the two years (26 months actually) leading up to each US election. Why? Because the US government and associated agencies do their level best to inflation the heck out of the economy leading into each election (see tradesystemguru.com/co... ).

The moral of the story is that since WWII, not one major recession has occurred in the two years leading up to an election. With the exception of 1987, bear markets and recessions have all occurred in the two years post election. A system that bought the Dow at the mid-term election low in September 25 months before each election and sold at the end of November each election year would have had 17 winning trades and not one losing trade.

Given the excesses that are in dire need of correction, I expect things to get a whole lot tougher in 2009 if history is any guide.

Matt Blackman
TradeSystemGuru.com

[User 146077]

Bill,

Buffet seems to agree with you re: market prospects, as best as I can interpret his recent thoughts. It saddens me to see such an un-level playing field in the market. This is as tough a market to anticipate as I've seen in my 35 investing years; logic and business fundamentals have been tossed aside, politics is clearly the force with which to be reckoned. How do we encourage young folks to save and invest once they realize the ability of the government to take the fruits of their labors away via inflation? How do we expect young investors to behave when we reward the taking of unwarranted risk and safeguard thoughtless behavior?

Anyway, thanks for sharing your thoughts. They jibe with mine. I've avoided much in the way of losses since July, 07 but have left money "on the table" this year...I still think the piper needs to be, and will, be paid before 2008 is over.

Fundamentals will ultimately prevail because the de-leveraging forces will prove impossible to ignore.

Coquina

[fxtrader07]

@alpha seeker: you couldn't be more wrong. there are now myriads of - mostly poorly written- articles on SA seeking to sell you this stock or that stock. bill has earned a reputation with me for trying to figure out the bigger picture on a consitent, yet flexible basis.
so bill, keep up the good work. even though i do not always share all your views , your columns belong to my few truly regular readings on SA these days.

[adan]

wow, gonna fwd this one on to a bunch of people - thank you much!

[special1person]

"You can see the desperation in the eyes of the Talking Heads on Financial Entertainment Television. There is no soul behind the words. These people are hurting. They have families who are in tears having lost their homes in the Hamptons."

Surely, this must bring a tear in the eye of every politician looking out for the Already Rich 1%?