Market Outlook: Three Weeks, Three Months, Three Years

Includes: DIA, QQQ, SPY
by: Mark Hines

No one can predict the future, and no one knows where the market will be in three weeks, three months, or three years. However, I believe the market has given us enough information to make some higher probability bets.

Three Weeks: Over the next three weeks there is an increased likelihood that we will see the fruition of a reaction that has already repeated itself several times over the last year. Fear in the market will grow, panicked selling will ensue, bottom-callers will get long, and another bear market rally will begin. Check out this graph of the stock market fear indicator (the VIX) versus the S&P500 to see the very strong negative relationship between the two, and to see the general market reversal that occurred the last four times the VIX eclipsed 30 (which by the way the VIX is headed towards 30+ again sometime very soon).

Look for the VIX to rise into the low to mid 30's sometime over the next few weeks as an approximate signal of the short-term bottom. The fear and panicked selling will likely be caused by more bad news from Freddie and Fannie, more bad news from investment banks (Citigroup and Merrill report earnings this week), options expiration (which occurs this week), continued increases in oil prices, or some other piece of bad news (some of the names change every time, but the general story remains the same). During all the bad news and panic, bottom-callers will get long causing another short-term bear market rally to begin.

Three Months: Within the next three months, the bear market rally described above will come to an end, the bottom-callers described above will have been wrong (joining the ranks of Bill Miller, Sovereign Wealth Funds, and many others), and the market will resume its downward trend because I believe it is very unlikely that anything will occur that is significant enough to all-of-a-sudden reverse all of the bad things that are happening in the market.

Housing won't turn on a dime, stagflation (slow economic growth accompanied by inflating food and gas prices in this case) won't magically disappear (the Fed's hands are tied on interest rates because they can't lower and raise rates at the exact same time). I find it extremely telling that Hank Paulson is working on procedures to allow more banks to fail in an "orderly" fashion (I don't wonder if he thinks the financial sector could get much worse before it gets better).

Central Banks around the World seem to be undermining the US Fed because they are already raising rates (e.g. ECB, Australia, India) while Bernanke wouldn't dare raise rates anytime soon in our struggling economy (not to mention it would appear strange to start raising rates only a few months after lowering them when there is supposed to be a 6 to 12 month lag before rate cuts take a real effect on economic conditions anyway).

Based on my assessment of the current market conditions, I believe "Negative Market Beta" stocks will continue to perform well over the next three months. If I'm not mistaken, the most commonly accepted definition of beta uses five years of historical monthly data to calculate beta risk as the covariance of an asset with it's benchmark (usually the S&P500) divided by the variance of the benchmark (in layman's terms: what is the relationship between a stock's price and moves in the S&P500).

This is not the beta I'm talking about. I am talking about stocks that have had a strong negative correlation with the overall market over the last twelve months due to the very specific economic conditions we are in right now (click here for one example of this type of stock ). More specifically, I like stocks that will benefit from a continued weak US dollar and also benefit from a continued insatiable customer demand. I believe it is reasonable to assume the US dollar may eventually strengthen versus foreign currencies such as the Euro due to nothing other than natural regression toward the mean.

However, in my estimation, it is very unlikely that it will make up all of the ground it's lost over the last five years in the immediate future (especially when the US stock market is stuck between a rock and a hard place with stagflation as described above).

There are several energy and basic materials names that I believe fall into this "Negative Market Beta" category, and you can check them out by viewing the energy and basic materials holdings section within my personal investment portfolio, and by viewing my investment thesis for each of these stocks by visiting my blog at

Three Years: I really don't have any idea where the market will be in three years. In the meantime, I am focusing much of my investments on stocks that I believe can be successful over the next three years regardless of what the overall economy is doing. One theme that I am focusing on is "Low Bernanke Beta" stocks. I define low Bernanke Beta stocks as cheap, global, non-cyclical, decent dividend stocks with some room to grow no matter what Bernanke does with monetary policy (click here for two specific names and more information).

Overall, I'm not making any recommendations to anyone because this is only my best estimation of what will happen in the future, and everyone knows no one can predict the future. However, I can say three things: One, if the VIX raises into the low to mid 30's you will likely see me purchase a small amount of very bullish calls in my personal investment portfolio to take advantage of a short term bear market rally. Two, I think select energy and basic materials stocks will continue to perform well due to our current economic environment. And three, I have every intention to continue holding my "Low Bernanke Beta" stocks in my personal investment portfolio for many months to come.