It's Hard to Be a Bear: Resist the Urge to Buy These Scarred Stocks

by Eric Roseman

On any given day the stock market posts a big triple-digit gain, it's almost natural to want to jump aboard and buy fresh positions. That's how I felt going into yesterday morning's trading after Tuesday's 260-point gain for the Dow.

But I'm going to resist the urge to buy.

Even with Tuesday's gains, stocks are still miserable right now. That's why my portfolios are now sitting with their lowest equity exposure since 2001. Instead, I'm stocking up on cash, reverse index funds, gold and gold stocks, and a host of other investments that zig when the market zags. That strategy has worked all along this year - until earlier this month.

A major trend reversal happened this month. Some of the biggest losses are impacting hedge funds. They're now suffering their worst month in eight years with an average loss of 3.5% heading into this week's trading.

Bearish Portfolios Take Another Hit - This Time in Commodities

The macro hedge funds or managers that take big directional bets with leverage have been riding commodities this year and shorting financials. Once again, that was a superb trading strategy until this month.

Bank stocks have been rallying this month while everything commodity-related, including coal, potash, and energy, has been getting massacred. Spot gold prices have remained virtually unchanged in July from June's closing price. However, the mining shares are down over 10%. That's causing some serious damage to all bearish portfolios.

The XAU Index or Philadelphia Gold & Silver Index is down about 13% this month and now trades well below its important 50-day and 200-day moving averages. This tells me that more selling could lie ahead.

Coincidentally, the pathetic U.S. dollar is actually holding its own this month. The dollar firmed up despite more bad economic news, including housing foreclosures, massive budget deficits, consumer confidence at 17-year lows and deflation destroying portfolio wealth since mid-2007.

As goes the dollar, so go the commodities markets. This historical relationship is negatively correlated. As the dollar rallies, commodities tend to decline, and vice versa. I do believe most of the dollar's decline is behind us, but I believe we have one more leg south.

The market is wrong in assuming the Fed will tighten anytime soon. There's just no way Bernanke will hike rates while unemployment is rising, credit is contracting, and housing is still hemorrhaging.

What $122 Oil Is Doing to the Markets

Oil is triggering a major trend reversal this month.

The price of crude oil is now correcting heavily. Oil has fallen from its July 11th all-time high of $147 per barrel and now fetches "just" $122 per barrel. Since oil and the rest of the energy complex is the largest constituent of commodity benchmarks, the CRB Index, and other raw materials indices are down more than 10% in July.

Needless to say, it's pretty ugly if you're long commodities right now. 

Oil Drags Down the Rest of Commodities

But let's put this somber mood for the bears in perspective...

The U.S. economy is not bottoming. I expect the economy to get worse as the year progresses with a bottom forming sometime in mid-2009, possibly sooner. Since stocks tend to discount a recovery in advance, it's still too early to buy stocks.

More bad news is coming - and not just in the United States. Earnings in Europe and Asia, excluding Japan, are still too optimistic and will be revised lower.

A Bearish Crystal Ball: The Index That Predicted the Bear Market Has Not Peaked Yet

Lowry's Index measures buying and selling volume trends. And so far, this index has not peaked. This index was correct in identifying weak buy-side volume as early as last August and warned a bear market was in the cards.

On days the stock market posts a big advance, like Tuesday, investors are not aggressively accumulating equities. In fact, they are still selling. Lowry's tells me that the point of maximum selling has not arrived.

Finally, and most importantly, the state of the credit markets is not improving.

Some segments are rallying, including the LBO market or leveraged loans. But most deals are not clearing and banks still have a massive back-log of paper they can't sell.

Furthermore, banks are reluctant to lend. Their battle-scarred balance-sheets are committed to rebuilding equity. Banks are struggling. Capital is scarce. Lending volume has fallen off a cliff since last fall and it's not improving. LIBOR rates remain elevated, junk bonds are still declining in value as default rates rise and most credit indexes are at all-time lows, meaning stress is at extreme levels.

What It Will Take To Get Me Excited about Stocks Again

The only bullish component supporting the stock market now is lower oil prices. I'd have to see oil trade south of $100 a barrel to get really excited about stocks again. In the absence of an economic crash in China, I doubt we'll see $75 or $80 oil again.

Also, a federal bailout or nationalization of Fannie Mae (FNM) and Freddie Mac (FRE) is a short-term bullish development after this bill passed in the Senate.

I assume investors love this arrangement because it will thwart systemic risk in the short-term. But what a disaster in the end! This bailout will result in much higher inflation as the government prints money like crazy to nationalize half of the housing market. Taxpayers, naturally, will pay for this mess.

The bears are right. The U.S. economy and the dollar have not bottomed yet. If you're a bear, then stay the course because stocks don't make historical bear market lows during the summer. Market lows usually arrive in the fall.

The bear is still alive and kicking and just wants to sucker more investors into believing the worst is behind us. It's not.

Comments

[investor88:]

Good article, it is also my general view to stay high in cash until the market really turns.

2008 Jul 31 08:24 AM

[Chris Lau:]

My thoughts exactly, right to the very negative point of sentiment. As I have blogged, the market is itching for something to happen, but a lot of it is wait and see. The housing market has to play itself out. The rebate cheque bandaid after-effects remain to be seen. Oil prices still threaten to go up (is China/India growing or slowing? We don't know for certain!)

2008 Jul 31 10:12 AM

[otbricki:]

I think the time to start accumulating is now. It is very hard to accurately call a bottom; and very easy to miss the runup after. The cost of being a bit early is lower than being late.

2008 Jul 31 11:11 AM

[TA:]

We've probably seen the lows but I don't expect the bear to end until sometime in Nov which is closer to normal by historical standards. So far this bear has been very average.

2008 Jul 31 11:43 AM

[Fedman:]

I'm a modest buyer at these levels. I've heard over and over again about the lessons of market timing and at least I'll be able to crow that I didn't buy at the top. LOL

2008 Jul 31 03:22 PM

[rhj123:]

With the higher minimum wage coming into effect, and with that driving up prices, Christmas spending will not be very good. There will be crash sales, dumping inventory, trying to survive. Thus, we have not seen the bottom. Maybe some time in the early spring...?

2008 Aug 01 11:59 AM

[wpdragon:]

yah, blame it on the minimum wage increase.... oh, this blog is funnier than cancer

2008 Aug 01 01:24 PM

[neeb??:]

This bear is not bear enough. I don't think the bottom will be seen until the fall,2009. So this one will keep to his cash and go very low risk.

2008 Aug 01 02:56 PM

[Stock Gambler:]

My day job is wholesaling building materials (39-yrs) and I can tell you the housing slump hasn't even started to hit bottom yet. On top of that, with commodity & oil trends up over the past two years, we are getting hit almost daily with building material increases, usually in the 8-12% range - shingles are on allocation right now across the country. So, with considerable rising costs during an economy turndown, I can only see an extension of the time frame to recovery. I see late 2009 and a DJIA of at least 10,250 (according to my charts).

2008 Aug 02 09:38 AM

[Fred Voetsch:]

On Aug 02 09:38 AM Stock Gambler wrote:

> My day job is wholesaling building materials (39-yrs) and I can tell
> you the housing slump hasn't even started to hit bottom yet. On top
> of that, with commodity & oil trends up over the past two years,
> we are getting hit almost daily with building material increases,
> usually in the 8-12% range - shingles are on allocation right now
> across the country. So, with considerable rising costs during an
> economy turndown, I can only see an extension of the time frame to
> recovery. I see late 2009 and a DJIA of at least 10,250 (according
> to my charts).


Reading this in May of 2009 I just couldn't help but laugh at that prediction of a low of 10,250.

Since then the Dow has gone to 6,500 and right now we are towards the end of what I believe will be a bear market rally that will soon falter and send the market down below 6,000 with 5,000 likely to be reach by year end, 2009.

Some more from the future:

Oil hit $35 a barrel, the Philadelphia Phillies won the World Series, Barack Obama is the first black president and Jim Cramer and Hank Paulson are in jail...oh wait, that SHOULD have happened but didn't. :-)

May 18 10:29 PM