We all know and heard of the tired analogy “don’t try to catch a falling knife” to describe the temptation of jumping into a declining market. There are certainly too many analysts or money managers that have been completely eviscerated and butchered by calling the bottom prematurely in the financials and housing market since fall of 2007. Don’t like playing with knives? Here’s a better analogy to use instead of the requisite kitchen cutlery.
Remember when you were a kid and your smart-ass uncle would wave a dollar in front of you and say: “If you can catch the dollar as it falls between your fingers, it’s yours.”
The game was a simple one, you being required to hold your thumb and index finger outstretched as the dollar remained suspended in between. You concentrated, fixed on the moment by thinking the task was way too simple. But once your uncle let the dollar go, you just weren’t quick enough to snatch the bill out of thin air.
The reason is that by waiting to see when the dollar was finally released, neural-transmitters from the cognitive decision making process in your brain couldn’t telegraph the message to your muscles fast enough. So close, so far away…
However, there was a way to beat this game once you knew the trick. After a few incidents of trial and error, you could learn to anticipate the release and snap your fingers shut just in time to claim your prize.
This is the fundamental difference between a reliance upon reaction time and the ability to anticipate ahead of foreseeable events. If everyone is standing around waiting to react when the markets finally bottom out or recover, it will be too late and you’ll miss the trade you were looking for all along.
If you learn to anticipate ahead of the curve by wading into the waters and continue to add to or fortify existing positions of your core portfolio, you will learn how to catch a falling dollar…
YOU’LL KNOW WHEN YOU’VE BEEN SCAMMED
There is a very interesting situation that is being set up in the markets right now, in fact, it may be potentially the biggest pop you’ve ever seen in an option expiration week. I’m not predicting this will happen as a recommendation to act on my opinion, because I could be wrong and I would hate to offer bad advice, but the markets are severely oversold. Whether this move occurs next week or soon thereafter, there will be a lot of investors that feel cheated by being forced to liquidate or relegated to the sidelines as spectators.
It may not happen due to changing events on the ground day after day, however, the set up is clear if there are major announcements in a global effort such as the recent implementation of unified rate cuts. Continued cooperation in the upcoming G7 finance minister meeting or confidence supporting the Paulson T.A.R.P. (Troubled Asset Relief Plan) may begin to catch fire. Remember, there have been absolutely extra ordinary measures made by the Fed to inject liquidity into the markets to unclog the drain.
Don’t underestimate the potential effects this will have on the economy by amplifying the liquidity and capacity for financial institutions to make money–in other words, don’t underestimate Wall Street’s greed and temptation to utilize the advantage of a steepening yield curve, or the ability to borrow short-term funds cheap and lend long at a much higher rate. It may take time to reveal itself but when it does happen, the markets will have already made their move ahead of the curve.
With current short-selling restrictions due to expire imminently you may, very possibly, see a massive downdraft into the end of the week and the most incredible bounce in the history of the markets following close behind. I hope there is not continued and unabated selling. I would much prefer that the markets remain calm and slowly build momentum over time. Hey, we all could use a timeout to regain some version of sanity.
I must take issue with those market guru chartologists and technicians that insist there needs to be an absolute concave pivot point that signals the green light for everyone to jump in the market and buy. I don’t doubt that professional traders and institutions are looking to drive the DJIA sub-9000 not because they have to, but because they want to and can.
Everyone knows stocks are cheap right now, but there are those that want to buy them even cheaper. It’s greed in a very perverse sense of the word because it comes at the expense of ordinary Americans and investors. With an estimated $2 plus trillion dollars in retirement savings and investments wiped away over the course of the last year, who walks away with unconditional impunity?
Average investors are forced to shop at retail prices, while professional and institutional traders like to shop at wholesale discounts and fire sale prices.
It’s really hard to buy into these institutional traders looking for this “moment” of absolute capitulation. No one really knows when the exact bottom occurs with the exception of looking through the rearview mirror on an empirical chart.
If you are an active trader in the markets, you have been witness to more blatant market manipulation than a crooked casino. It has become so out of control that it makes “The Sting” look like a futile exercise in morality.
But, sometimes a rigged game can be the best and only game in town if you line your positions on the same side as the institutional players that place and stack their bets. Let’s not pretend the underlying fundamentals of the economy are somehow any better, or any worse, than before the major mayhem in the markets erupted during the month of September and all the organized chaos that has ensued since then.
Simply stated, too many stocks are oversold and are worth owning on fundamental valuation. The markets are poised for a very dramatic reversal to the upside. For no other reason than it can’t go to zero, can it? If so, then all I can say is load up on canned food, water and ammunition because complete financial Armageddon is not a scenario you can profit from.
How rigged is this game? Well, 3rd quarter earnings for institutional hedge funds were abysmal. I think I read that 90% plus of existing hedge funds were down for the year by a significant percentage. So, if you’re having a tough time in the market you’re not alone when pros are getting blown out of the market. Hedge fund redemptions and people panicking to sell positions at any price have caused a liquidity draw on the potential buyers in the markets who have been noticeably absent without leave, hence falling prices unable to find a bidder.
But, if institutional players and hedge fund managers are to remain in business, they have to show a strong fourth quarter otherwise they are out of business. Period. Who would want to stay with a firm or professional money manager if they continue to lose money? Anybody can flush their own money down the toilet without the added assistance of maintenance and manager fees.
If markets pop on a major run into option expiration next week, you’ll know you’ve been scammed by professional traders. The amount of retail traders and investors that have been crushed under the weight of a credit debacle is unjust, literally, running competent players into the ground.
INTERESTING CLUES IN RULES AND RESTRICTIONS
There may be an interesting observation made by professional and well respected short-seller, Doug Kass, due to an existing “overhedge” in the S&P 500 futures contracts. Since there has been a restriction on short selling, hedge funds and institutions have turned toward shorting the highly liquid futures markets which, by the law of unintended consequences, has become a way to circumnavigate the rules.
Part of the problem is the inconsistency being applied here. When Chris Cox, head of the SEC, implemented new short selling restrictions, they forgot to coordinate or merge with the CFTC (Commodities Futures Trading Commission) and prohibit further manipulation of the stock market through continued selling pressure in the after hours and pre-opening trading of S&P futures contracts.
The futures markets don’t correspond to normal trading hours and, in my opinion, have always been questionable and less of an indicator of market fundamentals. Don’t forget, futures markets based on indices are cash settled derivatives.
Futures markets related to the major stock indices should not be allowed to trade outside of normal market hours, no different than other derivative choices such as option markets. It’s simply not fair and, as some have rightly pointed out, can be the leader and instigator, not the follower of market conditions.
Just like short selling, it’s a well crafted tool for dynamic hedging strategies when used to match trades and create liquidity between buyers and sellers, but the dark side of such derivatives is that they can be key drivers for stock market manipulation. It’s a short leap to make the same tool for good into a weapon of choice when a select few funds and institutional players want to drive high volumes in one direction and cause a cascade of sell orders.
Without having the other outstanding regulatory body on the same agenda, hedge funds are allowed to abuse the futures markets as an alternative hedging strategy. Futures contracts tied to stock indices should not be allowed to exploit pre-opening and after market closes, because you have an obvious dislocation that forces stocks to correct and adjust discrepancies to create parity against the index.
I have no problem with someone speculating on where the S&P 500 will trade, up or down, sometime in the future. I only seem to take issue when their position is less of a prediction and more of a “wink wink” guarantee.
HOW I AM PLAYING THE MARKET TURMOIL
There are real deals out there in the market, but you can’t buy based on the idea stocks can’t trade lower. You have to buy only on the conviction of adding to existing portfolio positions by dollar-cost-averaging, or believing that no matter how bad the economy can fall, these businesses will remain solvent.
I’ve continued to sell overhedged puts I’ve held on all major declines for profit to offset equity losses. I never expected many of these positions to come to fruition amid the reality we face now. I admit I could have done it better through the protective lens of hindsight, but I did not expect this continued acceleration to the downside. I still remain overhedged, but my vision is concentrated on the long-term outlook, even if the light at the end of the tunnel is a bit out of focus.
I really don’t want to continue adding stocks to the portfolio because I’m overweight more than I’ve ever been, but certain valuations demand that I keep averaging into existing positions. In this case, you should be looking for dividend paying stocks as a core component of your portfolio. There are many quality companies that are paying out yields well above Treasuries with all the upside once someone hits the ignition switch to activate the market and reignite the economy.
My advice is that whatever you decide to buy, attach a “married put” contract in case we are not consolidating around a bottom and the markets are a complete disaster, or we have a long sustained recession and there is no snap-back recovery.
If you are not comfortable using options then, please, stay away from the temptation to use margin and leverage. You must be willing to own whatever position you buy no matter where the market trades in the short-term. I would hate to see it, but this market could easily trade down another 1,000 points or more just to please players trying to game the system.
You will pay a ridiculous premium to do so if you buy put contracts against new or existing long positions, as the cost to insure will be very expensive due to extremely high levels in the “fear gauge” known as the VIX, but the risk of further downside action could cost you more in the end if you fail to offset the implied volatility. At least in combination with a long put contract against a position, you have the “option” to exercise the existing contract and selling your shares at the stated strike price if you are so inclined. By doing so, the risk to reward remains in your favor if the market does recover and you are allowed to ride the upside.
Freeport McMoran (NYSE:FCX), BHP Billiton (NYSE:BHP), and Vale Dolce Rio (NYSE:RIO) are just too cheap on a fundamental valuation basis for me to ignore. I am not calling a bottom on any of these prices, but I feel that current market value is worthy of any well diversified, income producing portfolio structure.
BHP still has a potential acquisition cost of their continuing buyout offer toward Rio Tinto (RTP), so it’s difficult to gauge an accurate valuation based on the unknowns of potential share dilution or the rising cost of secured financing.
The irony with BHP’s attempt to acquire RTP is that, in my opinion, they should just scrap that deal completely off the table if RTP wants to continue to play hard to get, and simply buy both FCX and Alcoa (NYSE:AA) for much less combined in total transaction costs. Alcoa would offer a larger aluminum exposure than what Rio Tinto acquired in Alcan, and Freeport McMoran would make BHP the largest copper and gold producer in the world.
RIO at 12 dollars is just plain ridiculous and an opportunity to own the largest iron ore producer in the world. It also enables you to play one of the most dynamic emerging markets in South America by buying into Brazil.
Freeport McMoran is probably one of the best buys on the street right now. You are being offered an interesting opportunity as hedge fund redemptions and forced liquidations have given you a rare gift. Freeport McMoran has been oversold almost into oblivion.
Under $40 a share, you are looking at a 5% dividend which is basically rewarding you to hold the shares long-term. Freeport recently raised their dividend to $2.00, or $.50 a quarter. That’s a monster dividend yield on a stock that is trading at less than 1/3 of it’s 52 week high.
Don’t bet the farm, please, but I can tell you after continuing to add more shares over the last few weeks, you are now able to purchase FCX at a price point lower than before they acquired Phelps Dodge. The p/e ratio is less than 5 x earnings and remains a long-term growth strategy.
Now, the downside risk is a slowing economy and demand destruction from China and other emerging global markets, but I don’t buy this assertion. You must separate the stock markets from the underlying economy that is booming. China’s version of a recession will be dropping from double-digit GDP growth to high, single digits which is enviable by all measurable accounts.
The thing is that at some point, even our economy must recover and when it does, our own domestic demand that is currently stalled will kick into high performance by demanding commodities to build and repair infrastructure.
If you don’t like the metals and mining stocks, look toward some energy companies such as British Petroleum (NYSE:BP), Exxon Mobil (NYSE:XOM), and ConocoPhillips (NYSE:COP) which look too cheap not to own. Same thing on the basic assumptions of global demand in that you are being amply rewarded to wait with a very high dividend yield and tremendous upside. No matter how much we all want alternative and renewable fuel sources, the fundamental draw on petroleum will continue to be the bridge that carries the transition from energy dependence to energy independence.
I don’t see direct credit exposure like the financial sector, and it is comforting to know that when you buy a metals and mining company, or even oil and commodities altogether, you are buying something tangible and real as opposed to non-transparent leverage ratios and incomprehensible balance sheets of opaque, Wall Street wizardry and financial companies.
Freeport McMoran’s dividend is relatively intact and, unless things spiral dramatically downward for a sustained period of time, you are being rewarded to wait until market turmoil settles back to normal levels.
Metals and mining remain heavily abused as a sector right now, but they are selling these stocks as if they were holding inflated p/e’s like those bankrupt, non-income producing tech bubble stocks of 2000. If you decide to nibble, do so with the knowledge they can continue to draw down further. I repeat, only buy if you are doing so without margin or leverage risk and be willing to own them beyond short-term chaos.
There are so many stocks that I like and watch out of the corner of my eye, yet, I simply have to remain focused and ignore temptations outside of the existing portfolio. However, the market is ripe with pickings if you are looking toward other sectors and would suggest that you turn to areas that pay a high dividend yield and offer the additional security blanket through uncertain times.
FCX, BHP, RIO are three tremendously oversold stocks I am willing to own through a recession and bear market. They are high paying dividend stocks and consider that any solutions put forth into the markets will have to be a very aggressive expansion of our monetary supply, hence, inflation risk down the line. It is not the immediate concern because stimulation matters more than headline inflationary risk. But, one of the worst possible outcomes is the dreaded “stagflation” word, which means inflation in a recessionary environment. This would be economic disaster.
China, India, Brazil and the “BRIC” emerging countries are not broken, the story is real and this global growth is hardly an illusion. But macro-economic realities are different from existing market conditions. Remember that the hedge fund liquidations that occur here domestically are the same exact traders exposed in the run up of the emerging markets.
The actual macro-economic reality has become completely dislocated from the way markets trade right now. This is panic inducing hysteria and a complete deviation from fundamental and current market value. While they are not necessary mutually exclusive in normal times, this divergence is the exact moment where amazing opportunity exists for the long-term investor.
Don’t confuse this dangerous collapse of deleveraging, forced hedge fund redemptions and liquidations from long-term value. When the magician comes along with their prestidigitation act and pulls the table cloth out from underneath you, the only thing left is the bill that’s due.
Disclosure: Author holds long positions in FCX, RIO, BHP