My intent was to present the second installment, "Making Sense of an Implosion - Part II". But this post already runs pretty long with timely information that I think could add value to your portfolios. I'll include that second installment in my next post. Let's get to it...
The markets continue to be buffeted to and fro by a financial storm inducing queasiness for all. Still, I have some interesting information that I am anxious to share with you so I am going to lead with my market wrap-up section.
Have We Hit Bottom?
I begin writing this article during the wee hours of Monday morning. Stock futures are pointing to a positive opening of the U.S. markets in a few hours after ending last week with the DOW up 431 and the S&P 500 up 41. Meanwhile the VIX (often referred to as the fear index) closed last week at an all time high of 70.33.
In my last post I illustrated the technical reasons why the S&P may find a bottom somewhere around the 800 level. Since then, I have been playing close attention to the VIX. In September I wrote, "A great index for clues about the future direction of the market indices is the Volatility (VIX) Index...The markets have a saying about this, 'When the VIX is high it's time to buy. When the VIX is low, it's time to go!'" With the VIX at an all time high you might think that you could capitalize now by getting in to the market early but I don't think that is the right move. In fact some of my calculations lead me to believe that we could see the S&P 500 decline to a level of at least 767 before finding a bottom. Here's why...
In addition to watching the VIX, I've also been monitoring the P/E ratio for the S&P; currently at 18.31. From past research I know that
- the average P/E over the last century has been 15.8;
- bull markets have always begun with P/Es below 15; and,
- you get to lower P/Es by lower stock prices, increased earnings or, some combination of the two.
What's in a Name?
In my January '07 missive I wrote, "Each month since August 2006 the curve has been inverted. According to Estrella and Mishkin's scale, the rate of inversion indicates a 25-35% chance of recession. In my estimation, the inversion isn't significant enough to warn of recession but certainly an economic slowdown. This warning sign tells me that we should be taking a defensive position in our investments." In fact, the yield curve didn't turn positive again until June of 2007 and, since the yield curve is looking out four to six quarters, you can easily see that we have been witnessing what the yield curve foretold.
So, here's the six million dollar question: is this a slowdown or a recession? In the late spring of 2007 gasoline - which had been in an up trend for the previous year - hit $4.00 a gallon in many parts of the country. Meanwhile, all of the talking heads on CNBC and Bloomberg went on ad nauseum about a recession. Mind you, the National Bureau of Economic Research (NBER) is the organization that maintains the standard on the beginning and ending of recessions. Because several metrics are used in the determination and, because many of those metrics are revised a number of times as the underlying data becomes finalized, the NBER typically reports the "official" start/end of a recession after the fact. But that didn't stop everybody that wanted face and mic time from stating with absolute certainty that we were in the middle of a recession.
Then, in August, the credit markets began to crack. All mention of the price of gas was abandoned by the media. I mean that story went from page one to page twenty in a New York minute. All of a sudden these very same talking heads changed the rhetoric from, "We are in a recession" to, "Are we entering a recession or, could this be a depression?"
The problem I have with these zipper heads (have I sufficiently conveyed my disdain for these people?) is that they present conjecture as fact because sensationalism sells advertising. Of course that can be perilous for folks that make investment decisions based on such "reporting". It is a perfect reminder that 24 hour news stations -like everything else - are driven by money. In this case, ad money. As a result, factual reporting takes a back seat to sensationalism and fancy graphics. I bring this up - again - to remind you that when it comes to your money, you must keep your own counsel. Never mistake one minute sound bites for "real news". There's always more than that to the story.
By now you are probably thinking to yourself, "Okay Bill but you still haven't answered the question." Well, the simple answer is that I just don't know. I do know that the yield curve indicator works. Now, at the time I forecasted a slowdown the yield curve had been inverted for 5 months and the rate had been pretty constant. I thought that anything less than a 50% negative spread did not demonstrate sufficient strength for a recession. Perhaps that assumption was incorrect; I will wait for the NBER announcement to see. In the end taking a defensive position on our investments was a good call and that is what really counts.
While I am on the subject let me point out that, by February of this year the yield curve was reflecting a 5% chance of recession. Between February and May the spread had become wide enough to indicate positive growth four to six quarters out. Meaning that we should being seeing signs of recovery between May and November of 2009. So, when the President (whoever it turns out to be) is given credit for bringing us back from the brink, you'll know that the recovery was in the cards the whole time.
Finding Alpha
Enough of what not to do. Let's talk about some of the opportunities out there. Looking at the price action you can see that as the price of commodities rise, equities have been declining. This is reflective of the supply/demand equation. When the last bull run began companies employed cheap commodities to build and sell products and services thereby increasing sales. As demand increased the supply of commodities decreased. Naturally, commodity prices began to rise. As commodity supplies became depleted the bull market matured and began to turn over while commodity prices have begun to rise reflective of the lower supply. Prices on these commodities will continue to rise until supplies become abundant relative to demand. From that point, as commodities once again decline in price, the next bull run will begin and companies will once again employ cheaper commodities to produce goods and services.
With that in mind, I asked myself this question: how can I capitalize on these commodity plays? The following table presents five ETFs that are comprised of futures contracts in various sectors. You would buy and sell these using the weekly price charts/moving averages. To help you get more acquainted with these ETFs I've included links to the appropriate Yahoo Finance pages.
| Symbol | Name | Description |
|---|---|---|
| DBA | Powershares DB Agriculture | Basket of futures contracts for corn, wheat, soy beans and sugar |
| DBE | Powershares DB Energy | Basket of futures contracts for light sweet, brent crude & heating oil, gasoline & natural gas |
| DBB | Powershares DB Base Metals | Basket of futures contracts for aluminum, zinc & grade A copper |
| DBC | Powershares DB Commodity Index Tracker | Basket of futures contracts for light sweet, crude & heating oil, aluminum, gold, corn & wheat |
| GLD | SPDR Gold Shares | Reflects price of gold bullion (held by the trust) less expenses |
Right now all of these ETFs are trading below their 50 WMA but I believe that this is just a pullback so don't expect them to stay there. Rather, this is a great time to begin watching them, wait until they are above the 50 WMA, and trade using the rules I have given you previously.
Of course if all of your investment funds are in your 401k account you would not have access to these ETFs. One solution is to establish a Roth IRA through Fidelity or E*Trade. Yes, all deposits to a Roth account would be after tax dollars. But increases in value and withdrawals during retirement are tax free which is a big upside.
You could invest additional funds above and beyond your 401K or, adjust your 401K deduction in this fashion: say you are currently putting 10% in your 401K account and your employer matches the first 6%. Lower your 401K contribution to 6% and put the remaining 4% in the Roth IRA.
Bottom line: investing in commodity ETFs provides a hedge against inflation and decreased future buying power.
I had promised myself that I wouldn't use this blog to discuss politics so I'm going off the reservation a bit here by including this piece. But, given the proximity to the election I thought this was timely. I hope you find it thought provoking as you consider who to vote for this election day...
My friends, the great citizens of these united states, as election day draws near I know that many things are on your mind. We find ourselves confronting challenges here at home and abroad. Many of you are understandably frustrated by the current state of affairs and now have an opportunity to choose a new leader to address these problems.
You have heard a lot from the challengers. Each of us have done our best to demonstrate our unique vision for the future; demonstrating our advocacy for change. You have heard a lot about the biggest issues we confront today: the war on terrorism and how to best continue its prosecution. The state of our economy and how best to get back on track by creating new jobs and alleviating the problems of homeowners that are in jeopardy of losing their homes. And, of course, our energy needs: finding a balance between our current needs and developing alternative sources and fuels to sustain our needs going forward. Yes indeed, you have many things to consider as you enter the voting booth on Election Day.
Now, you have heard much about my allegiance to the President and it is true, many times, based on the information I had available to me at the time, I agreed with his position. Other times I have not. And I could say the same for each of the other three Presidents that have held the office during my time in the United States Congress.
You have heard much about my voting record and allegations about my association with people involved in the Savings and Loan Crisis. All of these things are part of a public record that spans 26 years. And I will say this to you now: no one builds a career that long without making mistakes. But, it is a man of integrity that can learn from those mistakes, rise above them and do more and do better for the people he serves. I stand before you now, proud of the record that I have built. Knowing that I have served you to the very best of my ability.
Contrary to some of the things that have been said, this campaign isn't about the color of one man's skin or the age of another. It's not about the sex of one running mate or the acumen of another. And, it's not about effecting change because anyone that is elected President will bring change merely because each person is different and the situations we face will be different over time. You may have misgivings about how we got to this place; how your elected officials allowed us to become immersed in these problems. Hell, I am as frustrated as you are but, this election isn't about rehashing the past. It's about going forward. It is about...experience.
[pause...]
Let me ask you this: suppose someone you love needed surgery. Would you pick the surgeon with 26 years experience or, the one with just 4? The surgeon that has confronted many different problems - many unexpected - and helped his patient live and fully recover? It is an important question. In fact, each of you will have to answer a similar question on Election Day. Because this country, the country you and I love requires surgery. We will need to cut through red tape to get our energy program on track! Oh yes, we will need to focus like a laser to expose the terrorists that still threaten our well-being. And, we will need a clear cut prescription to address our economic ills.
[applause...]
Ladies and gentlemen, Senator Obama is a fine man. I have no doubt that he loves this country and will serve it well throughout his career. But today, at this time and this place, the candidate that assumes the Presidency must do more than promise change, he must know how to make it happen. Clearly, I have proven that I am the right man for the job.
God bless you and God bless the United States of America.
Thank you and good night.
[applause...]
Send your questions and comments to Bill Mazzacca
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