Dow 11,000? So what!
Market Update 2010-04-13
Contributed by Charles Guest, SinoCentury Guest Commentator
Yesterday the Dow hit 11,000 with great fanfare. Were you impressed? It is just a nice, round number. As I wrote last month, once we cleared the level of 1150 on the S&P 500 Index, the next level of major resistance would be at 1225. Yesterday the S&P 500 closed at 1197, so there is likely still room to run. At 1225 points, the Fibonacci 61.8% retracement number comes into play (for more info on Fibonacci numbers, click here). Once we reach 1225, we will have retraced 61.8% of the bear market loss since the October 2007 high of 1562. This is a key technical level which drives stock traders (who are about the only ones playing the market right now, since the average Joe was already wiped out twice, once in 2000-2003 and again 2007-2009).
As the stock market reaches S&P 1225, we face a major crossroads in the market. Will the market tumble or make a major move up? Given all the landmines which could blow up at any moment, we may resume the secular bear market. However, it is important to keep in mind that the next key Fibonacci retracement number is 1.00, meaning a possible 100% retracement of the entire bear market loss. That would take the U.S. stock market all the way back up to the S&P 500 Index’s high of 1562 that was reached in October 2007.
Which way will the market go? That is the dilemma. At the moment there are conflicting signals in the markets and the real economy. On the positive side there is a strongly positive yield curve, the ISM numbers are reading well above 50 (which indicate an expanding economy), and the advance/decline lines are good (which indicates a broadly rising stock market and not just a few stocks). On the negative side the Federal Reserve Bank has stopped purchasing mortgages, economic stimulus spending will begin winding down soon, home buyer credits will expire at the end of this month, the federal deficit is ballooning, sovereign debt is still a major problem in Europe, China's real estate bubble could pop at any time, P/E ratios are rich, the volatility index indicates a high degree of complacency (it’s only 15 points), the number of shorts is at the lowest level since 2007, and I could just go on and on!
So what's an investor to do? My inclination is to the bearish side, but I cannot completely discount a further rise in the stock market. I have accumulated a portfolio which I believe to be good long term, but it could be crushed in the short to medium term. I have already sold some holdings to raise cash levels. I had planned to sell more as we approach the 1225 level on the S&P 500, but over the last couple of weeks, I have come up with another alternative. I have been looking at an exchange traded fund which is designed to yield a return of one time the inverse of the S&P 500 Index. In other words, if the S&P drops 50%, this fund will increase 50%. This fund is the ProShares Short S&P 500 (SH ). By owning this fund, I can hold onto my stocks for possible future gains (albeit partially negated by reductions in the value of SH) and at the same time have some insurance against potential losses. I made my first purchase last week, using cash which was sitting idle earning practically nothing in the miserly money market. I plan to purchase more as we get closer to S&P 1225, and even more if we go up from there.
As a short fund, SH is not without risk. One risk is counter party risk. The fund consists of swaps with counter parties (JPMorgan Chase is the largest counter party for this fund). As Warren Buffet so famously said, "Derivatives are financial weapons of mass destruction." If we should approach a systemic meltdown scenario similar to 2008, then I would unload this fund (but by then I should have reaped my reward). The other major risk is market risk. In other words, if the market rises by 25%, you lose 25%. However, I am a betting man and would be willing to bet the farm that the market will at some point in the next 3 years return to today's level, thus erasing most if not all of any temporary losses.
So, what will you do? Hang on, sell, or buy insurance? That's up to you. We report, you decide. And we will all know more later. Meanwhile, happy investing.
Contributed by Charles Guest, SinoCentury Guest Commentator
Yesterday the Dow hit 11,000 with great fanfare. Were you impressed? It is just a nice, round number. As I wrote last month, once we cleared the level of 1150 on the S&P 500 Index, the next level of major resistance would be at 1225. Yesterday the S&P 500 closed at 1197, so there is likely still room to run. At 1225 points, the Fibonacci 61.8% retracement number comes into play (for more info on Fibonacci numbers, click here). Once we reach 1225, we will have retraced 61.8% of the bear market loss since the October 2007 high of 1562. This is a key technical level which drives stock traders (who are about the only ones playing the market right now, since the average Joe was already wiped out twice, once in 2000-2003 and again 2007-2009).
As the stock market reaches S&P 1225, we face a major crossroads in the market. Will the market tumble or make a major move up? Given all the landmines which could blow up at any moment, we may resume the secular bear market. However, it is important to keep in mind that the next key Fibonacci retracement number is 1.00, meaning a possible 100% retracement of the entire bear market loss. That would take the U.S. stock market all the way back up to the S&P 500 Index’s high of 1562 that was reached in October 2007.
Which way will the market go? That is the dilemma. At the moment there are conflicting signals in the markets and the real economy. On the positive side there is a strongly positive yield curve, the ISM numbers are reading well above 50 (which indicate an expanding economy), and the advance/decline lines are good (which indicates a broadly rising stock market and not just a few stocks). On the negative side the Federal Reserve Bank has stopped purchasing mortgages, economic stimulus spending will begin winding down soon, home buyer credits will expire at the end of this month, the federal deficit is ballooning, sovereign debt is still a major problem in Europe, China's real estate bubble could pop at any time, P/E ratios are rich, the volatility index indicates a high degree of complacency (it’s only 15 points), the number of shorts is at the lowest level since 2007, and I could just go on and on!
So what's an investor to do? My inclination is to the bearish side, but I cannot completely discount a further rise in the stock market. I have accumulated a portfolio which I believe to be good long term, but it could be crushed in the short to medium term. I have already sold some holdings to raise cash levels. I had planned to sell more as we approach the 1225 level on the S&P 500, but over the last couple of weeks, I have come up with another alternative. I have been looking at an exchange traded fund which is designed to yield a return of one time the inverse of the S&P 500 Index. In other words, if the S&P drops 50%, this fund will increase 50%. This fund is the ProShares Short S&P 500 (SH ). By owning this fund, I can hold onto my stocks for possible future gains (albeit partially negated by reductions in the value of SH) and at the same time have some insurance against potential losses. I made my first purchase last week, using cash which was sitting idle earning practically nothing in the miserly money market. I plan to purchase more as we get closer to S&P 1225, and even more if we go up from there.
As a short fund, SH is not without risk. One risk is counter party risk. The fund consists of swaps with counter parties (JPMorgan Chase is the largest counter party for this fund). As Warren Buffet so famously said, "Derivatives are financial weapons of mass destruction." If we should approach a systemic meltdown scenario similar to 2008, then I would unload this fund (but by then I should have reaped my reward). The other major risk is market risk. In other words, if the market rises by 25%, you lose 25%. However, I am a betting man and would be willing to bet the farm that the market will at some point in the next 3 years return to today's level, thus erasing most if not all of any temporary losses.
So, what will you do? Hang on, sell, or buy insurance? That's up to you. We report, you decide. And we will all know more later. Meanwhile, happy investing.
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