Time to Place our Bets?

by JDH on January 17, 2009

The question for us to ponder today: what impact will President Obama’s Inauguration on Tuesday January 20 have on the markets? Obviously there are three possibilities:

  1. the markets will go up;
  2. the markets will go down;
  3. the markets will stay the same.

Which option is most likely? I have no idea, so let’s think it through.

The DOW was down over 3% on the week, and is now down over 5% on the year, and that’s after the big crash of 2008. The bottom was around 7,550 in November, and we have not fallen below 8,000 since. I therefore conclude that, until we see otherwise, 8,000 is probably a good support level. We closed the week at 8,281, comfortably above that level.

My guess is that in the short term the markets will go up. The American media will be full of stories about the new president. There will be wall-to-wall coverage of his Inauguration speech, and the parties that follow. Many stories will be written about a “New Day for America.” All stories will be positive. Mr. Obama has yet to make any decisions as president, so he has yet to make any mistakes, so there is nothing bad to say about him, so all press stories will be positive.

Positive stories make people feel good. We will start to believe that yes, in fact, perhaps his stimulus policies will work to bring the economy out of recession. Perhaps all is well. We will all think “Hmmmm, perhaps I should take some of my cash and dip it into the market, just to see what happens.”

My late grandmother, when asked if she would like a piece of cake or pie for dessert, would always say “just a little.” (My father would, of course, always give her a big piece, which is what she really wanted). But that’s how it starts. We start with “just a little”, and if everyone puts in just a little bit of money, the markets will bump upwards. People will then see the markets going up, and they may start to believe that the bottom is in, so they will buy more, so as not to miss the rally. Momentum drives the market higher.

And that is exactly what I expect to happen. I expect that this will be an up week for the markets, perhaps significantly so, and I believe the up markets will continue for a few weeks, perhaps a month, perhaps longer. But not much longer. The chart of the Dow shows that the markets could bounce all the way to 10,000 without breaking the down trend line, and that’s my prediction: I assume we will bounce up to almost 10,000, but not through it, before falling back to the bottom of that range.

As you know from the 2009 Predictions Issue I am still a pessimist, so I believe that after this Inauguration Euphoria the down trend will continue, but for the short term, I believe the trend is up.

So, how am I playing it?

First, I am 50% in cash. I may very well be wrong, so I’m not risking more than necessary.

Second, I continue to hold my core gold and silver holdings, which will eventually rocket higher when the deflation ends and inflation begins.

Third, I have sold all of my short positions, (such as RSW – Rydex Inverse 2X S&P ETF).

Fourth, I may consider gambling by buying either a long ETF, or perhaps just picking up some out of the money call options on the S&P 500. I wouldn’t invest anything significant in them, but it’s probably worth the gamble. I may also consider a bull spread with options, which is somewhat less risky, but also has less potential for profit.

Finally, since we are talking about gambling, what bets should we place on Obama’s speech? If you want to place a bet, bet on alternative energy. I assume he will make a comment, very briefly and in passing, that “we can’t rely on fore gin oil, so we need to develop our own resources, including wind, solar and nuclear power.” If he says something like that, our uranium plays may get a bump, so if you are planning to place a bet, Monday (in Canada) or Tuesday morning may be the time to do it.

Since I don’t know what will happen, I will be a keen observer this week of the action, and I’ll have more thoughts next week.