Inauguration Over – Now What?

by JDH on January 24, 2009

In my commentary last week I asked the question: “What impact will President Obama’s Inauguration on Tuesday January 20 have on the markets?” I answered by predicting 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.

I therefore assumed that the markets would rise, so I said that:

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.

And that is exactly what I did.

On Monday the U.S. markets were closed for the Martin Luther King Jr. holiday, so on Tuesday morning, Inauguration Day, I placed my bets. I started by picking up some shares in RSU – Rydex 2X S&P 500 ETF, and ETF that is designed to increase by twice the increase in the S&P Index (and vice versa, of course; it drops if the S&P declines). As the morning progressed the markets continued to fall, so I “doubled down” by buying some call options (specifically the SPY Feb 85 calls, which are call options on the S&P 500 Index). I bought in tranches as the markets fell, and ended up paying $3.42 each.

Unfortunately for me my timing was somewhat premature; as President Obama spoke, and as Inauguration Day wore on, the markets continued to fall. So much for the instant euphoria I was expecting.

I guess I should have done some basic research. It turns out that 70% of the time the markets fall on Inauguration Day. The biggest recent fall was the day of President Johnson’s Inauguration, but that’s not surprising since he became president after the assassination of JFK. The next worst day in recent memory was President Reagan’s Inauguration; the market fell for the next year and a half, but then of course a 20+ year bull market started, so I guess you can’t over-analyze one day’s results. You can read Mark Hulbert’s column for more details.

Fortunately, Wednesday was an up day.

Thursday was a marginally up day, but Friday started off heavily to the downside. I did not want to be sitting on short term call options over the weekend, when anything can happen, so around 10 in the morning or so I sold the calls for $2.38, obviously a significant loss over the $3.42 I paid for them. Of course, as you can see from the chart, my sell point marked the start of the rally that continued until the end of the day. Had I held on, the options would have been worth around $2.65 at the end of the day.

However, I’m not losing any sleep over my decision. I expected there to be an Obama rally. There wasn’t, at least not to the extent and as quickly as I expected. When you are playing with options, you must take your profits, or cut your losses, very quickly. Sitting around waiting for a few weeks means the time premiums evaporate and you are wiped out. So I took my losses and bailed.

Fortunately I was not playing with significant dollars, so the loss doesn’t really hurt me. I held on to the RSU – Rydex 2X S&P 500 ETF, just in case the rally continues next week. I don’t have the same worries about time premium erosion.

So why was I wrong? Why did we not have a big uptick in the markets this week? It could be that the uptick will come next week; everyone spent the week watching Inauguration coverage on television, so people weren’t actively trading. It could also be that everyone is waiting for the details of the Obama stimulus package, and when it’s announced, the markets will soar.

Of course, it is also possible that the economy is in a mess, and everyone knows it, so no-one is buying.

My thoughts on the subject are well documented. I assume that President Obama is a smart, intelligent man. I assume he has smart, intelligent advisors, and I assume he will do what he thinks is necessary to “fix” the economy. Unfortunately, I don’t believe a government can “fix” an economy. I believe that only people can fix the economy. Only people can invent products, create wealth, improve efficiency, pay down personal debt, save, and do all of the things that can make an economy grow. “Stimulus” packages may bump up the economy today, but long term only taxes and inflation increase.

So, I continue to believe that we may have a bump up when the stimulus package details are announced, but in time reality will set in, and down we go.

Of course the big winner this week was the price of gold, and I’m pleased to say my blue chip gold holdings like ABX.TO – Barrick Gold Corp. and AEM.TO – Agnico-Eagle Mines Ltd. had good weeks, up 4.5% and 2.3% respectively. Silver stocks did even better. However, I see warning signs on the gold chart. It looks to me like $900 is a significant resistance point, for two reasons: First, we are getting very close to the down trend line drawn back from the highs in March, 2008. Second, the RSI is approaching 70, which has marked a significant resistance point for the last year.

Long term, and in fact over the next three or four months, I believe gold will be a great investment. However, I don’t believe the next few weeks will be kind to gold. I believe profit taking will kick in, and gold will fall into the $800 per ounce range. That will be the final buying opportunity in this cycle, and I fully expect to see $1,000 per ounce by the time the snow is gone in my corner of Ontario. (We have lots of snow on the ground, so I’m assuming it will be late March or early April before it disappears).

So, the strategy this week will be to place sell orders on half of my gold holdings at slightly above the closing prices on Friday, and take profits. I will do the same with my long ETF position. I am already sitting 58% in cash, which is where I want to be if I’m correct and we have one more down leg. I’m hedging my bets by retaining some gold and silver shares.

I hope I’m wrong. I would love nothing more than for this financial mess to be over. If I am wrong, I have cash, so my profits are capped, but I’d still be happy.

Unfortunately I believe that the real estate market has more room to fall, China is in a recession which will reduce their demand for our products, and make it harder for them to buy more U.S. Treasuries to prop up the U.S. dollar, credit is still very hard to get (which is what fueled the boom over the last few years), and price of oil is on a yo-yo string at the moment. It could be that all of this negativity is a contrarian indicator, but I doubt it.

As always, thanks for reading, and thanks for contributing on the Forum; we will all continue to muddle through this together.