Enjoy the Weekend

by JDH on May 23, 2009

The S&P 500 Index was at 935 on January 6, 2009, and then fell to 676 on March 9 before running all the way up to 929 on May 8. In percentage terms, the market dropped 28%, and then had a 37% rally. 37% rallies lead commentators to include that a new bull market has begun, and all is well. But here’s the thing: if you bought the S&P on January 6, and held all the way through the 37% rally, you would still be down 6 points. Even a 37% rally is not enough to recover from a 28% drop.

From the chart, it’s easy to see a series of lower highs:

  1. October 12, 2007: 1,562
  2. December 7, 2007: 1,504
  3. May 16, 2008: 1,425
  4. October 31, 2008: 968
  5. January 6, 2009: 935
  6. May 8, 2009: 929

Clearly, all is not well with the markets. We have had lots of rallies over the past two years, but each and every rally failed to take out the previous high. The failure after May 8 to surpass the previous 935 level is very bad news. Each successive “lower high” may only be 4 or 5% lower than the previous high (with the exception of the 968 post “crash” high on October 31, which was 32% lower than the previous high), but lower is lower.

On average each successive low after a high is 21% lower, and it takes 77 days to get there. Some are shorter. The drop from the peak on October 31, 2008 at 968 to the valley on November 21, 2008 at 800 was only a 17% drop, and it only took 21 days. The 39% drop ending on October 24, 2008 took 161 days.

If you want to extrapolate the average, from the May 8, 2009 high of 929 we are looking at a 21% drop over 77 days, so we will land at 734 on the S&P 500 on July 24, 2009.

And no, that’s not a prediction. Only a fool would compute some rough averages and assume that there is a repeatable pattern. That’s not the way life works. However, using those averages it’s not at all inconceivable that the markets will be lower at some point over the next two or three months than they are now.

What could cause lower markets? How about the bankruptcy of General Motors. Some commentators believe that the bankruptcy of GM would be an economic disaster, given the ancillary suppliers and support industries that would be hammered. Obviously bankruptcy hurts all stakeholders, but GM has been in bad shape for about 30 years, and the market has already discounted the share price, so it can’t fall below zero. (Here’s an interesting read on the history of GM’s mistakes).

The negative sentiment surrounding GM will hurt. The sell in May and go away philosophy will hurt. (Since April 30 the S&P is actually up 1.5%, but since the month’s peak on May 11 the market is down 4.5%, so selling the market in May appears to have been the correct strategy). The fact that the U.S. government’s deficit will no doubt be higher than $2 trillion this year is very bad for long term market health. After the recent rally insider selling has increased, and insider’s typically sell before a down leg. Unemployment remains high. Foreclosures are increasing. Etc. Etc.

I hate to spoil my American friend’s long weekend, but I am more bearish now than I was last week, or the week before.

My strategy is as follows:

First, hold cash. I am currently 80% in cash. My remaining holdings are gold and silver stocks, which I have continued to sell on up days. I will maintain a core position, but if the market tanks, everything will go down with it. Obviously having cash has hurt during the recent rally, but having cash will be wise if the market falls. My portfolio is up about 4% on the year, which isn’t great, but compared to the decimation of the past two years, and the fact that the market is down year to date, I’ll take it, and I’ll stay conservative.

Second, since I have yet to figure out how to play the short side of the market, so I am holding some RSW – Rydex Inverse 2X S&P ETF. These are short term holdings only. I sold some of them this week, and have sell orders already placed for next week. On weakness, I sell. If we have three strong up days, I’ll buy. I’m only using “play money” for these trades, since they are too risky to place any real money on leveraged ETFs.

Third, I am watching gold for a correction. It’s been strong recently, but as we all know the $1,000 level is a very strong resistance level, and I assume the market makers will do everything they can to hold the price under $1,000. That tells me I will have further buying opportunities, so I will be patient. Once gold breaks $1,000 it may quickly run to $1,500, and that’s why I want to have lots of cash on hand to take advantage of that buying opportunity.

Fourth, I am buying real things. Having money invested in a tanking market makes no sense, and what’s the point of working 80 hours a week and saving money if you can’t enjoy it. So, we are building a big shed on our property, and we are installing a pool. With the weak economy, swine flu, and the stupid security measures at airports I don’t plan to do a lot of traveling this summer, so I’ll do the next best thing and vacation at home. I’ll be spending the rest of today helping my brother in law install the racking in my new basement wine cellar. (I have no carpentry skills whatsoever, and he does, so I supply the food and drink, and he does the real man’s work). I will spend the rest of weekend planting the rest of my vegetable garden.

If the world tanks, at least I’ll have food, drink, and a cool place to relax.

Finally, I’m staying healthy. Sitting around worrying about the economy is not productive. With the return of nice weather I’m spending more time biking and running outside. I much prefer a morning run outside than half an hour on the treadmill watching the talking heads on CNBC, which only upsets me. My son and I did a 5 km run last month, and I’ve got another one next weekend, so that should keep me healthy and out of trouble.

And that’s my advice to you this Memorial Day Weekend. Shut off your computer, spend some time with your family, and use at least some of your hard earned money to invest in something you and your family will actually enjoy. Thanks, and see you next week.