TheMoneyGeek Unplugged

The past several weeks in the stock markets have been quite trying for anyone paying close attention to what’s been going on.  As of today (Thursday June 16), we are working on a possible seventh down week in a row in the stock markets.  Since 1933, this has only happened three times, while the markets being down six weeks in a row has occurred seventeen times. Tomorrow is our last hope of an upside rally that takes the markets positive for the week and avoids making history by being the fourth time we see seven down weeks in a row.  Despite how bad this may sound, the selling has not been so intense to be considered anything more than a normal stock market correction within this bull market.
 
Why are the markets so intent on going down? Well, as I described in my last couple of writings, the end of quantitative easing by the Federal Reserve (buying treasury bonds), an apparent slowing in the economy, continued debt woes in Europe (Greece is in the forefront this week), and the failure of Congress to pass an increase in the debt ceiling.  Employers remain reluctant to hire new employees due to uncertainty surrounding health care and other financial legislation (e.g., the burdensome health care costs involved with hiring a 25th employee).
 
Of course, with several weeks down in the markets, every doom and gloom scenario and “Johnnie’s come lately” hawking another “End of the World” book come out of the woodwork, make the talk and news show circuits and call for Dow 5,000 and S&P 300 (they’re around 12,000 and 1,268 right now.)  Just yesterday, noted economist and academician Robert Shiller declared that we are definitely headed for another recession (of course we are, but it won’t be this year and probably not next year!)  Am I concerned that the economy may be slowing? Of course I am.  But to date the weight of evidence is that we are slowing, not stopping or switching to negative growth.  We endured a similar “soft patch” last spring and summer and the markets have made new highs since then. I continue to believe (guess?) that the disruption in the global supply chain caused by the Japan earthquake tragedy has thrown a wrench into the worldwide economic recovery story and that the second half of 2011 will see growth re-accelerate. Those who state otherwise are also guessing.
 
I stated in my last “What’s Going on with the Markets” newsletter that I believe that we are probably headed to test the 1,257 (the Japan earthquake low) or 1,250 level on the S&P 500 stock market index. Today we hit 1,258 before settling up at around 1,268. Was today the bottom? I really don’t know (neither does anyone else).  But all the signs and indicators that I pay attention to would indicate that today’s successful test of the Japan low might be sufficient to give the market a bit of a lift, at least temporarily.
 
So what do we do in the case of a market correction like this? If the decline is more than modest or is expected to be more than modest, we hedge client portfolios with leveraged inverse funds or options. This helps us keep our investment positions in place while hedging the risk a bit.  While this doesn’t totally protect the downside, it does allow us to mitigate (and perhaps profit) from the downside in the markets.  When we hedge portfolios in this manner, we take a portion or all available cash and buy the inverse funds on a temporary or “rental” basis. We may be in these inverse funds for a few hours, days, weeks or months depending on the market action. 
 
By definition, a hedge may be a drag on overall returns while it is on, but it can also be profitable if you manage it properly and the markets are not too volatile.  When market indexes give signals that the downturn may be over and a new uptrend may be afoot, we take off the hedges to fully benefit from the uptrend.  While no one person (including me) can perfectly time the market top or bottom, you can learn the rhythms, signals and technical indicators of the market and protect portfolios.  While some may be concerned with trading costs of hedging a portfolio, keep in mind that commissions are relatively cheap (and quite cheap compared to the protection the hedges provide).
 
I expect that we will bounce back a bit tomorrow and perhaps rally over the next week or so because the market is quite a bit “oversold”.  As a result, I removed our portfolio hedges today (at a small profit) to take advantage of such a rally.  Summer markets tend to be low volume and volatile, so I’m not sure that any rally will be sustained throughout the summer, but I don’t see us selling off in a big way.  When a new confirmed market uptrend asserts itself, I will be the first to deploy new cash into the market.  I will however reiterate, as I have in the past, that no one should trade or invest based on my prognostications. While I continue to be positive on the market, you should consult with your own advisor (or us) before making any investment decisions based on my comments. 
 
We are happy to speak with anyone who might be interested in discussing financial planning or money management.  As usual, there is no obligation, pressure or cost for speaking with us. If you have any questions about this market update or any other financial matters, please don’t hesitate to contact us.

Today marked the fourth day in a row of intense selling in the stock markets immediately after the markets gave a technical “buy” signal last Tuesday.  Last Wednesday, the markets staged a hard reversal to the downside and have not yet recovered.

Economic indicators of late have been coming in worse than expected with recent slowdowns in manufacturing and hiring and higher unemployment claims. Last Friday the labor department reported the creation of 54,000 new jobs during the month of May while analysts were projecting 150,000-175,000 new jobs created.  Needless to say, the markets were disappointed and continued the sell-off that started last Wednesday.

While there are many possible reasons discussed for the market’s indigestion (e.g., the end of the Federal Reserve’s bond buying program in June, the earthquake in Japan, continued sovereign debt woes in Europe, lack of agreement in Congress on extending the debt ceiling, lower consumer confidence, high joblessness), no one really knows the exact reason why the markets sell off on any particular day.  As I indicated in a previous message, institutions take profits periodically on positions to help reset prices and make the market more enticing for those standing on the sidelines waiting to buy at lower prices.  While the institutions (who make up the bulk of buying and selling in the markets) may view slower growth as reasons to sell, they have not been selling with wild abandon by any means.  So one could say that the correction has been somewhat orderly (but any declines in prices are never pleasant).  In other words, institutions don’t appear to be positioning for a bear market or a recession in the near future.

My intermediate and longer term indicators are still bullish even as this 5% correction (so far) may get to 10%.  As a reference point, the markets corrected 13-15% last summer and that set us up for much higher stock prices.  While the gains we’ve seen so far will likely not be repeated, I still expect a respectable finish for the year with a positive return in the stock markets (though my crystal ball is in the shop, so please don’t make any investing decisions based on this prognostication.) The summer months tend to be volatile and of low volume, so market swings are frequent and sometimes abrupt.  I believe that corporate earnings (which ultimately drive stock prices) will continue to surprise to the upside (if they’re not hiring, then costs stay low).  The effects of the tragic Japanese earthquake, which caused a hiccup in the markets this quarter, will begin to wane and offer opportunities for companies to help with the rebuilding, and thereby also help with future corporate earnings.  Finally, the costs of oil and other commodities overall have come down and will ultimately reduce inflation pressure.

How should you handle this correction? For most, doing nothing may be the right answer and simply “ride out” this correction.  For my clients, I have once again begun hedging portfolios in case the correction proves to be more protracted than expected.  I have already become more defensive by reducing more risky types of positions and adding more defensive ones.  But in an overall stock market correction, ultimately 3 out of 4 stocks will follow the market down, so there’s no good place to really hide. As this correction plays out and support wanes for certain sectors, I will slowly scale out of those positions and wait to buy them back at lower prices as appropriate.  If necessary, I will add more to our hedges to reduce our overall equity exposure and risk.  New positions are on hold until a new uptrend is confirmed.  This is by no means a recommendation of what you should do with your portfolio if you’re a “do-it-yourselfer”, so please consult with a professional (like me!) if you’d like to protect your portfolio or figure out what you should do.  Every investor and his or her goals are different, and that’s how we handle each client–individually.  In any case, the correction may take us down to the 1250 level in the S&P 500 index (the March 2011 Japan earthquake low) or down to 1200 (less likely in my opinion).

With four down days in a row, we might see a bit of a relief rally tomorrow (Tuesday), but I’m not expecting any type of big reversal.  With the amount of selling that has been going on lately, I just don’t expect the markets to turn around that quickly and “rip” to the upside without a catalyst. Ultimately, corrections are healthy for the markets and they will recover in time. It’s just never fun to watch the markets (and our portfolios) go down, but if you’re a long term investor, this is merely a bump in the road.  If I see that circumstances have changed and my technical indicators flash warning signs, you can bet that you’ll hear from me again and I’ll be taking appropriate action.

I welcome your questions and feedback. If you’re not yet a client, keep in mind that your first consultation is complimentary and comes with no pressure and no obligation whatsoever.  As a fee-only advisor, I put your interests first and work as your fiduciary. Not all advisors can make this statement.