As I said in a previous report,
I try to keep my discretionary trading/investment decisions separated from my mechanical systems. I do this to achieve true diversity of strategy. As most of you know I've spent almost 20 years researching/testing and using mechanical investment systems. I follow those systems mechanically for the majority of my capital available to invest in liquid markets. Following those mechanical strategies is a simple matter of running my software which only takes seconds, analyzing my existing positions and possibly making a couple phone calls to get in line with what my strategies recommend. I do not overrule the mechanical buy/sell signals based on gut-feel or the technical analysis that I discuss in this space. I am also very slow to give up on a system. Quitting a system (or advisor) when it is doing poorly is almost a guaranteed loser. Due to human nature, the moment that you decide to quit is usually the point where the market or system is likely to turn. As long as a system is performing within realistic expected guidelines based on its history, I will allow it to recover. Usually when I do "retire" a system it will be because I'm as certain as I can be that the system is not suited for what I see as the likely market future in the intermediate-long term.
The year 2000 is a perfect example.
It became very obvious to me that the unsustainable gains from 1995-2000 had lost momentum and the market was far overdue to a regression back to a sustainable appreciation rate. I had just completed some consulting work for a large money manager who strongly had the same opinion. That work was to create for them a very conservative model as well as a hedging strategy. Since many of my clients are far smarter and more connected than me, and based on my own personal opinion, I abandoned all aggressive strategies and went extremely conservative. It was a very good move. And quite frankly I have not returned to an aggressive mode since then. My entire line of research with ULTRA 10 was designed to be very conservative and that again paid off big for me in the recent bear market.
All of that is too say,
I should paid closer attention this week to a strong seasonal bias. I was itching to go long and while hindsight is 20/20, I think this would have pushed me into that position for my discretionary accounts.
Easter Seasonal Bias (better late than never)
As tested by
ULTRA's HDAY system, the last trading day before Easter has a huge upward bias.
Since 1942 being invested in the
SPX on the day before
Easter has resulted in 62% winners with only one
loss of 1% or more in 68 years (1997). On the day before
Easter, the
SPX historically appreciates at a 97% annual rate (over ten times the normal appreciation rate of the
SPX). That is a bias that should have never been ignored in this space especially since I was looking for a reason to go long. (It's only money...)
What threw me was that many of my strategies contain the bias that goes long for the three days prior to Easter (the default
HDAY parameters in ULTRA), which since 1942 has resulted in 69% winners and an appreciation rate of 60%, which is tremendous for a 3-day stretch. So I did largely participate in yesterday's gains but that doesn't mean anything in the context of this report and therefore I apologize. Strong seasonal biases belong in this report and will be in the future. It's easy to make mistakes in this business...
The day after Easter has a big bearish bias. Only 41% winners with a historic appreciation rate of -31%, which is about as negative a bearish bias can get. But it's only a one day bias as the next day historically appreciates at a 70% annual rate.
Since we closed yesterday at R1 (chart below),
it makes sense that we'll at least get a one-day pull back as those who are disappointed that the break didn't occur on the close take profits, hedge, and take speculative shorts. But that is in the absence of surprise news this holiday weekend. Again, if I were working for President Obama, I'd encourage him to put something out this weekend that would be a huge positive surprise to the markets so to be rid of R1 once and for all.
President Obama has stated he doesn't follow the markets,
which he proved to me in a 3/24/09 press conference where he stated that the US dollar was "extraordinarily strong", which I found to be a rather odd statement. On that day the U.S. Dollar Index (
USDX) closed at 85.82 definitely above its 03/17/08 low of 70.93 but still far below the 07/09/01 high of 120.11. In any case, I generally agree with the President that policy should not be designed to please markets. But in our current situation, it appears to me that making sure there is not another market leg down is of paramount importance.
One of the problems I have with yesterday's Wells Fargo profit report,
is that bank profits were never the main problem. The problem for banks was not on their income statements but rather on their balance sheets due to declining (and/or not
appraiseable) asset values that act as collateral for their assets (such as loans they've made). When a relatively stable bank like Wells Fargo has
basically an unlimited amount of free money to loan, how could they not make big profits?
The long-term stability of our banking system,
depends on asset values (like real estate) stabilizing in value. One of the important factors needed to stabilize real estate is a recovery of our population's perceived wealth (IE. 401k values), and an improvement in their outlook for the future. Daily news of a
consistently rising stock market can do wonders for the attitudes of our people even if they are not significant investors.
With all the blame being thrown around,
by and to politicians and businessmen, the fact remains that if the real estate market had not crashed, this financial crisis would not have occurred. Of course, real estate markets were rising at an unsustainable rate. But in a perfect world they would have slowly regressed back to a sustainable appreciation rate by moving sideways or slightly down until the markets normalized. This would have allowed banks to handle the number of
foreclosures within their normal processes. It would have also resolved the problem we have now with the inability to produce reliable appraisals due to the lack of comparable properties. Historical comparable sales mean nothing in a collapsing market.
Except in scarce markets,
or in cases where value is added to a property, most real estate properties historically rise at the rate of consumer inflation (IE. no "real" increase in value). That is the healthy rate of appreciation and still allows for property owners to make plenty of profit. For most properties, profit (equity) is produced for the owner due to the leverage provided by the mortgage.
A simplified example:
A $100k property that rises 5% in a year (to $105k) while consumer prices have risen 5%, hasn't gained any real value. But if the owner has only put $20k down and borrowed the rest, he gets 5-to-1 leverage which produces his profit. In this case, the property rises to $105k. His investment is now $21k (considering the 5% inflation). So his profit is (105k-100k) / 21k = +24%.
Unfortunately, the same leverage also works in reverse.
Assume the same property but with 0% inflation and a 10% drop in value. The owner's loss is (90k-100k)/20k = -50%. For many owners, this loss can essentially wipe them out and motivate them to give up and walk away from the property which puts it on the market eventually by the lender in a
fire sale, which depresses values in that market further.
I wrote all of that to state one simple thing.
In order for there to be a recovery both in markets and the economy, the collapse in real estate values must end now. Every thing else is extremely minor in comparison. If our country's real estate market takes another 20% hit from here, all the banking balance sheet problems will return and be far worse than the last round. Real estate appreciation rates must return to be similar to that of a reasonable rate of consumer inflation. In my opinion that is where most of our federal policy should have been targeted. Hopefully, natural tendencies will prevail and it will occur regardless of policy. But in my opinion, right now, Easter weekend 2009 is a great
opportunity to help that occur by issuing some timely policy announcement that is friendly to banks, real estate, and therefore the stock market so that R1 is obviously taken out for good.
Enough rambling for today. Have a great weekend!
The SPX gapped above NL? and traded above it for much of the day but has now fallen back below. The SPX has also formed a small Head-and-Shoulder Top (HST) today that was confirmed by dropping below the neckline ST-NL. This HST implies a drop to 855 which would also fill the G1 gap. But by doing that the ST-S2/ST-R2 channel would fail implying a further drop to 835 which is on ST-S1.
Now that R1 has obviously pushed the 
