Trader’s Narrative

To catch up on what you missed and to prepare for next week, here are just a few picks from the past week’s reading list at news.tradersnarrative.com.

• “Dumb Money” by Daniel Gross (look forward to Ritholtz upcoming book)
• US Tax Burden Near Historic Low (what? didn’t hear you, too busy teabaggin’)
• Get a 120 page report FREE from Global Market Perspective (limited time offer)
• David Tice: S&P 500 set to plunge 62% - that’s a real bear!
• Cramer attacks Jon Stewart for ambushing him
• Get a Free Subscription to Futures Magazine
• Yale economists discuss the financial crisis & Geithner’s response (must see video)
• Why we should have not only saved Lehman Bros. but invaded it.
• Warren Buffett’s investment in a Chinese electric car company
• Where in the World is Paul Volcker? and why is he so quiet?

Follow the link below to get much, much more:

And remember to check regularly since there are new links added everyday.

Week Ahead: US Results, Data Dominate

Bears are cute and cuddly, until they tear off your head and feast on your carcass. The bear rampaging through Wall Street has taken the poor S&P 500 index down 52% at its deepest level. In case anyone is still keeping track of these sort of things, that’s off the charts.

It is a deeper loss than the bear market we last saw in 2002 in the aftermath of the technology bubble, and it is deeper than the “oil shock” induced bear market of the 1970’s, mercifully ending in less than 2 years from the top in October 1974.

The only bear market that lasted longer and created more devastation was the 1929 aftermath which sliced off 90% off the market’s valuation from its top by the time it was over.

It is the weekend and time to lick your wounds and get ready for duck the swats of this ferocious bear. Don’t forget to check out news.tradersnarrative.com for continous links to articles, breaking stores and analysis. Here are a few examples:

Buffett seems to have been taken off guard like many investors. Way back in 2007, well before the market topped, Berkshire Hathaway (BRK.A) wrote European style put options on the S&P 500 index and 3 other international indices for the next 15+ years. Does that mean that now, more than ever, the market is “cheap”? or did he make a massive blunder?

Fairfax’s Prem Watsa, who many liken to Buffett, recently removed protective hedges and for all intents and purposes went long the stock market after many years of forecasting doom and gloom.

Obama is reported to have tapped Hillary Clinton to be Secretary of State. Hmm…. that strikes a bell. Who was it that mentioned Hillary as the next Secretary of State two months ago?

If the embedded videos don’t work here are the links to them: Hillary Clinton and Recession Watch.

Before we say goodbye to not just a bad October but the worst month since the 1987, here is a quick roundup of the sentiment landscape:

Sentiment Surveys
According to ChartCraft, the Investor’s Intelligence sentiment survey shows newsletter editors little changed in their outlook this past week: 23.1% bullish and 52.7% bearish. That is still an extremely high level of pessimism for a normally cheerful bunch. Remember, doom and gloom doesn’t bring in the subscription coin.

The retail investors on the other hand continue to be nonchalant. The AAII weekly sentiment survey showed a small uptick in bearishness to 40.6% and a small downtick in bullishness to 37% but still the over all mood is way too cheerful for me. As a contrarian I’d be much more comfortable to see the average person continuing to be pessimistic about the market before getting too excited about a lasting rally.

Options Market
Like many, I continue to wrestle with the options market, trying to make some sense out of the data it generates. For more, check out not only my own thoughts about this crazy options market but some of the most respected technical analysts out there today.

The ISEE sentiment continues to be ambivalent about this whole chapter in the stock market. I have no idea why but it has totally broken down and although I continue to watch it, it is tough to ascribe a rationale for its moves or to glean a message from it.

The CBOE put call ratio (equity only) went up on Thursday and Friday implying that options traders on average were not totally buying the most recent rally.

Short Covering or Real Buying?
The reluctance to see Tuesday’s rally as “real” is shared by many. After all, the majority of the biggest one day gains in the stock market have occurred during brutal bear markets. A reader contacted me wondering if it was “just short covering” or “real”? I’m not sure if it makes much of a difference. The short interest ratio for the Nasdaq is very high, which is traditionally a bearish omen. Any other ideas on how to distinguish between a “real” rally and a short covering one?

Lowry’s 90/90 Day
The market continues to make people stare at their screen like goldfish, widemouthed and blinking in amazement. Tuesday’s rocket ride sure felt like a 90-90 up day, which according to Lowry’s research is a prerequisite for a new bull market. We’ve seen repeated 90-90 down days but finally got a decisive buying stampede. Up volume demolished down volume by a ratio of 19:1 - the most exaggerated ratio since last year.

If you still haven’t, read Paul Desmond’s seminal work in my free trading resource section (Reports & Articles)

Consumer Confidence
This should be an interesting holiday season for the retailers. The American consumer is not only incredibly dissatisfied with everything in general, they are extremely pessimistic about the future. Like so many other indicators we’ve been watching during this bear market, the Conference Board Consumer Confidence (Expectations) plunged to its lowest level ever.

That is lower than the aftermath of the 1987 crash, the bear market in the 1970’s and the public’s reaction to the tragedy of 9/11. Which says a lot. Consumers are basically shell shocked. The spending orgy, fueled by easy credit, is gone. Now comes the hangover.

From a short term perspective this may appear to be bad news but historically troughs in consumer sentiment have been a great contrarian indicator. After I mentioned it as a condition of a new bull market, it rebounded briefly but the message is unmistakable.

Greybeards
In the past few weeks we’ve seen Warren Buffett, Doug Kass and Steve Leuthold all saying pretty much the same thing: they are buyers. Which leaves one wondering. If you are going to fade these guys, you better be incredibly lucky and incredibly smart. It is possible they are wrong - but highly, improbable.

Here are some thoughts with my own conclusions at the end:

Ned Davis Research
A very respected institutional research house, Ned Davis’ company relies on 12 indicators covering sentiment, volume, volatility, and breadth. Right now ten are flashing a cyclical buy signal. But a unanimous result isn’t needed for it to be valid. For example, in the bear market bottom of 2002, only nine of Ned Davis Research’s indicators was indicating a buy. But they are not recommending to their institutional clients to start buying. They want to be patient and wait for a retest of the lows. If market internals are healthy on such a retest, then they would suggest going long.

Stock Market Cycle
There are patterns in the market’s history. But so far this year, the market has forged its own path. An election year should be a positive for market returns, especially in the later months of the year. But not this year.

The four year stock market cycle means that 2010 is the year to watch. But according to the decennial cycle, the 8th year in a decade has been good historically. Unless we have a miracle, this year will also be an exception. Here is the master of market cycles, Peter Eliades offering his views:

Credit Squeeze Relaxing
Both the TED spread and the LIBOR rate have receded. As well the price of “insurance” on default for banks has also dropped. There are mounting signs that we are seeing a thaw in the credit freeze that paralyzed the market. My only quibble is the short term rate (90 T-Bill rate) which continues to be pushed down. The bond market is telling the Fed to lower rates. Hopefully they will listen (unlike all the previous times) and get ahead of the situation rather than playing catch up.

Volatilitius Maximus
Volatility has been absolutely insane. There is no gentler way to put it. We’re seeing double digit (or close) moves in the market daily. It is both unnerving and exciting. And here I’m not just referring to the sky high VIX index but also to the breadth numbers which show extremes. The good news may be that such volatility has been historically associated with market bottoms. As I wrote two years ago, extremes in market breadth with the advance decline numbers swinging from one extreme to the other to gather “fuel” for a sustainable trend to be established:

Smart Money vs. Dumb Money
At every inflection point in the market, we witness the smart money and the dumb money do different things. This is how wealth is transferred from one group to the other after all. So far we’ve seen Warren Buffett extract very favorable terms with General Electric (GE) and Goldman Sachs (GS). Terms that the US government hasn’t gotten. That’s another issue though. Although you or I may not be able to negotiate the same terms, it is still valuable to watch what the smart money is doing.

Which reminds me of Tony Oz’s video where he called a bottom. Faced with a melt-up, he did what any smart trader would do, sell into the wave of buying.

Corporate insiders are also considered “smart money” and they have accelerated the rate of their purchases, pushing the buy-sell ratio to 2:1. This is very unusual because usually it is the other way around as insiders sell shares which are given to them as part of their compensation package. But caution is warranted because insiders are notorious for being early to the party - as much as one whole year.

The other end of this see saw is to watch the “dumb money”. I’ve gone into detail over the past sentiment overview regarding the public’s and retail investor’s pessimism during this crisis so I won’t rehash it here. Now that we are getting the first glimpses of the bulls returning, the most important aspect of contrarian sentiment comes into play; watching how the “dumb money” reacts to a recovery in the markets. If they continue to be fearful and pessimistic, even when the market recovers, then the chance that it is a real floor is much higher. But if they quickly switch sides, then we will see more downside.

Conclusion
My own hunch based on all of the above and more, is that this is a cyclical bottom. It is tradeable, and the volatility provides amazing short term opportunities for trigger happy traders but we are far from a secular bottom. You’ll know we’ve hit that when stocks and the whole equity culture of the US and the world changes. When people start outright hating stocks or even the thought of investing.

When everyone laughs at you or feels sorry for you for even hinting that it may be time get back in the stock market. When the valuation pendulum swings way to the other side and measures, whether based on price earnings or price dividend are so outlandishly extreme that you do a double take. That’s when you’ll know we’ve hit a secular bottom. One for generations.

Jim Rogers and Warren Buffett are on different sides of the recent government bailout. Rogers calls the US more communist than China, adding that the Fed bailout is “socialism for the rich“:

If the video doesn’t show up, you can see it here.

Buffett sees things differently: “I wouldn’t change anything in the plan myself,” adding in his own interview with CNBC. “It’s the best deal and the most sensible deal available now.”

More relevant links at news.tradersnarrative.com