Pairs Trade

Defined in Investopedia, a pairs trade is matching a long position with a short position of two different stocks in the same sector.

In this environment where we see whole sectors going down, there are always good stocks taken down with the bad.    This happened with technology in the early part of this decade and it’s happening now with financials.

With the invention of ETFs, I think pairs trading could work well here.  Here’s the way it works, I’m cautious on the banks and financials in general but I think certain stocks are getting beaten up unjustly.  For example, we’re seeing Goldman Sachs going down with Lehman Brothers.  I can buy Goldman Sachs and short Lehman Brothers and try to make the spread essentially.  Another way to look at it is you can afford to buy the good ones but hedge yourself with shorting the bad ones.

I also like shorting the bad sector using an ETF but going long the individual stocks in that group.  Are you worried about steel?  You can short SLX (steel ETF) and go long U.S. Steel (X).  X is near a high while the steel sector is flattened out recently.

It’s not a complicated strategy but it can be used in the short-term or long-term.  You can use it in the short-run if you bought a good stock but worry about it going down further because the sector is taking you down.  You cover the short position when you think the sector is doing going down.

But, in the long-term owning Goldman Sachs while shorting Bear Stearns wouldn’t have been a bad move either.

Use this sell off to identify the best companies in the world on sale.

90% Down Day

People have been asking me for some time are we there yet?  Has the market bottomed?  We’re getting closer.  Any monkey could tell you that.  Today, the volume on the NYSE is about 90% downside volume and 10% upside volume and it’s been deteriorating all day.  This shows some panic.  But, we need to watch the next few days very carefully.  If we get 3 or 4 of these over a short time period and then we immediately get some 90% up days, that may be the bottom we’ve been waiting for.  We may be under 11000 on the Dow at that point. 

Our job will be to uncover our shorts and buy longs in a short amount of time to take full advantage of the panic.  Also, watch the close.  Let’s see if the volume picks up as we go into the close and let’s see if the market finishes on its lows of the day. 

Getting nasty out there.

Could A Meaningful Bottom Be Coming Soon?

For those of your that have been reading my blog for a while, you’re perfectly positioned and can sleep at night because you are actually going up on a day like today.  I really hope you have taken the advice from this blog seriously.  I watch over millions and millions of dollars so one of my eyes is always on my screens watching for what’s moving and where the risks are. 

The last few days have been interesting because we’re not rallying where we should be.  I had mentioned yesterday we were mildly oversold and I expected a mediocre rally.  This is actually a better scenario.  If we can’t even rally where we are supposed to, then we might be headed for a spike in fear and outright distribution of stocks.  We’re getting very close to the lows of 1256 which was the intraday low in early March.  Here’s what we want.  We want to break through those lows and see all the technicians say “uh oh, now what?”  That will cause a big spike in volume and fear.  That will be the place to uncover the shorts for a nice multi month trade. 

For now, it’s getting too late to short if you haven’t already.  Gold still looks good and I’d still buy GLD.  Also, note that DUG is up today on a day where oil is up almost $4.

So, enjoy these days and look at them as opportunities (if you’re positioned properly).  Also, remember being short enables you to hold your good stocks that are getting beaten up.  It’s about the portfolio, not the individual positions.

Is Something Different Developing?

The last two days, we’ve seen kind of a rotation out of the strong “stuff” and into the weak and beaten down “stuff”.  Are materials, agribusiness, & energy all turning and heading lower for weeks and potentially months?  While at the same time, have financials and homebuilders bottomed?  I think we’re at the end of the quarter and there is some locking in gains on some of the winners.  At the same time, there are some great bargains out there in areas such as money center banks.  So, maybe traders are nibbling on that with their profits.

But, I’m very suspicious of this up day.  In the past few weeks, we’ve seen days like today where the good is going down and the bad up.  What we really need to see is a broad based rally with good breadth.  So, I believe we’re seeing an oversold rally.  The percentage of stocks above their 40-day moving average is about 18%.  25% is typically oversold.  Fear is near a level it was in early June.  Some fear but not enough for a sustained rally.  I think this is an oversold rally that could take us up 2-3% on the indexes but will more than likely need to be sold into.  We need to make a new low in the markets to draw some real fear.  If we get that over the next couple of weeks, then we could really be putting in a meaningful bottom.  Remember, technicians said we had a successful double bottom in the spring.  What about a triple bottom?  Bear markets end where nobody expects them to.  So, new lows could be that place.  There is still no demand and plenty of supply.  Because we’re oversold, the market could go up higher on the Fed decision because they will spin it into a positive event.

Bottom line, continue to use sell disciplines and don’t be afraid to continue to trade.  I’m not covering shorts at these levels even though I know we’re oversold because there are too many indicators that aren’t extreme enough.  I think this will be an oversold rally similar to what we saw a couple of weeks ago.  It was the rally that really didn’t happen.  So, I’m still cautious but wouldn’t be surprised to see some up days.

Consumers Not Too Confident

I think a lot of the various economic reports that come out don’t really matter over the short run.  The market typically is going to go in the direction it wants and uses the economic news as an excuse for that direction.  But, there are a few that I watch because they are so correlated to the equity markets.  One that I watch is consumer confidence.  Consumer confidence came out this morning at 50.4, which was much less than expected and is now at a 16 year low. 

To refresh your memory, I’ve posted this before.  But, look at consumer confidence going back a few years at how well consumer confidence is correlated to stock prices.   The S&P 500 is in orange and consumer confidence is in white. 

As you can see, this is a monthly figure and it has gone down and then bounced back.  But, now it’s been in a steady decline for about a year.  The other scary thing is that it’s not showing any signs of reversing.  You can’t rely on any one thing.  But, this is just a piece of the puzzle to see where markets are going.  Combine this with weak demand for stocks and increasing supply, fear not at it’s highest level, unemployment continuing to rise (which is highly correlated to stock prices), and you have a market that’s still struggling.

 

Big News Out Of China

Crude oil is down almost $5 per barrel today after China announced it would increase the prices for gasoline & diesel by 17% and 18% respectively.  By reducing subsidies, it would put more pressure on individuals in China and hopefully curb some of the demand, thus bringing down the price of oil.  In addition, they are raising prices of jet fuel as well.  The rise will be effective July 1st. 

This took the market by surprise with the Olympics right around the corner.  Also, this came just days before the world’s biggest oil produces and consumers meet in Saudi Arabia to develop plans to combat fast rising oil prices.  Energy companies are falling today and DUG is up about 3.5%.  I’m still long this.  In addition, gold is up over $9 on the active month.

Equities seem to like this news.  If the global economy can keep growing without commodity prices going up 10% every week, we may be in good shape going forward.  But I disagree with the market that the Fed is going to raise rates anytime soon.  We have an election this year and rarely do they raise rates in an election year.  I think the Fed has scared the market enough.  Ten year treasuries are now at 4.2%, which is high on a relative basis. 

On another note, Citigroup came out today an announced they will have “more substantial writedowns” in future quarters.  But, the stock is only down 2%.  We’ll see if the bad news from these stocks starts to get ignored by Wall Street.  Citigroup also announced they are purchasing a Brazilian brokerage firm.  Even during all this mess, these big strong companies still improve themselves in other ways.  That’s why I’d still buy Citigroup and put it on the shelf for a couple of years along with Goldman Sachs.

The Rally That Isn’t Happening

Last week, we were mildly oversold and ready for the markets to temporarily rally.  They did rally for about 5 minutes.  The downtrend is continuing and it just illustrates how weak the market really is.  The brief rally we had for a few days had the same characteristics that the rally had in March and April.  A rally based on sellers pausing, low volume, and weak demand. 

I believe one of the reasons we’re seeing this type of action with no real rally beginning is for two main reasons.  The first is the devastation in Iowa.  Crops could be down 50% this year vs. last because of the rains.  That’s causing commodity prices to continue up.  It doesn’t matter what the dollar does in this environment, more demand and less supply means higher prices.  That’s tough for an economy that was trying to recover.  We also have several places around the world either raising interest rates to control inflation in their own country or threatening to.  One way to get commodity prices to come down is to have everyone simultaneously raising interest rates and kill the global economy.  That’s not the way we want prices to come down.  But, I believe that’s what equity investors are fearing.

So, don’t take off your short positions yet.  Continue to trade and look for strength.  I’m still seeing strength in gold.  Gold is outperforming as I stated it would a few days ago.  In addition, oil which opened the day down is actually up now and has had a big reversal.  Interestingly enough, the oil & gas stocks are actually down still.  So, I’m still holding DUG and slightly down on it.  If the equity markets really fall apart, I think DUG will start moving up fast. 

The best thing that can happen to the equity markets right now is for a fear based sell off like we had in January and again in March.  If that happens and fear spikes, we’ll get a great place to cover shorts, get long and at least enjoy a 1-2 month trade.

Gold Looking Even Better

There’s been a ton of talk regarding the dollar and what our government will do about trying to strengthen it.  I think instead of analyzing that and all the variables that can make the dollar go up and down, I’d rather study gold using the technicals.  I’ve had much better success trading gold over the years using technicals than the fundamentals.  I’m seeing a lot of my buy signals coming in the area of gold & silver.  This time, it’s not just the commodity, but the gold stocks.  That’s encouraging if you’re long gold, which I am.  I think gold has a great shot at reaching the $925 level for this little go around. 

I’ve mentioned several times when stocks go up a lot, they tend to give back half of that gain before resuming up again.  Gold was around $650 last summer before it made its monstrous move to $1012.  It fell to around $840 back in late April, early May.  We’re now seeing the beginning of a new run I believe.

Don’t Short Yet

Hopefully you’re not too late to the party.  But, if you’re a new reader of mine and you haven’t been short and you still own a ton of stocks, don’t do it just yet.  The stock market is oversold and I said on the air yesterday that it wouldn’t surprise me to see a few days or even a couple of weeks of higher prices for equities.  It’s just the ebb and flow of the markets.  Too many people leaning one way. 

I think it’s funny how we had 2 key pieces of data come out today that normally would have taken prices lower.  But, because the market is oversold, the higher than expected CPI is being ignored.  In addition, at 9:00, the University of Michigan Confidence number came out at 56.7, an extremely low reading (a 28 year low).  This is usually correlated with the equity market.  But, when that number came out, the Dow was up 40.  It’s now up 130.  Everyone spins the data the way they want.  It depends on if the market is oversold or overbought.

So, if you own stocks, enjoy the run for a few days.  I actually covered some shorts yesterday for a quick trade.  But, will look to re-enter that as we go up here over the next few days.  Now, I want to be clear that we aren’t so oversold that I’m looking for a 2 month rally.  I’m looking for a 2 week rally.  We never got to the type of fear we saw back in March.  So, this is a bounce (dead cat bounce).  A reversion to the mean if you will.

Do not ignore this market.  This is where we are supposed to rally temporarily but that doesn’t mean you can walk away because it could turn down in an instant.  Don’t lean too much one direction or another.  Don’t be too long or too short right here.

Quick Market Update

At 1:30 CST, the market is recovering some of its losses but the markets are all still down about 1%.  Oil, once again is the big story up almost $6.  But, even bigger than that are the agricultural commodities.  Wheat up over 7%, corn and soybeans up almost 4.5%.  With central banks around the world threatening and some actually raising interest rates to stop this commodity boom, their endangering global growth and throwing us into a serious recession.  The market senses that I believe and the fear is starting to pick up as I stated yesterday.

Looking at the internals, about 75% of the volume on the NYSE is down and of the 90 financial companies in the S&P 500, 92% of them are down.  Glad to be short financials right now.  That trade is paying off big time.  On the flip side, of 37 energy companies in the S&P 500, 81% are up.  My oil short is down slightly today but the financial short, and small and large cap shorts are doing very well.

I’ll be hosting The MoneyMan Report tonight from 4-6 p.m. CST on 1110 AM in Houston and Dallas/Ft. Worth or on www.bizradio.com