On March 26, 2008, I posted the following:
“Looking for a few stocks to go short as the bear market continues to run its course? check out these below, as of the morning of Wednesday, March 26th. The usual disclaimers apply, I take absolutely no responsibility and you have to make your own entry/exit calls. If you know how to make good trading decisions, this should be no problem.

Symbol Company Tuesday’s closing price

ARGN Amerigon, Inc 16.15

CSGP Costar Group 43.55

GMCR Green Mtn Cof 31.79

LAMR Lamar Advertising 36.75

WFMI Whole Foods 33.21

TWI Titan Intl 31.97

TOL Toll Brothers 23.95

WGO Winnebago 18.14

And if you want more exposure on the short side, check out the ultrashort S&P 500 reverse ETF, (symbol: SDS). To profit from a decline in the spx you would go LONG this security.”

All of these positions (with the exception of GMCR) are showing a nice gain.  Three of these positions should be closed – ARGN, TWI, and WGO.  ARGN’s closing price yesterday was 2.5, TWI closed at 5.86, and WGO closed at 4.93.  That means the returns on these positions were 84.5%, 81.6%, and 72.8% (using yesterdays close as the exit price).  Not bad….  Also, I suggested to go long SDS on that day when it was at 62.86, it ended the day yesterday somewhere over 120 — over a 90% gain…. -John Bardacino

As many investors (Warren Buffet included) have been attempting to pick a bottom in this bear market over the last few months they are learning that this is a poor risk/reward proposition.

Mainstream and traditional investors have a great fear of missing a bottom in the stock market.  This (among other things) creates bear market rallies that smart traders and investors use to get short on the dominant bear trend. In my view, an investor or trader should exploit the actions of traditional investors, who usually wind up as victims of our inherently flawed economic/political system.

Its good to have a healthy dose of contrarianism in the mental framework that guides your decisionmaking, but it must be done in the right context….  Thus, I offer some advice:

Maximize caution at market turning points – Just because stocks are cheap and have fallen a great deal does not mean they can’t fall farther and get cheaper.  Price action must always be your guide.  Weak market should be sold, stong markets should be bought.

Align tactics to strategy and expections – If you buy something because you feel it is cheap, it may take a long time for the value to be realized.  Warren Buffet can hold onto something for 10 or 20 years, and oftentimes never sells… are you prepared to do the same? If you buy something just because it has fallen 80% in price and you feel it is a good “value” do not be surprised if it falls another 50% from where it currently is – if you expected the price to rise short term you may wind up very disappointed.  THis is usually what happens with companies that are not true “value” plays.

Minimize contrarianism at at support, resistance, and market extremes -Are you contemplating taking a contrarian position just because market prices are at some support or resistance level or some extreme price level.  This is contrarianism just for the sake of contrarianism.  Is there any real justification for being contrarian – are there any fundamental reasons outside of prices being low that would make you want to own stocks – the economy continues to fall apart and so are earnings so why be contrarian?

Minimize the need to be first on a new trend – this is just a poor risk/reward proposition.  Let the others be guinea pigs, you can always enter a trend early after it is clear that is has been established.  This is a much lower risk/higher reward proposition.

Never attempt to pick tops or bottoms – In a bear market, attempting to pick a bottom is known as “catching a falling knife.”  It usually ends in tears.  As a bear trend becomes more mature and prices work their way lower the risk reward does indeed change, and hedging should be adjusted to reflect that fact.  With the Dow at 11,000 I would be far more aggressive shorting that I would be with the Dow at 8,000.  But I would still be short and not long in this bear market.  I would be more careful and hedge differently as the bear market became more mature, but I would never go predominantly long until I was convinced the trend had changed.  In short, trying to pick a bottom is a poor risk/reward proposition, to do so is to fight against the dominant trend, and fighting a dominant trend most often leads to failure. -John Bardacino

Here they are – Obama’s biggest promises from his “blueprint for change” campaign speeches and advertisements…. I wonder how many he will keep?  Actually, we would be better off if he made no promises and did less.  That would mean less damage to the economy.  How I miss the days of political gridlock back in the 1990′s, it was great for financial markets….

A Checklist Of Obama’s Many Promises:

Taxes
Give a tax break to 95% of Americans.
Restore Clinton-era tax rates on top income earners. “If you make under $250,000, you will not see your taxes increase by a single dime. Not your income taxes, not your payroll taxes, not your capital gains taxes. Nothing.”
Dramatically simplify tax filings so that millions of Americans will be able to do their taxes in less than five minutes.
Give American businesses a $3,000 tax credit for every job they create in the U.S.
Eliminate capital gains taxes for small business and startup companies.
Eliminate income taxes for seniors making under $50,000.
Expand the child and dependent care tax credit.
Expand the earned income tax credit.
Create a universal mortgage credit.
Create a small business health tax credit.
Provide a $500 “make work pay” tax credit to small businesses.
Provide a $1,000 emergency energy rebate to families.

Energy
Spend $15 billion a year on renewable sources of energy.
Eliminate oil imports from the Middle East in 10 years.
Increase fuel economy standards by 4% a year.
Weatherize 1 million homes annually.
Ensure that 10% of our electricity comes from renew- able sources by 2012.

Environment
Create 5 million green jobs.
Implement a cap-and-trade program to reduce green- house gas emissions.
Get 1 million plug-in hybrids on the road by 2015.

Labor
Sign a fair pay restoration act, which would overturn the Supreme Court’s pay discrimination ruling.
Sign into law an employee free choice act — aka card check — to make it easier for unions to organize.
Make employers offer seven paid sick days per year.
Increase the minimum wage to $9.50 an hour by 2009.

National security
Remove troops from Iraq by the summer of 2010.
Cut spending on unproven missile defense systems.
No more homeless veterans.
Stop spending $10 billion a month in Iraq.
Finish the fight against Osama bin Laden and the al- Qaida terrorists.

Social Security
Work in a “bipartisan way to preserve Social Security for future generations.”
Impose a Social Security payroll tax on incomes above $250,000.
Match 50% of retirement savings up to $1,000 for families earning less than $75,000.

Education
Demand higher standards and more accountability from our teachers.

Spending
Go through the budget, line by line, ending programs we don’t need and making the ones we do need work better and cost less.
Slash earmarks.

Health care
Lower health care costs for the typical family by $2,500 a year.
Let the uninsured get the same kind of health insurance that members of Congress get.
Stop insurance companies from discriminating against those who are sick and need care the most.
Spend $10 billion over five years on health care information technology.

Source: Investors Business Daily, Page A11, Tuesday, November 11, 2008

Many people have been telling me “we’ve hit bottom.”  My usual reply is “well, were getting there but were not there yet….”  Rallies will continue to be sold, they are just short term rallies against the dominant bear trend.  The rest of October will continue to be down for equities, generally speaking, but there is a high probability that we get an election rally that could last into December as the so-called January effect takes hold for a month or so….

Then the reality will set in that Obama is not much different from the other politicians and the Obama rally will fail.  Even if the Dow rallies back to 10,000 it would not hurt the dominant downtrend one bit, it would just provide a new entry point for the next leg down.  In percentage terms this bear market is already up there with the best of them, but in terms of the length of time, it could easily run another 6 months to a year.  Like I said, it all depends on how much damage the next administration does – Bush will be tough to beat in that department as he and his neo-conservative pals have done a huge amount of long term damage to the country – government spending, wars, loss of liberties, etc.

Whether or not an Obama administration could help the financial markets remains to be seen. All he would really have to do is scale back the wars, limit the size of government, stop the bailouts and let the malinvestments work themselves out of the economy and we would probably be out of trouble and back to a bull market by mid 2010.

But I am not optimistic, he is basically a socialist (and not much different from McCain). There is an opportunity but in typical bureaucratic fashion they will squander it.  Government will continue to increase in size, become a bigger parasite on the private sector and continue to screw up the economy, and given that the democrats will likely control congress as well, they will have ample opportunity to increase government interventionism (of course the republicans would do the same!).

Currently,  we are suffering the negative effects of government regulation, government sponsored entities, and the Federal Reserves monopoly on interest rate setting.  Contrary to what the mainstream press is saying, Laizzez-Faire capitalism did not create this mess, a lack of it did, this mess was caused because we do not have free markets that can properly judge risk.

Bailouts waste money and prevent malinvestments from being worked out of the system.  The governments actions are putting us at risk of a Japanese style decade long recession.  At the moment there is no inflation as credit destruction is greater than credit creation, but that will only last so long as the Central Banks of the world are creating money out of thin air at an alarming rate and desperately trying to reinflate the global economy.  The likely longer term scenario then becomes an inflationary one.

To a degree, this could be mitigated by a strong dollar, and that is why politicians are hoping the current rally in the dollar will continue.  Having the world’s “reserve currency” allows you to get away with a lot of things that you normally would not be able to., and as I previously wrote, the EURO will eventually completely collapse, as it is a horribly flawed currency, and that will help the USD rally.  Over the long run, currency markets are a simply a game of which country is relatively the least miserable.

So, in sum, this bear market in equities has been quite severe in percentage terms, but temporally speaking it has not been severe relative to past bear markets.  The economy continues to weaken and the government continues to make matters worse with more intervention.  There is likely a bear market rally right around the corner say beginning after the election and lasting into January that could take the indexes up as high as 15-20% but that would not hurt the dominant downtrend.  Beyone the next rally (after January) the dominant trend will likely take us lower over the next 6 to 12 months to new lows on the major equity indexes. -John Bardacino

On June 1 when the EUR/USD was trading near its peak I wrote the following in a post titled “Has the EUR’s long term bull market ended?”:

The EUR has been in a bull market since 2002 but the economic and political fundamentals of Europe are not looking too good these days…and there are some dark clouds on the horizon for this currency when you consider the broader global socioeconomic framework….The EUR may very well rally further in the short and intermediate term, but fundamentals determine long term trends, and the long term trend for the EUR is reaching a turning point. I think it is a safe bet that a few years from now the EUR will be significantly lower, and looking farther out it is not a stretch to say that the EUR will be disbanded when countries like Italy leave it so that they can go back to depreciating their own currencies.

The dramatic speed with which the credit crisis has taken hold of the global markets has sped up the EUR’s future demise.  In light of this I offer some new predictions: The EUR will be at par with the USD by June 1, 2009.  Italy will be the first country to withdraw and the EUR will collapse and be disbanded no later than December 2011. -John Bardacino

Just as the incredibly horrible Paulson Plan bill passed the House of Representatives on Friday, equities markets tanked.  The reality of this Bill is setting in.  I started reading parts of the 400+ pages of this monstrosity and was forced to stop due to acute nausea.  It is nothing more than a gift to special interest, does not address the root causes of the credit crisis and does nothing more than make a bad situation worse – oh yeah, it also gives the IRS new powers to invade what was left of US citizens privacy and there is some kind of tax break for toy wooden arrows….

So while the dominant downtrend gains in strength and equities prices (along with other markets) continue their slide, what will be their next move?  Bernanke will lower rates, probably half a point.  Its more of a symbolic move because rates are close to 0 anyway and the fed has been massively adding to the money supply.  When they do announce this easing (they have a meeting at the end of October), it will create another short term rally against the dominant trend that will provide yet another opportunity to increase short positions.  The equities markets will then continue to sell off (except for brief rallies such as when the Fed announces an easing).

After the election (and assuming Obama wins) there will be a rally in equities, mainly for psychological reasons, that will last throughout December and into January, which are traditionally good months – the so called January effect….  This is a rough scenario for where I see equities prices headed in the near future…. -John Bardacino

I view the financial markets in terms of which theory is accepted by market players and increasing or decreasing in truth (or verisimilitude). The current dominant theory can be labeled “the sky is falling.” This theory and its effects will continue to increase in verisimilitude (degree of truth) in the days and weeks ahead. Short term reactions against the price trends that this theory has produced should continue to be seen as opportunities (ie: short term rallies in the stock market as opportunities to get short (or get out of long positions) – generally speaking).

Yes, things are ugly and about to get uglier before they begin to improve. The Fed is desperately trying to reinflate the economy but it will not work quite yet. Congress is only making it worse by giving billions of taxpayer dollars to special interests and not allowing market forces to clear all the malinvestments that have built up over the years. Ron Paul is right, bad Federal reserve policy and other gov’t stupidity such as gov’t sponsored entities (fannie mae, freddie mac) and all the other dumb policies, rules and laws that distort the market created this mess.

Don’t be a victim, instead see it as opportunity and exploit the effects of the flawed institutions that create the boom bust cycles such as the one we are experiencing right now.

How? by understanding the effects and positioning yourself to profit from the price action.

An important value that must reside within your mental framework that you use to guide your decisionmaking should be the following:

“Maximize the utilization of the inefficiencies created by government policies”

As far as equities, short term rallies against the long term dominant trend should continue to be shorted.

Commodities are obviously in a very strong short and intermediate downtrend which will continue until we get through this most recent bust cycle, my guess is that it will last for another 6 months to one year. Over the very long term commodities are still in a secular bull market, and the federal reserve banks of the world are determined to reinflate the global economy.

In the short and intermediate term, we have deflation, in the long term we will once again have a major problem with inflation in the future given the lagged effects of the Fed’s actions on the economy.

US Dollar – As stated here in June the EUR has become a “relatively more miserable currency.” But the USD remains relative more miserable than the Asian currencies over the long term and the price action and trends will reflect that. -John Bardacino

Is it time to start preparing for the next boom-bust cycle?

I can remember sitting in a graduate economics course back in the fall of 2001 that was being taught by a very bright man, who, like our current Fed Chairman, held a degree from MIT.  However, unlike Dr. Bernanke, our professor actually understood the effects of monetary inflations….  The topic was growth in the money supply and the lagged effects that it was going to have on the economy. At that time, the various commodity indices were near multi year lows, oil was trading around $20 per barrel, gold was forming a base between 250 – 300, the US Dollar was at multi year highs and forming a top, and the stock market had begun a bear market after hitting all time highs earlier in the year.

The Real estate bubble was about to launch into full blast mode, and of course, commodity prices would then rally. The discussion centered on criticism of then Fed Chairman Greenspan and government(s) in general. We were discussing the money supply, inflation and financial bubbles. He (our professor) was discussing recent increases in the money supply and deficit spending and the effect it would have on inflation and frustratingly compared the then current situation to the early 1970′s and said…”that’s something to look forward to…”

Such is the flawed nature of our governmental/economic/social institutions…. The point of the lecture in that class was not to explain why bubbles occurred – that was easy – financial bubbles are an effect of an inherently flawed system….. The more important point was that when we got out into the real business world we would need to know how to not just survive them, but exploit and prosper from them.

In the fall of that year, we all knew it was a short matter of time before the country went to war. In September of 2001 we did not know which specific country, (now countries) was going to be invaded, we just knew that the government was going to make someone pay for what had happened, even if its (long term) foreign policy was the indirect cause. It was becoming obvious what would happen – the government would expand and go into debt, the Fed would print more money, the USD would decline, inflation would accelerate.

Clearly, we are presently in the bust phase of the most recent cycle, but if the above graph is any indication of what the future will bring, the seeds of the next boom-bust cycle are currently being planted.  Combine this with yet more increases in moral hazard due to another bailout and it is almost inevitable.  Yes, there are risks of a long drawn Japanese style decade long recession, but I am of the view that we will see even more and larger bubbles in the future. It may be about 2-3 years away because the effects of this bust need to be worked through, but the next bubble will come, and for reasons that I will get into in the future it will likely be a bubble that involves equities (of course, the immediate and intermediate trends for equities is down). -John Bardacino

Banking expert Bert Ely: “I have run the numbers looking at the capacity of the industry to pay the tab. Assuming that bank insolvency losses don’t get way out of line, which I don’t think they will, then the industry can handle it. It’s not going to be cheap, but the banks can handle it and clean up their own mess.”

Read the whole interview here: http://us1.institutionalriskanalytics.com/pub/IRAMain.asp

Bad regulations got us into this mess, congress is about to make a bad problem even worse with a bailout of Paulson’s buddies on wall street.  This monstrosity can still be stopped.

So how can you profit in the future given where we are at currently in this particular boom bust sequence?
In a prior post titled “I don’t trade stocks… I trade theories” I wrote the following:

“I don’t invest in financial securities, I invest in theories. At any particular present moment, the markets have embraced a certain theory, and my portfolio should be positioned to exploit the effects of that theory. As the collective of market players continually adjust the degree of truth they give to a theory, the value of your portfolio will change. It may not sound significant, but approaching money management with this mental framework is more in tune with the reality of the world. Understanding the flaws in the economic and political institutions that we live in is key to understanding what will happen to a market theory, and as a result, securities prices.
There is always a theory that is dominant, and at times the markets may change their focus between two theories that are competing for dominance. Other theories wait for their time to come, until their degree of truth (verisimilitude) rises enough for them to have an impact on prices and unseat the dominant theory.”

Given the recent actions of elected and non-elected bureaucrats we will soon re-enter an attempted monetary reflation, the specifics of which I will spare you. Just be aware that it involves the creation of a lot of new US Dollars and the monetization of a huge amount of bad debts. The effects are inflation, a weaker dollar, higher bond yields, higher commodity prices and (eventually) higher stock prices (but not before further declines and volatility in the short and intermediate term). This will occur after a deflationary recession… Right now it does not have much verisimilitude, but as the monetization theory eventually increases in dominance, one would want to be long Asian currencies vs the USD (Yuan, JPY, AUD), long commodities (gold, oil, etc), short treasury bonds, and eventually long equities (after a further drop in the short and intermediate term) – the trend for equities is presently down but that will likely change in the future as money leaves the bond market. -John Bardacino