Doug Kass recently predicted the S&P500 stock index will finish the year at 920.  It is currently right at 1000 (on September 2, 2009).  I agree with the prediction of 920 sometime in the next couple of months.  I think 900 may be possible and even lower to 875 based on the bottom set in July.  But unlike Kass, I think the market will rebound by year end.  I will wait for signs of a possible rebound once this current drop (begun last week) is further along.  The signs of the bottom to this dip will be a stall in the decline just as the recent market top was shown by a stall or resistance around 1040.  The rebound will happen when the market goes up on bad news.  I think that may happen during the Q3 earnings season the middle of October into early November.  I am still thinking that 1200 is a possibility by year end.  This would completely retrace the panic selloff starting from the Lehman collapse on September 15, 2008.  So, if we wait until 900 to redeploy our cash raised the past few weeks, that could provide a nice 33% finish to the year.

Where Kass is probably wrong, along with many others on Wall Street, is that there are just too many people with a bearish market view.  There is virtually  no one on the financial networks (CNBC, Fox Biz, etc) today saying that the selling should be ignored and the market will go much higher.   There are just no Bulls as far as I can tell.  The market always confounds the consensus position.  It has to in order to work.  If there are a majority of bears, then by definition, there is hardly anyone left to sell.  Once all of us who had our finger on the trigger, pull the trigger, there isn’t anyone left to sell.  So, I think the decline will be shallow and the market will rebound in 6-8 weeks.  This can’t be like the panic last year because all the retail investors that bailed out in the fall and winter are still on the sidelines.  People who sold everything in January and February never got back in. 

There are a lot of factors to a panic that are missing right now (as they usually are, fortunately).  To get a true financial panic, first everyone must be euphoric and unaware of or discounting trouble.  Then when the decline starts because the market just can’t go any higher (everyone who is going to buy has bought), investment holders must be forced to sell at any price by margin calls or other financial misfortune.  Last year, there was a cascading of events that are no longer in play.  Most importantly, the leveraged, collateralized securitization market, the core of the trouble, is almost completely unwound (except CMBS, which is where there is still concern).  The leverage in 2007-08 was in the carry trade, which is what caused the dollar to soar and interest rates to drop when foreign currencies were sold and dollars bought to cover margin calls.  The securitized loans are mostly back inside the big banks now with backing by government guarantees or in private hands where they have been de-levered which allows them to be held to maturity, if needed.  So, there are no large institutions needing to dump stock or other financial instruments into an illiquid market to raise money to stay afloat.  That is a big and significant change.

On the way down, I am using portfolio hedges to protect my positions.  I like the SP500 Double Inverse fund by Proshares, with ticker SDS. 

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I like this ETF because it is a double short of the SP500, which is a pretty basic / broad index of the market and includes all the big financials, techs and energy companies.  I also hold another hedge, hte Proshares product called DUG.  DUG is basically the double inverse of the energy market, something like IYE but with a little Materials exposure too. 

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I use it to hedge all my Materials and Energy exposure, although I also use covered calls for this on stocks like Suncor that have good premiums.  I also have used covered call options on the Canroys, but the premiums are not very good because of the large dividends.  It is just an alternative to outright selling them. 

Even though it has become popular, I don’t do those Direxion 3X ETFs.  They are just too wild for my taste.  Even the doubles are a little scary and I am careful to keep my exposure balanced with opposite long positions.  I don’t bet naked short, even now when I am pretty convinced the market is going lower.  The market always goes up in the long run, so being short should be very tactical and short term.  I don’t want to get caught on the wrong side of that trade.

The market is hanging right at the 200 Day EMA. Yesterday (3 June) for most of the day, it looked like that average would act as resistance and the market would head lower in the range it has established the previous two months, down to 875. But, in the last half hour, the market recovered half its losses for the day. We all know that the last hour is the most important time of the day and shows the psychology of the market best.

Today, on really lukewarm unemployment claim news, the pre-market got stronger. Art Cashin, who has been calling for a correction the past two weeks, admitted just now that the market SHOULD go lower, but WANTS to go higher. He is looking today to see if the market heads higher off the 200 D, as he thinks it might. Any excuse for a good news will result in a market surge. Tomorrow’s unemployment report will be the excuse. Consensus expectations are for 550K job losses. If the market comes in at 525K, that will be reason for a surge.

Still, the market needs a correction and sometime, probably when least expected, it will come. So, I am keeping my hedges (covered calls) on.

Doug Kass has a terrific track record of predicting the tops and bottoms of recent markets.  He has been known as a short seller the past several years as he thought the market over-valued.  Now, however, he has picked March 5, 2009 as the bottom and has gone long.  He was nearly alone in his convictions on that date, but has recently been joined by more and more investors, including yours truly.  Why does Kass think we have reached the bottom of this Bear?  Read on for more:

http://www.seabreezepartners.net/newsArticle.asp?id=449

March 24, 2009

Why the Bears Are Wrong
By Doug Kass, The Edge

I continue to believe that the early March low represented a yearly and, quite possibly, a generational market bottom.

The mustard seeds for the economy and the U.S. stock market have begun to take root.  The rate of change in 10 of 12 factors in my watch list are improving.

On Feb. 17, I presented a watch list of conditions that, if in an improving trend, would likely indicate that a sustainable up move is possible for equities.

It is time to review this checklist (and add one more factor) to determine the market’s standing. Our new grades and those of two weeks ago are in parentheses and will be updated in the weeks and months ahead.

1. 1. Bank balance sheets must be recapitalized. Yesterday a comprehensive bank rescue package was introduced. It is obviously too early to consider its full impact, but the details of the program suggest to this observer that it will likely be effective in clearing toxic bank assets. (We grade the package a B+, up from a D+ only two weeks ago.)
   2. Bank lending must be restored. While bank lending standards remain tight, my view is that yesterday’s announcement of ring-fencing toxic bank assets will almost unquestionably succeed in unclogging the transmission of credit. (Grade B, up from a c previously.)
   3. Financial stocks’ performance must improve. Financial stocks have finally awakened from the dead, and the recent outsized move to the upside could foreshadow continued market strength. Historically strong relative performance in the shares of asset managers — such as Franklin Resources (BEN), T. Rowe Price (TROW) and AllianceBernstein (AB) — presage a better equity market, and Monday’s strong group action was conspicuous in its outperformance. (Grade B+, up from a D.)
   4. Commodity prices must rise as a confirmation of worldwide economic growth. Beginning two weeks ago, commodities’ prices began to strengthen, and the Fed’s message last week accelerated that trend. Gold, copper (at the highest level since November) and crude oil (over $54 a barrel) continued to rise yesterday, reflecting a combination of continuing inflationary and currency debasement fears coupled with the possibility that worldwide economic growth might stabilize sooner than later. Finally, the TIPS market is forecasting some higher inflation, and a little inflation is better than a lot of deflation. (Grade B, up from a C+.)
   5. Credit spreads and credit availability must improve. Spreads remain worrisome and the transmission of credit remains poor, but the economy should gain traction as public policy is implemented, money is made more available and lending terms are liberalized. (Grade D, flat from two weeks ago).
   6. We need evidence of a bottom in the economy, housing markets and housing prices. As I have written, the retail industry has exhibited evidence of sequential improvement in the January through March period. Other economic signs are somewhat more ambiguous but, nevertheless, are showing some life. Months of inventory of unsold homes are declining and so are mortgage rates, but home prices have yet to stabilize despite an improvement in the affordability indices and a better relationship between home ownership and rental costs. Nevertheless, yesterday’s strong existing homes sales release raises the specter of a better spring selling season than most anticipate. I contend that housing could surprise to the upside and might lead most other economic indicators higher. (Grade C+, up from a C-.)
   7. We need evidence of more favorable reactions to disappointing earnings and weak guidance. I am encouraged by the better price action in the face of poor earnings results and guidance in a wide range of companies, including Freeport-McMoRan Copper & Gold (FCX), FedEx (FDX), Airgas (ARG) and General Electric (GE). (Grade B+, up from a C+.)
   8. Emerging markets must improve. China’s economy (PMI and retail sales) and the performance of its year-to-date stock market have turned decidedly more constructive, but other emerging markets remain moribund. (Grade B up from a C.)
   9. Market volatility must decline. The world’s stock markets remain more volatile than a Mexican jumping bean. (Grade C+, flat with two weeks ago.)
   10. Hedge fund and mutual fund redemptions must ease. I am comfortable writing that the worst of the redemptions are behind the asset management industry. Nevertheless, the disintermediation and disarray in the hedge fund and fund of fund industries still have a ways to go. And while brokerage account liquidations appeared to have decelerated last week (coincident with rising share prices), my high net worth brokerage contacts (such as Baron Von Broker) continue to experience account closures and a panicked constituency. (Grade C, up from a D).
   11. Marginal buyers must emerge. Low invested positions at hedge funds and by individual investors no doubt fueled March’s market rise as the fear of being out has begun to replace the fear of being in. These two classes could continue to be the near-term marginal buyers fueling stocks. Corporate acquirers could also emerge as important marginal buyers, and the recent step up in merger and acquisition activity — for example, Genentech (DNA), Petro-Canada (PCZ), Schering-Plough (SGP) and Daimler (DAI) — is a concrete indicator that another important marginal buyer has surfaced. As the year progresses, a meaningful upside move awaits a broad asset allocation move of pension funds out of fixed income and into equities. (Grade B, up from a C.) To the above factors, I am adding a 12 factor in my watch list:
   12. The market’s internals must improve. I am comforted by a number of improving technical conditions that have emerged since the March low and that have continued in force over the past two weeks since the market has made program off that nadir. Indeed, the conditions of the recent low were different than others — in sentiment, volume, number of new lows and in intensity. The move from the October lows to the March lows indicated growing fear and gave way to rising cash positions and the loss of hope, but the market’s internals were improving. November’s DJIA low of 7,552 was nearly 11% below the October low of 8,451, and the March low of 6,547 was 22.5% under October’s low. While each new low was more frightening than the prior one, however, there were improving technical and sentiment signals. For example, NYSE volume at the October low expanded to 2.85 billion shares; at the November low, volume dropped to 2.23 billion shares; and at the March low, volume was only 1.56 billion shares. As well, new lows traced decreasing levels: At the October low, there were 2,900 new lows; at the November low, there were 1,515 lows; and at the March low, there were only 855 new lows on the NYSE. Moreover, the combination of last Tuesday’s 12:1 ratio of advancing stocks over declining stocks coupled with that day’s 27:1 up-to-down volume ratio has not occurred in almost 65 years. Remarkably, yesterday was the fifth 90% upside day in March, which is evidence of a broadening market.

In summary, 10 out of 12 factors (including our newest, market internals) on my watch list are in an improving mode. Though many variables are currently accorded relatively low grades and the outlook remains debatable, the delta (rate of change) in almost my entire watch list is improving and flashing a green light for the U.S. stock market.

A classical wall of worry is being reinforced by an overwhelming consensus that the recent advance was a bear market rally. Moreover, the negative “chatter,” as Jim “El Capitan” Cramer describes it, appears loosely constructed and fails to credibly argue against the salutary effect that $4 trillion of stimulus will have on the domestic economy.

Based on the 12 considerations comprising my watch list, I respectfully disagree with the prevailing negative consensus, most of whose members failed to properly analyze the cracks in the foundation of credit, in the economy and in equities two years ago. Indeed, it remains my view that the fear of further investment losses and possible investor redemptions are clouding many managers’ objectivity in assessing the markets.

In the fullness of time, public policy aimed at stimulating the economy (in general) and in housing (in particular) should bear fruit, as will the ring-fencing of toxic bank assets serve to unclog the transmission of credit.

While it is unrealistic to expect a straight up move, I am growing increasingly confident in my variant and optimistic view that the early March low was not only a yearly low but, quite possibly, a generational low.

Coming Monday, March 30:  Jeremy Grantham 1st Quarter Commentary

From Jake:
Brian I am still not fully invested in the oil group, with the commodity bubble expected to bust I have invested lightly in this area. Any suggestions? Maybe short term? I have CANROYS but wanted to invest more before the run up but did not want to be taken out in a couple of months. I know hard to answer but any thoughts.
Otherwise a great day for me positioned well in all areas! Thank you!

My Response:
I think the Canroys will do very well short term and long term. In the mid term (2 mths to 12 mths) I am expecting a commodities correction. I think there is a lot of hot money in commodities that is parked there while the recession worries play out. I think that hot money (traders and hedgies) will move back to U.S. equities once the all-clear is called for the market. I expect that to happen anytime from June this year to March next year, sooner more likely.

Short term (next 2 months) I think Canroys will benefit from the hotness of the energy market. The Canroys hedge some of the product forward, but not all of it. So, they are benefiting from the higher energy prices on a daily basis, as they sell some production into the spot market. Also, as futures contracts expire, they will write new futures contracts at the current higher prices to lock in this level. So, there cash flow will dramatically increase the next 12 months, way above their budget forecasts, which are mostly in the $60s for oil and around $7 for gas (this info is in their annual reports).

Regardless of market concerns over the Canadian tax consequences, eventually, the value of this cash on the books must be rewarded. There could be a large special dividend, an acquisition which would increase future revenue and cash flow per share, or a takeout, which would result in a large premium on the stock price. I expect a 50% increase in price in the stocks if not taken out. If one of the small Canroys, like Daylight or Baytex for example, are taken out, they could double in value over a couple of days.

So, I think this is a great entry point for the Canroys, though it would have been even better a month or two ago (Daylight has gone from $6 in mid-January to $10 today, for example)

Regarding the Long term, 12 months to 10 years or more in the future, oil and gas will get more and more expensive as demand increases and supply stays flat if we are lucky. After 10 years, I expect alternative technologies to began increasing energy supply in general, shifting demand. I think solar will become a much bigger factor as new technology improvements drive production costs down. Wind, geothermal and wave energy will also be increasingly important. As fuel cell and battery technology improves, more vehicles will operate on electricity which can be produced by solar sources (wind and wave energy is indirectly derived from the sun, as is hydro power from rainfall into reservoirs). I expect biofuels like ethanol to become less and less important. They are very inefficient to produce and compete with the food supply.

I think Solar will be the most immediate winner in alternative energy and I am working in this industry, so can keep an eye on it up close. Today I am buying a small tracking position ($1000) in a new ETF for solar energy called TAN. Solar has had a big run and might pull back quite a bit in the likely coming commodity correction. So, I will buy more gradually looking for a better point to add a big position.