december 2009 - your markets monthly
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December 2009Volume 1, Edition 13
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In this edition:
Will 2010 Be as Good as 2009? - Guest Contributor: Simon Maierhofer
FAQ: What is a Margin? FAQ: How much should you trade? - Guest Contributor: Guy Bower
CFD Commodity Recommendations are here! - Information on our new service
Technical Indicator of the Month: Williams %R - by Jason Achjian
Recommendation Program update - Commodities Basket Recommendations - William Chien's CFDs - Seasonal Spread Trading
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Will 2010 Be as Good as 2009? by Simon Maierhofer
John Templeton's observation that bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria might never have been more apropos than it is today.
There are many pieces of Wall Street wisdom, some work, others don't, but John Templeton's quote is one to remember. In fact, it may be the single most important and most profitable principle for investors.
History shows that this principle is as easily forgotten, as it is simple. That's probably what makes it so effective. Investors, in particular fund managers and analysts (more about that in a moment), should frame John Templeton's advice and display it prominently, or use it as screensaver.
The reason we talk about investor sentiment is because it has reached extremes not seen in years. Couple this with a 65% rally in the S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC) and you have a possible recipe for disaster.
A bittersweet privilege
21st century investors had the bittersweet privilege of eyewitnessing the bust of several bubbles. Even though the bubbles all occurred in different asset classes, they had one common denominator - sudden and unexpected destruction.
A balloon that has been punctured does not deflate in an orderly way. That has been the case with technology (NYSEArca: XLK - News) in 2000, real estate (NYSEArca: IYR - News) following its 2005 top, and the broad US stock market (NYSEArca: SCHB - News), which topped in 2007 and tumbled in 2008/2009.
If you are one of the lucky few investors who foresaw all those asset bubbles, there is no reason to continue reading, if you aren't, it might be a good opportunity to reevaluate following the guidance that didn't keep you out of asset bubbles.
2010 - On the cusp
As 2009 is winding down, various indicators have reached trigger levels not seen in months, even years. None of those trusted gauges have bullish implications. This means that 2010 might get off to a very rocky start.
The Volatility Index (Chicago Options: ^VIX), also called VIX or fear index, measures how concerned options traders are that prices will drop. As with all sentiment indicators, the value of the VIX lies in its contrarian application. For the first time since August 2008, the VIX has now dropped below 20; a reading that has foreshadowed trouble in the past.
Shortly after this August 2008 extreme, the ETF Profit Strategy Newsletter brand-marked the financial sector (NYSEARca: XLF - News) a 'downward spiral with no stop-loss provision' and recommended short ETFs such as the UltraShort Financial ProShares (NYSEArca: SKF - News) and UltraShort S&P 500 ProShares (NYSEArca: SDS - News).
Within six months of the August VIX extreme, the S&P (NYSEArca: SPY - News) lost 45%, while financials dropped over 75%.
Looking back further, we notice that the VIX also fell below 20 in May 2008. Just from May to August 2008, the S&P dropped 12%. Of course, the VIX also fell below 20 in October 2007. We all know what happened thereafter.
Be careful who you trustMost of us look for a pro when it comes to matters beyond our knowledge. For a health issue, we visit a physician, for car trouble we go to a mechanic, etc. When it comes to investment guidance, however, trusting an advisor may not be the best thing to do.
Investors Intelligence is an organization that tracks about 140 financial newsletters. In October 2007, 62% of the polled newsletter writers/advisors thought prices would go up further. Only 19.6% were bearish. The rest thought that the market would move higher after a brief correction. We know today that 81.6% of those advisors were proven wrong.
The opposite happened in March 2009, when only 26.4% of the advisors were bullish. This time, 73.6% were proven wrong. Going against the grain, the ETF Profit Strategy Newsletter issued a strong buy alert on March 2nd. Stocks have rallied 65% since.
From blessing to curseWhat goes up must come down. That pattern has been established by history and the latter part (coming down) generally happens when least expected. This 65% rally from the March lows has morphed from blessing to curse. Now that the profits have been reaped, all that this rally does is mortgage 2010 growth.
The above Investors Intelligence and VIX readings show that the majority of traders, investors, and advisors did not see any of the major market turns coming since 2007. In fact, the vast majority of Wall Street has been wrong-footed consistently.
Once again, investors and advisors have set the stage for a major blindside. The number of bulls tracked by Investors Intelligence has reached the highest level since December 2007 while the number of bears clocked in at the lowest level in over six years. This is in addition to the message conveyed by the VIX.
The extent of the damageWe mentioned above the declines following extreme readings in October 2007, May 2008 and October 2008. Each decline was different in character but each lead to lower lows. October 2007 was followed by lower prices in May 2008, which was followed by lower prices in September 2008.
The rallies in between the above-mentioned secondary highs never advanced beyond flash in the pan status and did nothing more than once again trick investors into buying stocks at higher prices. Odds are, the rally from the March low will become known as the biggest flash in the pan, or sucker rally, since the Great Depression.
But, this time is differentThe most fascinating facet of investment research is the consistent appearance of the 'this time is different syndrome.' The market does what it's always done, but every time a top of larger degree is upon us, we find excuses for stocks to move even higher - just to be disappointed time and again.
If the stock market were a person or entity, it would probably compare investors to a poker player that falls again and again for the same bluff. The best way to call your opponents bluff is by knowing his hand. Well, here's what the stock market has in store for us.
Perception, to a large extent, is what drives the market, but perception is not real. Perception, like a poker player's face (aka poker face) can differ widely from the true value (aka the actual hand of cards).
If you boil it down to the basics, you come up with this formula:
Valuation + Perception = Market Value
Obviously, perception is the big fluctuating variable. Eventually, however, the market will always disregard perception and reset the market to its proper valuation. At that time the formula is: Market Value = Valuations
In other words, your opponents poker face may be enough to up the ante for a while, but when it comes time to settle the score, only what's in your hand counts. The same is true for stocks. In the end, only true value counts.
Calling a bluffWith its gravitation like pull, the market has a way of bringing stocks down to a fair valuation level. This level can be measured by simple yet effective indicators such as dividend yields and P/E ratios.
Major market bottoms, such as in the 1920s, 1930s, 1950s, 1970s, and 1980s saw P/E ratios drop to multi-decade lows while dividend yields rose to multi-decade highs. Right now - and even nine months ago - P/E ratios are the highest they've ever been, while dividend yields are close to their 1999 all-time lows - the opposite of what you'd expect to see at a market bottom.
The November issue of the ETF Profit Strategy Newsletter includes a detailed historical analysis of P/E ratios, dividend yields, and other reliable indicators plotted against current prices to determine a target range for the ultimate market bottom. Indicative of their implications, we've dubbed the indicators the 'Four Horsemen' - yes, the March lows are in serious danger.
It may not be apparent just yet, but the market is bluffing its way to higher prices. The time to settle the score is speedily approaching. Will you call the market's bluff and prepare for a major decline, or will you be blindsided into holding stocks at the worst of times?
Article details:Will 2010 Be as Good as 2009? - Yahoo! Finance
Many of those new to trading will have difficultly understanding the concept of a margin. This