I wrote last week that commodities may see some downward pressure as the CME raised its margin requirements.  To my surprise, it didn’t have much effect.  But, today, we’re seeing wheat and soybeans down over 5.5%.  Oil is down $3.63, and metals are down between 1-3%.  The market appears to like this so far.  Over the next few days, it’ll be a good test for commodities.  If it can overcome the new margin requirement selling, then we know there’s more demand and less speculation in prices of many commodities.

At midday, the Dow is up almost 100.  I’m using this opportunity to add a little short as I need the market to prove itself to me.  Until otherwise noted, this is a sell the rally market.  It’s unfortunate, but true.

Financials and tech are leading the way today.  Up volume is beating down volume about 2:1.  Nothing to write home about.  I don’t doubt we’re in a bottoming process and one of these times, these rallies will hold.  That’s why I continue to reiterate flexibility and being nimble.  If you’re a slow mover (401-K, etc.), I’d stay heavy cash.  But, for an average portfolio, there is still whipsaw risk.  I covered some short last week only to add some back on today.  This isn’t a science and you have to leave yourself room for minor mistakes in order to commit the big ones.

Reducing exposure is the prudent move right now.

The last couple of weeks had some signs that we were likely to begin a sustainable rally and possibly things were changin.  We were technically oversold, the Fed was throwing money at the economy, the financials were rallying, commodities were selling off, and equities were moving higher.  But, not so fast.

I’ve mentioned that some of the fastest and biggest rallies come in bear markets.  This is what bear markets do.  They suck you in.  They’ve mildly sucked me in the last few days.  I bought a little tech and covered some shorts.  Fortunately, I’m still not 100% correlated with the market and way ahead of all the averages for the year.

Review 

After studying all the data I can possibly review, here’s what I know:

• The economy based on some leading indicators has stabilized.  Unfortunately, it’s probably stabilized in recessionary territory.  Not necessarily a deep recession, but a recession nevertheless. 
• The Fed is doing everything in their power (perhaps too late) to grease the wheels and this will help eventually.
• There is still way too much supply meaning everytime the market goes up, there are plenty of sellers ready to dump stocks causing prices to go down.
• Some of the long-term oversold indicators that show the market is completely washed out and the selling is exhausted is not present.
• The rally that started a couple of weeks ago with promise lost its steam this week.
• There are some great stocks out there that are really cheap and worth buying right now.
• Whipsaw risk is still high along with volatility.

It’s amazing to me how this market can toy with all of our emotions.  Unless you’re practically day trading, you’re penalized for moving too fast.  If you buy after 3 days of rallies, you get burned.  If you short after a few down days, you get burned.  I’ve been stressing flexibility and nimbleness.  This is definitely no time to let pride get in the way.  If you bought something you shouldn’t have and it’s down but you know deep down you shouldn’t own it, you have to take your losses and move on.  The shorts I covered early in the week I wish I had back. 

When the market is in a tough spot like it is now, you have to say to yourself, “am I going to be caught in or out?”  I choose out everytime.  That means unless something changes, I’ll be adding back on a few shorts next week with my cash to reduce my overall exposure to stocks.  Not how I would have drawn it up but that’s what separates good traders from bad.  Good traders admit their mistakes, cut their losses, and move on.  They live to fight another day.  Bad traders hang on saying to themselves, ”I’ll sell it when I get even”.  That’s calling paying to be right.  We get information and we trade based on that.  Then, the data changes, and you have to adapt.  The data changed quickly this week.  

Income

I want to reiterate the need for income in times like these.  I have 40% of my money in income producing securities yielding 8-10%.  That’s stable and it’s there every month.  But, the 60% that I don’t have in income producing securities is allocated towards capital gains.  That means buying something and then trying to sell it to the next guy for more.  Right now, that’s hard to do.  So, make sure you own some income producing securities.  Not treasuries yielding 3.5%.  There are various energy trusts that are attractive now and various types of bonds that can yield high single and low double digit income. 

Since January 17th, the market is practically flat even thought it’s been real volatile.  So, if you’re a buy and hold investor, you haven’t made any money but you’ve been terrified.  If you have income investments, at least you have 2 months worth of income which can help your total return. 

Trading vs. Investing

I fundamentally believe this market is in a bottoming process which can take several months.  Weak economies are followed by strong economies.  It just takes time.  The problem right now is the fact that there is simply no appetite for stocks, no demand.  Until that changes, you can trade but not invest.  As the weeks go on, the weak market is giving us all time to make our “investments”.  Buying extreme fear and selling optimism is still working as it always does for short-term “trading”.

Position yourself

So, the week ended with more disappointment as there was no follow through.  For the next couple of weeks, either the fear will start building again and we’ll once again get oversold, meaning too many bearish people  or some good news will come out and buoy stocks higher.  The market is still responding better on good news and holding its own on bad news.  That’s something different we haven’t seen in a few months.  That’s definitely encouraging.  Bottom line, pay attention.  If you’re holding a diversified portfolio of mutual funds, you’re in a dangerous position.  On the other hand, if you’re 100% cash, it may feel good, but you’re going to miss some big up days.  My choice, continue to own the rails, agriculture, natural gas, technology, and some healthcare.  The stuff that’s working.  Add to the plenty of cash and shorts on the weak areas and and you’ll sleep better at night. 

Have a great weekend.

The Chicago Mercantile Exchange, which is the exchange where various commodities trade has just announced they are raising the margin requirements for trading commodities.  Commodities are bought with borrowed money and now they are requiring more equity to buy those commodities.  This goes into effect today meaning many hedge funds and commodities traders will have to sell commodities immediately to meet their margin requirements which could put a lot of downward pressure on all commodities.  This could be good for the equity markets as commodities have been moving the oppposite direction of the stock market.

This is the type of news that may give the rest of us a golden opportunity.  This could artificially create supply which brings prices down.  Once all the initial selling is exhausted, normal supply & demand comes back in the market but you and I are left with cheaper entry prices.  Oil may be the exception as an Iraqi explosion had oil prices over $107 this morning. 

This news is like requiring you to put more down on your house 5 years into your mortgage.  Let’s say you initially put down 20% to buy your house.  One day you get a phone call saying you need to put down an extra 30% so you have 50% equity in the house.  If you don’t have the money, you have to sell something, probably the house.  That’s what is happening today in the commodities markets.  Had they eliminated $0 down mortgages and made everyone put at least 20% down, you wouldn’t have had the mortgage mess we’re in today.  For the next few years, everyone will be trying to pop any potential bubble in fear of the bubble getting too big and bursting. 

The goal is here is to reduce speculation by weeding out the guys that really shouldn’t be playing this commodities game.  This means pretty much squeezing out the small speculative inexperienced hedge funds. 

The market is getting a good test today.  After being down almost 200 points early on, it’s giving it the old college try to recoup some of the losses.  If we can continue to get a buy the dip mentality, that would be very encouraging for a more extended rally.  The next stop for the S&P 500 is 1390.  I think we’ll work our way up to there fairly shortly.  If we can get through there, 1440 is next.  This is all technical jargon but basically others are watching the same thing I am.

I’ve been concerned about the weak volume.  However, I think if you combine the improving fundamentals with slightly better technicals, we could have a sustained rally. 

For today, I’m sitting pat.

I’ll be filling in for Dan Frishberg on The MoneyMan Report from 5-6 p.m. CST. tonight on the Biz Radio Network 1110 AM in Houston and 1360 in Dallas/Ft. Worth at 5:15 p.m. or on the web at www.bizradio.com . 

The consumer confidence just came out and it is at multi-decade lows (64.5 now vs. 110 in July 2007).  This is very correlated with the S&P 500.  The S&P is down about 80 as I write.  A couple of things pop out to me.

First, this is a lagging indicator.  So, we know people feel lousy right now.  That’s how recessions are.  The stock market eventually focuses on the future.  When you’re in a trough (recession), the next thing you start looking forward to is expansion.  Since it’s lagging we need to be in front of it, not trading it after it comes out.

Secondly, this is really what we need for a test.  We need the market to pull back on weak internals.  Low volume, low downside volume, etc.  We also need to see buyers really step up and take advantage of the “bargains”.  You don’t want a market that run away from you.  We need 3 steps forward and 1 back.  We’ll see how today and the next few days shape up.

I’m still short and owning a lot of cash in addition to my longs. 

I’ve attached a picture of commodity prices measured by the CRB Index which is in orange and treasury rates on 10-year government treasuries in white.  Notice how they have been correlated going back to the early 1970s.  But in the early part of this decade, they began the decoupling process.  Commodities started racing up and treasury rates have continued to stay low.

First of all, they have been correlated because when commodities start to rise, interest rates go up as inflation comes into the picture.  Then, high interest rates cause less demand and commodities fall.  So, why have things changed and will they start to be correlated once again?  Yes and no.

There is a logical explanation of what’s goin on here.  Emerging markets are demanding more commodities than the supply.  Therefore, prices have risen.  But, why have rates not gone along with them upward.  This is because as emerging markets have developed and used more commodities, they have placed their capital in U.S. markets through the purchase of U.S. Treasuries.  Why?  Because they know they will get their money back even if it’s earning crappy rates and the dollar’s weakening.  So, more bond purchases mean lower interest rates.

Think of it like a gentleman’s handshake agreement.  We think of it, they manufacture it, we buy it, they use the proceeds to buy our bonds.  This keeps our rates down and keeps us refinancing and buying consumer electronics.  So, we get cheap products and help financing our country and they get prosperity. 

So, will it continue?  That’s the real question.  I believe over the next few years (and perhaps months) as our economy recovers, our long-term interest rates will rise and commodity prices will at least not go up as fast.  But, commodities are in a secular bull market and I don’t think they will be falling by 50-75%.  They will have corrections like they are having now but they are corrections.  In addition, I don’t think interest rates are going to double digits.  So, yes, I think we’ll see this gap tighten but the correlation like we saw in the 1970s, 1980s, & 1990s isn’t coming back anytime soon.

Commodities continued their slide today and there’s no reason to believe it won’t go until at least the end of the month (quarter).  Many hedge funds got long commodities as easy money.  When the selling started, everyone ran for the exits.  Hedge funds lock in gains at the end of a quarter because their pay is based purely on performance.  So, this sell off is likely to go on until the end of the quarter.  I’m hoping everyone takes their eye off the global growth story and we get in at even cheaper prices.  Emerging market stocks have been hammered and now commodities are following.  Hope you have cash to take advantage of some of this volatility.  I do and will.

I’ll be on the air tonight on the Biz Radio Network 1110 AM in Houston and 1360 in Dallas/Ft. Worth at 5:15 p.m. or on the web at www.bizradio.com .  Also, tomorrow I’ll be filling in on The MoneyMan Report from 5-6 p.m. CST.  Hope you’re listening. 

Have a great Easter weekend.

Commodities continue to sell off this morning.  Gold is down another $25 per ounce.  Other soft commodities are down around 3%.  I think this is all good news. 

1. First of all, when markets eventually bottom, they have taken down almost every sector.  Commodities and agricultural stocks were really the last hiding place.  Now they are correcting.  So, that’s positive. 
2. Secondly, lower commodity prices help our economy as consumers won’t pay as much for bread, milk, etc.  It’s only a couple of days, but the moves are big and it does help.
3. Lastly, commodities selling off means the dollar is strengthening.  As that happens, this attracts foreign investors into our markets lifting stocks.

2002 & 2003 All Over Again?

I would not be surprised to see this market act just like 2002.  We made a bottom in the fall of 2002.  But, the market really struggled moving back and forth until March of 2003.  Many remember March 2003 being the bottom.  But, the official bottom was October 2002.  It would not surprise me to see this market rally from here only to fall again over the next few months and eventually bottom.  We’re in a process it appears, not a v-bottom.  That’s fine.  That gives us all time to re-position and get into the best companies in the world.

For the next 2-5 years, I still like technology, global growth companies, healthcare/biotech companies, aerospace/defense, & financials.  Financials are becoming the best bargain with technology not far behind.  But, if commodities keep selling off, you’re going to get your chance to buy those stocks you’ve been watching run up for months like agribusiness, steel, coal, etc.

So, don’t get too aggressive here but if you’ve been on the sidelines, dip your toe.  But, we certainly don’t have the enthusiasm for stocks we need to say the selling’s over.  I still like the strategy of shorting the overall market with ETFs and buying good quality companies on sale.

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