This Week Crucial to Investor Emotion

Though I'm currently being taught that many scholars and businesspeople believe that stock market prices represent the entirety of all available information, I disagree. I see the stock market as a much less rational creature; along with true facts and information, fear, emotion, rumors, and expectations share responsibility for driving prices and creating price swings.

The major markets (S&P 500, Dow, NASDAQ, and most international markets too) have endured wild fluctuations over the past year and a half as they shed 50% of their value. Below is a chart of the S&P 500 over just the past six months, after the index had already lost a significant portion of its value.


After establishing a new multi-year low late last week, the S&P 500 had a spectacular rebound, rising roughly 80 points - adding more than 10% to the index's value.

I was on spring break this past week, which allowed me to waste plenty of time lounging around watching CNBC. While I don't take too much from that channel to heart, watching the various personalities, traders, and interviewees provides a good sense of sentiment on the street. At the end of the week, the depressing fog certainly seemed to be clearing and some people seemed downright cheerful. A few actually resented the steep rise as they had hoped to initiate some long positions at better prices.

The week was kind to the general markets, but certain beaten-up stocks did even more exceptionally well. GE bottomed at $5.87 last week, but recovered to nearly $10 by Friday's close. General Motors (GM) more than doubled from an intraday low of $1.27 last week to close at $2.72 on Friday. PNC, a bank of national (and moreso local, due to my Pittsburgh roots) significance, began the week under $18 and closed at $28.

Last week's rally may have been caused by any different number of factors. Some scary unknowns became known; both GE and Berkshire lost their AAA ratings, but credit outlooks were reset to stable, allowing investors to feel a little relieved and reassured. Mark-to-market rules are under review, and any suspension or alteration of them would likely lead to writeups and increased capital cushions at virtually every financial institution. Other commentators think that some sidelined money may have flowed into the market, and after the gains began early in the week, additional investors threw even more tinder on the financial fire.

Some people are less optimistic. Considering the depressed, pathetic pre-rally prices of stocks like GE, GM, and many others, some people argue that much of the reason for the rally this week was short covering.

No matter the reason for what is now history, the market action this week may stifle and reverse, or enhance, the movements of this past week. The S&P 500 now sits at approximately its November low; it may not be able to cross that resistance level, but if it does, it should have a new level of support. (Note: I'm not a technician and I don't believe too deeply in technical trading, but because enough investors do, it sort of becomes a self-fulfilling prophecy).

Disregarding any technical indicators, simple emotional sentiment is hinging on the first few trading days of this week. After a 10% gain, many people want to believe that the market has turned a corner; they may be willing to commit more capital or cover any outstanding shorts if they see a little more proof that the markets will continue skyward. On the contrary, the good feelings of this week will be forgotten if markets stutter early in the week, as investors are inches away from writing off any gains as a bear-market rally in a formerly-undersold market.

Various nuggets of news will likely drive sentiment this week. FedEx (FDX) reports earnings, and they are often considered to represent the general economic environment; a positive report will reassure jittery investors, while a bleak one may estinguish existing goodwill. Nike (NKE) and Oracle (ORCL) also report earnings, while GE will provide some information about their financing arm. A spattering of other economic news and company reports will augment the aforementioned ones.

I don't have any fresh capital to invest at this point, but I'm eager to see how the markets will move. On one hand, I too share the opinion that I don't want things to go up too far, too fast - I'd like to buy some good companies at the current firesale prices! However, I think many stocks are currently oversold, and an extention of last week's rally doesn't seem irrational to me. Only time will tell...




Buy a Kindle 2

Terrible Tuesday

After US Index Futures trading on global markets had priced in a 5% plunge when the markets open today, the Fed decided to try to salvage the situation by cutting rates by 75 basis points.


Immediately, futures gained lots of lost ground, as Nasdaq 100 ETF is only pricing in a mere 2% decline. (QQQQ quote taken 8:30 AM).

But was this the right thing to do?

I'm not so sure.

First, let me establish that I don't want stocks to fall. I own an Ultrashort Oil & Gas Fund (DIG), which can be seen as a hedge against oil (and the entire economy), but I am very, very long, which is clearly not the place to be right now. I'd like nothing better than to see the market go up 20% tomorrow, but for logical, meaningful, substantial reasons.

The Fed's early cut is purely symbolic, not something that will actually have an effect on the financial situation in America. Since the policy (rate cuts) take many months for their effects to be felt in the economy, realistically, waiting until the meeting to cut 75 points would have provided the same stimulus in the second half of this year. If anything, I think it may have been better to cut then - if things got even worse, then they could cut a full point without making it seem like the sky is falling.

I can't say that a decline of "only" 5% isn't bad (especially since some stocks I own, like Countrywide (an arbitrage, at this point)) were set to open down 10% or more. But global markets have faired even worse over the past two days - Indian and Chinese markets are down 10-20% since last week.

It's hard and unreasonable to tell people to do this, but if people could just act rationally, and avoid clicking "close" next to all of their positions, we'd be a lot better off. For example, I follow Activision (ATVI) and Electronic Arts (ERTS), two stocks who should have shot up after news of an absolute blowout of video game sales numbers during the holiday season. However, both were flat (or down) last week after the announcement was made, and both were/are pricing in a 5% dip today. Clearly, if we're in a recession, people are still buying Guitar Hero and Call of Duty; if anything, investors should be buying up shares of a seemingly-stable niche.

Now that the day's news (BAC's awful earnings and the Fed cut) are on the table, it looks like markets will open down about 3%. What they do during the day is anyone's guess - We could finish positive, or we could lose 10%. According to WSJ articles over the weekend, markets have priced in 80% of the impact of a recession - this potential decline today should increase that figure further. I truly believe that a recession is fully priced in; there's clearly some stocks that are still overvalued (I think that tech like Apple, RIM and Amazon are still grossly overvalued), financials seem to be fully discounted.

Barrons wrote an article about the bond issuer MBIA this weekend; they stated that the company's liquidation value is at least $30, while the stock currently trades around 8. Countrywide is being merged into BAC; the terms of the deal, which can be broken but are generally unconditional, priced CFC around $7; now, when CFC converts into BAC at .1822 shares, you're essentially buying BAC stock for $25 (instead of the market's $33) if you buy Countrywide today.


If you can stomach a short term loss, in five years, they should identify early 2008 as the best buying opportunity in years. Yes, the economy may not be great. Yes, the subprime problems are not over yet. But companies (and the entire market) are heavily, irrationally discounted, and an investor with a strong stomach will thank his nerves a year or two from now.



"I trade with TradeKing: $4.95 stock and options trades, plus lots of tools. It's simply the best way to invest. Click here to find out more.

SHORT!

I want capitalize on the current volatility.

Right now, my real-money portfolio is nearly 90% invested; I have some SPY puts, and then about 8 different stocks. I'm happy with all my positions right now, so I'm not really looking to actively trade that portfolio soon.

However, I just entered a trading competition sponsored by my university. Finally, I get to employ lots of risky strategies that I wouldn't do with my real money.

The competition opened today, and my first move was to short, short, short.

I shorted:
Apple
Bidu
AIG
Amazon.com
Google
RIMM
QQQQ
Petrochina
SPY
F

If the market continues to be sour (after the 3% loss on Nov. 7), the returns will be lucrative. All of the above stocks (except for the exchanges, F, and AIG) are high-growth momentum plays. If momentum stops, there's no telling where the floor will be.

Of course, I'm long stocks too (I'm about 1m more short than long in a $5m portfolio). I own:

BWLD
ANF
ATVI
TM
JAVA
and a few others that I'll update later.

Literally every stock, both long and short positions, fell today, but the shorted ones fell more, so I'm currently in the lead.... after the first day of trading.

As for my general take on the market:

It seems like there's a lot of reasons why there could be a correction now. The dollar is crashing, oil is still high, Morgan Stanley just wrote down $4B, WMU, Freddie Mac and Fannie Mae are under review for lending policies, and the market has just been strong lately.

Could the market rebound nicely tomorrow? Sure.
Could it fall 10% over the next two weeks? Believe it.

Predicting the market movement on a day-to-day basis is impossible and fruitless, so I cannot and will not say if the market will be up, down, or flat tomorrow.

But keep in mind that stocks like Apple, Google, and Baidu have P/Es that are 2 or more times higher than there rest of the market. When momentum runs out, it's a recipe for disaster stocks like those above. Google is itself a big enough entity to drag down the entire market; just keep an eye out for the potentially-dangerous situation that this can create.