the current market condition

I talked earlier about the qqqq's (nasdaq100) putting in a potential double bottom, while the other major indices, the spy(s&p500) and the dia(dow30) had not. This divergence creates a dilemma. In the past my experience shows that divergence in the major indices often does not last long. So will the qqqq's break below the support and the spy/dia come down to support and create a double bottom, or will the qqqq's tread water until the spy/dia come down to support, or will the spy/dia rally created a racing double bottom (a double bottom with the right leg down not going all the way down to the support level)?

Now it is becoming a little more clear. The qqqq's have not created a double bottom. The spy and dia are starting to form a symmetrical triangle (see here for a definition http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:chart_patterns:symmetrical_triangle )

Now the symmetrical pattern often is a continuation pattern, which means once completed the stock continues it's move up if in an uptrend or down if in a downtrend. But often it is a reversal pattern, which means the stock changes direction from up to down or vice versa. Generally if the trend is not well established, meaning the trend has not been in place for a long time and is not well defined, then the possibility is that the pattern will be a reversal. Here is a chart of GS that shows this symmetrical triangle as a reversal pattern. Note that in this case there was not a real uptrend just a channeling between 230 and 170 or so. Note that the break out of the triangle's lower trend line was tested when the stock rallied back up into the lower trend line. At the point it failed to break the lower trend line to the upside confirmed the break to the downside.

Below is an example of a symmetrical triangle in gld that is a continuation pattern. Notice the triangle that formed in Nov-Dec last year. In this case it broke out of the upper trend line and never tested the trend line. Note in this case that there was a much more well defined trend in place when the triangle formed. Also notice that another triangle is forming as we speak.

The crux of the matter is that it may be difficult to predict the direction the stock or market will move after a symmetrical triangle forms. The most important thing is which way it breaks. It is also nice if it tests (and passes) the broken trend line but as with gld this does not always happen.

Back to the major indices or their tradable cousins their tracking etfs. Looking at the qqqq's we see a potential symmetrical triangle forming. The double bottom never formed. Also there is not a good place to draw a trend line and if you did it would be very steeply down, almost unsustainable down. So now I believe the potential is for the symmetrical triangle reversal pattern to form. Note this pattern is also forming in the dia.

Looking at the dia below we see a similar pattern forming. Although in this case there is a little more definable downtrend line that can be drawn.

The conclusion is that we are now seeing the major indices correlate in that they are all consolidating. They are all making a similar symmetrical triangle pattern. While we cannot know which way we will break from this consolidation, we do know what to look for. We look for a breakout and based on the direction we can get a sense of the direction of the next move. Since these are major indices I would expect a break and then test. If the test confirms the breakout then another significant move up of down can be expected.

On another note. When you look at the gld chart above we see another triangle forming currently. It looks as if it will break to the upside again. But I do have to wonder how much further gld can go without a major correction. It has had a very big run.
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Where i am at.

Over the last several years I have tried to get educated about basically how money works. The more I read the more I realized that I needed to start doing something to try to achieve financial independence. Having read Rich Dad Poor Dad by Kiyosaki and many other books I have started to look at money in a whole new light. While RDPD does not provide any concrete advice on how to get rich or reach financial independence it does provide a framework for understanding how money works. And I believe without that framework it is a losing battle to attempt to secure your retirement or reach financial independence. The reason is that many of the myths bandied around as fact are detrimental to your financial future. But that is a discussion for another day.

As a result of my education one goal of my life is to become financially independent. First what do I mean by financially independent. Well in my case I mean that I have enough passive income coming in every month to cover all my expenses and to provide me a comfortable life (basically the lifestyle I have now + a little bit more free cash). What do I mean by passive income? Well I mean income that I do not have to work for. As a simple example a stock dividend or rent on a building you have professionally managed are examples of passive income. It is income you did not work for. It is income that comes from your money working for you. One thing to note that in some ways a beggar that get's enough to live on is independent, but his income is not passive. If he does not go to work (begging) he makes no money.

If you think about it we all are trying to be somewhat financially independent by retirement. We try to have enough saved so that we no longer work, but have enough income coming from stocks, bonds, and investments to live on. The one catch is that we also hope for social security which makes us very unindependent.

So back to my goal of being financially independent. This is a great goal, but the question is how to do it? Well one thing I have learned the hard way is that this is going to take some time and it is not going to be easy.

One of my first attempts at this was to invest in Oil and Gas Joint Partnerships. Basically companies put together a group of investors to fund the drilling, completion, and production of an oil or gas well. In this case I have had some success and some failures. One interesting note is that I have been left with some concrete assets in the process. I still have two ventures that I do absolutely no work with, but which I get a check every month. This is the definition of passive.

The problem with O&G Partnerships is that they are very hit and miss. You really need to invest large amounts of money spread over many projects to reduce risk. I do not have enough money to do this right. It also will not make you rich. This is my key discovery. The returns of some projects can be huge, but because you need to spread out the money the net returns of your overall investment is much less.

If I had a lot of money sitting in a pile I would invest 20% of it in these projects as net overall I would make a decent return on my money. But earning 20% does not get you financial independence. Also to do it right you either need to hire someone to find and invest or you need to do it yourself which then is a job.

What I have learned is that I need more control over my money. I cannot just hand it to someone and expect them to make me money. There just is no incentive for them to do well with my money.
As a result of this experience my conclusion is that to achieve financial independence I need to start my own business. But what business and how do I do it? Well more to come in my next post.
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Exited the qqqq's

While i needed to go out of town and did not feel comfortable leaving my long qqqq positions on so i exited Friday of last week. We still appear to be in the same position as last week. We may be forming a double bottom on the nasdaq 100. We also may be forming a double bottom on the S & P 500 as well. In this case the double bottom would be distorted in that the second low did not make it all the way down to the first low. This is actually a position sign.

Before i rush out and buy a bunch of stuff i need to understand if this potential double bottom is different from the one put in on March of last year. One difference is that at that time the 50 day moving average was above the 200 day average. This is a more general bullish indicator for longer term institutional investors. Right now things are different in that the 50 is below the 200 and both a pointing down. Another differnce is that in March the market was in a consolidation period for 3 months before the double bottom formed. Right now we are clearly in a decline not a consolidation period.

My guess is that if the bottom forms we have limited upside potential. I keep trying to figure out what is the near term target we could expect. Getting to 13000 on the dow seems the furthest we could go at this time. What is the impetous to get to 14000 again? So for now i will sit out and watch. I do have a small gold position i am sitting on. It is starting to look like a symetrical triangle is forming. Although this will be smaller than the one that formed in Nov-Dec of last year, this sets up for a possible further rise. As always we don't know until the pattern completely forms and then breaks out. If it breaks lower then i'm out.
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long and strong? Not really.

Well i started taking some light long positions in the qqqq's today. I am doing this because we are in the process of testing the January lows in this ETF and i believe it is likely we will see a bounce here. I am not very confident as this market is brutal, but I'm stuck dipping my feat in somewhere.

I think the biggest concern I have is that the nasdaq 100 (qqqq etf) is the only major average that is at the January low. The S&P 500 and dow jones industrials still have some ways to go before hitting the lows in January. So we have a divergence here. The fact is the tech stocks as represented by the qqqq's have been beat up a little bit more than the rest of the market. That is why they are already back to test the January low. So will the tech stocks lead a bounce here or will they mark time while the other averages decline further to catch up? This is impossible to say, but i do know we are at some significant support on the qqqq's.

If you look at the January low it was a little below 42, but this is also the low put in on March of last year. In March a strong double bottom formed and the ensuring rally raged all the way to 55. Given the level of support going all the way back to March of last year and the action today which saw a significant rally before the bears took some shots, I think that this level is not going to just be sliced through without a fight.

I'm not calling for any long term rise in stocks from here, even though you can see if this level holds you could form a double bottom, I'm just looking for a rapid short cover rally which should last no longer than the last one. If we break 42 we have to bail.

The other concern is the bond insurance companies. If more finally get downgraded or someother really bad news comes out this could trip things up pretty good. But i have to think that some of this is starting to get priced in.

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walking away and the quitclaim deed

I am reading over and over again the efforts of some counties to force banks or homeowners of homes that have been abandoned to pay to clean or keep up the place. In the case of a homeowner who has stopped paying a mortgage and moves it is not always the case that the bank takes the home back.

You as the homeowner own the home. It is titled in your name. The urban myth that the "bank" owns the home is not true. They have a security interest in it, the mortgage, but do not own it. Just look at the county title records for proof of this. The result of this is that if you abandon the home you are still responsible for it until the bank formally takes it back. But what if they don't?

There are more reported cases of banks not taking the homes back because they "lost" them or just don't want to pay for the process of getting them back. So who owns it? Well the original homeowner still owns it. As such you are still responsible for taxes and upkeep. In these cases homeowners are being dragged into court to pay maintenance costs the city incurs to keep the home from becoming dilapidated.

So if you are considering walking away what can or should you do? Well first you need to consult a lawyer and a CPA. You need help on the legal and tax consequences of the decision. In addition one small thing to consider if you live in a state that has this type of deed is the quitclaim deed. In California the quitclaim deed simply states that the grantor (the homeowner filing the claim) gives up any interest in the property. Now I am not a lawyer and am not giving legal advice, but the point is this may help assure you have at least a record that you gave up all claims to the property.

In this case it may create many weird issues because this deed just releases claim to the property, it does not really transfer interest such as with a grant deed. So when you bought the place you got title via a grant deed, you relinquish title, and then who has title? I'm sure the lawyers would have a field day with it.
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ps - see a lawyer if you are considering walking away. if you do this you cannot undo it. So if things should turn around you won't be able to claim ownership or sell it or anything else.

They shot csco today

Very interesting after hour action in cisco. I was listening to the first part of the conference call and everything was fine. They made the numbers and the stock was rising a little. I left and came back an hour later to find out it was down 8% or so. The crux once again was guidance. As usual lately the guidance going forward was tepid. It is unlikely any company can escape the negativity right now. The crux is that the E in the P/E ratio is open to interpretation and is not very reliable right now.

This is great news for me as i'm short right now. As always the difficult part for me is to switch over to a more bullish tone when necessary. I'm starting to think that some of these stocks are really getting cheap, even if you whack off 20% in future earnings. The problem with bear markets is that you can never tell how far down we will go.

So i will look to the charts to show the way. If we hold the recent lows we could setup for a nice double bottom which could lead us into a steady increase in stocks over the next few months. This sounds counterintuitive, as we will still be in or just entering a recession, but it is just too easy right now to just short any stock before they report and make a chunk of money. This game will get played out soon.

As far as all the old and new horsemen? I think they all are dead.
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I can only hope more people ... walk away

More stories of people walking away from their homes are making it around the news these days. My first reaction was that wow these people are irresponsible. Many of them knew exactly what they were getting into when they signed on the dotted line, but now that the house is going down in value they are walking away, even if they can afford the payments. The people i am talking about are generally not sub prime because they otherwise have good credit and as i said, they can afford the payments. In these cases they choose to not pay.

There is a pro and a con to this situation. On the one side the fact that these people walk away is a good thing. Look the fact is that for them to stay they will basically have to dip into or in many cases wipe out any meager retirement savings they have. This will just create the next big disaster when all these people reach retirement age and can no longer work, but have no money saved because they tried to save their house. There already are cases of this. Since your house is a liability and not an asset, giving up the few assets you have to save a liability is a recipe for disaster sure to be followed by a steady diet of dog food come retirement time.

The bad thing about this situation is that the investors must be pissed. Look if i bought a mortgage security with the understanding the rate was going up and it was low risk because it was "independently" rated AAA, how do you think i feel if you freeze my rate or the borrower just walks away even if they can pay? Furthermore how do i feel if you prevent me from foreclosing to try to recover my losses?

See what the dumb dumbs running the show are not telling you is that the last few years of the real estate boom were a lie. They were fabricated out of really easy lending standards and cheap money coming from foreign investors. Could you have had the boom without these foreign investors buying these securities? The answer is clearly no! So what do you think is going to happen when you try to go to all these investors that you are screwing over for more money? I'm sure you will get the middle finger.

The point is that the credit bubble is not going to be fixed anytime soon. The investor side of the equation is such that they will not lend again soon. I imagine many dumb pundits on cnbc would give some lame excuse why this is not so, but remember they are just plain liers. Even if they do start loaning again they must charge much more to cover

1. extra risk due to possiblity of the government freezing rates or changing the terms of the loan agreement after the fact.
2. extra risk due to the new acceptance of walking away
3. extra risk to cover legal costs to make sure you have actually recorded title correctly
4. extra risk due to lack of available 3rd party insurures.

Inspite of the negatives of people walking away i view it as a good thing in the long run for the country as a whole. The reason is that it highlights an acceptance of a misstake and a willingness to move on past it. Trying to hang on to a home that is depreciating even if your rate is frozen makes no sense. The home is not magically going to be worth more 5 years from now.

One interesting note the rate freeze proposals. Think about number 1 above. One of the key benefits of doing business with and in the US has always been our stable legal system. The rate freeze just wipes out one of the benefits of doing business in the US and makes it a liability. If you think about it how can you make an investment here if the government can come in after the fact and just invalidate your legal contract? The answer is you can't do business here. I think this under reported fact will effect our economy for decades to come

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unwise moves

I find it very frustrating that my Dad who is 73 years old just moved some of his retirement money into a group of mutual funds that are invested in various stock markets. Given his age and the fact that he will need the money (possibly soon) this is obviously bad advice. Now i know my Dad and i understand the way the conversation probably went down with the guy that sold him the funds, but there still is no excuse.

Dad: So what is the return i get now on this garunteed principal fund?
Sales Guy: Oh it's 4%
Dad: Well that's not good. I need to get more.
Sales Guy: Well we have other funds ...

Any financial advisor / salesperson should understand when someone in there 70s is telling them to put money they may need soon into the stock market, this is not a good thing.

Even if you are a die hard buy and hold guy, you should understand that at some point you must exit the stock markets as you cannot predict the near term gains (losses). Since you are in or near retirement you do not have time to recover any losses should they occur. The net effect is that my Dad is sure to lose a decent chunk of money. He is going to check on it by looking at his statement in 90 days. Well by then who knows where he will be at.

Given that the dow 30 has dropped 13% as of this writing from the October highs it is easy to see how much damage can occur in a short period of time. Also given the nature of the world financial markets, which are becoming more correlated, it is difficult to diversify your way out of trouble.

It's interesting how i can lose out to a sale's guy. Who are you going to listen too, your son who loves you or some guy selling mutual funds. Well the "some guy selling" mutual funds won out.

I hope we get lucky and he only loses a little bit. That way he will take action to unload into some investment more appropriate for him. I just shutter to think of the fees. If they charged him loads i will really be teed off!
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Google implosion

Well the 1 google put paid off nicely. I purchased at $22.60 on 1/25 and sold for $50.80 on 2/1. For a net gain of about $2800. The amzn puts were a different story. I was involved doing other things so i ended up holding on to them. This was a big misstake as it recovered most of the losses. Currently i am down about $350. I will look to unload at the most timely price i can this coming week.

In both cases a not bad quarterly result was sold off agressively. So far it looks like the goog drop will stick a little more than the amzn drop did. So what we are seeing is multiple contraction. From my previous post where i talk about the PEG ratio you can see that any reduction in the estimates going forward can have a great effect on what investors are willing to pay for a stock. We saw this with apple and many other former highflyers.

I currently put on some shorts, but i have to admit i'm concerned i might be wrong. So my position size is relatively small. On the S&P 500 we are coming into the previous support area near 1400. This could offer serious resistance, but i think we need some negative news to inspire the market to sell-off from this level. If there is little news this week then it is possible the market will keep advancing through this resistance. And it could actually cause a short squeeze.

On the other hand we could get more news on the mono line bond insurers. If they do get downgraded that could instigate a sell-off.

The bigger picture is that there is more bad news to come and this will continue to pressure the market. It is most likely that one or more homebuilders will declare bankruptcy and that one or more smaller banks will as well. At some point in the future when the Fed get's the rates down to 2% or so; bad news will pop out from somewhere. Then The Fed will be powerless to do anything about it and the market will know it. If dropping rates from 5.5% to 2% didn't "solve" the problem how is dropping rates to 0% going to help?

We will see but for the next year i can only see a negative bent to things. The debt bubble needs to unwind, consumers need to clean up their balance sheets, which means they need to cut back a lot. All the Fed's latest moves do is encourage people to borrow more, but they are already tapped out. If you cannot service your current debt load how can you borrow more? You can't. You must cut back even if the rates are really really low.

We will see how things play out. The markets tend to have nothing to do with the real world so you could have a rally in the stock market while the average Joe is struggling. So never buy the story, just watch what the charts are telling you.
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interesting day

When i bought the 1 google put i forgot to buy my 1 amazon put at that time. Fortunately today Mr. Market gave me an opportunity to buy 2 at a good price. Looking at the amzn after hours it looks like it will pay off. I have to admit the google put is a gamble. But i'm working with bear market rules which losely state good news is bad, bad news is horrible, and great news is just a lie.

We will see what happens but looking at the market sell-off of the post fed cut rally i believe i have a greater than 50/50 chance of it paying off.

It's looking to me like we had a little rally into the declining moving averages and as such the decline is to continue for now. We will see about tommorows job numbers. Whether they are good or bad my guess is the birth death model will have a heavy effect.
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walking away PII

One point i forgot to make in my last posting was that, while the pundits and permabulls were dismissing any concern about a housing bubble, the sources i was paying attention too were highlighting the nature of the bubble and the consequences. Who was right?

Well the issue is there are always permabulls and permabears in any market, housing included. So who do you listen to? Well neither. You should read both sides and decide for yourself. But frankly i pay attention to those who see both sides of the issue. In this case Bruce Norris is the definitive resource about the housing markets, especially in Southern California. While he was recemmending sell, morons like Jim Cramer were pumping the home building stocks. Who knows more about it? Not Cramer.

This also highlighted for me an interesting thing. Cramer was pumping the homebuilder stocks basically out of a lack of understanding of the industry and many of the challenges it faced. One example was that Cramer was stating that builders only build what they sold. Well not true. What about the 40% cancellation rates? And why are they still building even now? The anwser is that they are stuck finishing a project due to commitments, insurance, and a myriad of other reasons pointed out by Norris.

While these minor little details seem unimportant to the big picture, they are. Why? Well the fact that builders must finish what they started means that they are forced to keep building inventory into a declining market which exaserbates the situation. It is a key in understanding when to buy real estate or the homebuilders.

In my case I got married and we ended up selling both our homes. We still have the nut there and we are renting. In this case we did not time the real estate market we just looked at the facts. Should i rent this condo? No it was a losing proposition because rents would not cover the mortgage plus taxes AND i could sell now two years after my wife bought for nearly twice what she paid. Should we buy this house (and moreover rush to submit an offer in 1 hour)? Well no. Because we can rent a better place for half as much money each month.

So in some ways you only need to use your own common sense. Run the numbers yourself and you will see the right thing to do. The numbers will tell you when it makes sense to buy a house. They will reveal that "hey i can buy for the same price i rent and get the tax benfits". That is when you buy (think how far we need to come). To summarize be very careful where you get your information from. It can really hurt you if you are not careful.

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walking away.

I remember only a few years ago the pundits and otherwise morons talking about how the resets in home mortgages, although a problem for some, would not be a problem in general. They claimed that most people could handle the increased payment and would do whatever it would take to stay in the home. Well 60 minutes just dispelled that myth last night. See this blog here for a good discussion: http://globaleconomicanalysis.blogspot.com/2008/01/60-minutes-legitimizes-walking-away.html



The crux is very simple. Even if you could pay the mortgage why pay it? Why struggle to pay it and sacrifice to hold onto a house which is loosing value? The answer for any rational person is you stop paying. Although it is difficult to determine the exact declines, for most people in this situation a quick back of the envelope calculation would reveal they lose more each month than the pittance that actual goes into equity. This assumes you are actually building equity, which does not apply to those in the interest only stage of their loan.



But some would counter what about your FICO score? Well the people in this situation have already done the analysis and figured the hit they take is worth it. Also they realize that their credit cards or at least some of them won't be canceled so they can still get by. But this brings up a very good point. These people realize a foreclosure will bring a mark on the record that may prevent them from buying a home for the next 7 to 10 years. And the point is they don't care. So they don't care and will not be in the market to buy a home again for 7 to 10 years. So what does this say about the recovery and next real estate market boom? It's a long way off!



I do not believe the 60 minutes story is an isolated incident. In our neighborhood we have the same situation. A family that certainly can pay the mortgage let the NOD get filed. I was not aware of this until recently, but my guess is they stopped paying the day they bought a nice new Cadillac SUV. Mind as well buy the car while it's easy ...



The crux of the matter is that this part of the American Dream is a lie. Ala Kiyasaki (Rich Dad Poor Dad) a house is not an asset but a liability. This episode in our history should teach people that. It's not that we should not aspire to own a nice home or a nice car, but we most aspire to truly afford a nice home or nice car. Only if we can actually afford it do we buy it. What is a good indicator of being able to afford a home? Well how about you can put down 20% and your income meets the 28% front end ratio (Monthly Housing Payments/Gross Monthly Income) and the 36% back end ratio (Total monthly expenses/gross monthly income). Oh is this not fair?



Well how about this. What happens to all these people who did not meet these requirements and bought homes only later to be foreclosed. How many lost ALL their retirement savings trying to save the house? See the next shoe to drop is the devastation this is doing to peoples preparedness to retire. There is only one way to sum this up.



It is really really bad.

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But what about my dog!

Now I'm reading stories about sending payments to retirees. It's not that i have anything against retirees, as my Dad and all my Aunts and Uncles who all participated in making me who i am, are retirees, but please why not send a check to my dog.

The crux of the matter is this money proposed in the stimulus package is being made up out of thin air. As such it devalues all the other money that was created out of thin air before it. The way to clearly see this is look at the price of gold in dollars and look at the dollar index. What you see is the consequences of making all this money. The cost of it is the rise in prices.

So will these checks make up for the steady rise in prices due to the declining dollar and the rise in commodities, which all are linked to the rapid creation of money? The answer is most likely not. If you have paid an extra $50 a month for gas and an extra $50 to heat your home and an extra $20 a month in food price over the last two years what did that cost you? 120 x 24 = $2880. So if you get $1800 back, assuming a couple, you are still in bad shape. And since the markets have responded to the announced stimulus with more rises in gold and more commodity price increases you can be sure that there is more inflation to come. My guess is the price increases to come more than offset what the average Joe gains from the rebate.

The point is you don't get something for nothing. There is a hidden cost to this stimulus package. You mind as well just admit it is insane and give checks to cats, dogs, and pet reptiles as well. Hey Petco needs to get some of the money too!

I suppose the thing that pisses me off the most about these checks is that the government is just plain asking you to do the wrong thing with it. They want you to spend it. They don't care if you are already in over your head in debt, your job is in trouble, or you are facing serious illness, they just want you to spend, spend, spend. I think it is pathetic that if you teach your children to take the governments advice they are doomed to bankruptcy ... well if they can still actually file for it. Disgraceful!

I will add the check to my rainy day fund which looks like I will need before too long with the clowns running the show right now.
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The qqqq's apple problem ...

I'm not an expert on how the NASDAQ 100 index is calculated but the other day i looked at the "holdings" and was shocked to see the percentage of the index made up of apple. Checking here
http://www.powershares.com/products/overview.aspx?ticker=qqqq

we see that apple by far dominates the index by making up 10.74% of it currently (note this changes daily). We currently have the case where the qqqq is a slave to apple. When apple does good so do the Qs, but when it doesn't the Qs will have trouble overcoming the pressure applied by aapl.

Other NASDAQ-100 holdings
Apple Inc. 10.74%
Microsoft Corp. 6.95%
Google Inc. (Cl A) 5.34%
QUALCOMM Inc. 5.17%

From the NASDAQ website i see that they review the holdings quarterly, but given their criteria for doing a re balancing aapl would need to rise to 24% of the index before this would be done. I always thought of the qqqq's as being one of the more balanced ETFs, but this is not the case. It is almost like you should not bother with the qqqq's and just buy appl instead.

This highlights that for ETFs it is critical to check the holdings. They often are not as diversified as they sound. If you were for example under the belief that apple will continue to decline for company specific reasons, but all the other large cap tech stocks will do well and because of this belief you buy the Qs, then you will not perform as desired. That aapl component in the Qs you bought will restrain the gains you may see in the other stocks.

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A little bit of a gamble?

Or a sure thing? Today i purchased one Google put. My logic, or lack their of, was that they have been one of the annointed 4 horsemen of the market like apple, and given the beating apple took after they met numbers and lowered guidance i believe there is a reasonible chance Google is due for the same outcome when they report next week. It is also interesting that apple did get beaten up pretty bad before they reported, just like google is now.

Now given that buying or selling a stock right before they report numbers is more akin to gambling than trading i have bought only 1 lonely put option. But given that 1) we are in a bear market and as such bear rules apply, such as good news is bad news and bad news is horrible news; 2) Google is priced to perfection in terms of the expectations for growth and as such any lowering of the forcast will have a significant effect (see my earlier post about the PEG ratio); and 3) from a technical basis goog is breaking down and the rally yesterday looks like a great short entry because it rallied into the declining moving averages.

Check back next Friday for the results.

the fear shows it's face today ...

It looks like the shorts got a little panicked today and rallied the market to the close. What? Don't you mean "bargain" hunters came in and bought the market? NO!

To understand this you must understand what it means to be bearish or a bear. A bear believes the market will go down and furthermore a bear usually positions himself to profit from this decline in the markets.

The current markets have been controlled by the bears and are STILL controlled by the bears. As a bear you tend to short the market. This means you borrow stock to sell. You hope to profit by buying back the stock at a lower price and hence profiting. This is a really hard thing for novice market players to understand, but critical to understand what is going on right now. You sell first, then buy back the stock. You must buy back the stock at some point and if the stock keeps going up your potential losses are infinite. So when you are shorting you must be careful and quick on the buy trigger. You do not short and log off your computer for a year.

My guess is the pace of recent declines had some wanna-be shorts enter late, like Friday and Tuesday. These shorts are in a risky position because we are nearing some major support levels and we have already had such a large sell-off we are very oversold. So my guess is that as today went on and there was no continued sell-off they realized we were not going to crash. Slowly as some of the longer term shorts started taking profits the short term shorts rightfully panicked. Hence the rapid 300 point rise in the last hour or so. Bargain hunters are more apt to buy a little over time and will try not to rally the market. They have big money and are not as agile. There is with no certainty that you can say this is exactly what happened but it is more plausible than saying bargain hunters rushed-in. You have the tape and that is all you have to try to figure out what is going on. The tape points to a short cover rally.

Why is this important? Why is it important to know that it was shorts covering vs. bargain hunters? Well if bargain hunters did come in that would be a more positive sign for sustainability of the gains. The reason is the true bargain hunters have a longer time frame in mind than the bears covering their shorts. The bears are just as likely to enter tomorrow again with more selling. The point being. True bargain hunters portend a stable sustainable bottom, shorts covering portend more declines to follow.

If you look at the fact that shorts face infinite losses, you can easily put yourself in their shoes and see how they could quickly be faced with the need to buy at ALL COST. Buying into a 200+ point rally is more likely to be someone covering a short, than a bargain hunter.

So what you are seeing is fear driven buying vs. fear driven selling. The reason there is a lot of volatility right now is that it is a bear market which by definition is controlled by the bears. Since the bears have very itchy trigger fingers they move the market very fast both ways. It's chasing greed on the way down and fear on the way up.

Don't get caught in false rallies. There are many people short now so i would expect a significant rise over the next week or so, but to me it is a shorting opportunity as this is not yet done. The bear market is just starting.

When it comes to being a bear, i frankly am an expert. I have been mostly bearish for many years and as such when i talk about what the "shorts" are facing I'm really talking about me.
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It had to happen ...

Apple imploded yesterday. Fortunately i had no position in it. As one of the "four horseman" it is significant even though it had been getting pummeled for several weeks. The crux of the matter is that growth has slowed. When growth slows growth stocks get hammered. Why is this? Why do stocks with otherwise small outlook changes get hammered? The reason for this can be seen in the PEG (Price to Earnings Growth). The PEG Ratio provides the rationale for paying what seems an exorbitant price for current earnings. The "Annual EPS Growth" rate becomes a multiplier in determining price. Lets look at the PEG:

Price /Earnings
PEG Ratio = ----------------------
Annual EPS Growth

So let's say you have a stock trading at $100 per share that earned 2$ per share (trailing twelve months) P/E = 100/2 = 50, and is growing at 50% annual rate. The PEG ratio is:
PEG =50/50 = 1.

So in this case the market is willing to pay $50 per $1 of earnings because the growth rate is 50%. Another way to say this is the market will buy the stock to a PEG of 1.

Now let's say they meet the numbers but revise the outlook down such that the growth rate slows to 40%. What do we have. Note the P/E did not change as they met the numbers (a little bit simplified i admit).
the new PEG = 50/40 = 1.25

But the market still may only pay up for a PEG of 1 so now the stock is overpriced. What does the price go down to? We can solve for price and get this equation (note we use the orignal PEG the market was willing to pay aka 1, with the new Annual EPS Growth value)
P = Earnings x Annual EPS Growth x Orignal PEG = 2 x 40 x 1 = $80

So this is how a "rational" market gives a stock in a good company, that only guides down a relatively small amount, a big 20% haircut. If the PEG was used to value the stock lower and push the price higher on the way up in EPS growth it has to work the otherway around on the way down.

So we see that for growth stocks the Annual EPS Growth estimates are critical to what the current price of the stock is. It is literally a multiplier in calculating the current Price of the stock. As such it makes growth stocks highly subject to wide changes in price due to relative small changes in outlook.

Be careful.
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Big misstakes

Today i made serveral big misstakes. To start I was not positioned well going into the open because i had some call options from the Friday before. It was not a misstake to have these calls, as these were small reasonable bets given the previous week's action. The first misstake was to sell these immediately upon the open. I should not have done anything right away as given the size of the gap down the odds were that we would rally after the open. Frankly Mike Swanson called this perfectly last night here.

http://www.wallstreetwindow.com/content/node/5677

Next i tried to go short via some puts. This just obviously was chasing the markets, which is always bad. In my defence i was thinking i would not be able to get in on the short side if i did not move. I was concerned we would hit a circuit breaker. But in hindsight this was just not the right thing to do.

The one good thing about all this is that from the peak of 14000 or so on the DOW Industrials i have been able to make money and have dodged the entire decline. So while i took a 4% loss today i have dodged a larger 15% decline i would have taken if i had been blindly long and strong.
I also am hopefully now positioned a little better to deal with the potential snap back rally we should have.

Right now the shorts might be really annoyed if they did not take their profits yet. I know i would be. This opens the possibility of a short sharp, although temporary, rally from here.
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Really poor performance by the brokers today!

It's bad enough to have a tough day in the markets, one in which you have made some misstakes, but on top of that my broker just plain stunk. In this case the popular online broker here referred to simply as TD was just plain horrible. I was unable to login for nearly an hour. In addition some of my orders where just disappearing.

Now i understand the volume today was very large, but i had the same issues back in August during the last bottom/crash. You would figure they would get it together and be prepared. They certainly new this was going to happen given the overnight declines in global markets.

It is just plain unacceptable to have these problems given today's technology. I will seriously be looking for a new broker.
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Protect yourself

While the market sell-off has been sever and has left us oversold by many indications, there is still potential for more disastrous declines. The global sell-off today highlights this risk. The global markets appear to be more correlated than ever with the US markets. What really is happening is that the world is losing some faith in the US financial system.

Why is this? Well it started with the sub-prime mess. At the root. The entire wallstreet machine setup a fraudulent system to make money at the expense of homeowners and investors. The homeowners were the chumps who went into debt and the investors were the chumps who bought the debt. In between wallstreet made billions packaging these debts. They profited by selling them here and more importantly abroad. The reality is that much of the housing boom was funded with foreign money via the sales of securities abroad.

As investors abroad realize the losses they lose faith in anything wallstreet has to offer. This is because they were lied to by wallstreet and the rating agencies who rated otherwise crappy debt as AAA. If wallstreet is capable of lying on this scale about these mortgage securities are they not equally capable of doing this in the stock market. Since the modern stock market is held together mearly by faith in the system, any distrust is a serious issue.

They tell you owning a stock is owning a piece of a corporation. On the surface this seems like a great thing. But in practicality due to the nature of today's markets and due to the fact that most stocks pay little if any dividend, what you are buying is virtually worthless. The only reason you pay so much money is that there is a belief that it is worth something.

Now i know these statements are almost heretical, but let me explain. If i make an investment i need to get a return on that investment. The return i expect is regular cash payments that over time will return my entire principal and a profit. Many years ago this is what you would get, in the form of dividend payments, from the purchase of a stock. Based on this you actually could invest in a stock and the stock market. But since most stocks pay very little in the way of dividends what should i pay for them?

Now you are told "but they will appreciate over time?" Well the answer is maybe. No one knows for sure and "past performance is no garuntee of future profits." In some ways the current stock market is not an investment vehical but a speculation vehical. We must remember that an increase of sales, earnings, or anything else like eyeballs (from the late 90s) does not directly translate into a return to the investor. Since you cannot buy the whole corporation you cannot get at the benefit the increase sales or earnings brings. Dividends are the only direct payout to the investor (and yes i understand the theory behind buybacks).

The simple point is that we have another lapse of trust in wallstreet. It will take time for it to blow over. As the crisis spreads from subprime to alt-A to prime to credit cards to car loans to cable bills you will only see more of this. In each case the defaults will rise and unethical games in how the system works will be exposed. The distrust will continue.

At this time i have a few long positions i took because we are at support on the dow 30. But i may need to reverse this depending on the opening action on Tuesday. The big picture i see is that it is still all down for now, so any rally is a short entry point with the caveat that there could be a big, although temporary rally, on an intra meeting rate cut. That is why i have some small long positions right now.

But back to the main point. Protect yourself! The risk is just too great to be sitting there long hoping things don't get worse.

I do find it interesting how this is playing out. When i look at valuations on the S&P i don't see them as overvalued. As such it would seem ludicrous to think we could have a market crash. But the key is that the E part of the P/E is totally open. With 20% of the market financials and financials being the life blood of all other industries, any drop in the E estimates can suddenly make the undervalued market look very overvalued.
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The limiting factor

I was watching a TV show recently about the incredible increase in computing power and the concerns that someday computers could be smarter than us and destroy us. What i found interesting was one part that was referring to Moore's law, the statement that computing power doubles approximately every 2 years. But what everyone seems to miss is that by definition Moore's Law must come to an end. Why? Because at some point you cannot make things any smaller.


Being in the chip design business i have seen first hand the progression of Moore's law. But with each generation of process technology the problems get more difficult to overcome and the costs continue to sky rocket. The original law has changed from doubling every 18 months to the current 2 years. There is discussion the law will need to change to a doubling every 5 years. This pushing out of the "schedule" highlights the challenges involved and brings into question when and if it ends. But it needs to be noted the death of Moore's Law is both a technical issue and the financial issue.


On the technical issue. The dimensions of the devices are getting so small that the components being made on the chip must be measured in widths of atoms vs. nanometers. At this size quantum effects are the order of the day vs. conventional EM theory. Does a wire only 50 atoms wide act as a wire? The answer is maybe?



In addition can light be used to image the devices at these dimensions? Again the answer is maybe? Although in the lab we can move individual atoms with very expensive equipment, we cannot and most likely will not be able to manufacture the millions transistors at this scale.



The solution appears to be carbon nanotubes. They have the potential to solve some of the technical issues, but they are not yet mature. And if they do come into use, they do not scale. The size of the carbon nanotubes will not shrink significantly over time. Another problem with carbon nanotubes is revealed by recent studies of ill health effects (http://www.sciencedaily.com/releases/2007/03/070330185008.htm). This brings into doubt how quickly this technology can safely be deployed. The simple way to understand this is you cannot shrink an atom. So even if you magically got to the point you could make a transistor out of one atom, you could not go further.



Here is a link to the latest available road map. The challenges described to continue Moore's Law are very daunting in deed. http://www.itrs.net/Links/2007ITRS/ExecSum2007.pdf


The cost issue is the other limitation. Only Intel and a few other companies and groups can afford the latest 45nm fabs. At a 3-5 billion dollar cost they are the only ones that can make it pay. This will also limit the speed of integration as it will take longer with each generation to reach break even on your investment. Companies will be forced to stay at a larger generation longer even if they posses the technical skill to move on. In addition the mask costs continue to sky rocket. They currently are over a million dollars for the latest devices.


The crux of this is that i think there is a natural limit to the scale we can reach. Let's call this Mike's Law. My educated guess is that Moore's Law will fail no later than the year 2018 at the 18nm process node for technical reasons. However it may fail sooner for financial reasons. So what effect would this have on the semiconductor industry and all the other industries that rely on ever increasing advances in computing power.



At the expiration of Moore's Law the semiconductor industry will be mature. Therefore all industries that rely on it will also be mature. You will see the stagnation of the software, consumer electronics, and all Internet related industries. Fundamentally this ever cheaper and more powerful chip technology has driven growth in all the tech and consumer sectors. If the chip companies cannot provide more for less anymore then there can be no new computers, software, phones, and consumer products. Look why buy a new phone or computer if the new ones don't offer anything more than the current ones. These products cannot offer anything more since the underlying chip technology cannot advance after the end of Moore's Law.


I know this is a stretch for most people as we have been living with Moore's Law for so long, but it is just common sense to know it must change. As far as the replacement, there is none. Carbon nanotubes, quantum computers, can only offer a one time step down in size, one last burst of increased integration before there is no where else to go.



Going back to the doomsday scenario of machines out smarting us? Hopefully the Mike's Law limit will be reached before machines become self aware. I can only wonder if this limiting factor is God's way of saving us from ourselves.


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Understanding it.

As you will find out, much of my time is spent dealing with the stock market. I thoroughly enjoy trading and furthermore see it as a requirement to achieve my retirement goals. I started watching the stock market in the late ninties when the tech stock mania was in full force. I can remember buying a little superconductor tech company and watching the price go from $5 to $30 in a week. At that time you could buy anything and just wait. Sure enough it would be your turn to catch the wave. Like most i lost all of the gains and then some. Ever since i have traded, invested, and studied the markets.

I have gone through different "understandings" of how the markets work or how i thought they worked. I believe now i am finally starting to get it. To really "get it" you have to tune out most financial advice given on radio, tv, and print. Here are a few things i finally understand about the stock market and more importantly the advice you get about it.

The first thing to understand is most advisors are not advisors but salespeople. They really are only interested in selling you a product. That product being stocks in some form. It could be a solicitation to manage your money for a fee, to sell you a mutual fund, or to give you a stock pick. The real goal of any of these products is not to help you retire, but to make the seller and various associates money.

The second thing to understand is that most pundits you see or read consider themselves spokesmen. As such they feel they must always promote the market even when doing so will lose you money. Look at most of the shows on cnbc for examples of this. Also understand as well that all government officials from the president to the the chairman of the Fed will always lie to you and say everything is fine when they know it is not. This stimulus package is not happening because everything is fine. It is happening because they already have the preliminary numbers and know we are in a recession.

Third you must understand that stocks and the stock markets have cycles. These can run over very long periods, these cycles include periods of serious decline, and as such only buying is seriously restricting your potential gains and furthermore even threatening your ability to retire. If you think about it. It is nonsensical to think you should always ride out declines.

Fourth understand the truth about riding out declines. It is simple math to understand that if you lose 20% you need to earn 25% to get back to where you started (see chart below). This is because your increase is on a smaller amount of money. If you lose 50% you need to earn a 100% to get back to even. The question. Is it more important to make money or not lose money? Obviously it's more important to NOT lose money.

So what to do? When i hear advice i only pay attention to people who go both ways. What do i mean? If the person espousing advice is always short or always long i know they are dangerous. I only pay attention to those who are recemmending to go long and short, depending on what is happening in the markets. I only listen to people using technical analysis to make decisions. What i have found is that charts don't lie, people do. A great story will not stop a stock from imploding.

I have learned that most things in life do not come easy. It offends me that the entire financial investment community is telling you that it is easy. Just give us your money, keep giving it and everything will be fine. Everytime i see someone in their 60s or older working at a burger joint, i know the lie is exposed. My retirement and financial future is too important to blindly hand over to others.

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