Are you being Fooled by the Numbers?

Fool me once, shame on you; fool me twice, shame on me

US Labour
The Department of Labour reported the following:

• initial claims was 492,000, a decrease of 94,000 from the previous week's unrevised figure of 586,000
• advance seasonally adjusted insured unemployment rate was 3.4 percent for the week ending Dec. 20, an increase of 0.1 percentage point
• advance number for seasonally adjusted insured unemployment during the week ending Dec. 20 was 4,506,000, an increase of 140,000

The positive spinoff was that the rate of unemployment declined. Remember though that in December, people are in holiday mode.

GM Rescue Unwise
The Treasury Department said it would invest $6 billion to stabilize the troubled company. This would seem to be good because up to 25% of buyers were unable to make a purchase because loans were not available. GM is announced that it would offer financing as low as zero percent for up to five years on select new cars and trucks.

Lax lax financing in the banking sector for homes resulted in foreclosures. GM is now accumulating consumer debt, hoping to increase demand until the economy improves. The risk is that the economy does not improve in time for GM.

It seems to be smoke and mirrors. It is like giving vitamins to someone who has a flu. As I stated in a previous entry, GM should still be worth zero.

U.S. October Housing (Some real numbers)

• Prices fell 18 percent in October from a year earlier, according to the Standard & Poor's/Case Shiller Housing Index
• Prices fell 2.2% month-over-month
  
• Only 2.5 percent of Americans say they plan to buy a home in the next six months

Although there has been Santa Claus Rally over the past few days, volume is light. On the plus side, volatility has declined substantially since mid-November when the Dow hit low numbers. Still, the economic numbers are very grim as the markets enter 2009.

Arguments for Deflation - From John Mauldin's Newsletter:

See below. I have high-lighted text most relevant for the investor with a long-term approach to money management:

Now, I argued above that the Fed is not really expanding the money supply, so far. But within a few quarters, we will be facing outright deflation. The Fed is going to monetize at least a portion of what will be a $1+ trillion dollar US deficit. They have announced they are going to purchase $800 billion in mortgage-backed and other types of consumer loan assets. That will be a direct infusion of dollars into the economy. That is serious monetization. But they may feel they have no choice if they want to keep the US economy from going Japanese.

When someone becomes a Fed governor, they take them into a back room and perform a DNA transplant on them. They come out of that room viscerally, almost genetically, focused on preventing deflation from happening on their watch.

How much monetization will be enough to halt deflation and overcome the slowdown in the velocity of money and the rise in personal savings? No one knows. There is no fancy equation or model which can encompass all the factors, or at least not one I know of.

We will also soon see which of the additional deflation-fighting policies that Bernanke outlined in his 2002 "helicopter" speech the Fed will adopt. It is highly likely that we will see more than a few of them. It is quite possible that we will see the Fed start to set rates on longer-term bills and even bonds in an effort to pull down longer-term rates for corporations and individuals.

We will explore all the deflation-fighting options and what the results might be in future letters, but remember that there will come a time when the Fed will have to "take back" some of the liquidity they are going to provide. That means we could be in for a multi-year period of slow growth after we pull out of this recession. And this recession could easily last through 2009.

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

Counter-argument for the Small-Cap Sector

Don Vialoux mentioned in his newsletter today that there is seasonal strength for the small-cap sector:

Small Cap stocks on both sides of the border are recovering following the end of tax loss selling pressures. iShares on the TSX Small Cap Index popped yesterday and is close to breaking above a base building pattern. A trade above resistance at $8.78 will complete the pattern. ‘Tis the season for small cap stocks to outperform the market!

http://www.timingthemarket.ca/techtalk/2008/12/30/tech-talk-for-tuesday-december-30th-2008/

Norquay's book was also mentioned. Ken Norquay is Director and Chief Market Strategist of CastleMoore Inc. The key point made about 2008?

"Buy-and-hold no longer works in the sub-prime mortgage business or in the stock market."

In the 1970s, mutual fund manager John Templeton used to tell us: “We shop the world looking for unrecognized value [in the stock market]. We buy these stocks and hold them for three or four years until the value is recognized.” Perhaps modern investments should be managed the way Sir John once managed his mutual funds.

Now-a-days CastleMoore tells us: “Buy, Hold and Know When to Sell.” Perhaps modern investors should adopt the CastleMoore Way.

We have to learn from their mistakes. We have to learn from our mistakes too. There should be mass firings of the directors and senior managers of the financial big three and the auto big three. Should there be a few firings in your personal investment world? 2009 is a good year for you to find a better way, before you too need a bail out.

Investor Conference Calls

Absolute Software is a software Company in Canada. The company develops software for notebooks that will "call home" if it gets stolen. Absolute first caught my attention when it produce very solid earnings in 2007. Its big win was getting a contract from Dell and from Best Buy. But by mid-2008, when I listened to an investor conference call hosted by the company to discuss its quarterly results, but things sounded odd. The company did not sound very positive. Answers to analysts' questions were not as concise as I would have liked. By next quarter, Absolute announced that customers were scaling back purchase of its product. Smaller companies were watching its cash flow and were cutting back on purchases.

Moral of the story?

• Investors who buy individual stocks need to go that extra mile to understand a company by doing such basic research as reading quarterly reports and listening to investor conference calls (leaving that work for professional money managers is another option)
  
• Small-cap companies will continue to suffer more so than larger companies in the coming quarters due to the credit squeeze and to the weak economy
• Small-cap software (IT) companies will become even more attractive investments as valuations continue to fall.

Below is a chart for Absolute Software. Notice the stock broke support at the Fibonacci 38.2% line in September. Selling was heavy with volumes well above average. Recent trading pattern has not been convincing. Look for the stock to re-test the $2.55 level.

Psychology of Investing

Currently Reading:


One aspect of investing that requires attention for any trading is trading psychology. By that, I mean all of us would benefit from a trader coach of some sort to identify our strengths and our weaknesses. In 'Beyond the Bull,' Norquay touches upon inner trading psychology and the psychology of the markets as a whole.

Norquay employs the Eastern philosophy of Buddhism in his discussion of market trading. I could relate very well to this approach.

Two points I would like to highlight about the book are:

• Achieving a state of objectivity (a multi-step process) sets stock traders apart to the next level
• Like all things in life (including relationships, for example) being a good stock market trader requires work. Stock market trading is no different and requires constant work. It does not end.
  

Eyes on Christmas Shopping

• Christmas accounts for 14% of annual sales
• Top sellers: Nintendo Wii, Samsung's 52-inch LCD HDTV, the Apple iPod touch and the Blokus board game.
• Mark Jan. 8 on your calendar, when retailers report same store sales,

Source:
AP
Retailers slash prices to entice holiday shoppers
Friday December 26, 10:04 am ET
By Lauren Shepherd, AP Business Writer
http://biz.yahoo.com/ap/081226/after_christmas_shopping.html

I still favor the software entertainment industry. In particular, I am monitoring Electronic Arts (ERTS) but favor Activision (ATVI).

Activision will be releasing Diablo III (anyone every play Diablo I, back in the day? It is a classic). Its Guitar Hero franchise appears to still be strong, and has other very good titles such as Call of Duty (World at War) and Need for Speed. Still, technical charts suggest the stock will face further weakness.

To obtain a stock alert on when I enter positions in ATVI or any stocks discussed, sign up on kaChing and click "follow manager."
http://www.kaching.com/kaching#portfolio/5916/holdings

Prediction for Consumer Discretionary Performance in January 2009

Below is an introductory text taken from John Mauldin's Newsletter:
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/default.aspx

Have you done your Christmas shopping yet? Research shows that more of us are putting it off in expectations of better prices. In other words deflationary expectations! The prices I have seen while out shopping the past few weeks are simply amazing. I have to admit to have made a few purchases for some items that I was not planning to buy just yet because prices were off by 60% or more. A few days ago a friend came in sporting a new black cashmere sweater top with jeweled embroidery and quite fancy. She said she got it at Saks. But the real story is that when she walked into Saks looking for a present for her kids they handed her a coupon with a 30% off any one item from whatever price it was already marked down. That top? At one point it was almost $500. She bought it for $75. I have to confess that made me worry about retail sales and future unemployment. I like low prices, but I like profitable companies and employment. I went and talked to a Saks salesperson a few weeks ago who had been there 25 years and asked if they had ever discounted like that before Christmas and he said never. It was Saturday in New York and the place looked busy. I asked why? And he said, "The store is empty during the week." And I bought a few sweaters at 60% off. Tiffani just got some presents from J Crew at over 60% off. Before Christmas! How many readers have seen the same sales? And yet shopping is down?

As a side note, this year most of the kids and in-laws are all going to get a Visa gift cards so they can take advantage of what I think are going to be even better sales after Christmas. It is not that Dad put off his shopping to the last minute (which I did) but the kids are really looking forward to finding their special items on sale. I wonder how many more are doing that?

[...]

John Mauldin, Editor
Outside the Box

US Housing

For November 2008

• existing home sales declined a record 8.6 percent.
  
• median home price fell 13.2 percent (annualized figure) to $181,300.
• The pace of sales fell to a 4.49-million-unit annual rate.

Source: http://www.bnn.ca/news/5750.html

This does not mean that REITs and home builders are "sell" or a short sell in the medium term. The reason is that we do not know if these sales figures represent a housing slump bottom. The weakness in this sector is being exasperated by the difficulty in obtaining loans. LIBOR figures are suggesting that borrowing will become easier, but at a little at a time. Unfortunately, in the short-term, we are not there yet.

When Things get Complicated, Keep it Simple
I have stated numerous times in past entries that the stock market rules have changed, thanks to the Federal Reserve actions. That is not to say that these actions (in the form of bailouts for example) should not be carried out, but they do change the playing field. Stock market valuation analysis cannot be applied with absolute certainty, because forecasting such things as growth rates, margins, and revenue will be inaccurate. Take, for example, GM. Traditional fundamental analysis would result in recommending a giant sell call (in neon lights). With the government stepping in, the stock is not trading at its market worth of zero.

Remember another market rule: don't bet against the Fed. When the new administration in the U.S. is lead by Obama on January 20th, he will be spending at least US $700B. This will give the market a boost, but who's paying for all of this? Have the previous bailout bills been paid yet?

How does one keep things simple? Look at fewer indicators to get a gauge on the economy. Two things. Housing and borrowing costs. It is best not to look at just one housing market figures, but a variety of them, since one measure does not tell the whole story. I would closely monitor foreclosure rates, the Case-Shiller index, and new home sales figures.

On borrowing costs:
"But the undeniable reality remains. According to Merrill Lynch’s High Yield Master Index, the spread between high-yield bonds and comparable Treasuries has increased from roughly 600 basis-points to 2,072 bps since June according to Bespoke. This means that companies in the high yield bond category still face interest rates north of 22% to borrow – not a situation conducive to healthy balance sheets, especially in a deteriorating economy."
http://tradesystemguru.com/content/blogcategory/34/68/

What to do When Bad News Gets Worse?

I have a short story about cash being king. In November last year, I was in line at a bank to cash out matured savings bonds. The ticker prices were scrolling across the LED board. Citigroup had corrected to $14 (from $20) the last few weeks. In that month, the markets had only anticipated losses in the subprime arena. Business Week already speculated greater losses in other areas of lending, but that was not yet revealed. A thought had come to mind for me to use the cash proceeds to buy Citigroup.

Why?

Any experienced investor will know that cash is perceived as boring and unproductive in a portfolio. From an emotion standpoint, it is difficult to do nothing, to sit on cash, and to not invest in something in hopes of producing a higher return.

We all know the story now about Citi. Losses continued to mount, and housing prices continued to fall throughout 2008.

A year has passed since I passed this trade. The economic fundamentals are still terrible, and momentum is still building even faster now in what appears to be the worst economic storm for all eternity (well, at least as long as capitalism existed)! Does this mean that investors should be holding all cash? With the U.S. now at 0% interest rates, there is no more room for the government to lower the cost of borrowing. Its only option now is to buy up distressed debt and to spend a substantial amount next year.

Investors need to foresee the consequences of all of this:

• Tax rates must rise (the city of New York is already seeing this happen)
• The US dollar must collapse (it is already correcting) - see chart
• Gold will rise speculatively - a new bubble might form here...why? Because the only thing more attractive than the US dollar is gold (and no other currency)
• Various industries still need to fall, unfortunately (auto, housing, banking)

My investment strategy therefore remains the same:

• Cash is more than king, especially when we are in a deflationary environment
• Gold will still rally (but in a deflationary environment, money will eventually need to find a better place to be than this commodity)
• At some small, almost random point in time, something new will emerge. Identify it, and invest in it.

It is only now that I am starting to value the idea of having a money manager. Pay for someone to identify a trend (seasonal analysis) or a company/sector (fundamental analysis), and to time it correctly via basic technical analysis.

Quantifying Human Spirit

Every day that goes brings another dose of bad news. Think of the bad news layered into a ball. At the core is the deflating home sector and consequently the falling banks. Factor in job losses there. Now on the next layer is manufacturing, namely the auto industry. More job losses. The negativity (and economic spread) inherently spreads over consumer spending. The month of December will be most indicative of the weakness in spending...yet I remain foolishly hopeful.

Two things keep me hopeful about an end to gloom for the economy. The first is economic policy. The U.S. is throwing what will amount to trillions of dollars at this layered negative ball. A trading rule is "don't bet against the fed." This time should be no different. Even if this "solution" is short-term, the markets will still move up for maybe even a few months.

The second thought that comes to mind is human spirit. Look at how the markets behaved during the Olympics. Maybe what the world needs are more festive events and celebrations that would bring people together. People get together, socialize, network, are a happier bunch who will not have their mind on the ailing economy. I for one would rather have a positive spirit, and I would certainly want to spread that around. Aren't smiles infectious? As a point of contrast, it should be recognized that one would not be smiling after losing a job.

Human spirit cannot be quantified by economic models or equations.

Now, back to some observations that we might be seeing some reasons for the market to stabilize and even trade up at least in the short-term:

1) Retailers have been discounting items so much that consumers are still spending (See Best Buy stock, for example)

2) Oil prices have popped considerably, which should make inflation a non-issue as more money floods the economy

3) The newly-elected US government will have massive spending plans in January 2009.

Will Mortgage Rates Reach 0% in the U.S.?

In short, no.

The Federal Reserve is poised to cut interest rates tomorrow, to almost 0% (0.5%). Why does that not mean consumers will get a mortgage of 0%, to have credit card rates cheap, or to borrow money in other ways like loans for free? The rate cut policy is for the most part a tool that will not be useful by any measure. The problems that we are all well aware of now won't simply go away by lowering interest rates. Banks are still de-leveraging (they need to raise cash by selling down assets), so lower rates will help them reduce borrowing costs.

There are a number of technical signals that need bearing note:
1) Gold is trading along a "channel" and is poised to break the upper channel


2) Oil has corrected substantially, and OPEC is planning to cut 2M bpd, a significant amount. Yet volumes don't support a call for higher oil prices. My call is $30 for a barrel of oil. This is due to the market being more likely to overshoot on the downside. In the meantime, enjoy lower prices at the pumps.



3) U.S. Markets have been trading up from lows, but on lower volume. Volatility has also declined, but it is still well above a more reasonable 35. Examples are DJIA and S&P500. The Toronto Stock Exchange has been trending, but does not have much upside.


Personal Notes: KaChing.com

Here is my virtual (for now) portfolio:
http://www.kaching.com/kaching#portfolio/5916/holdings

My participation in KaChing has been rewarding. By next year, the organization running the application will allow the community of real investors to choose from the participants. KaChing is effectively testing its participants, and the best traders might get a virtual office in California as a Portfolio Manager.

My standings are as follows. These are just statistical numbers. The more relevant performance measure will be known over time.

• 6 month virtual return 26.7% vs -36.1% (S&P500)
  
• 58 followers
• Ranked 12 / 40 (Elite)
• Ranked 377 / 32,200 (Premium, 3 month performance)
• Ranked 1,331/323,240 (Basic)
  

Expect Nothing in December and You Won't be Disappointed

What is there to expect for December? The rules have changed, economic news remains dire, and yet the market has rallied these past few weeks.

In Matt Blackman's weekly newsletter, Matt really summed up well the problems of trading profitably in today's markets:

"
Mass market manipulation changing the rules

James Grant was interviewed this week on the Business News Network about his new book – Mr. Market Miscalculates: The Bubble Years and Beyond. Grant didn’t mention the word manipulation but that is exactly what is going on if you really listened to what he is saying (see Video of Grant’s interview below). The Fed, which exhausted its $800 billion asset base months ago, had doled out or promised something in the order of $4.74 trillion as of November 24 according to Bloomberg. And that doesn’t include any commitments made since. According to Grant, that works out to an annualized growth rate in Fed assets of more than 2000%.

In his zeal to play Robin Hood to Wall Street banks and brokers, Bernanke has effectively changed the rules for doing business in markets. Stocks that should plummet are soaring and those that should outperform but are not privy to special TARP or bailout benefits are getting hammered. Treasuries and bond performances are equally perplexing for the same reason. That Bernanke and company have refused to be transparent about who gets Fed money and the terms of the loans makes the bailouts as well as the massive amounts involved all the more suspicious (see article "Bernanke..." below). Neither the Fed nor government will tell us where this money is coming from but it isn’t hard to figure out the answer.

Trading rules will have to be re-written as long as the government and Fed play buyer of last resort bailing out poorly run companies at taxpayer expense. But the unintended consequence is that it will keep those investors and traders who normally jump in during a market correction in the hunt for bargains on the sidelines, at least until they understand how to play the game now that the law of market gravity has been repealed. "

With that in mind, I am still not convinced that the market rally from its November lows will hold. For one thing, the indexes (DJIA for example) are approaching moving average resistance levels. Second, economic indicators are all still weak. The two figures that concern me are unemployment figures and falling home sales / prices.

It is possible that there will be a "Santa Claus" rally or that we have already seen the "market bottom," yet these are just short-term technical trading opportunities. They are, at best, hopeful events at a time when the markets will keep falling well into 2009. Fundamentals do not support the market from continuing to fall as we enter 2009.

Investors and the media are also fixated on the pending big bailout news for the US automotive industry, but will 14B do the trick? These companies have huge liabilities and inefficiencies. $14B will only be the start of more money needed to save these companies. I do not disagree that something must be done to keep these companies running. After all, there is an obligation for the government to do what is necessary to avoid massive unemployment in this sector.

I'd like to end this entry with a bright note. At some point in time, the morale of people will improve. They will eventually regain optimism and confidence in the markets. They will realize that oil is no longer over $100 a barrel. Consumer goods will be cheaper than ever. Lending will start to loosen. Money will be available again for borrowing. The demand for housing will start to pick up again, and prices will stop falling. It is just that this won't happen this month.

The Part about Still Having Bad News

With each passing week, the economic news gets worse. For example, the Institute of Supply Management reported that the service sector reached an all-time low of 37.3% in November. Unemployment in the U.S. was 4.09M, its highest since December 1982. The numbers continue to be dire, but the three numbers investors need to keep an eye on are the following:
1) New Housing Sales and Average Home Prices
2) Volatility Index
3) LIBOR Spread

The first is obvious: the lower the average price of a home, the greater the mortgage paper loss is for US banks. The second, volatility, will give investors some indication on how convincing a rally or a sell-off is. It is very, very difficult right now to make a good investment decision if no trend exists. At best, there are wild fluctuations. This environment might benefit the day trader, but not buy and hold long term investors.

Finally, the LIBOR spread will indicate an investor's willingness to take on risk. It has been narrow, so that is at least a good sign.

This video is long but valuable. Shiller has some insightful ideas. They are good in theory, but can they be implemented in practice or accepted by government law makers?

Shiller says crisis may last for ‘years and years’
http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vwJrIHv24Ics.asf


Hot Stock: Short EWC (iShares Canada)
Canada is only starting to feel the pain of woes in the U.S. The commodity bubble earlier this year has literally popped, the housing sector is starting to weaken, and the automobile sector is imploding. The only positive is that the US dollar has strengthened, perhaps making Canadian exports more attractive. These factors make Canada an unfavorable place to invest. Although I am long on gold, I believe that shorting EWC @$15.26 would be profitable. According to P&F charting, EWC may reach $10.50. Note also that HXD is a bear ETF for the TSX60.





The Good News

Congratulations to kaChing, formerly known as FSX Player. The facebook application completed its registration as an investment advisor with the SEC. Many of my readers have been skeptical about the merits of playing investment challenges. Some say they don't have the time, but in today's markets, sometimes inaction is the best action to take, with real money.
Here's a blurb from kaChing:

What does it mean that you are a Registered Investment Advisor with the SEC now? It means the best managers on kaChing can now make some serious “bling”, REAL MONEY managing a virtual portfolio on kaChing. How? By earning high risk-adjusted returns and attracting a large following, we will soon (second half of ’09) allow your followers to link their brokerage account to your behavior. You will be paid a convenience fee (our term for mgmt fee) and a percentage of the commissions generated by your follower’s broker. Just as Ebay powersellers have bustling businesses on Ebay, you can have your own investment business on kaChing. To give you an example of how much money a successful manager on kaChing can make: Let’s say you have the following:

* 2,000 followers
* Your followers have an average account size of $10,000
* Assume 1% convenience fee (our term for mgmt fee)
* Assuming you make a few trades a month (you earn a percentage of commissions)
* Total = $350,000 revenue split between YOU and kaChing