09 September 2008

It's Good To Be Short

Top Gear's Richard Hammond (bloke on the right) survived a horrific drag car crash thanks to his lack of stature. Like the Hamster, it's a good thing I'm short.

During Monday's ridiculous run-up, I sold my ultra-long Dow shares into the rally for $60.55, from a cost basis of $63.96, or a loss of 5.3%.

Yes, I know, ouch. That's quite a haircut on an ostensibly conservative holding. But I thought this rally was my best opportunity to unload my large long position. The bear market rally since July just wasn't going to surge towards profitability for my Dow shares. The taxpayer's/government's takeover of Fannie and Freddie may have taken a wee bit of uncertainty out of the market, but this isn't the kind of news that should nourish a bull rally of any significance.

So I went short. I took the proceeds from my long Dow position, and loaded up on shares of the ultra-short S&P500 ETF (SDS) at $67.99, and added to my ultra-short financials ETF (SKF), making the new cost basis for those shares of $108.84. The value of these positions is now more than the 5.3% loss I incurred on Monday.

I also added to my gold ETF (GLD) at $76.95, bringing its cost basis down to $78.13.

The market today acted like a properly hurled boomerang--it went up, and came right back down to Earth:

Here's one opinion from Douglas A. McIntyre that Monday's F-squared rally was for suckers:

In community college Economics 101 students learn that there can be dips in bull markets. Usually these are caused by a single event like a change in the party that runs Congress. The same holds true for bear markets. Suckers jump in on one piece of news or another. The market spikes up. A week later, it's gone.

The Fannie Mae (FNM) and Freddie Mac (FRE) rescue pushed the market higher and may do so for a few days. In Asia, they know better. The rally never made it beyond the first 24 hours. Markets turned down in Day Two.

The overwhelming evidence is that almost no one benefited from the government taking over the agencies. The rest of the economy is in the toilet. A lot of data has come out in the last day underscoring that point.


The market really did not rally. A few stocks did. GE (GE) sits at $29, still relatively near multi-year lows. Boeing (BA) faces a strike which could go on for months. That will hurt earnings and employment at scores of its suppliers. Boeing's shares could clearly drop. Ford (F) is barely off a 20-year low. The same could be said of Microsoft (MSFT).

If the stock prices of Washington Mutual (WM) and Lehman (LEH) tell any tale it is that they will have to be rescued or cease to exist as independent companies.

Most of the seminal stocks in key industries are still well down and have little prospect of recovery.

If a recession is defined by the breadth of its damage, this is already a powerful one.

Trader Mike provides pithy agreement with the above notion of a sucker's rally:
Two things stood out to me as I looked through the charts though. First was the S&P 500 stopping right at its 50-day moving average. So I'm watching the action there closely. Second was the striking weakness in technology. The QQQQ actually closed lower thanks to weakness in GOOG and AAPL. That technology weakness really makes me think that this relief rally will be short lived.
Beyond the current calamities affecting the stock market, there are also broader negative seasonal trends, i.e. as summer turns to fall, the markets also fall.

You want some proof of this assertion? I have several sources for your enjoyment.

First, Bespoke says September consistently stumbles:

As the unofficial end of Summer draws near, market activity is likely to pick up in the coming weeks as traders set themselves up for the end of the year. If history is any indication, the last four months should provide some improvement to this year's double-digit percentage losses. History shows, however, that September could present some rough sledding before any rally occurs.

In the chart below, we show the average historical trading pattern of the S&P 500 during the last four months of the year. The blue line shows the S&P 500's trading pattern from 1960 - 2007, while the red line shows the average of the last ten years. As shown, over both time frames, the S&P 500 typically declines during most of September before staging a year-end rally beginning in late September/early October.

Jim Kingsland wrote a year ago
that September is the cruelest month:

Stock investors are bracing for a bad September -- knowing it has a well-deserved reputation for being the worst month of the year.

Since 1929, stocks have declined an average 1.2% in September, compared with an average gain of 0.59% during all months of the year.

"There's been a frequency of negative numbers," says Sam Stovall, chief investment strategist at Standard & Poor's. "September is the only month in which it falls more than it rises."

Why is September so bad? Part of the reason is a seasonal slowdown of money flowing into the market, so there's less new money to push up prices. In addition, Stovall says some mutual funds "have October as fiscal year-end, and may be selling losing positions from mid-September until mid-October."
And Mark Hulbert at Marketwatch agrees that September sucks, but he thinks the phenomenon is an example of correlation without causation, a.k.a. data mining:
My favorite illustration of this phenomenon, which long-term readers of my column will recognize, comes from David Leinweber, founding director of the Center for Innovative Financial Technology at the University of California at Berkeley. Several years ago he searched through all the data on a United Nations CD-ROM to find the indicator with the most statistically significant correlation with the S&P 500. His discovery: butter production in Bangladesh.
Hulbert debunks some unconvincing arguments for September's malaise, e.g., parents sell stocks to pay for tuition, but he didn't dig deep enough in the interweb to find Kingland's explanations.

All things said, I'm inclined to follow the seasonal trend, as well as the broader market trend, which means I'm long gold and otherwise short.

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