There is an endless number of subjects I could write about, but tonight I'd like to focus on how I'm trying to read the market. I'll start with a trading axiom, which I've grown to find very true: You can pick the direction or the timing of the market, but you'll rarely nail both.
There's four main metrics which I analyze: structural (macroeconomics, currencies, politics), psychological (investor psychology, social mood), technical and fundamental analysis. This is more from a trading point of view. If it were long-term investing the analysis would be a bit different.
1. I'm putting the least amount of emphasis on fundamental analysis. With the consumer deleveraging, rules changes (FASB 157, naked short selling), government interference (Obamacare - Healthcare nationalization, further stimulus, or any acronym for banks to swindle money from U.S. taxpayers), and it's very hard to forecast what future earnings may be and what type of growth companies will produce. It's simply too hard to attach a multiple to a stock and be confident that you'll get it correct. There will be some analysts who are spot on, and may even earn a name for themselves for a quarter or two, but that's simply due to the law of probabilities. When looking at different asset classes (mainly distressed debt, real estate) fundamental analysis plays a much bigger role.
2. Next is the structural metric. This is more of a big macro themed metric, which should always be in an investors mind, but may not be something to necessarily trade on. European banks, predominantly Eastern Europe, are on the brink of failure. Technically they are insolvent due to the fact they are so overleveraged, that many of the banks have assets which range from 4-7x greater than those countries GDP. Think about it. The banks have "assets" which are 4-7x the amount of money the entire country produces in a year. So a bailout is literally not possible...at least not economically possible.
Saying politics are playing a huge role in the markets is an understatement. Many of the rhetoric coming from Washington is a catalyst for a market move each day. With the seeming socialization of many huge sectors of the U.S. economy, politics will continue to play a larger role in determining how this market will function.
Last part of the structural metric is the most important. That is currencies. This is one market which is extremely hard, if at all possible, to manipulate. With the U.S. dollar being under constant fire and our Federal Reserve taking a weak dollar (bailouts, quantitative easing, debt issuance) stance, you have to question how long foreign investors will want to hang out to assets denominated in USD. Also, the dollar is the worlds reserve currency. We've already seen China and Brazil work a deal so that their trades will be settled in local currencies rather than dollars. This is the slow, but seems to be steady, transition away from the USD. This will have MAJOR implications over the global economy. This is a wild card that must be kept on everyones radar.
-The weakness of the dollar since the March lows has been one of the driving factors behind the market rally. This has also contributed to the doubling of oil in that time frame and the rally in commodities as well.
3. Technical analysis is better used in context rather than a catalyst. Much of technical analysis goes in hand with my last and most important metric at this time, which is psychology. Picking up on trends, resistance, and support levels, has proven to be a solid strategy to use during such tumultuous times. The only problem is that many of today's investors are using the same strategy. Like anything else in the the markets, once a trade becomes too popular and the herd starts moving in, that should be your cue to get out.
4. Last and what I currently believe to be most important is psychology. The psyche of investors right now is fragile to say the least. With markets still down around 40% from the 2007 highs and up 47% from the March low of 666, you can understand why. The government has provided drugs to act as symptoms for our disease, but I believe they are only masking the disease or kicking the can down the road. Thanks to government intervention, no one knows what's next to come from Washington. This has created a world of uncertainty and that's the one thing investors fear most.
We've had a euphoric rally in the past five months. Investors were sick of the gloom and doom, 666 seems to serve a psychological turning point (mark of the beast), second derivative data showed signs of deceleration of the downfall, and honestly, the market was just due for a bounce. Many of the biggest market bounces come in the context of a secular bear market, which is what I believe we are still in. A great earnings season (thanks to great operations management, not revenue growth or sales) has acted a major catalyst to send this market close the 1,000 level, but 980 is a huge resistance level.
I believe we are in the midst of a temporal transition which is transition from peak to trough (temperament) and emotions run highest at this point. There are not many economic data points that should send the market higher. A move to 1,100 wouldn't surprise me, but I look to get short in certain names and sectors as this rally moves on.
Without going into too much detail, I hope that provides a decent summary into how I am trying to read the markets at this time. Everyone has their own approach and I'm not trying to influence anyone one way or another, just trying to provoke thought. Hope all is well and good luck tomorrow.
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