iBankCoin
Joined Oct 26, 2011
153 Blog Posts

February Trend Report

Mutual fund cash levels

July 2011 3.3% cash
August 2011: 3.4% cash
Sept 2011 3.8%R
Oct 2011 3.5%
Nov 2011 3.5%
December 2011 3.5%

historically very low

10 year PE 22.47 (EP yield 4.45%) Historically slightly higher but still reasonable.

S&P div yield 1.97 (historically low)

10 year treasury around 2% (historically near all time lows)

The stock market has recently taken off. Although the monthly chart is now confirmed bullish on the parabolic SAR and MACD histogram is close to turning bullish, the monthly chart is overbought at the same time it is turning bullish. Meanwhile the daily and weekly charts are egregiously overbought.

So although there may have been a very brief period of time to get a bit less cautious, that time is quickly changing.

Holding treasuries is perhaps even more vulnerable as the RSI as well as the slow stoch is overbought.

So what is one to do? This is where focused effort can be placed into looking at correlation and a margin of safety. Risk off should remain a fairly large portion of your portfolio, profits should be taken in both risk on and risk off and cash should be raised.

If you seek to trade, you can use daily, weekly and to some extent monthly signals on individual etfs. However, if you are less concerned about trying to time the market and less inclined to rotate your portfolio through trades, you should look to find a margin of safety and undervalued names as well as look at the monthly chart. A bit of both methods perhaps is ideal as it will cut down the correlation of your portfolio even more, and allow you to invest with multiple time perspectives in one portfolio.

Your long term return should seek 3 things things. One is a high Alpha at all times. You want to identify securities that are trading well below their value to buy. (You also may seek those that are trading well above their value to sell) This is “seeking the outliers” in the following chart. It is buying $1 for 50 cents.

The 2nd thing is basically to shift the beta based on market conditions. This is timing the market as a whole. You can either shift into selling a greater percentage of assets that are overpriced, and out of those that you own that are underpriced, or you can use index ETFs to shift assets. 
You want a higher beta when the probability of the market trading higher is large, and a small or negative beta when the probability of the market trading higher is low, assuming all else is equal.
I prefer to monitor my correlation to the S&P and aim to reduce it when the market is vulnerable, but also I use a balancing act between general ETFs such as the TLT, UUP (and other currency etfs) and SPY,QQQ,FXI and other index etfs.
Generally you want to watch the market trend and the overbought/oversold signals on multiple time frames to keep everything in perspective and to reduce your position size of risk assets when the market is vulnerable to a correction, and shift into more aggressive holdings and a larger beta when the capital is shifting into the market.

The third thing is to monitor overall correlations among your assets. This is often overlooked, but the thing that is important is to reduce your correlation. When the markets crash, the people that do best are those that have assets that are not strongly correlated with the market. Many assumed the subprime mortgage crisis would not effect everything else, but in fact it did. There was a greater correlation than people realized and those that thought they were diversified by holding stocks of different kinds were in trouble.
This can be illustrated by the following using a bit of thought.

You get a greater return by 2 independent bets at 1/2 the "optimal" bet. Therefore, more independent bets provides superior long term returns. In the stock market everything has a correlation, so no bets are really completely independent at the same time. However the closer the correlation between multiple assets to zero and the closer the return/risk of these bets, the more these principals come into play. So aside from shifting your beta while maintaining a high alpha, you also must be diligent to be sure you can do your best to reduce correlation. If the future were completely known and you knew where every stock and every asset would be, there would be no need for diversification and reduction of correlation. If the future were completely random, that would be all that matters, so some of just how correlated you are depends upon how accurate you are as a prognosticator and how clear your crystal ball is. The same goes to how much you ramp up your beta when you see the future in stocks as a bright one, and your individual skill as a stock picker should depend on how much effrt you spend in selecting individual names vs broad index funds. I will try to reserve the trend report for helping assess where we are and how to plan (beta, allocations among large general classifications, correlations), where as the trend trader will be reserved for assessing individual assets among those groups.
I would continue to remain defensive. Your beta should remain low. Your correlation to the market should be low or even negative at this time. You should run through each asset you own relative to every other asset.
There are two types of correlation, one how your overall portfolio correlates to the market. The other being how your overall portfolio correlates to itself. Unless you have certainties about where stock will go or a high level of confidence or an extreme amount of difference in value, you generally always want your portfolio to have close to zero correlation with itself with multiple assets.
But the shift of risk relative to the market sometimes referred to in some situations as "beta" has to do with the conditions. Bullish conditions should have a higher beta and higher correlation with the market. Beta also refers to leverage where this correlation calculation does not.
http://www.sectorspdr.com/correlation/

How much you shift your beta depends not only on conditions but on how aggressive you want to be. Generally I might say that a uptrend monthly chart with an uptrend weekly chart with both overbought should be perhaps slightly more bullish than a downtrending monthly chart with an uptrend and overbought weekly chart. However we are more overbought than before on a weekly and daily level so it’s relatively moot.

If you find it difficult to reduce your positions, one way to do it is through shorting an index ETF. I tend to try to avoid owning overbought markets so I will sell them and do my best to rotate into somewhere less overbought. Regardless, the art involves alpha, beta, and the right balance of correlation. It is no easy feat, but if it were easy, there would be no one to take the other sides of our trades, and no fiscally irresponsible money manager to lose through volatility over time for us to gain. Which brings up the question, why help other traders? First, sometimes a little information does the people you teach more harm then good if they do not apply it correctly, or only apply some of your teachings. There is a saying that a little knowledge is more dangerous than none at all, because it can result in the overconfidence that leads to ruin. Secondly, because there are trillions of dollars in the stock market, many people already know this so the damage you do by helping is negligible, and the gain you get from sharing and learning the knowledge yourself is worth it. The people who teach the information they learn, learn better and recall the information better. This is why I don’t mind blogging from time to time, while giving myself a journal of sorts to look back on as well.

February

commodity valuations
http://www.wikiwealth.com/commodity
commodity etfs
http://etf.stock-encyclopedia.com/category/commodity-etfs.html
currency valuations
http://www.wikiwealth.com/country
currency etfs
http://etf.stock-encyclopedia.com/category/currency-etfs.html
bond etfs http://etf.stock-encyclopedia.com/category/bond-etfs.html
   
reits etfs
http://etf.stock-encyclopedia.com/category/real-estate-etfs-reits.html
resource etfs http://etf.stock-encyclopedia.com/category/resource-etfs.html
   
asset allocation etfs
http://etf.stock-encyclopedia.com/category/asset-allocation-etfs.html

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It’s a bull market you know!

FLY AKA JESSE LIVERMORE AKA Old Mr. Partridge wins again…

For those not in the know, the title is a reference to Jessie Livermore’s book, Reminiscences of a Stock Operator. A passage of it reminds me of the Fly with regards to people trying to convince him to sell YELP.

In it, he describes an old man named Mr. Partridge who would always walk around telling people “it’s a bull market you know”.

“Why, this is a bull market!” The old fellow said it as though he had given a long and
detailed explanation.
“That’s all right,” said Elmer, looking angry because of his disappointment. “I know this
is a bull market as well as you do. But you’d better slip them that stock of yours and buy
it back on the reaction. You might as well reduce the cost to yourself.”
“My dear boy,” said old Partridge, in great distress “my dear boy, if I sold that stock now
I’d lose my position; and then where would I be?

Jesse Livermore said the important line here,

“And right here let me say one thing: After spending many years in Wall Street and after
making and losing millions of dollars I want to tell you this: It never was my thinking
that made the big money for me. It always was my sitting. Got that? My sitting tight!”

Here is a more complete passage:

“One day a fellow named Elmer Harwood rushed into the office, wrote out an order and
gave it to the clerk. Then he rushed over to where Mr. Partridge was listening politely to
John Fanning’s story of the time he overheard Keene give an order to one of his brokers
and all that John made was a measly three points on a hundred shares and of course the
stock had to go up twenty-four points in three days right after John sold out. It was at
least the fourth time that John had told him that tale of woe, but old Turkey was smiling
as sympathetically as if it was the first time he heard it.
Well, Elmer made for the old man and, without a word of apology to John Fanning, told
Turkey, “Mr. Partridge, I have just sold my Climax Motors. My people say the market is
entitled to a reaction and that I’ll be able to buy it back cheaper. So you’d better do
likewise. That is, if you’ve still got yours.”
Elmer looked suspiciously at the man to whom he had given the original tip to buy. The
amateur, or gratuitous, tipster always thinks he owns the receiver of his tip body and
soul, even before he knows how the tip is going to turn out.
“Yes, Mr. Harwood, I still have it. Of course!” said Turkey gratefully. It was nice of
Elmer to think of the old chap. “Well, now is the time to take your profit and get in again
on the next dip,” said Elmer, as if he had just made out the deposit slip for the old man.
Failing to perceive enthusiastic gratitude in the beneficiary’s face Elmer went on: “I have
just sold every share I owned!”
From his voice and manner you would have conservatively estimated it at ten thousand
shares. But Mr. Partridge shook his head regretfully and whined, “No! No! I can’t do
that!”
“What?” yelled Elmer.
“I simply can’t!” said Mr. Partridge. He was in great trouble.
“Didn’t I give you the tip to buy it?”
“You did, Mr. Harwood, and I am very grateful to you. Indeed, I am, sir. But ”
“Hold on! Let me talk! And didn’t that stock go op seven points in ten days? Didn’t it?”
“It did, and I am much obliged to you, my dear boy. But I couldn’t think of selling that
stock.”
“You couldn’t?” asked Elmer, beginning to look doubtful himself. It is a habit with most
tip givers to be tip takers.
“No, I couldn’t.”
“Why not?” And Elmer drew nearer.
“Why, this is a bull market!” The old fellow said it as though he had given a long and
detailed explanation.
“That’s all right,” said Elmer, looking angry because of his disappointment. “I know this
is a bull market as well as you do. But you’d better slip them that stock of yours and buy
it back on the reaction. You might as well reduce the cost to yourself.”
“My dear boy,” said old Partridge, in great distress “my dear boy, if I sold that stock now
I’d lose my position; and then where would I be?

Elmer Harwood threw up his hands, shook his head and walked over to me to get
sympathy: “Can you beat it?” he asked me in a stage whisper. “I ask you!”
I didn’t say anything. So he went on: “I give him a tip on Climax Motors. He buys five
hundred shares. He’s got seven points’ profit and I advise him to get out and buy ‘em
back on the reaction that’s overdue even now. And what does he say when I tell him? He
says that if he sells he’ll lose his job. What do you know about that?”
“I beg your pardon, Mr. Harwood; I didn’t say I’d lose my job,” cut in old Turkey. “I said
I’d lose my position. And when you are as old as I am and you’ve been through as many
booms and panics as I have, you’ll know that to lose your position is something nobody
can afford; not even John D. Rockefeller. I hope the stock reacts and that you will be
able to repurchase your line at a substantial concession, sir. But I myself can only trade
in accordance with the experience of many years. I paid a high price for it and I don’t
feel like throwing away a second tuition fee. But I am as much obliged to you as if I had
the money in the bank. It’s a bull market, you know.” And he strutted away, leaving
Elmer dazed.
What old Mr. Partridge said did not mean much to me until I began to think about my
own numerous failures to make as much money as I ought to when I was so right on the
general market. The more I studied the more I realized how wise that old chap was. He
had evidently suffered from the same defect in his young days and knew his own human
weaknesses. He would not lay himself open to a temptation that experience had taught
him was hard to resist and had always proved expensive to him, as it was to me.
I think it was a long step forward in my trading education when I realized at last that
when old Mr. Partridge kept on telling the other customers, “Well, you know this is a
bull market!” he really meant to tell them that the big money was not in the individual
fluctuations but in the main movements that is, not in reading the tape but in sizing up
the entire market and its trend.
And right here let me say one thing: After spending many years in Wall Street and after
making and losing millions of dollars I want to tell you this: It never was my thinking
that made the big money for me. It always was my sitting.
Got that? My sitting tight! It
is no trick at all to be right on the market. You always find lots of early bulls in bull
markets and early bears in bear markets. I’ve known many men who were right at
exactly the right time, and began buying or selling stocks when prices were at the very
level which should show the greatest profit. And their experience invariably matched
mine that is, they made no real money out of it. Men who can both be right and sit tight
are uncommon. I found it one of the hardest things to learn. But it is only after a stock
operator has firmly grasped this that he can make big money. It is literally true that
millions come easier to a trader after he knows how to trade than hundreds did in the
days of his ignorance.
The reason is that a man may see straight and clearly and yet become impatient or
doubtful when the market takes its time about doing as he figured it must do. That is
why so many men in Wall Street, who are not at all in the sucker class, not even in the
third grade, nevertheless lose money. The market does not beat them. They beat
themselves, because though they have brains they cannot sit tight. Old Turkey was dead
right in doing and saying what he did. He had not only the courage of his convictions but
the intelligent patience to sit tight.”

The important message is sticking to your plan

Here’s an interesting statistic that I have found but have not personally verified…

In bear markets (losses of 10-20% or more per year) 80% or more of all market participants beat buy-and-hold.

In sideways markets (+/- 5% per year) 20-50% of all market participants are able to beat buy-and-hold.

In weak bull markets (annual advance about +10%) about 10% of all market participants are able to beat buy-and-hold.

In average bull markets (annual rise about +15%) about 3-5% of all market participants are able to beat buy-and-hold

In powerful bull markets (annual rises about +20%) only about 1-3% of all market timers beat buy-and-hold.

In monster bull markets (annual advances of 25-50%) less than 1% of the market participants beat buy-and-hold.

In hyperinflations (rises of some hundreds of percentage points each year) no one is able to beat buy-and-hold for a year or longer.

I would imagine that applies to WINNING STOCKS too.

It’s easy to beat bear markets by just exiting positions every now and then and not being exposed to the entire downward move. Tight stop losses or trailing stops will help avoid bear markets in most conditions. However, you are generally better off trying to join bull markets. Of course that assumes you can anticipate them.

Have you made over 100% since 2009 bottom? Of course, by the time many people start holding, and start to believe in the market and decide to “buy and hold for the long term”, it’s usually too late…

That’s why you have to trust signals, whatever signals you use. I have a bit of a bipolar nature in my trading in that I have longer term holds which I may occasionally rebalance in the short term, and then I have a portion of my portfolio reserved for trading. If not for the longer term trades, my account would be volatile and there would be times when I trade poorly where I would wipe my account out. I learned the hard way.

Many people use the 50 and 200 day MA as a sign of when to hang on. When you get a golden cross (short term MA passing longer term MA), hold onto your positions you are in a bull market. That is a simplistic way and objective way that isn’t always right, and if you use shorter time frames, perhaps you’d rather use the 20 day and the 100 day. A pull back below 50 day, particularly on strong volume is a good time to take some of your profits. This applies to individual stocks as well as the market’s moving averages.

March 2009-March 2010 SPY rose over 75%.

March 2010-March 2011 only around a 10% increase.

March 2011-March 2012 only around a 5% increase (major setback crashing to lows in October and then rallying from there).

March Trend Report shows we are in a bull market, but we have been for quite some time. We are overbought on many indicators, but when does one consider shorting and getting bearish as opposed to sitting in more cash than risk on assets?  Overbought doesn’t mean much, although it means a bit more if the RSI is overbought, and more importantly, if it was just overbought and closed below overbought it is more susceptible to a larger decline.

My core strategy which is conservative that I have been tracking is still ahead of the market just slightly since October 15th when I started, but let me tell you it has slipped significantly and the market has played catch up. At this rate I will be unable to stay ahead of the market.

This market is leaving me with very few options but to get more aggressive If I want to beat it. I don’t know if this market will end it’s uptrend very soon or not…. One way or another though, I am going to be getting more aggressive…. Perhaps I will allocate more capital into natural gas, perhaps I will find some stocks which are down significantly and undervalued. Perhaps I will look at the growth stocks that still present value. Perhaps I will instead look to trade other areas. Commodities, currencies and so on.

I do not like losing for very long.

For now I got a bit more aggressive than I normally would under such circumstances and perhaps my plan going forward will be a bit more aggressive.

The biggest problem with trying to time the market is sometimes the top never comes, or at least it doesn’t for years. The nature of a timer is to move in and out of the market, not stay in it.

Now while I am tempted to do things “all or nothing” and go in hand over fist into this market, I do not believe the market is stable. So I will employ some more creative tactics such as buying some calls here and there, adn perhaps even some puts if the price is right. and it gives me enough time. Oakshire Financial recently pointed out a good play involving a spread where you buy puts in the XLF and cover the cost by selling puts in the S&P.

Wall Street Elite recommends the simultaneous purchase of XLF June 15 PUTS for $0.39 and sale of SPY June 103 PUTS for the same price in equal numbers.

http://oakshirefinancial.com/2012/03/19/great-odds-on-a-bearish-options-play-xrt-and-xlf/

I don’t like writing puts naked 9without the capital available to buy it if you get it assigned to you), nor do I wish to be restricted and feel I have to have that much capital available, nor do I like selling options even at that low of a strike price, when the VIX is this low and options are this cheap and the market has been in an uptrend. I would rather play a call in the short term in the same area or in a different area. for now I think the XLF is still stong and will outperform until the market pulls back so I like actually buying JUNE XLF 16 calls and SEPTEMBER XLF 15 puts. A pretty neutral play but mostly is bullish short term, bearish long term.

I am not against ever selling puts, but I want to do it in an extreme scenario like on the S&P in 2009 when the VIX is super high and the price already has declined so much and I can sell way out of the money puts long term and still collect a nice premium with very minimal chance that I will ever have to buy it, and would be happy if I could that cheaply.

The one thing scaring me a bit is energy’s recent performance. The XLE does not look good. That could be an early indicator the market is ready to top out if energy does not rebound. However, if it does, it could build a base here

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Pull back likely

With markets severely overbought now, you have entered in the area where the return is likely to be less going forward and the risk is likely to be higher. The reason being that the more people that buy, the less on the sideline and elsewhere available to fuel the rally. Of course in the US, the money supply can certainly be expanded, but it is unlikely or at least less likely for a rally to continue for a significant length of time without a pull back.

Although over a short time period, bears are prone to getting squeezed out, providing potentially additional upside for those looking to make a quick trade, over the intermediate term, stocks will likely present a lower reward at these levels at higher risk, and the buying power is more likely to fizzle.

Stocks will be running into resistance based on volume profiles. There is a lot of transactions that may occur in this range, but not a lot higher. We can perhaps support maybe SPY 133 before the buying power fizzles. It will take a significant amount of buying pressure to push above these spikes in volume. We also will be in the upper range of price

We are quickly approaching levels where the transactions pick up. The number of transactions puts a ceiling on pries for the time being because it would require a lot more buying demand to overpower it and is more likely to take time.

More importantly, going into these levels we are overbought on both a weekly and a daily chart, while a monthly chart remains in a downtrend with a bearish divergence (but is testing it’s limits). This is additional evidence that there will not be enough buying power to drive much farther past these levels.

And the daily chart is egregiously overbought as well.

Not only the slow stochastics which is more common, but we are overbought in the RSI and nearing the upper bollinger band. The Dow and Nasdaq aren’t looking much better.

Yes stocks can remain overbought longer than many people anticipate, however, it just doesn’t tend to be sustainable. At a bare minimum you simply have to consider reducing into this strength. You may be able to get away with it, but it only will take that one 1929/1987/flashcrash type day to ruin years worth of returns if you are aggressive into that. One of those days can wipe out all of the days in your trading career in which you pushed the envelope and got ahead of everyone else. If you are managing other people’s money professionally, it’s a different story. People freak out if you only make 5% when the market is up 7% and when you are only up 3% but everyone else is up 1% they love it. That’s just how it is. But as an individual investor, you should recognize the luxury that you have of not having to beat any particular benchmark on a regular basis and if the market proceeds to throw you out in front of a freeway picking up nickles you are not forced to play. This is the insanity that goes on that leads to conditions being at such extremes. The money flows into the fund manager’s hands and they have to put it to work before the other guys do and then they have to put it to work to keep up with those around them. They flock together and crash together.Have fun playing that game with them if you like, I will use the extremes as opportunities to do the opposite, even if it means underperforming into a hot rally.

Of course, as mentioned in the trend reports, mutual fund cash levels have still yet to raise significant cash, and that makes the stock market vulnerable on a longer term basis as it lacks the mutual fund buying power. We have not been at levels this high since before the November crash that took place followed by the S&P downgrading the US credit rating.

Additionally QE2 effect is perhaps going to be wearing out soon, and Europe’s crisis will eventually come to a head. Nevertheless the question “what if it doesn’t” and “what if all the negative stuff has been priced in for quite awhile now” is relevant and valid.

Nevertheless, if you are ever to consider to initiate a short position, I would begin to build a position at these levels. 133 on the S&P may be a bit more ideal if we get there. Certainly a reduction of risk and an increase in plays that do well in a bear market makes sense here. If there’s ever a time to take some profits, it is now. If you want to play with the odds in your favor, you have to reduce positions when stocks are higher and the trend is stale to the upside. Right now the weekly and daily trends are stale, and the transactions are on the high end or the range. I can’t imagine getting a better opportunity. It may be a bit more prudent to wait and if SPY hits 133 until you can then start to short. As we saw before the flash crash as an example, or before the May top in 2011 stocks certainly can stay overbought for awhile. Trend following only works until the trend has played out, then you must leave the pack if you want to avoid becoming a lemming and falling off a cliff. That doesn’t mean you have to go against them and short, but it becomes a possibility.

At some point, you have to recognize the advantage from following the trend is gone if the people you follow lack the buying power to push it higher. You don’t have to be a hero and lead the bearish crusade against the bulls, but you should at a minimum scale back. In the post trend trader I talked about a contingency plan for if the weekly uptrend continued and we got into significantly overbought territory across the board, and to have plans to potentially get more “aggressively conservative”. I believe it is a good time to do just that and begin to shift into an even more conservative portfolio, and possibly consider dipping into bearish territory if this continues for much longer. I don’t know how long this “aggressively conservative” period of time will last but it potentially could be short lived if we get drastically overbought on a weekly and daily timeframe and continue the charge upward, closing the month high enough to result in reversing the monthly trend from bearish to bullish, or if we pull back sharply and no longer have such extreme conditions, and then we may build a more sustainable rally. With everything overbought, the dollar could pull back and the market rallying for even longer would not be out of the ordinary before it has perhaps a healthy correction and maintains an uptrend.

Despite the overbought nature, capital is seemingly concentrating into stocks right now and flowing into stocks strongly enough where the monthly trend is likely to shift to bullish if we do not get a pull back very soon. It is unfortunate that it had to become so overbought on a daily and weekly timeframe to do that, but if we get a close around these levels or higher, it will signal a change in the monthly trend.  The monthly trend provides both a sense of direction on whether liquidity is increasing or decreasing and whether growth expectations and longer term capital movements are going into stocks which further helps productivity. All the capital in stocks could further provide opportunity for companies to invest that capital, which could lead to increased production and growth (to a degree for awhile) until the market becomes over-saturated with capital. It is only after a significant monthly rally that this occurs and it then lacks the opportunity to continue to put it to work at a high return and growth becomes impeded by the market itself as competition grows and gets in the way of itself and too much capital becomes a problem for companies and too few places for that capital to go and too high of expectations of growth and an inability to meet those expectations or continue to support such sentiment. It is a delicate process handling an increasingly overbought weekly and monthly chart if the trend changes bullish. Ideally we will pull back strongly and be closer to oversold on a weekly and daily timeframe as we finish just strong enough to change the trend on a monthly chart if we are to rally. However, even if that happens there is still a bearish divergence in the monthly chart as stocks made higher lows as the slow stochastic and RSI made a lower low. So there is a higher probability than not of a change in trend, if it occurs to be a false move.

I wouldn’t be too concerned about the monthly trend changing on us just yet though, for now you still should be expecting a pull back to be a high probability event and this very well could turn out to b an excellent selling opportunity, particularly if the downtrend continues on the monthly chart and we get another wave down.

In my personal account I bought a TZA position today. I couldn’t resist speculating here.

Mock portfolio using principals I have discussed on here is up nearly 14% since October when I started due to some arbitrage gains, and some adding and reducing at the right times with different assets. Considering the bearishness I have tended towards, I consider this an impressive feat. If I played the weekly uptrend a little more aggressively to the bullish side it would have been more impressive.

Higher risk and lower reward does not automatically mean betting against the market will be profitable, it just means that you should be able to find other assets that support a better reward with lower risk, that aren’t so vulnerable, and that reducing position may be a good idea. Also, shorting as a hedge to reduce position size if you aren’t really willing to sell individual names may be one way of reducing your risk. There is most likely a higher probability than usual of a pullback right now, or at least a pause in the action. If you aren’t using this price run up as an opportunity to take profits and reduce positions, when are we ever going to be overbought enough where you are? Personally, I do think betting on the pull back is likely to be profitable, but I am not willing to do so too aggressively, other than just to reduce the risk exposure of my portfolio. I do not feel comfortable buying many currencies or treasuries in large quantities, so shorting to reduce exposure seems prudent.

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Predictions For 2012 Part 2

1) (space reserved to insert something that happens in 2012 after the act to appear prophetic)
2)The increased leveraged in the euro to try to save it will be like an atom in nuclear fission with 1 too many protons… It becomes unstable until it causes a chain reaction. We’ve seen it happen time and time again after efforts to keep Greece alive continued. Now yields are blowing up everywhere and they may come up with one final “solution” but it won’t be until a culmination of everything unwinding until they will be able to stop it.
3)Suddenly capital flees europe and goes into the dollar. Capital flows into the US even as it prints like crazy.
4)Some country (if not 2 or more) defaults sometime next year and soverign debt blows up, setting up fear of default everywhere else and yields higher.
5)Prior to this news there is a panic spike higher in the dollar and possibly demand for US treasuries and possibly the Yen.
6)This should correlate with stocks being sold to buy up treasury bonds in final stage of yields declining to the panic bottom.
7)The US government will attempt to inflate away all the capital inflows that they have received from Europe assuming the capital will keep coming in, so they will be spending more than they receive (also for the purpose of inflating away their future and current expenses through inflation).
8)As a result capital will flow out of bonds and into assets like stocks.
9)Real estate will bottom in this time along with interest rates (for now). The strength of the dollar initially will drive prices lower. People from Europe who now upon the collapse realize that they cannot live off the government in Europe anymore will seek to become US citizens. The Yen will also strengthen and the more the dollar drops later on in 2012, the more migration from Japan and other places there will be, but specifically Japan.
10)Stocks will TOP at March or April 2012, June at the LATEST, if they haven’t already.
11)Stocks will bottom in early Spring 2012 to late summer 2012 for a long time to come depending on if they can kick the can for another several months or only just
12)Gold will be mostly flat as it will have to pause before it continues the strong uptrend
13)A few celebrities will die. At least one will be a big surprise. But likely candidates include Pat Summerall, Ross Perot or Bob Dole (if he’s still alive)
14)The anti wallstreet as well as anti government movements will intensify and eventually contribute to some kind of “antiestablishment” party.
15)When bond yields bottom, and there is a default, there will be a realization that the government debt is not as safe as people thought, upon realizing this once unrealized risk, bond yields will start to skyrocket.
16)Capital will migrate into the stock market heavily from that point on into 2013 and beyond. The FED will be forced to raise interest rates eventually, but it will appear too little too late, and over the next several years they will continue to hike the rates
17a)We will see a Romney-Gingrich ticket… The possibility of a “third party” is very real now, it could very well be one “by the people“. If this goes through and picks up steam, what I predict will be a Romney-Gingrich ticket will win. If not, Obama pulls through provided the stock market and economy can bottom and recover early enough in 2012. (I don’t think so).
17b)I predict Ron Paul will pull the upset in Iowa, and Romney takes New Hampshire. The establishment candidates will get together and vote in Romney. No way are people concerned about religion after they elected Obama and his controversial pastor Jeremiah Wright as well as the “my muslim faith” flub.
18)There will be a currency realignment around the world on the horizon, as the euro goes under. Maybe not 2012 but soon. The dollar will not be the world reserve currency 5 years from now, or if it is, there will be either a 2nd world reserve currency, or a 2nd US currency.
19)Although the “3rd party” if you can call it a party will not win in 2012, they will have a realistic shot at taking it in 2016 as unemployment in the US fails to decline due to the cheap labor overseas and fading industrial based nation as we continue into the information age and age of technology.
20)The “internet revolution” will pick up steam.
21)In the future may even enter into mania mode sometime between 2013-2016 as the business cycle climaxes to it’s peak. The measures taken to prevent this decline will manifest themselves drastically on the next up cycle, resulting in some over priced stocks and a very large decline.
22)Something unusual will happen. Technology will evolve and mathematic modeling of the world will begin to take place and it will constantly be refined. Through this process, something big in science will fall apart, and perhaps science itself will be replaced over time by computer modeling of reality.
23)Sometime in Romney’s 1st term there will be a pre-emptive strike in Iran setting off a chain of events with unintended consequences. If this occurs, move away from major cities out into the mountains somewhere because this could create huge instability sometime down the line.
24) If the magnitude of the 2012 damage in the stock market is bad enough, riots will break out, and possibly more wars.
25) A new Breton Woods agreement will take place sometime in the next several years
26)Stem cell research breakthroughs will occur, and cloning will be done of stem cells. Genetic mutation and experimenting will exist and behind the scenes governments will use genetic mutation to create super soldiers, or so the conspiracy theories will say.
27)Brett Favre will unretire again.
28)The Lions will upset the Packers in the playoffs, the Giants will beat the 49ers, The Saints will take their division and Giants-Lions will win the superbowl. In the AFC, although the Raiders will have a legitimate shot at beating the Steelers (or the AFC North Team), they will come up short due to a contraversal call by a ref and a missed field goal by Janikowski. The Steelers will beat the AFC East team such as the Patriots, and lose in the superbowl. If the Raiders make it, they will beat the Giants. I must have forgotten 2 teams or something. Probably Saints and Falcons as the other two teams, and the Saints could easily win.
29)Gerald Celente will be arrested for some stupid stunt such as throwing gold bricks at somebody.
30)A new Religion will be formed as opportunists seek to make money on the 2012 paranoia and they seek guidance and profits that will lead them… I mean prophets… or do I?
31)Al Gore will claim he invented Cloud Computing and Steve Jobs will come back from the dead and punch him in the face… and Bill gates too just for fun.
32)Many of my predictions will appear to have not come true… and then just when you think they won’t be, they will look even more wrong. While this may appear to be correct, it is an illusion and I will actually be proven correct given enough time, if only in another dimension.
33)Warren Buffet will be exposed for some scheme.
34)Many major institutions of the world will continue to fall apart in some way.
35)The group known as anonymous will soon be exposed and no longer “anonymous”.
36)Oil will skyrocket as Israel bombs Iran (pre emptive strike)
37)As such, oil will go north of $200 and possibly close to $300 even though under normal conditions it would be difficult to surpass even $150
38)There will be so many unintended consequences that it may change everything
39)One such unintended consequence could be a currency realignment
40)Another consequence is the rise of a third party that has already started between tea party, OWS and now the “people before party” party’s candidate, and so on, that a third party candidate will take over 30% the popular vote.
41) Some information about Area 51 will be released, then denied, then released again, meanwhile area 52 in Utah will be the new place to hang out.
42)As evidenced by my other predictions that extend beyond 2012, the world will not end in 2012… However, civilization will undergo major change and the series of changes will eventually lead to the result that could eliminate modern banking systems and other major institutions such as churches and colleges, and replace it with something else. The rise of the internet revolution will result in a sort of “meet up groups” to help people get together and solve problems of the world although I suspect profit will still be a primary motivator in some way, even if the profit is determined by public treasury and some kind of voting system or something crazy.
43)A nearby supernova will blow up somewhere in this galaxy causing a 10.5 earthquake and potentially opening the doorway for science to consider that earthquakes may be caused by supernova causing a shock-wave that results in vibration that shifts tech tonic plates, and causing a change in our understanding of the universe. Meanwhile Dr. Hawkings will be ejected from the shock of the earth letting out a mechanical sounding “no” that will be heard by aliens.
50)none of this is relevant
51)I will eat a sandwich
52)The stock market will find a way to destroy itself
53)At least one of these is a joke
54)At least one of my predictions are sarcasm
55)see #56
56)See #55
57)If you are reading this, you either don’t follow directions in a loop indefinitely, or are not blond…
58) Everything you know is wrong, even that which you appear to be right about will only be true because your perception of the world, and perception of “being right” is actually wrong. One day you will realize this and realize that nothing you know can be correct, because you can only know reality by associating everything you know by your 5 senses, which in fact may be just as flawed as everyone else’s way of interpreting reality. If you do not understand this, see #55 and 56 indefinitely until it makes sense.
59)People will become bored with predictions by Jan 31st, and bored with resolutions 2 months into the new year
60)The Fly always wins even when he appears to be losing, which is why he doesn’t mess with Hattery or Chuck Norris.
61)Gold bugs will appear to be stepped on, jakeG be damned in 2012 as gold declines. However, like cockroaches in a nuclear storm, they will emerge unphased in 2013 as gold continues it’s run. This is probably not a major “top” type of event that we saw in oil in 2008 with a massive sell off, but a more healthy “correction” that needs to happen.
62)

 

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2012 Predictions part 1

Here is a post titled investing in 2012 for survival that I drew up. I will copy and past it below, and then add additional predictions.

If you want to know what the first 2Qs or perhaps even 3Qs of 2012 will be like, play Monopoly with no cash for passing go and half the starting money as usual. Properties may go fast initially, but then money becomes scarce, mortgages will be common, and soon properties will be auctioned, The person who conserves his cash will then have the ability to survive and get properties for less than the mortgage value available on the home as the “auction” will force prices lower. Those stuck playing the “old rules” of asset accumulation, and borrowing heavily to accumulate properties early and often will be in serious trouble later on when money becomes even more scarce.

Even those who have monopolies on boardwalk and park place will end up not having the funds to build houses, so those that live within their means and keep things tight to the belt will survive and position themselves to thrive when the opportunities hits. Calculated patience and caution is what is advised, and then there becomes a point where you must shift aggressively into accumulation where the rules will change and suddenly the deflation will have run it’s course even though everyone repeats the story as if it will get bad forever indefinitely. Making trades below intrinsic value for cash actually can make sense in this game, because you in monopoly can calculate that there will be more deals and everyone else will be even more short of cash than they are now. So even at the expense of giving someone else a monopoly, provided you take their funds to build houses will make sense since there will be opportunities on the auction block later where you can accumulate properties to generate more cash (by buying below the mortgage value), have cash to force trades into people who are near bankruptcy, and collect monopolies yourself in areas in which you can afford to build. In the stock market in real life, when liquidity dries up, selling assets below intrinsic value can make sense if other people will be forced into liquidation, thereby having less cash to be able to keep all the assets at their current PEs, and even better deals will become available. However, there is a very fine line between doing this and overdoing this. Eventually the people that are on margin and leverage collapse, the excess credit collapses, and those waiting for an opportunity strike and start to go on margin making up for that which was lost, and the markets refuel.

Knowing this well in advance, you should keep your options open by having lots of cash at all times and employing a strict minimum such as 40% that you must not go below.

Here are my predictions for 2012.

The increased leveraged in the euro to try to save it without an ability to print like the fed, and the fed having a different policy, globally will be like an atom in nuclear fission with 1 too many protons… It becomes unstable until it causes a chain reaction. We’ve seen it happen time and time again after efforts to keep Greece alive continued. Now yields are blowing up everywhere and they may come up with one final “solution” but it won’t be until a culmination of everything unwinding until they will be able to stop it.

The sovereign defaults will finally hit in 2012. Rates have risen dramatically and if €600 billion euro will be rolled in Spain and Italy in 2012, the national debts will begin to explode strangling the economy producing stagflation as was seen in the US during the late 1970s.

Capital fleas Europe initially for thee dollar. Shortly after the default event, everyone who will ever get into bonds will have already done so at maximum velocity. That means there will finally be a bottom in yields and a top in treasury demand in the US, the lack of new buying pressure will finally form a bottom around the middle of 2012. June will be the “panic” month.

In spite of trillions more of stimulus, deflation will hit as new debt comes due, but food prices and fuel prices will go up. Stagflation will occur due to slow global growth and domestic inflationary policies. Gold bugs will proceed to move into their bunkers in spite of falling gold prices.

“protect capital” is the #1 theme of 2012. This means more cash. Also, more frequent “rebalancing” and allocations a bit closer to the vest when bullish, (close to equal amounts risk on and risk off) and being more cautious about using leverage in arbitrage deals, and elsewhere.

Real estate will bottom along with interest rates shortly after the panic. The real estate “bottom” this year will be part of the first “double dip” assuming you don’t call the volatility a double or triple dip already. The real estate rally that unfolds will take a handful of years but not be great and it will never quite recover to the 2005 highs before it makes another multiyear decline.

The CDS market lack of “default” is triggering a sell off in bonds and spiking yields in Europe, while treasury demand in the US spikes. The “legal” insider trading of government official (while having a conflict of interest and working on the bill that effects companies they invest in) also feeds into the dissent along with MF global and potentially other scandals, and people will lack the trust needed to continue to buy goods and services, fuel the economy, push prices higher, and so on.

So in 2012 be sure to protect yourself

Just when you think things possibly couldn’t get worse they will, and soon people will forget that things eventually will also get better, but they will. As usual the cycle will return as the deals available are much more affordable even though earnings seem to be non existent. Loans will be non existent except for a few very intelligent ones. The most credit worthy will get loans and this will ensure that those that do get loans make good ones, businesses will be bought for cents on the dollar at some point. Eventually as things stabilize more people will be willing to take the risk, and that will result in a complete 180 as people go back in, and plus selling pressures can’t persist forever. When no one seems to be buying and a collapse seems possible, is when there will hardly be any buyers, but those that do will be able to get the best price. As soon as they start to go, rally will squeeze shorts. Short bursts of contra trend rallies will occur first, but eventually, the rally will be real and truly be the opportunity of a lifetime. Additionally there will be aggressive policies perhaps even extreme ones as allowing the fed to buy property or employing some agency that will buy property. Over time, unemployment will get worse, and this will be very bearish for real estate, however that does not mean there won’t be times of panic when people do anything for cash.

Expect cash to be king. Expect turmoil. Expect an increase in antiestablishment mentalities against big government (tea party) and big business (OWS) which will result in a 3rd party in 2016. There is a movement that is close to the 2.9million signatures needed at americans elect (americanelect.org) that could potentially shake things up in 2012.

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The Fall Of Rome, Supply Shortages & Hyperinflation

I received a critical anonymous comment by someone on my 2012 trend report. One particular comment was justified as I made a serious typo talking about a spike in treasury demand but mistakenly said treasury yields. In the context I talked about selling into strength of the spike upwards, but I certainly understand the criticism in that regard.

However, one such criticism was directed at my comments about hyperinflation, that I made suggesting that too much money wasn’t the only factor in hyperinflation, and that confidence was just as important. I am not saying that too much money isn’t a common cause, just that there are other factors.

Even if you consider hyperinflation to only be caused by too much money, there are other things that lead to those policies, such as unfunded liabilities and shortage in government treasury that require debasement or default to pay for, both of which have consequences, but in a republic, the only policy that makes political sense is debasement, as if you default you will probably not be reelected and there will be turmoil and rioting against the establishment.

The definition of hyperinflation is typically “too much money chasing too few supplies”. In a gold standard, if you run out of gold, you are in trouble. In a fiat currency, if you lose confidence you are in trouble.

Rome had no ability to mint coin at will. They did have the ability to mint coin using some lead and silver and gold so I am not going to say there wasn’t debasement. In fact there certainly was.

However, they had several things working against them before their collapse. Romans kept detailed records, so more information is available on Ancient Rome than any other ancient culture.

One such thing working against them was population decline. The ability to produce as a society becomes problematic when half your population dies. As rome sought to expand the empire in wars, many soldiers died. Angered, many barbarian villiagers raided the city, killing civilians as well as stealing supplies. To make matters worse, soldiers brought back the plague.

Here’s a graph I found plotting Rome’s population


The fate of Rome had clearly begun to change direction with the rise in the financial problems during the reign of Marcus Aurelius (161-180AD) when there was a sudden explosion of calamities afflicting the empire. The Parthian war erupted which would prove to be very expensive. And this is when the army spread the plague.

Government workers (Military Soldiers) were promised retirement benefits. The politicians were cheered for providing it and Rome in a free republic was made up of elected representatives.

The surplus left by Antoninus Pius in 161AD of some 2.7 billion denari in the treasury was reduced to a mere 1 million under Commodus by 193AD.

The Germanic tribes began to invade from 160-171AD there were many frontier breaches along the Danube as well as other invasions from different tribes including the attack on Buetica by 14 Moorish rebels in 171AD. There were a number of revolts in this period including a very serious one in Egypt (early 170’s). The Roman currency was not drastically debased until well after this.

There was increasing hunger and plagues during the 3rd century that devastated Rome as barbarian invasions began bringing a new gene pool. This hit the rural slave population the hardest, contributing to the further depletion of the slave labor force. Between 180AD and 280AD, Rome’s population probably declined by at least 30 percent. This contributed to the contraction of agricultural labor that was the largest economic sector, which became the single most important cause of declining economic trend behind the Roman economy. The economic crisis had tremendous impact causing enormous suffering for ordinary Romans. This lead to shortages, and required greater expenses by the government as supplies were more scarce, which with the treasury greatly reduced at this time, required great amounts of debasement. It was the shortages of supplies, including the government’s treasury that lead to the debasement, not the other way around.

It was the combination of the promises made by politicians that could not be kept, the decline of the labor force, and the rising costs of military that lead to shortages of government treasury. The government had very little choice at this point but to mint coin, employ aggressive taxation and make promises it couldn’t keep without currency debasement, or default to keep the republic going for a longer period of time. If they defaulted, it was possible the military themselves would turn on the leaders. The “inflation” was only done as a result of there not being enough and money not going far enough because of shortages. This was the result only because of aggressive military expansion and the use of a slave labor force in the race to economic expansion and military conquest.

It is not as if the choice of currency debasement was made in isolation. The expenses of war and military expansion rather than cultural expansion lead to supply shortages, and economic shortages. It was only when Rome was near bankrupt and supplies were scarce that they attempted to print their own money, and not much had to be printed to contribute to hyperinflation as the labor force had died and supplies were in very short supply. People were not going to give up their food when it was scarce and the famines existed for any price.

Similarly in the US, government official sought reelection by spending the nation’s treasury and making promises that could not be financed, and the combination of unfinanced promises and military expenses got to be too much and the only way to maintain some of the power of the US was to turn on it’s bondholders via the closing of the gold window. The government owed far more gold than they had in it’s reserves at the current price, not to mention the growing number of unfunded liabilities. The possibility existed for a run on the government’s gold via exchanging the debt payments for gold from the US treasury, (somewhat similar to what happened during a run on the banks in the great depression only the US treasury was the bank). To protect the nation’s gold reserves Nixon granted the treasury the ability to debase the currency at will, even though it was supposed to be “temporary”.

The one downfall of a republic (elected representatives) is that elected government officials will make promises we can’t keep as long as they are allowed to, and that means eventually even under a gold standard, we will be forced to go off of it like Nixon did at some point unless there are limits on how much government can spend and how much unfunded liabilities they can create. That is not a criticism of a free republic, but instead the lack of us to recognize the problems of history and guard against them.

Hyperinflation occurs when people don’t trust the currency. Even when there is a fixed amount of currency, eventually there is a tipping point that occurs if too much spending is done. The printing money is only done after the government comes up short on cash and decides to debase the currency. It is the supply shortages and debasement of currency that result from the unsustainable policy of promising what cannot be delivered as an alternative to default. If the government were to instead default on it’s promises, and (globally) no one bought their debt as a result or wanted their currency, I believe the currency would not be accepted internationally and be worth closer to it’s intrinsic value (in this case, the melting value of gold per ounce, in the case of paper money the value of using it as paper), and it’s value would likely still be diminished, even if no additional printing were done.

If they create a new currency instead, and the old currency fell out of favor and was accepted by fewer and fewer people, even if the currency was burned so there was very little of it left, without the public confidence and usage, it would become a very inelastic market where the very few amount of people who trade it determine the price. Like a rare piece of art, it can be worth quite a bit as a collectors item and antique, or very little if it’s not a historic piece of art and not appealing to the buyer’s tastes, depending upon the value the relatively few people give it.

Certainly debasement of a currency has a tendency to cause a loss in confidence but blaming too much money on the problem I feel is not looking closely enough at the root causes, which is government’s mismanagement of the money supply, war policies that lead to supply shortages, and government unfunded liabilities.

Regardless, although it certainly could be a significant factor, with all due respect I believe it is fallacy to assume that the only factor on whether there is high inflation is the supply of money, and that the precursor to “too much money” is “too many promises” or money and/or supply shortages.

If you think differently, unless you can show me evidence otherwise, we will have to agree to disagree at this point.

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January 2012 Trend Report

See also the 2012 trend report.

Stocks remain in a monthly downtrend, but a weekly uptrend although the weekly uptrend is now overbought. The economy is in a very vulnerable position here.

It starts in Europe. A sovereign default occurred in Austria in 1931 that kicked off a wave of others and the great depression. Some chatter is heard about the problems in Europe having similar consequences this time around.

The problem is with Spain and Italy as they will likely roll their debt in 2012, yet the interest rates have risen drastically in the last Q of the year so this will be costly and their debt will rise.

Meanwhile, in the US we have large trade deficits and debt to GDP of over 100%, unfunded liabilities over 100T but the 10 year treasury yield should close this month at an all time low as it currently is 1.91%.

Additionally there is a lot of old debt coming due. If we look at the peak in debt in 2007 in the United States, only one slice of the real money supply, the general leverage stood at nearly $60 trillion. So if you think $3T will put a dent in that, you are saying that leverage only declined by 5% from 2007. There is mark to market accounting, so any official numbers will be inflated. Put even 25% deleveraging and there will be no inflation from QE1 and QE2 as the 15T in debt destruction will put deflationary pressures and foreclosures and bankruptcies and shortages on payments, meanwhile the new debt being created can potentially lead to inflation in other areas, or the combination of “stagflation” as Milton Friedman once predicted. Perhaps that will not come in the US as interest rates are currently at all time lows, however, it seems the global economy is interdependent and we risk a global contagion from what may play out in Europe. It would surprise me to see slow growth, high unemployment (which we have) and high inflation (which we have in terms of real goods).

Not helping the situation, is that there isn’t exactly a lot of cash and room to spare in terms of the market.

Liquid Assets of Stock Mutual Funds
Percentage of total net assets
http://ici.org/research/stats/trends/trends_10_11
July 2011 3.3% cash
August 2011: 3.4% cash
Sept 2011 3.8%R
Oct 2011 3.5%
November 3.5%

With cash levels low, if there gets to be a shortage of liquidity, and people start to withdraw money from mutual funds, they will be forced to sell, which will further depress prices, causing others to want their money out. It really won’t take much for capital to flow out.

Here is where the trends are at…

daily overbought

weekly overbought

monthly downtrend and bearish divergence

TLT looks significantly overbought but potentially making one final parabolic push with room to go higher for the time being. Volume is going parabolic.

Treasury all time lows hit on a monthly close below 1.94

10 Year Treasury Rate Chart

 

Even gold looks vulnerable

Don’t get me wrong, gold has sold off significantly already, it never made a parabolic move as it stayed within it’s trend channel, and still might… I am not exactly ready to bet heavily against it, but with the deflationary scenario we face, and all the buying pressure that has occurred in gold over the last 10 years, don’t tell me it is immune and isn’t at least vulnerable to a constructive correction here.

2012 is such a significant year. The euro could finally collapse, because skyrocketing yields will lead to budget shortfalls, riots occur when they even talk about austerity, now they implement it, costs of entitlements around the world hit as the baby boomers hit retirement age and more start to get social security checks. Austerity measures will take place and government will lose control of the people in Europe.The capital flow into the US will seem like everything is great as US treasury yields will potentially go even lower in one final run, as tlt goes parabolic, but then what? More people are buying treasuries than ever, but that buying pressure cannot continue forever. The time to own treasuries would have been over the last 30 years when your yield was over 10% when treasuries outperformed stock in what seems to be a very atypical result. The time to exit gradually is now, particularly into a strong move upwards and a panic in Europe. The time to short treasuries may finally arrive, particularly near TLT 140.

I believe a major buying opportunity will arrive, maybe as early as June, maybe not until 2013. Particularly in real estate.

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2012 Trend Report

Rather than title this the January Trend Report, I want to look a bit more ahead and provide a more detailed report. So I will just call this the 2012 Trend Report.

Briefly the Jan trend report has the following stats right now

(daily OB)
weekly OB
(weekly divergence in slow stoch (kinda) @115)
monthly downtrend
monthly bearish divergence

Very bearish.

Even if you are a day trader, you still want to heed the market’s longer term warnings so you are more prepared to adapt quickly as conditions change, and recognize the vulnerability of the market. You also may wish to use a small amount of long term holdings to reduce your portfolio’s correlation to the short term moves and reduce volatility of your portfolio. Currently we are near the worst of both world’s the uptrend on the weekly chart is overbought. The monthly downtrend is still intact. Technically, we are vulnerable. But look around you if you doubt the vulnerability of the market. The RSI on a weekly is not overbought, as this is much more rare.

Stocks aside, this month’s trend report will put in focus US 10 year treasury yields. In spite of the downtrend that may continue to bring prices lower into 2012, I think that treasuries are not safe as I wrote about in the posts: “Accept And Respect The Unknown” and “Risk is largely unknown” (currently saved as drafts and not posted yet).

Bubbles typically result in a decline that brings you back to the prebubble level taking you near the previous lows or exceeding them.

 

Typically post bubble decline’s result in a 50% to 90% decline. In the case of tech bubble there were many tech stocks that were losses of 99% from the top, however the nasdaq top of around 5000 and low of around 1000 was “only” an 80% decline. The duration of time depends on the asset. Oil in 2008 went from high of $140+ to low of $30 or something but it was over 75% and near an 80% decline.

I could go on with other bubble examples, but that’s another post.

Unfortunately Treasuries and Gold have a much longer time frame then say oil. When US treasuries stop selling at auction, gold will probably go up.

 

10 Year Treasury Rate Chart

Betting against an oil bubble was much more profitable, because time is on your side. Provided you can get in relatively close to the top, which can be very difficult… You can make monster gains, especially if you use options. As an example… Some 50 cent far out of the money options in USO were worth $20 by the end of the Oil Bubble. The oil bubble dropped in a period of 6-8 months from above 140 to below 40, losing over 70% of it’s value in a short period of time. From there, oil then increased in value about 150% from the low to where it is now around $100/barrel. Commodity bubbles in my research seem to be more common, as there are perhaps more volatile swings due to the leverage tied to it. If I wanted exposure to gold, at this point, I would look to miners, and not the metal itself. Due to short term disapointments in expectations of earnings suppressing the prices, miners are very cheap if you just want the exposure to the gold at a discount. Long miners, short gold is a decent hedge to take advantage of the disparity.

There are three plays when you spot a “bubble”.

1)The higher risk method using the “greater fool theory” and watching volume and the parabolic move to try to bank a lot of money in a short period of time.

2) Betting against higher prices, and gradually over time dollar cost averaging into a bearish position such as long term OTM puts

3)Waiting for a decline of at least 50% and then if you think value presents itself, consider the contrarian play of taking a small position size and gradually increasing your exposure as prices decline. (You may also consider only playing deflated bubbles if they hit extremes such as 70% or 80% losses or more). This doesn’t mean to automatically just look at price and not consider whether or not there is a fundamental reason to owning that asset class, but to use those as initial criteria for considering contrarian plays.

Right now the opportunity seems to be available in the contrarian play for betting on treasury yields going higher (which in this case is betting against treasuries), or betting on Dow/gold, or perhaps even betting on natural gas. Natural gas is a play where you will be early on. Inventory is high, access to new natural gas seems pretty abundant. However, it is only out of these conditions that it’s usage will become more comercial, and potentially used in other things or as a solution or alternate source of energy that becomes more common, which eventually will work off the inventory but by the time you realize it, prices could be significantly higher.

 

Nevertheless, eventually the inventory will be worked off, and if you wait for the growth prospects in this area, the bottom will have already came and gone. Contrarian plays are very tricky. You want to buy enough to take advantage of the low prices, but little enough to have cash to accumulate the position gradually, and not very much to respect the amount of time it may take until the position turns profitable, and also you want to be able to add to the position and increase in how much you add so you can roughly aim for adding the most as close to the bottom as you can. You should be looking to deploy half the capital you use towards this position on the way down, and half on the way up, with as much as possible as close to possible on the bottom. Easier said than done. But always start smaller knowing full well there will probably be lower prices, and that you are probably early. Additionally, contrarian plays should only make up a small amount of your portfolio, unless they are somehow no-brainers that everyone else overlooked except you (not likely, and not often). You may be down for a few years before things turn around though, it is not fun being a contrarian most of the time. Which is why this should only be a very small peice of your portfolio. Much like the theme has been in the past, doing so will reduce your correlation. You will be owning this on a much different time frame than most, be adding in a different way, and be selling on a different wavelength as well.

Right now treasury yields have certainly met both criteria that you often see. A drastic parabolic looking run up in the 80s, and a decline of 50% to 90% (currently above 85%). So from that perspective, the bottom in YIELDS is close if it has not already occurred. If we flip this upside down, we can see that starting from the low demand (or high in yield) of the early 80s treasury demand went parabolic upwards (as yields fell). If that’s the case we have entered bubble territory in treasury demand. By that measurement, it still could have a ways to go as bubbles tend to run a little longer than many expect and the end of it is when the demand skyrockets and you see yearly gains in days or weeks.

edit:15.32 is actually the top on a monthly close basis, I was using a yearly basis. That puts us at a 87% decline. If yields were to decline a full 90% from that top, the yield would be 1.53% at the bottom.

Good luck with timing such a long term move. However, certainly betting on yields going up now seems to make sense if you have a long enough time frame. It would not be unusual to lose 20% or so before the yields bottom, so you have to be able to endure a big loss, and also hold off for a big enough gain in order for it to be worth the loss. Even if yields cut in half again and again, the upside is much greater than yields simply going up to 3.88 (double to offset risk of a near “100% loss”), and I certainly think there is a better than 50% chance of it going up to 3.88 before it goes to zero. So needless to say, I do not feel comfortable referring to US treasuries as “risk off” trade for very long. For this reason, In the “trend trader” I have put emphasis on the dollar, rather than stocks.

Treasuries often function very differently, but the concepts of a closed group of people with a relatively fixed amount of money plus an increase (or a rare decrease) of a few percentage points each year… and among this, people having to determine where to put their capital, it is more similar than many might think. In any asset class there is a certain point that gets reached where demand can’t continue to feed the shift in capital at the same rate. This is when prices generally decline, and capital eventually as a result will shift away. There is a point when the buyers overwhelm the sellers, but eventually the few sellers within a group will not become buyers until prices are much lower. Eventually the buyers simply run out of capital to continue to fund the growth of a particular area. It doesn’t matter what the earnings are or growth rate is. Although certainly those with higher growth rates may have a larger threshold for how much capital increases they can take, and prices can go much higher in those areas, there are also the sudden drop offs when estimates get higher and higher and actual growth must slow. In high growth areas, the decline is going to be much greater. However, in points of extreme, these assets can represent very high return and low risk, where when they are overbought the chances of the rally being fueled higher and higher declines more and more until the return is low and the risk is high.

Contrarianism is about avoiding the blow off tops and even betting against them, and identifying the sell off panics and forced liquidations. It’s about betting against the heard when the heard is very one sided.This comes with the asterisk that you also must avoid situations when the heard is very mixed, which is most of the time in most markets. yet another reason why contrarianism should almost never be your entire strategy.

A lot of people (particularly in the Austrian Economics field) try to say hyperinflation only has a single cause and that’s too much currency. That is far too simple. Supply shortages can contribute just as much as cash excesses. Deflation of debt can potentially put a damper on what otherwise would be inflation. Gold is not at $2000 right now because of the old debt payments coming due and the deleveraging of likely tens of trillions since 2007.  Bombed out local supplies or trade embargos can result in too few supply. Individual areas can show hyperinflation if there is shortages, but sometimes there can be shortages of just about everything important. Droughts and shortages of food can occur. On the monetary supply, too FEW dollars can also result in hyperinflation in rare scenarios if confidence is lost. If for example, you try to use Beanie Babies as money in 1999, you could probably get away with it. You could pay for a haircut in Beanie babies and the barber might take money out of his own pocket because he would rather have the Beanie Babies. But when the confidence is lost in the “money” and counter-fitting is possible, and people stop trusting them, and people stop trading in resources for this “currency” it becomes worth less and less. If you use “Disney Dollars” one year when Disney is super popular, you might be able to exchange them to someone for real dollars, even if that amount is discounted significantly from what you paid. They may have value relative to something else. But what if Disney stops making them and people no longer have confidence they will be able to use “Disney dollars” even in Disney World? It’s very possible that you have very little value and won’t be able to find a buyer. The market becomes very inelastic, and can become worthless if you can’t find a buyer. The problem is, since very few people set the market place, if enough people decided they want Disney Dollars, it could become a collector’s item and be worth far too much. Certain antiques without much functionality become worth far too much from a select group of people that want it at any price. I do not think that would be a common response for a long period of time for most currency, but it is possible. Hyperinflation is NOT ever out of the question regardless of how much printing is or isn’t done. However, neither is deflation. The demand or lack thereof can still occur for a reason of confidence.

Just because currencies made of paper tend to go bust at some point does not mean it can’t take hundreds, or thousands of years before they lose their value. In a market place, if everyone can afford something at $1, people may not respect it’s scarcity. It is only when prices start to rise and people become afraid they won’t be able to afford it, that prices really start to climb. It can take a very long time and not be linear at all. Then prices increase and even though a lot of people may be able to afford it at $1, and maybe sellers may be willing to, if the only transactions taking place are between a few very rich people setting the price, prices can become very distorted. Well they may very well be willing to consume the remaining supply and people may do whatever they can to buy it. However, what happens when these few people and those buying on credit as a get rich quick scheme and everyone else in the world that is caught up in the mania suddenly stops buying or runs out of funds to do so? After the people who can no longer afford it bid up the price of an item, it is up to those remaining who can afford it. If they want to continue to buy it and push it until it is above their price range, and then those after them wish to do so, they can, but they have turned it into a ponzi scheme. So this is what the contrarianism is about recognizing when either buying pressures or selling pressures are unlikely to continue. More realistically, it is about what people choose to pay AND can afford. The dot coms had plenty of billionaires on the sideline, while the millionaires (some on paper), and middle class were going nuts bidding up these things based upon expectations that every single dot com name would make it and the Internet would be here forever, and that some of these companies could grow with such huge amounts overnight that it was worth buying everyone of these in hopes you could catch Microsoft or Yahoo, or Google or QCOM or CSCO or JDSU or whatever was hot back then. Even if that was true, more dot coms would join and not go public, some would beat out the public companies, many would not survive, and it could be 10 years before they went up to hopes. In that time, there’s no telling what could happen and in a blink of an eye it could all change as well. More importantly, you can’t have such a large percentage of the market bid up dot com stocks. I am not saying you could have recognized the top, but you certainly could have recognized that owning these was becoming increasingly dangerous as the novelty of owning them grew.

Understanding the “cycle” is about respecting things can change, and positioning yourself away from the risks. Adding lower and selling higher.

I think that treasuries may have a bit of upside left but there’s no telling when that will change. Even though I expect stocks to decline, I no longer feel that buying treasuries is a good trade to protect against the decline. I compare this to somewhere around December 2008, maybe November depending on how much upside in TLT is left. What happened then was treasury demand peaked well before stock prices bottomed. UUP or the long dollar index did well against the grain of TLT for a brief period of time of a few months until March 2009 when stocks bottomed.

There are TWO reasons I point this out
1)To point out that the treasury market will potentially act as a “tell”, when the stock market is NEAR the bottom. (rising bond yields occurs first, as the transfer out of bonds may occur before they put that money into stocks.)
2)To alert you to limit exposure to treasuries, particularly into a big rally the first half the 2012 and perhaps even eventually consider going SHORT for those who can handle enough pain for a long enough time to be a long term contrarian play.

Personally I see a lot of evidence that the capital is going to continue to flea Europe and that Europe is going broke and that the Euro can’t survive. That could mean a HUGE spike in treasury demand at some point in time this year. The last point in time just before market extremes are generally when the biggest moves occur. When everyone races to beat each other out of assets and into other ones, when the panic buttons are then pressed, and when people don’t know what else to do. So if this does happen as expected, it’s wise to be positioned to start shifting the other way into it and going against the grain. Perhaps that price move has already happened in treasuries, it’s hard to say, but although the trend is lower yields, the tendency is for trades like this not to last forever, and right now it is in “contrarian” territory where betting on treasury yields is becoming risky in spite of the mild inverse correlation that bonds have with stocks.
You could also make an argument that it makes more sense to be short treasuries before you are long stock because of the tendency for the “smart money” (bond holders) to use strength to exit bonds early in order to raise capital to deploy gradually into market declines. To me it is more a question of “timing”. I think that I would wait until you get the bearish signal when we come down from overbought levels signaling the momentum change. You can use a monthly, weekly or daily chart and spot overbought readings in treasuries. Some times you have to be willing to do the opposite. The “infinite loss” may seem possible as it did in 2008, but have faith that the market will eventually return and “buy when there is blood in the streets” if people seem to panic in 2012 and liquidity dries up.

Treasuries are in fact very vulnerable even though they may seem like the only safe place, especially when a crisis hits and it seems like the only place that is “safe”. Overbought markets tend to stay overbought for a lot longer than oversold markets, but nevertheless, you should be scared to put your money into treasuries for an extended period of time. It’s always toughest, especially for those who manage money and have people expecting you to produce high returns when the market is producing high returns (like in October) and to hold lots of cash when you can get a yield from treasuries, but sometimes you have to be able to endure, or else be very nimble and ready to go against the grain once the floodgates open and the “boiling point” is reached. Water does not boil in a linear fashion, nor do human emotions function linearly. things get worse and worse and the world holds together and people get worried but only when a major shock hits do they panic, and they may seem to have a good reason to do so at the time, but the profit opportunity starts around the same time panic does.

What’s unclear is if the ECB will be granted the ability to print unlimited amount of money like the Fed can, rather than forcing the rest of the world to. If they do, they will be able to prevent the yields from skyrocketing in Europe, and the contagion will probably not spread to the US. They also could make a “euro bond”. If a solution occurs capital could migrate back towards Europe and away from treasuries. That would be a game changer. However, even if things collapse, there will still be a panic spike high in treasuries, and whatever the resolution is will put money away from treasuries enough to cause rates to rise at least a little bit from here. Now even if there is no solution, and there is major deflation, it’s possible that people sell everything including treasuries, or that at some point the demand is high enough to sell treasuries and the demand is low enough that stocks become attractive.

However, even as the ECB could be allowed to have an elastic money supply, the ratings agencies don’t like the plan for the US to make spending cuts “automatically” and then suddenly these “automatic” cuts are repealed. Another cut by S&P isn’t too unlikely in that scenario.

The more I think about it, the less safe treasuries seem and the more treasuries as the “risk off trade” sounds like an oxymoron. So although it’s possible for capital to shift drastically into treasuries first even more than already done, and perhaps TLT could go parabolic, it should be used as an opportunity to further reduce treasury position, and/or potentially get short, or add to shorts in treasuries, or increase the inverse ETF position. At this moment with the market overbought, I am not personally ready to do so, and even have a small amount of TLT.

This really is starting to shape out to be a no brainer though. Even Buffett called the treasuries a bubble in Februrary 2009 when yields were 2.87 and the yield is now trading at less than 70 cents on the dollar or if you prefer putting it another way, yields were previously 50% higher (when Buffett called them a bubble) than they are now. Buffett has never been known for his timing and yields could still go lower first and as I have said, very likely will at least briefly, when the crisis really hits, but that doesn’t mean the risk is justified because the downside to betting on treasuries (or against yields going any higher), over an extended period of time is tremendous.

However, Buffett eventually will prove to be right, most likely. As far as timing goes, it just feels like we will see a sharp decline and a potential panic if things aren’t resolved in Europe, and I can’t see treasury demand not peaking very soon, perhaps this year (2012).

Correction: 1982 14.59 top is on a YEARLY closing basis. The MONTHLY closing basis high is 15.32.

One thing know is that when rates get high, the levels of inflation the government needs over time in order to inflate away the expense is high.

Additionally this is what the treasury chart looks like. I think we could easily have an early formation of the head and shoulders pattern, which perhaps takes TLT to 130 or so at the peak, maybe 140.

Although TLT is overbought on a monthly time frame, on a weekly it has just begun another uptrend, in spite of just coming off overbought and heading near it again. Nevertheless I think in spite of the potential for it to rally and go parabolic here, and in spite of the fact we are in an uptrend on a daily, weekly AND monthly chart, the risks are far too dangerous unless you are to trade it for maybe 6-7 months or less. It is probably too aggressive as a short as the timing has to be ideal to short unless you are hedging. I would probably wait until TLT gets overbought again on a weekly chart before I think about aggressively entering TBT or TMV (or getting short TLT, UBT or TMF), or until a downtrend is triggered in treasuries. Adding a tiny bit of exposure at some point as a contrarian bet may make some sense, perhaps on the next TLT bounce.

In general, the “risk off” is changing dramatically, as treasury bonds will not continue to be the “risk off” trade. The dollar does diverge from treasuries sometimes, as it did in December 2008. The real “risk” is more so prevalent in the risk of lost money over the next 10 years to inflation. Believe me, I know how ridiculous it seems to some how you could possibly talk about inflation now. But once the Continent of Europe goes all “Atlantis” on us, or actually fixes their problems rather than fiddling as Rome burns, and economic trade starts to take place and increase, there will be inflation. The business cycle will continue to push things higher for another handful of years after that and only then will things be at risk again at unraveling, just for long enough for people to claim the world is ending and for prices to be very cheap again.

There even does exist the possibility of default. That occurs by delaying the payment because of budgets not met. It also can occur because of the rare potential for the government to go all Madoff and try to follow Greece and force a haircut on the bond holders, or potentially to ask the fed to do so thus having the money created float without it being owed or owed plus interest in 10 years. How much spending does the government due just on interest payments to foreigners alone? This is going to force us into more debt to meet our obligations and the more we borrow, the worse it gets, but any “solution” will also seem equally dangerous. Eventually, however the whole system will have to be reformed.
There is the possibility of a currency alignment where the dollar is not the world’s reserve currency. I realize these risks may be small, but when you are only talking about a very small return, there doesn’t need to be a lot of risk there for it to be a problem in the reward/risk ratio department.

Eventually does that money make it back to cash? perhaps. However, I think the market will decline first provided there is no resolution. I think it will decline dramatically at that. AND THEN as treasuries are also declining and everyone is liquidating, suddenly there is a final “bottom” that is made. This decline I feel will be quick and prices will be lower, testing the 2009 bottom and perhaps making new lows. I don’t know where the range exactly is, but below 10,000 seems likely. I think things are most vulnerable around the summer 2012 just as they were in 2011.

As for stocks, earnings multiple compression looks to be in place.

http://www.multpl.com/
Current 10year trailing PE is 21.17

The year 2000 high was a PE of 43.77
Let’s look at some previous declines
1899-01-01 22.93
1921-01-01 5.12
1929-01-01 27.08
1933-01-01 8.73
1966-01-01 24.06
1980-01-01 8.85

2000-01-01 43.77

Jan 1899 to Jan 1921 there was a 77.6% compression from peak to trough (on yearly closing basis)

1929 until 1933 we had a 67.76% compression

1966 until 1980 we had a 63.22% compression

From 2000 until 2009 we had a 65% compression.

You could also look at that in terms of a “% per year decline” average by dividing by the duration and 2000-2009 represents the 2nd greatest decline with a 7.2% decline per year vs 1929-1933 decline of 16.9% per year.

There are a lot of different ways to slice it, but assuming we are still in a phase of multiple compression may be a little bit on the aggressive side of things. If you are okay with that, fine. We also are on the upper sides of a fairly normal range, so there is some sense in being cautious. Deflation or stagflation is likely and that is probably not so good on stocks. Eventually yields will bottom and multiple expansion will take place over time. Of course in deflationary environment, earnings will contract, and in stagflation they probably will as well so if multiples do expand before the environment changes, it still won’t be all that great for stocks just yet.

The lines are a crude estimation of the range, with the middle area being the more common, and outside of that representing outliers. I didn’t do a statistical analysis of where the top 25% and bottom 25% or “upper quartile and lower quartile” range are. However I would suspect the more likely direction based upon this alone is lower and multiple compression and a retest of the lows. With history as a guide, any post bubble bottom results in a pretty steep increase of price/earnings multiple expansion. It’s entirely possible the bottom hit in 2009. It would certainly not represent anything we haven’t seen before throughout history.

Dow/gold is crashing. In the face of multiple compression. This is a sign of low growth, and monetary expansion.. Stagflation. I mentioned this briefly in the December 2012 report
http://home.earthlink.net/~intelligentbear/com-dow-au.htm

The good news is it is relatively close to a strong very long term uptrending channel, however we certainly could crash below it first. Dow/gold collapsed from 1966-1980 and from 1929-1933. Treasury yields declined significantly as well during those time-frames. Debt consolidates, people are forced out into cash, and in 1929-1933 cash was gold. 1929-1933 dow/gold declined 89.13% peak to trough. In 1966 until the gold window was closed, it was a decline of around 88.89% before the dead cat bounce, and an overall decline of nearly 97% peak to trough by the time it bottomed. Dow gold was 43.7 in it’s peak around 2000 but went below 5. This is a decline of around 88.56%. So it would not be unusual to see a shift at some point back to dow outperforming gold.

2012 is a major turning point. The reason is a confluence of events, but partially because of the government problem. The treasury bonds peaked around 1982 on a yearly closing basis. Well the 30 years I would venture to guess were also lacking demand at that time, and I would guess that a lot of those are mature and payments come due this year. Much of the debt the US owes simply goes towards paying interest payments. Fortunately in some ways, capital is flowing out of Europe. This will give the false impression that US government bonds are still considered “safe”, rather than a temporary shift of capital away from risk. Additionally, the baby boomer situation is bad. It won’t be until 2016 that the earliest of the baby boomers will hit 70 and be legally required to make minimum withdrawls out of their 401ks, however, the transition to safer portfolios will probably hit before then, and there will be a big need for new money flowing into the market. Social security gets collected as early as the age of 62. When you include these liabilities that have been promised but not been funded, the government comes up short in a big way. The government has a debt of over 15 trillion, but unfunded liabilities of 116 trillion. The debt to GDP in the US without these unfunded liabilities is still over 100% and nations around the world are betting heavily that more money printed=more GDP and that we grow our way out. And we do what seems humane at the time in paying trillions in healthcare (even though specific healthcare companies will benefit more than others), not considering what happens when we can’t pay for it all.

Japan is a culture of tradition. When things get bad, they buckle down and work. They even have a saying “the nail that sticks out gets hammered”. They have started to work hard and working for less, lowering costs. To compete, governments around the world have done different things as well as businesses around the world.

1)Businesses have cut back on employees, benefits, borrowed more money, or all of the above

2)Governments have either cut back on ‘benefits’, borrowed more, or both.

3)Citizens have organized protests due to austerity, special interests and bank bailouts and “tea parties” and so on.

4)Production increased

The nation is a bit divided on how to handle the issue. Unfortunately, it is the consumers that power the demand of businesses, and the demand of businesses dependent upon other businesses, depend on those consumers to keep the businesses around. Production increasing means more goods and there is a shortage of capital due to budget shortfalls. The combination is deflationary. The ECB functions a lot different than the fed. They cannot expand their monetary supply indefinitely as it’s needed. So globally, any printing effort by one country lowers exports and causes pressures on another country to compete with lower prices. Germany, the “tea party of Europe” as The Fly has called it will cut back on spending anytime they feel they can’t keep up on a production basis to remain competitive, and any effort to inflate could potentially just boomerang back at us. There is a balancing act that goes on,. Right now the problem is with real estate which always is a drag on the economy more than any other recession because of the “wealth effect” or in this case the “inverted wealth effect”. If people have no equity in their home, they feel restricted and are forced to be cautious with their expenses. Any effort in stimulating will not take effect until the next part of the cycle, and will only contribute to the excesses of the next bubble. People will only spend when it is too late, and people tend to not realize the severity of the problem until it’s obvious to everyone.

I would expect gold to pause in 2012. Currently gold is in decline, but the question is whether it will hold up better than the market like in 2008. It perhaps will not.

That means it declined around 85% as well. So both treasury yield and dow/gold is close to approaching it’s limits for what you see in a “typical” post bubble decline. That means the easy money has been made, much to the chagrin of JakeGint’s and Hugh Hendry’s alike.

That doesn’t mean we couldn’t see a larger decline. If you decline 90% rather than 80% the difference between 80% and 90% from it’s peak is a 50% loss from 20% of the peak (80% decline) to 10% (90% decline) and a 100% gain from the low to 80% of the peak if you instead bought at a 90% discount from the peak.

However if you want to use contrarianism to identify VALUE, most likely the areas in which a bubble has deflated is a good place to look, or at least to prepare to do so. For the record, I do think Gold will still be a good hold over the very long run, however I would NOT be surprised if AFTER this downtrend, we see ourselves a tremendous opportunity in DOW. If you mastered the GOLD trade or the TLT trade up until this point, pat yourself on your back and scale back your position a bit. It’s not a “win” until you sell. Complacency can occur when you start telling yourself “I bought gold 50% lower than here, I can afford to lose by holding longer” If you missed out, I believe there will be an opportunity in gold after a pause in the action, but I am much more skeptical about treasuries. Please understand the DRASTIC difference in time frames I am talking here. In other words, if you can trade for a few weeks, or a month or two or handful of months and can get out by then, there certainly could be more upside for a few trades. However, do NOT ignore these signals and fail to make some kind of cautionary adjustment, or you will risk getting caught with the herd when it runs off the cliff.

“Caution” to some people may mean taking the win and taking a vacation. Caution to others may mean smaller position size trades, or increasing your cash position. Contrarians aren’t always the best TIMERS but believe me, when an opportunity to be a contrarian comes along in a rare, generation long signal, do not get caught up in the hype…

Believe me, I do NOT like the market right now… I do not like the risks that everyone seems to be at least somewhat aware of. It makes me sick, but nevertheless a SMALL position is okay and a LARGE cash position is fine. This way you won’t get blindsided by an overnight solution to the Euro such as allowing the ECB to print at will like the fed does. The black Friday Surprise and Santa Clause rally is probably a little more of a shorter term rally, although fundamentally for the long term it probably could/will improve fundamentals, but it does not change the various risks associated with the Euro zone.

Nevertheless, around the corner there is support for an uptrend post Euro Garbage Day rally forming a bottom eventually.

Stocks may be in decline. Mutual fund cash levels may be too low. Treasury yields may be spiking all over the world except the US, and global contagion could be spreading. The economy is not in a good state right now… But, with that being said, there are a few very bullish variables. Personally, I would expect the following to happen
1)Early to mid 2012 we enter a deflationary vortex much like late 2008 into 2009
2)Mutual fund cash levels skyrocket as a result and are forced to capitulate continuing the short upward spike of mutual fund cash levels, perhaps even to extreme “highs”.
3)Meanwhile the foreclosure rates skyrocket again as all the mortgage resets hit the banks putting maximum pressure on the banks to liquidate.
4)Banks are forced to do another round of consolidation (musical chairs) and may initiate a firesale
5)A default takes place, and bond holders are shocked, including US bond holders at some point. The demand could spike on this event forming the top, or they could start migrating away a little earlier
6)The euro will either collapse, or come close to collapse until finally a real solution occurs. A eurobond would be a major start, the ECB having the ability to expand the money supply more like the fed where it is closer to unlimited would be the next best thing yet would have some inflationary risks.
7)During this, gold does NOT outperform the market

Once these conditions are met, there will be another bogus plan that will be inflationary, but the key thing is, the worst will be behind us, in spite of the fact that it will seem to be getting worse. Stock prices will be bought ahead of things getting better. The “bullish” things going on such as a low dow/gold will either be better, or not much worse. The low treasury yields in the US will either be lower, or not much higher. More importantly stock prices will be much lower, mutual fund cash levels will be higher, much of the “downside risk” that was unknown will be realized and priced in, and stocks will be able to form an amazing bottom and rally for years. I predict we will see new highs as early as 2013, but that may be pushing it. I do think that once this bear market ends, we will eventually see conditions set themselves up for a very bullish time period in risk asset prices, particularly stocks. In spite of setting “parameters” I may in fact break my rules and go “all in” if everything is aligned perfectly. That may not happen, but I may accept the risks of being early if we get the perfect storm, a climax peak followed by a decline in treasury yields, a raising of cash while stocks are extremely oversold on a monthly chart, mutual fund cash levels spike, stock prices fall to say under 7,000, and UUP spiking to a peak overbought levels and a super fearful event. Finding the courage in such an environment will prove to be difficult. ….

…….

………

Part of “following the trend” is being able to avoid the stamped off the cliff. It is also about being able to be selective but occasionally recognizing the rare opportunities and getting aggressive. It is about anticipating the NEXT trend and knowing how it could play out.

Well, we had subprime, now we have soverign debt defaults at the same time we are having the next leg down with option ARMs and ALT-A and all the mortgage resets cannot be delayed for too long. We will have lower prices that drive down the neighborhood price, and the deflationary private debt met by the increased inflationary pressures on the public debt. We do have risk that the US government will freeze spending having reached their limits and not wanting to expand government. Things could get much worse. However, they could also get much better, and after the &!*^ hits the fan in terms of prices, eventually assets become cheap, eventually loans are only given out to people who make intelligent investments, eventually the smart and bold take the leap creating a strong foundation. Eventually the people that sell low are not going to have any more to sell, and the buyers are going to start to want in, in anticipation of things getting better. The short sellers eventually want to cover. Eventually things do get better, even as they appear worse, and they have to turn, starting a new trend.

So knowing this, what are some things that could turn it? That’s what you need to look at. Low interest rates means an ATTEMPT to stimulate low economic activity, and when it’s needed is when there is pessimism. This is when things are low priced.

Low interest rates means there is high demand for bonds. It means that it does not need to offer a premium to compete with stocks. In other words, stocks are at a low demand… Investors and lenders are selective. It means people are downplaying RISK of holding treasuries and over pricing risk in stocks. Unfortunately this information is a bit paradoxical when measured with the fact that with interest rates, investors tend to compare returns on a relative basis (stocks are riskier and should have a higher yield than bonds by a few percentage points) and higher interest rates REQUIRE a higher return, meaning prices need to be lower (or growth and growth expectations higher) and yields need to be higher. Fortunately with rising rates, the economy is expanding, and yields are risen to compete with and attempt to attract more capital. Loans are taking place in the private sector, and the public sector will probably spend with higher GDP growth and growth estimates (also governments will spend a lot when they have high treasury demand that occurs just before Rising rates). Money will get injected in the economy when rates are falling and economic climate is bad, and that money will start to be lent out aggressively when it expands and through the functions of the money supply, the money injected will multiply. So rising rates can be bullish as wealth transfers into stocks, and wealth grows. Although in theory it is bearish because the cost of borrowing goes up, it doesn’t always correlate, as rising costs may trigger a “get in now” attitude. In theory people buy more when prices are lower, but in practice they do not do so with investments as much as they are expected.

 

Sectors:

Fundamentals:

The following represent decent fundamentals

http://www.wikiwealth.com/company:healthcare
http://www.wikiwealth.com/company:staple
http://www.wikiwealth.com/company:telecom
http://www.wikiwealth.com/company:utility

Conclusion:
The time seems right for a BEAR MARKET decline that will likely end fairly soon, perhaps in 2012. Bond Yields are likely to bottom in 2012 first, and a pause in dow/gold or temporary rally is very possible if not probable. We certainly could rally for a month or two before we set up the decline without breaking any of our trends or signals. However, I believe the bias should remain to the downside for now.

List of 2012 predictions to come later. Also, other contrarian plays and a hisstory on contrarianism if I get to it.

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December Trend Report Update

I haven’t yet put out this December report until now because we are testing the boundaries and I wasn’t sure if we were going to see a new signal. We are very near overbought on a weekly chart and we are testing the upper boundaries of the downtrend on the monthly chart. With a significant enough move upwards the trend will change on a monthly basis, but with smaller a move upwards we will reach overbought in the weekly charts without changing the monthly trend. Much of this could change relatively quickly to signal that you should be either more cautious (overbought weekly without a trend change in monthly) or more aggressive (If a new uptrend on the monthly chart is signaled. But being that we are 7 days into December, if I wait until a signal changes there will be no December report at all so I will just tell you to be flexible in this volatile market that does not need much volume to fuel large moves due to the low mutual fund cash levels.

Additionally, I will be providing a more detailed trend report for 2012 later.

Some contrarian signals worth keeping an eye on in the future will be that dow/gold is fast approaching the long term support and I suspect we see gold pause in 2012


Also relevant is that it is down in the 50 to 90% range decline that you tend to see when bubble’s deflate. However, dow/gold has a history over the last 100 years of making such extreme moves, so perhaps this could be considered somewhat “normal”.

The 10 year treasury yield is coming off bubble highs that are not typical and are now also in the 50% to 90% decline range. Although there were days below the level, it has so far failed to produce a monthly close below the Jan 1941 low of 1.95. Right now it looks like we are essentially testing the lows on the yields.

keep track of updated 10 year treasury yields here.
I believe betting on higher yields is probably not the best idea when the market is looking weak, although there is still a chance yields could perhaps bottom in 2012, but more importantly it represent high risk in bonds that many people may not be aware of. Additionally, Low interest rates typically mean low expectations for stocks and growth as investments are bought on a relative basis. If you get a 3% yield putting your money in the bank and a 5% yield for a 10 year treasury you will need more than just a 7-8% yield to justify investing in stocks. Stocks will need to be more undervalued to justify the investment, or the expectations of growth must be higher. However, if you only get 1% interest at the bank and 2% interest in a 10 year, a 7-8% yield seems much better, and stocks should be considered much more attractive when bond yields are low (if you still expect them to yield 7-8% overall return), especially if expectations of growth rise in the future as wealth transfers out of bonds and into stocks.

Mutual fund cash levels are still near significant lows which is in contradiction with dow/gold and low interest rates being at ‘lows’. As a result I suspect we could see an extreme move at some point until these contrarian indicators are more in agreement. The path of least resistance seems to be lower, taking mutual fund cash levels higher… As the euro problems eventually reaches some kind of culmination at least in the next few years.

Liquid Assets of Stock Mutual Funds
Percentage of total net assets
http://ici.org/research/stats/trends/trends_10_11
July 2011 3.3% cash
August 2011: 3.4% cash
Sept 2011 3.8%R
Oct 2011 3.5%

(november 6.4, December 6.6?)

“The surveys of 56 leading investment houses in the United States, continental Europe, Britain and Japan showed a typical balanced portfolio held 6.6 percent of its assets in cash, its highest since at least December 2010, from 6.4 percent last month.”

http://news.yahoo.com/investors-brace-2012-higher-cash-stocks-reuters-poll-142220114.html

I don’t know if the spike up in November and December based on the survey can be reliable, but if so they have at least begun to take measures to raise cash and it would be a lot more healthy time to own stocks if true than it was in July.

Levels are still fairly low. This means there isn’t much left funding the rally and that the market is both prone to volatile moves as well as an eventual correction, or temporary bear market. Much like the end of any bubble when there is no longer cash to fuel the rally, a panic is more probable in this environment than in an environment where there is lots of cash on the sidelines. However, that is an over simplification as mutual fund cash level is low because money is flowing in and the federal reserve is currently expanding the money supply. The question is whether or not both public and private debt will continue to rise at a fast enough rate to increase the money supply. At some point it is likely it will not, which is why this is such a contrarian indicator that is more a signal of caution than a signal to trade on.

With Macroeconomic environment structurally unsound and the ECB forcing the rest of the world to print rather than making the ECB have the ability to have a more elastic money supply, they are delaying what should turn out to be a pretty significant problem at some point. I think we will see destruction around mid 2012 before a very significant low takes place most likely both in yields and real estate and possibly stock prices. The federal reserve’s actions have lulled mutual funds into complacency. You really could argue the decline of cash reserves has been in play since the early 90s
. That certainly doesn’t have much on the 30 year decline in bond yields though which I think is most likely out of these to bottom in 2012, which means bonds are actually quietly becoming a “higher risk” investment (relative to it’s return) in spite of people viewing them as the contrary.

This could be seen as a bullish trend in treasuries, except for the fact that much like treasury bonds, it is historically very low and the trend is getting stale, and it too has declined well over the 50% requirement for a bubble to deflate, and the yields have the clear characteristics of a blow off climax, exponential top that a bubble has, followed by a sharp decline of over 50 to 90%, which hits the previous lows or undercuts the lows.

You probably don’t want to chase multidecade trends, but if you must, there are often a climax bottom/top to close your positions into, so hopefully for those chasing there is that parabolic move. It is an aggressive strategy, but perhaps worth considering the “greater fool” strategy if you are good at the financial game of chicken.

Believe it or not… not much has changed since the November Trend Report in terms of price trends in stocks. The stock prices continue to trend up on a weekly chart, and still have not broken the boundaries on the monthly chart. The limits are being pressed though and significant movement to the upside this month should reverse that trend. However the weekly charts are nearing overbought levels. In fact according to the slow stochastics, the dow is currently just barely overbought. The daily chart shows slow stochastics are at overbought levels as well furthering the case to be made of reducing risk. I would take profits into this strength and remain cautious. As we close out the year, I suspect the market will be vulnerable to a cascade downward sometime in 2012, and perhaps a panic if the ECB continues to print until eventually they run out of money (unless they are given the power to print an unlimited amount, something the Germans seem to fear) in spite of the already low treasury yields in the US and low expectations. If you got more cautious near overbought levels and then you rebalanced and got a little less cautious you should be able to ride the wave the right way.

There are many issues involved and eventually it connects towards being a political problem.

Things to look for to change the structure of the problem are
1)The ECB is given power to operate more like the Fed with an elastic money supply (power to print at will to prevent a bank-run).
2)A central Euro Bond is created
3)Mutual funds raise significant amounts of cash over time so that a sell off doesn’t risk further selling by everyone simultaneously.
4)The structure of leverage needs to be greatly toned down or it needs to be clear who can cover the obligations.

If an investment bank that sold derivatives to someone and the bank suddenly can’t pay, who fits the bill? Does the person buying derivatives even know who has the other side so they know whether or not they will get paid back or so they can attempt to price in the risk of not getting paid? Or do they just assume everything is okay and become complacent? What about those betting heavily on the decline of the bank that goes down, now how many more people betting against the failure on excessive leverage are in trouble? What about people with deposits at the bank who’s deposits were used to speculate on derivatives? What about all the debtors if you suddenly have a shortage of the cash? Bank runs would previously happen when something like 6% of the overall cash supply is withdrawn all at once, and the fed was designed to step in to prevent this from happening. The ECB has a limited ability and could eventually run out. But there also is some amount of change in each derivative’s underlying asset value that if exceeded, a derivative run could occur (depending on the derivative, the exposure, the overall amount of leverage, and how connected each asset is to each other and each investment bank is to another and so on). Well judging from the last bailout, it appears that tax payers and consumers and eventually bond holders are on the hook to some degree. Not 100% because Lehman didn’t get bailed out. TARP money and AIG bailout and Bear Sterns via non recourse loan by the federal reserve and what have you.

5)If the federal reserve is just going to print the money, this could bring up another problem of skyrocketing debt to cover the panic type events, and if so it is more reason why debt should only be allowed in times of national emergency, because how can you suddenly fund payments for potentially as bad as many times the global GDP without consequences? But realistically, that is not the system. The system does unfortunately have the side effect of perhaps too strong of central government.

There are many structural problems that can’t easily be satisfied without reform, but extreme reform that essentially would ipe out the system to start over would probably be too destructive.

 

While the weekly chart is actually showing a bullish divergence as it makes higher highs in the slow stochastic while price makes lower highs, the monthly chart continues to show higher lows in price while the RSI makes lower lows. The price action is not to be trusted.  The important thing remains the trend which also is in conflict with the weekly chart showing an uptrend still. The monthly trend is more accurate and results in greater moves but a longer time period. However the weekly is still to be respected. The allocation in the trend trader is cautious and will get more cautious if we hit overbought on the weekly chart without breaking the monthly trend. Additionally, it is worth watching the trend channel shown above, although you should still be cautious because of the likelihood that this is going to be a false move due to the bearish divergence, you should still watch the key levels of support and resistance, perhaps to slightly adjust or use it to rebalance and reassess your positions. I believe a decline is still coming, but you must remain flexible, and betting against assets going up is traditionally a low probability trade unless everything lines up, so the alternative is to have a larger “risk off” position and minimize the “risk on” position unless the ideal set up occurs. Unfortunately Things just aren’t in alignment to make that kind of bet. Instead, being cautious and participating in a mixture of “risk on” (stocks, gold, oil, commodities, etc), “risk off (currency trades, US treasury bonds, Cash) and relatively “delta neutral” (complex options strategies, or else arbitrage plays, bullish and bearish bets in anticipation of earnings, pair trades, post earnings pair trade plays, etc), with a cautious or aggressive weighting depending upon the signals you are getting makes sense. At the moment it is one of caution. Should the crisis escalate to panic due to a number of things such as euro problems, defaults, or further US downgrades setting off fear of a global contagion, not only risk on assets are at risk but even potentially some arbitrage deals that may be dependent upon financing may have difficulties. Others may get cold feet… If possible they will find a way to weasel out. Such recently happened between Skyworks Solutions who was going to buy out Advanced Analogic Technologies. Skyworks made accusations of “fraud” and that the numbers weren’t correct. Advanced Analogic fired back with a counters that they weren’t honoring the terms of the agreement. Finally Skyworks Solution said it would buy it for a slightly lower offer ($5.85 instead of $6.0+). In another deal TAM and LFL were in agreement of a deal until a regulatory investigation delayed the deal “6 to 9 months” and that the merger would likely not take place until the 4th quarter. It still has not gone through. This type of things happens. Deals still go through they just get delayed. This makes using options as leverage to beef up these returns more risky, esp when the market is vulnerable, and the annualized return could end up significantly lower than initially expected if the deal gets delayed. As such, these “risk arbitrage” plays are not as “neutral” to market conditions as you would ideally hope, especially when market is vulnerable, however they do still have the ability to help to lower your correlation and boost your return in all market conditions. They do have a very high success rate in all conditions if you don’t measure a “delay” or a lower offer as a failure. Talking about arbitrage is something that books have been written on and cannot be covered briefly, but the concept is the important part. The concept is that REDUCING correlation is often productive to boosting your return on risk even if the return of that other asset is less. Some misunderstand this and say “diversification” or slightly better “multiple asset classes” for this same reason, but that only sometimes and only partially reduces your correlation. A portfolio with a return of 7% gain with a 2% drawdown is better than one with a 10% gain and a 4% drawdown. Use leverage and your 7% return becomes a 14% return with roughly 4% drawdown (plus leverage costs), or use less leverage and be somewhere between if you can’t handle it. The return on risk is what is important and the LEVERAGE is what you use to determine the magnitude of that risk/reward profile that determines your return. Reducing correlation through relatively “delta neutral” strategy(such as arbitrage), as well as owning a mixture of “risk on” and “risk off” is a great way to boost your return on risk. Now taking the THEORY of this and putting it into practice is another issue. If you pick individual stocks, there are risks among those companies. You might have the downside of investing in some bad companies in with the good if you just pick an index fund such as the SPY, and you might take on stock’s individual risks to a limited degree but you avoid the risk of a real shocker that can wipe out a huge portion of your cash such as accounting fraud, or an FBI raid and findings of illegal activities, or a major lawsuit, etc. Increasing positions reduces this risk but has the cost of a lot more fees and it is more difficult to manage more positions and you risk making mistakes. So it’s a trade off you have to deal with. I prefer using ETFs mostly with a few occasional individual value stocks with a small amount of capital and even smaller amount of “option gambles”.

In conclusion of this trend report, a lot of cash and “risk off” assets are advised and confirmed with the monthly trend. The “arbitrage” deals must be picked cautiously and you should make sure they are not heavily dependent on financing.

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Trend Following Strategy Using Sound Money Management Principals

I’ve decided to keep this blog on ibankcoin specific to trends. To keep this blog on topic I made a post at stocktradinginvestments.com titled Kelly Criterion Shows Decreased Correlation Increase Return. The short version is the picture worth a thousand words.
Kelly-Criterion

Reducing correlation (and thus increasing your independence of your bets) is important because you can reduce your draw-down, or increase leverage in multiple uncorrelated names and keep the same draw-down with higher long term returns. If you lose 20% you need 25% gain to make up for it, but if you are invested in uncorrelated assets, a 20% loss will be much smaller as your overall portfolio, even if you have multiple uncorrelated bets with leverage. That is the idea.

What’s this all have to do with trend following?

As great as it would be to go “all in” in the best possible area and get every single call right, that isn’t realistic.
This is why I propose you set minimum holdings for risk on assets (stocks,natural resources&commodities,etc) and minimum for risk off assets (currencies&cash, bonds,). But also consider other lowly correlated opportunities. Depending on the trend, you would adjust your weightings, but not necessarily neglect opportunities if it keeps your portfolio’s correlation low.

When stocks go down when you expect them to go up, if you are 100% invested in stocks you not only are down in your position, but you also lose in opportunity to rebalance at lower prices, and in some extremes even change your allocation to be more aggressive. There is a fine balance between trend following and value investing. Value investing principals would suggest that if you are bullish if a stock is at $100 you should be more bullish if a stock is at $90. Trend following is often, but not always, in conflict with this, especially in individual names vs indices. This means you have to be positioned within a trend both to take advantage of the directional move, and also to take advantage of fluctuations in prices away from the trend (contra-trend moves), and to position more heavily if the signals are stronger. But unless you are 100% certain or the move severely outweighs the downside of it going against you, you do not want to be 100% in any asset class. Additionally because daily and weekly volatility (noise) exists within a monthly trend, it still may be right to have some funds you can transfer, despite also being “right” about trend direction since we still may have opportunities to add stocks lower in a monthly uptrend, or add to TLT or “risk off” trade at a lower price in a monthly downtrend (downtrend in equities, that is). For this reason we set parameters.

So we set parameters of maybe 75% maximum and 25% minimum for both risk off (bonds) and risk on (stocks). (You could certainly go with less or more depending on how you want to push your risk, and maybe make an exception or two). We also want to keep what we learned from the linked to post in mind and make sure an area of low correlation has it’s place.) Having this much is a bit more for longer term traders and contrarians looking to preserve enough cash in the event of a big plunge. If you are more nimble and more accurate go ahead and change this, but the rare times you get caught long in a big decline or vise versa, you will often make up for all the opportunity you missed out prior to the big run. Another solution would be to find more pair trades and hedged positions.

Overall though, you have to not only keep track of the trends in stocks, but in the alternative investments.

To keep things relatively simple, I came up with a general guideline to follow for stocks. I started with defining what type of trend we are in . We can be in 4 trending conditions:

Monthly trend up, weekly trend up

Monthly trend up, weekly trend down

Monthly trend down, weekly trend up

Monthly trend down, weekly trend down

Then I threw in overbought and oversold conditions. Within each of those trending conditions there are 4 possibilities. Either no extremes, weekly extremes, monthly extremes, or both weekly and monthly extremes. This gives us 16 potential scenarios to account for. (In reality there are more because 3/4ths of the trend signals for example can signal an uptrend) If you want to use The PPT OB and OS signals there are 32 potential scenarios.

The simple way is rather than make 16 more adjustments, to just note the 16 conditions first then as a rule of thumb subtract 10% from stocks and add 10% to bonds when PPT OB and -1% from stocks and +1% to bonds every additional 0.1 OB points it gets. And for PPT OS to add 10% to stocks and subtract 10% from bonds and add +1% to stocks -1% to bonds every additional 0.1 OS it gets. A more complicated solution would more aggressively sell the overbought signals and more cautiously buy the oversold signals when weekly trend is down (but not oversold), and more aggressively buy the overbought and more cautiously sell the oversold when weekly trend is up (but not overbought).

Then I went through each condition and came up with a potential allocation. To keep it less complicated I just chose “Arbitrage” as the low correlation play mixed in with “treasury bonds” and “stocks”. In reality, “gold” “natural resources” should be considered for “risk on” plays as well. And “currency”should be added in addition to “bonds” for “risk off” plays. Adding in MORE lowly correlated assets and using leverage when appropriate will increase return without at the expense of volatility and long term growth.

In some conditions, leverage is allowed to be added depending upon the asset class.

Since originally writing this article, I decided to keep an eye on these as a guideline, but to change the individual assets. So the principals remains in tact of what percent is “risk off” asset and what percent is “risk on” and what percentage is “arbitrage” or “minimal correlation” to the rest of the portfolio. But the actual percentages changes based on trend.

As you saw in my most recent post the trend trader, I came up with a sort of “model portfolio” to follow in the current conditions. In reality, I may shift a lot more heavily to arbitrage if the deal is right and I may leverage it if the deal itself does not seem to require leverage. For example, if Apple or Google bought something smaller, they would probably have enough cash on their balance sheets and the concern of the deal going through would not depend on availability of credit. If the economy turns south in a hurry as it is vulnerable to do in a monthly downtrend and weekly downtrend, or monthly downtrend with a weekly overbought condition, deals can fall through, so avoiding leverage, keeping that percentage of your portfolio towards arbitrage small, and being cautious makes a lot of sense. There are those I know who just trade pre earnings both long and short certain names, This would be a pretty low correlation type of trade so “arbitrage” when market isn’t vulnerable to sudden credit contraction and rising LIBOR rates isn’t the only way to have a near 0 correlation, it’s just the one I am going with. Earnings has larger moves in a short period of time and may require greater number of trades at a smaller position size to reduce potential for a large downside swing in portfolio size. What I am trying to communicate here are the PRINCIPALS though…

You can use the trends, or use value weighting or whatever signal you want for adding lower and selling higher via rebalancing, or more aggressively repositioning your allocations. But A very often overlooked goal is how your overall return on risk within a portfolio comes out. And to do that, it requires multiple assets with low correlation weighted towards which ones have a higher probability of equal upside/downside or greater overall edge, and a focus on low correlation. Once you can accomplish that, you can determine your return based upon leverage and how aggressively you position one way or another.

I have another post I will work on that further illustrates this difference in leveraging up your returns vs no leverage given everything else is roughly the same.

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