Just what exactly is this window dressing that they talk about?  There’s always a lot of talk it at the end of the quarter.

Mutual fund managers have to report their portfolio’s holdings at the quarter end and disclose them in their funds’ marketing materials.  And sometimes there’s a bit of subterfuge as they will buy and sell certain things at the end of the quarter to make their portfolios look better than they actually are.  They’ll get rid of their ugly positions that have performed poorly or are unpopular, and they’ll add positions that are trendy or have recently gone way up.

It’s sneaky, and they do this to deceive you.  When you consider buying a mutual fund and look at the most recent list of stock holdings, they hope you’ll get excited about all the great stocks they hold, nevermind the losers they just bailed on.  Shopping for a mutual fund can be really tricky, but don’t worry, in the coming weeks and months we’ll show you exactly how to identify the good ones and use them to build a winning portfolio.

Theoretically, all this window dressing is supposed to have an interesting effect, exacerbating gains in certain stocks and losses in others.  Stocks that have run up throughout the quarter can run a little further than they should.  It’s a very difficult phenomena to measure and even more difficult to trade.  More often than not, we just hear it being used as a lazy answer for why some stocks go up and others go down around this time.

The real take-home point here is simply that there’s a lot of monkey business in the markets, both in actual market activity and in the reporting of market activity.

That may or may not come as a surprise to you.

Market Recap

As is typical for holiday weeks, this has been a relatively quiet one.

If you need further proof, consider the middle of Tuesday’s trading day.  I was watching Bloomberg when they went live to their reporter from the floor of the NYSE to get an update on the markets.  She had little important to report, just news about the light trading volume when suddenly a collective “OHH!!” erupted from all the traders in the background.  Was it shocking news?  A surprise bankruptcy?  A terror attack?  No, the floor traders on the NYSE were watching a live car chase in Dallas that apparently had just resolved itself with a “smashing” conclusion.  What is it about car chases?

This week we have had the typical beginning/end of month economic reports, but there have been few surprises here.  We’re still losing jobs at a 400k-500k per month clip; manufacturing is still weak and contracting, though the pace of contraction is narrowing;  consumers are still historically nervous, but less so than they were a few months ago; and housing prices are still going down.  I doubt any of that shocks you.  None of if shocked the markets.

Last week was a little more interesting as we had the release of the latest statement from the Federal Open Market Committee.  Unless you were an English major in college or have an improbable fascination with rhetoric, it’s difficult to appreciate or even understand the brilliance and the nuance of these Fed statements.

This the market does have trouble with.  Usually Fed days are volatile ones.  The market rallied impressively before the release of the minutes and sold off immediately after the news was out.  A classic case of “buy the rumor, sell the fact,” one of our favorite, though admittedly over-used, Wall Street adages.  Turns out the Fed said pretty much what everyone thought they were going to say – and we’ll provide our own paraphrasing here: the economy still stinks but we’re no longer falling off the cliff and we’ll continue to do everything we can to promote recovery and keep inflation from going bananas.

So there you have it, the economic story remains essentially unchanged.  But there remains a lot of risk out there.  The market is pricing in a return to snappy growth, a presumption we are reluctant to accept.  Instead, we agree with Bill Gross that the era of 3%+ annual GDP growth that we have come to know and love is gone.  The new normal is GDP growth of 1%-2%.

The market has been rallying off both good news and bad, but keep your eyes and ears alert, because news and data that suggest the economic recovery will be longer and slower than everyone seems to be anticipating is the kind of news that could really sink the market.  Until then, traders can feel free buying dips and selling rallies to participate in a market that clearly wants to move higher.

Interesting Technicals

The most interesting technical event that we’ve seen recently was the market kicking off last week with a 90% down day on Monday.  Market breadth can be very important, and we’ll make frequent reference to it.

“90% down days” are days where 90% of the volume is down volume, where at least 90% of all shares traded on the exchange did so at a lower price than the day before.  Basically, it’s a day where everything goes down.  They’re nasty days, but very significant and have an interesting double meaning.

Over the longer term, they’re bearish, as they indicate a temporarily near-universal desire to sell, days where the entire crowd runs for the exit at once.  They can presage a larger, extended move down, or can signify the reversal of a bullish trend to bearish.  A lot of times on days like these the crowd is just acting silly as crowds sometimes do, but more often than not, when everybody runs for the exits at once it’s because somewhere in the theater there’s fire.

There certainly could be fire in the theater right now, but you still might be able to get out in time and avoid the bruises from forcing yourself through a crowded exit.  Over the short-term, 90% down days tend to be followed by quick rallies lasting from a couple of days to a week or so, and that’s exactly what we’ve seen since last Monday.

Tactically speaking, we’d much rather do our buying when there’s blood in the gutters and assets are cheap than when stuff is expensive and everyone’s out dancing on the street corners.  However, caveat emptor.  Playing with fire can be both fun and profitable.  But do it carelessly, and you will get burned.  Trading for 90%-day bounces can be extra dangerous during sustained crashes and this wiped a lot of traders out last October when we saw several of these days in succession.  This is neither for novices nor the faint of heart.  But it’s certainly something to be mindful of the next time you turn on the news and see that the market had a disastrous day.

Conversely, 90% up days tend to be bullish over the long term but are often immediately followed by sell-offs lasting a few days to a week.  These are days where everyone’s piling into the theater, usually because something legitimately good is playing inside.

Buying on days like this can be really frustrating and we usually just avoid it altogether.  You’re paying a high price, probably more than you should be paying on a short term basis.  Generally, 90% up days this are followed by sell-offs lasting from a couple of days to a week or so as the market relaxes a bit before resuming the bullish march upward.  So if you’re disciplined enough to let the crowd be, it’s possible to avoid the rush and still make the beginning of the feature.

The next time the market has a huge day, one where 90% or more of all stocks are up, think about taking profits if you’re looking for some short-term gains.  If your horizon is a little longer and you do want to own stocks, it can be worth waiting for that pullback before buying in.

If all this sounds to you like rational advice, you’re exactly correct.  But investors usually engage in the exact opposite behavior.  90% days are 90% days simply because everyone is doing the same thing at the same time.  Herds are funny things.

Independence Day

I do love the 4th of July.

It’s free from the stress of Christmas, the psychological anxiety of New Year’s, and the trendiness of all the consumer-driven holidays.  It’s a beacon of fun and relaxation in the midst of the long, hot summer, a time to gather friends and family, to fire up some burgers on the BBQ and have a cold beer (or two).  It’s a powerful symbol as well, a reminder of the ideals we all share as Americans, the great notions of freedom and independence that have been handed down to us from our founding fathers.  It’s a time to keep in mind that we are who we are as a country exactly because we chose not to follow the herd.

So get outside and enjoy the weather.  Kick back on the lawn and watch some fireworks.  Have a wonderful 4th and we’ll see you back here next week.

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We’d like to kick things off by describing where we’re at right now in the markets, and we’ll begin with the stock market because it’s likely the most interesting to you or the most relevant.

2008 has been rehashed a million times already, so all we’ll say about it is this: it was a tough year.

At this point in time, against the backdrop of historical performance, there are two very different ways of looking at the stock market, each elegantly summarized by two statements:

- “The market has gone up over 40% since March!”
- “The market is still down over 40% since 2007!”

The first lesson of the day is to always question blanket statements or flashy facts.  A lot of us simply let the facts speak for themselves.  But the people you see on TV or read in the Wall Street Journal reciting these facts are clever, and they’re using them as a tool to tell a story. In the world of investing, facts do not speak for themselves.

But these two statements taken in conjunction essentially cover our view of the stock market. The stock market is way below its all time highs.  In March it just put in a new 10 year low on the S&P 500, and since then it has bounced significantly higher without any whole-hearted retest of that low.

Broadly speaking: the stock market is in the midst of a long-term, secular bear market, and has had a powerful, short-term rally off the recent lows.

If you’re new to the world of sophisticated investing, here’s wha— actually, hold on a second. If you’re tuning in today and you consider yourself a novice when it comes to investing, give yourself a huge pat on the back.  Congratulations!  Thanks for giving us a bit of your time and in exchange we promise to make it worth your while. Stick around, and before long you will become a sophisticated investor.

Here’s your first lesson about market trends.  It’s an easy one to understand, but people seem to forget it all the time, even the econ wonks.  Markets do not move in a straight line.  The reasons are fantastically complex, due to so many factors that neither you nor I nor any of the most powerful super-computers in the world can wrap our minds (or processing cores) entirely around them.  But markets move in erratic ways, and the problem with erratic movement is that it gives anybody evidence to make any sort of case about which way the market is ultimately heading.

So is the market going up or down from here?  The real answer is both – but that doesn’t help you unless you’re interested in collecting pearls of Zen wisdom or getting in touch with your inner Investment Buddha.

Perhaps this will help:

We’re preaching various levels of caution depending on your investment horizon. Young investors, or investors with horizons of 10 years and beyond, should feel comfortable working their way back into equities at this point (if you’re still on the sidelines) assuming you can tolerate possible short term losses of 20% or greater. Tactically speaking, investing on pullbacks is a fine idea, but if you’re a long term investor and are too fixated on tactics, you’ve got your priorities totally backwards.  We’ll get into the tactics vs. strategy debate a little further down the road.

If your investment horizon isn’t quite so long, we suggest staying out of equities altogether.  Everywhere you turn seems to be talk about inflation, but it isn’t here yet folks, and may not be for longer than you might be thinking. The reality is that the environment is still very much deflationary. In deflationary environments, cash and high quality debt are by far the best investments.  There’s nothing wrong with holding a bunch of cash right now, especially if you don’t have access to any good alternative funds.  So don’t worry, we’ll let you know exactly how and when to set your portfolio up to protect against the inflation monster in case we do find it growling on our doorstep.

If you’re a trader, buying the market or high beta stocks on dips and keeping a tight stop is completely appropriate here. Even in the face of a powerful bear market rally, we had pretty good luck in here with quick market shorts from March through May, but in June we’ve stopped searching for short trades, and have been looking instead at places to go long the market. It’s fast trading though, just buying dips and selling into the next rally.  The market has pulled back recently, and we’ve bought in a little bit with our own trading.  We’re monitoring it very closely and plan to act quickly upon hitting our profit targets.  We’ll keep you posted on how this works out.

For what it’s worth, 2009 so far has been the year of the trader, and we think this environment will persist for some time.  Plenty of ups & downs, lots of volatility, rapid trend reversals, and very dynamic fundamentals.

Sorry, long-term investors.  Life is more difficult for you now than it probably ever has been in your investment lifetime unless you were active in the mid 70’s (in which case, we’d love to hear some of your stories). 

That’s why we launched this newsletter.  We aim to help you navigate these tricky waters, and hopefully learn a little about life and ourselves along the way.

If that sounds like a good deal, we’ll see you back here next week.

Welcome aboard!

Thank you for stopping by.  Our goal for each issue is threefold:

1)  Informative – We’ll recap the most significant market events of the week, everything important you’ll need to know to sound really smart at your next cocktail party.

2)  Actionable – We’ll help you interpret market action and develop trading and investing strategies.  Not only will you sound informed, but your golf foursome will be impressed with your clever methods for profiting in the markets.

3)  Entertaining – Market news sites and investing blogs are a dime a dozen, but hardly any are well written and fun to read.  Education is a lifelong process.  We try and make learning enjoyable for kids, so why can’t adult professionals have a little fun with it too?

The world of high finance and investing has a reputation for being arcane, abstruse, and even a little cabalistic.  During times like today, that reputation is reinforced as average citizens are left baffled by extreme economic events while markets and politics move in mysterious ways.

Bacon wasn’t kidding around when he related knowledge to power, and those with extensive knowledge of finance exert considerable power over those without it.  The “Business Elite” are advantaged in many ways, most of which boil down to simple education.  They understand the nuances of the industry while others do not.
 
Our ongoing mission is to arm you with this same knowledge, to make it accessible and empower you to develop sophisticated investment portfolios.