Saturday, October 04, 2008

Stock Market Update 04 October 2008

Another unprecedented week in the markets. Wachovia goes down (taken over by Wells Fargo) and a $700 billion bailout package gets approved on Friday.......and the market falls on the news.

There is an old saying that there is always a bull market somewhere but over the past few weeks the ONLY bull market has been in the U.S. dollar. Unbelievable but it is what it is.

I made a switch to my provident fund as of Friday’s closing price. I have moved out of the Euro and the Australian dollar funds and into the USD. See charts for details.

I have held my Fidelity International Bond fund (as of today) until I see what the USD does next week. As the bond fund is unhedged, it has taken a beating due to most of its holdings being non-USD denominated (and the USD having been so strong as of late).

Should the USD show continued strength I will be moving out of the bond fund. For now I will continue to hold both the USD cash fund and the international bond fund as it gives me a neutral delta hedge. See chart for details.

To start with, here are the year-to-date returns (01 Jan 2008 to present) for the funds I currently hold within the Provident Fund A and B accounts:

Core Holdings (currently approx 91% of portfolio):

BlackRock/MLIM USD Cash Fund: -0.35% (new entry)

Fidelity International Bond Fund: -7.22%

Exited Funds:

Fidelity Australian dollar Fund: +4.83%

Fidelity Euro Fund: +2.62%

Ongoing Equity Purchases (currently approx 9% of portfolio):

BlackRock/MLIM Equity: -26.87%

Fidelity International Fund: -30.35%

Russell Global 90 Fund: -27.37%

Representative Charting Index:

Dow Jones World Index: -29.22%

Here are the charts (click on all charts to enlarge):

Dow Jones World 6 year monthly chart:

-chart went bearish in Jan/2008 when the monthly closing price for January closed below the 12 month moving average.

Chart continues to be BEARISH.

Dow Jones World 10 year weekly chart:

-chart went bearish in late December/2007 when the 13 week moving average broke below the 34 week moving average with the MACD confirming by crossing below zero.

Chart continues to be BEARISH.

Dow Jones World PNF Traditional chart:

-chart went bearish on a price break below 264 in August/2008. Project price target based upon the structure of the chart is 156.

Chart continues to be BEARISH.

Dow Jones World PNF 1-box chart:

-chart made a great call turning bearish in June when price broke below 288

Chart continues to be BEARISH.

Dow Jones World 1 year daily line chart:

-chart turned bearish in early June when price broke below the 50 day moving average in combination with the red -DI line crossing 60 and the MACD crossing below zero.

Chart remains BEARISH.

As you know, I have been waiting for an opportunity to move back into equities at the right time to catch what I expect will be a strong bear market rally.

I have mentioned in the past that there has not been enough fear in the market to all that to happen. Now there is:

VIX Historical chart:

This chart is a historical view of the VIX; the Volatility Index published by the Chicago Board Options Exchange (CBOE). Here is the definition:

The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the 'investor fear gauge'.

There are three variations of volatility indexes: the VIX tracks the S&P 500, the VXN tracks the Nasdaq 100 and the VXD tracks the Dow Jones Industrial Average.

The first VIX, introduced by the CBOE in 1993, was a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors' expectations on future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

One of the better ways to make money on the long side of the market is when everyone is fearful. This contrarian way of investing is based upon the simple premise that when everyone is bullish they are already in the market (pushing price up) and therefore there is no "new money" sitting on the sidelines to propel price higher. When everyone is scared and bearish, that means they out of the markets (pushing price down) and a lot of money is sitting on the sidelines waiting to re-enter.

I monitor the VIX to determine the degree of fear in the markets. A reading >30 usually indicates sufficient fear in the markets to enter a long trade. However, if you really want to catch a bottom you need the VIX to get up into the red box I have outlined on the chart.

Note that on Friday the VIX hit an intraday high of 48.40 and closed at 45.14. The only 2 times it has hit these levels was in late 1998 (associated with the collapse of Long Term Capital Management (a U.S. based hedge fund that collapsed and just about took down the world’s economy with it) and July, 2002 (which marked the end of the bear market from 2000). Both were excellent buying opportunities.

Normally I would be going 100% long based on this but I know there is bound to be some distortion of the VIX due to the ban on short selling that is currently in place.

Having said that, my finger is on the "buy" button and I will be buying as soon as my short term charts indicate it is safe to enter the markets.

Based on the readings on the VIX, we are very, very close.


As I said in the opening, the only bull market of late has been the USD.

It has been on a rocket ride north that has taken everyone (including me) by surprise.

USD daily 6 month chart:

The USD shot out of its previous trading range like a cannon. From its breakout level of 74 it move to 80 (8.1%) at a unbelievable rate of change.

I said at the time it was overbought and due for a correction; that occurred at another stunning rate with a drop from 80 to 75 in 6 trading days (a 6% decline) ending with a bounce off the 50 day moving average. Since then it has gone from 75 to 81 in 9 trading days (8% move).

Unbelievable volatility.

USD daily 10 year chart:

The key to note is on this longer term daily chart the previous resistance at 80.39 has now been broken (the USD closed Friday @ 80.47). The re-test of the broken trend line that I said I expected has occurred. The RSI is no longer in overbought territory.

That is BULLISH for the USD short term.

USD weekly 3 year chart:

The 13 week moving average has crossed above the 34 week moving average in combination with the MACD above zero.

This longer term view of the USD is BULLISH.

USD Monthly 10 year chart:

At the end of August price closed above the 12 month moving average. The previous resistance level at 80.39 is clear on the chart and has been broken to the upside.

The long term view of the USD looks BULLISH.

Euro weekly 3 year chart:

The 13 week moving average crossed below the 34 week moving average 4 weeks ago confirming the MACD cross which occurred earlier.

The Euro is BEARISH.

Euro monthly 10 year chart:

At the end of August price closed below the 12 month moving average, signally a new bear market in the Euro.

This chart remains BEARISH.

Australian dollar weekly 3 year chart:

The 13 week moving average has crossed below the 34 week moving average confirming the MACD cross.

The Australian dollar is BEARISH.

Australian dollar monthly 10 year chart:

In August the Australian dollar closed below its 12 month moving average signaling a new bear market.

This chart remains BEARISH.

Based upon the previous longer term signals in the Aussie and Euro, I have been watching for a USD correction to moving out of the Aussie and Euro and into the USD.

While I expected a short term decline in the USD, I did not expect the retrace and subsequent renewal of the USD uptrend to be so violent. As such, it has caught me (and everyone else) somewhat off guard.

A price break above 80.39 was my "line in the sand" and it has been broken to the upside. It appears technically that the USD has started a medium to long term uptrend that should last some time.

Based upon the above, I switched my Euro and Australian dollar funds into the BlackRock/MLIM USD cash account as of Friday. I do have some hesitation in doing so (due to the money market fund having credit default swap exposure) but I am counting on the $700 billion bailout to reduce the risks associated with money market funds holding mortgage backed securities in their accounts.

Bond Fund:

Fidelity International Bond Fund 5 year chart:

This has been a real disappointment. Fundamentally the premise behind investing in an international bond funds is sound (based upon the assumption that as countries around the world go into recession you will see coordinated interest rate cuts worldwide along with bond price increases).

The problem (as I mentioned in a previous blog) is because the Fidelity Bond Fund is unhedged it is exposed to "other currencies" that depreciate within the portfolio (so any gains in foreign bond prices is offset by foreign currency depreciation). There are bond funds that hedge the currency exposure but we do not have access to them in our provident fund.

To illustrate my point, ponder the following:

-the Fidelity International Bond fund peaked 17 Mar 2008 @ 1.266
-the USD bottomed the same day (17 Mar) @ 70.70
-the 10 year US treasury bond peaked the same day (17 Mar) @ 121.81

Since that date (17 Mar 2008):

-the U.S. treasury bond has fallen by 4.77% (as have other countries bond prices), yet
-the Fidelity International Bond fund has fallen 13.9%, and
-the USD has risen by 13.82%

As can be seen, while I have only shown the U.S. 10 year bond, the bond fund has fallen dramatically not due to the bonds it holds but due to the strength of the USD.

This fund does best when stock markets are weak and the USD is weak. It does poorly when stock markets are weak and the USD is strong (as is the case currently).

I will hold this fund for another week to assess what happens. My moving into the USD has hedged my position to essentially neutral. The last line of support I have clearly drawn on the chart. If this is broken to the downside I will exit my bond position.

Bottom Line:

-I am looking for an equity price bottom to occur very soon (in fact, it could have been Friday) based upon the VIX.

-The USD has shown unbelievable strength and appears to have started a long term uptrend.

Based upon the above, as of Friday I have switched my cash position into USD and out of the Euro and the Australian dollar.

As of today, my "strategic" positions are as follows:

-50% BlackRock/MLIM US Dollar Cash Fund*
-50% Fidelity International Bond Fund*

*(actual positions: cash 45.10%, bonds 45.55%, equities 9.35%)

*percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary several % from that posted (refer to current % holdings).

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