Tuesday, 8 April 2008

Dumb money inflows, artificial rally, volatility, and more...

The markets over the last two weeks have been quite interesting to observe. In part thanks to the new credit facilities from the Fed, the banks bought more time to settle their issues. And, oh boy, there are still plenty of them. It will take quite a bit of time, maybe even a year or two, to clean up the risky mess associated with asset-backed securities and derivatives.

I do not really buy into recent bursts of optimistic chatting from government officials, analysts, and some traders that the worst is finally behind us and we all should move back into the market and load on fantastically cheap stock deals. It is not behind us, it is just a (relatively weak) bear market rally, which is largely being artificially engineered by big institutional players, with the full support and involvement of the Fed and drafted foreign monetary authorities.

This cheap money from the Fed is in part being used here to create the visibility of a super-pooper market rebound. The funds, banks, the Fed, and the government behind them are all in play trying to paint the rosy picture and convince the public that all is back to normal and we are all back to our direct flight to prosperity. That’s not quite true. I just do not see the fundamental reasons behind the recent rally attempts. The banks secured financing? 3+% gains in a single day? So what? The move looked so artificial, and the intervention was so obvious. "Putting lipstick on a pig" is the right expression to describe what is going on right now in the marketplace.

On a more personal note, I have been working on my short-term trading strategy lately, mostly on paper. By the end of the year, I should more or less have my trading system in place, with key components tested and settled. Meanwhile, I am quite tolerant to my current performance results. My small balance is up 4% since November 2007, which is not much but is still much better than the negative market performance over this period. Several losses (all unrealized, except one) in my portfolio were associated with: (1) any long-term holdings that I originally decided to buy when I opened the account; and (2) two stupid losses (one realized and one not), for which I am fully accepting my personal responsibility and which happened as a consequence of me deviating from my method and relevant criteria. I think that the discipline and the method are the two most important things for any trader. If you do not have both, you will lose in the long-term.

By the way, Questrade finally paid the overdue $50 referral credit. I actually complained about the delay with this payment in one of my recent posts. Well, with a 1.5 month delay and several calls to their customer service, they finally fulfilled their marketing promise. The issue’s been settled and closed now.

On the negative (and unrelated) side, I was unpleasantly surprised to learn that stop loss orders do not work on Canadian securities traded on TSX. How come? Is it just a Questrade thing or it is the exchange-related rule? That’s not very good. I am quite reluctant to trade U.S. stocks now because of the large volatility in the recent exchange rate movements. Giving up several percent of profit only due to a large change in the exchange rate (plus a big FX margin collected by Questrade) is really not an optimal idea given small sizes of my trades. Anyway, we have to use what we have, but not having stop loss orders in place on Canadian stock positions is not pleasant.

We can expect a very entertaining market activity over the next several weeks. The Fed and the Co (including all the banks, investment services firms, and funds) will try hard this week to break the 1,395 mark on S&P500, 12,800 on Dow Jones, and 2,400 on Nasdaq Composite. They are desperately trying to show that the momentum has been reversed and the worst part is over for the stock markets. Alas, the markets' history and the wisdom of top market players suggest that the current situation is merely an intermission before the second leg of the Bear market action. It is way too early to start shopping for bargains because there really ain’t any yet. This does not mean that there are no short-term trading opportunities. In fact, there are plenty, but very high levels of volatility should be taken into account when executing short-term plays.

Let's see what the new earnings season will have in stock for us. Many large Canadian and US banks will use Visa IPO proceeds to cover up the ugly losses and writedowns that they will have to report either now or at the end of the next quarter (or more likely, during both reporting periods). The other U.S. firms will ride on weakness of the U.S. dollar and their relatively strong international sales.

I think we will also see a lot of cases when a firm reports poor results, yet "miraculously" beats pessimistic analysts' estimates, and enjoy a boost in its stock price. The analysts, most of whom by the way happen to be employed by the Wall and Bay Streets, must be already very busy in drafting such plays: bad estimates - better than expected results - everyone is enthusiastic and happy, completely forgetting that a market-beating firm is still a piece of poorly performing and too risky garbage. The top executives will get their bonuses, the analysts and their bosses will get them too. And we will move on to the next stage of big lies.

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