The Blog<\/h2>\n
Sometimes, things move very fast. A lot can happen in a month, especially these days. So I have started up an investing blog at http:\/\/mingloinvesting.blogspot.com, which I update a couple times a week. I\u2019m not really a day trader, so that\u2019s why I don\u2019t blog every day, and I don\u2019t think a day will tell you much about a trend. The blog will be an assortment of topics \u2013 sometimes trades, sometimes a look at specific stocks, sometimes a discussion of macro issues and trends. If you feel so inclined, feel free to check it out. <\/p>\n
This Month: A Different Conversation<\/h2>\n
It wasn\u2019t long ago that we were talking about how to avoid disaster. At the beginning of March, it was all about nationalization, the uptick rule and short selling. There was this sense of urgency, that something had to happen, something had to be done, the system had to be fixed. Washington was moving \u2013 slow by Wall Street\u2019s clock, but surprisingly fast for D.C. standards. This week, as I noted in my blog, there wasn\u2019t really a weekend bombshell, no dramatic Sunday night news that would change markets on Monday. <\/p>\n
Today, the conversations aren\u2019t about disaster; they\u2019re about the shape of the recovery \u2013 how fast? Late 2009? Or 2010? The Dow has had a run from the 6,600 range to 8,410 today. And it was a straight, one-way trip up. The skeptics yelled and screamed all the way up, and they\u2019re still there. Yet the price action couldn\u2019t be denied, and the breadth of the rally (whether it\u2019s a bear market rally or not) couldn\u2019t be denied either. Almost all sectors \u2013 financials, tech, consumer discretionary, energy commodities, transports, etc. \u2013 had a rally. The only ones who didn\u2019t participate were the boring defensive stocks \u2013 the P&Gs, the JNJs, the Altrias of the world. <\/p>\n
So what happened over the last month? Well, lots actually:<\/p>\n
- \n
- Government Action<\/b> Last month, we talked about the beginnings of solutions from Washington. Since then, Washington has come out and said that no bank will fail the stress test, and that there will be capital available for any of the banks that need it. There could still be substantial government ownership of certain banks, but the fears of nationalization that sent the Dow down to the 6,600 range have largely subsided. Mark-to-market accounting has been adjusted and the return of the uptick rule in some variation is fairly certain. Bernanke and the Fed have been active in the markets, supporting lending and purchasing Treasuries to keep interest rates low. Also, two major government programs, the TALF (Term Asset Backed Securities Loan Facility) and the Public-Private Partnership (PPP) are getting under way.<\/li>\n
- Better-Than-Expected Earnings<\/b> Wells Fargo led the charge by announcing much better-than-expected earnings early in the earnings season. Goldman Sachs followed, and so did other banks. It was evident that banks were making money by borrowing at near zero interest rates from the government and lending it out, and through investment banking activities. Looming losses in loans, commercial remain and credit cards remained, but the market soon had hope that the banks could actually earn their way out of the mess they were in. The subsequent rally allowed a handful of banks to issue debt and to recapitalize by offering stock, suggesting that at least for some, a government rescue would not be necessary. Outside of financials, the market found that many companies and industries had been priced for disaster, earnings were better than expected, and doomsday wasn\u2019t really at our doorstep. Bespoke Investments compiled the following chart, which shows that as of May 1, 2009, 62% of reporting companies have beat their earnings estimates.<\/li>\n
\n<\/a><\/div>\n
- Better-Than-Expected Economic Data.<\/b> Make no mistake, we\u2019re not out of the woods by any means. This month, the market celebrated the fact that the rate of decline had slowed. Yes, a funny statement to make, but it\u2019s only a testament to how bad things looked a month and a half ago. Most encouraging for the market was the fact that real estate prices weren\u2019t going down as fast, and records for period-over-period decreases weren\u2019t being broken. <\/li>\n
- Credit Markets Are Improving.<\/b> We all know that lending has been at a standstill. Banks haven\u2019t been able to borrow, the inability to re-finance was threatening to destroy several major companies. Fortunately, a thaw in credit markets seems to be in the making: <\/li>\n
- \n
- LIBOR<\/b> has fallen, reducing the cost of borrowing. LIBOR, which stands for the London Interbank Offering Rate, represents the rate London banks offer other banks. On 4\/29, three month LIBOR was 1.04%, compared to 1.19% a month ago and 2.87% a year ago. The following chart from www.bankrate.com highlights the changes over the last month and the last year.<\/li>\n\n
![\"Key](\"http:\/\/www.asiancemagazine.com\/files\/200905_LIBOR_sm.jpg\")
<\/a><\/div>\n- The TED Spread<\/b>, which is the difference between Treasuries and LIBOR, has also declined to 90 basis points this month. The TED spread is a measure of risk, and as you can see from the following chart from www.bloomberg.com, the TED spread jumped in October and November when fear was very high. <\/li>\n
\n![\"Key](\"http:\/\/www.asiancemagazine.com\/files\/200905_TEDSpread_sm.jpg\")
<\/a><\/div>\n- Bond Yields<\/b> are declining. Over the last year, the yield on the Lehman Brothers US Corporate Bond Index has been as high as 9.09%; today it\u2019s at 6.92%. In other words, it would have cost as much as 9% for a company to borrow; now it costs 7% or so. The Lehman Brothers High Yield Index, which represents higher risk debt, has seen an even bigger change. Over the last year, the High Yield Index has been as high as 22.49%; today, that index stands at 15.27%. If you want to look this stuff up yourself, you can find the following chart in the \u201cMarket Data\u201d section of the Wall Street Journal:<\/li>\n
\n![\"Key](\"http:\/\/www.asiancemagazine.com\/files\/200905_BondYieldssm.jpg\")
<\/a><\/div>\n- The VIX has dropped<\/b> One of the most interesting things to watch over the last year has been the VIX, which is the volatility index. You\u2019ll see in the following chart from www.yahoo.com that way back when, in May\/June of 2007, the VIX very low, under 10. Through the last half of 2007 and through much of 2008, the VIX spiked, often hitting 30. In October and November, when we thought Armageddon was upon us, the VIX jumped again, this time to the 80 range. Since then it has fallen back, but had a hard time breaking under 40. Finally, this April, the VIX fell below 40, and today stands at about 32. All in all, that means things are stabilizing and that confidence about the future is returning.<\/li>\n<\/ul>\n<\/ul>\n
\n![\"Key](\"http:\/\/www.asiancemagazine.com\/files\/200905_VIX_sm.jpg\")
<\/a><\/div>\nAll in all, it\u2019s been a very good month for the market. So let\u2019s take a look at the Dow. Looking at the chart, it\u2019s as if that big drop in February never happened. We\u2019re basically back to where we were in early January, but the fundamentals underlying the market look much better. <\/p>\n
\n![\"Key](\"http:\/\/www.asiancemagazine.com\/files\/200905_DJI_sm.jpg\")
<\/a><\/div>\nTrading & Investing Lessons<\/h2>\n
One of the most difficult challenges of the last two months in the market (since March 9th, when this rally began) was trying to decide how far this rally would go. The answer determines whether you jump in or jump out. And that could have a big impact on your returns. Now, I believe it\u2019s very hard to pick a bottom \u2013 or a top, for that matter. But at the same time, I can\u2019t help asking the question, and seeing if we can learn something in the process. <\/p>\n
Over the last two months, you could have woken up any day, and there would be a strong bull argument, and a strong bear argument. The naysayers were everywhere, and many spent a long time waiting for the market to correct. As we all know, that hasn\u2019t happened. The price action has been relentlessly positive, even in the face of bad news. Today, the press reported that Bank of America needed some $34 billion of capital. If you had announced that any time in the last year, BAC stock would have cratered and the Dow would have been down several hundred points. Today, the market was up 101 points. That tells you a lot about how much sentiment has changed. <\/p>\n
During this rally, many said, \u201ctoo far, too fast\u201d. They looked at historical examples and said, \u201c21%? That\u2019s too much, there has to be a pullback.\u201d And yet the market is now 27% higher than the March low. And then there were the technical indicators \u2013 the number of stocks above their 50-day and 100-day moving averages was huge. Technically that\u2019s overbought, and still the market moved up. <\/p>\n
I don\u2019t mind telling you that I was just as confused as the market was. I caught some of the early part of the rally, and then jumped out, waiting for a pullback. After that, I did some very specific trades and put some money into long-term winners such as Goldman Sachs. So I don\u2019t have a insightful answer for you on how to tell if a rally will continue, but I do have some things that I would pay more attention to next time. <\/p>\n
First, I would try to remember to challenge my own perspective. <\/b> For the last year, we\u2019ve been in a market where you buy the dips and sell the rips (the spikes) within days (or even in a day) because we could be certain that another market dive was coming. We were very much in a pure trader\u2019s market, and that pattern is changing. <\/p>\n
In fact, we broke another pattern. For the last two years or so, after earnings, we blissfully ignored the downside and said to ourselves that we were okay, we were going to recover. Then earnings would come along, reality would be harsher than we thought, and stocks would nosedive. And after earnings, we would repeat the pattern. This time, we had the reverse \u2013 we were convinced that earnings would be disastrous, and the reverse happened: earnings were better than expected, and the period before earnings was the time of greatest fear. If you think about it, this eventually had to happen if the market were to bottom and turn. <\/p>\n
Underlying this change was a subtle shift in market psychology. <\/b> We all know that the market is a forward-looking creature. We say that, and it\u2019s obvious by itself. What\u2019s less clear is how to apply the concept. The idea of \u201ctoo far, too fast\u201d is inherently a backward-looking approach. That thinking can make it easy for us to miss the fact that in April, the market was beginning to look forward to a recovery. Through that lens, everything looked inexpensive, and the possibility that we had marked the bottom gave people the courage to jump in the market. So the thought of a recovery six to nine months down the road became more important than the fact the we had already run up over 20%. <\/p>\n
If we look carefully, we\u2019ll see numerous examples of how, over the last month, the market has ignored \u201ctoo far, too fast\u201d and focused on the long-term possibilities. Case and point would be natural gas, where we have record high inventories, record low demand and the lowest prices seen in years. Aubrey McClendon, CEO of Chesapeake, a major natural gas company, says that he expects normalized gas prices of $7-8 in 2010, compared to $3.50 today. Natural gas companies have said they expect a turn toward the end of the year, and that 2010 should be a very good year as inventory corrects, demand increases, and prices increase. So the market is looking six months in advance, which explains the recent run up in natural gas. Look around, and you will see a similar action in other commodities and other sectors. <\/p>\n
So for the next time, keeping flexibility in mind, keeping in mind that old patterns would reverse, would help us spot a turn in the market. <\/p>\n
Second, I\u2019ll put forth a hypothesis: to look for a turn two to three quarters after the worst part of the crisis. <\/b> We may very well mark March 2009 as the low, but I would argue that March wasn\u2019t the worst part of the crisis. I think it was October to November 2008, when things were collapsing, companies were going bankrupt, and massive numbers of people were getting laid off. That created terrible, terrible numbers in December 2008 through January 2009. And that led to horrendous expectations for first quarter 2009. As it turns out, those horrendous expectations were too much; the low of March 2009 wasn\u2019t necessarily reality, it was expectation. Of course, at the time, we didn\u2019t think so. At the time we were wondering if Dow 5,000 was a possibility. Remember that? <\/p>\n
Third, and most important, was the price action. <\/b> Take a look at the following chart of the S&P. In particular, look at line 4, which basically is a line drawn under the recent lows. You\u2019ll see that the S&P hasn\u2019t broken below this line to downside since this rally started. In fact, each time it\u2019s a approached this line, it\u2019s bounced back. That means that each time there has been a pullback, buyers came back in and drove the market back up. <\/p>\n
\n![\"Key](\"http:\/\/www.asiancemagazine.com\/files\/200905_S&PTechnicals_sm.jpg\")
<\/a><\/div>\nAnd in fact, you\u2019ll see a relentless pattern of higher highs and higher lows. That means there\u2019s lots of support for this rally, and until it breaks, there\u2019s a decent (though not foolproof) argument for a continuation of the rally. <\/p>\n
Admittedly, it\u2019s difficult to do this in the beginning. You\u2019ll see that if you draw the lines at the early part of the rally (lines 1 and 2), the line is quickly broken. But the rally did settle into a pattern, and since mid-March or so has not broken that trend. <\/p>\n
I always say I\u2019m not a chartist. I always need to understand the psychology behind the lines and the charts. <\/b> So let\u2019s think about this. In order for this kind of price action to be sustained, it means that new buyers have to be continuously coming into the market. One thing that helps me is to remember that \u201cthe market\u201d is made up of lots of different groups. And all those groups have to come in and commit for the market to go up. <\/p>\n
So here\u2019s a scenario that would explain the price action. And this is rough, and I can\u2019t prove it\u2019s 100% accurate, but let\u2019s call it a hypothetical explanation to prove the point. <\/p>\n
The market is comprised of traders, short sellers, medium term growth players, longer term value players and very conservative players, such as mutual fund investors. For most of the last year, the longer term and safer money has been on the sidelines because every rally has been met with a reversal. So through the crisis, rallies have been driven by traders buying on good news, and short sellers covering. Some growth players may have jumped in, and even some value players, but the longer term money stayed on the sidelines because they were convinced that the market would head back down. On the whole, there have been more sellers than buyers, and supply of stock has exceeded demand. <\/p>\n
This April, we had a different dynamic. The belief that we had hit bottom in March 2009, and the sense that the banking system would survive, brought in the longer term money. Add the string of better-than-expected news, and now the medium and longer term players, and even some of the conservative mutual funds jumped in. In other words, there was more demand than in previous rallies. And that explains the length and duration of this latest rally. The traders are the first to move, jumping in and getting the rally off to a good start.<\/p>\n
During this rally, much has been said about all the money sitting in cash on the sidelines waiting to come in. What happened in April is that we had a change in money flow. <\/b> Take a look at the chart below from Bloomberg on May 1, 2009. Over the last half year, supply of stock has exceeded demand. In April, with more buyers entering the market, we had demand increasing. People sitting on the sidelines have started to commit. <\/p>\n
\n<\/a><\/div>\n
And keep in mind this fact about the market: sometimes, the market is more about money flow than fundamentals. <\/b> This explains why we have such a big and long rally. It also implies that we will correct soon. We\u2019ll talk about this in a moment, but the rally has been about a 27% move; the fundamentals haven\u2019t changed by that much. <\/p>\n
One more note about the price action: a key indicator demand was the breadth of the rally. <\/b> If you look back at the last month, you\u2019ll see, as mentioned earlier, that almost every sector of the market has had a rally. So the rally may have started with Wells Fargo and financials, but it quickly spread to other sectors, including tech, transports, energy, commodities, retail and consumer discretionary. And a widespread rally is a key to supporting the upward price action that we saw. <\/p>\n
Fourth, and lastly, it was possible to trade the range in the rally. <\/b> If we look at the previous chart, you\u2019ll see that the rally staying within a range between lines 3 and 4, the line connecting the highs and the lows. Once the range has been established, one strategy (and keep in mind, this is for those that have time to trade), it would have been possible to trade the range. That means buying whenever we hit the bottom of the range, and selling at the top. Now, I wouldn\u2019t say this is for everyone, because this requires a lot of time and attention. It also means putting in stops and automatic sell orders to maintain control over your position. So this is only for those that have the time and the inclination. <\/p>\n
Looking Forward<\/h2>\n
Now that we\u2019ve looked at the last month in detail, let\u2019s look forward. We now know the results of the stress tests, and they have been positive for the market. The essential conclusion is that it\u2019s not as bad as it could have been, and that has caused a rally in the markets. By the time this article is published, there should be substantial profit taking. <\/p>\n
The question is, what to do after? I think we are in for a sideways move or a correction over the next three to four months, and that includes second quarter earnings. In fact, I\u2019m leaning toward the correction. As I mentioned earlier, we were pessimistic before first quarter earnings, we were pleasantly surprised through earnings, and now the likelihood more good news that will move us to the upside is very low. Also, as I\u2019ve said, we\u2019ve had a 27% move upwards, but the fundamentals haven\u2019t really moved by such a large amount. <\/p>\n
To me, a correction means a buying opportunity for the longer term. And I will bet that the longer term money that we talked about above \u2013 the value players, the mutual funds, anybody that has been on the sidelines and missed this rally \u2013 is thinking the same thing. If you believe that we have some clarity after these stress tests and that we\u2019ve seen stabilization of the financials, then you\u2019d have to believe it\u2019s safe to enter the markets for the longer term. <\/p>\n
We\u2019ve also talked about the loan, commercial loan and credit card problems that remain in the background. Make no mistake, these problems are still there. So expect that to dent the markets as well. Still, the difference today may be that we believe we can manage those problems. So expect pullbacks, but unless the news is much worse than expected, I don\u2019t think we\u2019ll have a re-birth of the doomsday fears that we\u2019ve seen over the last six months. That also argues for some kind of correction that should be a longer term buying opportunity. <\/p>\n
And here\u2019s a particular opportunity to look for: buying soon after the capital raisings that will occur. We all know that with the stress tests, lots of banks will have to raise money. In fact, all companies will look to raise capital and strengthen their balance sheets if their stock price is high enough. Generally what happens is that when a secondary offering occurs, the stock price goes down because existing shareholders are diluted. However, the fact that the company raised money is a positive; it\u2019s balance sheet is now stronger, especially relative to others that haven\u2019t raised money. So we often see a rise in the stock price after the secondary. And usually, the secondary is offered at a discount to the current stock price; this also helps drive the price up after the offering. <\/p>\n
This only works if the secondary offering is a sign of strength and helps separate the company from its peers. Recent examples of this include Goldman Sachs, Northern Trust and US Steel. Goldman had a secondary offering when it announced earnings, and the stock sold at about $123. In the days after, it drifted as low as $115, but soon rose above $130. The fact that Goldman could raise money showed that it was stronger than other banks, who have not yet been able to do so. Dow Chemical is expected to offer a secondary, and I wouldn\u2019t get involved in that; it comes more out of weakness than strength. <\/p>\n
Another area to look at: the laggards, which have been the defensive stocks. In this recent rally, a lot has been written about how the \u201clowest\u201d quality stocks have had the biggest runs, where as the blue chips, the slow and steady \u201chigh quality\u201d stocks have barely moved. And this makes sense. The \u201clowest\u201d quality stocks were the ones that were most likely to fall apart. If that is no longer the case, they\u2019d have the biggest rebound. Meanwhile, the safe, \u201chigh quality\u201d defensive stocks haven\u2019t dropped that much, so they\u2019re not going to have the biggest rebound. However, going forward, as the money on the sidelines starts coming in, they should improve. <\/p>\n
A good example is Philip Morris International (PM), which I hold and have recommended. For the last month, the stock has been sitting in the $35-$38 range, while other stocks have had huge moves. Over the last couple days, it\u2019s broken $40, and looks like it will continue to move to the upside. It\u2019s still down since the beginning of the financial crisis, but it wasn\u2019t battered as badly as other stocks. To me, it looks like a catch-up stock. <\/p>\n
I know this article has been long, but it\u2019s been a interesting month, one that deserves some more analysis than what you see in the news, so I hope this has been helpful. Also keep in mind that I encourage you to consult your own investment advisors before making any investments. I don\u2019t claim to always be right; I can only present you my logic, and I hope you will take the time to do your own homework and decide if you agree or disagree with the arguments presented here. <\/p>\n
Until the next time, sleep well. <\/p>\n
Ming Lo is an actor, director and investor. He has an A.B. from Harvard College, Cum Laude, and an MBA and an MA Political Science from Stanford University. Prior to going into entertainment, Ming worked at Goldman, Sachs & Co. in New York and at McKinsey & Co. in Los Angeles. <\/p>\n
All material presented herein is believed to be accurate but we cannot attest to its accuracy. The writings above represent the opinions of the author, and all readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed may change without prior notice. The author may or may not have investments in the stocks or sectors mentioned.<\/i><\/p>\n","protected":false},"excerpt":{"rendered":"
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- The TED Spread<\/b>, which is the difference between Treasuries and LIBOR, has also declined to 90 basis points this month. The TED spread is a measure of risk, and as you can see from the following chart from www.bloomberg.com, the TED spread jumped in October and November when fear was very high. <\/li>\n
- Better-Than-Expected Earnings<\/b> Wells Fargo led the charge by announcing much better-than-expected earnings early in the earnings season. Goldman Sachs followed, and so did other banks. It was evident that banks were making money by borrowing at near zero interest rates from the government and lending it out, and through investment banking activities. Looming losses in loans, commercial remain and credit cards remained, but the market soon had hope that the banks could actually earn their way out of the mess they were in. The subsequent rally allowed a handful of banks to issue debt and to recapitalize by offering stock, suggesting that at least for some, a government rescue would not be necessary. Outside of financials, the market found that many companies and industries had been priced for disaster, earnings were better than expected, and doomsday wasn\u2019t really at our doorstep. Bespoke Investments compiled the following chart, which shows that as of May 1, 2009, 62% of reporting companies have beat their earnings estimates.<\/li>\n