Monthly Archives: April 2009

Bullish on Oil

U.S. Oil Fund ETF (USO)

U.S. Oeil Fund ETF (USO)

The U.S. Oil Fund ETF attempts to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. I was unable to find a chart that I could annotate and post of the commodity itself, so this will act as a proxy. Addressing the downside risk first, the longer term triangle bearish pattern suggests the possibility of a 50% retracement in the spot price of crude. The realization of this scenario would price crude around $25 a barrel. Technical analysis confirms that my previous downside target of crude under $30 is in fact possible. However, when I made this prediction, crude had not bottomed and the economy was not improving. Commodity prices are more supply and demand sensitive than equities in regards to the physical assets. The pricing of equities is done on a supply and demand basis, but here I’m referring to the availability or use of the physical commodity. This downside price target was plausible, and even likely if the economy would have stagnated in March. The economic improvements have greatly reduced this possibility, but to respect technical analysis, we should not completely eliminate the chance of this downside price target being realized.

The upside potential, on the other hand, looks very promising. Technically, the shorter term pennant bullish pattern suggests the possibility of a 10% increase in the spot price of crude. The realization of this scenario would price crude around $60 a barrel. This short term price target seems very probably as we head into the summer driving season and approach the start of hurricane season. Another pattern found on this chart is the cup with a handle pattern. This pattern is known as a bullish continuation pattern. The cup is not as clear in this chart because it appears a little more “V” shaped than the actual spot price of crude does. The handle is the consolidation that has occurred after crude reached upside resistance around $55 a barrel. The handle typically represents the final consolidation/ pullback before the breakout. The smaller the retracement is, the more bullish the formation and significant the breakout. Based on this pattern, the longer term upside potential is an approximate 40% increase in the spot price of crude oil. This translates to about $75 a barrel, which has been my end of the year price target on crude for about a month now. The volume on the breakout should increase substantially as crude trades above the handle’s resistance. A dramatic increase in volume will be the final confirmation the breakout is underway.
This Bloomberg article supports my assessment on crude.

Dow 10K

SPX

SPX

 I know the title says Dow 10K and this is a picture of the SPX, synonymous with the S&P 500, but they track each other close enough to make the point. In addition, the price weighted nature of the Dow, versus the market capitalization weighted nature of the SPX causes some problems in forecasting. Nevertheless, the market bias is higher.

Chart Interpretation:
I have use Fibonacci retracements to show target levels as well as trend lines that suggest a head and shoulder reversal patter, also known as a Kilroy Bottom. According to the retracement levels, closing above 849.32 on the SPX is bullish and suggests the index will trade higher, more specifically to its next resistance level: 962.25. In my newsletters on www.marketfallacy.com, I called the possibility of a bottom on March 10th just shortly after the intraday lows of 667 on the SPX occurred on March 6th. This link is to the March 10th newsletter http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-10-09_2009-03-11.html. In the same newsletter I also suggested it was very likely the SPX would trade at or near 815 and the DJIAat or near 7900. In the weekend edition on March 15th, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-15-09_2009-03-15.html, I called the bottom. With the SPX closing at 806.12 on March 24th, I increased my target  on the SPX to 875, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_3-24-09_%7C_Dont_Fight_the_Fed_2009-03-24.html. On the 2nd of April, http://marketfallacy.com/newsletter/files/Market_Fallacy_%7C_4-2-09_%7C_Cramer_Calls_Bottom_2009-04-02.html, I increased my targets once again. On the 2nd, the SPX closed at 834.38 and the DJIA7978.08. Please do not misunderstand me, I by no means am patting myself on the back for these calls, I simply wanted to post reference points to support why I changed my targets.

In addition, the purpose of bringing up the forecast is to explain what I was seeing when I made these predictions. In another article I’ll explain how I predicted that the DJIA would trade in the 6000’s all the way back in August of 2008 (DJIAwas trading in the mid 11000’s). In early March, I saw the current Kilroy Bottom forming. After drawing a neckline at almost 875, I realized if the trend holds, the SPXwould have to trade above 1000. I know the chart shows a neckline at around 950, but the interpretation of the charts are subjective. On a side note, I believe that if you are truly gifted at the stock market, you should be able to take the same information, the same charts, and tell one person why they should buy, then walk into the next room and tell another person why they should sell. The difference is probability or likelihood that the current trends or information will be realized.

Most bears are calling for a significant retracement. Some bulls are even secretly hoping for a slight pullback in fear that the markets cannot sustain the current up-trend. Let me first begin by saying, I was one of the more bearish traders in the Fall of 2008. Until recently, I thought I was watching the collapse of the greatest empire ever, the United States. However, the last month has given me much hope. America is the land of opportunity, and the current market environment is a huge opportunity. Because of these opportunities Americans have always overcome adversity, whether it’s the bombing of Pearl Harbor, September 11, 2001 World Trade terrorist attack, natural disasters such as fires in California or Hurricanes hitting the coasts of Texas and Louisiana, Americans have always shown perseverance. Unfortunately, in order for there to be good opportunities there have to be bad ones. During the past 8 months talking to different investors, I have continually reminded them that if the want the coin they have to be willing to have both sides, heads and tails. This translates to: If you want economic boom, you have to have economic recession. It’s completely natural, and in fact a very good thing. Through economic recessions, the economy gets rid of the companies that should not be, in order to prepare itself for the ensuing expansion.

I made this reference to the show that I have not always been as bullish as I am currently for two reasons. The first reason is hopefully to establish some credibility and the second, very similar to the first, is so that I could show that I change as the facts change. Until recently, there has been a lot of uncertainty in the market. Generally, markets do not like uncertainty, and as a result volatility increased. During the increased period of volatility, negative news compounded this uncertainty and exacerbated it. This resulted in psychology driving the markets rather than facts. Fear and lack of trust produced the bankruptcy at Lehman Brothers. Yes they were probably insolvent as well, but once there is a run on a bank, it almost always goes under. The bears that are left are hoping for results of the stress test or a bankruptcy announcement from General Motors to reverse this market. I seriously see these events as very positive. It’s about expectations. We all know that GM is struggling, it won’t surprise anyone if  they file for bankruptcy. I think the market might actually rally on this information as there will be less uncertainty. Additionally, results of the stress test will reveal which banks can survive andwhich will fail. Again, uncertainty will exit the markets because the bad banks will fail while the good banks have the backing of the United States Government. I know that this post is under the technical analysis tab, I’m getting to its technical relevance. But first I need to say one more thing about the banks. Some people have suggested that banks raising additional capital is bearish. While I’d agree that this without a doubt means the need more capital, obviously because they wouldn’t raise capital if they didn’t need it, but do not agree that it is bearish. The fact that Goldman Sachs was able to raise $5 billion this week without the backing of the government is huge. It means that once again people are trusting the banks to do what they do.

Now for the technical relevance of all this fundamental information. I think the markets will continue higher to approximately SPX 1000 before any significant retracement occurs. At that time I am going to reduce the size of all my long positions, but I am not going to short the market. My reference earlier to changing when the facts change will be reiterated here. Unfortunately, economists such as Nouriel Roubini are going to all the credibility they have established over the last year quickly. Nouriel Roubini, also known as Dr. Doom, is a professor of economic at Stern school of business at New York University. He predicted the real estate bubble in September of 2006, and the ensuing sub-prime crisis in September 2008. Many people viewed him as very pessimistic, just as they did to me when I told people the DJIA was headed to the mid 6000’s. Nevertheless, he received much credibility and respect for his predictions. Sadly, he thinks the economy has not bottomed, and is on the verge of losing all the credibility he gained in the last two years.

Having said this, as the SPX approaches 1000, I expect a significant retracement in the range of 20-25%. This would move the SPX back down to around 800, still approximately 20% off the March 6th lows. Remember if the SPX does get to 1000, it will have rallied approximately 50% off the bottom with virtually no down movement. Markets do not move in straight lines, although this might suggest otherwise. According to Elliot Wave Theory (EWT), we have ended the down-wave and are now in an up-wave. This change in trend is due to the violation of rule one of the three consistent rules of EWT: 1) wave 4 cannot enter wave 1’s territory 2) wave 3 is never the shortest impulse wave 3) wave 2 never exceeds the start of wave 1.

If the markets continue to follow technical analysis, a continuation of the up-trend to approximately SPX 1000 followed by a 20-25% retracement are supported by the forming of the Kilroy Bottom, Fibonacci retracements, EWT and even fundamental analysis. All of the technical analysis just covered have very similar targets, with a small margin for error. Regardless, it has been very accurate and profitable for me since suggesting the possibility of a bottom in early March.

Mendoza Ranked #2 Undergraduate School

The University of Notre Dame received the number 2 undergraduate business school ranking for the Spring of 2009. Mendoza, the Notre Dame business school, was ranked 3rd in 2008 and jumped the University of Pennsylvania’s business school Wharton. The University of Virginia’s business school McIntire, ranked 2nd last year also jumped Wharton, and is currently ranked 1st.

Business Week sites Notre Dame’s focus on ethis and strong alumni network as key factors in setting Mendoza apart from other undergraduate business schools.

http://www.businessweek.com/bschools/rankings/
http://www.businessweek.com/magazine/content/09_10/b4122048934051.htm

Academia and the Random Walk

With the exception of a few, I think most would agree that academia could not translate theory into practice, nor could many fund managers translate their practical knowledge into academic theory. This unfortunately is due to the widely accepted concept known as Random Walk Theory. Many academics do not feel it is possible to add value, in terms of risk-adjusted returns, to investing. The Random Walk Theory asserts that it is impossible to outperform the market on a consistent basis. It views managers who empirically challenge this theory with skepticism suggesting chance correlation is more likely than proof that managers can outperform the market. They will generally agree that exceptional stock picking or market timing skills are not widely held among the many financial managers on Wall Street. I tend to agree that probably only a small percentage of Wall Street managers can actually beat the market, on a risk-adjusted basis consistently. But please do not misunderstand what I’m saying, I do believe it’s very possible to beat the market consistently. The only reason we do not see this more commonly is because the managers that can beat the market get over run by greed, causing them to lose sight of the basics. An example of this is Bill Miller. Bill Miller beat the S&P 500 index for 15 consecutive years from 1991 through 2005, but the current economic downturn has ended his streak. What happened? He lost sight of his basics which overexposed him to the financial downturn.

Academia generally holds the view that opportunities do not exist to add value to investing. If they believe in mispricings at all, they typically argue that one could not profit off of these mispricings successfullyenough to demonstrate, statistically speaking, that they have either stock picking or market timing abilities. This view holds relatively well considering it stems from the Efficient Market Hypothesis (EMH). I believe in the EMH, and this is why I believe it is possible to consistently beat the market on a risk-adjusted basis.

The Efficient Market Hypothesis suggests that stock market efficiency causes existing share prices to always reflect the most relevant information. As a result, stocks always trade at their fair value which in turn makes it impossible for investors to purchase undervalued or sell overvalued stocks. These assumptions imply exceptional stock picking or market timing impossible and the only way to obtain higher returns is by purchasing riskier investments. This is why the reference to risk-adjusted returns is so important. However, the three forms of market efficiency attempt to explain why such returns do happen.

Weak-Form Efficiency suggests that future stock prices cannot be predicted by analyzing historical stock prices. More specifically, this form implies that past returns are not indicative of future returns and that technical analysis cannot be used to exploit the markets. Weak-Form does believe certain fundamental analysis could provide excess returns to fund managers. Semi-Strong Form Efficiency suggests that share prices reflect all publicly available information and adjust to new information very quickly and in an unbiased manor. As a result, neither fundamental nor technical analysis techniques can be used to produce excess returns. Strong-Form Efficiency suggests that share prices reflect all information, public and private, and no one can earn excess returns.

Now that the three forms of efficiency have addressed, I will explain why I feel it is possible for us to have an efficient market and have people beat the very same market. First it should be noted that because people do earn excess returns, Strong-Form Efficiency does not hold. If Strong-Form is rejected, the possibility of having both an efficientmarket and people beating the same market very possible. I believe that markets are not efficient, but that they work towards efficiency as a result of the market participants. I believe that they never really achieve true efficiency because as they begin to converge to the truth, the truth changes. The truth can change for 2 reasons: 1) the facts have changed, that is new information enters the market or 2) enough market participants hold a contrarian view.

The purpose of the stock market side of this blogis to attempt to reveal that market fallacies exist. More specifically, the market fallacy that suggests consistent risk-adjusted returns are impossible.

Stock Market Post Introduction

The are currently two sub-categories within stock market: academia and technical. The academia category will discuss the assumptions of the academic world and how they relate to current news. The technical category will discuss aspects of technical analysis and how traders use technicals to trade. For more in depth analysis of the current market environment, sign up for my newsletter at www.marketfallacy.com. The analysis in the newsletter will attempt to give a broad market bias, as in long or short, while posts on this blog will be more specific and driven by readers. Also, due to time constraints, the blog will be updated most often and on a more timely basis, whereas the newsletter will be sent out only a couple of times per week.