Risk/Reward Vol. 96
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION UPON INVESTING. RELY ON NOTHING STATED HEREIN.
"How does it feel?/How does it feel?
To be on your own/With no direction home
Like a complete unknown/Like a rolling stone"---lyrics "Like a Rolling Stone" by Bob Dylan
"The measure of who we are is what we do with what we have."---Vince Lombardi
""Set it, and forget it."---Ron Popeil's directions on how to use the Ronco Rotisserie
"gimme pound, gimme pound, gimme euro, gimme yen
i'm international baby
i'm international, pay me"--- lyrics from "Pay Me" by Usher
As stated last week, I will not reinvest in the stock market unless and until some certainty surrounding Europe's sovereign debt situation emerges. The mixed messages emanating from the Continent this week only add to the confusion. Here is a sampling: on the plus side, a promise from the summit of leaders of more unity; the European Central Bank (ECB) extending from one to three years the term of its loans to Eurozone banks; the ECB implying that ample liquidity will be made available for these commercial banks to buy sovereign debt; summit leaders hinting that in the future private bondholders will not take "haircuts" , but to the negative, the ECB categorically refusing to be the sovereign debt buyer of last resort; major French banks downgraded by rating agencies; and the UK refusing to join in the unity move. What does this all mean? I don't know, and the commentators are giving little guidance. If you want an excellent summation of the confusion, read today's Financial Times most notably John Authers' Comment. Accordingly, I remain on the sidelines until the impact of this weeks's action (or inaction) is understood--at least for the most part. Allow me to explain.
I usually spend Sunday afternoons fine tuning my market acquisitions and divestitures for the upcoming week. Having exited (again) last week with firm conditions on my re-entry, I spent Sunday, instead, reviewing my conduct since my first exit en masse in July (see volumes 78 and 79 at www.riskrewardblog.blogspot.com ). My forays in and out since then have been unworthy of me, and I am fortunate not to have lost more than a modest amount. Given a redo, I would have stayed out entirely. My desire to grow my nest egg pales in comparison to my need to maintain it. That said, had this period of uncertainty occurred during my retirement, I could not have afforded to go 6 months with my nest egg merely gathering moss. I would have needed some income to "roll" my way---but, pray tell Mr. Dylan, from what direction?
Inspired by an Aaron Rodgers comeback and the words of Vince Lombardi, I realized that doing nothing was not acceptable. I had to do something--and do it with what I had. So, first things first, on Tuesday I did what any sane investor should do. I bought Lady Barbara and me one share each of the stock of the Green Bay Packers. Huge dividends will be paid in grins this summer when we attend our first shareholder's meeting at Lambeau Field.
Second, I researched, contemplated and discussed with my investment muse the concept of directional trading. Directional trading is a simple strategy used by traders who take positions, either long or short, on the belief that they are able to correctly predict movement upward or downward. It can be deployed upon individual stocks or, thanks to the emergence of exchange traded funds (ETF's), upon market sectors or entire market indices such as the Dow Jones Industrials or the S&P 500. Thus, if a trader were reasonably certain that on a given day the stock market were going up (long) or down (short), he/she could place a bet using a single, a two times (2x) or even a 3 times (3x) ETF on the direction, long or short, and hedge against a loss using a stop order.
The following will provide a real life example of the strategy. On Thursday, I awoke in time to hear the news conference of Mario Draghi, the head of the ECB, wherein he announced, to the world's chagrin, that the ECB would not be the purchaser of last resort of European sovereign debt. Based upon my reading over the past several weeks, I knew that a more positive answer was "baked" into the market and that the news would have a negative impact--at least until Friday's summit of European leaders. So, at the opening on Thursday, I bought SDS ( a 2x S&P 500 short ETF) at around $19.50 per share and immediately placed a stop order mandating a sale if the price fell to $19.40 which would occur if the market went up. (Remember, short positions go up when the market goes down.) Like Ron Popeil, I just set it and forgot it. My gambit held the promise that I would receive two times the percentage drop in the S&P 500 (assuming it dropped), and I limited my exposure to $0.10 ( 0.5%) per share if the market went up. As I suspected, the market fell throughout the day, and I sold my position a few minutes before close. The S&P fell over 2% that day, which meant I made roughly 4% because the ETF I used doubled the impact. (P.S. This also means that losses mount twice as fast--but I was hedged.) I placed no "bets" on Friday because I had no feel for how the market would absorb the news from the summit.
My contemplated future approach is simple. There are 3 or 4 days per month when I have an almost-certain feel as to market direction---good/bad job numbers, good/bad economic data, a huge surprise/disappointment, an international incident, etc. On those few days, I intend to place a 2x or 3x directional bet, hedged by a very conservative stop loss--such that should the market go in a direction opposite my bet, I will be out with very little lost. By putting a modest amount on the line (no more than 3% of my nest egg), I would be able to meet my monthly income needs in retirement if I predicted correctly 3 out of 4 times per month--- assuming the move up or down were significant, say, 100 points or more on the Dow. Don't worry, loyal readers, I am starting with itsy, bitsy, tiny, baby steps and keeping track of my success rate. Wish me luck. Your thoughts and comments are appreciated.
Despite the market's uptick on Friday, I see little encouragement on the immediate or intermediate horizon. Treaty change may comfort some, but it is months away, if all. Moreover, the jury is still out as to whether the promised liquidity from the ECB will prompt Eurozone banks to even hold the sovereign debt currently on their books, let alone buy new issues going forward. According to today's Financial Times, Eurozone banks still hold 513bn Euros worth of the sovereign debt from the PIIGS, having shed 65billion Euros worth of it since March. Do they really want more exposure? Why? In this regard, note that the news from the summit overshadowed a pronouncement by the European Banking Authority that as a consequence of failing a "stress test", 31 large European banks will need to raise an additional 15billion Euros in capital if they intend to conduct business at their current size. Frankly, unlike Usher's vixen, I don't see the international equity markets giving these banks pounds, euros or yen. Their only means of complying is to shrink by selling assets and reducing lending activity. For reasons previously discussed, this, in turn, will severely limit credit availability globally which traditionally is dependent on loans from large European banks.
On the domestic front, the news is also not cheery. Dow favorite, DuPont, cut its profit forecast. More importantly, the EPA announced a preliminary conclusion that the presence of benzene and methane in the drinking water in a rural Wyoming town came from a nearby fracking operation. This connection is what environmentalists have been seeking in order to shutter the explosive growth of this oil and gas exploration technique. Why the Obama administration wants to curb fracking is beyond me, but it does. If it succeeds, the prospect of US energy independence and tens of thousands of high paying jobs are out the window.
I apologize for casting negativity on your upcoming holiday. I sincerely hope that the prospect of Eurozone treaty change and the ECB's promise of liquidity to Eurozone banks stems the run on European sovereign debt, and that some relief from these wild swings in the stock market prevails. Next week should give some signs. Watch the interest rates on Italian and Spanish debt. But whether the stock market stabilizes or not, I intend to prosper.
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