Recap of 2010 Market Performance & ETF Tracking Error

After a couple weeks off from posting through Christmas and the end of the year, I'm back to recap the year. Santa Claus showed up at the end of 2010 to add to the gains while the economic calendar and geopolitical environment presented no impactful news to derail the advance. The primary US index, the S&P 500, mounted a solid 13% advance for 2010 closing a volatile year that included a 17.1% correction from high to low mid-year. The last four months of the year alone offered a 19.85% return as fears of a double dip recession and a meltdown in Europe abated and stocks recouped the drawdown.

I have had many conversations recently about the advantages and disadvantages of ETFs so I thought it would be worthwhile not only to look back at last year's performance in various markets but to compare these markets to their primary respective ETFs. I am wholly convinced that ETFs are the best bet for the vast majority of investors who control their own accounts, easily topping individual stock-picking and mutual funds.

Market	Benchmark Symbol	ETF	Benchmark Performance	ETF Performance	ETF Tracking Error
Dow Jones	$DJI	DIA	11.02%	11.11%	(0.09%)
S&P 500	SPX	SPY	12.78%	12.84%	(0.06%)
Nasdaq 100	NDX	QQQQ	19.22%	19.04%	0.18%
Russell 2000	RUT	IWM	25.31%	25.30%	0.01%
Gold	/GC	GLD	29.72%	29.27%	0.45%
Copper	/HG	JJC	32.53%	29.04%	3.49%
Crude Oil	/CL	USO	15.17%	(0.71%)	15.88%
Natural Gas	/NG	UNG	(21.18%)	(40.58%)	19.40%
US Dollar	$DXY	UUP	1.42%	(1.60%)	3.02%

Data based on thinkorswim closing prices.

The equity market ETFs do an excellent job of tracking their benchmarks with the SPY and DIA actually outperforming marginally after fees during the year. As has been reported across the financial world, the commodity ETFs that trade in futures contracts, JJC, USO and UNG, have large tracking errors. These ETFs are crushed by the rollover costs associated with contango, a concept far too many retail investors do not understand. GLD, which holds the physical metal, must only pay storage costs. It is not surprising then to learn that a new ETF backed by the physical metal for copper will debut in 2011 but will carry a hefty storage fee of 1.5% as copper's equivalent weight to gold results in much larger volume.

I think copper and crude oil are best used as indicators for equity markets. The relevant ETFs are garbage and without a substantial education in futures trading, these markets are simply out-of-reach for most non-professionals. Equity ETFs, on the other hand, are excellent vehicles for achieving low-cost diversification. While investors may be giving up some of their opportunity to achieve alpha it is often best to accept beta and to just worry about the front-end of consistently depositing money into the account. Yet, the game is fun, that's for sure, and active investors can always put most money aside and play with the rest in search of alpha.

Overall, the economy is improving, companies are making more money and stocks are pushing higher. The elephant in the room is clearly the US jobs picture which will likely improve in 2011 as productivity growth slows and firms look to improve the top line by hiring. Here's to a prosperous 2011!


Brandon R. Rowley
"Chance favors the prepared mind."


*DISCLOSURE: No relevant position

Christmas Time: Light the Tree, Buy Stocks

I'm back in New York and back at my desk after a nice, long Thanksgiving break. The market is on speed today with the Dow up 250 points right now after Monday's big intraday reversal marked a significant change in the action. It seems to me that stocks are primed for a Christmas rally to tack onto this year's mild 8% gain in the S&P so far. November was a healthy 4.4% pullback and buyers are back to start December. Overall I'm not all that concerned with the market itself but am focusing on individual companies as I wrote in mid-November.

Is the rally justified?

One of my favorite bloggers, Wade Slome over at Investing Caffeine, has a great post out titled "Another Year, Another Decade" highlighting the prominent undercurrents driving the market:

• GDP Growth: You wouldn’t know it, but we have experienced five consecutive quarters of GDP (Gross Domestic Product) growth with a recently upwardly revised Q3-2010 growth figure to +2.5% (from previous +2.0% estimate).
• Job Growth: Although the unemployment rate has stubbornly remained in the 9.6% range, the country has created more than 1million jobs over the last year, thanks to ten consecutive months of private job creation. We’ll find out more about hiring trends this Friday.
• Record Profits: S&P 500 profits are on track to exceed the $88 peak profit earned by the index in 2006 (Thomson). Corporations may not be hiring in droves, but the cash is piling up for increased investment and pent-up hiring. Unprofitable companies generally do not hire.
• Changing of the Guard: Regardless of political leanings, with Presidential re-elections only two years away and Republicans gaining control of the House, some common ground between the Right and the Left could be found. Specifically, gridlock is the default, but there is genuine potential for compromise on taxes, fiscal restraint, tax relief, and investment incentives with the aim of sparking job creation.
• Holiday Cheer: Holiday sales got off to a good start judging by “Black Friday” (the day after Thanksgiving) and “Cyber Monday” – the day after Thanksgiving weekend. Sales on Cyber Monday rose +19.4% versus last year, according to Coremetrics. Traffic to retail stores and websites over Black Friday weekend increased by +9%, reportedthe National Retail Federation.

I think there's a lot to be optimistic about, especially as a trader/investor. With common sentiment seemingly still so negative, opportunities abound for those willing to believe in the recovery and find values. I've excluded the list of negatives here because there will always be negatives but the underlying currents remain very strong indeed.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Nothing relevant.

N. Korea Pissing Everyone Off, Stocks Give Back Yesterday's Rebound

Source: The Week

Kim Jong-Il pissed off the world again last night as North Korea fired 100 rounds of artillery at Yeonpyeong Island in the Yellow Sea killing two soldiers and wounding 16 soldiers, three civilians. South Korea responded by shooting 80 rounds back. This sort of provocation always seems to lead me to some sort of existential exasperation where I think: "Why does this guy still exist? Can't he just not be anymore?" His people live in desolate poverty yet he remains committed to living far outside developed society. Even Castro has admitted to making mistakes in his communist path and has endorsed his brother's reforms.

Coupled with the increasing uncertainty and fears of contagion surrounding the Irish bailout, the escalation in the Korean Peninsula has the market giving back yesterday's afternoon rebound. Easily overshadowed was the positive news of a GDP reading revised higher showing 2.5% for the third quarter instead of the advance report of 2%. Sure there's plenty to be pessimistic about but are consistently seeing slow and steady improvement across most metrics.

One positive is a look at the new economy as TechBook put out a post stating that recent sales in shares of privately-held Facebook value the company at $35 billion. Remember, Facebook was founded in 2004 and has received $836 million in funding. Assume all the funding came up front (which it didn't) and the return works out to a 70% annual growth rate. The quick-minded using the rule of 70 will see that the company has been roughly doubling every year. Amazing how these stories of truly life-changing innovations and unprecedented adoption rates get lost in the shuffle of macroeconomic fears.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: I wish I was long Facebook.

Thanksgiving Week Means Christmas Shopping!

Thanksgiving week is here and the Christmas shopping season will soon begin. While the American consumer still seems to be struggling, they are expected to hit the stores anyway in full force. The S&P 500 2.4% off highs and questions swirl of whether we'll see a further pull-in or the always fun Santa Claus rally.

Volume will be light and action will likely be muted this week but all we need are some promising Black Friday and Cyber Monday numbers next week and the floor could be set for new 2010 highs. So run out and buy your kids some Squinkies before they're sold out!

Thoughts on an approach to this market

I had a great time last week enjoying a few beers talking stocks and markets with The Reformed Broker himself, a heavyweight in the financial blogging arena. It's quickly becoming a common theme among the smartest minds I've run into that adopting longer timeframes and larger ideas is a must for finding outperformance. We are all seeing the markets change before us with the wild volatility of the last few years quickly dying out. The last few years have been fun for the active trader: a 55% collapse from late-2007 highs to early 2009 lows followed by an 80% rally to April 2010 highs and then a flash crash just to scare the bejesus out of anyone trying to hold on to companies.

Yet, I'm of the opinion that it would unwise to believe this will continue. As fear abates, volatility will fall and the best companies will begin to shine through the mess. Concerted and orchestrated actions between and among governments and central banks around the world should be calming mechanisms for financial markets and open up the paths for innovation and reward. Finding great companies and sticking with them, in my opinion, will be the best strategy for 2011 and beyond.

As a side note, Josh also let me in on Instapaper, already a life-changer for a financial news junkie like me. It even integrates with Google Reader so I can better sift through my daily blog reading! Awesome idea.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Nothing relevant.

Focus on Individual Companies in this Pullback

The S&P 500 dropped 2.2% for the week after rallying for nine straight weeks. Bull markets, especially new ones, are difficult to get involved in because with everyone wanting in, the perfect entries are snatched up very quickly. As is often stated, stocks rise on an escalator and fall on an elevator. The pullbacks are always the clear buy areas in hindsight but fear always accompanies buying into a declining market especially when CNBC carts out all the permabears to scare us all.

The macro versus micro battle rages on

It is amazing to see how persistent the battle between the micro and the macro has been over the last year. Whenever macro worries have hit headlines the market has declined with high correlation between stocks and assets. Once we solve/delay/forget the problem stocks are freed up to continue their rally on the steadily improving micro picture.

As Zacks Investment Research laid out this week, third quarter earnings have been great on the whole. With 7/8ths of the companies in the S&P 500 having reported, we've seen 72.7% of all reporting firms do better than expected, 79.4% report positive year-over-year growth and total net income reported up 27.4% year-over-year. Full-year total earnings for the S&P 500 expected to jump 42.0% in 2010, 14.3% further in 2011. Bottom up valuation puts P/E at 14.9x for 2010, and 13.1x for 2011.

With tailwinds from round two of quantitative easing and greater clarity on the political front with the midterms out of the way, the market may be primed for greater upside. China may tighten which could impact global growth but it's not some out-of-the-ordinary possibility as they have been slowly curbing inflation for the last couple years already. And imagine that, Europe's debt woes were not perfectly and entirely fixed with the ECB's debt package; but coordinated action from officials should be able to prevent any renewed panic.

Ignore the market, find good companies

The initial move off the March 2009 bottom was fast and furious as the S&P catapulted 80% higher in little over a year. This summer's correction represented the first significant worries of a double dip and we were reminded that the developed world is still dealing with too much debt. Yet, the last two months showed the strong resilience of our markets and in short order we rallied right back to April 2010 highs.

I will be the first to say that I don't know if there's more downside in the market up here. I am very optimistic over the next year but I just couldn't tell you whether the market will go down or up next week. But, quite frankly, I don't think it matters all that much. For most of the last three years, ignoring the market's moves was nearly impossible and possibly deadly. Heightened correlation made it imperative to watch the general market closely and many chose to just trade it directly as a basket.

As we rally further though, the market is somewhat less relevant. The S&P is up 7.5% year-to-date but what has that really mattered for the likes of Apple (AAPL) up 46% YTD, Baidu (BIDU) up 169%, Netflix (NFLX) up 214%, Salesforce.com (CRM) up 56%. There are extremely impressive, innovative companies out there doing great things. These companies are rapidly growing their earnings and will perform well in any moderate market. Barring a complete collapse which I believe is highly unlikely, a company like Apple will keep making more iPads and iPhones and we'll all keep on buying them.

I think the key to not being the guy in hindsight who says that was the pullback to buy (but didn't actually buy) is focusing on individual companies and stocks that provide compelling setups. My focus is on some of the companies I've been writing about like Google (GOOG), EMC Corporation (EMC) and Potash Corporation (POT). I don't find predicting whether the market will be up or down 2-3% this week as a worthwhile endeavor but I do think EMC around $21 or POT around $130 could create very attractive entry points. Finding good stocks trading around solid levels will be my focus in the coming days.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long EMC, POT.

A Much More Sustainable Equity Market Advance

Goldman Sachs released a great chart in October showing S&P 500 earnings per share against the index's prices. The chart tells a very interesting story about the last decade and gives some indication about what Goldman thinks this market will look like in the coming year.

Late '90s were years of multiple expansion

The late 1990s saw a massive rally fueled by enormous public appetite for anything in the technology sector, in particular any stock with '.com' in the name. At peak prices in March 2000 the S&P 500 was trading 29 times 12-month trailing earnings. Not only was this a extremely high market valuation historically it was based on unsustainable earnings. Both the 'P' and the 'E' of the P/E equation were terribly flawed.

While many huge and important innovations rose out of the 1990s technology explosion, along with it came many more inviable businesses touting entirely unrealistic expectations for growth. Valuations on a large swath of technology firms were completely out of whack and would correct once the music stopped.

Stock prices started to decline and simply didn't stop. Yet, the P/E on the market rose! Prices couldn't fall fast enough to maintain the same valuation. After dropping for a year and half and losing 26% in value the S&P ended the year 2001 with a whopping trailing P/E of 47. The S&P finally bottomed in late 2002 after a total fall of 50%.

Next rally built on shaky leveraged foundation

The next major leg up in the market was largely financed by leverage. Financial sector profits exploded driven by major legislative rollbacks that allowed for super center banking institutions and unlimited leverage for the top five investment banks. Section 20 of Glass-Steagall should not have been repealed and the 2004 SEC leverage exemption was a significant precursor to the eventual destruction seen at the top five investment banks.

Yet, much of this underlying leverage in the system went unnoticed by investors. Though, investors had learned from the technology bubble not to accept such radically high valuations based on ever-rosier and optimistic outlooks. The end of the third quarter in 2007 the S&P had a more modest trailing P/E of 19, just a month before the top in prices.

But, as the cracks in the housing market began to reverberate through financial markets, banks found themselves wildly overleveraged with now illiquid markets for their derivative securities. Stocks rapidly disintegrated wiping out 58% of their value in a year and a half.

What can the next rally look like?

After a decade of over valuations and leveraged earnings, can we enter a period of sustainable earnings growth with moderate valuations? Goldman Sachs has a 12-month target on the S&P of 1275 while they predict earnings will be $89 per share, only $2 off the all-time high in October 2007. This would result in a much more modest trailing valuation of 14x at the end of 2011 if the scenario plays out. Investors are much more pessimistic about future economic growth in the US than they have been in the last decade and are consequently assigning lower multiples.

If the valuation question is tackled, the sustainability of earnings is next to consider. The most levered names in finance are gone, namely Fannie Mae, Freddie Mac, Lehman Brothers, Bear Stearns, Merrill Lynch, AIG and Goldman Sachs and Morgan Stanley are now banks subject to leverage limitations. Earnings have dramatically rebounded fueled by capacity cutbacks across the board and a surge in worker productivity. This type of corporate cleansing has forced companies to streamline and do more with less.

With much of the leverage washed out of the system in the 2008 crash and widespread pessimism about the US economy keeping valuations muted, the S&P may be entering a period of sustainable advance in prices. Private company hiring is slowly returning and revenue growth is strengthening demonstrating that EPS growth is starting to come from the top line, the necessary support needed for continued growth.

Brandon R. Rowley
"Chance favors the prepared mind.

*DISCLOSURE: Nothing relevant.

Bernanke Gives Us $600B in QE 2.0, Equities Soar

US Futures are trading up 1% following the Fed's announcement for QE 2.0 yesterday in the amount of $600 billion. Republicans also handily captured majority in the House of Representatives and gained seats in the Senate. Tokyo followed yesterday's rally in the US with its own 2.2% gain and London trucked higher up 1.8%.

Don't fight the Fed

I hit out of my dollar position yesterday after waiting around for a month for a rally. I certainly underestimated the Fed's willingness to stimulate the economy. With GDP growth in the 2% range consistently I thought the Fed would, at the very least, not continue to ease. I understand the Fed's mandate to promote full employment and I'm done fighting them. I lost some in the long dollar trade but what hurt me the most was the distraction it caused from where my strongest abilities lie.

This month I'm going to reduce my concern with the macro picture and focus my time on sectors and companies. Understanding individual companies will yield the greatest amount of benefit to me rather than attempting to guess whether the Fed will roll out large QE or small QE. Ultimately the repeatable and scalable strategy I am always building towards will be dependent on the micro level.

No stopping this rally

And just like that we're back to the April highs in the market. Four months of decline, flash crash, equity fund withdrawls, bond bubbles, range-bound action, double dip recession, Greek bankruptcy, PIIGS, head and shoulders, Hindenberg Omen...it's over. This was the harshest correction in this rally off the March 9th lows. First was the 9% pull-in in June 2009 where panicked traders thought we were heading back to the bottom and second was the 9% pull-in in January 2010 as we doubted the possibility of a positive earnings season. Now we've seen a 17% drop as the first true stall in the economy since the reflation began and we went running for the exits. Yet, our economy remains resilient continuing its long, slow trudge back to life helped by a very accommodative Federal Reserve.

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Nothing relevant.

All the News You Can Handle this Week: Elections, QE 2.0, Jobs Report

It's November! Fall, leaves, turkey, Thanksgiving, what a great month! My posting was relatively light for the month of October as I spent much of the month in a more hands-off position with a large dollar position and a few good stocks I like. Given the 3.7% gain in the S&P 500 this positioning has not been acceptable. Coming off a great September I entered a far too cautious mode and made several mistakes with the culprit being either too much activity or a lack of patience. Yet, a new month is here and this week has about all the upside/downside catalysts you could hope for. So, enough with the past, time to think about the next few months.

Could we ask for more news flow?

Tomorrow we have the midterm elections, Wednesday the FOMC is widely expected to announce some quantity of asset purchases as QE 2.0 begins and Friday is the monthly jobs report. So, we all know the Republicans are anticipated to pick up seats, QE 2.0 is expected somewhere around $500 billion and we're looking to maintain an unemployment rate of 9.6%. At this point, I don't see much point in guessing what the numbers will be or what the reaction will be. My trades reflect the belief that QE 2.0 will be less than is priced into the markets and the dollar has bottomed for the foreseeable future.

A rundown of where we are: The S&P 500 has rallied 17.5% from the July 1st lows and sits just 2.6% off the late-April highs. The dollar index is hanging out just 1.6% off October lows. While I have been looking for a dollar rally, the price action last month has done little to convince me my idea is correct up to this point. My stops are in place near the lows. The 30-year Treasury bond is 4.5% off highs yet 14.2% off April lows.

For next few months, I see more upside

Whether or not QE 2.0 is $250 billion or $750 billion and whether or not the market drops 1% this week or advances 1% following Friday's jobs report I see the market being supported by yet another very strong earnings season. We continually see macro worries causing volatility in equity prices but, over the long-term, stock prices will appreciate in line with earnings growth. Over 70% of companies have beat analysts' EPS expectations for yet another earnings season with estimates too low.

My overall trading plan is to continue trying to buy stocks on weakness and sell them into strength. This is an obvious goal but my point is to maintain this mindset and not fall into a game of trying to pick tops and predict pull-ins. I think volatility will continue to fall over the next several months and correlation will also decline. (This may certainly not be true this week but I would see a large pull-in as a buying opportunity.) The April decline in equity markets following the European debt crisis stoked fears of a double dip recession and led to a 17.1% correction in the S&P 500 from high to low. I believe a double dip is not in the cards in the near term smartly avoided by quick, concerted actions by the ECB and continued expansionary policies from the Federal Reserve. A fast and furious rally off the September lows caught many by surprise but it has correctly forecasted the quick return to relative calm and the slow, but sure economic recovery we are experiencing.

While I am long the dollar which currently has a strongly negative correlation to equity markets, I do not think that correlation necessarily must continue and we have had plenty of times historically of concurrent rallies. It is a separate trade from the specific equities I hold and will perhaps be a hedge should the market come in and correlation remains high. We'll see how it all plays out.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long UUP.

October Ends with Positive GDP Surprise, QE 2.0 Next Week?

October's last trading is today falling on a Friday and featuring the advance 3rd quarter GDP reading. After the 8.8% gain for the S&P 500 in September, October looks to be another move to the upside of roughly 3.5%. The Bureau of Economic Analysis reported advance GDP quarter-over-quarter annualized growth of 2.0% exactly inline with economists' expectations. Notably, the price index ticked up 2.3% versus the 1.8% estimate showing some higher inflationary pressures. (News Release)

All eyes now shift to the major events of next week. Next Tuesday is election day where Republicans are anticipated to have significant gains in seats. Yet, probably more importantly is the FOMC meeting on Wednesday where it is widely believed the Federal Reserve will announce round two of quantitative easing. Consensus seems to be somewhere between $500 billion and $1 trillion with notable outlier estimates from Goldman Sachs analysts claiming anything short of $4 trillion will have little impact.

Markets are likely to sit in a holding pattern while we await the Fed's decision. I am skeptical of QE 2.0 and see this morning's GDP number as evidence that the economy is still in recovery mode and does not need additional monetary stimulus. While the Bernanke Fed has been very dovish I think we may see a more cautious toe dip rather than a full plunge into QE 2.0. Markets seem to have counted some of their chickens a bit early here and some level of QE is already priced in. I have been long the dollar throughout October but the trade has really gone nowhere so far. The lows are my out and I will also await the FOMC policy statement.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long UUP.

Contrarian Trade: Buy the Dollar (UUP)

Per my post last week I purchased the dollar through the PowerShares ETF (UUP). My timing in the short-term (< 1 month) may not be perfect but I am willing to step in at the current prices with the expectation of higher prices in the intermediate term (1-6 months). I am still bearish on the dollar in the long-term (1 year +) but probably not for the reasons most would think.

Why be bullish now, isn't QE 2.0 coming?

The primary argument for a lower dollar is Helicopter Ben's "promise" for QE 2.0 which will further debase the currency. Yet, the crucial question in any trade is not whether a certain future event will happen but whether or not that expected event is priced in. By my estimation, QE 2.0 is certainly priced in and we are beginning to see some outlandish calls on the total quantity. Former Bush economic adviser Marc Sumerlin publicly stated that the Federal Reserve needs to pump $6-7 trillion into the US economy to have a meaningful impact (CNBC). I see this possibility as a near impossibility, I only address it as a sign of the level of dollar pessimism and ridiculous easing expectations. The Fed's balance sheet currently stands at $2.3 trillion, up from $800 billion pre-crisis. If the Fed has only bought up $1.5 in assets since the crisis struck, it is extremely unlikely they aggressively expand to the levels Sumerlin is calling for. The legitimacy given to these high-end calls leads me to believe a smaller amount of QE must already be factored into current market prices.

Many relevant minds are announcing their opposition to further quantitative easing. Pimco's Mohamed El-Erian believes further QE will be "ineffective". Renowned economist, Joseph Stiglitz recently stated that "additional monetary stimulus will clearly not solve the problems caused by lack of global aggregate demand" and believes fiscal stimulus is the only solution. George Soros came out to say "quantitative easing is more likely to stimulate corporations to devour each other than to create employment". Clearly, opposition is mounting and I believe even Bernanke understands that liquidity in the system is not the problem, the velocity of money is. Velocity is a force the Fed can do little to influence.

Frankly, I don't think QE 2.0 is coming

The Fed uses a variety of tools a achieve its objections of price stability and full employment. The markets have very positively reacted to Bernanke's added language in the most recent FOMC policy statement released on September 21st in which the committee stated:

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate. (Federal Reserve)

If we judge asset prices following the FOMC meeting, we can see that the Fed has regained an important policy tool: language. Bernanke has written in the past about the powerful use of language as a tool for influencing market behavior. Given the Fed's willingness under Bernanke to engage in creative methods of easing, the market fully believes in the floor they are providing assets. In response, we see many assets rallying and, most importantly, we see inflation expectations rising: a good thing! The iShares Barclays TIPS Bond ETF (TIP), a proxy for the return on TIPS, has surged 3.5% since the September 21st FOMC meeting.

The break-even rate between TIPS and 30-year bonds reached 2.29% on October 6th, an indication of higher inflation expectations (Bloomberg). TIPS, Treasury Inflation Protected Securities, are a closely watched indicator by the FOMC. Bernanke watches markets and often reacts to their demands. But, through his use of language he is quietly achieving his goal of supporting asset prices and building in inflation expectations. There is no need for more QE if the market itself creates the outcome just by knowing the Fed is willing to fight for said outcome, inflating assets. This is good and should allow the Fed to do nothing.

In the long-term, I am bearish on the dollar because I'm optimistic!

Contradictory? Not in the least. I am bearish on the long-term prospects for the dollar only because I am extremely optimistic about developing countries around the world, especially the BRICs. Brazil, Russia, India and China are the world's rapidly growing economies marked by millions of people lifting themselves out of poverty every year and improving their lots in life. As countries around the world rise relative to the US, their currencies will appreciate against ours. I cannot say it enough, this is not to the detriment of the United States. Increased trade and higher standards of living are better for everyone. We will not be losers, our currency will simply depreciate against others as their economies grow in global influence.

I still believe the US will be a leader in innovation but the inventions in the last few decades will allow economies around the world to make leaps ahead in the race where we had to walk previously. My favorite example is the cell phone, a device that has changed the world dramatically increasing efficiencies in communication and business. Previously, telephony was only possible after miles and miles of lines had been laid in the ground requiring massive infrastructure investments prior to widespread usage. Now, throw up cell phone towers in key places, sell everyone cheap cell phones and viola, you've got telephony for your entire economy. These leaps will allow developing economies to skip steps and advance much more rapidly than we ever did.

Overall, we'll see. This trade has a major catalyst coming up on November 3rd, the Fed's next FOMC meeting, where many believe QE 2.0 plans will be laid out. I think pessimism is far too high and there's a very realistic possibility that QE 2.0 will never occur, or at the very least be lower in quantity than markets are pricing in.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long UUP.

Overnight vs. Daytime Market Returns

Absolutely fascinating study of market returns for the active trader to consider:

Hat tip MarketSci Blog via Crossing Wall Street

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Nothing relevant.

Today's Lesson: Paying the Price for Not Respecting Valuation

None of us would be involved in the financial markets if it weren't challenging, right? I am down significantly today giving back all my gains from yesterday's large advance. Two stocks I bought yesterday saw negative news overnight with Gleacher & Co cutting F5 Networks, Inc. (FFIV) to Neutral from Buy and Intel announcing its development of a tool that will allow applications to run on Intel processors as opposed to the Arm Holdings (ARMH) based processors most run on today. I also bought Salesforce.com (CRM) which suffered today from the blanket selling seen across the much-hyped cloud computing space.

Most momentum styles are vulnerable to rapid and wild swings in sentiment and today's severe move lower in these names cost me a lot of money. But was this just bad luck? I would say no. I think this is clearly a mistake of mine for paying up for these companies. As I work on my skills in momentum swing trading, I understand how useful it is to study the fundamentals of the underlying companies. Only then do I use my feel coupled with some pattern recognition to time entries and exits.

Quite simply, I ignored the fundamentals yesterday when I bought ARMH, FFIV and CRM. FFIV is trading 37 times forward as an internet service provider, ARMH is trading 44 times forward in the competitive semiconductor space and CRM is trading 74 times forward in the cloud space. On the other hand, there's a companies like Apple (AAPL) still selling at a cheap 16 times forward even after a 50-point advance and Google (GOOG) trading 17 times forward even after momentum kicked in and the stock jumped 17% in September.

Momentum trading and value investing are probably about as opposite as could be. But, there are some very useful ideas from the value style that can be applied in concept. My thought process in seeing yesterday's trades as fixable errors is applying the concept of "margin of safety". While most movements in the market are completely uncontrollable, the long-term value investor is taught to find valuations that offer a compelling margin of safety so that downside risk is limited. This theory can greatly enhance even a momentum trader's decision-making process and is somewhat proven today.

Stocks touting very high valuations are typically the love of the high momentum crowd and can often become extremely overvalued vulnerable to downgrades and negative news. For an extended momentum stock, the last buyers are likely very weak hands so the first whiff of problems sends them scurrying for the exits. FFIV is currently down -7.2%, ARMH -2.9% and CRM -6.3%. Compare this price action to GOOG down -0.9% and AAPL down -0.3% compared to a Nasdaq down -0.6%.

Basically I conclude that I chased stocks that carried no margin of safety and exposed myself to a level of risk not present in other plays. I should have bought more GOOG and never should have let AAPL run without me. Instead, I picked up other overvalued stocks ignoring their very rich valuations and was run over today in the stampede for the exits today. Yet, I respected my stops and I live to fight another day!


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long GOOG.

Market Vaults Higher Easily Clearing 1,150

Up, up and away!

Equities vault higher

The S&P gained 2.1% today handily reclaiming the 1,150 level as the market leaders retook their places at the front of the line for investors. I have been on the sidelines since before the FOMC announcement two weeks ago anxiously waiting for the pull-in that occurred last week. But today was a day to jump back in even though it felt early, as it always seems to. The rally's cause has been pinned to the Bank of Japan's announcement last night that it is embarking on an unconventional quantitative easing initiative that involves buying ETFs and REITS. How crazy is that! Central banks, seemingly just since Alan Greenspan, have shifted the core of their focus to inflating financial asset prices, a major departure from their past stated goals of measuring CPI versus employment.

The large gap up was expected by very few traders and I likewise did not anticipate it and missed the bottom prices of yesterday. Yet, I shook that off and went after a few names early on after today's open. Notably, I snatched up Google (GOOG) at $529, Salesforce.com (CRM) at $114 and F5 Networks (FFIV) at $109. GOOG is back in breakout mode and heading higher while CRM was less exciting but I'll stick with it as it holds $110. FFIV had no pull-in at all in the last two weeks and looks primed to run. I missed the buy on Apple (AAPL) and am still kicking myself for not buying it early in today's session. I am most confident about AAPL and GOOG given their relatively low valuation and still very exciting businesses.

Amazon (AMZN) and Baidu (BIDU) also got away from me and their rich valuations have me hesitant to chase. I'm also watching Netflix (NFLX) and VMWare (VMW) closely for possible buys. Anyways, after messing around in oil service names, I was happy to get back to stocks I'm more comfortable trading. I have also recognized some clear mistakes I made in my oil trade. Murphy Oil (MUR), Hess (HES) and Apache (APA) are names much more levered to the underlying price of oil in contrast to the derivative service names I bought last week. This is painfully obvious now in hindsight and I will not make this mis-allocation in the future. I'm sticking with this trade for October but will be looking at better levered names on a pullback.

Ventured into a dollar long today

I bought the dollar (UUP) as per my post this weekend where I outlined my belief that pessimism is far too high against reality. The dollar index has a 57% allocation to the euro so the core of the bet is against the euro. This is precisely the trade I want to make as I think the US's economic prospects are much brighter than Europe's.

I've got some good thoughts together for a post I am writing for tomorrow titled: "Traders' Least Understood Concept: The Coefficient of Likelihood". So look forward to that!


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long GOOG, CRM, FFIV.

Stocks Pullback to Start an Impactful Week of News

Stocks see persistent selling before stabilizing mid-day

The S&P 500 closed down 9 points (0.8%). E-mini traders in Chicago must have been depressed after the Bears were beaten down to their third string quarterback in an overall awful showing for their offensive line. Or perhaps the market was due for some selling as we begin a big week with earnings season beginning and the monthly jobs report on Friday morning. Shorts are positioning against the 1,150 level and longs think 1,120 will hold. The selling was controlled and continuous throughout the morning before finding some buyers at 1,130.

Q3 earnings season kicks off on Thursday

Alcoa (AA) gets the ball rolling for Q3 earnings season on Thursday after the close. The numbers are not going to be great, that much we know. The Q3 data will be based on revenues and earnings from July through September, a rough patch for the US economy following the late-April break in equity markets as we fell with the European debt crisis and heightened worries of a double dip recession. Many companies across the spectrum witnessed their slowest few months of business throughout this summer since early 2009, the beginning of the initial rebound in the global economy.

Ultimately though, the only important outcome will be investors' reaction. Can we ignore these reports? The Q2 earnings season response was marked by the negative macro economic environment overwhelming the generally positive micro results from individual firms. Can the spin on Q3 become the flip scenario? Perhaps the positive macro outlook (ie. avoiding the double dip) can outweigh the review-mirror look at the micro from Q3. This is all just a hunch but I think after some initial selling to give the market a healthy pullback after September's strong rally, market sentiment could quickly shift as investors look forward believing the correction from April's high discounted too much pain and the outlook is, in fact, quite bright for 2011. Take these thoughts with a grain of salt.

Oils get whacked despite crude's recent surge

My trades in the oil sector didn't cooperate today vastly underperforming the market. I hit out of Tidewater (TDW) with the continued weakness in the name. This idea is just not working out like I thought it would and I'm not going to be stubborn with it. I am much more comfortable in technology stocks but I'm trying to discover opportunity in other sectors as the leaders take a rest. Crude oil itself closed flat fully holding onto last week's gains. Perhaps I should have simply bought crude rather than messing around in companies. I'm taking a closer look at Murphy Oil (MUR) and Hess (HES) as names more directly levered to the price of oil if the sector can find a bid this month as I've been expecting.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long CXO, WFT.

Mini Flash Crash and Oil's Surge Make for Eventful End to September

Tuesday's mini flash crash in shares of high momentum technology stocks (AAPL, BIDU, AMZN) marked the short-term top in the market's leaders. My first reaction was to assume that more weakness in the names was likely and that thesis played out for the rest of the week. While I was kicking myself for selling AAPL at $283 on the way up as it powered higher almost hitting $295, shares are now back below my sale price and presenting opportunity once again.

My general mentality is to buy this pullback in the leaders. That is clearly easier said than done if risk control is your number one priority. I still think AAPL is a $325 stock and $270 looks like a fairly defined level that would be a gift to traders if the price becomes available. Tuesday's flash lows were $275 so that price may attract some buyers. I haven't ventured back in yet but I'm closely watching.

C'mon RiM, pull it together

Is Research in Motion (RIMM) really this slow and/or stupid? Shares gained 2.7% this week as the announcement of Playbook (RIMM's competitor the iPad) excited investors this week. Yet, RIMM plans to release the Playbook in early 2011 right around the time Apple will likely be putting the finishing touches on its second generation iPad. How many people have you heard say they would love an iPad but they're going to wait for the second generation? I must ask, what are the guys over at RIMM thinking? This will quite possibly be the worst time to release the Playbook. For the Playbook to gain any traction I would have to think it needs to hit markets ahead of the iPad. This is another stumble in the long, slow decline we're witnessing in this company.

Sticking with oil companies for October

The trade for October looks like it may be in the oil sector. Crude oil surged over $5 for the week for a huge 6.8% jump. The Department of Energy released very bullish inventory data showing large, unexpected draws in stockpiles. I anticipated this rotation into energy well and started buying some oil names on Wednesday morning (SLB, CXO, TDW, WFT) and was rewarded when the data surprised traders and fueled buying in energy markets. Gasoline and heating oil also vaulted 7.9% and 7.0% for the week, respectively.

Oil prices were very tame throughout nearly the entire month of September as the equity market rallied 8.8% for the month. Only in the final days of the month did oil prices begin to reflect the much more optimistic sentiment about the global economic recovery equities have started pricing in. Oil's participation in this rally has swayed me to the bullish camp as the S&P teeters with some indecision around the 1,150 level. The energy sector as tracked by the Select Sector SPDR (XLE) has been lagging broad market down year-to-date against the S&P 500's 2.8% gain. With crude back over $80 per barrel I am sticking with this oil trade and will be looking for higher prices throughout the month of October. I typically struggle when trading commodity names because of the characteristically streaky price action but hopefully I can hone my feel for these stocks this month.

Note: Tidewater's (TDW) action on Friday was less than encouraging as worries mounted about their 3Q earnings and shorts pressured shares lower. Neil Carvin had a great write-up at Seeking Alpha on the company. With a 13.5% short interest shares may continue to be volatile. I am still positive on the space and with the world's largest servicing fleet TDW should be a derivative beneficiary of higher oil prices. I won't let the losses add up though if downward momentum picks up.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long CXO, SLB, WFT, TDW.

Missed Some Upside, Chase is On

A week for crying over spilled milk

After selling all my positions except Google (GOOG) on Tuesday I watched as the high beta technology names charged higher without me. I feel like a little kid who got off the bus too early and then didn't know what to do. At the very least, I did not try to fight the runaway train as many other traders engaged in the futile and unwise attempt of picking tops. Don't fight it! There is simply no purpose in trying to catch every gyration. There will likely be far more money to be made in building a list of stocks to watch and then buying on weakness if and when the market pulls in.

The market has exhibited impressive strength and it seems that this move has just been the beginning of a much larger move to the upside. In terms of health, leaders have led. This is exactly that action we want to see in the start of a new move. The S&P 500 has gained 9.5% in September alone yet, it is up only 3.0% year-to-date. The market has a week and half until Alcoa's (AA) kicks off earnings season on October 7th. I expect some slowdown in action as we near 3Q earnings reports where we can, once again, begin to obsess over the short-term results of every company.

A quick rundown of my indicators

Doctor Copper has continued powering higher demonstrating the consistent global pickup in demand for the important industrial metal. Copper is already challenging the April highs at the $3.60 level. This is as opposed to the S&P 500 which currently trades 5.8% off the April highs. Copper is still the best indicator for equities I have found for the current environment and barring a large drop in the metal I think equities will follow it higher and can even catch up should it see some consolidation at these previous highs.

The so-called Treasury "bond bubble" has fallen from the headlines as quickly as it hit the front page with 30-year Treasury bond futures now trading 3.7% off highs. I don't believe bonds were ever in a bubble as I think that is a complete mis-use of the term. Yet, I think bonds will be a particularly poor investment in the long-term as I am not nearly as pessimistic about the economic future as yields are pricing in. While interest rates likely remain low for the foreseeable future, the Fed is fueling the chase for yield outside of the bond markets. Falling bonds should be bullish for equities and perhaps the high volume flow of funds from equity mutual funds to bond funds will halt (ICI Reference).

The dollar, following a multi-month rally throughout the European debt crisis, is locked in a steep downtrend. There is still quite a ways to fall before hitting previous 2010 lows at $74.227. A weakening dollar should do nothing to stop a rally in equities and may just help it along.

Gold is an interesting story trading at all-time highs and edging up on a daily basis. Much of the investment thesis seems hyped to me with inflation very low and debt problems subdued. Overall, I think the extremely low interest rate environment we are in allows investors to sit in gold as an alternative with no fear of missing out on returns from other "safe" investments even should gold do nothing. With no return from cash, why not sit in gold as a hedge against another possible debt crisis or some unexpected jump in inflation? Though I do understand that while we do not see inflation in the CPI, we are clearly seeing commodity inflation and this should translate to higher consumer prices down the road. Finally, the Fed may be nearing accomplishment of its inflationary mission.

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long GOOG.

Rates Unchanged, Market's Undercurrents are Weak

Fed does nothing, verdict not in yet on my selling

Well, the jury is out on my selling this morning after the entirely random moves following the Fed's 2:15 release gave no indication of likely future direction. I had been taking small profits along the way but locked up the rest of my profits today, except for Google (GOOG). The daily candlesticks in Apple (AAPL), Amazon (AMZN) and Goldman Sachs (GS) lead me to believe I am right for now. There are other cues that make me think I am right. The 30-year Treasury futures gained 1.2% on the day while gold jumped following the FOMC announcement gaining $9 on the session and hitting new all-time highs. While the action in gold and bonds today may not be inherently bearish, it sure ain't bullish. On top of these cues, copper has stalled. So, all in all, I'm happy to move to the sidelines after catching a great move and I'll be looking to buy weakness in individual companies I like.

Everyone's a critic of the Fed these days

The market jostled back and forth after the Fed announced that it will leave rates unchanged and will not be initiating QE 2.0. Paul Krugman immediately responded: "We’re failing in our mandate to deliver full employment; meanwhile, inflation is below target; therefore, we’ve decided to do nothing." But of course Zero Hedge took its cue from gold: "Sorry, Ben, can't feed Wall Street cake and then dilute it too. Gold's dramatic surge to fresh all time highs, more than makes up for the spike in the S&P...In other words, on a relative basis there was more capital going into precious metals, and more specifically, away from linen and other infinitely dilutable paper, than going into stocks." While I would imagine neither of these two have any respect for the other, the divergence of opinion is stark, not that that is surprising.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long GOOG.

Taking Profits Ahead of FOMC Meeting

Selling nearly everything

Time will tell if I'm right but I am ringing the register here this morning selling nearly everything that I've been holding for weeks since I argued that the bottom is in for 2010. This includes my positions in BIDU, AAPL, EMC, IMAX, V and my few-day play on NFLX. I am still holding GOOG as I think that move has a ton of room based on the report I wrote last week arguing that Google is a Value Play.

Honestly, the bulk of my reasoning for selling is simply the overwhelming urge I feel to sell. Logically, we've had a monster run poking through the last level of resistance traders have been watching. The sell-off in bonds has halted and copper's advance has stalled. The FOMC meeting this afternoon represents a major unknown variable that could be a catalyst for selling pressure. Stocks may continue somewhat higher and, to be clear, I have absolutely no desire to short but I think I will be able to buy back positions at lower prices in the coming weeks.

Just my two cents...we'll see if I end up with the egg on my face after the meeting.


Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long GOOG.

Another Inside Day, Apple (AAPL) Ramps Up, RIMM and ORCL Beat

Low end of the range bought again by the bulls

Another gap down was bought today in a day with a range even tighter that the previous couple sessions. The S&P traded within a 6-handle range but again showed a bullish bias closing on the highs of the day and near the top of the range. This has been a very healthy pause in the market as the initial leaders (NFLX, CRM, VMW, PCLN) have absorbed some needed profit-taking. Apple (AAPL) and Amazon (AMZN) refuse to take a rest.

After hours earnings reports from Oracle (ORCL) and Research in Motion (RIMM) blew away the Street and both stocks are rallying in the post market. ORCL reported EPS of $0.42 versus $0.37 estimates and beat on the top line. Shares are up 3.5% in the after hours.

RIMM will likely dominate the headlines with its report of $1.46 versus $1.35 expected EPS and a beat on the top line as well. RIMM amazed the Street with its bullish guidance for Q3 EPS: $1.62-$1.70 versus analyst expectations of $1.39 and revenues of $5.3-$5.55 billion versus $4.8 expected. RIMM is trading up nearly 8% following the release. With nearly 6% of the float short they'll be on the run tomorrow.

Apple to rule the world

Apple (AAPL) has reclaimed control of the market and is determined to take us higher. Shares of AAPL gained over $6 today (2.35%) as the iPad hits the world tomorrow for the first time. I continue to think $240 was an absolute gift and new all-time highs are all but inevitable now. My target remains $325 on this momentum run. Trading at just 16x forward earnings, this target may very well be conservative in the longer-term.

Doctor Copper is still resting

Copper has been an excellent leading indicator although I have lessened my focus on it somewhat recently. The equity market has some "catch-up" room where it could conceivably rally with copper taking a rest. Copper pushed through $3.50 today before seeing some selling. A move over $3.53 would make me significantly more bullish on equities.


Brandon R. Rowley
"Chance favors the prepared mind."


*DISCLOSURE: Long AAPL.

Bulls Snatch Up Small Discounts Off Open for Strong Close

Tight, yet bullish tape

Stocks gave the bulls slight pause this morning with a small gap down but managed to march higher throughout the day and close on the day's high up 0.35%, retesting yesterday's highs of this almost 3-week rally in the market. The S&P 500 futures have been trading in a tight, 10-handle range between 1110 and 1120 for a third day now.

I have very little to add other than this thought. I have been mentally prepared for a pull-in around this level but it almost seems as though one may not come. I have been slowly scaling out of some stocks, now fully flat the SPY and AMZN in particular. Meanwhile I'm picking up shares of some midcaps I like. I have seen nothing worth shorting other than perhaps some extended leaders (PCLN, NFLX, CRM, AMZN) but even then, I don't see that trade as worthwhile. That would count as "hard money" in my book, to quote Laz. I would much rather wait for the pull-in and look for the next, much larger move. Apple (AAPL) is quickly retaking leadership of this market closing over $270 today.


Linkfest:

Pimco Betting Against Deflation, Really? ~ Shocked Investor

Missing Best & Worst Days of S&P 500 ~ The Big Picture

Poll Shows Investor's Distrust ~ Crossing Wall Street

United States of FIRE ~ The Reformed Broker

Updated Housing Prices vs Rent, Median Income ~ The Big Picture

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Long AAPL.