1050 or 1250? which direction

March 14

Dear Friends and Fellow Traders,

The S&P market topped out on 1/19/10, declined almost 10% and quickly moved to erase those losses over the next 5 weeks. I did say this would be the year of the trader with the market indexes going nowhere while individual stock pickers, traders and the like would do quite well. Recently I heard the phrase "fade and trade". I still like buy the dips and sell the rips especially with cheap OEX options.

This week we should get the answers we've all be waiting for. The market abhors uncertainty. Early next week Senator Dodd will re-introduce "His" financial reform bill versus forwarding a hoped for bipartisan version. I understand that markets may not react well to his version of reform.  We learned the "Sorbox" only placed costly new regulations on companies that did nothing to prevent another Enron. See 2,200 page report on Lehman last week. Sounds like another Enron to me. Regulation, while helpful, will never prevent fraud.

Shortly thereafter Ms. Pelosi will set a vote for "Obama Care". Passage looks better now because of a deal for the final completion of the government takeover of student loans will be submitted for passage at the same time. Big government Dems just love another takeover of business from the private sector.

Right now the stock markets are extended with very few good entry points. Stocks are vastly overbought and far from cheap. Liquidity is everywhere. Deals and rumors of deals are rampart. The problem is the market is being fueled by massive trading in highly speculative ideas and not the names that should support the market going higher in the near term. Therefore, most portfolio managers (PMs) are under performing making a trying year again for buy and hold PMs. The lack of PM performance should do wonders for our EOM and EOM markup trades.

The good news is that the M&A calendar should explode over the balance of 2010.  Buyout firms are exploring financing to do $5-10 billion deals. They have the equity money and are dying to lock-up those huge management fees for the next 5-7 years. M&A activity should limit any decline to less than 10% in most markets.

A review of some lessons from an old guru Bob Farrell:
From time to time it's always good to look back and review lessons from past greats we have or should have learned over our investment career s as long as we are willing to learn from our mistakes.

1. Markets tend to return to the mean over time.
2. Excesses in one direction will lead to an opposite excess in the other direction.
3. There are no new eras - excesses are never permanent.
4. Exponential rising and falling markets usually go further than you think.
5. The public buys the most at the top and the least at the bottom.
6. Fear and greed are stronger than long-term resolve.
7. Markets are strongest when they are broad and weakest when they narrow.
8. Bear markets have three stages.
9. When all the experts and forecasts agree, something else is going to happen.
10. Bull markets are more fun than bear markets.

Personally, I'm not so sure of #10. I always cry when bear markets end. Somehow down profits come almost 3X faster than up profits.  We can thank Doug Kass for reminding us of the lessons learned from Bob Farrell, one of the great technical analysts of my time, who spent his entire career with Merrill Lynch.

Summary:
Here is pretty much what I've learned especially after 2008 that may be added to the list and probably caused a greater decline than should have taken place because all financial firms believed the government would always bail them out and will best be remembered as the "Greenspan Put", the Fed will act to save the markets and the economy when needed.

The hubris of these firms caused them to believe that government cannot withstand much pain in the economy or the financial markets. The Fed and/or governments will take enormous risks in such interventions especially if the expenses can be conveniently deferred to the future. Some of the price tag is in the form of back stops and guarantees whose cost is almost impossible to determine. i. e. the black hole of the GSEs (Government Service Enterprises) like FRE and FNM and even AIG.

I believe the above will, over time, prove to be false. However for the present, investors believe and even governments believe that with little cost governments alone can rescue markets.  At this time Obama and senior Dems believe that all crisis are to be used to give government greater control over the economy and our lives. Their mantra is "don't waste a crisis or government can do it better." Looking ahead should tell us that we are probably doomed to a lasting legacy of government tampering with financial markets and the economy which is likely to create the mother of all moral hazards.

This government, as are all governments, is blissfully unaware of the wisdom of Friedrich Hayek (1899–1992), an Austrian-born economist and philosopher known for his defense of classical liberalism and free-market capitalism.  Friedrich writes, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." See the lead Barron's article this week, The $2 Trillion Hole, promised pensions benefits for public-sector employees represent a massive overhang that threatens the financial future of many cities and states. I'm adding the government hole is at least 15Xs this number. Welcome to the next Greece big time.

Trade of the Week:
The S&Ps have rallied, I believe, 10 straight days. Wow! Thursday, I wrote on the final "C" Intraday Chart we'll look at puts again for tomorrow only options will much cheaper and they were. The US market gapped up to new multi-year highs at the opening Friday morning. In anticipation of the gap, I sent a pre-market Alert Email suggesting the usual NET hedged strategy.  Specifically, build a long cheap put position into rallies and buy S&Ps on weakness to hedge and hope the market (after the puts are paid for) blows out to the upside. We can hope can't we?

The 525W puts traded as low as $0.45.  The market early on gave indications of being range bound so I closed out my hedged position rather quickly in the Chat Room for a profit after the puts hit $1.55. That’s 2X in about an hour! See attached NET Money Chart 2010-03-12.

Shortly after closing the put trade, I sent another Alert Email to use the day's extremes to buy even cheaper options later in the day. The longs were trapped on the false BO (breakout) up while there was a rather large support area near 1140-42 that should contain the downside.

The market never made it back to the day’s high. However, near 3:30 PM the market was in the process of testing the day's low creating a great high probability RT/F EOD buy setup. I noted in the Chat Room we could start to scale-in to the 525W calls starting at $0.35 small and scale-in bigger if price went lower. The OTM calls were only $0.50 and were the perfect throwaway long for a rally back to the morning break down level. I could see the calls going back to a high near $0.90-$1.00. The calls hit a low of $0.10 a short time later. I had a nice long OEX position at $0.22 average. Had the OEX not stopped trading at 4:00 PM the calls would have closed over a $1.00. If hedged as I did into the rally the trade only lost ½-3/4 of a point on the short E-minis.  However, the calls hit. I believe at a high of $0.80 and closed over $0.50. Yes, the call was the perfect throwaway long trade for a nice double at least.

BTIM Update:
BTIM closed at a major breakout/resistance quad top at a 60% daily chart sell retracement. With any luck a BO could send the stock over $6.00. At $6 I would button-up some profits and look to buy BTIM back when the updated warrant prospectus becomes effective with a $0.30 discount on any early warrant exercise. Early exercise is done at $1.70 for 50% of the warrants versus a $2.00 exercise price on 10/31/10.

Remember buy the dips and sell the rips. 2010 is the year of the trader.