The Tycoon Report

Which Way Now?

Wednesday, May 20, 2009 | Teeka Tiwari

At the very minimum, the market appears to be taking a breather here. It’s always difficult to gauge how far traders will take 'em down. The question on everyone’s mind is whether we will see an orderly consolidation or a resumption of the bear market.

It seems that everyone is calling this move a bear-market rally. Everyone can’t be right, so the pullback may be shallower than most people think ... or not!

Signs of Hope?

It really is a toss-up at this point. The bulls are eager to share their “green shoots” theory, while the bears justifiably point to the lack of concrete good economic news.

Typically, the markets will rally far in advance of an actual recovery. But we’ve been here before, and investors have been repeatedly burned by bear market rallies during the last 12 months. Given the scope of this most recent rally, I think you can make a case for the Dow Industrials not having to trade back all the way down to the 6,500 area for a retest of the lows.

We are certainly seeing supply come back into the market, and a pullback looks to be in the cards. However, if I had to go out on a limb, I would opine that any reversal here would probably result in a higher bottom. A whole new leg lower from these levels would require an entirely new round of epically tragic business news.

So, we are forced to ask:

Is the Worst Behind Us?

One of the lynchpins is certainly employment. However, the employment numbers are a notoriously horrible forecasting tool because they lag the economy. To date, the Street has priced in a 10% unemployment figure, but anything significantly above that would be a nasty surprise to the markets.

Housing prices appear to be stabilizing but, like the jobs picture, if housing starts begin to materially worsen, then it will shoot the “green shoots” theory to shreds (pun intended).

The other wild card is oil. Sixty bucks a barrel and below will be well-tolerated by the market. A move to $75-$85 a barrel, though, will have the analysts pounding the calculators revising their forecasts lower.

I think the banks are making a mistake paying back the TARP funds too early. Forget for a second that it's taxpayer money. If you can get access to super-cheap money (which the TARP money is), then you want to borrow as much as you can for as long as you can. That money was given to them to be put to work in the economy, and that’s where it should go. It does us more good in the form of new credit than it does sitting in the Treasury.

So, when the big sell-off comes -- and, believe me, it’s in the offing -- you will want to have plenty of short (bearish) positions in your portfolio, but don’t get too greedy. You are going to want to be nimble. I don’t think you’ll be able to hold shorts all the way down like you’ve been able to do for the last two years -- while short positions are critical to help you profit from downside moves, you should watch those positions very closely and be prepared to close them quickly.

The Good News and Bad News About China

There is a lot of talk that the Chinese are going to rotate away from U.S. dollar-denominated bonds and will begin dumping their Treasuries. A lot of people are spilling a lot of ink over this issue. The thing to remember is that China does not have enough domestic consumption to support the rate of economic growth that it has grown accustomed to.

They need the U.S. market to sell into in order to support their own economic growth. So, a gradual devaluing of their dollar-denominated assets may just have to be written off as the cost of doing business with the United States. At this time, there is no other palatable alternative for them.

Now, it won’t always be this way. When China grows up and can support itself through its own internal consumption, we’re going to have a problem. The questionably good news for us is that’s going to be a long time in coming.

If you are looking for some long-side investments to make, then you are going to have some great buying opportunities over the next few months. You may want to focus your buys on countries and sectors that are expected to experience above-average rates of economic growth.

I still think, on a pullback, you may want to get long Chinese construction and financial stocks. Their long-term outlook is outstanding, and there are many Chinese Exchange-Traded Funds (ETFs) that trade here in the States that provide great diversification for your portfolio.

Let me reiterate, though, don’t buy them now. During the last few months, we’ve made great returns on our China ETFs over at my automated trading service, Sector Hunter. But Sector Hunter is telling us now that the China sector is showing warning signs of being extremely overbought.

The sector undergoes massive bull and bear runs and gives investors several opportunities each year to buy into the group on the cheap. It also provides some excellent shorting opportunities, as the bull moves have a tendency to get very overdone. China hasn’t put in a trading sell signal yet, but I expect it to do so soon.

Just like the bull market of the '90s, China will experience volatility -- but the overriding trend is up, not down. This means that investors would want to buy the dips and, where appropriate, trade the volatility when the appropriate short signals are given.

If you have your own system for identifying when China is rotating in and out of favor, you have a tool that you can use to make money with for years. If you don’t, I invite you to take a look at Sector Hunter. The system is designed to get you in when pessimism is highest and get you out (and short) when optimism is running rampant.

The next few years look to be sentiment-driven traders' markets. So whether you take a look at Sector Hunter or not, it’s a good idea to start thinking about having some type of system to gauge which sectors deserve your investment dollars, and which do not.






Teeka Tiwari
Chief Investment Officer
ETF Master Trader