Today I would like to share with you some of the thoughts I passed on to my paid subscribers this week. It takes a special person to be able to handle the ups and downs of an options portfolio, even when you are following a conservative strategy.
In order to trade options, you must have a temperament that can handle wide fluctuations in portfolio value. It is simple as that. Last month we lost about 15% in spite of the market not being exceptionally volatile (but Implied Volatilities (IV) fell a lot).
The month before that, we had gained 14%. In September, several of our portfolios earned over 50% in a single month (when IV was increasing instead of dropping). Monthly changes of these large amounts are considerably greater than typical mutual fund or stock investments (although the 40% drop over two months that occurred this year was an exception to the rule). And other investments, like real estate or bonds or savings accounts do not fluctuate in value like this on a month-by-month basis.
The odds of exceptional annual gains are still on our side. When the market stays flat or fluctuates moderately in either direction (except in those rare months when IV falls significantly), our portfolios should gain in value. In two of three of those scenarios (flat market or a moderate drop), mutual fund investments will not gain in value, but our portfolios should do very well.
The last few months of market action have been extremely unusual. These conditions will probably not occur again in our lifetimes. We should not use the results over these months as a definitive statement of the worth of any investment strategy, especially one which is leveraged like our Mighty Mesa Strategy.
I suspect that a year from now, we would come out with an entirely different conclusion than we would make today based on the last few months of extreme market volatility. I, for one, really look forward to the New Year of investment returns.
The holiday shortened week left much to be desired for the seasonal bulls.
The S&P 500 finished the week lower 1.7% on anticipated low-volume holiday trading. As I stated in the last report the last seven trading days of December are higher 80% of the time. With only three days left the market has some work to do if it wants to live up to its historical billing.
The week was once again filled weak economic news. November existing home sales declined another 8.6% from October and new home sales fell 2.9% to a pace of 407,000, the lowest in 18 years. Furthermore, the median sales price fell 13% to $181,300, the largest decline since record-keeping began 40 years ago.
“The interest rates aren't helping as much as we had hoped," said Russ Graber, an agent with Coldwell Banker in Des Moines. "My guess is you're going to see more refinancing than people moving. I don't think people are going to want to put on more debt."
If the housing news wasn’t dour enough, initial jobless claims climbed to a 26-year high, personal income and spending fell 0.2% and 0.6%, respectively and durable orders declined 1.0%.
To top off the week of poor economic news the Q3 GDP numbers came out and as expected the economy contracted at an annualized rate of 0.5% in Q3.Economist David H. Wang said the final Q3 GDP was a wash. "GDP came in as expected, but we can see the clear, continued drop in consumer spending, which is indicative of a prolonged recession," Wang said. "So it's stimulate with glee, to make the recession flee."
Now the focus, at least over the short-term, will be concentrated on the ability of the S&P to advance next week and continue the overwhelming bullishness that typically occurs during the last few trading days of the year.
"I think we could have a year-end rally, but it's got a formidable headwind in the form of tax-selling, in my view," said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors. Tax-loss selling is when investors sell their poorly-performing stocks to realize a loss for the year, which can reduce their taxes in upcoming years.
Even with the downturn early in the week, the S&P has managed to hold the 850 level (which has acted as a strong area of support over the past few weeks) when the closing bell sounded Friday. This is certainly a short-term positive going forward and could lead to further gains as we head into 2009.
Again, on a seasonal basis the last 7 trading days of December have finished in positive territory 64 out of the last 80 years (80%) in the S&P with an average return of 1.2%. The max gain was 2.0% and the max loss was -1.0.
Next week I hope to bring you a recap of 2008 and what the market outlook looks like for 2009. Hopefully, my crystal ball will have a few insights.
Overbought/Oversold as of December 26, 2008
Major Benchmarks