Weekly Stock Option Trading Tips: November 10, 2008

Short-term market activity is largely based on emotion rather than reason, and it is impossible to predict how collective emotions will be swinging in the short term. Except that we know that there is a cycle of emotions, and people tend to move in one direction until the pain (or euphoria) causes them to pause and reconsider.

For two days last week, the market focused on the 6 ½% unemployment rate, a number that had not been this high for 14 years. Inevitably, sometime in the next few weeks, some people will re-frame that statistic and think about the 93 ½% of Americans who do have a job. Many investors will realize that their personal life has not really gotten much worse, and that life goes on. The government seems eager to do something about the economy, and will not allow a protracted slowdown like the 1930's to happen again.

I can vividly remember how I felt after the 9/11 disaster. How could life as we knew it continue on, I thought? How could I ever get on an airplane again? Why should this market ever recover? And then a few days later as I was driving down my driveway listening to the local radio announcer playing my favorite same old songs and talking about the most mundane local things (like preparing for the invasion of the leaf-peepers in early October), it suddenly occurred to me that nothing really had much changed in my personal life, nor would it. A feeling of mellowness spread through my body and some of my natural optimism returned. I was ready to accept the possibility that the market might just go back up someday.

On a collective basis, that is how the market operates. For many months we have been thinking about the R word (while also worrying about the possibility of it getting worse and becoming the D word). Every layoff that was announced, every lowered earnings outlook, every new foreclosure number released - all contributed to our fears that a recession is on the way or already here. Many people dumped their stock, and the market fell by a huge amount, wiping out several years of gains.

And inevitably, at some point, people will start thinking about the 93 ½% number and make their own journey down their own driveway, and take a peek at the stock price of their favorite company and see a lower number than they have seen in many years, and get that feeling of mellowness that allows them to take a little nibble in the market. Collectively, the spreading feeling of optimism (or at least, muted pessimism) will cause the market to start edging back up.

We don't have any idea of when it will happen. But it will. We can be certain of that. The market has already gone down so far that the smart bet will be that the next big move should be to the upside. We don't want to suffer losses in our portfolios when that recovery takes place - it was bad enough suffering the losses when the meltdown came. It would be doubly painful to experience similar pain when the recovery finally comes.

So far, the Terry's Tips investment philosophy has been a great success. We hold leveraged positions that do best if the market doesn't fluctuate much. For the last couple of months, volatility has been greater than it has in the history of the market. We should have been killed in this kind of world. But the truth is that over the past three months, our composite portfolio values have gone up. When volatility eventually falls back to normal levels, as it inevitably will, we should enjoy gains that substantially outperform the market in general.

After a nice rally last week, the market quickly reverted back to its bearish ways this past week.

However, before the stock market collapsed into the largest two-day decline since 1987, it was witness to a remarkable event that would forever alter the political and social landscape of the country.

The rally last week that carried into Tuesday, was aptly named the "Obama Rally", and for good reason. Tuesday evening the United States would elect its first African-American president in Barack Obama and the first Democrat in eight years.

The rally that occurred on Election Day was the strongest in stock market history as the S&P gained 4.1% on the day. .However, the euphoria would not last long.

"We don't know if it's the end of the bear market yet, but it looks as though the bear has taken a nap," said Sam Stovall, chief investment strategist at Standard & Poor's equity research. "So investors are thinking, let's enjoy a bit of a relief, both from the market's lows and from the endless pre-election rhetoric."

On Wednesday, economic concerns quickly moved back to the forefront and the uncertainty that had plagued the market over the past year was plainly evident again as the market began what would eventually be a 10.0% decline in the S&P.

It must be noted that the decline came on the heels of an 18.0% gain over six trading sessions in the S&P so a pullback was expected, but the breadth and strength of the decline made it clear that there was more behind the pullback that simple profit taking.

The sharp decline was initiated by the ADP employment report which reported a loss of 157,000 jobs in October, the largest decline since 2002 and far worse than analysts' expectations of 100,000.

The report would come only two days before the Labor Department announced the highly anticipated October employment report and signaled that the report could be far worse than the expected decline of 200,000. Uncertainty (and nervousness about the upcoming jobs report) was once again palpable.

"Markets hate uncertainty," said Callom B. Jones V, a stockbroker with Perkins, Smart & Boyd in Fairway. "No one knows where we're going to go with the economy, taxes, regulation and banking, among other things. ... If we have follow-through, we may crack below 8,000" on the Dow in coming days.

Some of the sales pressure on Wednesday, Jones suggested, came from institutional investors selling significant positions in highly liquid stocks.

"When you can't sell what you want to sell, you sell what you can," Jones said. "You're seeing people sacrifice dollars for speed."

The sharp decline would continue Thursday, as the market digested more bad economic news.

The retail sector announced that same-store sales declined 0.9% (actually a far worse 4.2% if Wal-Mart was excluded). It was the weakest October in 39 years for retailers. The numbers suggested that shoppers will remain skittish throughout the holiday season.

However, even though the retail numbers were a surprise I think the biggest surprise was the record 1.5% interest rate cut set forth by the Bank of England. The move brought the rate to just 3%, which is its lowest level in more than 50 years.

Graeme Leach, chief economist at the Institute of Directors, while welcoming the cut, said: "The reduction shows that the MCP think inflation is yesterday's story and deflation is the risk for tomorrow.

"We think interest rates could touch record lows of 2 per cent or less by next time next year. The sooner we get interest rates down, the less is the risk of a long and deep recession."

Overall, there were not many bright spots on the economic front this past week. September factory orders declined 2.5%, the October ISM Index moved below 50.0 to 44.4 which is viewed as the line between expansion and contraction and yet the market had still not been faced with the most anticipated economic report of the week.

On Friday, as a week filled with political glee and economic sorrow, the Labor Department announced the results of the employment report for October.

It was announced the 240,000 jobs were lost and prior months were revised higher. The unemployment rate kicked up to its highest in 14 years at 6.5% and the overall job losses zoomed past 10 million which was highest in 25 years.

"There is no light at the end of the tunnel, and the outlook is pitch black," said Richard Yamarone, economist at Argus Research.
And Bernard Baumohl, chief global economist at the Economic Outlook Group, said the report "depicts an economy still in free fall and without a safety net anywhere in sight."

"The U.S. recession is deepening," said Michael Gregory, economist at BMO Capital Markets Economics. The final quarter of this year is getting off to a "particularly ugly" start.

Technical Mumbo Jumbo

Last week I stated that historically, weak Octobers lead to a bearish first week in November so it will be interesting to see if that precedent holds up with all of the madness that the market has to absorb next week.

The aforementioned historical precedent held up this past week and hopefully the one below will hold up as well.

Historically, Wall Street has enjoyed a bounce in the fourth quarter after a presidential election as investors breathe a sigh of relief that the long election cycle, with its accompanying uncertainty, has ended. - Sharon Otterman, NY Times

Indeed, the market looks poised for a fourth quarter rally. An intermediate-term seems to be in place and the jump on Friday seems to signal that the bad news has been "baked in" for the fourth quarter.

Currently, the major indexes are in a neutral state on a short and intermediate-term basis and coming off "very oversold" levels that were established Thursday. It is rare to see the market move back to such levels over a short period of time so I think that we could see high price levels as we move towards the New Year.

Insider trades have picked up and have moved to positive for the first time in months and has spiked to a new high. This is generally a good sign going forward and one that I will be watching as we move ever closer to 2009.

Also, weak Octobers, often lead to positive Novembers. Buying after the first week of November has led to substantial average gains in the market. Furthermore, back to back -4% losses in the Dow (occurred Wednesday and Thursday of this past week) have also led to positive gains 12 out of 13 times when this type of scenario has occurred.

Basically, all signs over the intermediate-term lean towards the bullish camp. As always, only time will tell.

Weekly Stock Options Trading Tips: November 10, 2008

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