Tags: currency

More Reasons Why the Markets Are Near Bottom

By    |   Monday, 20 October 2008 03:03 PM EDT

Investors have been through some crazy times lately, so I’d like to continue along the lines of last week’s article and give you even more reasons why the financial markets are nearing a bottom.

Last week, mutual fund redemptions were at an all-time high. The best investments I’ve ever made were when the masses were running for the exit doors and I was running for the entrance. Historically, the crowd gets it wrong. So if you’re simply betting that the crowd is wrong and you invest in a contrarian fashion to them, you tend to do much better.

I have three mentors in the markets I regard highly: Jim Rogers, Dennis Gartman, and Warren Buffett. They all have this type of philosophy, and they are some of the best investors I know of. And they’ve been around a long time and have invested through many booms and busts.

I guess you can say I like to learn from a lot of gray-haired guys. I’m not impressed with a 20-something year old who made a huge return for a few years. He hasn’t seen the first rough patch yet usually, and you don’t know what he’s made of yet. With Rogers, Gartman, and Buffett, you know exactly what they’re made out of because they’ve each been professional investors for over 30 years.

Last week, Buffett did something unprecedented. He said he was starting to accumulate U.S. stocks in his personal portfolio.

When Buffett sees value and starts buying up things like a madman, I take note. He’s got a long track record of being right, and not to mention he’s America’s richest man right now. If you want to make money, talk to someone who’s made some.

You will remember last week that I mentioned things like the VIX (Volatility Index) had never been higher since the indicator was created. A huge spike in volatility historically shows a bottom is at hand.

The Dow has almost been cut in half from its all time highs (just over 14,000 down to about 7,900.) When you have a major index cut in half, it’s a great time to start accumulating for the long term. History shows that the following year you will likely be glad you did. However, even if it takes three to five years, that’s still a short time in the grand scheme of things.

So value is being created before our eyes to those who will realize it and put fear aside.

Last week we talked about mutual fund redemptions, but this week I want to add to that list: hedge-fund redemptions

Hedge fund investors tend to be a bit smarter, more seasoned than your average retail investor. However, they can get spooked too.

Anyway, just the fact that the sell-off has permeated not only through the retail investor but also now into the experienced, seasoned crowd tells me that it’s an even better time to invest. If you invest now, when these guys are being forced to liquidate their positions, you will not only beat the average Joe out there, but you will beat these guys at their own game, too.

That doesn’t happen very often.

These guys have gotten scared with 1,000 point swings on the Dow and Nikkei several times recently. It’s simply just too much for them to bear, especially since they are leveraged.

It’s very dumb to be highly leveraged in anything right now with such historic swings taking out some of the best. That’s why you need to invest with cash when it comes to stocks and invest with very low leverage in the carry trades that I mentioned from last week (EUR/JPY, USD/JPY, AUD/CAD, and AUD/CHF). Remember that some of these are just coming off of 10-year lows.

Remember, a stock market bottom will forecast a carry-trade bottom of the most beaten-down carry trades for sure (in my opinion). You will notice that I’m a very macro guy. I’m a currency investor who takes the temperature of things like stocks and commodities all the time because they tell me a lot about what is going on in my own market. This tips me off to a lot of good moves long before my peers see it in the currency market.

I’ve been a very successful stock market timer but realized that I can make so much more headway more quickly in the currency market since there are no commissions, trends last longer, the fills are better on my orders, and I can use a touch of leverage more safely in that market.

I think my final reason for a market bottom is the most compelling — gas prices.

If you think the tax rebate was big (which caused a small bounce in U.S. stocks), and you thought that the $700 billion package recently was a big deal, consider the savings on the drop in gas prices too.

Here’s one thing that many people are missing right now: High gas prices act like a tax on the whole world, but especially the United States since we do more driving and have to import the majority of our oil. And as oil goes up, so does gasoline over time.

According to the American Automobile Association, the average price of gas in the United States is down 22 percent from a month ago and nearly 30 percent from the summer's peak of $4.11 a gallon.

When traffic flows are measured in America and the average gas mileage is factored in, this means we save an average of $1.42 billion to $1.88 billion annually for each each penny in price that gas drops. So there’s another $150 to $200 billion dollars in savings that a lot of people just aren’t factoring in.

So with the Federal Reserve and other central banks around the world pushing every lever and turning every knob that they’ve got to get the global economy going, and the huge gas savings added on top of this (in addition to the $700 billion dollar package and rebate checks), it’s all going to turn the markets around.

Bottom line: This recent volatility has been a huge confusion to many investors, and that’s what’s formed the volatility. But you have to realize that the times when most are uncertain, are the times you should be the most certain. History proves that if you invest and can hold out for a few years minimally, then you come out on top.

So the bottom in stocks that is forming even now will also form a bottom in these select carry trades (EUR/JPY, USD/JPY, AUD/CAD, and AUD/CHF). In times like these, it’s best to broadly diversify among all of them because some will bounce back better and quicker than others. Whatever you’ve invested in the currency markets, position size-wise, and make sure you invest with about one-third of what you normally do.

When volatility goes up, your position size has to come down. That’s how you bring down the volatility for your own personal account while it goes crazy for the masses.

If you use stops, they must be three times wider as well. So positions that are three times smaller with three times the stop distance still risk the same amount of dollars as before. But what it does is make it to where you can handle the swings against you in the short run so that you get the benefit of the new uptrend as it forms.

Most investors will be so highly leveraged in this market that they can’t even make the turn in these pairs from downward to upward. Don’t be like them. Take these words of wisdom from someone who’s been investing a long time in many markets. Cut down position sizes when volatility is high. You will find that others will put on the position sizes they’ve always done and don’t know why they blew up their account.

Meanwhile, your account is poised for greatness in the months ahead as you position yourself properly now.

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Investors have been through some crazy times lately, so I’d like to continue along the lines of last week’s article and give you even more reasons why the financial markets are nearing a bottom. Last week, mutual fund redemptions were at an all-time high. The best...
Monday, 20 October 2008 03:03 PM
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