I have adjusted my downside target slightly since the market internals are messy and chaotic something that often happens at market bottoms. Ultimately, the S&P 500 should decline to some point between 1257 and 1230. From there, it should rally but the question is whether it will be just another bounce or the real thing.
Several factors must be present for a convincing bottom. In the options markets we need the number of puts to calls purchased to increase substantially. The Volatility Index called the VIX must also move higher. The volume on the New York Stock Exchange will also have to move up over the six billion mark and the strongest sectors will have to decline. We call it “selling your winners.” This should all happen within an emotional environment of near panic and extreme pessimism. I know that’s not a pretty picture but it is a necessary condition for a bottom.
Right now and for most of the week the stock markets have been oversold and have been due for a bounce. This could happen at anytime but don’t mistake that for the real move upward. You can bet if financials lead then it is not a rally with legs. On the other hand once the market bottoms if the energy sector, natural resources and possibly information technology leads the advance then odds are it will be a more sustainable move higher. Meanwhile, traders have been building short positions while every attempt to rally has been met with a wave of selling so, in my opinion, the bottom is building.
From the volume of calls I received this week it is pretty clear to me that investors are nervous. Certainly the constant drumbeat of doom and gloom from the financial media doesn’t help the mood either. Let me try to put the present downturn in perspective. In my career, I have seen over 30 stock market corrections throughout the world. Many of them, especially those overseas, have been far, far worse. Yet, every one of those markets has come back stronger and higher than before. The same thing will occur this time. My philosophy is to buy snow blowers in the summer, straw hats in the winter and stocks during big sell offs. I plan to do that this time. In over 25 years I’ve not been disappointed yet. For now, my advice is to turn off the computer, skip the business section of the Sunday paper and instead enjoy this Fourth of July weekend.

As I wrote last week, the next stop on the S&P is 1256. I fully expect that target to be reached. If it holds there, it would be the third successful re-test of the lows first tested in February and then again in March of this year. And what if it fails? The next support would be around 1180-90, another 5% down from here. That would put the S&P 500 25% below its peak, about average compared to past corrections the S&P has endured. If that occurs you may want to use some inverse ETFs to hedge your portfolios (see this week’s “Inverse Securities—How to Protect your Portfolio in Down Markets”).
But don’t forget the “Bernanke Put”. That’s the name investors have given to the government’s intervention each time the markets appeared on the verge of deep crisis. In February, the Federal Reserve announced a cut in both the Fed Funds rate and Discount rate just as it seemed the market would break 1270 support. Then again in March, when we reached that level again (thanks to the Bear Sterns crisis), both the Treasury and the Federal Reserve announced their now-famous bail out deal. If any market decline appeared to becoming a free-for-all, I would expect intervention.
And there are still plenty of weapons in the government arsenal. Congress, for example, could eliminate the tax on dividends, allow investments in the stock market to be deductible on a temporary basis or maybe give public companies a tax break for buying back their own shares. All of the above and many more options could turn this market around on a dime if necessary.
But so far this appears to be a classic recession-type correction and nothing more. What we have not seen on this third re-test yet is panic selling on high volume. We need that in order to put in a convincing bottom. It is also usually an excellent time to buy if you have the stomach for it. My hope is that once we reach that level the markets will simply meander about for the rest of the summer before moving up in September.
Why September? It usually takes 12 months from the date of a Federal Reserve rate cut before the effects of that stimulus start turning up in the economic numbers. Since the first interest cut was in September 2007 the math is obvious. By fall, I expect an increasing stream of good economic numbers. At the same time I believe that investors will catch “election fever” as the presidential elections draw near. Promises of change from both candidates will create higher expectations and hope that the new president will tackle the array of problems that beset the nation. These factors will combine to propel the market upwards into the end of the year. So take heart, stay the course and even if we have some dark days ahead remember it’s always darkest before the dawn.

Exchange traded funds are index funds, which mean they invest in a set number of stocks, bonds, currencies or commodities that mimic whatever index they have targeted. If their underlying index goes up so does the fund and vice versa (for those unfamiliar with ETFs, please re-read my March column “Exchange Traded Funds have Come of Age” for further background on these securities).
An inverse ETF does the opposite; it goes up when the markets and sectors go down. Inverse or “short’ ETFs are available on various worldwide indexes including all the major ones here at home like the S&P 500, the Dow and NASDAQ. You can also hedge yourself with various sector and style funds. They are liquid, trade just like stocks and do not require large investments in order to hedge a portfolio.
Granted, you can accomplish this same purpose by the more traditional method of selling shares of stock short but that involves borrowing money and stock from your broker, establishing a margin account (similar to a loan), paying an interest charge for the privilege and receiving margin calls when the stocks you sold start to go up in price. Sound complicated, it is and successful short selling requires a great deal of chutzpah, skill and experience.
There are also put options and futures but they require you to open both future and options trading accounts. Besides, most brokerage firms will not allow investors to engage in such transactions unless they can furnish convincing proof that you the investor have the understanding and skill to engage in trading these instruments and understand the risks involved. With inverse securities you simply buy shares of an ETF when you are nervous about the markets or on a particular industry and sell your position when you think the coast is clear.
Let’s say you have a number of stocks and mutual funds in your $100,000 portfolio. You have spent a good deal of time and effort in putting these investments together. Along comes a year like 2008. All the sub-prime, credit and inflation problems have descended upon the market and battered your portfolio to the point that you just don’t want to take any more losses. But you hate to sell because you just know that the stocks you own will win out in the years ahead.
You could buy a few hundred shares of an inverse ETF, for example the Proshares Short S& P 500 (symbol: SH) for $67/share. Sure enough in the days ahead the S&P 500 declines by 5% while your investment in SH rises to $70.35/share. So what you might lose on your stock investments you gain on your short ETF. You can buy as many or as few as you like depending upon how much of your portfolio you want to hedge.
There are several families of funds that offer inverse ETFs such as Proshares, Powershares, Market Vector and more. Just Google the subject and explore the websites. You will discover that there are also leveraged inverse ETFs which double your inverse returns. These funds can accomplish this by using derivatives, futures and options. That means you can hedge your portfolios with just half the securities that you would need on a one-to-one ratio. That’s called leverage.
But let me give you a heads up on buying and selling inverse ETFs–don’t speculate. You can loose your blouse (or shirt) in this market if you start betting on market swings. There are some inverse ETFs that can move up or down 10% a day or more especially in several volatile markets like financials, oil, gold and currencies. Here you will be competing with the big boys, the hot money and they make a living picking off individual investors. Use these securities with the sole purpose of protecting your investments in stressful times.

I have said before that when oil breaks the stock market could take that as a welcome sign and move higher. However, weighing on that move is the continuing problems in the banking sector where more write-downs, write-offs and a seemingly unquenchable thirst for additional capital have nipped every attempted rally in the bud.
Treasury Secretary Paulson expressed his own on-going concerns about the financial sectors on Thursday when he urged the government to give more oversight authority to the Federal Reserve in regulating financial markets. The photo of two Bear Sterns hedge fund managers in handcuffs on the front page of most papers Friday simply illustrates the on-going problems that still need to be confronted by the banks and brokers in this country.
A new topic of concern has also surfaced. Investors are questioning how much of the money the Federal Reserve Bank has been lending to banks and brokers have contributed to the speculative rise in the oil markets. Recall that over the last few months the Fed has allowed both banks and investment banks to borrow billions at very low rates. The objective of that bail-out was to coax these lending institutions to turn around and loan that money to their existing customers and thereby break the credit logjam. The evidence suggests that only a small portion of that money has reached the target market to date.
The explanation thus far has been that instead of lending the money out, the banks/brokers have been hoarding the cash. Yet some believe that a lot of that money is finding its way onto proprietary trading desks where, desperate to make back some of their sub-prime losses; some big financial institutions have been making a quick buck by speculating in the commodities markets. If true, this could be a major embarrassment to the Fed and the Treasury.
In the meantime, natural gas hit my target of $13.20/mmbtu. but commodities do have the tendency to overshot technical targets both on the down as well as the upside. Recall that my price target for oil was $128-130/bbl. and oil continued to climb by another $10/bbl. before stalling. The announcement that China is planning to hike their subsidized energy prices by a whopping 18% may put a dent in the bull’s case for oil short term although oil still finished the week at a lofty $134.62/bbl…
Gold, on the other hand, seems to be perking up a bit and is now above $900/oz. It is conceivable that the “hot money” may abandon their speculative positions in energy and move into gold now that everyone but the Terminator is out to get them. Other commodities like copper, aluminum and grains are also moving up on the back of inflation expectations and the impact of flooding in the mid-west. See my column on “Water—down to a trickle” for more about food and water investments.
So what does a reader do if the market faces a down draft here? One can go to cash but I wouldn’t advise that. Cash pays you nothing and inflation erodes its value everyday. Treasury bonds are a traditional haven but after Friday you can believe that bond prices are already higher and once again the yield won’t keep up with inflation. There are income funds which will pay you a decent return and I suspect you will lose less then in stocks. And then there are inverse securities, exchange trade funds that go up when the stock market goes down. Few investors use them although they were conceived as a hedging tool in situations just like we face in the markets today. Be sure to read next Friday’s column on the subject or if you can’t wait feel free to call, e-mail or write me using the information below.

Seventy percent of world water use, according to the Earth Policy Institute, an environmental think tank, is used for irrigation (farming), 20 % is consumed by industry and 10% goes to residences. At the same time, demographic shifts like expanding population, migration to cities or from one region to another have conspired to increase the demand for human drinking water. Take our own country, for example, where the main growth in population and migration over the last few decades has been to the south and the west. This same phenomenon has occurred in countries as far a field as China, India, Iran and Mexico, to name a few.

While this human development was underway, industry has also expanded tremendously in areas of the world which until recently were largely subsistence Agra economies. China and India are the most obvious examples of this emerging market industrial revolution. As a result, the demand for water in industrial production has also increased (for example, an often-quoted statistic is that it requires 62,000 gallons of water to produce one ton of steel).

Finally, with the increase in global population and wealth the demand for food (farming) has also skyrocketed. All these factors are competing for a very scarce resource when you consider that only 2% of all water worldwide is fresh water. Some areas do have a sufficient supply of fresh water but unlike oil and other commodities, transporting water is not cost-effective and requires much more care in transport.

The trade-off therefore is between three competing variables and the demand for drinking water wins out over both industry and farming. Industry places second because this promises a higher standard of living for most folks then agriculture. Thus by default, irrigation is getting the short end of the stick.

Historically, water shortages, droughts and such were purely local affairs but not today. A drought in say India or a devastating earthquake in China might mean a poor or non-existent grain/rice harvest. Either country can make up that shortfall by buying in the international grain markets at a price. Countries where water is scarce can now satisfy the demands of a growing population, an expanding industrial base and burgeoning cities by diverting water from irrigation while importing grain to offset their loss of food production. Since a ton of grain requires 1,000 tons of irrigation water, importing grain is a great way of importing water.

Today and into the foreseeable future, some of the greatest foods producing areas of the world are running out of water. Central Asia, the Middle East and North Africa, in addition to India, Pakistan and the United States are all big players in this dilemma. As demand for water (food) increases so does the price and that’s one of the reasons you are paying more at the supermarket for everything from meat to mangoes.

Wall Street is quite aware of this water shortage and a thriving market now exists for all sorts of water investments from utilities to desalinization plants to filter companies. My own firm, Dion Money Management, has been investing in an exchange traded fund called PowerShares Dynamic Water Resources (symbol: PHO) for some but not all of our clients which tracks what is called the “Palisades Water Index” a wide array of stocks that are involved in all facets of the water sector. In our work it appears momentum is working in PHO’s favor. There are various individuals stocks listed on the various exchanges as well. If you are interested drop me a note and I can steer you towards some of them although in a fledgling industry such as this my advice would be to diversify as much as possible. As for investments in grain, some clients also have a holding in Powershares DB Agriculture (symbol: DBA) another ETF that invests in corn, wheat, soy beans and sugar ().

As in so many other areas where once abundant resources have suddenly become scarce, new methods and approaches will be required. Two keys to stabilizing are above and underground water supplies will be raising the price of water and stabilizing population. The expansion of new communities into scarce water regions will have to slow and in many regions wasteful water practices like lawn sprinkler systems and the Sunday afternoon car washing will have to end. In many locales, initiatives like these are already on the books. I predict that as water scarcity grows you will see more and more regulations and a higher and higher price demanded for another resource that until now most of us presumed was inexhaustible.

May’s Consumer Price Index gained 0.6% versus 0.2% last month and was the largest rise in six months. It simply underscored the inflation threat that is obvious to you and I but until now had seemingly escaped the government’s notice. Yet, because the number was not as bad as many feared, the market moved up on the news (go figure). At the same time retail sales for last month rose an unexpected 1% which kind of contradicts economist’s forecasts of a slowing economy. Of course, the government’s stimulus checks began arriving at the same time so May could have been a one-off event in a declining retail sector. Given the unknowns, the stock markets performed in schizophrenic fashion closing down on the week.
In the meantime, the bond market had a similar game going. Traders who usually make bets on future Fed fund rate moves have priced in a 67% chance that the Fed will raise rates ¼ point in August and a 97% chance they will raise rates no later than September. If the Federal Reserve does raise interest rates the hoped- for impact would be to cap commodity prices and at the same time boost the dollar. That would be a good thing. However, raising rates would not be good for a number of sectors of the economy with housing and consumer lending two of the more obvious victims. There is also a chance that rising rates would tip the economy backward and take a lot of shaky lenders and borrowers along with it. Given that U.S. foreclosures jumped 48% in May from a year ago (one in every 483 households), that is a real threat.
So in the short term, Federal Reserve Chairman Bernanke and his Board Governors are out on the stump trying to talk up the dollar. Whispers of possible coordinated Central Bank intervention to bolster the greenback are rampant and the magic is working so far. Of course, as with all verbal communications, at some point words must be backed by action. But right now, it provides a tiny bit of space between a rock and a hard place.
As for the markets, energy continues to call the shots: oil up, market down and vice versa. The S&P 500 is in no man’s land but the technical picture is not good. The S&P finished flat for the week at 1360 while the NASDAQ (2454) was down and the Dow (12,307) up slightly. Volatility has moved up again. Although the S&P index has some support at 1325 a failure to hold there would indicate further downside to th1250 area or so, and that my dear reader would be a decline of 6-7%. So don’t be a hero because it’s no time to be aggressive.

Not to be outdone, both Democrats and Republicans spent the last few days dredging up every issue, every pet peeve, and every preposterous claim concerning energy over the last 20 years. Pointing outraged fingers at each other across the aisle, the Senate Democrats proposed and the Republicans blocked a barrage of measures which were meant to bring oil companies and the “speculators” to their knees. When they got tired of blaming each other, both sides competed to see who could slam both the oil industry and Wall Street the most.
On a personal level, I received an e-mail recently from my local fuel company urging me to contact congress today. It went on to blame speculators and investment banks who were using loopholes in commodities law to drive up energy costs and reap record profits at the expense of the American family and small businesses. They quoted “some experts” as believing that as much as 60% of the cost of a gallon of gasoline or heating oil can be attributed to pure speculation. All this sounds impressive but like the sub-prime mess, it’s a little late for theatrics.
If you filter out the rhetoric what becomes clear is that none of our politicians have a clue on what this country needs the most—a coherent and far-reaching energy policy that includes alternate energy sources, conservation and a total change in the nation’s consumption habits. Instead we get the same old rehash of scapegoats and failed policy initiatives. So, to me, it’s not surprising that there is push to repeal the 26-year-old moratorium on drilling for oil and natural gas in Alaska and the outer continental shelf. They are still quoting the same old estimates of 86 billion barrels of oil and 420 trillion cubic feet of natural gas. Even Obama and McCain, who are vying for the right to lead this country into the future, have failed to offer a comprehensive energy policy or until recently even named energy as a priority.
Yes, I do think that global speculation has contributed to the rapid rise in energy prices but only on the margin. Today you can trade commodity futures in London, Singapore or Dubai. It is going to be difficult for America to dictate to these sovereign nations how to trade securities in their own markets. And remember its not just America’s Citibank, Morgan Stanley and Goldman Sachs that are playing the futures market. Plenty of foreign institutions buy and sell commodities in Europe and Asia as do millions of individual investors worldwide.
How does taxing U.S. oil companies wind fall profits really impact anything when 80% of the world’s oil is owned by foreign companies and countries. It may give us a certain feel-good rush to do so but in the end you know Washington will just squander the extra tax money on pet projects anyway. Those are all stop-gap measures that fail to provide an answer to the basic issue.

One thing is for certain. As long as the politicians can keep our focus on this three ring circus of congressional hearings, windfall energy taxes, imposing regulations and investigating exactly who and how this dastardly deed was perpetrated on America no one will ask why this country has never developed an energy policy in the 25- plus years since the first energy crisis hit back in the late 1970s.
I think lifting the moratorium on drilling for Alaskan oil is a mistake. It would simply be a short-term solution that would leave our children and theirs’ with no energy reserves at a time when the world’s oil truly runs out. It could mean the difference between our nation’s future prosperity and even survival
In the end the solution to rising energy prices, like global warming, is too big for any one government to legislate. As I’ve written before, I believe it is up to each one of us to take action. Giving up your gas guzzler, spending money on new windows or insulation, car pooling and a hundred other initiatives are at your fingertips. It will demand sacrifice, millions of us working together and a lot of patience something Americans are not accustomed to doing in our Twenty-First Century culture. But it can be done. This nation has proven that time and again throughout our history.

An avid sports fan, you can usually find this dark-haired Bronxville, N.Y. native striding through his firm’s cavernous trading floor talking to traders about stocks and markets. His customers, a vast array of money managers and other institutional investors throughout the world, manage trillions of dollars for clients like you and me. Back in the day, when he first took a stand on gold and oil, he recalled, his opinion was met with disdain, even contempt.

“We were aggressive believers in gold and gold stocks in October, 2001. Gold had bottomed and begun to move higher. I met tremendous disagreement with that call. Institutional investors demanded a reason why gold and then energy were moving up but there was no inflation, no financial crisis, and no currency problems. I didn’t understand it myself. The only thing I knew was it was changing direction.”

John, who has been analyzing markets for 15 years, admits it is really difficult to look at a chart and see what is going on with a stock. His desk is stacked with charts sandwiched between books on economics, finance, baseball and sports legends.

“If someone can identify which direction a security is going in a chart then that goes a long way in characterizing a stock or any security,” he admits, but he uses more than technical analysis in his work.

“The components I look at besides technical analysis are market sentiment, bonds, interest rates, currencies, commodities and what I call news response syndrome,” he explained. “How does a news item impact the security or the market? Does bad news cause a security to go up or down? This gives me clues but it is not enough by itself.”

In his work Roque maintains a balance sheet of positive and negative assets analyzing all his components before making a decision on a particular investment. Most of all he tries to discover long term trends which contradicts the oft-cited criticism that technical analysis demands a short term, trading mentality.

“That’s a misnomer,’ he argues, “and tech guys do themselves a disservice by being perceived in that way. Guys that concentrate on trends do a better job over the long term. I’m not a trader.”
He believes the toughest part of his work is to be cognizant of a developing trend and not to listen to detractors spouting conventional wisdom. “We almost always get taken out of our game, like a good player who is booed by the crowd to the point he starts to believe the ridicule. In baseball it’s called acquiring rabbit ears.”

Roque’s ears, last I looked, were still normal sized under a shock of thick black hair so it would be fair to say that he is an exception to that rule. I asked him what his views of the markets are now and in the months ahead.

“During the last big correction in 2003 it took the S&P 500 nine months to recover. We tested that bottom three times in July, October and a final retest in March of 2003. It wouldn’t surprise me that this correction continued through the summer months.”

Roque believes basic materials, energy and natural resources will lead the markets out of this correction and higher both here and overseas. Ultimately, he believes energy will be a bigger weighting in the S&P then financials.

“I go through a ton of charts on a weekly basis and I keep coming up with great mid-cap energy stock charts. The big guys don’t see them because their market cap are too small for them but over time most of them will grow into large cap stocks and then they will buy them.”

As for commodities in general, he believe they are in a corrective phase. “These kinds of corrections can be sharp and debilitating. They shake you to your bones and end up shaking you right out of your position.”

But long term he thinks they are under owned compared to 15 years ago when all the big research houses on Wall Street had commodity departments and institutional investors regularly invested in commodity stocks .

“As prices rise I think more and more professional investors will be forced to throw in the towel and start investing in these markets.”

Sectors of the market he would avoid are healthcare which has underperformed and financials.
“A lot of people believe financials are going to be the leadership group going forward but I disagree. In my opinion, stocks that make ten year lows do not lead the market higher. Once broken, a group takes many years to recover. They will be poor performers for some time to come.”
He is also not a big fan of bonds right now and expects long term interest rates to move higher in the near future as well as the dollar. Roque believes inflation is a real threat which is part of his bullish case for commodities in general. He predicts the Producer Price Index may well top 9% before all is said and done.

“If history is any guide, inflation is going higher and only Wall Street strategists, economists and Fed Board Governors think otherwise.”

At the same time, Bernanke said he would do whatever it takes to insure that “the dollar remains a strong and stable currency.” And just in case we missed it, he repeated the message twice in two separate speeches this week. Investors know that there are only two ways of strengthening one’s currency: central bank intervention or a rise in interest rates. Neither prospect seems possible right now.

Investors do not believe that the Fed would risk raising rates and sending the economy into a deeper recession. Nor do they believe that there is a coordinated global Central Bank plan afoot to support the dollar. Remember global food is priced in dollars. Given the riots and protests in many foreign capitals as a result of rising commodity prices, no foreign government is anxious to see those prices rise even higher.

So given the prospect of higher European rates, the greenback dropped against the Euro sending commodities skyrocketing. Oil spiked over 13% in two days to $139/bbl., helped along by tensions in the Middle East and a Wall Street analyst’s prediction that oil could reach $150/bbl. by July 4th.
If all this sounds familiar, I would urge you to re-read my March column “Is Stagflation Worst than Recession” for more insight into this conundrum. It seems to me we are caught between a rock and a hard place right now. Inflation is climbing, the economy is slowing and the on-going credit crisis among the banks and brokers is just a bit too dicey to risk taking any concrete action (raising rates) against inflation right now.

So what’s a reader to do? Don’t panic and stay put for now. The S&P 500 closed at 1360 a little over 4% from my first downside support of 1300. The markets are still in a trading range. If commodities, especially oil, continue to march higher the stocks will go lower. My bet is that oil is in a classic speculative blow-off. Sit back and watch the fireworks. I expect we will re-test the lows but maybe at a higher level than 1285-1300. So far this is looking like a classic third leg down in a market bottoming process. If so, I would be prepared to start buying on the way down because I think the rest of the year will be up.

On the other side are inflation concerns voiced simultaneously by Federal Reserve Chairman Ben Bernanke who acknowledged that “longer-term inflation expectations have risen in recent months” while across the pond the head of Europe’s ECB, Jean-Claude Trichet, warned that he may tighten interest rates as early as next month for the same reason. Higher rates in Europe would mean a lower U.S. dollar. Their combined comments produced an immediate rise in commodity prices, led by oil as the world’s two most powerful central bankers acknowledged that inflation was real and climbing.
At the same time, Bernanke said he would do whatever it takes to insure that “the dollar remains a strong and stable currency.” And just in case we missed it, he repeated the message twice in two separate speeches this week. Investors know that there are only two ways of strengthening one’s currency: central bank intervention or a rise in interest rates. Neither prospect seems possible right now.
Investors do not believe that the Fed would risk raising rates and sending the economy into a deeper recession. Nor do they believe that there is a coordinated global Central Bank plan afoot to support the dollar. Remember global food is priced in dollars. Given the riots and protests in many foreign capitals as a result of rising commodity prices, no foreign government is anxious to see those prices rise even higher.
So given the prospect of higher European rates, the greenback dropped against the Euro sending commodities skyrocketing. Oil spiked over 13% in two days to $139/bbl., helped along by tensions in the Middle East and a Wall Street analyst’s prediction that oil could reach $150/bbl. by July 4th.
If all this sounds familiar, I would urge you to re-read my March column “Is Stagflation Worst than Recession” for more insight into this conundrum. It seems to me we are caught between a rock and a hard place right now. Inflation is climbing, the economy is slowing and the on-going credit crisis among the banks and brokers is just a bit too dicey to risk taking any concrete action (raising rates) against inflation right now.
So what’s a reader to do? Don’t panic and stay put for now. The S&P 500 closed at 1360 a little over 4% from my first downside support of 1300. The markets are still in a trading range. If commodities, especially oil, continue to march higher the stocks will go lower. My bet is that oil is in a classic speculative blow-off. Sit back and watch the fireworks. I expect we will re-test the lows but maybe at a higher level than 1285-1300. So far this is looking like a classic third leg down in a market bottoming process. If so, I would be prepared to start buying on the way down because I think the rest of the year will be up.