How to survive the market sinkhole

August 10, 2007

First, we should be clear about why some of this is going on. Aside from all of the underlying fundamental and very apparent technical conditions that helped to get us to this point, there is one overlooked item. This is definitely the repeal of the uptick rule.

According to Investopedia the “short sale uptick rule was, “established by the SEC that requires that every short sale transaction be entered at a price that is higher than the price of the previous trade. This rule was introduced in the Securities Exchange Act of 1934 as Rule 10a-1. The uptick rule prevents short sellers from adding to the downward momentum when the price of an asset is already experiencing sharp declines.”

That was what it used to be. But on July 6th, in a stunning reversal, the rule has been lifted. The intent was to help stabilize markets in a declining market. In that type of environment, as sales increased, certain traders (“shorters”) were locked out of adding to the selling pressure.

You know, I just thought of something; they must think we are stupid because I think I hear that analysts are now saying that the economy is slowing and not healthy. I am sure I did. In fact, did Joe Battipaglia say he is 50% cash? I think he did…. Was this what they were all saying just a week ago? No, I do not think so.

I am so sick of the talking heads telling us that they are in or out when they only seems to tell us where they are when the market is moving in their direction. Honestly, I am hard pressed to even believe I just wrote that, but it is so seems so obvious.

The regulators have given us this volatility by removing the safety trigger and holding of by any significant FED moves. It is very clear that no matter what is said by the gals and fellas on the tube, the regulators are the ones that need to take it back. The way this needs to be is by “operation flood-me.” This is the way in which the FED comes in and puts some additional liquidity to help avert a credit gridlock. During this vacation heavy time, traders are gone, business is slower and credit will traditionally slow.

This morning the FED added an additional $19 billion of liquidity though open market operations over what they have done last week. That is a good thing that helped to pull the index futures off of their early morning low’s.

Here is what needs to be done. (Assuming you have cash as we have advised since mid-July)
1) Do not panic
2) Do not panic (needed to be said twice)
3) Buy a FEW shares of the most “beat-up” areas:
a. Apple is getting oversold, nip softly
b. Housing stocks are in the toilet, look at dollar cost averaging in to TOL, KBH (carefully)
c. If you are BRAVE, add a very small position of financials (SCHW is a good start and then add to larger firms such as LEH)
d. Re-evaluate your International Equity Mutual Funds. Move allocation to domestic securities.
4) Watch for further FED action.
a. If they continue to add liquidity, go back to #3 one more time and then go to #5
b. If they discontinue the liquidity flow, Skip to #7
5) Look to add positions that held up through the storm like:
a. ZUMZ, SNDK, ZEUS, STLD, NOK, SFLY
6) Continue to scour the portfolio for positions that underperform and add sell stops
7) Add fixed income positions in the form of AA or better rated Preferred Stocks
8) Add Sell Stops across portfolio to contain risk. Be careful not to panic….
9) Do not get sucked into the Automatic bounce but slow down and think about your moves. If they do not work out immediately, stick to your disciplines and adjust accordingly.

Later today, we will have a more detailed discussion of a few of these important items. We will also post a podcast with a roundup of the important portfolio protection and market opportunities later today. Make sure to subscribe.

Horowitz & Company clients may be long and or/short some of the positions listed as of the date of this writing.

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Comments

3 Responses to “How to survive the market sinkhole”

  1. David on August 10th, 2007 10:26 am

    Acually, the former perma bull, who was bullish the entire 2000-2003 bear market was bearish for a little while. The first time I heard him say that, my jaw dropped…

    The problem with the market I think is the dip buyers. We open down over night, and a rush of buying keeps comming in.

    My real fear is the wall of Worry. Last summer, the boobs on the tub kept hitting us with all sorts of panic stories: inflation, war in the middle east, bird flu, etc. Here, all I keep hearing is that everything is all right, and it is just a financial problem that is distinct from the real economy. “Buy stocks now, because in five years, you’ll be happy you did” was a quote from Mark Haines yesterday.

    Cramer, while taking about Armageddon, is still saying buy stocks…

    I do not understand how, in a consumer driven economy, which has be sustained over the last four years by low interest rates, spurring home prices and allowing easy money from home equity withdrawals and low interest credit card offers.

    Economics takes place at the margin. The entire economy does not have to stop to have a recession. It is when that last shopper decides to pay down his credit card, instead of going out to dinner, or the consumer who can not spend because he can not make his mortgage payment that stops the economy from growing.

  2. kio on August 10th, 2007 3:32 pm

    This panic will last a next month or so. Then a period of the stock market stagnation - from 12 to 18 months. Then a burst in stock prices.
    The Fed will follow the events:
    was lucky to get scaling for my prediction on SP500 returns.
    The new scale corresponds to the drop in yearly returns during the last several days. In previous comment (
    http://futuresboard.com/?ab=board&forum=2&board=8&thread=3534
    July 9, 2007), timing of the current drop was perfectly predicted. SP500 will reach a new bottom value in the next two months of around 1330.

    So, the new plot for the MA(12months) SP500 returns is as follows.

    Figure 1
    http://thumbsnap.com/v/mUXOzUpd.gif
    Comparison of observed and predicted monthly returns. The observed returns are MA(12).

    Figure 2.
    http://thumbsnap.com/v/IJmE0zuQ.gif
    Cumulative observed and predicted returns from Figure 1

    Figure 3.
    http://thumbsnap.com/v/G887ufZJ.gif

  3. What do Schwab and Bernanke have in Common? on September 11th, 2007 9:52 pm

    [...] would be a nice move for SCHW as volatility increased within the domestic equity markets. (See Survive Sinkhole and Podcast 22 [...]

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