The Contrarian Trader

Stock market, economic and political analysis for the intermediate term stock, commodity and equity option trader.

Archive for December 2006

The “VIX” is in…..

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Yes, the Volatility Index also known as the VIX put in a new multi year intra day low last week. What you can read into that event is that there is little to no fear in this market. So yes, the “VIX” is in for what could be a nasty sell off in this market. The theme of the week last week was the pumping of the Airline Stocks on merger and acquisition talk. By the end of the week the sector’s prices had returned to where they started, once again the little guy was left holding the bag. CNBC received the order from home office to pump the stock of their parent company GE which broke out on huge volume. The S&P 500 “broke out” this week to brand new highs but, don’t get to excited. Friday’s price and volume action was very disappointing. You may say that I am nuts! What is wrong with me? The index closed higher on huge volume. What could be wrong with that you say? In a word “churning”. When you have an up day on huge volume that we saw on Friday you would expect more of a point gain. What we can interpret from the price and volume as we saw on Friday is that there was a lot of sector rotation and profit taking. The Banking Sector also continues to help support this market. When will the rally on the S&P 500 be over? Watch the BKX ,when the Banking Index finally begins to correct you’ll see a market decline because it’s the banks and the winged tip jackals on Wall Street with their computerized trading that is keeping the market up. On the NASDAQ we saw similar price and volume action that accompanies churning. The Semi Conductor Sector continues to struggle to break out above its current resistance levels. Without the participation of the Semi’s it’s going to be difficult for the NASDAQ to have convincing break out. The markets are extremely overbought and two weeks remain in 2006. We are not predicting a sell off in the markets until after the early 2007. The PE ratio on the S&P 500 is now around 20 which have in the past few years represented a top of the trading range. With decelerating profits it’s hard to justify the rally and expansion of PE’s. All hopes are pinned on the FOMC reducing interest rates in early 2007. With job markets still strong and the threat of wage inflation as well as core inflation it’s going to be hard to make the case for a reduction of rates. Add to the list the declining US Dollar which would further deteriorate if the FOMC lowers rates. Sure, the US Dollar had a strong week on the back of Bernanke and Paulson going hat in had to China but I wouldn’t expect the rally to continue. It’s a new world and the Communist Chinese are our number one financier.What I expect to see happening for the remainder of the year is more of the same. Pre market you will see CNBC hype the market by “reporting” via company and sector upgrades and then the subsequent squeezing of the shorts and a continued rally of the banks which will prevent a major sell off. Using history as a guide it’s highly unlikely to see the markets sell off. The markets are overbought but they can stay overbought for a pro longed period of time.We will cover our current holdings in Monday evenings Contrarian Commentary. We are planning to add to our current short positions to take advantage of what we see as a fantastic opportunity to profit from the coming correction.If you have any questions please feel free to email me at Robert@TheContrarianTrader.com Robert Desmond

President & Chief Investment Strategist

The Contrarian Trader

Bad Luck that saves you money…a Trader’s Tale

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A couple of weeks ago a I received an email from a great member John who I frequently email during the day. He had asked me to take a look at Biovail (BVF). Normally I would take a look at the chart and do a review of the key fundamental statistics and give my honest opinion. But on this day I didn’t due much of a due diligence. I respectfully replied to him NEVER! I was blunt and short for a reason. The main reason being that I had hoped to persuade him not to trade the stock. Why you might ask?  Well, a number of  years ago I was long Biovail. I owned quite a bit of it. As I do each morning I sit with great anticipation watching for my Level II screen to light up with the red and green colors that greet me each day. On this particular day however one stock sat white in color. You see this normally with thinly traded stocks, it may take a minute to catch a bid. But (BVF) was no thinly traded stock. I did my research and my worst fears came true. Biovail did not open that morning because of a ” truck accident the previous night that was carrying a large batch of their product Wellbutrin. It would have a material impact on earnings. Around 11am, (BVF) opened for trade. It opened sharply lower then it’s previous nights close. Long story short…in the blink of an eye I lost $20,000.00. Bad luck? Perhaps, but just because you were burned by bad luck doesn’t mean you shouldn’t learn a lesson from it. To rationalize what the event I decided to evaluate what had happened and to perhaps learn a lesson so that I may avoid a repeat situation in the future. “Turn Chicken Sh__t into Chicken Salad” as my Dad would say. Here is what I had learned. Biovail’s management was suspect by the Wall Street analysts for being lets shall we say slick. Isn’t that the pot calling the kettle black you might ask? Lesson 1: It pays to listen to rumors of bad management. Avoid these managers like the plague. If the street thinks you are a dishonest then you must be bad.  There are plenty of other companies to trade. Lesson 2:Trust your gut instinct. Your gut instinct doesn’t reveal itself to be correct until after the fact. If your gut tells you to get out then, get out while the markets are open to you. Lesson 3: Use money management techniques. Short term traders by necessity are less diversified in a speculative portfolio.But, by simply being a speculator doesn’t give you the right to exist for any length of time without having some diversification in your portfolio. Lesson 4: First out best out. That’s why I lost only$20,000. I acceptted my loss only a few seconds of the stock being open. It was the longest market order ever.  Had I waited for a counter trend rally the loss would have been staggering, I got off lucky. The reason why I brought this story up was because of Daystar Technologies (DSTI). I love sell offs, that’s how I have made what I have made. I am very good at buying stocks during  times and conditions when very few people are willing to offer a bid. Daystar was getting hammered by big sellers these past few days. The $5.30 support level was the bottom of it’s trading range, it should have rallied off of it. What happened? Nothing..it sliced right through it. This happens sometimes, then late in the day you get the buyers coming in to make it close over support… a key reversal day. This morning it was so oversold it felt like re -entering the trade was like taking candy from a baby. After I re-entered however what bothered me was the reason why I had entered. Taking candy from a baby? There are no free meals on the street. As the stock began to slip again to new intra day lows I got that Biovail feeling again. After I hung up the phone with investor relations at Daystar I had drawn two  conclusions from my conversation. 1)Daystar was up for sale 2) There were no bidders. I sold not two seconds after I hung up the phone using a market order. As I was carrying a very large line the last thing I wanted to be doing one weekday morning was sitting at my Level II screen with my coffee in hand waiting and hoping for Daystar to open up. We no longer have Daystar Technologies as a Buy Watch. To the markets, listen, you can expect this game playing to go on for the next couple of weeks. They are going to hold the market here by doing what they did this morning. The spiked the market by squeezing the short on the back of the retail numbers. It’s the same old thing. They’ll keep upgrading earnings forecasts, sectors and individual companies through to New Year. Watch the Banking Index (BKX) it was up all day. Why? Here is how it goes. Morgan Stanley will call down to the floor when they see the S&P 500start to slip and begin to buy back their own stock. As it’s the Holiday Season and all the wing tipped jackals await their bonuses the good ole’ boy club the boys over at Citi, and Goldman Sachs will lend a hand and buy back a few shares as well. This keeps the markets from selling off. As I have always said, the Banks, Brokers and Insurance companies make up almost a quarter of the S&P 500. That’s huge. So, if the financial sector heads higher nobody panics. You just watch when the BKX heads south, that’s when this market comes apart at the seams. So, obviously we are out of DSTI. We no longer hold this position nor do we intend upon trading it again as it’s soundness as an ongoing concern becomes an issue that we need not be involved with. Stop losses are tight across the board. We will keep them open so long as they hold above support. I am still gradually purchasing the SPY March 139 Puts and will do that to average into the trade. We have a very large VIX May 25 call position as well. If this market corrects we will be in a fantastic position to take advantage of it. When the correction is over there will be some really great stocks on sale.

Robert Desmond

President & Chief Investment Strategest

TheContrarianTrader

The Contrarian Trader >> The Week Ahead Forecast

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bull_fight_by_vegasmike.jpgThe employment numbers came out on Friday and wow! We grew jobs which is great for the economy but not so great for those speculating that the Federal Reserve will lower interest rates anytime soon.That’s why we added to our  position in the SPY March 139 puts It is my contention that although there may not exist the rampant speculation in the .coms and technology stocks that we saw in 2000 there is a speculative bubble built into the market by those betting that the Federal Reserve will lower interest rates in the first half of 2007. Federal Reserve Chairman Bernanke has put the markets on notice that policy decisions would be based upon the most recent economic data. As long as there is job growth in the United States there is no reason for the Federal Reserve to lower interest rates anytime soon. There are certain indicators that are flashing on my screen that tell me the smart money is beginning to think more in terms of a neutral stance with a potential bias to the upside for interest rates. Take one look at the US Dollar which rallied last week. Perhaps it was an oversold reaction but it coincides with a weakness in the Utilities Sector which is dependent upon lower interest rates for a continued rally in the XLU.

Why do rates count so much? Great question. The economy has had such a great run since March 2003 due to the massive boom in new home construction and the ripple effect that it has had on the economy. The affect of lower interest rates sparked a rally in existing home prices which leads us to our current situation. Introductory adjustable rate mortgages are due to convert to higher  rate mortgages in the coming months. People are now running to the banks to wisely refinance those existing mortgages to longer term fixed rate mortgages. There is one problem, the values of the home that they purchased only a couple of years ago is now worth less then the amount due on the mortgage. What say you? How can this be? That is going to be the reaction of thousands of home owners across this country. The rally you are seeing in the Housing Stocks now is a false rally. Let us see if these stocks can come back in an successfully retest these lows. With a new Democratic Congress I’ll bet you are going to see Congressional Hearings into the underwriting practices of the major banks like Citi Group (C) in the coming months.

As my readers can attest I have been saying to tighten up their trailing stop loss orders and begin to accumulate a short position in the markets. Going into the Christmas and New Year Holiday’s you can expect that the “window dressing” will continue as well as some tax loss selling which appears largely to have abated. After the first you can expect to see profit taking by those who chose to avoid taking capital gains in 2006 thereby deferring those gains into 2007.

The S&P 500 last week closed higher on good volume. It held support at the 1400 level which is critical. The key indicators to watch these next couple of weeks will be a) Volume b) the Advance Decline line. If the S&P 500 continues higher on declining volume on a weekly basis this rally is suspect to say the least. Volume and broad participation is what matters now. Profits have been decelerating and all hopes have been pinned on the the Federal Reserve lowering interest rates. By most measures on an intermediate term basis the markets are overbought and ripe for a correction. I think that great buying opportunities will present themselves in the coming months. But with the VIX near historic lows and with improving technical indicators (Disclaimer: We are long the VIX May 25 Call options), decelerating profits, a declining US Dollar and inflationary pressures (anyone taken a look at the steel stocks lately?) it remains far from certain and my opinion at his juncture that a Federal Reserve rate cut is not an option. The inverted yield curve is forecasting a recession which was backed up this week by the ISM’s manufacturing numbers falling below 50. A number below 50 indicates that manufacturing in the US is contracting where as a number above 50 would indicate expansion.

In closing we are not forecasting a sell off like we saw in 2000 nor are we suggesting a market crash as seen in 1987. What we do forecast is a 10% correction in the stock market. I have not closed out all of our long positions but, my tightened stop loss orders have allowed the market to close out some long positions.

This week we closed out:

LOJN March 15 call options which we opened a position on 11/30 we closed out for an 18% profit.

DSTI which we re entered this week we closed out 50% of the position for an 6% loss.

COH which we opened as an intemediate term trade was closed out this week. This trade was inspired by Susan, a dear friend who in my opinion, was in need of a great handbag. She still remains a dear friend and as I appropriatly termed at that time a very Classy Lady. We closed this position with a 28% profit. Susan is a Dietitian for Hospice and a major advocte. Did you make a few dollars off of the “Susan Trade”? Then please, give a few dollars to HospiceCareNetwork.org

To our members we will conduct an analysis of our current Long/Short positions in Monday evenings Contrarian Commentary.

If you have questions with regard to this our forecast please email me at Robert@TheContrarianTrader

Robert Desmond

President & Chief Investment Analyst

The Contrarian Trader