The Perfect Upside Storm

For the last three years, I have been calling for the collapse of our highly leveraged economic system. With this in mind, I chose to position my client’s portfolios for this Armageddon. I utilized high degrees of cash, assets non-correlated to the stock market that pay predictable cash-flows, and also vehicles with income and principle guarantees.

My strategy was a contradiction to the normally accepted practice of positioning money across all asset classes, and of course, positioning long. I defied accepted practices of Modern Portfolio Theory and focused on the following question: Will the path of least resistance be up, or down, given the economic maelstrom I saw coming? I deduced down. Next: What sectors would show the greatest misfortune by the unraveling of leveraged mortgages, the cornerstone for all our problems. I deduced homebuilders first, and the financials second. Therefore, I focused the brunt of my stock market positions by shorting (betting against) the homebuilders and financials. It was the second best call that I’ve ever made in my thirty-six year career. The best call will be left for another time. That opportunity will present itself shortly. But I digress.

Currently the question to ask is: What is next for the stock market and ultimately the economy? I continue to believe that there is more trouble ahead for both. However, keep in mind, the stock market rarely goes straight up or straight down. Therein lies the opportunity. I’ve been asked many times by people who have made money during this difficult time period (my clients), and by those who have lost as much as 50% and more: Can I make more, and can I make it all back? I believe strongly the answer is yes. Both are possible.

So, what is the strategy? It is not to repeat the policies of the past by hoping things will turn around. Hope is a sucker’s play of which I happily like to bet against. Let’s first determine the players in this drama. The players are: Money managers, traders, President-elect Obama, and the employed, or soon to be unemployed.

Money managers have lost vast sums of money for their clients this year (this manager excluded.) They need to salvage some kind of positive performance for the remainder of the year in order to help make year-end account statements a little more palatable. Therefore, they will look for any sector or sectors that show the best upside potential. Then, like good Wall Street lemmings that they are, they will all follow into the trade. We saw it the other day with Hewlett-Packard ($34.64 as of 11-21-08) up 12% in one day. However, I don’t believe the technology sector offers much upside. Too much uncertainty about IT spending, and the lack of consumer spending on electronic gadgets.

What about financials, the most beaten down sector? I don’t think so. Too much uncertainty of what is on their books. In addition, there is too much potential for real government interference. (Eg. Citigroup $3.77 as of 11-21-08.) Definitely not retailers due to the death of the consumers. Healthcare? A potential.


Here’s where the next player comes in: The traders. The daily guys and gals who sit in front of the screens playing moving averages, candlesticks, stochastic, and many other byzantine terms. But make no mistake, they have a dramatic impact on the daily stock market movements.

What I asked myself is: What is the second most beaten down sector that not only could run dramatically to the 50-day moving average, and produce a double, a triple, or even a quadruple and still be technically broken? In other words, still be a downtrend, yet still offer some great upside. Answer: Commodities.

Bring in the next player: President-elect Obama, who continues to say, much like China has said, that the way out of our current malaise is the rebuilding of infrastructure. Obama has been tapped as the next FDR by the media. Textbooks show that FDR instituted the greatest public works program in history. Unfortunately, it didn’t work. We never escaped the throes of the 1930’s until planes arrived at Pearl Harbor.

The next player: Employees, soon to be unemployed. As the unemployment rate rises, companies will be allowed to fail, and people will look for new jobs. Where will those new jobs be created? Ask yourself: What does it take to build a bridge, a road, an overpass? It takes steel, cement, aluminum, and much more. Jobs, workers, paychecks, salvation. Wrong! However, the perception, I believe, will give impetus to a major move in those stocks that fit this bill.

In the past, I have shared with you my strategy for the downside. Now, I’ll share my strategy for the upside. Companies with good dividends that have fallen very far and very fast. Companies that fit for the money managers, and companies that fit for the traders. Companies that fit for the promises of President-elect Obama, and companies that fit for the unemployed. Companies that fit for the re-building of America.

There is a perfect storm building for basic materials to the upside. Remember, it’s only a trade. But I think it could be a very good one.

Till next time,

Bill

Long – UYM, ACM, TEX, and looking for more.

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