Is that a Bear Knocking?

Is that a Bear Knocking?

Hi, Friends,

Perhaps, with the S@P 500 now down -6.18% for November amid the continuing shelling of the financials due to the sub prime meltdown. Consumer confidence has sunk to a 13 month low according to the University of Michigan Consumer Confidence Index and the Dow managed to shed -4.1% for the week while the NASDAQ led the parade downward with a weekly loss of -6.5%.

The general market is hanging on above long term trend lines but is now perilously close to bear market status. Only 18 ETFs out of the 72 I monitor show any kind of short term strength. Overall market risk is very high.

We have already automatically shifted our focus from portfolio accumulation to portfolio protection, and if a bear market develops, we will transition to positions and sectors that can continue to profit even as the markets decline.

How We’re Doing

This week’s market action demonstrated some key elements of sector rotation trading.

Here’s a quick synopsis:

Sectors that are hot can turn on a dime and collapse just as fast as they went up. This week we were stopped out of ishares China 25 Index, FXI, for a realized gain of 26.4% since the trade was initiated on September 4th. The reversal in this ETF was breathtaking as it went from a high of $219.56 on October 31st to $182.0 on Friday, a -17.1% loss in 7 trading days. And that’s why trading with stop loss positions are so important in sector rotation.

Diversification across the portfolio is important. Members who entered FXI in September or October walked away with nice gains, but new money added on November 1st suffered a 10% decline in FXI. However, averaged across all five positions, the portfolio is down -3.66% so far in November compared to -6.18% for the S@P 500.

We are automatically switching from portfolio accumulation to portfolio protection. With our exit from the China position, we are automatically raising cash levels in the portfolio to protect us from further declines in the market. If this decline continues, we will continue getting stopped out and locking in gains or minimizing losses.

Two of our positions are largely uncorrelated to the S@P and should help protect us from further declines in the general market. These are two of the strongest remaining sectors and show no signs of weakening yet.

If a bear market is confirmed, we will switch to positions that can profit from downward trends in the markets.


The View from 35,000 Feet

The fly in the ointment, of course, is the continuing fallout from the sub prime lending situation and resultant credit crunch. Financial stocks are widely represented on the S@P and with the likes of Merrill Lynch, Citicorp and Wachovia taking huge hits, the S@P will continue to experience downward pressure.

Furthermore, rising oil prices and a collapsing dollar will add to the general malaise. Fed Chairman Bernanke told Congress this week he expects the economy to slow ‘noticeably” well into next year and he pointed out the problems associated with continuing weakness in the housing sector and potential inflation stemming from rising oil and commodity prices.

All in all, as I wrote a couple of weeks ago, Gentle Ben and his Merry Band of Feds are between a rock and a hard place. They need to continue lowering interest rates to stave off a financial collapse, while at the same time, they need to hold interest rates steady or even raise them to stem inflationary pressures.

The short term solution will be lower interest rates.

Longer term, as the credit crisis and housing problems are worked out, the shift will be to higher interest rates and inflation fighting.

The Week Ahead

Significant reports this week include:

Tuesday: September pending home sales
Wednesday: October retail sales and Producer Price Index reports
Thursday: Consumer Price Index Report

Sector Spotlight

Leaders: Precious Metals, Energy and bearish dollar
Laggards: International, Technology

So, it’s easy to see how quickly market leadership and strength can change or “rotate” from sector to sector. We will maintain our current positions and stops and let the market tell us where it’s going rather than trying to guess what’s going to happen next. The key to success is following a disciplined, unemotional trading system no matter what we hear around us, and on December 1st, we will rebalance the portfolio to reflect what the signals are telling us then. Expect continued volatility through the remainder of this month.

Watch for a new Special Report, “Surviving Sub Prime,” that I’ll send you early next week.

I am an ex Air Force Officer from the Viet Nam era, and, though I was never in combat, appreciate Veteran’s Day as a time to honor our men in uniform and their families, particularly during these troubled times.

Last Veteran’s Day, I arrived in Portland on a flight from Washington, D.C., on a dark, drizzly night and watched a flag draped casket coming off the plane and being met on the ramp by a military honor guard. The soldier’s Mom and Dad were waiting for him on the tarmac, and as his Mother’s hands went to her mouth, I witnessed firsthand the meaning and depth of their sacrifice.

Have a great holiday weekend and please take a moment to honor that soldier and his brave companions.

Your partner in prosperity,

John Nyaradi
Publisher
Wall Street Sector Selector