 NASDAQ Rocket:
2003's Greatest Attraction
Ralph Kettell
Archives
July 30, 2003
The wildest
amusement ride this summer (and fall) may not be at a theme park.
You'll have to call your broker for a ride on this baby. The
NASDAQ Rocket is the greatest roller coaster the world has ever
seen and is coming to you courtesy of Alan Greenspan and his
great dollar-printing machine. This baby has a drop that will
make other coasters seem like mere kiddie rides. Buckle up your
seat belt, tighten down the safety bar, and more importantly
say your prayers. The drop is coming, slowly at first, but it
will drop off when you least expect it.
If you are
looking to climb aboard for a ride, you are just a bit late as
this one left the station in October. It has been clicking up
the track, click, click, click from about 1150 to 1776 (a very
patriotic height). However it is now over the top and picking
up a little speed. Slowly at first with a few bumps, but gradually
faster, faster, and faster till you can't stand it. Let me off
you scream, I can't take it, please let me off. This ride is
definitely not for the faint of heart or those with a weak constitution
or a bad back. Sorry, but you should have read the fine print
before you got on.
When the Rocket
really gets rolling, watchout! The bottom of this drop is all
the way down at 900 or maybe lower, and that's if the track doesn't
break from the huge stress and strain. Then with the cars barrelling
down the track at full speed look for the Rocket to fly back
up to 1350 before the next thrilling drop. No, no, NO! let's
not get ahead of ourselves. The purpose of the article is to
talk about this part of the ride: the impending drop and its
timing and magnitude.
Why do I believe
the market, and in particular the NASDAQ is going to reverse
course and resume its bearish ways? Where do I start? Insider
selling is accelerating; interest rates are almost as low as
they can go; the economy is moribund, but looking brighter (so
the "experts" claim); the PE ratios are still in the
stratosphere; and to top it off complacency is running rampant.
Let's dissect
these factors one at a time. Insider selling is at phenomenally
high levels. If the men and women running the major corporations
in this country are selling their stock to beat the band, they
must think they'll be able to buy it back considerably cheaper
at a later date. They have a much better handle on leading indicators
for their business than you and I. While they do not have a 20/20
crystal ball, the conditions that they can discern for the near
and intermediate term future must appear quite dim.
As for interest
rates, the short term rates which the Federal Reserve can control
are getting close to as low as they can go. The long term rates
which the Fed cannot control have recently taken a turn for the
worse (as far as the Fed is concerned) i.e. upwards. This trend
is having a significantly negative impact on the mortgage refinance
business. This is a problem for the Fed, because excluding the
stock market; the mortgage business may be the only business
in the country that was growing. The United States no longer
has a significant manufacturing base, our predominant businesses
are printing and distributing dollars, making loans, and trading
stocks. We are headed for the Japanese problem of zero interest
rates, zero room to manoeuvre, and zero (or worse) growth.
The so called
"experts" who claim the economy is improving are largely
the same folks who failed to recognize that the U.S. was entering
a recession in 2001/2002. When they finally admitted publicly
that the economy had slowed down a bit, they promptly claimed
the recession was over. Pray tell, how can you declare a recession
is over when you never declared one to begin with? In any case,
I find it difficult to believe that the economy is really improving.
Just ask the poor unfortunate folks who are out of work or those
who have had to take a much lower paying job after they were
laid off.
For the sake
of argument let us suppose the experts are right, and the economy
is starting to grow again. How will a recovering economy affect
the stock market in light of the lowest interest rates in over
half a century and perhaps the largest money supply growth of
all time? It would eventually (if not sooner) translate into
higher interest rates to moderate the growth in a recovering
economy and prevent a surge in inflation. Any rise in interest
rates would be disastrous for the stock market, especially against
the backdrop of the incredible PE ratios that stocks currently
command. The equity markets are performing a huge balancing act
on the point of a sword and the least disturbance will knock
it over and impale the players (riders) on that sword.
Now to the
critical point, the rampant complacency! The market players have
become complacent to a level which portends a major sell off.
The VIX or volatility index is a measure of the implied volatility
of options on the CBOE (Chicago Board Options Exchange). When
the VIX is high it means that investors are worried about losses
in the markets and are trading as if the market is going lower.
They are nervous and are anxious to protect their precious investment
capital. Conversely, when the VIX is low, the opposite is true.
Investors are complacent, because the market has been going up
and they see no reason for the trend to change. They are trading
as if the market is perpetually going up and have little to no
defensive position in place.
The past few
days have seen the VIX drop to levels not seen since March of
2002. At that time the market had also grown complacent and simultaneously
overvalued. I decided to short the NASDAQ. The vehicle I chose
to short the NASDAQ was Profunds Ultra Short OTC symbol USPIX.
There is normally a $7500 minimum investment for this fund, but
if you use Ameritrade the minimum is $2000. I suspect that most
major brokerages have a similar deal with Profunds.
My two primary
reasons for choosing USPIX were that I could own it in my IRA
(neither shorting nor options trading are allowed in most IRAs)
and also the leverage of the fund. USPIX invests in NASDAQ futures
and the managers attempt to match the inverse of the performance
of the NASDAQ with a 2X gearing. This means that for every 1%
drop in the NASDAQ, USPIX should rise about 2%. The downside
of the 2X gearing is that a 1% rise in the NASDAQ typically results
in a 2% loss.
My trade from
last March through July resulted in over a 100% return in about
4 months. I entered the positions starting on March 21, 2003
when the VIX closed at 19.98 and USPIX was $40.67. I sold the
position between July 17th and July 29th for an average sale
price of $83.61.
The chart above
shows USPIX versus the VIX. The basic premise of this trade is
to buy USPIX when the VIX trades below 20 and exit the trade
when the VIX gets above 40 or 45. The exit strategy is more difficult
than the entry as the valuations get very choppy when the market
has a severe decline. In order to not get whip sawed on this
trade, I suggest that you wait till the VIX hits your sell target
and then sell equal amounts of the stock on 5-7 successive trading
days. You should look for a double or more of your entry price
as this trade has generated those sort of profits three times
since 2000.
Before trading
mutual funds, you should understand some of the limitations.
First, when purchasing USPIX (and most other funds), the orders
have to be placed by 2:00 PM. This gives the fund managers some
time to adjust prior to the end of the trading day. When selling
USPIX, the orders have to be placed by 3:00 PM. These time constraints
can be a bit of a nuisance as the market often swings one way
or another in the last hour or so, and you have to commit yourself
to buy well before that. There are days when I got "hurt"
by a few percent on the entry or exit of these trades, but in
the end they worked out very well indeed.
This trade
can be very profitable while at the same time being a lot less
risky than trading options or going short. The timing is not
as critical as with options and if you buy a bit early you can
wait a couple of months till the trend reverses. That having
been said, USPIX is not a fund to buy and hold. It grinds relentlessly
lower as time goes by due to the 2X gearing of the fund and the
volatility of the NASDAQ. However, using the time tested contrarian
strategy outlined herein; you should be able to bag a nice profit
in the next few months,
As a bit of
a diversion from the main theme of this article, I am very bullish
on gold and silver shares at present. I have most of my portfolio
tied up in them, but I have been putting a bit into USPIX recently.
The USPIX/VIX trade is a great way of diversifying your portfolio.
One potential advantage of doing so is that when the stock market
crashes, it usually drags gold stocks down with it. When this
happens, you can cash out your profits in the USPIX and pick
up some more of your favourite gold stocks at nice pullback prices.
When the stock
market crashes, the coincident drop of the gold shares is caused
by a lack of liquidity in the market. It happened in 1932, in
1987 and most recently last year. When the market falls far enough
and large numbers of investors get margin calls, they have to
sell stocks to meet many of those calls. Invariably investors
will sell the stocks in their portfolios which are showing a
profit. When the general market is dropping, the only share group
showing a profit are the gold shares. The drop in gold shares
does not usually last very long and provides a great opportunity
for nimble investors to add to their gold share positions.
At major market
turning points the crowd is always wrong (by definition). Don't
be afraid to swim against the tide. Contrarian strategies such
as the USPIX/VIX trade shown above can make you more money than
any momentum trade and you'll be able to sleep nights.
July 30, 2003
Ralph W. Kettell, II
Archives
email
Disclosure:
The author is not an investment advisor and this article should
not be construed as a recommendation to invest in the discussed
securities. The author is merely presenting some possible scenarios
and what the potential risks and rewards associated with an investment
in these securities could be. The author has not been paid to
write this article, either in cash or securities.
Disclaimer:
The author's objective in writing this article is to make potential
investors aware of the possible rewards of investing in this
mutual fund and to elicit interest on their part in this stock
to the point where they are encouraged to conduct their own further
diligent research. Neither the information, nor the opinions
expressed should be construed as a solicitation to buy or sell
this stock. Investors are recommended to obtain the advice of
a qualified investment advisor before entering into any transactions.
_______________
321gold
Inc
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