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Mark's Market Blog

5-17-09: How to be Dumb

By Mark Lawrence

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The markets are showing a great uncertainty in future values. We're told that the recession has bottomed, the end is in sight, and this is why the markets started going up. However, things are not so simple or clear as that. I had personally thought that the S&P would top out this cycle at 850 to 875. In fact the top so far is 930, 10% higher than my 850 value. Since reaching that top the markets have broadly declined, but we're still at 883, comfortably ahead of my 875 number even after a week of nearly 10% declines. The market even briefly traded above its 150 day moving average of about 900, normally a very bullish sign. However, I think we can all agree these are hardly bullish times.

S&P 500, February 17 2009 to May 15 2009

It's said we all learn primarily from our mistakes; if this is true I'm in line to be among the smartest living humans. I've made several big mistakes in the last eight months, and I think it time to at least catalog the ones of which I am aware (the "known unknowns" as it were.) My first mistake was made back in September when I thought this was a more or less normal cyclic recession, and I jumped heavily into stocks at an S&P of 1050, 35% down from the peak. Today this 1050 number looks like Mount Whitney. I was completely blind-sided by the US banking collapse. It's small consolation to me that Warren Buffet made the same mistake - somehow he's still worth about $40B, which is roughly $40B more than I'm worth.

My second and single largest mistake was jumping into GM stock at about $7.50 per share, currently about $1.10. At the time I had thought that this recession would be over by summer 2009 (that's roughly now), and the new contracts they were negotiating with the UAW would lower their costs dramatically and put them in line to make a small fortune. Today we all see that the number one question is when this recession is over, will there be a GM. Chrysler has already entered bankruptcy, and the judge has significantly approved Chrysler's plan to sell their major assets out of bankruptcy to a new company owned by the UAW, Fiat, and the US government. The remaining junk will linger in bankruptcy court for a couple years, but after being cherry-picked by Fiat and the UAW there's little or no value there. This bankruptcy is shocking as the government has engineered an end-around past bankruptcy laws: normally the secured creditors get first pick of the assets, but they are being forced to stand in line behind the unsecured creditors, the UAW retirees. This bankruptcy is a huge transfer of assets engineered by Obama from Wall Street banks to retired UAW workers. At this instant it appears inevitable that GM will follow into bankruptcy with a very similar plan. GM currently has about 600M shares of stock outstanding, worth about $1 per share. They plan to issue 60B new shares, which will apparently be worth about one penny per share, and give these shares primarily to the UAW and the government. Then they will reverse-split the stock, taking back shares and issuing new shares, one share for each block of 100 old shares. So stockholders who own 100 shares today worth $100 are going to wind up sometime in July or so owning 1 share worth perhaps $1. Again, stunningly, the secured creditors have been forced to the back of the line by Obama, using TARP as his hickory switch. In the one year chart below we can easily see that GM has been on a straight line downwards for more than a year, and this bankruptcy and the near-total wipe out of the existing stockholders is right on schedule.

GM stock, May 15 2008 to May 15 2009

My third mistake was selling my remaining stock a month ago at an S&P of about 860. I missed out on an extra 10% gain. I made this mistake by being emotional, I was tired of being negative for so long and I jumped at the first chance to get out positive. I also made my mistake by simply selling my shares: it would have been better to put on a stop limit order. Stop limit orders come in several flavors. The simplest is to say "If the stock drops below $xxx, sell it." In a raising market you can raise your stop limit order each day to be a few percentage points below the current price, thus locking in most of the gains while continuing to own the stock and ride the price upwards. A more complicated version is the "Trailing stop limit" order. With this order, you specify a dollar amount, and if the stock drops more than that dollar amount below its previous high, it gets sold.

Trailing stop order in a raising market

In the chart above this looks very beautiful and simple. Is it really this simple? Unfortunately, no. Let's look at one of the stocks I previously owned and sold: Apple. Below is a different kind of chart, an open-high- low-close chart. The chart is made up of a bunch of vertical lines; each line goes from that day's high to its low. The lines are red if the stock went down that day, green if it went up. On each vertical line there's a small tick pointing to the left, this tick marks the opening price. There's also a small tick pointing to the right, this tick marks the closing price.

Apple stock, February 17 2009 to May 15 2009

In the chart above we see that Apple's raise in price was not at all straight line. In several instances the price hit a new high then dropped in the next few days. Any trailing stop loss we entered would have to be calibrated to let those days pass by. From March 26 to March 30 the stock dropped by $7.50. On April 7th, April 15th, and April 20th it dropped by $6 compared to the previous high. For Apple we would need a trailing stop of about $8 to avoid these issues, about 8% at the current price level. Apple hit a high of $133.50 on May 6th; with a trailing stop of $8 I would have sold my shares at a price of about $125 on May 12th. In fact I sold them at a price of $113.50 on April 2nd, leaving $11.50 per share on the table. If the trailing stop had been set at 10%, $10, my shares would have sold on the same day but at $123.50, still leaving $10 on the table. I made similar mistakes selling my Google and SPY stocks, leaving a bunch of money on the table. Note that you cannot think that the shares could have been sold at $133.50, it's pretty much impossible to call a market top like this. Also note that if the current downturn turns out to be just a short term correction and Apple keeps going up to $150 per share and beyond either strategy cuts you out of the future profits.

My last (known) mistake was a classic: by selling my stocks in early April, I was betting against the FED. For the last 8 months the FED has been spraying money at the US economy like water through a six inch fire hose. Anytime the FED gets it in their heads to increase the money supply until prices go up, then prices are going to go up. In the long term markets always have their way, but in the short term the FED can make pretty much anything happen. The rule on Wall Street is never bet against the FED.

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