Bear Market Bounce Check-up - including solar and gold
By Dr. Duru written for One-Twenty
July 31, 2008
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It has been two weeks since I declared: "...this climactic low is incrementally more convincing than all the previous five put together. So, risk/reward tells me I have to at least nibble here." I think it is now time to do a quick check-up on the bear market bounce that is underway. Overall, I like the action when I take a step back away from the head-spinning daily action.
The Backdrop
I understand why skepticism reigns supreme about this bounce. We have already seen five climactic lows in the past 18 months and nothing feels like it has truly improved to convince a lot of people that better times are just around the corner. In fact, things feel a lot worse, and each low has required stronger and stronger government intervention to keep things propped up. This time around, we had the Federal government getting its bluff called on its backing of Freddie Mae (FRE) and Fannie Mae (FNM). With toxic mortgage paper backed by these GSEs circulating the globe, the U.S. government can ill-afford to allow these entities to blow-up. At this point, allowing these GSEs to fail would be like Uncle Sam declaring that the quote stamped on all greenbacks - "this note is legal tender for all debts, public and private" - has caveats. In other words, their failure could start a global run on the U.S. treasury with dollars flooding the market faster than any currency printing press could spin. For extra cream on the top, the SEC decided to get serious about enforcing its existing rules against naked short selling rules singled out specific financial institutions for an extra warm group hug. And like a good mother hen, the SEC has also told us that if we have nothing nice to say about a publicly-traded company, especially a financial institution, please do not say anything at all. If this low does not hold, I simply cannot imagine what new tricks the government can create to save us for the umpteenth time. Perhaps we will get laws preventing the sale of stock altogether. But in reality, if the lows break yet again, it should be time to admit that the market needs time on its own to do a final purge of burdensome excesses and then heal itself. At some point, we stop looking for the magic bullet that turns the ocean liner around on a dime.
The Technical Case
At the end of last month, I made the case for why a triple bottom would not hold on the S&P 500. Only after that support broke did we finally get the spike in the VIX that everyone seemed to be looking for. Once again, that spike, this time to 31, provided a bottom. We even got a rally with good follow-through the next day. In an earlier piece, I indicated that this is exactly the kind of behavior I want to see in a convincing bottom: a bounce and then little time for the tentative to get back in at those "discount" prices. During this bottoming process, the T2108 indicator spent a historic 16 days under 20% (see "Does the VIX Need to Spike at A Climactic Low?" for more details on the importance of this). With only the 1987 crash and the Iraqi invasion of Kuwait marking the two other periods in the past 22 years that were even more oversold than this last swoon, you have to sit up and give the bottom-callers some real attention now. We may not recover the highs from 2007 for years to come, but you have to increase the odds that some kind of lasting (and tradable) bottom is closer than ever here. Earlier this year, I guessed that the low on the S&P 500 would be put in at 1200. So far so good, but there is a whole lot more work ahead, and it will take at least 6 months to prove this low can hold. Our last 5 climactic lows lasted 5, 3, 2, 2, and 3 months before being re-tested and/or broken.
Both the NASDAQ and the S&P 500 are now sitting in a sloppy congestion pattern and have a good shot at ending July flat or even in the green (see charts here, including notes on resistance levels). Either way, this would be a remarkable accomplishment for a month that was filled with such high drama and could provide a shred more hope for the stock market. This is a good time to break out the stats I drew up when looking at how the S&P 500 tends to behave around May when I tried to take a different approach to the age-old adage to "sell in May." Since 1962, there have only been 6 years where the high from May was never achieved for the remainder of the year. The May high on the S&P 500 was 1440. This gives us our bear market bounce target of a 12% jump from here. This may sound like "crazy talk" because of the real doom and gloom that surrounds us. However, we should recognize by now how swiftly the mood can shift in a bear market despite whatever reasons exist for the market to behave differently. For example, we now have a catalyst in place in the form of falling oil prices. That could be all the reason the market needs until such time it recognizes that oil prices are falling because the global economy outside the U.S. is grinding to a halt.
The Wild Solars
Speaking of falling oil prices, two weeks ago I noted the surge in shorts on the USO and said: "The shorts will eventually be right on oil, but timing is everything here, and I suspect they are not trying to make long-term bets." Little did I know I was writing at the exact (recent) top in oil. At the time, I was focused on considering the impact a fall in oil would have on solar stocks. After a wild up, then down, then up again ride, solar stocks in the TAN and KWT ETFs are roughly right around where they were when the oil fever last broke (KWT is 5% higher). I think we solar enthusiasts should declare a small victory on that one. Maybe, just maybe, we will take our oil "savings", for however brief a time we may earn them, and invest, not simply consume.
I have written a few pieces recently on solar stocks, including that last one where I compared the shorts in the USO to the shorts in the solar stocks. My report card is as mixed as the wild fluctuations in the stocks themselves. I first warned about the short-term risks in solar stocks only to see my two main examples, First Solar (FSLR) and Evergreen Solar (ESLR) turn around and give me reasons to be short-term bullish. On June 24th, I made the case for playing FSLR into earnings. It looked good for all of two days or so before I was forced to change strategy. I bought and sold puts as FSLR swooned. The stock missed my stop by a few pennies on July 3. In two weeks, it soared back to the starting point of the pre-earnings trade. In another two weeks, it had a shallow swoon and came right back to the starting point. Through it all, I gradually came to accept that I was going to make a play for the earnings themselves with a target to sell a pop on headline earnings BEFORE the conference call. We have too often witnessed solar companies report stellar headline earnings only to get faded hard during or after the conference call after folks start to worry about this or that. FSLR's earnings this time around displayed the kind of strong execution we have come to expect, but their guidance still did not seem to justify the high premium in the stock. FSLR peaked in the after-hours just under the all-time high before the conference call, and it settled just above $300 after the call. All-in-all, the reward on this trade was very good, but I think I took on far too much risk to earn that reward. Going forward, I will be looking to see whether FSLR can make a new all-time high and hold it. I think it is very likely that FSLR stays stuck in a wide range from $200-$230-$330 or so as it grows into its valuation. I also took careful note that FSLR's cash position was hurt by manufacturing start-up costs. Now that the insiders may be done selling their millions of dollars in FSLR stock for now, watch for FSLR doing a secondary like so many other solar companies have done recently.
Evergreen Solar (ESLR) was my big disappointment. I should not be surprised as they have spent years disappointing investors with many promises and little to no profits. I bought calls in June thinking that the second announcement of huge contracts would finally sustain higher prices. Those went out worthless. ESLR also crimped its stock with another cash-raising round. So, despite billions in contract backlog, ESLR is back to "show-me" status. Its chart (not shown here) is a mess with numerous points of upward resistance. I see little reason for it to break out of the $8-13 range anytime soon.
For the longer-term, I have added 5N Plus (VNP: TSX) to my basket of solar plays. It has finally pulled back under $10 again marking my first entry point. Between TAN, 5N Plus, Solarworld, and Arise Technologies (APV: TSX), I think I have my fill of solar. However, I will be looking for a few shorter-term opportunities. In particular, my next project will be to examine the correlation across individual solar names around earnings time. I noticed several solar stock running hard the past two days into FSLR's earnings (although some of that is certianly due to potentially positive subsidy news out of Spain and the U.S.). I am particularly intrigued with Sunpower (SPWR) with its high short-interest and string of recent good news.
Stumbling Gold and Other Commodities
On June 28th, I made the case for retaining my gold position. Since then, had a small rally of 7% or so before spending the last two weeks giving it all back. I am still bullish gold until the Federal Reserve raises rates. The current strength of the dollar may be related to some anticipation of further inflation-fighting tough talk from the Fed, but I think it will stay talk for quite some time...at least until America's financial system can walk out the hospital in one piece. I am again eyeing the 2008 breakout around $83 as an entry point to add to positions.
In the meantime, I am particularly intrigued by the action across the commodities space. As I have noted earlier, July 2nd was a major blow to the commodities bull when everything from coal to steel to agriculture was slammed with massive losses. It had all the look of an exclamation point at the end of a major rally. One of the only stocks I have seen that has even come close to recovering those losses is Cleveland-Cliffs (CLF). It closed at $116 right where it was before the July 2nd sell-off. CLF reported earnings Wednesday night and the post-earnings reaction will be key to revealing whether there is near-term hope for other steel, and coal stocks. Potash (POT) is another one to watch. POT has gone parabolic for several years. It quickly recovered from the July 2nd selling back is now back under those levels even after reporting stellar earnings. I am watching commodities closely because I think sustained weakness will indicate further economic weakness somewhere down the road. It would be something like the inflation relief that will not seem to feel as good as we had expected. In particular, watch carefully what happens after the Olympics are over, and perhaps China slows down to catch its breath...
That's my bear market bounce check-up. Pulse feels fine but that blood pressure is a little high. Let's see whether another dose of Federal Reserve meetings next week can help you feel more like you did last year.
Be careful out there!
Full disclosure: Long S&P 500 in an index mutual fund. Long QLD, GLD, GG, TAN, VNP (Canada), Solarworld (Germany), Arise Technologies (Canada), and FSLR puts (left-over from hedged position). For other disclaimers click here.