Sunday, January 06, 2008

2008 Predictions and Investment Plan, Part I

Everywhere I look, there’s a 2008 prediction of some sorts, so I thought I’d chime in as well. However, I'm more concerned with concrete actions based on these predictions. Part I will cover my outlook and plans for the US stock market. Emerging markets, gold and other commodities will be covered in Part II.

US market
Before I begin, let me suggest a reading of this week's newsletter from John Mauldin, titled Forecast 2008: Recession and Recovery. I share most of his views, the difference is he explains it a lot better than I can.

After a tough 1st week, culminating with a very weak jobs report on Friday, recession talk in the media has reached somewhat of a crescendo. Although I have talked about a housing-lead slow down/recession for about a year, I’m still not sure if we’ll get a technical recession, defined as two consecutive quarters of negative GDP growth. What’s holding me back is not a belief in the “resilience of the economy” but rather the sleight of hand in government inflation statistics that could provide a politically expedient boost to the GDP. Clearly, this difference in semantics cannot deter me from predicting a bear market, conventionally defined as a 20% drawdown. For S&P, which peaked at 1576, it implies a downside target of below 1260.

Indeed, the charts of S&P are far from healthy-looking. On the long term chart, we’re sitting right at a multiyear support. At same time a closer look at the daily chart indicates that a bounce is not imminent. The usual sentiment indicators such as the VIX and the put/call ratio both indicate more pain before stabilizing.

I bought some SPY puts before closing on Friday. I usually don’t do this after a big downward move, but I had thought that a “Black Monday” was a real possibility. If there is a silver lining in this dour outlook, it’s that I still think the bear market won’t be anywhere nearly as bad as the one in 2000-02. For one, I plan to get together a shopping list for financials in the middle of the year. It will most likely be comprised of names like GS, BAC and WFC.

Action plan: Sit tight with base metal and energy positions through anticipated weaknesses. Pay more attention to breakouts of key financial stocks and consider taking positions in Q2/Q3. Hedge US market exposure by maintaining put/inverse fund positions (but take profits often!). The real danger to my portfolio is a more severe bear market than anticipated. To wit the well-known 17 and 43 week EMA crossover (more on this later) will be monitored closely.