When references are made to the world's "oldest profession," I sometimes wonder if we're not exactly referring to market manipulation. In this country alone, market operators have been employing all sorts of market manipulations for more than 100 years.
What may surprise you is that most of it isn't illegal or even improper; in institutional circles, it's actually viewed as shrewd business.
One such manipulation was put on display this week – a news development that had me howling in disbelief and left me in awe of the evil genius of Goldman Sachs Group Inc. (NYSE: GS).
But if we step back, there's a lesson here – a lesson that points to real potential profits if we stop to understand what's about to happen before our very eyes. It's a lesson that I preach to investors – that the institutions that operate the market and maintain its very framework, also "influence" that market's movements. In fact, this real-market "case study" confirms the profit strategy that I've set out in this special report.
These machinations are completely legal. But they do happen and those who understand that also have the opportunity to profit from that knowledge. And you don't even have to be part of the institutional elite to do so if you know what to look for.
Let me explain…
Surely you have heard by now that the Goldman partners have decided to pay their top brass in stock instead of cash bonuses this year. So do you think it is any coincidence that Goldman shares have mysteriously declined recently? After one of the most profitable years of all time due to the company's involvement in dozens of sovereign and corporate debt and equity deals, and its successful prop-desk trading of the recent volatility?
If you had the ability to drive down the shares of stock that you were about to receive, wouldn't you do it? Goldman doesn't actually have to sell its stock to drive its value down; all its treasury department needs to do is stop supporting it during the day with buybacks.
As noted, it's not improper, it's just smart business. You can see how much Goldman's stock has fallen – compared to an industrial company like 3M Co. (NYSE: MMM) in the chart above. Since mid-October, Goldman shares are down 12% while 3M is up 9%. I seriously doubt that the pounding of Goldman's stock relative to the shares of 3M is occurring on the basis of fundamentals; it's most likely all structural.
You can be sure that some of Goldman's financial-industry cronies will be announcing the same sort of stock-based compensation too, and it will turn out to be no coincidence that their shares have fallen dramatically while most other sectors of the market have been buoyant.
Once those bonuses have been paid and the prices recorded, expect the prices of these shares to levitate, as if by magic. My guess is that this will happen at the start of the New Year, if not late in December.
Be ready to swoop in and take advantage.
The past week amounted to a series of messy, choppy sessions that reflect normal, structural change that goes on at this time of year: Some fund managers engage in end-of-year tax-loss selling; other managers tidy up their accounts so that they look all nice and pretty for customers' last account statements of the year; and still others prey opportunistically on the prior two groups.
The choppiness occurs because of the meeting of these two opposite forces: Stocks that have been super-strong, like Apple Inc. (Nasdaq: AAPL), come under some pressure as investors rebalance their winners into other stocks. And of course others take advantage of those dips to add those winning names if they don't own them already. In short, there is just a ton of gamesmanship in the first two weeks of December that makes for uneven, seesaw action.
After the first two weeks are over, the month can get down to business. I expect that to be a renewed move to the upside that will leave pessimists, skeptics, naysayers and doom-n-gloomers wondering what hit them.
If that doesn't happen, you are welcome to wag your finger mockingly at the screen. But I'm not too worried. And just in case, don't start wagging your finger until the month is entirely done.
This week featured renewed strength in the dollar, more weakness among the banks, a weekly jobs claims report that was weaker than expected, and basically a bunch of pangs of potential nastiness that would have crushed a fragile market. And yet stocks shrugged off these items like a dog shaking off water after a jump in a cold lake. That is a sign of strength.
Breadth was quite good, and the decline of small stocks was really just a minor concern. There have been plenty of entire years in which small stocks suffered almost every single day and it did not matter one bit to the big dogs in the major market benchmarks. The year 1999 comes to mind, as the Russell 2000 was only up 10% that year going into the second week of December back then, while the big-cap tech stocks of the Nasdaq 100 were already up 75% year to date.
Across the whole market, there were 10 times more new highs than new lows, including book publisher John Wiley & Sons Inc. (NYSE: JW.A, JW.B), and one of my favorite health care values, Medicare specialist WellCare Health Plans Inc. (NYSE: WCG).
I am pretty sure that Wiley hit a new high in anticipation of the publication of my new book project, the first annotated edition of "Reminiscences of a Stock Operator." I just received my first copy hot off the press last week, and if I do say so myself it does look great. I am too chicken to actually read it because I am sure that I will find a typo, but I am told by reliable sources that it's really good. In fact, famed hedge fund trader Paul Tudor Jones, who wrote the foreword, said he got his copy early this week and "loved it." So really, if Jones liked it, you will too, don't you think? You can buy it at Amazon.com now (link above), and it will be in bookstores very soon.
"Reminiscences" is the best book ever written about the stock market, and considering it was published in 1923 about events of the 1860s-1920s, there has been plenty of time for someone to top it. My annotations provide the historic context for the action, as well as profiles of key characters, notes on the gambling slang with which the book is suffused, analysis of the trading strategies its main characters employ, deep thoughts on the hidden meaning of the book, and much more. Whether you are a trader, an investor, someone who is interested in American financial history, or are fascinated by the psychology of the markets, you will find it a gripping read. Not to mention an outstanding gift.
I have read the "Reminiscences" text 100 times, now, and I still find it fascinating. The author, Edwin Lefevre, was a master of creating scenes in which the agony and ecstasy of trading — outwitting brilliant competitors, being outwitted, creating deceptions and figuring out when you're being deceived — are described in forceful but colorful language that is immediately accessible.
As far as the instruments to use to effect this idea, here's my strategy: If you decide to be invested, then generally it pays to be invested in riskier assets — i.e. at this time, emerging markets in Latin America and Asia. That's why we are over-weighted internationally now. The non-USA markets are in a bit of a soft spot right now, but don't be alarmed. Sitting through these kinds of relatively minor fluctuations is the way to go.
The Week in Review
Large-cap stocks of the Dow Jones Industrial Average rose marginally last week, but techs and small cap stocks lost ground. The week opened well on Wall Street, but U.S. Federal Reserve Chairman Ben S. Bernanke put a damper on the mood by stating in Congressional testimony that the U.S. economy still faces "headwinds."
Last Tuesday, stocks retreated, following a downgrade of Greece's sovereign debt rating and slightly disappointing earnings reports from retailers Kroger Co.(NYSE: KR) and McDonald's Corp. (NYSE: MCD). A rise in the value of the U.S. dollar vs. the euro hurt commodity prices and the shares of basic materials producers. And word of the $3.65 billion loss by the real estate arm of Dubai World didn't help the mood.
By Wednesday, investors were in "never-mind" mode as the dollar fell, industrial powerhouse 3M Co. (NYSE: MMM) was upgraded, and companies reported a rise in inventories, which is seen as a vote of confidence by purchasing managers that the economy is improving. Most of the U.S. indexes recorded gains.
Thursday also saw an increase in prices. Despite a modest, unexpected rise in initial jobless claims, traders were more focused on gains in U.S. exports
And then Friday turned mostly positive amid a report of surprisingly strong retail sales in November; a lot of consumer-related stocks, such as Home Depot Inc. (NYSE: HD) and The Gap Inc. (NYSE: GPS) rose.
In the end we saw the Dow Jones Industrial Average up 0.8%, the Standard & Poor's 500 flat, the Nasdaq Composite Index down 0.2% and the Russell 2000 small caps down 0.4%. As of Friday's close – for the year – the Dow is up 19.3%, the S&P 500 is up 22.5%, the Nasdaq is up 38.9% and the Russell 2000 is up 20.2%.
In commodity land, we'll note that the spot price for West Texas Intermediate crude oil ended the week below $70 for the first time in two months. U.S. energy officials lowered their outlook for 2010 demand and boosted their forecast of OPEC and non-OPEC production. Oil and gas inventories were also reported higher. For the week, spot prices fell $5.17 per barrel to finish at $69.86. Compare that to the high of $81.64 on Oct. 21.
The dollar, as I said, was up quite a bit last week: The Dollar Index rose 0.9%, and that held down the prices of commodities like oil, grains and gold.
The U.S. economy enjoyed a good week of data reports, as retail sales, consumer sentiment and exports were all reported higher. The consensus still believes the recovery will be sluggish, but the data is showing that the upside potential so far is better than that. Retail sales are up materially, particularly at car dealerships but also at electronics stores, building materials vendors, sporting goods stores and bars.
For those with jobs, and more hopeful about getting one, "frugality fatigue" has set in and pent-up demand is flooding stores. Data suggests that December sales may be even better, as more people report waiting to the last minute to do their shopping. I was shopping at a Whole Foods Market (WFMI) last night, and a cashier told me that store officials told employees to plan for a Christmas Eve sales rush of two times normal volume even though they close five hours early, at 5 p.m.
As for consumer sentiment, it's picking up, too – and just in time, because confidence is very important for both retail sales and the market. The consumer sentiment models are all still very low compared to the past 10 years so there is much room for improvement, as you can see above.
Final word on last week's developments was a sense of stronger retail sales and international trade. These go together, as consumers are picking up the pace of purchasing foreign goods both here and overseas. Put these together with improved corporate earnings and it's a recipe for improved hiring this month and early in the New Year, as well.
The Week Ahead
We'll see a lot of economic data this week: Brace for news on inflation, housing starts and industrial production. But the big elements of the week will be news from the Federal Reserve's interest rate-setting committee on Wednesday, and then a quadruple-witching day for options and futures on Friday.
Monday (Today): Hit the snooze button. Nothing scheduled.
Tuesday (Tomorrow): Inflation reports. They're volatile, so you have to look at multimonth averages. There's only modest upward pressure, mostly on non-core energy prices, which were up last month by almost 7%. (And now they're down; which is why energy is not a core inflation number.) Consensus for the Producer Price Index is expecting a 1% year over year increase. I'm looking for 0.7%. PPI ex-food and energy consensus is +0.2%, and that sounds right. The Empire State Manufacturing Index rose slightly in October but data suggests it will be slightly down in November as well. Industrial Production was up slightly in October, and data suggests it was up in November, and that worker hours were also up. Figure +0.7%.
Wednesday: Consumer Price Index. It was up slightly in October, by 0.3%, after an 0.2% boost in September. Considering people were afraid of deflation a year ago, this is good. Housing Starts. They were down big-time in October, by -10.6%, after a 2% gain the month before. Expect an increase in November due to record-low 30-year mortgage rates, under 5%.
The Feds' Open Market Committee (FOMC) announcement will almost certainly leave the target rate unchanged at 0.25%. But we'll see if the language changes at all from an expectation of low rates for an "extended period" to something else. We'll also be looking for news on the Fed's assessment of the recovery and the unwinding of its balance sheet, which is another way of wondering if it's going to stop overly helping the mortgage market. Fed reporting days are volatile, with low trading volume before them and, lately, ultimately positive response from stocks.
Thursday: Initial jobless claims for the past week. Last week, the number rose for the first time in more than a month. But since continuing data has been down, it's likely that the past week will feature an improved number. Conference Board's index of leading indicators. It rose 0.3% in October, with most of the improvement due to the spread between the Fed Funds rate and 10-year Treasury yields. This should continue, so figure it's positive again. Philadelphia Fed's Business Outlook Survey for November. It was up the last two months, with improving employment a big factor. Should be up again.
Friday: Quadruple witching. This is the day that equity, commodity and futures options all expire. These weeks are usually volatile at the start and gentle at the close.
[Editor's Note: For the first time in 70 years, U.S. T-bills are paying 0% interest, while U.S stocks are continuing to rise. According to Bloomberg News, this last happened in 1938, when T-bill yields fell from 0.45% to 0.05%. Then came 1939, when stocks began a three-year slide that took the Standard & Poor's down 34% after the U.S. Federal Reserve prematurely boosted borrowing costs to battle phantom inflation.
Sounds eerily like the present, doesn't it?
Very few market columnists see the parallels. And even fewer see the differences. But as this column demonstrates, veteran portfolio manager, commentator and author Jon Markman sees it all. And that's why investors subscribe to his Strategic Advantage newsletter every week.
To navigate today's markets, investors need a guide. Markman is the ideal choice.
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