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“There’s always a bull market somewhere.” I love to use that phrase and to emphasize that one of our jobs as investors and traders is to do the work necessary to find and take advantage of today’s bull market. Sometimes it’s the overall stock market itself, and all one has to do is buy an index fund and go along for the ride. Sometimes it’s a particular sector of the market (health care, energy, etc.) and a sector fund will do the trick. Sometimes the bull market is in the bond market. Or gold, or commodities, or real estate. And for the full extent of my investing lifetime this has pretty much held true. Until now. At the moment the bull market is in, uh, er, give me a minute… okay, I know it’s around here somewhere. Well gosh, it seems to have been misplaced. In a nutshell, there has never been a time in our lifetime where everything has gotten killed to the extent that it has. Stocks, bonds (with the notable exception of treasury bonds - more in a moment), gold, commodities, real estate – you name it – has all tanked precipitously in 2008. Of course, you probably don’t need me to tell you that. Chances are you are already aware of this fact. If not, simply open your next statement.

In Barron’s Financial Weekly, Tom Sullivan noted in his “Fund of Information” column that there are 11,585 U.S. and International equity mutual funds in the Morningstar database. And incredibly, every single one of them is down for the year! Go ahead and let that sink in for a moment. The upshot is simply that if you invested in the stock market this year there was really - literally - no place to hide.

As I have written about a few times in recent weeks (“Citi Bailed Out; Other Turkeys Don’t Fare as Well”) I presently believe that -  while a very strong rebound that may last for months is likely in the works - it may take a lot longer for a “new bull market” to emerge. As a result I have suggested the idea of actually lightening up on stock holdings by selling into the next major rally. And the truth is that no one wants to hear it. In fact if the stock market were to rally strongly for the next several months - along the lines of the “typical” November to May rally (“Happy Days are Here Again…No, Really”), the vast majority of investors are going to “breathe a sigh of relief” and lapse back into the standard “the stock market always goes up or always comes back” way of thinking. This may lead to a great deal of long-term frustration - and ultimately despair - if in fact the economy and by extension, the stock market takes a few years to “right the ship.” 

The Only Bull Market In Town - While it Lasts

Okay, the truth is that I was slightly holding out above. There actually has been a bull market somewhere. Treasury bonds have enjoyed an excellent run. Not corporate bonds. Not GNMAs. Not muni bonds. But as you can see in Chart 1, t-bonds bottomed out in June and have advanced since, rallying especially sharply in the past month.

 

Chart 1 - December T-Bond Futures (also known as “the only thing going up”)
click here for larger view

Now on one hand this makes perfect sense. A weakening economy typically leads to lower interest rates and lower interest rates are the driving force for the t-bond market. At the same time this latest advance smacks of a fear driven “flight to quality,” as investors seek the perceived safety of treasury-backed bonds. This has happened on other occassions in the past. Historically, once a fear driven flight to quality buying panic in T-Bonds is over, the advance peters out. Consider the data presented in Chart 2. This chart was put together my Tom McClellan, world-class market analyst and Editor of the McClellan Market Report. What is interesting to note is how similar the current action of the t-bond market is to several other previous “blow off” tops - specifically, 1998, 2001 and 2003. There is no way to know for sure if that will be the case this time around except to wait and see.   

 

Chart 2 - Previous T-Bond buying panics and today’s market; Are T-Bonds “blowing off”? 
(Source: Tom McClellan)

As further evidence that the advance in treasury bonds has been driven primarily by “fear,” consider the fact that the rate of interest being paid on short-term treasury bills is now about 0.3%. As you can see in Chart 3, since 1990, short-term interest rates have plummeted from about 9% (denoted as 90 on the right hand side of the graph) down to approaching 0%.

 

Chart 3 - Short-term rates - Headed for 0%?

To put it another way, investors are essentially lending money to the government for next to no return just for the privilege of having the government keeping their money safe. Ironically, that very same government is meanwhile actively in the process of trying to give much of that money away to every badly run and/or dying business and/or borrower with a sob story - with the notable exception of auto manufacturers (note to myself: if it becomes necessary to go to Washington to beg for money, rent a beat up old car, not a private jet).

In a nutshell, given the crazy nature of today’s markets, it is absolutely possible that long-term interest rates will continue to fall and that t-bond prices will continue to advance. Nevertheless, given the sharp run enjoyed recently by the long bond, those still waiting for the right opportunity to panic into bonds might want to wait for a meaningful pullback first. Then panic all you’d like.

Pure Momentum

On a number of occassions and in a number of different places, I have written in the past about a system I developed that I call “Pure Momentum.”  Now it’s not really much of a “system” per se and the basic idea has been around for a long time so to say I “developed” it is perhaps a bit of an exaggeration. Nevertheless, in this business, trading methods seem to be held in slightly higher regard if you “developed” them and also if they have a catchy name. Also, the longer they have been around, the better. So let me reiterate that “many years ago” “I developed” “Pure Momentum.”  Impressive, eh?

Okay, all kidding aside, the rules are simple:

1. At the end of the month identify the Fidelity Select Sector funds that advanced the most over the previous 240 trading days and buy and hold those funds until the end of the next month;
2. Repeat.

Now, historically this has been an excellent investment method. But how does it fare when the stock market – including every single sector – melts down?  Well, there is some good news and some bad news. The good news is that as of September 30^th, there were no funds to buy. In other words, looking back from the end of September there were no Fidelity Select Sector funds showing a profit over the previous 240 trading days. That was also the case at the end of October and November.

So the good news is that during the market meltdown of October and November, Pure Momentum was 100% in cash. So what’s the bad news?  Simple: the market was lousy well before October and so far this year the return for Pure Momentum is -22.9%. Now, of course, one could argue that this is better than the 36% decline suffered to date by the S&P 500 Index. And this is true. Still minus 23% is minus 23%. The long-term results for Pure Momentum appear in Table 1.      

Table 1 - Pure Momentum versus S&P 500 Index

Summary

Uncertainty remains the watchword (“The Most Important Word for Investors in 2008”). What looks terrible may turn on a dime and rally sharply higher at any time. And what looks good today could vanish into the ether tomorrow. Now more than ever before, it is crucial to have or develop a plan - one with a keen eye towards risk management - and to follow it.

And FYI: relying on the stock market - or the government - to “bail you out” does not consititute a solid investment plan.

To search for previous articles written by Jay Kaeppel, please click here.

Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site

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