WHERE SHOULD YOU HAVE PUT YOUR MONEY IN 2006?

A weekly newsletter based on the fact that stock market sectors are made up of industries, that industries are made up of individual stocks, and that individual stocks in the same industries and sectors move as a group. The proven best way to profit from the stock market is to keep your funds invested in the stocks of top performing sectors/industries at all times, and the best measurement of performance of these sectors/industries is their price movement over the previous six months. Below you will find commentary of Sectors, Industries, and Stocks based on the most recent 6-month period as well as updates on the past week’s action...

May 19, 2006

A Bird in the Hand...

One of the best things about Simplespreading is that you know your goals before you go into a position, and can judge whether the position should be kept or cashed in at any time. This simple precaution would have saved investors in the gold markets recently. Take the example of Royal Gold (RGLD). On 10 March the stock could have been bought for $28.45 while at the same time selling the July 30 calls for a fat, juicy price of $3.20. The RGLD July 30 Buy-Write works out to a cost of $25.25 ($28.45 - $3.20). 
If the July 30 calls are exercised by the 21 July expiration date, the potential profit of $4.75 ($30 - $25.25) works out to a gain of 18.8% over the 4-month holding time. Annualized, that works out to about 56% - a really nice situation. 
But two and a half weeks later, on 30 March, with the stock having rallied up to $37.57, you could have sold the buy-write for $28.67. You could have sold RGLD stock for $37.57 while covering your short call (buying it back) at $8.90. Your profit of $3.42 ($28.67 - $25.25) works out to 13.5%. Do you play or do you stay?
There is absolutely no reason to hold the position one second longer. You've made 70% (13.5% divided by 18.8%) of your potential profit in only a few weeks. Why wait another 16 weeks just to gain an additional 5.3 percentage points? Every minute you're in the market, you're holding risk.
And that's exactly how it's worked out so far. 
Today RGLD closed at $28.68 and the July 30 call closed at $2.25, making the buy-write now worth only $26.43 - still a profit, but not nearly as much as before. And with 9 weeks still to go, anything can happen. The stock can easily rally back above $30 for the July expiration, allowing you to cash in on your full 18.8% profit, but it can also spiral downward into a loss. Although there are several adjustments you could make if adverse conditions continue, still you know you've lost out on profit and time.
The important concept to catch here is that when as much as 70% of your potential profit is handed to you in the space of a few weeks, you take it. Bank the profit. Roll the proceeds into the money market account and wait for another opportunity. And that's the essence of Simplespreading.

What Happened and Why

There's no shortage of explanations for what's happened to the world's markets over the past two weeks. Take your pick. Bernanke failed his first communications test with CNBC anchor Maria Bartiromo. Or interest rates might continue upward. Or the standoff with Iran might get worse. Or the dollar is about to go into freefall. Or energy costs will remain high. Or inflation is rearing its ugly head.  Or there's political trouble brewing inside the Beltway. Or the housing bubble is popping all over the place. Or we're about to fall into recession. Or Malcolm Gladwell's Tipping Point had been reached. Or simply it was David Clayton-Thomas' 'What goes up must come down, spinning wheel got to go around.' 
Or, make up a few yourself. 
The real reasons won't be known until hindsight delivers the verdict somewhere down the road. And even then, there'll be contentious arguments about what really happened and why it caused markets to react as they did. After all the effort has been expended analyzing the weakness, one thing stands clear: prices went down. Period.
Nothing new happened during this fortnight that hadn't happened before or had not been predicted before. It just happened now. The long-termers and fundamentalists are surprised and shocked. And rattled. They can be counted on to bring forth numerous explanations of why investors should be unconcerned. But how else could people who are 95% invested all the time with no tool in their toolkit with which to see any reasons to sell stocks react?
However, we know different. Previously on these pages we have discussed the weak technical underpinnings of the market. We touched on the glaring non-confirmations that were becoming more apparent day by day. We touched on the parabolic, and certainly unsustainable, price curves in raw materials, precious metals, and energy. And we have touched on how most Simplespreads should have been closed out either automatically by having your calls exercised or by outright selling of the buy-writes.
We don't presume to understand why something is happening at any particular time. That's why we have history to sort over the remains of the disembodied markets well after the fact. In the mean time, we welcome both the runups which provide us with profits and the selloffs that provide us opportunities. The bottom line is that it's good that the spinning wheel does go around, because that's the way it works.

FOR THE WEEK...Whacko! Again.

Metals & Mining held on to their first place rank over the past 6 months, but took a shellacking for the week. Still, 7 weeks on top has provided good profits. Manufacturing holds onto a distant second place. How Automotive can remain in the Top Ten is a good question. Aerospace/Defense continues strong. Transportation is losing some of its luster but gets a strong push from lower energy prices...relatively speaking. How many airlines are using the derivatives markets to hedge their energy costs? Southwest has stated they do. Leisure, including Restaurants, of which Burger King's public offering this week was the high point, remains strong. Energy is still in a strong uptrend but has to be getting long in the tooth, absent the next geopolitical uprising. It was a very bad week for energy stocks as oil dropped decidedly below $70/barrel. However, when at supports, this group can come alive in an instant. Consumer Durables is dull and boring. We wouldn't be upset to see them drop out of the Top Ten. Biggest surprise is how well Electronics holds on to its ranking in light of continuous bad news coming out of corporate headquarters. Some of its smaller stocks show strength. Chemicals revisits the Top Ten for the first time since last May. This only makes sense as other basic industry sectors have had their day in the sun recently.
The technical damage done here was extensive. Whether the major indexes will be able to recoup and mount another assault on Dow 11750 remains to be seen. If defensive issues rise to the top, then we can look for more market weakness. That's what we should be keeping our eyes on. Definitely not a time to get adventurous, although selected pockets of strength that present opportunities can be surveyed.

THE TOP TEN...