Options Expiration Dates Still Important

As I have indicated in the past, presently markets are heavily influenced by speculators. One of the most important tools used by speculators are options. And, options expire worthless after certain dates creating a lot of volatility.

The situation has not changed. Markets rose up until the days just after options expiration in January. That is exactly the same as what is happening today on 2/24/2014. (It is a clear sign that the market is dominated by speculators.)

But after reaching all time highs in January, market indexes fell by nearly 7% over the next two weeks. One cannot predict with certainty that the pattern will repeat, but it is important to remember that the markets are ignoring a lot of bad economic news.

It appears that speculators are still following the same “logic” that they have followed for a year: A) In a good economy, rising interest rates won’t matter and/or; B) In a poor economy, the Fed will continue or even expand its stimulus. I call this the “you can’t lose” belief.

History teaches that when a significant part of the market adopts this “you can’t lose” belief, it is a sign that there are very few buyers left and a market correction will likely come soon. It is particularly dangerous when those that believe the “you can’t lose” story are speculators. Speculators have a tendency to move like a herd, when they exit, usually they all panic and exit at once.  

Like all of history’s lessons, they are not right 100% of the time. And, the “soon” does not always mean next week, next month, or even next year.

So, we still have a lot of uncertainty and therefore what I perceive as a dangerous market. Buy, Sell or Hold?  As frustrating as it can be, Hold and caution still seems the prudent course of action for retired or close to retirement investors.

 

Stalemate....

Sometimes Mr. Market is depressed. Sometimes he is euphoric. And sometimes he is just downright confused.

I’ve warned in the past December that most stocks seemed to be a bit overvalued.  Come January 21, we saw a bit of a pullback. In fact, by February 3, we saw a drop of nearly 6%, both in domestic and international stock prices. 

Keep in mind that “markets” are made up of millions of investors but these millions can be placed into five major groups: Speculators, Institutional, Not Yet Retired Domestic Individuals, Retired Domestic Individuals, and Non-US Individuals. Each of these groups reacted a bit differently to the pullback.

All of the three groups of “Individuals” decided that the pullback was just the beginning of something worse and many sold off—so much that nearly $30 Billion was pulled out of equity mutual funds and ETF’s. To put this into perspective, flows into equity mutual funds in 2013 totaled about $130 Billion.  So $30 Billion out in only two weeks is a significant wave of selling.

Speculators, and Institutional Investors still confident that a “Buy the Little Dip” program would be successful (As it was in 2013) decided that 6% was enough for a “buying opportunity” and markets have recovered nearly half of the recent drop. Even bad economic news did not hold them back. No matter what bad news they hear, they seem to excuse it away……  It’s the weather. Or, some parts of the terrible employment report are good.  If it really is bad, then the Fed will step in and fix it. Since there are no other alternatives for making money thru investing, they convince themselves that the stock market must be on its way up. Keep in mind this is all “wishful thinking” and quite dangerous.

The truth….nobody is quite sure what, in fact, the near term future holds. The economy has been improving, but very slowly and only with the most massive global monetary stimulus experiment ever attempted.  And, the Fed is slowly unwinding that stimulus with the “Taper”.

So who is right..the pessimistic individuals or the optimistic risk taking hedge fund speculators and institutional investors?  Only time will tell for sure, but if you are part of the Retired Domestic Individuals Group, reasonable caution should be the order of the day.  Stay with a conservative asset allocation. (Not too hot and not too cold) and be particularly cautious with any excess cash.  If the speculators are right, you may miss some of the upside, but if they are wrong, you will have protected your nest egg. Sometimes doing nothing is exactly the right thing to do.

Keep in mind that speculators will exit the markets very quickly and “en masse” when they decide that “momentum” has turned to the downside. The longer we go without a healthy 10% correction, the more likely it will be larger than 10%. Remember the saying “Be fearful when others are greedy”. Well not everybody is now greedy, but a significant number are. So perhaps the appropriate saying for now is “Be careful when speculators are feeling greedy”. It is hard to make money in these types of market conditions but history teaches that it easy to lose money in times like these.

My best guess, markets will fluctuate and it is better than 50/50% that we will see better buying opportunities sooner than later.  Be patient and think long term---like 5 to 10 years out.

 

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.