Assessment of market directions for 2010

The market has hit its high for the last 12 months. S&P is up 70% from its March lows. The Russell 2000 index is up >100%.

There are conflicting outlook on its direction going forward.

Some believes that it will go down and have a double dip recession. The bullish camp believes the market will continue to go up.

Both camps have their sound and logical arguments. The bearish camp points to the foreclosures continue to hit market at record pace, high deficits of US$1.4 trillion this year which is > 10% of GDP, unemployment > 10%, potential bankruptcy of many big states like California, New York, etc, bleak European situation with the pending bailout of Greece and possibly Portugal, Italy, Ireland and Spain. 25% of US homeowners owe more on their loans than their homes are worth. Fund managers like Jim Chanos believes that China is in a bubble 1000 times worst than Dubai. Many Elliot waves practitioners have been predicting the next wave down since beginning of Q4 2009.

The bullish camp argues that the largest 500 companies ( excluding financial companies ) hold almost $1.2 Trillion in cash or > 10% of assets – the largest since 1960s. These cash can be used for increased dividends or acquiring weaker competitors if the market pulls back. Interest rates are record low. Companies can borrow at next to nothing and invest in cheap assets. The government still have 2/3 of its $787 billion stimulus money to spend over the next 18 months. The employed are working hard than ever. People are scared of getting laid off. So they work more hours for no additional pay. These have resulted in higher output, fixed costs and increased productivity. Inventory levels are low. Since the overbuilding of inventory in 2007 and 2008, inventory levels fell by 70% for some companies.

Now that is what I think. Short term the market WILL pull back. As of Tuesday, the market was higher 27 out of the last 30 days. The probability is that market will resume its growth for another 2-3 quarters short of another worldwide crisis that could trigger another avalanche or market hurricane. You only need a small tipping even to trigger a big crisis. It could be another big corporate or sovereign debt default, war broke out in Iran and Israel, the China bubble bursts etc.

The critical thing is how you react to the crisis. I react to the crisis using the strategies outlined in my post on “Dynamics of managing a collar trade”. Because of the uncertainties in the market, I keep my portfolio hedged and protected.

My fundamentals are clear. The huge printing of money will create a moving away from paper currency. So I will bet on US$ continue to decline, strengthening of CD$ and AUS$, rise in gold price and commodities and rise in interest rates. We may see commodities price going down if China bubble bursts in the short term. We may see a deflation cycle before inflation. We may see a sudden fear of the commercial housing and residential Real Estate because of mortgage reset

My option strategies will allow me to thread through these periods of volatility, greed and fear. It will allow time for my fundamental to work. I will continue to trade collars on oil, gold, commodity stocks, good fundamentals tech companies that has a worldwide market and TBT. All these stocks will move up eventually. I have also a list of stocks of companies with high debt leverages, poor fundamental business models and low cash generation that I trade with reversed collars.

With the help of the bullish market, I have achieved > 70% ROI for 2009. Sticking with these strategies, I believe I will still hit my target of 30% ROI for 2010.