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My Favorite Reader Questions, Answered

0 | By Shah Gilani

September has been a busy month for us.

While the country slowly starts to recover from numerous natural disasters, there was no chance to catch our collective breath. There was a Federal Open Market Committee meeting. There are threats abroad. There have been plenty of promises coming from the Administration.

The month is coming to an end, but it doesn’t appear as though anything is slowing down. With that said, I figured now would be a good time to do another Q&A.

We really appreciate all of our readers and subscribers here at Money Map Press. We especially love hearing from you, so don’t be afraid to comment on any of the articles. And we especially love hearing if you find any success from acting on our expertise, so make sure to keep us in the loop. We want to hear it all.

I found some incredible questions in the comments section and in the emails my readers send, and some of them I needed to answer. From which financials to invest in, to where you should be placing your stops, to the market’s personality, there is a lot to touch on.

Let’s get started…

Q: If the “Fab 5” are failing as the leadership stocks and financials are taking over, should we follow with our own capital and buy banks? – Annie D.

Right now, the banks are moving up on the prospect of tax cuts and interest rates moving higher, which will widen their net interest margins and profitability. Additionally, the rising and more volatile rates mean more trading opportunities.

Rising rates, I believe, are a given. That’s a plus for banks. If we get meaningful tax cuts (and that’s a big if) the banks will continue to lead. So, yes, I like the banks here. Bank of America Corp. (NYSE:BAC), Wells Fargo & Co. (NYSE:WFC), Citigroup Inc. (NYSE:C), JPMorgan Chase & Co. (NYSE:JPM), and Morgan Stanley (NYSE:MS) are all good. I don’t like The Goldman Sachs Group (NYSE:GS) here; it hasn’t been reacting positively to any of the news that’s moving the others.

However, a word of caution is warranted. If the Administration’s tax plans go to hell in a handbasket, and the market tumbles, the banks will see a good amount of profit-taking and Goldman will get hit hardest. The reason I’m in the “I’ll believe it when I see it” camp on tax cuts getting through Congress is that I don’t see Democrats going along with any plan. It’s not that they don’t want tax cuts, it’s that they don’t want to hand a victory to the President, and tax cut reform would be a huge victory. The game-playing here is frightening. Not much has come out of the Dems side, so far. In the backroom, they’re probably leading on the Administration. Then if they want to derail proposed cuts, they’ll come out against cuts for the wealthy and big businesses and claim there aren’t enough cuts for the middle-class, etc. And they’ll be right. That’s how wicked things are politically these days.

Lastly, if we do get tax cuts and repatriation, the tech sector should head higher too.

Q: What other stores like Toys “R” Us that are about to go bankrupt? – Scott M.

If Nordstrom Inc. (NYSE:JWN) doesn’t find a buyer soon, it’s likely headed into the rabbit hole too. Like Toys “R” Us, it’s been saddled with billions in debt, and debt service is an overwhelming capital allocation that should be going into more creative efforts.

Besides JWN, and I’m referring specifically to companies you can trade, there are a bunch of losers that are heading for bankruptcy. Occasionally I’ll tell you which ones we’re targeting in Zenith Trading Circle, where we’ve been on a tear since April. There are probably even more retailers that were taken over by private equity and buyout shops that are debt dogs out on their last walk. But that’s not important if you can’t bet on them crapping out.

The market is continuing to rally and the prospect of tax cuts is causing some investors (and a lot of speculators) to “rotate” into beaten-down, cheap retailers where there are huge short positions and players try and trigger short-covering rallies with their bottom-fishing buying. There’s a lot of that going on right now. But if the market falters, all those fake news fliers are going right back down, and hard. Most of them are going to die anyway, but a rallying market will breathe more life into them for only so long.

Q: You use “markets” as if these constructs had a personality. Isn’t it that they reflect the sum of all hopes and fears of all market participants? – Conrad L

The markets absolutely have a personality. Being hopeful or fearful are personality traits, aren’t they?

I’ve said for years, capital moves stocks, but people move capital. The psychology of investors is what moves markets. And people don’t realize it, but technical analysis is a map of their psychology in their fears and hopes and how that moves a stock.

Q: Given the amount of cash out there, is the Fed unwinding that big of a deal going forward? The 7 trillion you mention in stock buybacks alone may have been reduced significantly had investors had better options in the fixed income markets (i.e., government bonds), as companies may not have been issuing such a massive amount of corporate bonds to fund the buybacks. We wouldn’t have such elevated stock prices and a Fed without $4 Trillion of securities. – Scott R

We can talk about the Fed, what they’ve done, and who they serve on and on and on. It all comes down to their manipulation of rates to help their constituents, the big banks. The secondary beneficiary, which was planned, is the market.

Share buyback programs, courtesy of low rates and lack of viable alternative avenues for corporate cash made sense. Without a good feeling about the economy, companies weren’t willing to increase capital expenditures towards growing capacity and production, because they weren’t confident consumers could step up and buy their goods and services. So they invested what they had laying around in their own stocks. When rates remained low, they realized they could borrow and keep supporting their stock prices by extending buyback programs.

How that affected investors, who didn’t have good yielding options in fixed income or elsewhere, was simply to drive them into equities where management of companies had planned on a floor under their stock and other investors joining the party would lift stocks higher and higher. Then everyone would feel better because of the “wealth effect.” And, guess what? That black magic worked.

The Fed’s not going to take away the fairy dust too quickly, they know they will blow the top off the mountain they built, and they aren’t stupid. Crooks, yes. Stupid, no.

Q: What percentage do you recommend on our stops? – Chris N

That’s a great question. In a perfect world, it’s based on two things.

  1.  How much volatility is normal for a stock?
  2. Where is the support?

As far as volatility, if you arbitrarily decide to put a stop 5% below where your stock is, you might get stopped out regularly if that stock moves up and down in a normal, regular 7- 10% range. You must give stocks room to meander within their average range of movement. If you want a great technical measure of what kind of range a stock moves in, use “average true range” calculations. Look it up. It’s not simple to calculate, but ATR is ideal for defining the parameters of a stock’s natural movement.

Nothing’s perfect. After all, stocks change their patterns. But placing your stop just below their range is a good starting point. As your stock moves up, raise your stop accordingly. With a methodology like this, you’ll be moving the stop up slowly and not hoist it up too much just because the stock jumped. Calculating the new spike into the ATR will give you a new range of volatility.

Second, I use technical analysis to look for support levels. If I’m not using an ATR calculation, I’ll use a support level that’s not too close to where the stock is now, but the next level below. If I’m using both ATR and support levels, I’ll choose the support that’s below the lower parameter of the stocks volatility range (ATR). That may be a little too far below where I’d like my stop, but I want to give the stock room. If it’s truly too far below and I’ll lose more than 10 or 15% on the stock, I’ll fall back to maybe 2% below where the bottom of the stock’s ATR is.

Q: Is hedging for a downfall by buying VXX or TVIX a good idea?– Jan H

Yes and no. If you know there’s a drop coming real soon, then they’re both good. But who knows that?

Because we don’t know for sure, then when you constantly hedge by buying and holding volatility indexes, you’ll lose a lot on both. They’re both short-term instruments that lose value quickly once you buy them. They don’t track the VIX well over time, and in a bull market, they’ll cost you.

I prefer buying call options, a few months out, on the VIX itself if I think there’s a drop coming, which is usually accompanied by a spike in the VIX.

Sincerely,

Shah Gilani

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