Lockey News

HISTORY DOESN'T REPEAT ITSELF; IT SIMPLY RHYMES

It's always tense when market volatility increases. Historically high gas prices, terrorist attacks in Spain (are we targets of another attack?), upcoming Presidential election, weak job growth. All of these factors have coupled with the powerful growth in the economy to bring the rollercoaster volatility back to the markets. The indicators we closely watch have begun to erode and change direction. Things get especially tense when our indicators begin to change with the markets at such high levels. Of course, we have no crystal ball here, so we never know exactly how it will play out. We can go back and look at times past and evaluate how this time might look like some other but in the end you never really know. History doesn't repeat itself; it simply rhymes.

All too often we are tempted to take a knee jerk reaction and begin to sell stocks that have done nothing to suggest they were in any way becoming controlled by supply. After the past few years there are many investors who look at their portfolios and still see losses, even with the strong 2003 rally we just experienced. Although our clients captured the vast majority of the rally in 2003, many may still be underwater if they only began their investing endeavors in 1998; the S&P 500 today, even after a terrific run in 2003, is only back to 1998 levels. A correction from here would only cause many investors to simply give up.

"I've ridden this ride once before, and I refuse to do it all over again." Many investors won't do it again, and they will simply cash out of the markets and keep their nest egg in the bank (which by the way, is not even keeping up with inflation BEFORE taxes). I have no doubt there are many more investors out there just like this, who have only one shot at retirement and who don't have the "hold for the long term and everything will be all right" time left. For these investors the only answer is preserving what they have.

Keep your focus. The market will do what it wants to do. The indicators we follow, the Bullish Percents, are simply risk evaluators. The risk in the market can remain high even while the market moves higher. We've seen that happen since June 2003. Indiscriminately putting on hedges is almost as bad indiscriminatingly buying stocks in a high-risk area. So let's take a deep breath and go back to the same "lifeboat drills" we performed over six months ago concerning a similar period in the market where the risk was high and the market remained high.

Below is the NYSE Bullish Percent chart from 1982-1983. Notice how the index rose to 86% in November 1982 (highlighted in yellow). It then reversed to O's for one month and created a 10% correction in the Dow Jones. So let's say we see something of the same order in the near future, we then might expect a correction of about 1100 points. How many of us would "freak out" and panic if the Dow fell 1100 points?

I want you to also notice that the correction in December 1982 did not even carry below 70%. Keep in mind it takes a move to below 70% to change the risk level to Bear Alert (Remember that after the sell off in the markets the past several weeks, the NYSE Bullish Percent is still at 81%). Our risk level will not change until it crosses the 70%. So for the 10% decline in 1982, the risk level did not even change. Being in O's was a sign that at worst you did not have the football. Of course, it also could have culminated in a crash of astronomical magnitude! The point is we never know. This time it might prove to be a high-risk point in our investment program with only limited consequences. Only God knows how it will play out.

So instead of fretting about the things we can't control, we try to do the right thing, which is to focus on how to best manage the risk in the portfolio. Let your eyes now focus on the next reversal back up on this chart, the reversal to X's in January 1983. Keep in mind the index never went to the critical 68% level. This move starting January 1983 ended up going to June of that year and resulted in a 23% gain (highlighted in green). In today's numbers that would be about 2,300 points and take the Dow Jones to 12,500. We have precedent for this! The next reversal down started in July of 1983 and if you guessed that the same thing would happen again, you were wrong. This move ended up taking the market down to the 32% level. Now look past the chart.

NYSE Bullish Percent Showing 1982 - 1983 Market

90

                 X   X
                 X O 5 O
                 B O 4 O
80               X O 3 7
                 X C 1 O
                 X O X O
   O             X O X O
   O             X O   O
70 A             X     8
   O             X     O
   O X           A     O
   O 4 O         X     O 9
   O X O         X     O X O
60 O X 6         X     O X O
   O X 7         X     O   C 1
   O X O         9         O X O
   O X O         X         O X O
   O X O         X         O   2
50 O 3 O         X             O
   O X 8         X             O
   O X O C   X   X             O
   O X O X O 5 O X             O X
   O X O X O X O X             O 5 O
40 O   O X 1 X B X             O X O
       9 X O X O X             O X O
       O B O X 7 X             O   O
       O X O 4 8 X                 6 
       O X 3 X O                 7 
30     O X O X
       O X O
       O A
       O X
       O X
20     O




10
   8        8        8       8
   1        2        3       4

One thing that confounds brokers, investors, TV personalities and just about everyone else is how the "market," as dictated by the Capitalization weighted indices, does not always describe what is really happening in the stock market. Sometimes we are in a bull market in indices and a bear market in stocks, or a bear market in indices and a bull market in stocks. 1998 is a case in point. We could see the sell signals mounting. By May 13th 1998 the NYSE Bullish Percent reversed down from 74% and continued down to 20% without one breather or reversal back up. The NYSE Bullish Percent had dropped 24%, from 74% to 50%, by June 1998 and the S&P 500 was UP 2.9% during this time. By July many of the frequently quoted indices went to new highs, but the NYSE Bullish Percent stayed in O's. CNBC, Fox, CNN, NBC and on and on were falling all over themselves with the new highs in the market, but they missed the whole picture!

The Value Line Geometric, equal weighted index, was down 4.6% during that period, April to June 1998. These new highs in the indices lasted about two weeks and the down move was on. The next move in the NYSE Bullish Percent was the continuation of its O's to a low of 20%. This time the cap-weighted SPX dropped 15.6% and the equal weighted Value Line Geometric dropped 23.1% (during July and August). So, the whole way down the NYSE Bullish Percent never wavered and stayed in O's. The S&P 500 dropped a total of 12.7% and the Value Line Geometric dropped a total of 27.7%, more than twice the cap-weighted index. That year we were in a bear market in stocks and a bull market in indices. In the year 2000 the opposite happened and we were in a bear market in Cap weighted indices where the handfuls of stocks that control the whole market were literally collapsing. Determining what market we are in is essential to success.

How is LIG handling it now? Once the Over-The-Counter (OTC) Bullish Percent reversed, we evaluated the stocks in our clients' portfolios. We wanted to see if we had any individual OTC stocks in them. We did not. But if we had, we would have evaluated each position individually and determined what we would do if the stocks began to move lower. Our game plan would then be set for OTC. Our discipline was in place.

We then began to focus on the NYSE Bullish Percent. This index has not reversed yet but while we were doing Spring Cleaning we might as well look at these stocks too. We looked at each of the stocks (mostly Exchange Traded Funds or ETFs) and determined where we would cut and run, and whether we could sell any calls on the positions as they stood. There really is no premium in the options of these stocks to speak of, so we chose to use cash as a hedge. Right now all our positions are fine, but the pullbacks they have experienced over the past couple of weeks have eaten away some profits our clients had. If the NYSE Bullish Percent reverses to defense somewhere down the road, we will likely sell half my positions, raise our cash position from 30% to 50% and hang on with the rest and ride it out.

We have no stress, we have done what we can, and our game plan is established. If the market rises, we are prepared to enjoy it. If it declines, we have our plan established as to how we will manage risk. The key piece of the equation, though, is our clients are aware of the risk we are taking. Are you?