e hemorrhaging of market cap all over the globe.
What's on the menu? The usual culprits: financial institutions, technology stocks, conglomerates. In one of my newsletter portfolios that focus on short selling strategies, the shorting of American Capital, Ltd. (ACAS/NASDAQ) has generated a return of over 110%. But that was a subprime doozy, so no surprises there. A better example of how fortunes of many companies previously considered the safest and strongest have changed is The Dow Chemical Company (DOW/NYSE), which I shorted in the fall and which has generated a return of over 70% until last week. I also remember buying call options on this stock about two years ago, generating double-digit returns as well.
The insanity of this recession has skewed equity valuations so much that they are best described using teenage slang -- all out of whack! At face value, equities appear undervalued, but experienced investors and quantitative analysts alike are saying they're anything but! In fact, gurus are claiming that most of these allegedly undervalued stocks are worth far too much when considered within the current financial and credit crises context. To make matters worse, it appears that the U.S. government still isn't anywhere near resolving the issues plaguing the markets.
Mind you, when applying aggressive strategies in your portfolios, you have to acknowledge a few things. First, you have to be a speculator. Second, you have to accept the possibility that you could lose all your money, so the reasonable thing to do would be to invest only what you can afford to lose. Third, there has yet to be developed a bulletproof market timing strategy. I don't know of anyone who has never been wrong about market timing. For most, market timing has been a hit-and-miss kind of experience.
However, setting the market timing aspect of this aside, the fact remains that investors should actually be shorting equities in the short term, particularly in the U.S., because we're still neck-deep in the smelly stuff and the waves are coming. In other words, although some ground has been gained since that awful November of last year, it is not because fundamentals have improved significantly.
Surely, there appear to be false positives that I find responsible for many of the recent rallies. For example, the key volatility and risk gauge for U.S. equities, the VIX Index, is currently under 45. In comparison, it was at 80 back in November. Granted, a level of 45 is still considered historically volatile, but it can also be construed that reason might be returning to stock markets. Is it really? I don't think so, but who knows for sure anymore?
There is also something called the TED spread, a yield-spread indicator, which when wide points to a severe credit crunch. An illustration of this was the reading of 450 basis points in October of last year, which has narrowed recently to just under 100 basis points, indicating that credit is still tight, but at least some money has started flowing.
The bottom line is that, just because the investment climate is not as bad as it was in the fall of last year, it doesn't mean that it has improved either. And it certainly doesn't mean that the rallies we have seen so far this year are signaling that fundamental recovery is just around the corner.
Profit Confidential
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About the author
Inya Ivkovic, BA, MA, Senior Editor at Lombardi Financial, is the editor of Explosive Mine Stocks, Bio-Tech Breakthroughs and Payload Stocks. She is co-author of The Revenge to Riches Strategy: How You Can Profit from the Secret Greenspan Plan. Before joining Lombardi, Inya held several positions with large North American financial institutions, and has been an academic specialist for a securities institute, a trader, and an investment advisor. Inya's diverse market background and passion for stocks delivers an institutional perspective to Lombardi Financial readers.
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