Yesterday was another example of constructed technical bounces. As much as I love technical analysis in general, I hate this particular kind. The last time I wrote about this was 2 months ago, when bullish programs were supposedly trying to create support at 1400-1420. Back then, some people suggested that a triple bottom was formed as a result of their crafty efforts. I simply said I would ignore it because technical patterns that are manufactured just don’t hold up. So it wasn’t a shocker that we found our way 1000 points lower than the previously solid “triple bottom.” Yesterday’s programmed attempt to build support at 1280-1300 doesn’t do much to impress me either.

And one more thing, I heard more than a few comments about a “double-bottom” formed between the low on Tuesday and the low on Wednesday around 1275. Please read up on the requirements for forming double-bottom reversals, here’s a great explanation from Stockcharts.com. If you don’t like that one, try this one. Pay special attention (in both explanations) to how long it should take to form the two bottom points. It’s weeks or months, not hours.

Here’s a rule of thumb:

• If a pattern forms in minutes, expect that it is valid for minutes.
• If a pattern forms in hours, expect that it is valid for hours.
• If a pattern forms in days, expect that it is valid for days.
• If a pattern forms in weeks, expect that it is valid for weeks.
• If a pattern forms in months, expect that it is valid for months.

I am sure you get the point. There’s a lot of crappy technical analysis being offered up these days, please watch out.

• Tuesday - surprise Fed rate cut of 75bps.
• Wednesday - rumor of NY State bailout plan for monolines.
• Thursday - announcement of House of Representatives / Administration agreement on fiscal stimulus package.
• Friday - ??????

I am just wondering how many other interventions the government can create every day so they can limp along towards next week’s FOMC meeting.

An intervention a day….keeps the bear market away? An intervention a day….keeps the recession away?

MBIA says in the worst case scenario, it would suffer a $10 billion loss on the $673 billion it has insured. Nevermind that they only have a small fraction of that in actual capital. According to them, the probability of the worst case happening is 1 in 10,000. Counterparty risk is based upon this kind of thinking - telling everyone that things are okay because the risks are so small that only idiots would worry about it. Under that logic, I assure you that I am a giant idiot (bigger than my 6′ 5″ 250lbs.) I worry about counterparty risk and especially, the failure of the monolines. On a bigger scale, I worry about the failure of our financial system that has been built upon practices that promise to hedge risk while, in fact, they are the risk. CDOs were specifically constructed to supposedly reduce exposure to loss and enhance yields by blending some bad stuff with the good stuff. Maybe the risk of the worst case scenario was 1 in 10,000 for that too. Now it’s 1 in 1.

At some point, we need to come to grips with reality. The experts in risk and derivatives are the ones that created this mess. So which experts in risk will solve it? The same ones? Some government official? Some regulator?

We have a systemic failure and I have hinted at it repeatedly in prior posts. For years, financial engineers have engineered. Fiduciaries like pension funds and state/local government pools have bought it. They are sitting with a sizable percentage of assets based upon investment grade ratings that were premised upon this “don’t worry, the risk of loss is 1 in 10,000″ mentality. Now they are infected with SIVs, CDOs, Asset-Backed Commercial Paper that they cannot sell. Giving these assets anything less than an investment grade rating will precipitate a meltdown. Fiduciary rules require that these funds only hold investment grade assets. Who are they going to sell that stuff to? We are talking about trillions of dollars. And no one knows what the assets are worth because everyone (except for a few like E-Trade) have been afraid to sell them. Instead, the approach is to just take the hit through billions of writedowns - holding onto them hoping for a day when Humpty-Dumpty can be put back together again. The odds of that happening? I think it’s at least 1 in 10,000.

The market has climbed 500 points in 2.5 hours, supposedly based upon the rumor and hope that another government bailout - this one about the State of New York plan to stabilize the bond insurers - will save the planet. I am sure that Cramer will love this - he was screaming for this socialist idea yesterday. Use your judgment - is this good for the capital markets?

Regardless, volatility has two sides - down and up. Both are painful. Neither are sustainable. You have to pace yourself.

Do the math - is the slope of this rally’s move sustainable? At this pace, (500 points every 2.5 hours) we will be at record Dow highs in about 10 more hours of trading.

Get real. Pace yourself!

Most academics will tell you technical analysis is useless. For them I am sure it is. Read enough investment books like A Random Walk Down Wall Street and you’ll learn that fundamental analysis is the only way to go. Usually, most guests on financial entertainment will tell you that you cannot time the markets. Some stupid slogans like “It’s not timing the markets that matter, it’s time in the markets” will be thrown out there as “proof.” Then the idol worship gets injected when people discuss Warren Buffett and remind everyone that he is a fundamentalist investor. The inference is that to be a great investor like Warren you should shun technicals and focus on fundamentals. One of the biggest biases comes from Wall Street itself with the thousands of analysts, most of whom do nothing but study fundamentals. Never mind the scandals, the history of an overwhelmingly bullish rating system, the pathetic performance and all the other failures that are accepted and excused because the financial system believes in fundamental analysis.

The romantic view of investing is that long term is the way to go and short term trading is impossible and dangerous and wrong. Fundamentals are associated with long term investing….Technicals are associated with short term trading. Admiration and acceptance by association applies to fundamentals. Guilt by association applies to technicals. It’s just the way it is. I just heard…”stick to the fundamentals” by some moron advocating to “focus on the long term.” How comforting.

So, at times like these, I have to ask - How is the fundamental only approach working? Since July, how many times have you heard that stocks are cheap? Has it paid to buy on the fundamentals alone? They are getting cheaper and cheaper. Meanwhile, portfolios are getting whacked. As you probably know, I love fundamental analysis. But I am not in love with it. It has its strengths and weaknesses. Technicals help accentuate the positives of fundamental analysis and they help avoid the weaknesses. That’s why I do both at all times and that is why HEDGEfolios is not down for the year.

Others love to use technical analysis when they are desperate. I’ve written about this before (click here) and (click here). I don’t know about the Foxy Business Network since it makes me too sick to watch but CNBC and Bloomberg are showing way too many technicians. Worse yet, the reporters and anchors who don’t know shit about technical analysis are practicing the dark art. Shut up already - enough with the support level and trend line discussions, enough with the “retrenchments” (for the record Sue, it’s “retracements”), enough with the waves, shut up. If technical analysis is so useless and so dangerous, then just go back to believing that fundamentals are the only thing that matters. Because you know that once we are through this sell-off, that’s what the media will do. I like it better that way.

HEDGEfolios is still up for the year, about 0.2% through last night’s close. As I mentioned on Monday, last week’s negative action and the poor Friday close, pushed me over the bearish edge. I gave 296 new DOWN signals and only 17 new UPs (almost a 20:1 ratio). The most frustrating aspect of these signal changes was the fact that most of them were losers that I had kept faith in for quite a while (translation: TOO FUCKING LONG!)

Typically, the start of every year is rough on my performance due to several factors but as I go on, the percentage of winning signals trends toward a historical average near 69%. This year it is much worse than usual - 91% of all closed signals were losers with an average loss of 9.7%, most of which are wrong UPs. Worse yet, as I predicted yesterday, my system of using weekly open prices to track the performance of signals really whacked me. About 70% of the signals I gave this week are already losers due to the crappy open and recovery during the rest of Tuesday’s trading. However, this is a one-day phenomenon and over the longer term, I am optimistic most of them will work out.

The other day I was quoted as being “sanguine” on the markets for saying that I was holding onto my bullish bias. First of all, it’s funny for anyone to refer to me as “sanguine”. But in reality, until this week, I was only optimistic on 51% of the stocks I cover. Now I am still encouraged about 43% of the stocks. I don’t see much of a difference, but I suspect I won’t be confused with Mr. Sunshine anymore. Regardless, I do not want the market to go down. I only want 1998 stocks I have as DOWN signals to head lower, the other 1504 I want to go up.

The moral of this story is that HEDGEfolios reflects its name and my belief in a long/short hedging strategy - one stock at a time. Staying in positive numbers depends on that and despite all the volatility in the market, the HEDGEfolios database has hardly budged. Right now, the DOWN signals are contributing a gain that more than offsets the pain being felt by my wrong UP signals. Sooner or later, that will reverse and to stay in the black, I’ll have to shift back to being mostly bullish.

Many bulls were waiting for coordinated Central Bank action yesterday - specifically from the ECB. They didn’t get it. What they did get was a hawkish statement from Trichet that went like this:

“Particularly in demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility.”

Quite a contrast to Chairman Bernanke’s interpretation.

As I have said, I don’t believe in decoupling, but when it comes to Central Bank action, maybe it is relevant!  Actually, if you believe in decoupling, then it makes it hard to bitch about Trichet minding his own business.

As we “bounce off the lows” and hear questions about whether we will close higher today and whether we set a capitulation bottom this morning, I cringe. Beware short term smarties! These are the people who want to seem intelligent in the moment and later on, when things really suck they will shrink into the sidelines. I went negative based upon last week’s data…that’s what I do. I use the opening prices of each week to calculate my performance…that’s what I do. This morning, I will be slammed by recording the lows at the open if we end up trading higher. So be it! I make signal changes based upon what I think is a shift in direction for a longer time frame than a few hours or days. Last weekend, I was negative. Last night, I was negative. After the Fed cut, I am negative on over half the stocks I cover. There are far too many people who claim victory in the marathon based upon the first 100 meters. I was positive for weeks while the market crumbled and I managed to pull off a marginal gain through last Friday’s close. I went negative over the weekend, I intend to not have a losing month regardless of what happens in a few hours of trading. Today’s market is not about investing. It’s all about the short term opportunity to play volatility. If you like that kind of thing, good for you. Otherwise, stick to your longer term convictions.

Bernanke riding the Super Stallion (click here for image in previous post.) Yippee!! As expected, our government is once again trying to show it can do something nothing. Of course, the Fed has been super at screwing shorts for moments in time, but the problem with our markets is not the fault of the shorts. Overall, all these emergency measures of historical proportions have not done what they are promised to do each time the bulls moo for them. As usual, the stockonomists are running things. Tell me, other than stock market declines - what has changed since Friday to cause the first 75 bps cut in history? One week before the scheduled meeting! Will rushing to cut a few days in advance improve the economy more than it would a week from now? It gets a little tiring to see these guys with there ceremonial roles and attempts to calm markets. Especially when they repeatedly say they do not respond to what the stock market is doing or political pressure. If you are encouraged by today’s cut or impressed by the Fed more than you were on Friday when they didn’t cut, I hope you enjoy the fallacy of capitalism that exists in this country. When this rate cut fails, what will you hold onto?

After the beating that the stock market has dished out in 2008, I decided to check on HEDGEfolios performance. Despite being 61% UP signals at the New Year and 51% at the end of last week, the database managed to eek out a 0.10% gain so far this year. The power of hedging! If you believe in a long/short strategy and do a good job of picking which you think will go up and which will likely go down, you should be close to break-even. Obviously, compared to being down 9.7% on the S&P 500 index, having an intact portfolio at this point might make you feel good, maybe even confident. However, you must not get complacent or overconfident when you are outperforming. You must respect and fear the downside. It’s always a moment away in a volatile negative market like we have. I remain fearful and humble by looking at all my big losers. Out of the 1783 UP signals that existed on Friday (1/18), 1515 of them are under water for the year. The worst of the bunch are very ugly with 843 at a loss of greater than 10%. “Nothing to be proud of Rusty!” If you are a long-only investor, I see no possible way for you to have avoided this mess. Comparatively, 93% of the HEDGEfolios DOWN signals were correct with only 13 of the 1719 at a loss of greater than 10%. Once this week’s signals are uploaded and I have a chance to calculate the effects of the whacking we will likely get today, I will report whether HEDGEfolios was able to stay in the black. Regardless, when you can be objective about the difficulty of the last several weeks, please reconsider the long-only or indexing strategy. Is the pain of a bear market offset by the joy of bullish momentum?