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[ThatHawaiiGuy]

NASDAQ Rocket:
2003's Greatest Attraction
Ralph Kettell
July 30, 2003

The wildest amusement ride this summer (and fall) may not be at a theme park. You'll have to call your broker for a ride on this baby. The NASDAQ Rocket is the greatest roller coaster the world has ever seen and is coming to you courtesy of Alan Greenspan and his great dollar-printing machine. This baby has a drop that will make other coasters seem like mere kiddie rides. Buckle up your seat belt, tighten down the safety bar, and more importantly say your prayers. The drop is coming, slowly at first, but it will drop off when you least expect it.

If you are looking to climb aboard for a ride, you are just a bit late as this one left the station in October. It has been clicking up the track, click, click, click from about 1150 to 1776 (a very patriotic height). However it is now over the top and picking up a little speed. Slowly at first with a few bumps, but gradually faster, faster, and faster till you can't stand it. Let me off you scream, I can't take it, please let me off. This ride is definitely not for the faint of heart or those with a weak constitution or a bad back. Sorry, but you should have read the fine print before you got on.

When the Rocket really gets rolling, watchout! The bottom of this drop is all the way down at 900 or maybe lower, and that's if the track doesn't break from the huge stress and strain. Then with the cars barrelling down the track at full speed look for the Rocket to fly back up to 1350 before the next thrilling drop. No, no, NO! let's not get ahead of ourselves. The purpose of the article is to talk about this part of the ride: the impending drop and its timing and magnitude.

Why do I believe the market, and in particular the NASDAQ is going to reverse course and resume its bearish ways? Where do I start? Insider selling is accelerating; interest rates are almost as low as they can go; the economy is moribund, but looking brighter (so the "experts" claim); the PE ratios are still in the stratosphere; and to top it off complacency is running rampant.

Let's dissect these factors one at a time. Insider selling is at phenomenally high levels. If the men and women running the major corporations in this country are selling their stock to beat the band, they must think they'll be able to buy it back considerably cheaper at a later date. They have a much better handle on leading indicators for their business than you and I. While they do not have a 20/20 crystal ball, the conditions that they can discern for the near and intermediate term future must appear quite dim.

As for interest rates, the short term rates which the Federal Reserve can control are getting close to as low as they can go. The long term rates which the Fed cannot control have recently taken a turn for the worse (as far as the Fed is concerned) i.e. upwards. This trend is having a significantly negative impact on the mortgage refinance business. This is a problem for the Fed, because excluding the stock market; the mortgage business may be the only business in the country that was growing. The United States no longer has a significant manufacturing base, our predominant businesses are printing and distributing dollars, making loans, and trading stocks. We are headed for the Japanese problem of zero interest rates, zero room to manoeuvre, and zero (or worse) growth.

The so called "experts" who claim the economy is improving are largely the same folks who failed to recognize that the U.S. was entering a recession in 2001/2002. When they finally admitted publicly that the economy had slowed down a bit, they promptly claimed the recession was over. Pray tell, how can you declare a recession is over when you never declared one to begin with? In any case, I find it difficult to believe that the economy is really improving. Just ask the poor unfortunate folks who are out of work or those who have had to take a much lower paying job after they were laid off.

For the sake of argument let us suppose the experts are right, and the economy is starting to grow again. How will a recovering economy affect the stock market in light of the lowest interest rates in over half a century and perhaps the largest money supply growth of all time? It would eventually (if not sooner) translate into higher interest rates to moderate the growth in a recovering economy and prevent a surge in inflation. Any rise in interest rates would be disastrous for the stock market, especially against the backdrop of the incredible PE ratios that stocks currently command. The equity markets are performing a huge balancing act on the point of a sword and the least disturbance will knock it over and impale the players (riders) on that sword.

Now to the critical point, the rampant complacency! The market players have become complacent to a level which portends a major sell off. The VIX or volatility index is a measure of the implied volatility of options on the CBOE (Chicago Board Options Exchange). When the VIX is high it means that investors are worried about losses in the markets and are trading as if the market is going lower. They are nervous and are anxious to protect their precious investment capital. Conversely, when the VIX is low, the opposite is true. Investors are complacent, because the market has been going up and they see no reason for the trend to change. They are trading as if the market is perpetually going up and have little to no defensive position in place.

The past few days have seen the VIX drop to levels not seen since March of 2002. At that time the market had also grown complacent and simultaneously overvalued. I decided to short the NASDAQ. The vehicle I chose to short the NASDAQ was Profunds Ultra Short OTC symbol USPIX. There is normally a $7500 minimum investment for this fund, but if you use Ameritrade the minimum is $2000. I suspect that most major brokerages have a similar deal with Profunds.

My two primary reasons for choosing USPIX were that I could own it in my IRA (neither shorting nor options trading are allowed in most IRAs) and also the leverage of the fund. USPIX invests in NASDAQ futures and the managers attempt to match the inverse of the performance of the NASDAQ with a 2X gearing. This means that for every 1% drop in the NASDAQ, USPIX should rise about 2%. The downside of the 2X gearing is that a 1% rise in the NASDAQ typically results in a 2% loss.

My trade from last March through July resulted in over a 100% return in about 4 months. I entered the positions starting on March 21, 2003 when the VIX closed at 19.98 and USPIX was $40.67. I sold the position between July 17th and July 29th for an average sale price of $83.61...



The rest of it with chart:

http://www.321gold.com/editorials/kettell/kettell073003.html