September The Right Side of the Market

September 2010 The Right Side of the Market Gil Morales and Chris Kacher spoke on Staying on the Right Side of the Market in Uncertain and Volatile Times at the Sept. 11, AAII Los Angeles chapter meeting at the Skirball Cultural Center. During his career, Morales has been with Merrill Lynch, Paine Webber, William O Neil and Co. and now he is a managing director of MoKa Investors. He received his B.A. degree in economics from Stanford University Kacher founded an internet-based stock advisory service, later joined William O Oneil and Co., and then started a private fund in Switzerland. He teamed up with Morales in 2010 to start MoKa investors. He received a B.S. degree in chemistry and a Ph.D. degree in nuclear physics from University of California at Berkeley. Morales and Kacher wrote Trade Like an O Neil Disciple, subtitled, How We Made 18,000 percent in the Stock Market, published in August, 2010 by John Wiley and Sons. They had copies of their new book, which they were autographing and selling. The duo are trend followers who follow Bill O Neil in monitoring volume and price on charts to look for stock buy and sell points. While following O Neil, they have introduced their own methods, which are what they discussed in their presentation, and in their new book. They distributed a handout, which gave ten rules for pocket pivots. Pocket pivots are early buy points where there is up volume and the stock moves above the 10-day moving average. By buying at the pocket pivot point investors get a lower price by buying before the base breakout. Kacher came up with the pocket pivot concept in 2005. It helped him identify stocks to buy before their price gapped up 20 to 40 percent. He recommends keeping the process simple by following up 20 leading stocks in leading industries. The bulk of the talk was the presentation on ten rules for pocket pivots, using charts displayed on a screen to illustrate the points being made. The ten rules follow. Readers can go to www.aaiilosangeles.org, the chapter website, and look for the slides on the presentation to get an idea of how the rules are applied. One, as with base breakouts, proper pocket pivots should emerge within or out of constructive basing patterns. Two, the stock s fundamentals should be strong, i.e., excellent earnings, sales, pretax margin, ROE, strong leader in its space, etc. Three, the day s volume should be larger than the highest down volume day over the prior 10 days. See the RINO chart. Table of Contents Right Side of the Market.Morales and Kacher.p.1 Trade Like an O Neil Disciple..Morales and Kacher...p.3 Investment Outlook James M. Goldberg...p.3 Investor Education Dr. Don Gimpel... p.5 1

Four, if the pocket pivot occurs in an uptrend after the stock has broken out, it should act constructively around its 10-day moving average. It can undercut its 10-day moving average as long as it shows resilience by showing volume that is greater than the highest down volume day over the prior 10 days. See the NFLX chart for March-April, 2009 for an example of a pocket pivot in an uptrend. Five, pocket pivots sometimes coincide with base breakouts or with gap ups. This can be thought of as added upside power should this occur. See the VRX chart for base break outs. Six, Bad Pocket: do not buy pocket pivots if the overall chart formation is in a multi-month downtrend (five months or longer). It is best to wait for the rounding part of the base to form before buying See the RIMM chart, to avoid buying in a downtrend Seven, Bad Pocket: do not buy pocket pivots if the stock is under a critical moving average such as the 50-day moving average or the 200-day moving average. If well under its 50-day moving average, and getting support near the 200 -day moving average, it can be bought provided the base is constructive. Eight, Bad Pocket: do not buy pocket pivots if the stock formed a V where it sells off hard down through the 10-day moving average or 50-day moving average then shoots straight back up in a V formation. Such formations are failure prone. See the May 12, 2010 NFLX chart for a V shaped formation. Nine, avoid buying pocket pivots that occur after wedging patterns. See the CREE chart for a wedging pattern under the 50-day moving average. Ten, Some pocket pivots may occur after the stock is extended from the base. If the pivot occurs right near its 10-day moving average, it can be bought, otherwise it is extended and should be avoided. Give the 10-day moving average the chance to catch up to the stock, where the stock would consolidate for a few days, before buying such a pocket pivot. See the AAPL chart for a stock that never pulled back and later gapped up on high volume. Since selling stocks is where many investors have difficulties, it was helpful that Morales and Kachen reviewed their selling rules. They pointed out that use of the 10-day and 50-day moving averages in conjunction with the pocket pivot tool is governed by the seven-week rule. 10-day: Stocks that have shown a tendency to obey or respect the 10-day moving average for a least seven weeks in an uptrend should often be sold once the stock breaks below the 10-day moving average line. 50-day: If the stocks do not show such a tendency, it is better to use the 50-day moving average as the guide for selling. Los Angeles County Meeting Schedule Westside Computer Group Don Gimpel, 310/276-9875 dgimpel@roadrunner.com. Veterans of Foreign Wars Memorial Bldg. Culver Blvd. & Overland Avenue, Culver City. Ultra FS Version 11 User Group at 9 a.m.; then. Finding a Money Manager, at 10:30 a.m. both on Saturday, Oct. 2. Pasadena Group Meets at 7 p.m., at Pasadena Main Library, in the David Wright Auditorium, at 285 E. Walnut St., Pasadena. (Meets third Tues. of the month, except for August and December.) Topic for October meeting TBA. Contact, Ivan Wong at (626) 446-2486, IWong82762@aol.com. Mutual Fund Group Meeting at 10:30 a.m., Nov. 6, Topic TBA, Gunter Hagen 310/457-7404, ghagen1@yahoo.com. at Fairview Library, 2101 Ocean Park Blvd., Santa Monica. The meeting is free to the public Stock Selection Group Norm Langhout, 310/391-6430, normlang1@verison.net. Fourth Wednesday of the month at 7 p.m. Using IBD, CANSLIM stock selection method at Fairview Library, 2101 Ocean Park Blvd., Santa Monica. Topic TBA Los Angeles Chapter Skirball Center at 9 a.m, Sat. Oct.16, Don Gimpel and Joe Falcon on Looking for Attractive Investments in the Energy Sector; and Chris Greene on Backtesting and Quantitative Research Techniques in ETF Investing. Desert (Palm Springs area) Group Usually meets from 10 a.m. to noon, second Saturday of the month at Sunset View Club House, Sun City, Palm Desert. For more information, contact Patricia Gammino, fastnet@msn.com. Option Special Interest Group, meets Saturday, 9 a.m. to noon at Westside Pavilion, Community Room A, 10800 W. Pico Blvd. (corner of Westwood Blvd.) Time and topic TBA by leader Robert Morgan, rmwall-aaii@yahoo.com. 2

The rule can help prevent investors from selling a stock prematurely if it is simply not its nature to hold the 10-day moving average, and it tends to drop below the l0-day line often. Kacher and Morales studies of pocket pivots indicate that a pocket pivot buy point which results in an uptrend that is shown to obey the 10-day moving average for at least seven weeks following the initial pocket pivot should be sold upon its first violation on the 10-day line. A violation is defined as a close below the 10-day moving average followed by a move on the next day below the intraday low of the first day. Charts of BIDU, NFLX, AAPL and SPDR were put up on the screen to illustrate the sell rules. Kacher and Morales have a lower risk portfolio with low volatility that invests primarily in ETFs for retail investors who would like to invest with their firm. Investors interested in more information are referred to their book, Trade Like an O Neil Disciple and may go to info@mokainvestors.com. website to learn more. Trade like an O Neil Disciple Two former traders of William J. O Oneil and Company made 18,000 percent profit in seven years in the stock market, and tell, how following their system, you can, too. (With those kind of profits, who is to say that market timing does not work?) Gil Morales and Dr. Chris Kacher are the authors of the new book Trade Like an O Neil Disciple (John Wiley and Sons, Aug. 2010), 366 pages, hardback $60. The book is available on Amazon.com for $38. Morales and Kacher espouse a refined version of Bill O Oneil s CANSLIM investing method, and is a suitable read for intermediate to advanced CANSLIM followers. Basically they are trend followers, a method that in its core amounts to letting profits run, cutting loses short and managing risk. 3 The authors give a detailed examination of how to trade using CANSLIM, and what it was like working with Bill O Neil. Under varying market conditions, the authors document their trades, including the set ups, buy, add, and sell points for their successful purchases. They also turn the spotlight upon themselves to analyze their mistakes, including how much they lost, how they reacted, and what they learned from their winner and losers. The information on analyzing their mistakes and correcting them is useful and introduces a note of flexibility and humility into their discussion. The book introduces their idea of early buy points i.e. pocket pivots, their short-sale setups and Dr. Kacher s market timing tool. They also cover the importance of a 6 to 7 percent automatic stop-loss on stock purchases, the idea of sitting tight and taking your profits slowly, and the value of mastering your own psychology, so you can operate from a position of strength. Gil Morales is a managing director of MoKA Investors, and co-author, with Bill O Neil, of How to Make Money Selling Stocks Short. He received his B.A. in economics from Stanford University. Dr. Chris Kacher is also a managing director of MoKa Investors, and formerly was a portfolio manager for William O Neil and Company. He earned a Ph.D. in nuclear physics from the University of California at Berkeley. The Investment Outlook and the GEE Forces James Goldberg spoke on How Will the Gee Forces Affect the Returns on Stocks and Bonds? at the Sept. 11, AAII Los Angeles chapter meeting at the Skirball Cultural Center. Goldberg, president of Goldberg Economic Advisors, has 40 years of experience

in the economic and investment forecasting field. He was with Trust Company of the West for 20 years, and was president of the Los Angeles Chapter of National Association for Business Economics. The GEE forces are powerful influences on economies and stock markets. They include Greece, Goldman Sachs, the Gulf Oil Spill, Glitch, Government and Growth. By examining them a clearer idea of economic and market performance over the next 12 to 18 months can be gained. A story of economic anxiety begins by looking at government and growth. The unemployment rate was higher at 12.2 percent in 1983, and almost as high at 9.8 percent in 1993, but the nearly 10 percent rate in 2010 was stickier on the downside. Persistent unemployment is one of the biggest factors in the lingering recession. The relative strength of this recovery. one year from the bottom, at plus 3 percent is weaker than other recoveries. In 2003, the recovery one year out was 4.1 percent, and in 1983, it was 7.7 percent. The economy is recovering more slowly this time. The U.S. Federal Funds and the Bank of Japan rate have been near zero percent since 2009. The Federal Reserve moved to quantitative easing, going from $900 billion in 2008 to $2.3 trillion in 2009, where the figure stands today. It is possible there will be another quantitative easing in the first quarter of 2011. The federal deficit as a percentage of GDP is at 11 percent in 2010, compared to nearly 6 percent in 1983 through 1986, the second highest level since 1960. The deficit is at World War II levels, but there is no campaign to buy bonds to save the country. The federal deficit is near its limit. Tinkering with Social Security might be a way to reduce it. State and local governments went from minus.4 percent in 2008 to plus.2 percent in their budget positions compared to GDP. It is rare for state and local governments to run deficits, since they are not supposed to. California s unemployment at 12.3 percent in 2010 was higher than the national rate of 9.6 percent by 2.7 percent. Within California unemployment rates are variable, with the rate in Palos Verdes Estates being 3 percent, and at the other extreme around 20 percent in Compton. Employment is closely correlated with education and professional training. Back in 1982 the national rate of unemployment was 10.8 percent versus 10.2 percent in California, when the aerospace industry buoyed up the state s employment. The Consumer Price Index was minus 2 percent in 2009 and is plus one percent in 2010. That is mixed news, given that housing is a big factor and prices have been down. If housing prices dip down again, then there will be deflation, similar to Japan. Productivity for nonfarm businesses was at 6 percent in 2009, and 3.8 percent in 2010, showing that big business knows how to cut costs. At over 8 percent, corporate profits as a percentage of GDP were at record levels. The highest corporate profits since 1956 was back in 1964 when they were 7.7 percent of GDP. Goldberg turned his attention to a survey of the financial situation in selected non-u.s. economies. Japanese unemployment was at 5.3 percent in 2010, up from 3.8 percent in 2008. Unemployment in the Eurozone was 10 percent in 2010, up from 7.3 percent in 2007. China s growth rate dropped to just above 6 percent in 2009, rebounded to almost 12 percent and has settled down to just over 20 percent. Since 1992, when its growth rate was 14 percent, China s growth rate has never been below 6 percent. The BRICs (Brazil, Russia, India and China) growth rate dropped to almost zero in late 2008, and has since rebounded to about 7.8 percent. Deficits as a percentage of GDP in selected countries, the PIIGS, loomed large. They were minus 14.3 percent in Ireland, minus 4

13.6 percent in Greece, minus ll.2 percent in Spain, minus 9.4 percent in Portugal and minus 5.3 percent in Italy. By contrast in Germany the deficit was minus 3.3 percent. Greece is the worst case. Its credit default swaps went from 100 basis points in Aug. 2009, to over 900 basis points in Aug. 2010. Spain s credit default swaps went from 60 basis points in Aug. 2009 to 248 basis points in Aug. 2010. Crude oil prices hovered around $20 a barrel from 1987 to 1999, and then increased to over $140 a barrel in 2008, before dropping precipitously to $37 in 2009, and then rebounding to $80 in 2010. Exxon is shifting over to become a natural gas company. Natural gas prices also spiked in 2008 at $13.80, before dropping and settling around $4 in 2010. Goldman Sachs was a story of revenge. The stock traded at $185 in April, 2010, and dropped to $140 in August, 2010. The company settled with the government, after being blamed for the financial collapse. But the company had profits of $10 billion. Meantime, the financial sector has been flat-lining since Dec. 2009. It has shrunk as a sector of the economy. The Glitch Goldman referred to related to pre-may 6, 2010 flash crash market volatility. Prior to the flash crash the daily percent change varied between plus 2 and minus 3 percent. After the flash crash, market volatility ranged from plus 4.5 percent to minus 4 percent. Goldman s final chapter in his talk was his conclusions as to how his data and power-point charts related to the current economic and markets outlook. The GEE forces will keep downward pressure on P/E ratios. Investors need dividend increases, not buy backs and mergers. Strong sales growth must occur to buy low or nondividend stocks. Cost cutting is not a growth strategy. The market s dividend yield needs to approach the interest rate on ten-year Treasuries. The S& P need to trade near 800 to 900. Or, the interest rate on ten-year Treasuries needs to fall towards 2.0 percent. Or, dividends need to increase across the board. A combination of the following three are likely over the next twelve months: The S&P 500 should decline to around 1000 (between 900 and 1200). Ten-year Treasuries should move to about 2.2 percent (between 2 and 3.3 percent). And the dividend on the S&P 500 should rise to $23 per share from $22 per share. Regarding foreign stocks, the BRICs are safer than the PIIGS. The BRICs yield about the same as the S&P 500 (BFK 1.8 percent), but are much less restrained by the GEE forces. The EFA has a 3.2 percent dividend yield but the Euro poses big risks. On the Euro you must buy on the dips and sell on the rips. Energy is a big problem, Goldberg concluded. The energy sector amounts to 11 percent of the S&P 500, but only offers a 1.7 percent dividend yield. Exxon Mobil is a prime example of what not to do. It bought back two billion shares since 2005 at an average price in the mid sixties. This year the average price is in the low sixties (closing at $61.77 in the last week of September). Its acquisition of XTO was questionable, and its dividend yield is only 2.9 percent. BP looks more interesting, as its dividend could be restored by February, 2011, and it was yielding 5.5 percent before the Gulf accident. Financials are another problem area. They amount to 16 percent of the S&P 500 and have a dividend yield of only 0,7 percent. The government will keep pressure on banks to increase capital and withhold dividends from stockholders. Goldman Sachs Group is yielding 0.9 percent versus LQD yielding 4.6 percent. CXA yields 4 percent double tax free. HYG yields 8.5 percent, and JNK yields 9.2 percent. Large daily moves are persisting. With individuals exiting the stock market and hedge funds and traders becoming the main driving force, violent moves should persist. Individuals 5

are the buffer between short-term speculators and long-term institutional investors such as endowments and pension funds. U.S. Treasuries with maturities of ten years or more should be bought when the S&P 500 is rallying and avoided when the market trades lower. Investors must be careful when buying funds like VWESX, with a 5.2 percent yield, but a 24-year average maturity. The same holds true of long-term municipal bonds. Of the five-month return of various S&P 500 sectors, only utilities showed much promise with a dividend yield of 3.65 percent and a total return of 3.13 percent. Nine of the sectors had negative returns over the last five months. During the last five months, of international stock regions only South Africa had a positive total return of 1.35 percent, with a dividend yield of.88 percent. Austria was down the most at minus 13.34 percent. The dividend returns and total return of the fixed income sector was the best over the last five months. EMB had a dividend yield of 4.85 percent and a total return of 7.27 percent. LQD had a dividend yield of 4.58 percent, and a total return of 6.8 percent. CXA had a dividend yield of 4.01 percent and a total return of 5.8 percent. To get a sense of the persistent secular bear market of the last ten years, the returns of stocks were the worst at minus 17 percent, money market funds were positive 25 percent and bonds were positive 82 percent. Bonds did the best of the three over three-, five- and ten-year comparisons. In the question and answer period, Goldberg concluded that the country needs some good government policies. If unions would be more flexible on wage reductions, and Medicare and Medicaid were cut back, then the economic situation would improve. The Bush tax cut has cost $700 billion to date, and would cost another $1.3 trillion over the next ten years. To move forward, the country needs shared sacrifice. In a deleveraging cycle, the government cannot do much except tinker around the edges. Pension funds are underfunded. They may pay out less. If stock and bond prices went up it would rescue the pension funds. Something needs to be done about the U.S. debt. China may not want to turn over its U.S. bonds, as it has potential problems with North Korea and Taiwan. Japan is an object lesson to the U.S. It has an older population with a worse ratio of workers to dependents than the U.S. It has an export-driven economy, and does not seem to be able to stimulate the domestic economy. Its stock market dropped from 40,000 at its peak and has never recovered. Education Nuggets Dr. Don Gimpel said he had bad news concerning the state of the dollar, during his five minutes of investor education at the Sept. 11 meeting of the Los Angeles Chapter of the AAII at the Skirball Center. Gimpel referred his listeners to the website www.adrich.com, which has charts on the major market indexes. To learn more about the state of the dollar, click on the article by Fred Richards, Is the U.S. Dollar in Imminent Danger? Richards points out that U.S. government debt, which stood at $2 billion in 1900 increased to $13.75 trillion by September, 2010. By comparison, at the end of World War II, U.S. government debt was $259 billion. High end estimates of U.S. government debt range from $62 trillion to $110 trillion. With a gross national product of $14 trillion, the U.S. cannot service it debt and future liabilities. The U.S., being the world s largest debtor nation, raises concerns about the dollar as the world s reserve currency. Richards final query is: what happens when safe haven reserve currency status of the U.S. dollar is gone? Check out the chapter website, at www.aaiilosangeles.org. 6

Orange County AAII Announcements For more information about the Orange County chapter of AAII and their meetings, go to aaiichapterorangecounty@yahoo.com. Note to Pro Forma Contributors: Please have your copy emailed to the editor by the fifth of the month. Letters and comments are welcome. If you want to email an article about the fragile financial system, you will have a chance to appear in print and inform Pro Forma readers. Book reviews are welcome. Mail disks to: 319 Walnut Ave., Apt. 2, Long Beach, CA. 90802, or use email to send copy to the editor at wparme1@lausd.net, or call (562)-437-2412. Pro Forma Pro Forma Editor Pro Forma Editor, Emeritus William Parmenter Orvis Adams SIG GROUP CHAIRMEN IBD Meet-up/ AAII CANSLIM Mutual Fund Group Options Group Pasadena Group Palm Springs Group San Fernando Valley Group Westside Computer Group Norman Langhout Gunter Hagen Robert Morgan Ivan Wong Patti Gammino Evan Press Don Gimpel Pro Forma is offered free of charge exclusively via email and is also available for downloading from the Los Angeles Chapter web site at: www.aaiilosangeles.org. The American Association of Individual Investors is an independent nonprofit corporation formed for the purpose of assisting individuals in becoming effective managers of their own assets through programs of education, information and research. Pro Forma is published for advising members of the groups' activities and for sharing information. All material compiled without verification of accuracy to a specific task or computer system. All material provided in the ewsletter is for educational and illustrative purposes only. Comments are the views of their author and no other person or organization. Investing is an inherently risky business. Investors may loose their entire investment or more. Past performance is not a guide to future return. 7