The great Berkshire Hathaway index run-up

Now that Berkshire’s Class B shares have joined the Russell 1000, portfolio managers who paid a pretty penny can breathe easy again.

The runup this year in Berkshire Hathaway’s Class B stock (BRKB) is a good reminder of the power of an old kind of index arbitrage: buy high and sell higher, when the index-fund managers get in.

Usually, when fund managers engage in index arbitrage, they’re weighing the value of an index’s different stocks against each other, choosing the leaders and the laggards. But this year, there has been an easier strategy: cleverer hedge-fund managers or short-term investors just lie in wait until the announcement that a big stock will be added to an index; after the announcement, they buy up tons of the stock, driving up the price for the poor index-fund portfolio managers who are required to hold all the stocks in the index – so they pay exorbitant prices to own the shares.

Exhibit A: Berkshire Hathaway’s Class B stock has been zooming up for the past few days, most recently with a nearly 4% jump on Friday to close at $81.90. The reason: As of this morning’s open, Berkshire Hathaway has been added to the Russell 1000 Index. Berkshire is a giant, so it immediately ranked among the top 10 companies on the index, by size. Berkshire’s Class B stock alone will make up 1.1% of the Russell 1000 index. According to Goldman Sachs analyst David Kostin, 17.6% of the Russell 1000 holdings are now in financials, a full percentage point higher than they were before Berkshire joined.

The big jump in Berkshire’s Class B might cause some Russell 1000-following index managers to groan, but it’s probably a big relief to one group of investors: the portfolio managers who bought Berkshire’s class B stock at pretty rich prices after February 12, when it was added to the S&P 500 index. For those investors, who paid roughly $76 a share and up, things looked dark for a while in early June, when the stock dropped to $70 a share. Then, like Christmas in June, there was the announcement mid-month that Berkshire would join the Russell 1000, and all of a sudden the S&P 500 index-followers could breathe easy that the stock was worth something again. Overall, it’s hardly been a bad play: Over the course of seven months, Berkshire’s Class B stock jumped from around $65 a share in late January, around the time the stock took a 50-to-1 stock split, to $81.90 as of Friday’s close.

Of course, none of this could have happened until Berkshire’s leader, Warren Buffett, chose to compromise on his opposition to short-term investing. Buffett always liked to keep his company’s stock an exclusive playground for long-term holders — witness the Class A shares (BRKA) trading at $122,300 each these days — but the 50-to-1 stock split in Class B stock was reportedly spurred by Buffett’s need to find a wider universe of investors to help finance Berkshire Hathaway’s acquisition of the Burlington Northern Santa Fe railroad. The stock split dropped the price of Class B shares from $3,275 each to more like $65 each.

The enormous growth in the trading volume of Berkshire’s Class B shares shows the success of Buffett’s populist move. Before the S&P 500 move, Berkshire’s Class B traded at around 5.5 million shares a day; now, it’s more like 10.18 million shares a day.

These boosts are temporary, of course; as of Monday morning, Berkshire’s Class B already started to pull back, dropping 1% in early morning trading to around $81 a share. Of course, if any of those Russell 1000 index managers find that the Berkshire Class B stock loses even bigger chunks of its pop after the index-buying games are over, they might just have to swallow their hard luck: there aren’t that many more indexes that the stock can list on.

By Heidi N. Moore, contributor – Source: http://wallstreet.blogs.fortune.cnn.com/2010/06/28/the-great-berkshire-hathaway-index-run-up/

Investors Get Back $18.31 Trilion

Below we highlight the total market capitalization of stocks both globally and in the US.  At its peak in 2007, total world market cap was $62.57 trillion.  By the lows this March, world market cap had dropped to $25.6 trillion!  That’s a loss of $36.97 trillion in stocks globally.  Since the March lows, however, world market cap has risen $18.31 trillion back up to $43.9 trillion.

In the US, market cap has risen $4.88 trillion from its low of $8.09 trillion in March.  The peak in total US stock market value was $19.14 trillion in 2007, and the current value of all US stocks is $12.97 trillion.  The US accounts for 29.5% of total stock market value in the world.

Source: Bespoken Research

Sentiment Update

Investor’s optimism swooned a bit this week after a volatile week and a few days of steep declines.  The viability of the rally is being questioned now.  According to the AAII bull/bear poll the % of bullish investors now stands at 34% – a relatively neutral reading during this bear market.

Click for larger image

Meanwhile, the longer-term oriented Panic Euphoria model points towards better days ahead while the State Street Investor Confidence model shows highs that haven’t been seen since the middle of 2008.  These are certainly mixed readings and provide little guidance in the near-term.

S&P Price Action

One interesting price level to look at when coming off of market bottoms is whether or not a new bear market (20% decline) would take the index back to new lows.  Up until recently, a 20% decline would have meant a lower overall low, but if the market were to top out now, a new bear wouldn’t mean the March lows would be violated.  This acts as an additional level of support.  As shown below, if a new bear market started following yesterday’s high, the -20% threshold would only take the S&P 500 down to 725.79, which gives investors 50 points to work with before the index reaches the March low of 675.

Source: Bespoken Research

Past Years Most Correlated With 2009

With the market dropping big in the first two months of the year and then rallying big over the last two months, investors are wondering where we go from here.  We have a cool file here at Bespoke that looks at the market’s pattern in the current year and finds prior years with the most similar patterns.  The file looks at the correlation between the year-to-date returns of the Dow at any point in the current year with all historical years. 

Since 1900, there have been two years that have a correlation with this year (as of May 5th) of more than 0.75 (1 is perfectly correlated).  These two years are 1982 and 2000.  As shown in the chart below, the chart patterns through May 5th have been very similar for all three years, although the moves this year have been more extreme.  The current year is most correlated with 1982 at this point, and as shown below, the Dow actually topped out in May of that year and went on to make a new low, only to post huge gains in the last quarter of the year to finish up 20%.  If the rest of 2009 plays out anything like 1982, it will be painful at first but sweet in the end.  In 2000, we had a similar decline through early March, saw a big rally into the Spring, and then traded sideways for the rest of the year to finish down 6%.

Overbought Stock Levels and Lengths

Investors are worried that the market is set to pull back now that we have reached overbought levels (1 standard deviation above the 50-DMA).  However, markets can stay overbought for long periods of time just as they stayed oversold for months at a time during the most recent bear.  The S&P 500 has now been overbought for ten days in a row.  Since the bear market started in October 2007, the only other streak of consecutive overbought days ended at 15 last May. 

When we look at streaks of overbought days going back to 1928, however, the current 10-day period is nothing but a blip on the screen.  As shown below, there have been thousands of similar or more extreme streaks of overbought days, so just because we’re overbought now doesn’t mean we can’t stay overbought.

Source: Bespoken Research

What are the markets trying to do? – Richard Russell (Dow Theory Letters)

“The market situation has seldom been more confusing. Many analysts are convinced that we are in a new bull market. Others (me included) believe we are in a bear market correction (rally).

“Because of the confusion, I’m going to step out and make a few guesses (might as well, since nobody really knows what’s going on).

“(1) I believe that we’re in a secondary (upward) correction of a bear market. I’m going to guess that this correction could rise further or at least last longer than most people are expecting. A bear market rally is supposed to convince the majority that a new bull market has started. The rally will often continue until a large number of investors are back on board, and then the bear will kill them as it fades away, leaving the new optimists high and dry and with losses.

“(2) Gold is in a downward correction of its primary bull market. Gold may decline or stall until it convinces the majority of gold-fans that the gold bull market has died. Holders of ‘paper gold’ and gold futures and options will be frightened out of their holdings. What we’re experiencing now is the big correction that often occurs prior to the third speculative phase in gold. Holders of physical gold (coins, bars) will do best, since they will tend to hold on to their gold positions no matter what.

“So what are the markets trying to do? They’re doing what they always do, keep investors in the equity bear market and keep investors out of the gold bull market. Why would they do that? Because that’s the very nature of markets. Markets tend to thwart the majority. And that’s logical and self-evident. If markets existed to make money for the majority, then most market participants would be millionaires, and we know that sadly, that is not the case.”

Source: Richard Russell, The Dow Theory Letters, April 7, 2009.

Three Key Tips On How To Buy And Trade Penny Stocks Wisely

More people are inclined towards buying and trading penny stocks rather than regularly traded stocks because it is deemed as a cheaper option. Also, the easiness of entering the penny stocks market is attracting more investors, but this does not mean that less risk is involved. In fact, most people do not know that the penny stocks market is highly volatile and always changing.

In its simplest sense, penny stocks are also referred to as a microcap stock or nano stock. The usual trading price is under $5 per share. It is common practice that penny stocks are offered by companies who are just in the startup phase or companies who are facing financial problems to inject additional and quick cash in their businesses.

Before you delve in the buying and selling of penny stocks, keep in mind the following tips to be able to do so wisely.

Do your research

Many people are more prone to buying and trading penny stocks because these stocks are low in cost. But before you actually take an active part in this, you must do your research well. If you go online, you will be able to look into a lot of websites discussing penny stocks. Read through them and educate yourself to have a better grasp of what they are. In times like this, especially if there is money involved, it is advisable to be wise in your decision and the best thing that you can do is to use the information that you have accumulated to your advantage.

There are also many online websites that do stock analysis and gives a list of attractive stocks that are selected through studying stock market trends.

Use expert analysis in deciding which penny stocks to buy

If you are new to the buying and trading of stocks, you can turn to the analysis of experts when you are choosing which kind of penny stocks to buy. These experts will be able to tell you the specific kinds of penny stocks that are very attractive to buy at a given time. They can also give you advice in terms of keeping or getting rid of the current stocks that you have. If you want to be a successful stocks trader, you must be able to determine when to buy and when to sell, especially for smaller stocks.

Choose the right stock analysis system

You must be able to choose the right stock analysis system that will help you in deciding what specific kinds of stocks to buy and trade. Remember that in this kind of business, losing money is inevitable. There is no stock analysis system that is completely accurate all the time.

Now that you know different tips on buying and trading penny stocks, you will be in a better position to actually go out in the market and put these tips in actuality. The most important tip is to educate yourself. If you know how to use the information that you have to your advantage, you will be a successful investor of penny stocks in no time at all.

By: Nir Dotan

5 Things to Do Before Trading

Here they are.

1. Understand your personal financial situation
2. Understand diversification
3. Select the right portfolio holder for you
4. Do all the research necessary
5. Realize that it will be a bumpy ride

Let me address them individually.

Understand your financial situation
I would actually say “financial and life” here.  Trading is part of your life, not sepeate from it. That is something you need to take into serious consideration. There is the obvious decision about how much money you can put to work in the market. On top of that you also have to think about how much time you can commit.

Understand diversification
For traders this is a bit different than for investors. Diversification in investing is attempting to keep from having all of your money negatively impacted by one set of circumstances, like a downturn in a certain sector. Because traders are in and out of positions relatively frequently, this isn’t as much of an issue. Diversification in trading is more about making sure you have sufficient trading opportunities. Generally speaking, the longer your trading timeframe the more markets and/or securities you need to play.

Select the right portfolio holder
In investing this can mean any number of things from brokers to mutual fund companies to DRIP managers. There are a number of considerations involved there. In trading it really comes down to just the broker. You need to find a broker that suits your specific needs and with which you feel comfortable. By all means seek information and feedback, but in this end this is a decision that only you can make.

Do all the research necessary
Trading is not something you can just jump into and expect to do well. It’s pretty much like any other activity worth pursuing. It takes time to get good at trading. It takes work and study and practice. At times trading will be frustrating and in the beginning it can most definitely be overwhelming with all the different markets, instruments, and ways to trade them. Realize going in that you’re going to have to put forth considerable time and effort.

Realize that it will be a bumpy ride
This one pretty much speaks for itself. There have been all kinds of adjectives used to describe trading and dozens of metaphors applied to it. While it may not make things better, going into trading with the realization that there are going to be any number of ups and downs can help make riding them out a bit easier.

Now I’m not going to say these are the five things to do before trading, but they are among the things you should do before taking the plunge.

Does Forex Trading Really Live Up To All The Hype?

By: Ian Armstrong

If you’ve heard of Forex trading (also known as foreign exchange trading), great. It’s one of the hottest topics around right now and its popularity is growing. What is it, though, and how can you as an average trader make money in it?

Forex is also called “FX,” and both are short for “foreign exchange.” Foreign exchange doesn’t get a lot of press like options, stocks and commodities. However, foreign exchange is in fact the biggest market in the world and it can offer investors a huge opportunity for profit, done right.

When you trade in foreign exchange, you don’t trade in bonds or stocks. Instead, you trade in currency. Simply, you buy one currency and sell another. As exchange rates go up and down, you either make or lose money, depending on what you’ve traded.

With foreign exchange trading, you aren’t investing in a single company or group of companies, as you might with mutual funds, for example. Instead, you’re investing in a nation’s economy. You are betting that the overall economic health of one nation will get better as compared to that of the second nation in your “currency pair,” or the pair of currencies you are utilizing to trade.

As an example, let’s say that you are dealing with the Japanese yen and the US dollar. Your research seems to tell you that the US dollar is undervalued and will increase in price, and at the same time, the Japanese yen is going to lose value. With this scenario, you would execute a trade so that you buy US dollars and sell Japanese yen. If you are right and the exchange rate rises, you make a profit. If you’re wrong and the exchange rate falls, you’ll lose money.

It sounds easy, but it’s really not. Currency prices can be very difficult to forecast, because so many factors contribute to a shift in exchange rates. You also have to remember that you always trade in pairs when you do currency trading. In effect, you sell one currency while simultaneously buying another. Therefore, you can’t just look at one nation’s economy; you have to look at the economies of both nations you are working with.

Finally, you don’t have to limit yourself to just one pair of currencies, such as the US dollar and the Japanese yen. In fact, there are many currency pairs you can work with. If you’re just starting out, though, stick to the seven major currencies listed below:

AUD – Australian Dollar

CAD – Canadian Dollar

JPY – Japanese Yen

GBP – British Pound

CHF – Swiss Franc

USD – US Dollar

EUR – the Euro

In fact, if you are a small investor, you’re likely just going to concentrate on these currencies; save the other currencies for more experienced and/or larger investors.

National Australia Bank Floating Rate Note – NABHA

NABHA Details – please refer to the PDS for full information

• The interest rate 1.25% pa above the 90 Day Bank Bill rate (close to official RBA cash rate)
• Interest payable quarterly
• Trades on the ASX like a normal share (code: NABHA)
• The debt is rated as “AA” by Standard &Poor’s
• Face value of $100

Currently NABHA is trading at $64.30 with a yield paid quarterly on the face value of the the note. 

If NABHA traded down to $60 you would have an unrealised loss of 6.7%. Also if NABHA traded up to $72 you would have an unrealised gain of 11.97%.

More information

For more infomation & PDS - NABHA PDS

To view payment yield history - http://www.nabgroup.com/0,,34595,00.html

Enquiries please call Eden on 1300 368 316 or email eden.hage@tricom.com.au

Investing in China and other Emerging Markets through ETFs

Tricom Trades gives investors the ability to invest in the emerging markets such as China, India, Brazil, and Russia, while still keeping their capital in Australia.

This is done through Exchange Traded Funds (ETFs). These funds are designed to track the stock exchange of the nation that it represents, moving up or down with the underlying index. ETFs have become increasingly popular with investor wanting to catch the next wave of growth in these emerging markets.

Biggest Dow Point Gains and Percent Gains

Today’s 497.48 point move (6.84%) for the Dow was the 5th biggest one-day point gain and 23rd biggest one-day percentage gain.  Below we highlight a list of the biggest point and percentage gains for the Dow since 1900.  We’ve now had 11 400-point up days during the current bear market, so as happy as they make investors feel, they haven’t been out of the ordinary.

Source: Bespoke Research

You Will NOT have a Market Reversal Without this Index …

Some investors were excited last week with a nice market move on oversold conditions.

Is it real, or is it part of a market attempt to find a bottom?

Think about it … who or what got us into this whole trouble? The answer is the Banks.

So, it makes imminent sense that the banks are going to have to show that they are out of trouble and trending up before the stock market can find its way to a new Bull Market. This is important, because over 13% of the S&P 500 is made up of Financial stocks.

Therefore, let us look at Banking Index today (symbol: $BKX).

This daily chart goes back to 1993, 17 years ago.

On Friday, the Banking Index closed at 25.59. That was a level just above the 1993 and 1994 support levels. As you can see on today’s chart, the drop after the Banking Index’s 2007 peak has been precipitous.

In fact, the down movement in the past two and a half years erased 14.5 years of up movement. The fall in the Banking Index depicts the seriousness of the the financial troubles this country is in.

So, what is the Banking Index telling us now?

The daily chart looks pretty depressing. But, take a look at the close-up insert in the upper left hand corner. That is a picture of the Index’s movement since January of this year.

First, note the fan lines. We have had rising fan lines which is a sign that the Banking Index is trying to stabilize.

Sounds good? Not quite yet … note the arrows I drew in the close-up. They still show lower/highs and lower/lows … a classic definition of a down trend. Until that changes, the Banking Index will remain in a technical down trend.

So, what we are seeing is a mixture of two conditions … one negative and one positive. This could be a basing attempt which would translate into the Banking Index trying to establish a hold-able bottom. While that would be good news, it hasn’t happened yet. Such an event is a process, not an instantaneous happening.

So, be patient. The Banking Index is showing some progress … it now has to show a trend reversal and that will take some work.

*** Feel free to share this page with others by using the “Send this Page to a Friend” link below.

Leveraged ETF Performance

Below we highlight the year to date performance of the many leveraged and inverse ETFs available to US investors.  But first we want to highlight the 3x ETFs to show their year to date performance versus the indices they follow.  Remember, these ETFs are meant to track the DAILY performance of the underlying indices, but many investors unfortunately hold them as long-term investments, where the performance can be way off.  As shown below, the 3x long large cap ETF (BGU) is down 41.55% year to date while the index it tracks is down 13.99%.  This is right inline with where performance should be.  However, the 3x inverse large cap ETF (BGZ) is up just 26.78%.  Investors hoping for 3x have only gotten 2x in this case.  The same holds true for the 3x inverse small cap (TZA), which is up 41.57% versus the underlying index’s decline of 20%.

Where performance gets really bad is in the 3x inverse financial ETF (FAZ).  While the underlying financial sector is down 28.15% year to date, the 3x inverse ETF is up just 0.34%!  Investors who wanted to bet big against the financials this year using FAZ have been correct in their prediction but haven’t made a dime on it (well maybe a dime).

Below we highlight the 25 best and worst performing leveraged and inverse ETFs year to date.

Technical Talk: S&P 500 up against resistance levels

Back to where we started … As seen in the graph below the S&P 500′s multi-day rally back from the dead has brought the index smack dab backup towards its recently broken support zone near 780 to 740. This zone of resistance is likely to stall this rally short-term given the fact so much trading activity occurred around this level before it finally gave way. However we are never one to argue with the tape and certainly the advance/decline stats as well as the up to down volume readings the last two days suggest this market may be able to overcome this resistance easier than we would have previously imagined.

Click on the graph for a larger image

Additionally with AAII Bullish Sentiment as low as 18.92 last week there is certainly enough bearish sentiment out there to suggest investors are under-invested and sideline cash is quite ample to support a continued bear market bounce. With the quarter ending in just a few weeks we would also imagine that institutional (long only) managers will add liquidity here as to not fall too far behind the market relative return numbers.

If this resistance zone is taking out over the next few days week then the next resistance zone for the S&P 500 would be at 950.

All Hail the Uptick Rule!

By David Gaffen
An already exuberant move in the equity market was bolstered by none other than Barney Frank (D-Mass.), who said he expects the “uptick rule” – a requirement done away with in July 2007, which required investors to wait until a company’s stock rose before it could be sold short – to be restored in about a month.That the removal of the uptick rule has damaged markets has been an article of faith for investors for months. The rule was removed in July 2007, and markets have tanked, ipso facto, the uptick rule is responsible. (The second pillar of evidence comes from the past- it was first put in place in 1938, at the tail end of the worst period for stocks in history. Once again, quod erat demonstratum.) Never mind, of course, the overleveraged financial industry sinking as if trapped in a tar pit under the weight of bad loans and the high cost of servicing their debt.

Since the rule was officially suspended on July 6, 2007, the markets have gotten hammered. Volatility has certainly picked up, with the Chicago Board Option Exchange’s volatility index rising from levels in the low 20s to the 40-to-50 range it finds itself in currently. Traders were indeed glad to hear that discussions were taking place. Gordon Charlop, managing director at Rosenblatt Securities, said that “the fact that they’re looking at it and discussing market structure is positive.” He tempered his enthusiasm, saying that “as far as the short-sale rule specifically, it still remains to be seen.”

That may be because the evidence to support reinstating or forgetting about the rule is thin. A non-profit research institute called the New England Complex Systems Institute conducted a study released in November 2008 argued that the number of stocks with big percentage declines increased after the uptick rule was done away with (authors of the study wrote an editorial in the Wall Street Journal in November). They found that there were 32 instances in which an individual issue saw a 40% drop in one day or more in the 12-month period beginning Sept. 30, 2007, compared with just 14 names in the 12-month period beginning March 31, 2000.

The problem, however, lies in the issue of correlation vs. causation. Markets have also been roiled by the banking crisis – one that has been compared unfavorably to the Great Depression – and economic growth contracted in the fourth quarter at its greatest rate in 25 years. It’s going to repeat that trick in the first quarter. In the meantime, short interest has declined rapidly in the last several months. As of July 15, 2008, just after the rule was rescinded, New York Stock Exchange short interest totaled 18.608 billion shares; on Feb. 13, 2009, it had declined to 13.802 billion shares.

“I think it’s a feel-good thing so Congress and everybody involved can act like they’re doing something concrete,” says Eric Newman, a portfolio manager at TFS Capital. “I don’t think the short-sellers have made it any worse.”

Still, the rule may end up fading into the sunset before long. And if it does – after major averages have declined by more than 50% in one of the worst bear markets in memory – some will invariably point to the rule’s restoration. Quod erat demonstratum.

Key ETF Performance

Below we highlight the one-day, five-day, and one-month performance of key ETFs across all asset classes.  Today was a strong day across the board, with small caps and mid caps doing slightly better than large caps.  Value stock ETFs actually outperformed growth stock ETFs as well.  On a sector basis, the financial ETF (XLF) was up the most with a gain of 14.86%, and outperforming the second best sector (Industrials) by a wide margin.  Globally, the Russian market ETF (RSX) was up 12.93%, followed by Italy (EWI), and China (FXI).  Commodity and US Treasury ETFs were the only areas of the financial world that were down today.  Looking at the one-month performance of all of these ETFs, however, snaps investors back to the reality that things are still pretty bad out there.

Explaining the Berkshire Share Price

One of the more annoying aspects of stock-market commentary is the idea that there is one ideal actual-value price for any given stock, and that the market price is either above that price, in which case the stock is overvalued, or below it, in which case the stock is undervalued. This is the kind of thing that investors do when they look at sum-of-the-parts analyses for companies such as Berkshire Hathaway, and start saying that the stock is trading at the value of its cash and investments, with Warren Buffett and 75 operating busineses thrown in for free.There’s another way of looking at Berkshire Hathaway, however, and that’s through the lens of its credit default swaps, which are now trading at a whopping 535bp — pricing in a probability of default which is much greater than one would ever expect from a triple-A company with barely more debt than cash.

If you take those numbers seriously, then maybe the market isn’t valuing Buffett at zero. Remember that historically Berkshire Hathaway has traded on a price-to-book ratio of about 2: if you gave Buffett $100, and he spent that $100 on shares of American Express or Coca-Cola, then the market would value those shares, as owned by Warren Buffett, at $200.

On the other hand, if you plug in a 60% recovery value, the market is saying that there’s a 13% chance that Berkshire Hathaway is going to default at some point in the next five years. (A handy formula for you: the default probability is the CDS spread divided by 1-R, where R is the recovery value.)* If Berkshire defaults, the equity will be worth zero.

So it seems to me that the market is still valuing Buffett’s investing skills at a premium. If there’s a 13% chance of his company going to zero over the next five years, and presumably a substantial chance on top that the stock will decline markedly but not go all the way to zero, then in order to justify the current share price there has to be a pretty big chance that the stock will double or more over the next five years.

Now it’s entirely possible that the CDS market is overdoing things, and that the chances of BRK going to zero are much less than 13%. But even so, the share price is essentially the result of a probabilistic calculation: look at the range of possible future values of the company, and the probabilities associated with those values, and then discount them at a rate which goes up with the volatility and uncertainty associated with the share price. Given that Berkshire is — like all insurance companies — a leveraged financial institution, and given also that many of its investments (GE, Goldman Sachs, American Express, Wells Fargo, etc) are also leveraged financial institutions, it stands to reason that a sensible investor will apply a pretty high discount rate these days, even if he doesn’t believe the CDS market. What’s more, the lesson of the past 18 months or so is that stock-market investors ignore the CDS market at their peril.

I have no idea how much of Berkshire’s past profitability can be attributed to the fact that it had a triple-A rating, but I know for sure that that rating ain’t worth much any more. And when a company which has grown used to its triple-A then loses it, in name or just in market perception, the consequences are not pretty. So my feeling is that Berkshire has moved from being a safe-and-sound stalwart to being a much riskier stock. It might go up a lot from here — there’s surely as much upside potential as there is downside potential — but it doesn’t really feel like the widows-and-orphans investment that it has been in the past.

*Update: Actually, it’s worse than 13%. I used the formula for a one-year default probability, not a five-year; the five-year default probability is technically up in the 60% range, but at these levels I’m not sure that really means much if anything.

Does Yesterday’s 90-90 Lowry Up Day Change Anything?

Yesterday’s +3% snap-back rally was one of the famed Lowry 90%-90% days. For those unfamiliar with the term, these are climactic days coined by a research report by Paul Desmond written in 2002 (you can find the original report in the free trading resource section – in the Articles and Reports section).

90-90 days are defined by two conditions:

1. Volume is extreme so that 90% or more is either devoted to downside volume or upside volume.
2. Points are so extreme that they are 90% or more either gained or lost to the downside.

These days are significant because historically, every single major shift in the nature of the market has been presaged by the presence of one or several 90-90 down days (representing panic selling) followed by 90-90 up days (panic buying).

We’ve seen quite a few of both 90-90 up and down days during this vicious bear market. So much so that they have tended to be given less and less attention. Yesterday’s extreme up day was even more significant because it was on the heels of a 52 week low. We’ve seen these before too:

But before you get excited, consider that for all its glory, the rally was an inside day. That’s hard to believe since it was so powerful. But it still didn’t engulf the previous candlestick.

As well, the volume was nothing to write home about. It was higher than the previous session’s but compared to the November low, it came up short.

Most of the impetus for the rally came from a massive short covering rally in the financial sector. The Philadelphia Bank Index (BKX) was up almost 14%.

As well, Lowry Research continues to be unimpressed by the market’s behavior. In a recent reports, Paul Desmond says:

“A lot of investors were hoping the market would hold at the November 2008 low. As those hopes were broken, investors tend to panic. We’re really at a critical stage.”

Until the market eliminates those investors who bought high but are still reluctant to sell and take a loss, it will not achieve capitulation. A sign of approaching capitulation will be a slowdown in the rate of selling. That will set the stage for investors to begin looking at opportunities. We’re still into a healthy bear market.”

For all its significance and predictive qualities, the concept of 90-90 days is just one of the many tools that Lowry Research uses to analyse the market. Their most important indicators are proprietary and measure buying power & selling pressure. According to these indicators, Lowry Research is still advising clients to stay on the sidelines because investors aren’t done selling.

Check out my previous in depth report to find out more about Lowry Research and a sample of their analysis of the market (including charts of their proprietary Buying Power and Selling Pressure indicators).