Strategy vs Tactics

When it comes to investing, I’ve learned that I’m a strategist, not a tactician. My inability to pull the trigger and cut my losses when a trade loses 20 percent in the first two days means that even though some 75 percent of my short-term trades are positive, I lose overall.

Strategically, on the other hand, I’ve done quite well. I just sold off a two-year position in an equity that, in combination with currency appreciation, turned in a very nice 236 percent return. Its sister position, despite a nominal decline, still managed a 22.4 percent return. Not bad at all. And going into gold at 270 didn’t hurt either. So, let’s talk strategy.

The conventional wisdom has it that this is just another summer swoon, and that the markets will rise into the election. That’s possible, to be sure, as I am no prognosticator. My errant predictions of 15 months ago should suffice to prove otherwise. But, as there seems to be a certain amount of interest, I thought I’d share some of my thoughts on the current situation.

What I got wrong, I think, was partially due to my failure to think the Elliott Wave concept all the way through. The people at EWI tend to look closer at the charts than at the calendar, and I never stopped to consider the following basic point: If Intermediate Wave (1) took 640 trading days from March 2000 to October 2002, how could anyone expect Wave (2) to be complete in March 2003. That’s six months, about 125 trading days, far too short to be a reasonable countertrend to a 640-day wave. It is, in fact, close to the MINIMUM possible time-relationship at 19 percent. Based on the historical averages, projecting a 1280-day countertrend wave would have been as reasonable.

Is it possible that we have now seen the top of Wave (2)? The March 5th high for the S&P 500 this year marks 402 trading days from the end of Wave (1), or 62.8 percent of the time. In those 402 days, it rebounded back up to 75 percent of its peak. The QQQ hit its high earlier, on January 20th, marking 322 days of rally, which means that it rebounded to 32 percent (from 16 percent) in half of Wave (1)’s time.

We are told that Wave (3) is usually the big one, but for the sake of conservative argument, let’s assume that it is identical in length and performance to Wave (1). This would bring us to expect a bottom at the end of July 2006, with the S&P 500 at 580, the Dow at 6800 and the QQQ at 6.50. Sound impossible? I don’t think anyone expected to see the Cubes under twenty only two-and-a-half years after it hit 120 either.

If we did see the crest of Wave (2) a few months back, then we can compare how the decline so far compares to our expected down wave. In the case of the S&P 500, it’s declined 9.4 percent in 14.5 percent of our projected 640 days. The QQQ has declined 13.3 percent in 20 percent of the time. This could indicate a) nothing if I’m off-base, or, if I’m strategically correct, b) the speed of the decline is going to pick up pace at some point in the relatively near future.

The SPX/VIX ratio tends to support the latter theory. Small crashes of 20 percent in a month have tended to take place when this ratio is in excess of 80. Yesterday, when the morning rally peaked, that ratio hit 80.24 for the third time since June 23rd. Technicians will have no doubt noted that the three major equity markets have all now broken through the support of their 200-day moving averages for the first time since April 14, 2003.

In any case, time will tell.