MARKETVIEWS.TV

Interview with Ike Iossif

By "Zapata"  George

09/15/2007 10:00 AM PST

Q: On 8-3-07 -based upon the price pattern of the SP500 over the previous 4 weeks- you  identified several  price scenarios which -in your view- had the highest probability of unfolding over the following 4-6 weeks. On 8-31-07  (see DP report) you narrowed them down to just two, where are we now?

A: So far, the actual price pattern has been almost identical with  the  suggested one. On 8-31-07 the SP was at point "1" since then, it declined  to point "2" and then rallied back up to point "3" -as  expected. Notice that point "3" is a critical one, because according to our scenarios, that is the point from which the SP will either decline, or, rally further by another 80-100 points. I want to emphasize that just because so far the price pattern has unfolded according to our scenarios, it doesn't  necessarily mean that it will continue to do so, but the  odds at this point, are better than even in favor of completion. In order for point "3" to become a "launching pad" for an 80-100 point move in the SP, the market will need a "catalyst." Coincidentally, next week, not only the FED is expected to lower rates, but also,  Goldman Sachs, Bear Sterns, and Lehman, will report 3Q earnings, thus,  the chances are pretty good that the market will get the   "catalyst"  that it needs  to spark an 80-100 point move in the SP over the next 10-20 trading days.

Q: Are you positioned -in advance- in preference of either the bearish, or, the bullish resolution?

A: I have no major positions  in anticipation of  either outcome. Our managed accounts are either  90%-95% in cash (if they were open prior to 2-1-07) or, they are 50% invested in fully hedged positions   (if they were open after 2-1-07) thus, our net exposure to the market is  minimal. Given the current elevated level of market risk, I believe the right thing to do, is to wait for the price action to confirm either the bearish, or, the bullish outcome, before making a major net commitment to the market,  even if it means missing out on  the first 20-30 points  of the move. As you  know,  patience is one of the most important, and necessary  virtues for long-term survival  in our business! 

Q: Do you have an opinion with regards to the final outcome?

A: Yes, I do, and I will discuss it in detail, but since you mentioned it, if I may, I would like to take the opportunity to point something out for the benefit of those listeners  who are managing their investments on their own. The key metric to consider before taking a position, is not the probability of being wrong, versus, being right -as many people think. It is the expected R.O.R adjusted for different market conditions.

Q; Can you elaborate on this?

A: Of course. To make things  simple, we'll assume  the following: an investor has a total risk capital of $10k, the dollar amount committed to each trade is always the same, and  he/she employs a trading system which has proven to have a 60%  probability of success under any  market condition ( conversely, the probability of failure is 40%) Now, we'll use the data I just gave you to  calculate  the expected ROR for the same market, but for two different time periods, taking into account the prevailing market conditions in each time period. Keep in mind that  for both time periods, the probability of success is the  same (60%) however during period A, the expected loss is 10%, and during period B the expected loss is 25%, while  the expected gain remains the same at 10%. Interestingly, although the probability of success is the same, for both time periods, the expected R.O.R. is not.

Expected R.O.R per trade for period A:

(60%*10%)-(40%*10%)= 6.0%-4.0%=2.0%,

Expected R.O.R. per trade for period B:

 (60%*10%)-(40%*25%)=6.0%-10.0%=-4.0%.

 So, my point is this:  Even if one's "opinion" is  correct most of the time, the actual returns from trading  on that "opinion" will vary from time to time due to differences in  the "market climate." Investors need to identify those times when -although  the  ratio between  winning trades and losing trades matches the historic one- the market climate is such, that results in negative returns, anyway. To put it simply,  even if three  out of every four   trades are winners, one can still end up losing money, if the loss from the one losing trade exceeds the gains from the three winning  trades. Consider the following: in the last 45 days the SP has had a net gain of 2 points, but,  intra-day it has traveled -on an absolute basis- approximately 500 points (see chart below) Moreover, it has rallied, or, declined in excess of 1% during the  last 60 minutes of trading, approximately 1/3 of the time, only to gap in the opposite direction the next morning!

In summary,  this is not the type of market that inspires "heroics" this is the type of market that requires patience. Market participants should look for a pattern they know  how to trade, and then wait for confirmation before taking any positions, so they don't get whipsawed. In addition, investors/traders must be willing to recognize that although they may possess a  high level of experience, skills, knowledge, etc., the market is bigger than all of us, and if  it turns  against us, not only we'll lose, but also, we'll lose more than what we had expected. You and I -and everyone else I know in the business- have had our share of such unpleasant experiences! It would be a lie if I proclaimed that I have been able to  recognize every single one of those times when the market appeared to be doing one thing, when in reality it was doing something else. Most of the times I caught it, a few times I didn't, and it cost me dearly.  Market participants need  to recognize that we are experiencing  one of those times, during which  risk metrics -even the very sophisticated ones- may not be able to capture the actual level of market risk.

Q: Ok, now please tell me your  opinion on the market. 

A: The SP has rallied 110 points from its August low, partly in reaction to the FED's initial handling of the "crisis" and partly from faith that "more help is on the way." The 110 point rally has discounted -in my view- a cut by 25 basis points, for the market to move further, something more is needed. Therefore, if the FED just lowers the federal funds rate by 25 basis points, and  doesn't make it clear in its statement that more will follow, then  I believe the SP will sell-off, and it will re-visit the 1420-1400 support zone. If it holds, then I would expect another rally towards 1490-1510. If the 1420-1400 support zone doesn't hold, the next support is at  1370-1360, and below that, we got the  1325-1315 zone. 

On the other hand, if the FED goes out of its way to accommodate the market, and none of the 3 big brokerage firms reporting 3Q earnings next week reports anything that catches the market by surprise, then the bulls will  have an excuse to push the SP towards the 1510 resistance level. If the SP rallies to 1510 from current levels, then it will be overbought enough to warrant a pullback to 1490-1480, which ought to be followed by another rally towards 1510-1525.

Q; What are the odds for either of the above happening?

A: Notice that over the past 5 trading days inflows and outflows have been at equilibrium, suggesting that for next week, the odds are even for liquidity to turn either positive, or, negative which means, over the short-term, the odds  between lower and higher prices are almost even, and thus, investors ought to be equally prepared for either outcome.

Q: In your view, what are the odds  that the SP has entered a bear market?

A: As you know I use a different set of MAVGs -other than the 50, 200 DMAs- to determine that. To conclude that the SP has entered a bear market, liquidity will have to turn negative, accompanied by a decline in price   down to  the 1350-1340 zone, followed by a rally that will fail in the 1370-1380 zone. As you can see, none  of these three conditions has been met, as of yet. Therefore, at the present time, the odds  still favor continuation of the bull market.

Lets take a look at one more  chart for the SP. The chart below shows the ratio of two different moving averages of daily lows, and daily highs. Notice how a negative divergence is followed by a sharp decline in price. In bull markets the indicator stays flat for about 8-10 weeks, then it turns up and quickly shoots up to the 50-60 level. At the moment, the indicator appears to be acting as if the bull market is still on. (see arrows on the bottom of the chart) 

Q; How about gold stocks?

A: So far, we have had a very sharp rally, bur no firm confirmation, yet, that a new multi-month rally has indeed started. Take a look at the chart below. First of all, notice that if indeed the rally of the last 4 weeks represents the start of an intermediate-term advance within the context of a secular bull market, then, this is only the first leg of the advance, and after a pullback to the  DMA,  another one, or, two legs should follow. Notice that in the previous three intermediate advances, the XAU rallied from the bottom on average 25%-33% non-stop, then it pulled back to the  DMA, and then it resumed its advance. During intermediate term advances, pullbacks to the  DMA, represent LOW-RISK ENTRY POINTS, we haven't had that, yet. As of Friday's close the XAU has rallied 33% from its August bottom, consequently, it should be pretty close to a pullback, if price finds support  at the DMA (green line, see arrows) and it reverses to the upside, then we will have confirmation  that an intermediate term advance   is under way.

At the moment because of the 33% advance, and because of the negative divergences shown in the 3 charts below, I believe that the upside potential is at most 10 points. If the advance is for real, then sometime over the next 5-15 trading days we should get a pullback with a magnitude of 7%-10%, followed by another leg to the upside of roughly equal magnitude (30%-35%) Those who are bullish on gold/gold stocks but  looking for a low-risk entry   need to remain patient for another 5-15 trading days. If an intermediate-term advance is indeed underway, a low-risk entry point should be no more than 5-15 trading days away.