Will Doomsayers Rule 2009?

• By Simon Maierhofer
• On 2:25 am EST, Friday January 16, 2009

Were you blindsided by the 2008 meltdown? I wish I could tell you: 'Don't worry, you'll get all your money back', but unfortunately that is not going to happen (anytime soon). Perhaps it will make you feel better to hear that you weren't the only one blindsided.

Mutual fund managers, financial gurus and analysts en masse lost more than 'just' (your) money. They lost their reputation and credibility. Unfair as it may seem, withdrawing your trust (and the little money remaining) is the only recourse you have against the composite financial world and/or its individual representatives.

'Living well is the best revenge!' This is harder said than done if your 'living well fund' is only worth half of what you think it should be.

Even large corporations like Microsoft didn't see the downturn coming. In 2007, Microsoft (Nasdaq: MSFT - News) hired 12,000 employees. That's 15% of its workforce in one year. Imagine the resources Microsoft allocates towards economic research, yet they hired at a record pace right before the fall. Even though Microsoft has done much better than the tech sector represented by the Nasdaq (Nasdaq: QQQQ - News), MSFT has to consider laying off part of its workforce.

An end to mockery

After years of mockery, doomsayers finally felt a sense of vindication in 2008. Perma-doomsayers not only lost out on massive gains culminating in the 2007 market top, they also lost credibility when they were actually right. After all, even a broken clock is right twice a day.

One economist who had accurately warned of a meltdown in the real estate sector (NYSEArca:  IYR), financial sector (NYSEArca: XLF - News) and equity markets (AMEX: SPY - News) is Nouriel Roubini. In 2006, Roubini discussed his theories which, as we know, turned into reality. A complete interview with Roubini's outlook for the stock market and real estate market is available to subscribers of the ETF Profit Strategy Newsletter.

A bad year for Dr. Doom

Vindication was denied for the impersonation of doomsayers, Henry Kaufman aka Dr. Doom. He received his nickname during the 1970s and early 80s when he consistently predicted higher interest rates and lower bond prices. Not only did Lehman Brothers, where he served as director and chairman, go out of business, Dr. Doom also had money invested with Mr. Madoff.

A look at the financial media reveals that there are as many different forecasts as there are opinions. Talk about analysis paralysis. Unfortunately most of them are wrong. It is for a good reason that savvy investors use investment advisor bullish sentiment as a contrarian indicator simply because they tend to be wrong.

Headlines to keep

In the summer of 2007, Smart Money Magazine touted from the cover page: 'Now is the time to jump into stocks and real estate'.  This view couldn't have been more contrary to the 'financial downward spiral with no stop-loss provision' we warned off at about the same time.

Another article that caught my attention was from the Street.com (on 12-16-08) titled: 'You are witnessing the stock sale of the century'. The article suggests that a new bull market began in November 2008.

It gets even better. On December 16th, Morningstar exclaimed: 'We think the Dow is trading at a 30% discount'. According to this article, Morningstar estimates the Dow to be fairly valued at 12,500 (56% higher than the current value). Since then the Dow Jones (AMEX: DIA - News) dropped another 10%.

I kept all the above article mentioned articles suspecting that only time will reveal the folly of such advice. When the Dow was flying high we predicted a drop to 7,500 followed by a November/December rally that would lead the Dow towards 9,150, followed by another drop towards and below the November 2008 lows.

In fact, on January 6th, we recommended to sell long positions with the comment: 'Dow 9,000 might be as high as we'll see it for 2009.' The Dow has dropped nearly 1,000 points since.

Reliable analysis

According to Morningstar, the Dow should trade around 12,500. According to our analysis, the Dow and all other major index benchmark have much further to go on the downside. The question is, which analysis is more reliable?

Let me back up a step. The reason that the bubble (called credit bubble) burst is that credit tightened. The inflating force behind the bubble was easy credit. Easy credit inflated the dollar. As such, the dollar is not an accurate unit to measure the stock market.

The only true measure of value is gold (NYSEArca: GLD - News). In 1999, one share of the Dow Jones was worth 41 ounces of gold. Today, one share of the Dow is worth 10 ounces of gold. Measured in real money, the Dow has already declined 75%. We discussed the implications of this in the November issue of our ETF Profit Strategy Newsletter.

Another measure is dividend yield. In times of economic distress, investors demand cash (dividends) up-front. ETFguide has pointed out that a 'the higher the better' approach in regards to dividends is foolish as the highest paying dividend sectors (real estate and financials) were, and will get hit the hardest. In short, the yield does not justify additional risk.

An analysis of dividend yields over the past 100 years shows that dividends reach highly elevated levels at major bear market bottoms. While some sector ETFs like the iShares DJ U.S. Real Estate (NYSEArca: IYR - News) and iShares DJ U.S. Financials (NYSEArca: IYF - News) pay hefty dividends, the dividend yields of the Dow Jones and S&P 500 have barely even cracked historical averages. 

Investor sentiment, an indicator of crowd behavior, is another indicator I like to refer to. This contrarian indicator led me to give a sell recommendation on January 6th. The optimistic sentiment leading up to the January 6th high rivaled the optimistic extremes present at the all-time high in October 2007.

Over the past several months we've utilized short ETFs such as the UltraShort Financial ProShares (NYSEArca: SKF - News), UltraShort Consumer Services ProShares (NYSEArca: SCC - News) and UltraShort Real Estate ProShares (NYSEArca: SRS - News) to hedge against the drop in equity values.

Sector short ETFs are of course more volatile than broad short ETFs such as the ProShares UltraShort S&P 500 (NYSEArca: SDS - News), ProShares UltraShort Nasdaq (NYSEArca: QID - News) and ProShares UltraShort Russell 2000 (NYSEArca: TWM - News).

A common sense analysis of the Dow Jones valued in true money, dividend yields and investor sentiment has provided reliable entry and exit points for short and index ETFs. Short term and long term implications of the above indicators are further discussed in our ETF Profit Strategy Newsletter.

We believe investing well is the best antidote against Wall Street's flawed advice. We also believe that amidst the larger down trend, 2009 will see the biggest counter trend rally since the October 2007 peak. You better make sure your 'living well fund' has enough left to enjoy this bounce

Buzz up!