Friday afternoon trapped the bears

At noon Friday, the Dow 30 Index was looking like it might dip below the previous Friday close of 10,686. The bears who held December puts were tantalized; while those up to their ears in November puts were... well being held up by their ears.

As November options were going to close in a couple hours, there was a lot of hoping and preying going on.

Suddenly, the oils (XOM), industrials (MMM), metals (AA), financials (AIG, AXP, C, and JPM), moved into high gear, followed by a few in the recently beaten down consumer group and healthcare (WMT, GM and MRK).

Yes, even GM and MRK were on fire Friday afternoon!

The bear trap had closed, and the remaining November put buyers saw their positions go to zero. It was really a sad afternoon for the bears.

The Dow 30 closed up +0.8 pct on the week; the S&P 500 and the Naz were both up +1.1 pct; and the Russell small cap index ended, like the Dow, up +0.8 pct W/W. While momentum is slowing, there is still some pop to this market, and the Dow 30 could hit 11,000.

Nevertheless, I am a bear, but since I do not often buy puts, Friday was actually a boring day for me. Some are calling me foolish, but I don't think this rally has legs.

Actually I believe the broad equity market is in a Distribution Zone preceding a 3 to 6-month pullback of perhaps 15 pct of total market capitalization. And so, I am generally not seeking capital gains, but have instead switched to a defensive posture to preserve capital.

Let me tell you why, and how I am positioned.

As I see the big picture, the U.S. Treasury yield curve is moving inexorably to an inverted slope, which is a definite negative for lending banks, and against prospects of further strengthening in the economy. The curve is flattening because there is an inflation problem, which requires the Fed to increase lending rates to the commercial banks so that fewer loans will be made of the kind to push inflation higher. At the same time the U.S. Treasury must print more USD to cover the immense government budget deficit caused by war expenditures and hurricane recovery operations.

Also, as interest rates rise, the Treasury must print more USD to service the government debt. Mom & Pop and Corporate America also have to pay more interest to service their debts, and they need higher prices/incomes to sustain day-to-day operations.

In summary there is (i) growing global inflation (ii) economic growth slowdown in the U.S. as well as prospect/possibility of a recession (iii) rising interest rates set by the Fed to combat inflation, and (iv) reflation by the Treasury to avoid recession and to meet the capital needs of the government.

That is a risky environment for capital markets. Government, Humungous Bank & Broker, Corporate America and Big Media are misleading you if, as and when you are told otherwise.

Today's economic and market conditions will evolve; however they do represent a much greater risk to capital than opportunities exist at the current price of equities. Hence my investment objective is to protect against risk, which means scaling down my expectations from an average 24+ pct annual return on capital objective to just +6 pct returns.

And so I am about 80-pct invested in cash or equivalent.

I believe that the bond market commenced a long-term bearish trend earlier. So for the best strategies to earn income from my portfolio I have switched entirely to a combination of T-Bills, high dividend yielding equities, and put writes (for income purposes in a short-term bullish phase for equities).

As a result of the M3 growth situation, the metals complex (for reasons of both investment and economic demand) has commenced a new rally that will likely take gold to the $550-$600 level within 3 to 6 months. I have a relatively big position there.

To meet my temporary objective of 6-pct capital return, I am 20-pct portfolio weighted in equities, of which 40-pct of that (=8 pct total) is in goldminer shares, including 0.5 pct in call options on gold stocks, put on November 17 as gold and silver were breaking out.

By writing put options against high quality goldminers, I was fortunate during the recent bear trap in gold to have the market put their stocks to me at very low prices, right before the rally in gold.

My objective is always to buy low and sell high, as simple as that sounds.

Leaving aside my expectations of capital gain on the invested 20 pct for the moment, I am seeking about 2-pct dividend yield, which would leave me a total return of +0.4 pct from what I refer to as the allocated portion of my portfolio.

Of the 80-pct cash or equivalent, I am actually about 43-pct in 3 and 6 month T-Bills (=35 pct portfolio weighting) anticipating a 4-pct return. On 35-pct invested, I anticipate a total return here of 0.7 pct.

I am also about 45-pct of the total portfolio (i.e., about 57-pct of the 80-pct cash or equivalent) invested in short puts of stocks that if ever put to me, at the strike prices I have chosen, would not make me unhappy. These are relatively short-term 3 to 5-month puts, where if I can receive an aggregate 9-pct return by using time decay and range-traded prices on the underlyings.

My total return from premium income is about 4.1 pct then. That gives me about 4.1 plus 0.7 = +4.8 pct return from what I refer to as the unallocated portion of my portfolio.

So, between the allocated and the unallocated parts, I am at about +5.2 pct annualized returns.

But with capital growth in my equities (e.g., my gold stocks), I ought to be able to raise that up to at least +6.0 pct return across the board.

I have taken very few risks; I sleep at night; and I am ready for the day that I call inevitable - the Accumulation Zone.

I may well be wrong, but I believe that the upside to the broad equity rally is now less than +2.5 pct; whereas I believe there could be a bear phase taking the Dow 30 to 9200 or lower. I want to be ready.

In the interim I believe +6.0 pct returns within a well-protected portfolio are satisfactory.