Wednesday, March 02, 2005


One of the blogs that I enjoy most is the Random Roger Blog. (

I think our long-term investment strategies are similar although he is apt to use funds where I am apt to use individual stocks. I am more the gun-slinger but we each practice similar portfolio diversification techniques.

Yesterday, Roger posted a blog that was a beautiful sight. Seeing the blog was one of those moments when you stop what you are doing and say, "Wow! This means the next move is going to be big".

The blog was about the latest IPO for stock-income funds. I followed the link but cannot even remember the name of the fund or other details now. There were several interesting signals including that it was not the first new fund of this type and it was the largest yet--fully subscribed.

Whenever there is strong demand for a specialized fund and there are new similar funds opened, the end is near! The strategy of the fund will soon be a poor strategy. I should be able to think of many precise examples. This phenomenon has happened many times. Each year, the most naive of mutual fund investors are likely to move to types of funds that did well last year. The new EFTs for Gold partially prove the point. Gold was up strong for maybe three years before GLD and ??? was started. Since then the price of gold has pretty much stalled. I am currently playing NEN for a bounce but the whole group looks "heavy".

In the current back and fill market, the income fund Roger wrote about is particularly noteworthy. For some months now, with the exception of energy, the market has "sloshed" back and forth. Even energy had a big down day Monday when the rest of the market was strong. Like so many other indices, the oil services index approached the old top and then collapsed. The Dow and the S&P have made similar moves. In other words, most groups are trading in relatively tight ranges--nothing breaking out. The NASDAQ 100 has in fact under-performed most other groups. Many a QQQQ option is bought and sold but this EFT has been relatively stable.

The stock-income funds write (sell) put and call options to capture option premiums. It is significant that the long-term treasury bond made a big speculative move a couple of weeks back and is now trading down. Very few investors want to get locked into 30 year rates of 4.5% but there are a lot of investors who would be pleased with an 8 or 9% steady income stream in the current market. In my experience, those who expect to average better than 9% in an option income fund are misguided, but again 9% would be excellent for an income buyer in today's market.

The problem will be when the market moves big. The option writer will get stung. Another problem is that when the strategy becomes popular, the premiums die; the net income captured becomes small relative to the risk of missing a big rally or only the option income is small relative to stock declines.

I treat the popularity of option writing as a strong buy signal. The idea being to go the oposite direction of the crowd. I cannot recommend that you buy risky options, but buying stocks without writing calls should beat the call writing accounts. However, remember that I am a semi-long-term investor. I hold positions for years. I like to mention my beach condos that I bought an average 12 years ago because I currently offer them for sale. But I have 25 year old shoes in my closet. I have silver and gold purchased 38 years ago and stocks purchased 20 plus years ago.

The US stock market is going to make a major move up between now and January 1 of 2006. Indeed I believe in the BULL BOOM BUBBLE over the next 5 years and a BIG BUST by 2011-20012. What I take from this most recent buy signal is that the next move is going to explosive. When it happens, a lot of short-term traders will sell into the move. The option sellers may re-purchase options at a loss to avoid the costs of trading out of the stocks. The funds that are committed to this strategy will then sell call options again only to lose again. They may hold the stocks through-out the rally but only net a small portion of the gain.

The problem is that it is too early for the market to get a read on the likelihood of Social Security reform. I believe Bush and Greenspan are going to apply more and more pressure as the year progresses. The real pressure will only come when it is time for congress to pass the budget. Theoretically this needs to be done before the fiscal year begins on October 1. In practice, the congress has been known to fight long and hard when a major change is proposed.

The budget actually has nothing and everything to do with Social Security. Bush has the votes to pass the budget; he will have to do some horse trading to pass social security.

Social security reform will be very positive for the market. Many believe that passing reform is at best a 50/50 proposition. I believe the odds are at least 80/20. I am discounting the passage now! I am basically going "all-in" now. I may be early but I will not miss the big move.