Reader Tom sent in the following parable (sorry, no link), which is most timely given the fact that the automaker bailout is on the front burner and has the markets moving higher in anticipation of some sort of agreement:

A Japanese company (Toyota) and an American company (Ford Motors or GM) decided to have a canoe race on the Missouri River. Both teams practiced long and hard to reach their peak performance before the race.

Ford folks are still scratching their heads and collecting bonuses…

This could be a real funny story, if it wouldn’t contain so much truth. I’m still against this or any kind of bailout for that matter, since it accomplishes nothing and only postpones the inevitable. It’s kind of like taking a band aid off your hairy chest (if you’re a guy). You can do it fast and painful or slow and painful, but you will have to endure pain.

The markets tumbled yesterday based on more evidence of a slumping economy along with lower oil prices and weak financials.

Safety seems to be foremost on investors’ minds as the Treasury was able to sell $30 billion worth of 4-week T-Bills at 0% for the first time since 2001. Translation: investors are willing to accept no return for having their money parked safely.

Pending home sales are declining, which sends a clear signal that the housing debacle is far from being over. Even modified mortgages ended up back in default within six months. An amazing 53% of borrowers, whose loans were modified in the first quarter of 2008 to help them stay in their homes, were more than 30 days overdue by the third quarter. So much for the idea of trying to keep people in overpriced houses they were not qualified to buy to begin with.

To me, all of these tidbits are signs of a continuously weakening economy, with the cheer leading stock market clearly running on nothing but fumes and hope. It will not take much to pull the plug on the current rebound. One major event, such as not bailing out the auto industry, will send the current bulls heading for cover.

The markets, supported by President-elect Obama’s plan to invest heavily into infrastructure, marched higher yesterday and continued their impressive short-term rebound.

Looking at the big picture, the rally over the past few days has now merely wiped out the losses sustained during the first five trading days of December. In other words, we’re still way down and have a long ways to go.

To me, it’s simply another bounce off the temporary bottom, based on hope and wishful thinking. Contributing to the rally were plans of short-term financing packages to bail out the beleaguered auto industry.

As I said in a recent post, I would not be surprised to see further temporary moves to the upside. This brings up the all encompassing question as to how high can we go and low will the next leg down be.

Mish at Global Economic Trends had some thoughts involving the Elliott Wave Theory which, according to his previous reviews, seems to be right on target. Take a look at the charts he presents on his site in respect to the S&P; 500. Here is his comment:

In Elliott Wave terms we are looking for a “wave [4]” bounce. The short term implications are bullish with possible retrace targets of 1008 for a 38.2% retrace or 1090 for a 50% retrace of “wave [3]”. The long term implications are rather nasty. Our “Wave [5]” target back down is approximately 600.

There you have it. The current bounce could be as high as 1090 with a subsequent long-term retrace target to the downside all the way to 600.

This downside target seems to agree with what others have forecast in terms of final bottom. Whether it will play out that way or not, will be revealed at some point in the future. Right now, I take this bounce for what it is and to me it’s not a major change in the trend but only bear market volatility.

Some readers like to listen to the financial gurus on CNBC and actually follow their advice. Here’s what Mark experienced:

I am a real fan of your investment letter and typically abide by it completely. However, I saw Meredith Whitney, the Oppenheimer guru, on CNBC this week forecasting a further “huge” decline in financials.

Wednesday, “SKF” started climbing rapidly and I thought that we were about to see another Friday 11/26/08. I bought into the ETF and since then it has declined 24%. Should I bail out Monday, or do you think that Whitney was right?

This is exactly the reason why I have stayed away from playing the short end of the market. Volatility is simply too high to make a reasonable assumption as to the short-term direction of the trend, whether in financials or any other segment.

While I believe that Whitney is right in her view (long-term) that financials are due to decline, the timing of it could be off as Mark just experienced. Nobody can look into the future, so blindly following an opinion voiced on national TV is a gamble at best.

If you look at a chart, you’ll see that SKF is above its long-term trend line, and therefore a buy. However, you need to have either deep pockets, nerves of steel or both to be simply holding this UltraShort ETF. That makes it suitable for only the most aggressive investors.

For the rest of us, if you do take a stab, you need to use a sell stop. UltraShort ETFs can move violently in either direction, so a larger exit point is required. Since I usually recommend a 10% stop for sectors, in the UltraShort arena, you may have to move that to 20%. Hopefully, you used “play money” or only a small allocation of your “serious money.”

I’d watch Monday’s market opening or the first couple of hours and, if the trend goes against you, get out. If there is a sharp drop in the market, monitor it closely and maybe Whitney’s forecast will turn out in your favor.

The key here is to always have a sell stop discipline in place. You may have to jump in and out several times taking small losses before the major trend finally supports your view. In the meantime, you need to make sure that you don’t get wiped out with one trade and then watch the market go your way.

Disclosure: At this time, we don’t have any positions in SKF.

One sunny afternoon, thirty years ago, when I was working as a young real estate broker in Southern California, I received “the phone call.”

It came from a friend of mine, and the instructions were clear: Go to the bank, get a $1,000 in cash, and meet him at a residence in an upscale neighborhood. And yes, bring a friend. While I didn’t get the money, I brought a friend, and we met at a very nice home, which was already buzzing with activity.

We could barely get through the front door, it was so crowded. The “proceedings” started within a few minutes and, over the next few weeks, I witnessed one of the most amazing pyramid schemes I have ever seen in real life.

The basic idea was that you bought into the pyramid at the bottom with $1,000. As demand for that bottom position increased, your name moved up the food chain until you reached the top about 7 days later, when you received the pay-off consisting of 10 envelopes for a grand total of $10,000 in cash.

I am not making this up. It really happened. For fun and entertainment, I spent many evenings following some friends around who were involved in multiple pyramids and subsequent multiple payoffs. Soon thereafter, $5,000 pyramids were starting, where the payoff was $50,000.

This went on for a few weeks when—all of a sudden—it was over. People still went to meetings, but the volume had dried up. Everybody’s friends were already involved at some place and, as in any pyramid scheme, the late comers were left holding the now empty envelope. The scheme had simply run out of people.

As quickly as it started, it had ended. Revival attempts quickly failed. In many discussions with friends, we came to the conclusion that any pyramid scheme that had pulled in this many people was not to be repeated in their lifetime. And so far this conclusion has been correct.

Why bring it up now?

Because that’s exactly what happened as the biggest real estate bubble in world history burst.

Artificially low interest rates in conjunction with fraud and deception (no documentation loans and no lending standards) enabled those who where not qualified to buy a home to get into the market thereby providing the volume/demand necessary to push prices higher benefiting those who got into the game early.

Eventually, just as in the above pyramid scheme I witnessed in 1978, the real estate orgy simply ran out of people to fuel the fire. Demand dropped, prices followed, buyers defaulted and the game was over.

The big question is will there be a recovery and when? There are some who possess better forecasting skills than I have, and their prevailing opinion seems to be that a bottom may occur in 2011 after all Alt-A and Pay-Option-Arm loans have reset.

I can agree with that. Where my view differs from many is that the expectation of a “V” type recovery in 2011 still exists. I think that is way off base.

As we’ve seen in my above pyramid example, once a large number of people have been financially hurt by any scheme, they will be hesitant to make the same mistake again in the future. Hence I believe that any real estate recovery will be in form of an “L” shape, which means that prices will move sideways, down and up in a similar fashion as we’ve seen mostly in the 80s and 90s.

Those, who are counting on an imminent recovery along with price increases as seen over the past few years, will be sadly mistaken. While real estate may again be a good long-term investment in the future, the times of quick and easy money generated from flipping houses were a one-time phenomenon, which may not repeat itself for this current generation.

MarketWatch featured a story called “Bottom feeding is for catfish.” Let’s listen in:

Every investor wants to say that he or she “bought the bottom” but anyone attempting that feat this year was in for a rude awakening. Bottom picking is a dangerous game and while we have all sorts of indicators to help us get close to that goal they all depend on an orderly market.

Bottom fishing is a good strategy when the overall market is rising or is at least stable. It is a bad one when a bear market rages and especially bad when things are as far out of whack as they have been this year.

[Emphasis added]

Read the last two paragraphs again because they contain the essence of what I have been writing about. You need to have some return to stability before the odds are in your favor again that a trend reversal is the real thing, and upward momentum can be sustained. The biggest obstacle to waiting for this point in time is an investor’s lack of patience, and the need for ego gratification that he was smart enough to pick a bottom.

The goal, however, should be to be on board when long-term sustainable trends are in place. Those are the ones you need to participate in, because they have the potential to generate above average portfolio returns. After all, isn’t that the main reason why you invest?