This upcoming week in the markets is probably going to be the most interesting since March 2009 when the S&P 500 hit the famous “666″ mark.

As I write this, the S&P futures are down 1.9%, gold is up a whopping US$59/Oz and oil is down $2.85. There is clearly a large amount of panic being baked in the marketplace. The cause is being attributed to the S&P downgrade of the US soverign debt but this is the trigger, not the cause. There are a lot more macroeconomic problems going on in the world that have attributed for this market meltdown while everybody tries to rush for liquidity.

August volatility futures were sleepy until they exploded in the past week:

I had earlier said that the market panic is likely to be over when it has reached 30-35, but I am now of the mindset that the volatility can get higher before the market has seen capitulation – I’m guessing now around 40-45.

Even when there is capitulation, the bears will likely not be done yet – part of dealing with market downtrends is that there will be significant periods of time (one or two weeks) where you will see sharp market rallies and people with cash on the sidelines will be stepping over themselves to get back into the marketplace. These will simply be more moments to lose money. As long as there are columnists and people on the television that are willing to say that this volatility presents a good time to purchase stocks, I do not believe this downtrend is over – it has just started.

What is incredibly contrary to the market action is the fact that corporate profits appear to be at incredibly reasonable levels compared to prevailing interest rates provided by “safe” (ahem) government bonds. It could be the case the market is predicting that such profits are going to evaporate in the near future or that such profits simply do not matter and liquidity is what is being traded, rather than equities in companies with solid fundamentals.

Investors must be able to be nimble on their transactions and try to buy when supply is at its highest, while selling when the demand has almost peaked. Selling in downturns or buying in uptrends will result in very sloppy executions.

This is reminding me of two other situations in the past. One was in the year 2000, when the Nasdaq went from 5,000 in March and crashed all the way down to about 3,000, only to climb back up to 4000 again in August before crashing to its ultimate low of about 1100 in October 2002. There was one day (April 4, 2000) where the Nasdaq went from 4283 down to 3649 intraday (a 15% drop), only to recover to 4148 at the end of trading (a 14% recovery). This was the most volatile day of trading I had ever experienced and was an omen that there were bad things coming down the pipeline.

Last Thursday was all down, but if my hunch is correct, we are going to see a lot of volatility this week, so be prepared to ride those ups and downs like a professional ocean surfer. Monday is going to start down, but the rallies and downturns are going to be as sharp as a razor blade.

That said, so many people think that the markets will tank on Monday that I would venture they main indices (S&P 500, TSX) will end the day up.

When you have no time to research in the market, forcing trades is a great way of gambling. You might get lucky, but you probably won’t.

The last two weeks has been the most positive in the markets in quite some time. This came to a halt on Friday when the market reacted heavily on some US data concerning jobs and employment, but the new economic paradigm is that human labour is expensive and businesses that attempt to automate all processes to avoid the human element will do better than those that are labour intensive. There are a lot of industries with labour costs that can not be automated (e.g. full service restaurants) and they will continue to become more and more expensive as government continues to raise the cost of labour.

Arctic Glacier (TSX: AG.UN) gave their unitholders the mother of all dilutions when they announced that they will be allowing their convertible debentures to mature into units. While this will allow the company to avoid creditor protection, their market capitalization is currently $12.7 million on a 32.5 cent unit price, versus the $90.6 million of debentures that are to be redeemed. Doing some simple mathematics says that unitholders will be holding 11.7% of the original company. Ouch!

Keep solvent, readers! The broad markets continue to be choppy.

The sentiment out there is feeling very negative – it appears that the momentum in the marketplace has completely stalled out – in fact, it can easily be described as negative.

There will probably be some sort of technical micro-rally in the next few days that will take the S&P 500 up a few percentage points, but my guess at the moment is that the next leg to drop are going to be commodities – even more so than present.

I am struggling to think of any “safe havens” for cash, and only core utilities (power, natural gas) come to mind – but these assets have been bidded up.

It may be that the only safe haven is cash.

Whenever I do equity research, I perform a stock screen for certain metrics, and then I give a superficial scan of the stocks that get spat out of the screener. It takes about a couple minutes per equity for me to determine whether it is worth my time to look further into the company or not – typically I throw out 90-95% of the companies in this process. For the remainder, I queue them up to look more thoroughly using a fairly standard methodology (a basic guide), and then if I continue to like what I see, I do some more depth on the industry in question and competitors, and other research.

Most of the time, when I do this extensive research, the equity is over my accumulation price target. More times than not you can rationalize why the market is giving the company the value it is currently trading at, so I end up setting a price alert if the stock goes under a certain price. An email gets sent to my inbox when this occurs. I then “set it and forget it”, and usually do not keep the stocks on my watch list until the price target is hit.

Once the stock hits the threshold price, I then re-evaluate the position to see if anything has fundamentally changed in my original analysis to justify the drop. The point of this process is to make sure that the news the market is pricing in is not fundamentally damaging to the business. Once this is done, then I can set some buy limit orders and then accumulate.

The whole point of this post is that there are typically dry spells when nothing reaches the price target. Then there are times where everything you set a limit for has the price target alert hit your inbox. Today was notable in that a couple stocks are now below my alert price – perhaps an omen?

On the right-hand side of my bookmarks, I posted a 5-year performance of about 22% compounded annually. This is a high number, and as the years tack on, this will likely become lower. 2011 is going to likely be a low single digit percentage year.

The mean value theorem in mathematics can explain why such a level of return is not likely to continue. Let’s pretend that every company I put my money in will have a 15% earnings yield (either retained or given out in dividends; it does not matter). In the long run, my portfolio will be able to increase 15% a year. However, in order to achieve a 22% return, I must invest in something that has a greater than 22% return.

If I cannot find those investment candidates, then in order to achieve 22% on a 15% investment base, I need to borrow money at a rate less than 15% and put it into that 15% investment.

The risk of this is that my capital might “blow up” and I will be forced to liquidate my assets at precisely the wrong moment. Another way of thinking about this is that I want to be investing at precisely the moment that everybody else is forced to liquidate, rather than an arbitrary point in time such as now.

Unfortunately at present I am having grave difficulty identifying candidates that will give these types of returns. I also do not feel comfortable with employing leverage, so I will continue to twiddle my thumbs and wait for a better opportunity. I also do not think ploughing into commodities is any sort of “fix” to this problem – there are much better lower-variation equities out there that will give you a more stable return on investment and also be able to provide inflation-adjusted returns over the long run. Even though it is abundantly clear that commodities such as inexpensive-to-mine oil is rapidly depleting, it is still no reason why the price of such commodities at some point will not go to marginal cost of extraction, or even lower (e.g. natural gas). Commodity markets are cyclical and investors should never assume that the trend will be continuously straight-line up. There will be brutal price corrections in the interim – they are just very difficult to predict.

My very quick judgment is that “buy Japan” has been contrarian mantra issued to so many people that it now is conventional wisdom.

There is always opportunity to invest in companies that are in the middle of massive public scandals (e.g. BP), but whether such opportunities become a good value is whether people massively misjudge expectations.

In the case of BP, it was a political execution that translated into a disproportionate hit on the share price. In the case of “Japan”, it is very difficult to make the same judgment.

Hence, I’m keeping my eyeballs elsewhere.

When I have tolerance for it, I browse the Canadian Money Forum. There are a staple of regulars there, some that know what they are talking about, and some that sound like they know what they are talking about, but don’t. Then there are the batch of people that don’t know what they are talking about. It is a surprisingly good indicator of retail sentiment, especially in the younger age category (who presumably don’t have access to millions of dollars of capital and can’t move markets, but would generally be indicative of the mentality of higher risk-taking individuals).

A large misconception I see concerns dividends. I will state the misconception:

Misconception: Dividends add value.

They do not. Dividends represent a direct transfer of cash from the company to the shareholder.

Sometimes dividends subtract value, when the consequences of taxation are considered. In Canada, the eligible dividend tax credit mostly eliminates the penalty of double-taxation for non-registered accounts. In the USA, qualified dividends receive preferential tax treatment, at least until December 31, 2012 with existing legislation.

A mistake that retail investors make is that a higher dividend yield means the company should be more valuable.