At a crossroads

I recently read about how George Soros thinks we are in act 2 of the credit crisis. It's the bear case which essentially suggests that governments around the world are going to go default and fall like dominos the same way banks did in 2008. Bears suggest that the chain of events will unfold similar to how they did in 2007-2008 when the subprime meltdown was the first symptom of the collapse that was to come. Greece is the equivalent to subprime they say.

The chant is getting louder and louder for restructuring of these debts. There is little confidence it seems that austerity measures alone is going to cut it in the long run. But, EU leaders are being stubborn and are not listening to the market. If debts are restructured and European banks take their write downs I think it would clear out the dead wood in the system and actually allow the market to resume its upward course in a sustainable way.

Market action continues to resemble that of a bear market. Again, I must stress that during bull market corrections it's not uncommon to see such bear market action but I have to admit this poor action has been going on too long. Since May 1, volatility has gone up tremendously and every time we've seen strength in the market it's mainly been done via gap up action. That's bear market behavior. I showed in my previous post how the Rydex ratio suggests pessimism may be overdone here but this may very well only pertain to the ST/IT similar to what happened in Mid August 2007.

We are at a crossroads here folks. The next 4 months or so is going to be very important. I've made the case well before this correction began that bull markets have a multi-month consolidation phase after about the first year (give or take a couple months) of their inception. Therefore, the action we've seen thus far could very well be such a consolidation. But there are some ominous signs out there. For one, there's been poor market action as I've described in prior posts but in addition to this, we also have smart money leading indicators turning decisively negative.

There's an outfit called Economic Cycle Research Institute (ECRI) who predicts business cycles based upon their proprietary leading indicators. I first heard about these guys in 2001 and they’ve earned my respect. They correctly called recessions and recoveries in advance. Currently their leading indicators have turned down decisively negative but the ECRI has stated that it's too early to say if this means that there's going to be a double dip or if it's just a moderation after the initial thrust of an economic recovery which has indeed happened in prior recoveries (this rhymes with the consolidation phase of bull market after their initial 12 month thrust).

Here's a chart of their leading indicator.

I got this chart from Hussman's site, a noted bear and he got it from Mike "Mish" Shedlock, another bear. I've also notice John Mauldin yet another bear; make mention on the ECRI data as well last week. There's no doubt that this chart is cause for concern. It's certainly has my attention and I respect the potential bearish resolution. But here's what I have to say to the bears that are using this chart. WHY THE FUCK WAS THERE NO MENTION OF THIS CHART LAST YEAR WHEN IT WAS HEADING UP? It's obviously because the chart didn't agree with their ingrained, stubborn bearishness they all had and so they dismissed it. But now that the chart actually favors their bearish outlook they are all quick to point it out. lol! This is a fine example of the confirming evidence bias. This is also why you shouldn't be mesmerized by the bears out there like so many were and still are. Most of these bears are permabears with big egos who will rarely admit being wrong, however they can provide valuable insights because after all, the market is a 2 way street...bear markets do indeed occur.

The next 3-5 months are going to be very critical for the market. With governments around the world slashing spending we are going to find out if this recovery is the real deal whereby the private sector is strong enough to take the baton from the governments which are slashing spending aggressively. The market is clearly worried about this which is fair enough....remember we went up 80% in 14 months and so anyone who got in early has a good reason to take money off the table.

My take: Step aside and wait for more resolution. Even if the bulls will win out, the market is likely not going to just go upwards and onwards to new highs like it did after prior corrections. A more likely senario would be multi-month base bulding. I'm looking for clues via the market as to what path will be taken. Keep an open mind and let the market tell you what to do. Right now market action stinks. Although we can certainly rally more here (the VIX and Rydex ratio are at elevated levels and the market is still IT oversold) I have little confidence to hold long positions with any conviction for a prolonged period of time because shitty market action suggests any rally can fall apart quickly. As a result of this I am going to consider taking ST trading positions both long and short with a limited amount of my portfolio. Ya I know.....I might fall victim of the meat grinder which is why I'm keeping things small and selective. If in doubt I'm just going to stay in cash. I'm not going to let a good year slip away by forcing trades for the sake of doing something.