First off, some comments about today's action. We finally got what I called good "market action" on the upside. We started off weak and ended strong building momentum slowly but surely throughout the day. It's only 1 day though and unfortunately the put/call ratio was rather low and the VIX collapsed too easily again. Am I being too picky here looking for everything to be just right? Probably. I'm game that today could end up being the low point for the next few weeks or so but I have nagging doubts that we’ve seen the worst. I realize that AAII sentiment is showing bearishness that marked previous bottoms, mutual fund investors have fled equities to the same degree as they have at previous bottoms (by the way, they withdrew another 5 Billion this week), bonds are very overbought and the Rydex ratio has also dipped back into pessimistic territory also consistent with bottoms. So what's bothering me still? Well, we got oversold but not the same degree as we did at prior solid lows this year. The VIX behavior is still bearish. It continues to drop too easily on rallies. We never got extreme readings in the put/call ratio...they got high but not the 1.2 threshold that has marked prior lows. Lest I forget, the macroeconomic data has turned decisively bearish which is something new this time around which could require chronic extremes in bearish sentiment before a lasting bottom can be made because during bearish fundamental conditions, what is considered "extreme" sentiment wise is different than when bullish fundamental conditions are in play.
But just how bearish are the "fundamentals"? Well, we haven't seen a broad rollover in earnings yet but with the macro data down ticking it could be just a matter of time. Intel guiding down today is a warning and it isn't a good thing for the rest of the tech space which has been the leader of this bull market. Cisco's John Chambers said a few weeks ago that his customers are showing uncertainty which echoes the warning from Intel.
As a result of the downward momentum in fundamentals bulls need to be careful trying to catch bottoms. There's enough pessimism right now to warrant a further bounce but if we do I think there would be another run at the lows in the fall. The ideal situation would be if we get a washout to SPX 1000 or lower accompanied by a big spike in the VIX and huge put/call ratio readings. I’ve been waiting all summer for such a thing but I realize Mr. Market doesn’t give a rat’s ass about my demands and we can bottom without such things happening.
Since I'm not so sure we've seen the true bottom but fairly confident that any more downside would be contained if we haven't, I've compromised with myself by making a partial commitment to the long side. I'm looking to take positions in stocks that are showing good relative strength and low correlation to the market. They are hard to find but I've already identified a couple and took a position in one of them. Last year at this time I did the same thing and I uncovered a few gems that really soared. There were duds as well but I managed to successfully cut the losers short while riding the winners fully. This time around it will probably be harder to repeat that feat.
Next week we will see a ton of important macro data. If the data is soft this will be really good test to see if the market has fully discounted the slowdown in the economy or not.
Saturday, August 28, 2010
Thursday, August 26, 2010
AAII sentiment in position for the bulls
We have a 2:1 ratio of bears vs bulls which is consistent with ST/IT market bottoms. The conflictions of the indicators is making my head spin. Which do I follow which do I ignore? Well, one thing this reading suggests is that if we have further downside in the market it will not be serious but taken alone at face value it's giving the green light to the bulls to make a charge higher right here right now.
VIX is worrysome
Alright, so the bulls pulled one out of the fire. I would have been inclined to fade that opening down for a quick trade if I wasn’t so busy soothing my cranky daughter. With the market oversold as it is, it's usually a good risk/reward set up to fade morning weakness like that for at least a quick intraday trade. Intraday trading is not my style but there are times, like now, when emotions are running high that good intraday opportunities present themselves.
But on the grander scale of things, I don't think we've seen the lows of this move. A big reason I feel why is the VIX. Despite the weakness we've seen it only got as high as 29 intraday before quickly retreating. Every decent bottom this year and other years as well has been preceded by a spike in the VIX of some sort. Instead, this time around the VIX has been slowing turning up, grudgingly rising when the market goes down but rather easily falls on days the market goes up just modestly like today. I've seen this happen before in the past and it's been a bearish sign. It shows a lack of fear, which is odd because I also see plenty of clear signs of high pessimism.
One indicator that is never talked about is the VIX futures curve. If you look at VIX options they are priced based upon this curve. What it can tell you is the expectation of future volatility is by the market. When the futures curve is steeply sloped it indicates expectations of volatility rising in the future (i.e. the VIX going higher in the future) and when the VIX goes higher markets go lower (the vast majority of the time). I have found the VIX futures curve to be a smart money indicator. It doesn't however give you precise timing. For instance the VIX futures curve was steeply sloped in early December and early March but it took well over a month in both cases before the market rolled over. So, basically when it's steeply sloped it's indicating that any rally in the market is on borrowed time. At ST market bottoms the opposite happened. The VIX curve became inverted.
Currently the VIX futures curve steeply sloped and has been so since mid July. This is how you can see what I'm talking about. Take a look at VIX options that expire in 3 or 4 months and look at the value of the call and put that have the strike price that is closest to the spot value (current value) of the VIX. For example, look at the call and put values of November VIX options with the 26 strike. The call is asking 7.6 while the put is only asking 1.1. The call is 7 times more expensive than the put even though the strike price and spot price are about the same! What this means is that VIX traders expect the VIX to rise substantially in the future thus the reason for the expensive calls. I've been watching the VIX futures curve since November of last year and it's been right every time. Again, the timing is not precise when it comes to market tops but when it's giving a warning signal it tells you the rally is on borrowed time and so if you went short you would have felt pain for a while but would have been rewarded eventually. On the other hand it has been pretty good timing bottoms (when the curve gets inverted and the puts trade at a substantial premium to calls of the same strike).
So, if VIX option traders expect a substantial rise in the VIX, it pretty much means that they expect to see the market have a sharp drop down still ahead. Now, you should never hang your hat on just one indicator but it's been pretty damn good since I've followed it. Even if you disregard all this VIX futures curve mumbo jumbo, we haven't seen any kind of spike in the VIX and it's plain to see with the naked eye that every meaningful ST or IT bottom in the past year and even further has had such a spike. The absolute number of the VIX isn't so important....it's the spike behavior that is.
Sure, we're oversold and it wouldn't be much of a surprise to see more of a bounce as traders play the game of chicken, but the VIX behavior is a big holdout here for me to be able to say go "all in" long, turn off your computer and go travel the world for a few months. That's really the type of moment I've been waiting for all summer long. Until then I will try to be nimble and opportunistic with quick trades.
Aside from VIX issues, bulls need to be careful because the economic data has now clarly rolled over which gives the "fundamentals" edge to the bears. Yes, earnings are still robust but they they are more of a co-incident indicator not a leading one. Eventually the market will get to the point where it's sold out having discounted the worst and no longer reacts poorly to such negative data points (at least for a while). There's no solid evidence to suggest this has happened just yet. One day doesn't make a trend and we did not reach extreme oversold levels on a technical basis not to mention a lack of a VIX spike....I know, I know shut the fuck up with this VIX talk already.
But on the grander scale of things, I don't think we've seen the lows of this move. A big reason I feel why is the VIX. Despite the weakness we've seen it only got as high as 29 intraday before quickly retreating. Every decent bottom this year and other years as well has been preceded by a spike in the VIX of some sort. Instead, this time around the VIX has been slowing turning up, grudgingly rising when the market goes down but rather easily falls on days the market goes up just modestly like today. I've seen this happen before in the past and it's been a bearish sign. It shows a lack of fear, which is odd because I also see plenty of clear signs of high pessimism.
One indicator that is never talked about is the VIX futures curve. If you look at VIX options they are priced based upon this curve. What it can tell you is the expectation of future volatility is by the market. When the futures curve is steeply sloped it indicates expectations of volatility rising in the future (i.e. the VIX going higher in the future) and when the VIX goes higher markets go lower (the vast majority of the time). I have found the VIX futures curve to be a smart money indicator. It doesn't however give you precise timing. For instance the VIX futures curve was steeply sloped in early December and early March but it took well over a month in both cases before the market rolled over. So, basically when it's steeply sloped it's indicating that any rally in the market is on borrowed time. At ST market bottoms the opposite happened. The VIX curve became inverted.
Currently the VIX futures curve steeply sloped and has been so since mid July. This is how you can see what I'm talking about. Take a look at VIX options that expire in 3 or 4 months and look at the value of the call and put that have the strike price that is closest to the spot value (current value) of the VIX. For example, look at the call and put values of November VIX options with the 26 strike. The call is asking 7.6 while the put is only asking 1.1. The call is 7 times more expensive than the put even though the strike price and spot price are about the same! What this means is that VIX traders expect the VIX to rise substantially in the future thus the reason for the expensive calls. I've been watching the VIX futures curve since November of last year and it's been right every time. Again, the timing is not precise when it comes to market tops but when it's giving a warning signal it tells you the rally is on borrowed time and so if you went short you would have felt pain for a while but would have been rewarded eventually. On the other hand it has been pretty good timing bottoms (when the curve gets inverted and the puts trade at a substantial premium to calls of the same strike).
So, if VIX option traders expect a substantial rise in the VIX, it pretty much means that they expect to see the market have a sharp drop down still ahead. Now, you should never hang your hat on just one indicator but it's been pretty damn good since I've followed it. Even if you disregard all this VIX futures curve mumbo jumbo, we haven't seen any kind of spike in the VIX and it's plain to see with the naked eye that every meaningful ST or IT bottom in the past year and even further has had such a spike. The absolute number of the VIX isn't so important....it's the spike behavior that is.
Sure, we're oversold and it wouldn't be much of a surprise to see more of a bounce as traders play the game of chicken, but the VIX behavior is a big holdout here for me to be able to say go "all in" long, turn off your computer and go travel the world for a few months. That's really the type of moment I've been waiting for all summer long. Until then I will try to be nimble and opportunistic with quick trades.
Aside from VIX issues, bulls need to be careful because the economic data has now clarly rolled over which gives the "fundamentals" edge to the bears. Yes, earnings are still robust but they they are more of a co-incident indicator not a leading one. Eventually the market will get to the point where it's sold out having discounted the worst and no longer reacts poorly to such negative data points (at least for a while). There's no solid evidence to suggest this has happened just yet. One day doesn't make a trend and we did not reach extreme oversold levels on a technical basis not to mention a lack of a VIX spike....I know, I know shut the fuck up with this VIX talk already.
Wednesday, August 25, 2010
Traders getting chewed up
On Aug 3 I mentioned how the charting service I used decisionpoint.com had just issued a LT buy signal after getting whipsawed with a sell signal near the July low. Well, they just issued another LT sell signal yesterday thus getting whipsawed twice. Will this sell signal be yet another whispsaw? Probably. These guys use mechanical buy and sell signals which are based purely on momentum as do a lot of traders. This type of momentum chasing both on the upside and downside has been a disaster since May.
I've been seeing a lot of trader types getting creamed by this tape. There's a trader on youtube that I follow just for laughs and to gain contrary insights since he is a small notch above a compulisve gambler. He recently checked himself into some sort of mental rehab clinic. It's not just the amatuers. Even the seasoned veterans are getting hurt. When guys like Drunkenmiller fold out of frustation you know it's tough. I personally have been largely inactive since early May. Just recently I have been getting back into things but I've been keeping it small and tight. I've done well so far this year and it mainly occured in the first 4 months of the year thanks primarily to a couple of big winning stocks but since then I've done very little remaining mostly in cash since early May. I don't like to talk about performance because it's bad Karma and it smacks of ego stroking....I'm just trying to say that often times I find my gains happen in short bursts which is followed by long periods of nothingness. I can go through long periods of inactivity when market conditions for me are not to my liking.
Professional managers and those who trade full time feel pressured to make money everyday, week and month. In the book Reminiscences of a Stock Operator (my favorite stock market book and a must read) one of the many insights of the fictional character "Livingston" (who is really famous trader Jesse Livermore talking about himself) is that you shouldn't be trading the market all the time day in day out. Another lesson along the same line is that you will lose if you try to use the market to "pay" for some item you want to buy. The reason for saying this is that often times the market is unplayable i.e. edgeless and too random and more often than not you will end up losing if you try to forcefully extract money from it such as trying to make a quick $40,000 so that you can buy that car that you want so bad. If you force the market to meet your needs you will lose in this game.
There's times when the best thing to do is absoutely nothing or play small but that can be quite hard in the ultra competative landscape for money managers and for the full time trader/investor who makes a living from the market. But that's just the way it goes. In Ocean's 11 Danny Ocean says the following in regards to casinos:
the house always wins. Play long enough, you never change the stakes. The house takes you. Unless, when that perfect hand comes along, you bet and you bet big, then you take the house.
In trading it's similar. If you play every hand you'll probably lose in the long run. Wait for a signficant edge before betting and when the perfect hand comes bet big (but not so much wherby if you are wrong you get wiped out). If you have to wait weeks or even months so be it.
I believe to be successful as a speculator you need to do the following
1) Only bet on premium opportunities
2) Properly identify such premium opportunities
3) Adapt quickly to changing market conditions
4) Planning and executing an appropiate strategy (entry, exit)
5) Conquoring yourself (emotions and biases)
If you fail at any of the above 5 chances are you will lose in the long run.
Ok that's enough philosphy for 1 day, now on to the market. It got smacked pretty good today on weak housing data. The market is now well oversold but with it closing near the low of the day it suggests there is still lower lows ahead or a period of basebuilding will be required before a sustainable rally will be able to take shape. If we do the old gap up and run rountine I will stress this again for the hundreth time, don't trust it unless perhaps your time frame is 1 day or less. Such rallies, are not sustainable as we have seen several times this summer....they can sometimes last a few weeks, but like with this July rally, they eventually fall apart.
As it stands now if you want to play the market you need to use gueralla tacticts and babysit positions keeping a short leash untill there are some really solid intermediate term signals which can cause you to be a strong holder....I'm speaking for myself here. Downside should be fairly contained from here because sentiment conditions are already bullish from a contrary perspective and the market is well oversold (but not extreme oversold). One thing missing is a spike in the VIX. It's simply too low here given the damage and it's only just turning up....that suggests a downside flush out lies somewhere ahead still.
I've been seeing a lot of trader types getting creamed by this tape. There's a trader on youtube that I follow just for laughs and to gain contrary insights since he is a small notch above a compulisve gambler. He recently checked himself into some sort of mental rehab clinic. It's not just the amatuers. Even the seasoned veterans are getting hurt. When guys like Drunkenmiller fold out of frustation you know it's tough. I personally have been largely inactive since early May. Just recently I have been getting back into things but I've been keeping it small and tight. I've done well so far this year and it mainly occured in the first 4 months of the year thanks primarily to a couple of big winning stocks but since then I've done very little remaining mostly in cash since early May. I don't like to talk about performance because it's bad Karma and it smacks of ego stroking....I'm just trying to say that often times I find my gains happen in short bursts which is followed by long periods of nothingness. I can go through long periods of inactivity when market conditions for me are not to my liking.
Professional managers and those who trade full time feel pressured to make money everyday, week and month. In the book Reminiscences of a Stock Operator (my favorite stock market book and a must read) one of the many insights of the fictional character "Livingston" (who is really famous trader Jesse Livermore talking about himself) is that you shouldn't be trading the market all the time day in day out. Another lesson along the same line is that you will lose if you try to use the market to "pay" for some item you want to buy. The reason for saying this is that often times the market is unplayable i.e. edgeless and too random and more often than not you will end up losing if you try to forcefully extract money from it such as trying to make a quick $40,000 so that you can buy that car that you want so bad. If you force the market to meet your needs you will lose in this game.
There's times when the best thing to do is absoutely nothing or play small but that can be quite hard in the ultra competative landscape for money managers and for the full time trader/investor who makes a living from the market. But that's just the way it goes. In Ocean's 11 Danny Ocean says the following in regards to casinos:
the house always wins. Play long enough, you never change the stakes. The house takes you. Unless, when that perfect hand comes along, you bet and you bet big, then you take the house.
In trading it's similar. If you play every hand you'll probably lose in the long run. Wait for a signficant edge before betting and when the perfect hand comes bet big (but not so much wherby if you are wrong you get wiped out). If you have to wait weeks or even months so be it.
I believe to be successful as a speculator you need to do the following
1) Only bet on premium opportunities
2) Properly identify such premium opportunities
3) Adapt quickly to changing market conditions
4) Planning and executing an appropiate strategy (entry, exit)
5) Conquoring yourself (emotions and biases)
If you fail at any of the above 5 chances are you will lose in the long run.
Ok that's enough philosphy for 1 day, now on to the market. It got smacked pretty good today on weak housing data. The market is now well oversold but with it closing near the low of the day it suggests there is still lower lows ahead or a period of basebuilding will be required before a sustainable rally will be able to take shape. If we do the old gap up and run rountine I will stress this again for the hundreth time, don't trust it unless perhaps your time frame is 1 day or less. Such rallies, are not sustainable as we have seen several times this summer....they can sometimes last a few weeks, but like with this July rally, they eventually fall apart.
As it stands now if you want to play the market you need to use gueralla tacticts and babysit positions keeping a short leash untill there are some really solid intermediate term signals which can cause you to be a strong holder....I'm speaking for myself here. Downside should be fairly contained from here because sentiment conditions are already bullish from a contrary perspective and the market is well oversold (but not extreme oversold). One thing missing is a spike in the VIX. It's simply too low here given the damage and it's only just turning up....that suggests a downside flush out lies somewhere ahead still.
Sunday, August 22, 2010
Will Q3 GDP be negative?
Interesting piece by John Mauldin this weekend. He mentioned that an outfit called Macroeconomic Advisers is forecasting a negative Q3 GDP. I don't know anything about the track record of these guys and it's just one firm's opinion but what I found interesting was the mention that the typical forecast for GDP by economists is in the 2.5-3.5% range which leaves quite a bit of room for disappointment. With the recent negative Philly Fed index reading and the 10 year near 2.6% I have to give the edge here to the bears especially with the 10 year at 2.6% which is yelling and screaming that a significant soft patch at the very least in coming. Double Dip? Quite possibly but it could also be just a soft patch. A negative GDP number would likely create a huge amount of fear mongering in the media and a sharp selloff in the market unless perhaps the market was already selling off significantly prior to the release of the data which I believe will be on October 29 (the advance estimate). Mark that day on your calendar.
I know I'm getting way ahead of things but if we do see a negative Q3 GDP number it's going to light a massive fire under the asses of those in Washington and all this talk about austerity is going to go out the window. I believe the Bush expiring tax cuts will be renewed.
In the interim it's going to be tricky. Last week's $9 Billion withdrawal out of equity funds is a very good ST bullish contrary indicator. The last 3 times a weekly withdrawal of similar magnitude occurred was early July, mid May and late January which were either close to or precisely at ST bottoms. The only time it's worth ignoring any extreme action of these mutual fund "investors" is when the market is in blow off mode. Since the market is not firmly in the grips of a downtrend this notion doesn't apply. I'll be looking for long set ups next week. The market is only modestly oversold here so ideally I'd like to see a little bit more downside bit it's not a pre-requisite
I know I'm getting way ahead of things but if we do see a negative Q3 GDP number it's going to light a massive fire under the asses of those in Washington and all this talk about austerity is going to go out the window. I believe the Bush expiring tax cuts will be renewed.
In the interim it's going to be tricky. Last week's $9 Billion withdrawal out of equity funds is a very good ST bullish contrary indicator. The last 3 times a weekly withdrawal of similar magnitude occurred was early July, mid May and late January which were either close to or precisely at ST bottoms. The only time it's worth ignoring any extreme action of these mutual fund "investors" is when the market is in blow off mode. Since the market is not firmly in the grips of a downtrend this notion doesn't apply. I'll be looking for long set ups next week. The market is only modestly oversold here so ideally I'd like to see a little bit more downside bit it's not a pre-requisite
Friday, August 20, 2010
Weak longs shaken out
On Aug 3, I made mention how the market was sucking in weak longs which was ST bearish for the market. Amongst the weak longs are the traders who are permabears at heart but now claim to “play both sides of the market", your run of the mill market technician and the mutual fund idiots...ooops did I say idiots?...sorry I meant "investors". Those same "investors" who poured $8 Billion into equity funds a few weeks ago now pulled $9 Billion out this week with the market down 4.5% since. Surprise, surprise, they got it wrong! The other sources of dumb money have also pulled in their horns after this dip. You see...they are called weak longs for a reason.
In today's game of chicken environment more than ever it's important to pay attention to the schleps of the market which I identified above and fade them or at the very least step aside for a better set up.
Regarding the idea of shorting bonds, I believe this is a crowded trade at the moment. I'm seeing a lot of traders contemplating or already in the same trade (some of whom have less than enviable track records). A similar thing happened in the fall of 2008 as bonds were making a parabolic surge. A lot of trader types shorted bonds thinking they were way overbought only to get ran over further fueling the upward move as they capitulated. It would have ultimately been profitable if these weak shorts hung on to their positions and took the pain for another 1-2 months but most of them probably didn't. Doug Kass is also quite bearish on bonds calling it a generational sell. If Kass ever gets something right he's often early (his bottom call in March 2009 was a rare time when his timing was excellent). I think we are in the same situation here with bonds as we were in the fall of 2008....if you short you probably will be rewarded in 2-4 months time but in the interim you will feel pain and frustration.
Thus, I'm lowering my downside target for the 10 year to 2.25%. On a ST basis bonds could see a bit of dip here. If the market rallies next week and bonds only sell off modestly that would be a tell that there is still one more surge left before they finally top out for good on a medium term/long term basis.
In today's game of chicken environment more than ever it's important to pay attention to the schleps of the market which I identified above and fade them or at the very least step aside for a better set up.
Regarding the idea of shorting bonds, I believe this is a crowded trade at the moment. I'm seeing a lot of traders contemplating or already in the same trade (some of whom have less than enviable track records). A similar thing happened in the fall of 2008 as bonds were making a parabolic surge. A lot of trader types shorted bonds thinking they were way overbought only to get ran over further fueling the upward move as they capitulated. It would have ultimately been profitable if these weak shorts hung on to their positions and took the pain for another 1-2 months but most of them probably didn't. Doug Kass is also quite bearish on bonds calling it a generational sell. If Kass ever gets something right he's often early (his bottom call in March 2009 was a rare time when his timing was excellent). I think we are in the same situation here with bonds as we were in the fall of 2008....if you short you probably will be rewarded in 2-4 months time but in the interim you will feel pain and frustration.
Thus, I'm lowering my downside target for the 10 year to 2.25%. On a ST basis bonds could see a bit of dip here. If the market rallies next week and bonds only sell off modestly that would be a tell that there is still one more surge left before they finally top out for good on a medium term/long term basis.
Thursday, August 19, 2010
Lessons from a Legend
Famous hedge fund manager Stan Drunkemiller just recently announced his retirement.
http://http//noir.bloomberg.com/apps/news?pid=20601109&sid=aQSyeyQp8fOI
He made big money for his clients during his 30 years and he did so riding big trends not by day trading, scalping or whatever you want to call it. I've said it here before; big money is made riding the big trends. If you want to become a winner like Drunkenmiller, you need to emulate what winners do. As per the article above here are some valuable points
Fierce Competitor
Druckenmiller’s friends say the money isn’t the reason he’s continued to trade long after becoming wealthy.
“It’s about winning -- he’s a fierce competitor
When you’re sure you’re right, no trade is too big. And the bigger your gains in a year, the more aggressive you can be. (comment: I don't agree with the notion that no trade is too big. If a trade puts you in a position whereby an small adverse move wipes you out then the trade is indeed too big)
“It takes courage to be a pig,”
"He’s also quick to change his mind when he’s wrong."
“I’ve always loved to play games, and face it, investing is one big game,” he said. “You need to be decisive, open- minded, flexible and competitive.”
“You need to have a certain amount of intelligence, but it’s wasted over a certain level. After that it’s more about intuition.”
I agree whole heartedly with this last statement. I've said before that you need to approach the market more so as an artist rather than a scientist...this has to do with the intuition part of the game which is critical to success.
I believe it takes both experience and natural ability to have good intuitive instincts about the markets. Some people are just born with sharp instincts but that's not enough. They need to be honed through experience and the person needs to be in the proper state of mind i.e. confident and emotionally dethatched from the market.
http://http//noir.bloomberg.com/apps/news?pid=20601109&sid=aQSyeyQp8fOI
He made big money for his clients during his 30 years and he did so riding big trends not by day trading, scalping or whatever you want to call it. I've said it here before; big money is made riding the big trends. If you want to become a winner like Drunkenmiller, you need to emulate what winners do. As per the article above here are some valuable points
Fierce Competitor
Druckenmiller’s friends say the money isn’t the reason he’s continued to trade long after becoming wealthy.
“It’s about winning -- he’s a fierce competitor
When you’re sure you’re right, no trade is too big. And the bigger your gains in a year, the more aggressive you can be. (comment: I don't agree with the notion that no trade is too big. If a trade puts you in a position whereby an small adverse move wipes you out then the trade is indeed too big)
“It takes courage to be a pig,”
"He’s also quick to change his mind when he’s wrong."
“I’ve always loved to play games, and face it, investing is one big game,” he said. “You need to be decisive, open- minded, flexible and competitive.”
“You need to have a certain amount of intelligence, but it’s wasted over a certain level. After that it’s more about intuition.”
I agree whole heartedly with this last statement. I've said before that you need to approach the market more so as an artist rather than a scientist...this has to do with the intuition part of the game which is critical to success.
I believe it takes both experience and natural ability to have good intuitive instincts about the markets. Some people are just born with sharp instincts but that's not enough. They need to be honed through experience and the person needs to be in the proper state of mind i.e. confident and emotionally dethatched from the market.
Tuesday, August 17, 2010
What's the deal with the bonds?
No, this is not a Seinfeld-like opening to a comedy bit. I'm talking about this eye popping rally in bonds that has sent the 2 year hitting record low yields day after day and the 10 year back to March 2009 levels. Is the bond market signaling double dip? Well, as I made mentioned a few weeks ago, I think there's more than just a flight to safety trade going on in bonds. The bond market is clearly signaling strong deflationary pressure is imminent which goes hand in hand with a weakening economy. So again I ask, is the bond market signaling a double dip? With the short end of the curve at 0% unfortunately, the yield curve can't get inverted to give us the reliable recession warning that it historically has been able to provide. In such a scenario when the short end is at 0%, I've always said to myself that a break below 3% on the long end (10 year) should be considered a dangerous sign and inversion-like but it's not per se because an inversion implies tight monetary conditions which tends to put a break on economic activity tipping it towards recession. Monetary conditions are clearly not tight overall. There is still a positive yield curve spread albeit a shrinking one. But it's hard for even the staunchest optimist to argue against the notion that the bond market is at the very least signaling soft patch in the economy (correctly or not).
Determining the implication of the bond market on equities is not so clear cut in my view. Generally speaking, a declining interest rate environment is positive for equities because it enhances valuations from the perspective that future expected cash flows become more valuable as they are discounted using a lower discount rate and lower interest rates is stimulative for the economy. But on the other hand, a low interest rate may be a harbinger of significant disinflation or deflation which goes hand in hand with a weak economy and although expected cash flows are discounted at a lower rate, the expected cash flows themselves end up shrinking significantly as a result of the deflationary pressures/weak economy which is a large negative for equities more than offsetting the positive implications of a lower discount rate.
Therefore, when it comes to interest rates and the stock market, the goldilocks analogy applies here....they have to be not too hot and not too cold to give thumbs up for equities. I believe we are now in the "too cold" territory and should be bracing for weak economic data points to hit the market for the next 1-2 months at least. Remember, the 10 year bond yield hasn't been this low since March 2009 when the economy was at its nadir and everyone was bracing for a depression. I don't think any economic softness will be so bad as to trigger a double dip but it's a definitely a decent possibility so I'll be on guard for it.
There's also the possibility that the big move in bonds has been fueled by a massive short squeeze from bears who thought the European sovereign debt crisis would spread to the US. There's no shortage of bond bears who for years and years have been calling for a collapse in bond prices. I know a friend who got murdered trying to short bonds in 2008 using TBT.
The ironic thing is that from a trading perspective, bonds now actually look to be a good short. As I said previously, the 10 year yield is just as low as it was when the economy was a complete basket case in March 2009. Therefore even if we do get a double dip the bond market has already priced in plenty of weakness and so after perhaps a knee jerk reaction to any surprisingly weak data points it's more likely to see bonds "sell on the news" and head lower. I'd be looking for the 10 year to hit 2.5% before contemplating a short.
We are at interesting junction here. I'm doing my best to be nimble and patient for good set ups. No long term commitments as this point.
Determining the implication of the bond market on equities is not so clear cut in my view. Generally speaking, a declining interest rate environment is positive for equities because it enhances valuations from the perspective that future expected cash flows become more valuable as they are discounted using a lower discount rate and lower interest rates is stimulative for the economy. But on the other hand, a low interest rate may be a harbinger of significant disinflation or deflation which goes hand in hand with a weak economy and although expected cash flows are discounted at a lower rate, the expected cash flows themselves end up shrinking significantly as a result of the deflationary pressures/weak economy which is a large negative for equities more than offsetting the positive implications of a lower discount rate.
Therefore, when it comes to interest rates and the stock market, the goldilocks analogy applies here....they have to be not too hot and not too cold to give thumbs up for equities. I believe we are now in the "too cold" territory and should be bracing for weak economic data points to hit the market for the next 1-2 months at least. Remember, the 10 year bond yield hasn't been this low since March 2009 when the economy was at its nadir and everyone was bracing for a depression. I don't think any economic softness will be so bad as to trigger a double dip but it's a definitely a decent possibility so I'll be on guard for it.
There's also the possibility that the big move in bonds has been fueled by a massive short squeeze from bears who thought the European sovereign debt crisis would spread to the US. There's no shortage of bond bears who for years and years have been calling for a collapse in bond prices. I know a friend who got murdered trying to short bonds in 2008 using TBT.
The ironic thing is that from a trading perspective, bonds now actually look to be a good short. As I said previously, the 10 year yield is just as low as it was when the economy was a complete basket case in March 2009. Therefore even if we do get a double dip the bond market has already priced in plenty of weakness and so after perhaps a knee jerk reaction to any surprisingly weak data points it's more likely to see bonds "sell on the news" and head lower. I'd be looking for the 10 year to hit 2.5% before contemplating a short.
We are at interesting junction here. I'm doing my best to be nimble and patient for good set ups. No long term commitments as this point.
Sunday, August 15, 2010
ST oversold with gaps to fill above
Well, now we have a market that is ST oversold with dowside gaps above to fill which suggests a move up is in the cards. Another plausible seneario is that the market grinds sideways or only goes modestly higher to work off the oversold condition before heading down again towards the July lows. If that were to happen I'd expect to see that the rally that follows will fill those gaps and perhaps more because as I said before, I believe a bullish resolution is ultimately what's going to happen with this trendless market. As I also said before, I will be quick to change course if the evidence suggests so. We'll just see what happens.
I'd be looking to play for a bounce intraday if a good set up present itself such a retest of Thursday's lows. I will not however be holding such positions overnight. This is still a ST traders market and there's no strong edge on either side on a medium term basis. Be careful out there.
I'd be looking to play for a bounce intraday if a good set up present itself such a retest of Thursday's lows. I will not however be holding such positions overnight. This is still a ST traders market and there's no strong edge on either side on a medium term basis. Be careful out there.
Friday, August 13, 2010
Still stuck in nowhere
I'm a big believer in market action. To me there’s a big difference between the following
a) A market advance of 10% in a slow but relentless fashion with daily action often characterized by weak or modest opens closing strong by the end of the day.
b) A market advance of a 10% characterized by large volatility gaping up and running on most of the up days.
To your run of the mill market technician, he makes no distinction between advance a) or b) because both will break above a certain trendline, moving average, resistance level, ect just the same. However, a) is indicative of sustainable, bull market behavior while b) is indicative of a rally prone to failure. b) is the type of advance that we have been seeing with any rally attempts since the market peaked in April and I’ve been harping about such “poor action”.
Mind you, we haven't seen "legitimate" bear market action either because the downside is also often done erratically via gap down action and the market is responding well to the upside on oversold conditions. In bear markets oversold conditions are either ignored or get cleared quickly before resuming the bear course (similar to how bull markets act with overbought conditions) and that hasn't been happening.
So, what do we have here then? We have a market that is trendless. Neither bull nor bear market behavior is present although at times the action does show traces of both. I called for a multi-month consolidation phase to the bull market coming into 2010 and it looks as if this is indeed occurring. I'm keeping an open mind as to a bearish resolution but I have my doubts. Although leading indicators have been pointing south which warrants caution in the ST/IT, the ingrained pessimism/doubts of market participants that I've noted over a year are still there which suggests market expectations are still low from a longer term perspective and with the market not confirming such pessimism (bears haven't done that much damage since the market peaked in April considering the advance that preceded it) my experience shows a bullish resolution is ultimately in the cards which suggests that any economic softness that comes our way won't result in the dreaded double dip.
In my view, the market lacks convictions because on one hand, earnings and interest rate trends are very favorable for equities but on the other hand, signs of a slowdown accompanied by still stubbornly high unemployment, soft housing and sovereign credit strains are keeping the upside in check and since there is no hard evidence of these concerns impacting earnings in a meaningful way, the downside is being kept in check as well. Under these conditions, a trading range mentality is most appropriate although it can be quite tricky to profit. A safer, boring approach would be to just sit out and wait for signs of a resolution to this range. I suspect there will be at least 1 more scare in the market which drives us back to towards the July lows or worse but not a lot worse.
You can squawk all you want about negative fundamentals that bears keep pounding the table about, but when the LT sentiment backdrop is like it is now it suggests that somehow, someway the bears aren't going to win on the grander scale of things...at least not for a while. Look, I don't disagree with some of the things the bears point out it's just that if they do turn out to be right it probably won't be before the market rises a lot further first. The 2003-2007 bull market is a perfect example. Bears were correct in 2002 by saying there was unfinished business on the downside but they got humiliated and taken to the cleaners for 5 years before being proved right and by then they were broke. The prime example is Prechter who has been LT bearish for more than 2 decades following a completely idiotic theory called "elliot waves". Anyone following him since his inception would have been dead broke come 2007 before this broken clock finally got it right. Thank God for the lemmings who believe in bullshit like elliot waves. Without such lemmings the market would be a harder place to make a living.
Either way, no matter which way the market breaks I'm going to do my best to be on the right side of it. You see, I couldn't give a flying fuck if everything I've been talking about turns out to be dead wrong but I was quick enough to adjust and profit going the other way. Profiting is all the matters. Stubbornly defending money losing positions for the sake of protecting the ego is not what I do. I have no ego to protect here. I have no bias. I have no "vendetta" against the market. I don't project my personal circumstances/feelings on my stock market outlook. I don't invest based on how I think the market ought to act like. Ok....I lied. I can’t say that I adhere to the above 100%. My humanity prevents me from achieving such pure objectivity although I do try my best to achieve such as humanly possible.
Human nature causes us to view the markets and the world for that matter through a glass window capable of being tinted in various colours. It seems to me that for most people that window is tinted black. When it comes to trading/investing your window must be wiped clean every day to a crystal clear shine....better yet smash that window! In The Matrix there's a scene near the end when Neo lets go of his inhibitions and finally sees the Matrix for what it truly is. At that point he is able to master it.
a) A market advance of 10% in a slow but relentless fashion with daily action often characterized by weak or modest opens closing strong by the end of the day.
b) A market advance of a 10% characterized by large volatility gaping up and running on most of the up days.
To your run of the mill market technician, he makes no distinction between advance a) or b) because both will break above a certain trendline, moving average, resistance level, ect just the same. However, a) is indicative of sustainable, bull market behavior while b) is indicative of a rally prone to failure. b) is the type of advance that we have been seeing with any rally attempts since the market peaked in April and I’ve been harping about such “poor action”.
Mind you, we haven't seen "legitimate" bear market action either because the downside is also often done erratically via gap down action and the market is responding well to the upside on oversold conditions. In bear markets oversold conditions are either ignored or get cleared quickly before resuming the bear course (similar to how bull markets act with overbought conditions) and that hasn't been happening.
So, what do we have here then? We have a market that is trendless. Neither bull nor bear market behavior is present although at times the action does show traces of both. I called for a multi-month consolidation phase to the bull market coming into 2010 and it looks as if this is indeed occurring. I'm keeping an open mind as to a bearish resolution but I have my doubts. Although leading indicators have been pointing south which warrants caution in the ST/IT, the ingrained pessimism/doubts of market participants that I've noted over a year are still there which suggests market expectations are still low from a longer term perspective and with the market not confirming such pessimism (bears haven't done that much damage since the market peaked in April considering the advance that preceded it) my experience shows a bullish resolution is ultimately in the cards which suggests that any economic softness that comes our way won't result in the dreaded double dip.
In my view, the market lacks convictions because on one hand, earnings and interest rate trends are very favorable for equities but on the other hand, signs of a slowdown accompanied by still stubbornly high unemployment, soft housing and sovereign credit strains are keeping the upside in check and since there is no hard evidence of these concerns impacting earnings in a meaningful way, the downside is being kept in check as well. Under these conditions, a trading range mentality is most appropriate although it can be quite tricky to profit. A safer, boring approach would be to just sit out and wait for signs of a resolution to this range. I suspect there will be at least 1 more scare in the market which drives us back to towards the July lows or worse but not a lot worse.
You can squawk all you want about negative fundamentals that bears keep pounding the table about, but when the LT sentiment backdrop is like it is now it suggests that somehow, someway the bears aren't going to win on the grander scale of things...at least not for a while. Look, I don't disagree with some of the things the bears point out it's just that if they do turn out to be right it probably won't be before the market rises a lot further first. The 2003-2007 bull market is a perfect example. Bears were correct in 2002 by saying there was unfinished business on the downside but they got humiliated and taken to the cleaners for 5 years before being proved right and by then they were broke. The prime example is Prechter who has been LT bearish for more than 2 decades following a completely idiotic theory called "elliot waves". Anyone following him since his inception would have been dead broke come 2007 before this broken clock finally got it right. Thank God for the lemmings who believe in bullshit like elliot waves. Without such lemmings the market would be a harder place to make a living.
Either way, no matter which way the market breaks I'm going to do my best to be on the right side of it. You see, I couldn't give a flying fuck if everything I've been talking about turns out to be dead wrong but I was quick enough to adjust and profit going the other way. Profiting is all the matters. Stubbornly defending money losing positions for the sake of protecting the ego is not what I do. I have no ego to protect here. I have no bias. I have no "vendetta" against the market. I don't project my personal circumstances/feelings on my stock market outlook. I don't invest based on how I think the market ought to act like. Ok....I lied. I can’t say that I adhere to the above 100%. My humanity prevents me from achieving such pure objectivity although I do try my best to achieve such as humanly possible.
Human nature causes us to view the markets and the world for that matter through a glass window capable of being tinted in various colours. It seems to me that for most people that window is tinted black. When it comes to trading/investing your window must be wiped clean every day to a crystal clear shine....better yet smash that window! In The Matrix there's a scene near the end when Neo lets go of his inhibitions and finally sees the Matrix for what it truly is. At that point he is able to master it.
Thursday, August 5, 2010
Mixed message
AAII sentiment just released today is surprising. Despite market strength, bulls actually dropped from 40% to 30% while the bears rose from 33% to 38%. This is contrarian bullish and suggests the market has room to rise further still or at the very least trade sideways with only shallow pullbacks for another week or 2. AAII sentiment alone doesn't invalid the bearish things I've been noticing but admittedly, it does at the very least suggest that the downdraft I'm expecting won't happen just yet and I should hold off on making the bearish bet I was contemplating. Keep in mind, my time frame is typically multi-week not day to day....day to day volatility should still be quite favorable for those who trade day to day or intraday.
Tuesday, August 3, 2010
Market sucking in weak longs
I love browsing some of the popular bearishly biased blog sites to monitor what the lemmings are thinking. Not that I think all bears are lemmings, it's just that these sites became very popular with the lemmings in 2008 when the bear was in full force. 2009 and 2010 sent a lot of these lemmings to the slaughter house and are now nowhere to be seen but there are still quite a few remaining as well as new ones who have joined the frey. A lot of the remaining lemmings have vowed to "play both sides" of the market after the spanking they took last year but they are still bears at heart making them weak longs if they do actually go long.
A lot of these lemmings it seems, are buying into this rally or are willing to buy on dips. At the very least, they are bracing for further upside. Meanwhile, another weak long the "Rev Shark" over at realmoney.com who deep down is also a bear at heart and for the most part has made disastrous calls at major turning points this year by getting overly bullish at tops and bearish at bottoms, has also turned bullish.
When you got bears turning bullish like this it's a dangerous sign because these guys are the toughest to be convinced of a rally and so when they are, it indicates the market is probably going to soon run out of "greater fools" to keep the rally going. Then you got other technically oriented types getting all bulled up because the market has broken some "trend line" or what have you. The guy who runs my charting service decisionpoint.com has just issued a LT buy signal when just few days after the July low issued a LT sell signal after the so called "death cross". Lastly, there was a huge spike in weekly mutual fund inflows which in the past year has led to immanent ST or IT tops.
Not everything is giving a clear cut sell signal but rarely does that happen. What is rare and actually happening is when you see lemmings from all walks of life turn bullish. This can't be a good sign especially when the market is overbought, the VIX is near 20 and the majority of the rally has been done via gap up action. There are quite a few unfilled gaps that lie well below.
For the first time in a long time I'm eying put options even though I know there can still be more headfakes and marginal upside.
A lot of these lemmings it seems, are buying into this rally or are willing to buy on dips. At the very least, they are bracing for further upside. Meanwhile, another weak long the "Rev Shark" over at realmoney.com who deep down is also a bear at heart and for the most part has made disastrous calls at major turning points this year by getting overly bullish at tops and bearish at bottoms, has also turned bullish.
When you got bears turning bullish like this it's a dangerous sign because these guys are the toughest to be convinced of a rally and so when they are, it indicates the market is probably going to soon run out of "greater fools" to keep the rally going. Then you got other technically oriented types getting all bulled up because the market has broken some "trend line" or what have you. The guy who runs my charting service decisionpoint.com has just issued a LT buy signal when just few days after the July low issued a LT sell signal after the so called "death cross". Lastly, there was a huge spike in weekly mutual fund inflows which in the past year has led to immanent ST or IT tops.
Not everything is giving a clear cut sell signal but rarely does that happen. What is rare and actually happening is when you see lemmings from all walks of life turn bullish. This can't be a good sign especially when the market is overbought, the VIX is near 20 and the majority of the rally has been done via gap up action. There are quite a few unfilled gaps that lie well below.
For the first time in a long time I'm eying put options even though I know there can still be more headfakes and marginal upside.
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