SPX 1175 held 3 times....don't hold your breathe for a 4th

I think we are at an inflection point here. I believe we'll either see the market hobble its way back to the YTD high by the end of December or break down very shortly. I'm thinking the latter. If we get the former, then I suspect the market will have unfinished business to do on the downside and the first 3 months of 2011 will be rather rough.

Notice that 1175 has held 3 times now. I wouldn't be holding my breath for a 4th. Sentiment wise, conditions are still not favorable. AAII sentiment popped back to almost 2:1 bulls vs bears last week and Investor's Intelligence sentiment has been at 2.5:1 bulls vs. bears for 2 weeks now. pcr data is also still nowhere close to oversold. This wouldn't be such a concern if price action was still acting bullishly but it hasn't been. Since peaking in early November the market has been sloppy and the chart looks toppy (I'm a gangsta rapper). This latest sideways action looks like as I suspected would happen a couple weeks ago which was choppy sideways action to work off the ST oversold condition of mid November before making another leg down.

It's often difficult and frustrating trying to capitalize on the short side in a bull market. So, be my guest if you dare try it. I prefer being heavily in cash. It keeps my sanity and objectivity intact.

PIIGS still not slaughtered

According to a recent bloomberg article, the average yield for 10-year debt from Greece, Ireland, Portugal, Spain and Italy reached 7.57 percent, a euro- era record. The spread of PIIGS bonds vs. German bonds is also at a record for 2010. It seems as if the bond markets aren't convinced enough regarding the latest actions taken to stem this PIIGS crisis or perhaps they are anticipating some sort of restructuring. Either way the PIIGS problems haven’t been slaughtered and that's probably going to keep a lid on the upside for the market at the very least. It could very well trigger a more significant downside move than what we've seen so far.

However, as I said earlier in the year, I believe somehow, someway this PIIGS problem will be eventually be resolved without derailing the bull market. I feel this way because in young bull markets the rising tide of economic activity lifts all boats and tends to deal with such problems which are in my opinion aftershocks of the 2008 meltdown i.e. problems that are based upon old news. In the 2003 recovery, a big concern was the huge shortfalls pensions had due to the 2000-2002 bear market. People feared companies would have to divert capital towards shoring up pension plans hampering capital investment thus the economy. The pension problem was also aftershock problem which resolved itself as the markets recovered.

As the recovery continues to gain momentum, government revenues around the globe will rise easing concerns of deficits while strengthening the ability for bailout giving countries like Germany to keep providing support. Germany by the way is already in a strong position, by far the strongest country in Europe economically. If some sort of restructuring does take place with PIIGS debt, European banks which own the debt would take a haircut. But again, the rising tide of economic momentum along with the steep yield curve could possibly allow banks to be recapitalized enough to take the blow. I say possibly because quite honestly, I don't know if the European banks would likely indeed be recapitalized enough. This is something I should research more.

Look, I'm by no means an expert about the situation in Europe. What I do know is that history suggests the issues in Europe will not be a bull market killer at this point of the cycle. It can certainly trigger a correction/consolidation like it did in the spring and summer but in the end it's all about earnings and monetary conditions. Earnings for the SPX have been strong and are not far off from hitting all time highs while monetary conditions are extremely accommodative. At the same time a large portion of public opinion is skeptical/cynical/hateful towards the market and that too suggests the bull market is far from being over. At the same time I get the sense that a quite of few of those people who have been riding the long side on the bull market aren't really true believers...they are just riding the trend with their fingers on the sell button the moment the market shows any hint of trouble and that too is a LT bulish sign Even I, with my LT bullish posture still have nagging doubts. I too hit the sell button with some of my positions when I think the market is in danger of a correction, which goes against what I preach when I say that the you will have a tough time beating buy and hold during a bull market. I can't help it. I'm a chicken sometimes. I have doubts. I want to maximize profits by market timing. I'm a Pretcher fan deep down.

Ok, the last point is a lie.

November rain

Nothing much really to say regarding the market. The correction continues to play out. So far this looks every bit like a correction given how most of the downside has occurred in the first hour of the trading day. But, it's quite likely the correction is not over despite the potential for more dead cat bounces. I will be patiently waiting for the dust to settle and I got plenty of patience.

Today I met with a former boss of mine "Joe" (yes that's actually his name). He's an advisor who gave me my first job out of school as his assistant. He wants me to manage some of his money for him. He's an accountant by trade and still practices it along with his advisory business (which he smartly leveraged from his accounting business).

Joe told me about his recent exploits into the forex market whereby his interest in it was sparked by his IT guy of all people (ya, I know....what the fuck does an IT guy know about forex?) One day his IT guy told him about a "black box" system he was deriving for trading currencies which was based upon back testing several types of technical indicators . Based upon this "back testing" this model supposedly produces 70% winning trades. Apparently it took this guy several months along with tons of computing power to come up with this winning "algorithm" and it's still not finely tuned yet. Joe is really excited about this and he's hoping that if this black box is successful he would give up his accounting and financial planning businesses. I smiled and nodded the entire time. Joe is a greedy man...always has been since I've known him. Joe is the kind of guy who wants to make a lot of money quickly in a way that seems easy or risk free... and so I'm not so sure if the word "greedy" is the best way to describe such a person. Anyhow, there are a lot of such people in the world....people who are looking for some sort of loophole in the system that allows them get "free money"and almost all the time these people end up losing their ass.

As Joe was talking to me about his forex spiel I smiled and nodded the entire time. Instead of telling him that he's being naive fueled by his greed-like tendencies, I took the polite path and told him that before he actually puts money on the line he needs to paper trade this "system" for several months to see if it actually works. He agreed that he would have to paper trade first but he would be willing to jump in for real after only a couple of successful months. Oh boy I thought. The best thing that could happen to Joe is that he loses money right away if he ends up trading forex using this idiotic black box idea and realizes that there's no holy grail in the market. Otherwise, he will get a false sense of confidence, bet big and then eventually lose big.

I am opposed to any black box trading system. These systems are derived/back tested using historical data and that's the problem. Every economic cycle is unique and there's no assurance that any particular variable/indicator which behaved a certain way in the past will continue to act the same way going forward. Take for example the Canadian dollar (the loonie). Only in recent years has the loonie been equated as a "risk currency". For at least the past 5 years the general equity markets and the loonie have been strongly correlated. It wasn't always this way. During the roaring bull market of the 1980's and 1990s the loonie was in a long term downtrend. So, a black box system could possibly do well for a while but then eventually the rug gets pulled from underneath it when the market changes stripes.

Black box systems also do a poor job of dealing with fat tails...the so called black swan events. The perfect example of this was the collapse of LTCM in 1998. This fund had a so called black box system derived from some of the greatest minds in finance. If these "geniuses" got their ass handed to them it gives me little confidence that some IT guy can come up with a holy grail to beat other forex traders 70% of the time.

I hope Joe doesn't quit his day job.

Less is more

I don't want to comment too much on the day to day action because quite frankly, it's not relevant to my style of investing/trading. In bull markets I trade a lot less than in bear markets because that's the best strategy. I won't lie though....if I strongly sense that the market is vulnerable to a major setback or consolidation I will pull the trigger on certain long positions that I think could be exposed and that's what I've been doing. I also did this in the spring and basically twiddled my thumbs the entire summer. During these past couple of weeks I have been raising quite a bit of cash. I just got rid of the one dog stock I had mal.to at a modest loss and I have partially cashed in on stocks that have made great runs such as psv.to and tec.to. I bought them about 2.5 months ago. I might regret doing so given that they are still holding up very well but I felt over exposed given my market outlook and it's easy for these rather illiquid stocks to go down quite quickly. I still haven't sold any wzl.to and isc.v. wzl.to just recently made its breakout and did so on a day when the market tanked big. isc.v is very undervalued and is consolidating very nicely here. You can just smell a breakout coming. They report earnings on the 29th. All of these stocks are basically in the same sector benefiting from the general rebound in drilling activity for oil and gas and new growth opportunities such as the Bakken and Marcellus shale.


When it comes to the markets the mistake most people make is that they over-trade. Most trading blogs obsess about and try to predict the day to day movements of the market. I'd be willing to bet that at least 85% of the people who do so lose money in the long run. It's just too random. It also makes you myopic and slow to identify when a change in the long term trend may have occurred. Take for example my daughter. I see her every day 12 hours a day and so it's hard for me to notice her change. My parents on the other hand see her 1-2 times a week and they always notice her changes.

Take a look at any yearly chart and you will see that you would only have to have made 2-5 moves the whole year to be hugely successful. The majority of the times you would be watching the market doing nothing either in cash or fully invested. Jesse Livermore was correct when he said the most important part of investing/speculating is the sitting....that is, being right and sitting tight or sitting tight waiting for opportunity when the risk/reward is heavily skewed towards a certain outcome before committing. It can be very difficult to just sit there and take no action for long periods of time when you do this for a living. It's very tempting to touch something similar to the urges of a male teacher at an all girls high school. More often than not, when I tried making something out of nothing i.e. forced a trade I regretted it. When I dabbled in a day trade I regretted it more often than not. When I focused too much on indicators such as stochastics, MACD and RSI I regretted it more often than not. My successes came from focusing on the larger moves ignoring the day to day minutia. I know I am guilty of commenting on it at times but I do it for entertainment purposes only!

As of now the market still has work to do before the same indicators and anecdotes which warned me about the correction give the green light for the bulls again. Yesterday's bounce looked a lot like a dead cat one. There's chatter out there about how we are in a strong seasonal period from now until the end of the year. That is indeed true and this strong seasonal period is one of the very few I find worth paying attention to when a bull market is on but in my book, my market indicators which are based on sentiment, always overrule any seasonal shit and right now the indicators still suggest vulnerability for the bulls even though bounces and sucker rallies could still occur.

ST oversold but it probably won't mean much aside from a dead cat bounce

Market action is quite similar to the begining of the correction that happened in Janurary. We saw a sharp move down that made the market very ST oversold to just about the same severity as it is now. There's 2 charts below. The first is the market and the second is the overbought/oversold indicator. The blue circles highlight what happened in Janurary and the green circles highlight what has happened now so far.  In Janurary, after the initial plunge, the market got very ST oversold and chopped around for about a week working off the ST oversold condition before making another move to lower lows. I suspect something similar will play out this time as well but don't expect every wiggle to be the same....no two historical charts are ever the same. Given that the market closed near the low of the day, the best the bulls can hope for is a choppy basebuilding action near current prices. That's unlikely however. I suspect we will eventually see lower lows.


Don't get too obsessed about the day to day wiggles. The bottom line is that the bears have the ball now and so let's see what they can do with it untill the indicators give the green light for the bulls again. Unless you're a day trader, bounces are not to be trusted at this point as it's likely a retest or lower lows will follow.

To my delight my long positions actually advanced as whole since the market started going down last week making new highs since I bought them about 2 months ago but I'm trimming/cashing out on any positons that are getting overbought because even though my positions have been fairly non-correlated with daily market action, that can only go so far when they get overbought and if the market has another stab lower in it which I think it does. If I'm right about the market, it's highly probablable these overbought stocks will come down to earth since most of them are in the oil ang gas service sector which is ultimately driven by the price of oil and gas (more so the former) and oil has been moving in lock step with equities in general.  These service stocks have done very well because they have reported a big surge in earnings in Q3. Their earnings cycle bottomed in late 2009 - early 2010 unlike with general equities in which earnings bottomed in the early 2009. There is still at least another year of an upswing in this sector so long as oil doesn't tank below $60 or so.

On on completely off topic note, go to google maps and get directions from China to Japan. Check out step #42.

Correction/consolidation likely in progress

Ireland woes, Cisco disappointment, China tightening fears...pick your excuse. When the market is ready to go down it doesn't matter what the excuse is because it's gonna go down. There's already talk about Ireland getting a bailout so maybe this causes a dead cat bounce back to 1220. But bounce or no bounce we're likely in a correction or consolidation phase for the next 2-4 weeks.


I like to check the advance/decline line anytime the market breaks above a prior high. If it makes a new high along with the market it confirms the bull market is intact because the internals of the market are strong. Near bull market peaks you tend to see a divergence between the market and the A/D line. Near the top as the market makes new highs, the A/D line doesn't, signaling weakening internals. A flagrant example of this was the bull market peak of 2000 whereby the A/D line had peaked in 1999 and was in steep decline until the market peaked about a year later. In 2007 when the market hit a new marginal high in October the A/D line didn't confirm, as it did not pass above the high it made earlier in the year. I circled this below on the chart. That was a warning sign not to trust that new high. Just prior to this dip the A/D line had made a new high alongside with the market making a new high thus giving the thumbs up for the bull market advance. This strongly suggests any downside from here would only be a correction not the beginning of a new bear market.

In addition, as far as I can tell no bull market has ever died before its 2nd birthday and if you're still calling the move from March 2009 a bear market rally you are in serious denial. But hey, I'm not going to get complacent about anything...ever. There's no law that says a market can't make a LT top with a strong A/D line...history however is strongly against this happening especially when there is still so many LT skeptics with consumer confidence closer to historic lows as opposed to historic highs which is when LT tops are made. You gotta go with the odds and the odds say correction no matter how scary it may get. The same above analysis could have been made in April just before the flash crash and that was indeed one scary decline. However, this time around the potential for downside is not as high because a) bond yields are far lower now than they were in April and b) Traders were more complacent in April compared to now as evident by the put-call ratio, Rydex ratio and VIX.

Observing how traders react to the downside will be the key to knowing how long and deep this will go. Already, the froth is unwinding with the put-call ratio reaching  0.97 on Friday and the VIX popping 10% . It’s just a 1 day reading though. We still have a ways to go before unwinding the froth

Tread carefully

I'm finally seeing signs of complacency/greed from the trading community. During the past few days, traders have been piling into calls sending the 10 DMA of the put-call ratio to 0.80 which is consistent with ST tops. Plus, this heavy call buying of late is happening in the face of a flat market. That's unjustified optimism i.e. greed and also typically what you see near short term tops. Next, Mark Hulbert from Marketwatch.com has noted that the average market timer he keeps tabs on is 60% long. Anything over 50% has typically been associated with ST tops. I've also been noticing some permabear types trying to reinvent themselves by "going with the flow" instead of always trading with a bearish bias. Therefore, they have been positioned long. lol! Where the fuck were you idiots 15% ago? These clowns are weak longs and will get easily shaken out on a 1.5-2% dip because they are still bears at heart. Remember what I said several weeks ago....a correction will only happen once enough weak shorts have been shaken out and weak longs sucked in. I think we are at or very close to this point when you got option traders, market timers and some normally would be permabears positioned long.

I noticed Cisco tanked hard after hours sending the futures in the red. Will that be the catalyst for the correction? I'm not so sure but again, regardless of what Cisco reported, the market is now quite vulnerable for the next few weeks so be careful. This doesn't change my long term outlook which is still bullish. Nor should you dump all your stocks just to avoid a correction. If they are strongly correlated to the market then it would be prudent to lighten up or take a defensive strategy such selling covered calls or setting up a collar. My stocks are for the most part fairly non-correlated with the market and I'm quite confident in their company specific fundamentals so I'm not going to take much action unless it warrants it for company specific reasons. I may consider a small speculative downside bet in the way of OTM March index puts. It would also serve as an insurance policy just in case my stocks do start moving in unison with the market.

Although we are seeing signs of froth from trader types, nothing has changed in regards to the underlying long term skepticism/bearishness in the market which is why I remain bullish longer term. If recent history repeats, the excessive bullishness currently being exhibited by traders types will likely unwind quite quickly if the market dips 2-3% because these jokers are just "going with the flow"....they don't truly believe in the bull market. Next thing you know they will be piling into puts near the bottom. I'm getting ahead of myself here. Let's see the "correction" happen first.

Clowns to the left of me jokers to the right

I love it when Larry Berman goes on BNN. The guy has been atrocious in making calls on the market for as far as I can remember and yet they still have him as guest on his own segment called "Berman's Call". Here's his latest views:


1) Gold: LT bullish ST bearish....buy on a correction at around $1300
2) SPX: looking for a pullback to 1165 area
3) Canadian financials: too late to buy
4) LT bearish on nat gas

If you fade these calls there's a good chance it will turn out to be right. So, without further ado I would like to present to you Bizzaro Berman's call!

1) Gold will either keep going up with only minor dips or it goes down lot further than $1300.
2) The SPX keeps going up with only minor dips or it goes well below 1160.
3) Its not too late to buy Canadian financials
4) Bullish on nat gas long term.

Tune in next week for another episode!

Let me talk about gold again. Berman is yet another "expert" who is long term bullish on gold but short term bearish saying to get in on a good correction. This has been the unanimous consensus for at least 1 month and if you listened you would have been still sitting on the sidelines, shorted or sold too soon watching gold go to new highs. This is a classic case of Mr. Market foiling the herd. By the way do you know anyone out there who is LT bearish on gold? Isn't if funny how after a 460% rise in the price of gold over 10 years everyone is LT bullish on gold? The same jokers I bet were long term bearish in the late 1990s.

Having said that though, I've noticed a lot of the same retail shmucks (I love this word) who were top picking the market getting run over had also been top picking gold and/or bottom picking UUP getting run over just the same trying to capitalize on a ST counter trend move. So many people out there are making the classic semi-sucker mistake of trying to be a smart ass by betting the other way of something that has made a strong move. People do this out of revenge or ego....revenge, because they missed out of the move and now they want to "get even" with the market betting the other way....ego because they want to be able to proudly say that they top ticked or bottom ticked something.

I've learned from experience and from others that 90% of the times counter trend trading i.e. top picking and bottom picking, is a losers play no matter how strong a move has been made are because a trend that's in place today is very likely to still be there tomorrow...that's just the way momentum works. The vast majority of my success has been going with the trend buying high and sell higher. That doesn't mean blindly chasing parabolic moves but rather looking for stocks that are gradually making new 52 week highs in a non-parabolic way without a lot of media attention. When I look for bottom fishing/turnaround candidates I want to see at least 5 months of base building/topping action or a reversal in trend.

Getting back to gold, you'll know when the gold bull market is over when the consensus calls for a correction and they get it right....chances are that correction will be the first move down in a bear market or crash. This is what happened when the NASDAQ bubble and oil bubble burst. In my last post about gold I said to keep an eye out for when gold trades 30% + above the 200DMA because that would when you should look for the parabolic blow off to terminate into a crash or new bear market. However, gold's cousin silver is already at 42% above its 200DMA! This is just about as far above the NASDAQ was from its 200DMA when it made its bubble peak in March 2000! This just goes to show you the difficultly in catching tops/bottoms. An extreme can simply get to an even greater extreme.

Arrogance

So much for the "sell the news" trade. I was watching BNN just as the fed made its announcement regarding QE. They had a few guests giving their take about it. 2 of them were bears one was moderately bullish. One of the bears talked about how we're going to be in the "new normal" of subpar growth for most of this decade (such an original thesis eh?) and how QE wasn't going to make a difference. The other bear was a frustrated floor trader who claimed how all this fed intervention is creating inflation via rising commodity prices and it's all going to end badly one day. What I found interesting about these guys, which is also common amongst today's bears, is the hand wringing, arrogant attitude they have. Bears have been dead wrong about the market to the point of embarrassment and instead of being humble; they dig in their heels and continue to talk tough. Anytime you see this type of behavior you know Mr. Market hasn't finished humiliating them. At what point are these clowns going to say "hey you know what I was wrong about the market". The retail shmucks who worshiped them are slowly but surely learning the hard way that most of these permabears are nothing but broken clock, arrogant pricks who will never admit to being wrong. They are no better than the "new era" permabulls who rode the market down in 2001 and 2002.


I want to say something about QE. Everyone is harping about how this is bad because the fed is "printing money" to buy bonds. This is not entirely true. People forget about the flip side to this equation. Eventually the fed will SELL these bonds back into the market thus "destroying money" in doing so. So, in essence what the fed is doing via QE is manipulating the mix of cash and government bonds held by the public. They are not creating new money on a long run basis because like I said, they are going to eventually reverse QE by selling back those bonds. But of course, a lot of people don't seem to or want to realize this. They just want to bash the fed no matter what.

Also, everyone keeps moaning about things aren't getting better, how unemployment remains high calling this a jobless recovery and that the fed is "pushing on a string". Guess what? I heard the exact same arguments in 2003! Eventually the jobs DID come and the fed's actions WORKED...it just took longer than normal and all along the stock market was making new high after new high signaling that things were going to get better. It seems that a lot of people out there don’t want the fed to succeed...they would rather see the economy collapse again. They say it's for everyone's own good to let "nature takes its course". But do you want to know the real reason why most feel this way? Ego. They bought into the doom and gloom hype after getting burned as bulls at one point in their life whether it was the tech crash or the 2008 crash. Now, as bears they are getting burned again and they are in denial just like they were when they were bulls. Its bizzaro 2001 folks!

Another bs thing I keep hearing from the retail shmucks is "the bull market is an illusion because gains in the stock market are only a reflection of US dollar weakness, so there's been little real gain." First of all, the dollar has dropped about 23% since the bull market started but stocks are up 75% therefore there is still indeed a "real gain". Second of all if this logic holds true then it must mean that countries that have seen their currencies rise must have an offsetting declining stock market. Well that hasn't happened. Countries that have seen currency strength have also seen soaring stock markets greater than that of US. So, the truth is that huge wealth has been created worldwide using whatever currency you want to measure it in.

Pretty much every major index in the world has hit fresh 2 year highs today. Overbought or not, this tells you the bull market is in full force. It seems quite unlikely with only 2 months left in the year the market is going to slip up in a big way before 2011. But given how overbought we are now, we will likely see at least some sideways consolidation in the coming weeks and yes, perhaps even the correction that so many people got burned trying to capitalize on. But you know what I always say, picking tops is dangerous game when a market closes right at a fresh multi year high because in such case it's very unlikely the market has seen its highest point, dip or no dip especially when most of the retail shmucks out there are still miserable and mom and pop investor is still MIA.

Big game of chicken about to begin

Bulls that were patient and brave enough to ride this rally up until now are probably tempted to take money off the table given election and QE uncertainty and you can’t blame them for doing so. Meanwhile the bears that got caught short in September and October and are still bag holding are probably close to throwing in the towel (not including the ones who got crushed and were knocked out of the game by force). Who's going to blink first the bulls or bears? You know what? I don't give a shit anymore. From now on, unless I see flagrant signs of a pending major turning point like in April, I'm not going to talk much about the day to day fluctuations in the market very much. My time is better spent researching individual companies and sectors. I did this last year late summer and it paid off big time. I've done it again this year and so far so good. Correction or not, I still believe this bull market has a ways to go and so long as that's the case conditions are favorable for sectors and individual companies that are thriving relatively better than others. It's not worth it to pass up on such opportunities fearing a correction in the general market because such stocks may not react to it much or at all. So long as it's not a 2008 type collapse you'll be sorry more often than not. You can use this post as an indicator that the top has gotta be in now (come on I know you're thinking it lol!). That's fair enough...go ahead and fade away! And I really do hope you make money picking the top! Seriously!


But I'm reasonably confident that any correction at this point would not be the end of the bull market and so that shouldn't deter me from buying stocks that are dancing to their own tune for the most part and have everything going for them (good valuation, positive trend in fundamentals, gently sloping uptrend chart). So, on that note I will likely be less active with my posts and I will talk more about the companies I'm looking at and less about the general markets until I see something really worth mentioning (such as if I'm getting an "all in" signal for a pending correction).