My resolution for 2012: brass balls

This is the time of year when I look back to see all the hits and misses I made. First the hits. Coming into the year my longs were almost entirely in Canadian small cap energy services stocks.  These stocks and this sector in general were winners in 2011 despite the TSX being down 12% or so for the year. Despite all the dips in the first half of the year, namely, the March dip due to the earthquake in Japan, I held my longs strong. I then started substantially cashing out in June and early July when I sensed a change in character in the market. My timing was excellent. These stocks tumbled alongside  the market shortly after...but now most of these stocks have either rebounded back to or above where I sold them! I'm not bitter about that because a) At their lows I no longer had the same positive LT conviction about the overall market as I did earlier in the year  b) Oil prices, which these stocks are largely dependent on, rebounded a lot more than I had believed possible.  When oil prices dropped below $80 in the summer I figured it was likely that base building would take place and therefore these stocks would do likewise. Of course, that didn't happen and instead oil, along with these service stocks, did a  strong V shaped rebound thanks in large part to geopolitics, something which is difficult to anticipate and account for.

Perhaps I should have nibbled on the stocks I sold  near their lows in October but even if I did, I could not have justified buying back anything close to the amount I had sold given a) and b) above. Oh well. Hey, shit like that is gonna happen. It's one thing to sell too soon for good reasons only to see the stock go higher and it's another to sell too soon due to emotional factors such as when despite your positive LT convictions you panic during a correction or you try to be smartass trying to bob and weave through every little rally and dip - that's a bonehead move and the latter is what I did late 2010 with PSV.to and got punished BIGTIME for it....you see there's a reason for my avatar.

My biggest bonehead move of 2011 was the failure to pull the trigger on buying TLT calls that I was contemplating  in early July missing out one of the biggest bond rallies in decades. The timing of that entry would have been impeccable. I wasn't planning on making a huge bet mind you....something like 5% of my capital....but that 5% bet would have resulted in an additional 10-15% to my results this year.  

Overall though I think I did Ok but only just Ok. While a 24% return this year seems pretty damn good considering what the world markets did (especially my home Canadian market which is down 12% ), I should have done better because I didn't fully capitalize on my convictions. Why? The answer is pretty simple. A lack of balls. You see, unlike most traders who tend to make the mistake of being overly aggressive and overly confident in themselves, I tend to be overly cautious. In general, my mistakes tend to be trades that I don't make as opposed to trades that I do. To my credit, I had only 1 losing trade this year and it was minuscule....essentially breakeven.  That's not as impressive as it seems because what I think it shows is that I'm playing too tight. I should have been making more trades which no doubt would have resulted in more loosing trades but also more winning ones as well and  the additional winners would have more than made up for the additional losers.

Anyhow, what's done is done. The best you can do is learn from your mistakes. So on that note, my resolution for 2012 is for me to grow a pair of brass balls (as inspired from the movie Glengarry Glen Ross). I need to be bolder. I need to believe in myself more. I need to take on more risk when the risk is worth taking.....the latter part of what I just said is key....being bold when there is little or no perceived edge is reckless and that's not what I'm talking about here. Trying to get "revenge" after you made a losing trade or missed out on what would have been a winning trade is also reckless. There's a fine line between boldness and recklessness....don't cross it.

As far as 2012 goes, as I said before I don't have a clue as to how it will turn out. Unlike last year though, it's very likely the market will be up big or down big.  As Russell Peters often says "somebody's gonna get a hurt real bad" - either the bulls or bears because we are going to find out next year whether the world economy be dragged into recession by Europe or not.

2012 certainty has the potential to be a very good year because expectations are low. There's plenty of "bullish fuel" in the tank given the significant equity outflows overall in 2011 and a rush to safety via money market and bond funds that rivaled what we saw in late 2008.  Despite all the turmoil in Europe, earnings did not roll over in the largest economy in the world, the US. Bears will point out that this is just a matter of time given some of the red flags out there like ECRI's recession call and the rolling over OECD leading indicator. I say "fair enough" to that but until we actually see some hard evidence I'm not going to fully embrace the bear case but nor will I fully embrace the bull case either at this point given the broken market action which suggests to me that this rally we have been seeing is dubious even though it can linger for a while still. There's also a few indicators like the smart money put/call ratio that suggest we're not out of the woods yet. I think there's a good chance we will see a significant sell-off sometime by the end of March and maybe at that point the market will be in a better position to advance in a sustainable way ...we'll see what happens.

So, given these cross-currents I am going to looking for both long and short opportunities. On the long side, I'm looking for deep value opportunities in the small cap/micro cap space - stocks that were perhaps unjustifiably dragged down or held back due to the general market malaise and could be ripe for a rebound via merger/acquisition or otherwise. I recently purchased 2 of such stocks.  On the short side, I'm looking to make an IT bearish bet on the market using put options when I get the sense that the market is "ripe" for the sell-off I envision in the first quarter of 2012.  At the most, I will only commit 50%  of my account to the above long/short strategy. I know I said I want to be bolder in 2012 and beyond but that can only be allowed when I have a substantial  LT edge/conviction on the general market which I don't. As a result I will only be willing to commit up to half of my account on any ideas.

Go with the flows

The best sentiment indicator as of late has been equity inflows. Despite how crazy market action has been with all these wild swings, if any rally was not accompanied by significant inflows it wouldn't be in danger of collapsing....you could still see big dips but not a complete retracement. The only 2 times since the August crash that we saw a spike in inflows were in mid September and late October, both of which marked significant tops and were followed by losses of about 120 points on the SPX.  Since the bottom in late November, despite how erratic and gap happy the rebound has been (which tells me ultimately it's gonna fail) it has attracted negligible inflows so far...in fact, on a net basis, there has been outflows since the November low. The lack of inflows along with other sentiment indicators has made me avoid the short side.

The other sentiment indicators I'm talking about are AAII and NAAIM.  AAII currently shows only a modest ratio of 1.2 bulls vs bears and NAAIM shows that active managers have only about 37% long exposure. Those are not the sort of statistics that make me salivate towards playing the short side....they both suggest there's more room for bullishness to rise before reaching the danger zone. One thing though that is indicating complacency is the VIX. At 21, it's pretty damn low considering the market volatility these past several weeks, not to mention all the fundamental issues out there that have yet been resolved. 

The VIX has hit one of my bear bet triggers. The other triggers would be AAII sentiment showing about 2:1 bulls vs bears, NAAIM at least 65% exposed long and of course, a spike in inflows. Obviously, there's no law that prohibits the market from tanking big before such stats are reached but from a risk/reward perspective, that's what I need to see to bet along side the bears. If I don't see it, I don't play it. Until then, I'm going to stick with strategy of picking away at some individual names that I can be a strong holder of should I get "caught" and the market does indeed tank big before I believed it was ripe to do so.  

Here's something I read this week that I found interesting. 

Money market funds  brought in $3.2 billion globally last week, extending their longest weekly inflow streak since a 12-week run during the financial crisis at the end of 2008, according to EPFR, a research firm that tracks fund flow data.

When I read things like this it makes me temper my conviction of a big bear market playing out. 

If the rush to safety is rivaling what we saw near the depths of the bear market lows in 2008 (when there was far more chaos and destruction compared to now) it suggests we are closer to a LT bottom then an LT top. And remember when I said back in September how the late night talk show hosts were making fun of the economy...something that I also saw in late 2008. Late 2008 wasn't the final bottom but it was close. 

The above makes me lean towards the thesis that although it appears likely the market will make another run to the lows in the weeks/months to come due to the shitty market action we have been seeing and a few other things, such a run to the lows would end up being the last move down completing the LT bottoming process that began in early August. As always, I will try my very best to be flexible and open minded about how things are going play out. One thing's for sure is that 2012 is going to be yet another interesting year in the market....aren't they all though?

Ok, that's enough stock market talk. When the closing bell rings Friday, turn off your computer and forget about the market. This is a time for family, friends and food! Remember how you felt as a kid this time of year? Try feeling that same way if you can. Don't be a miserable SOB.  I know this sounds cheezy....have a positive attitude and be grateful to be alive and in good health. We all want to make the best out of our life and that's not possible if you're negative or apathetic.  And remember, to be really successful you have to consistently do things most people don't do.

Merry Christmas!

Still Perplexed

When someone asks me where I think the market is headed for the next year or so, I can usually give them an answer. Whether I end up being right or wrong is not the point, the point is that up until now, at least I was able to have a reasonable amount of confidence and clarity to provide a market outlook for the next 1-3 years.  Anyone reading this blog since 2009 would know that the outlook I have had since the summer of that year was LT bullish. Coming into 2011, I believed the market would have another good year but it would have to go through a multi-month consolidation phase first at some point because the market was quite overbought. During this phase, I didn't think the downside would be more than 10%. Well, I was clearly wrong about that. Lucky for me I was largely in cash bracing for a correction. It didn't matter how much of a correction it turned out to be - I was safe.

Since the crash I've been having serious doubts about my longer term bullish outlook.  There are some economic red flags out there and other indicators that suggest we could be in for a new bear market driven by a global recession. At the same time, there are good arguments to be made against a new big bear market and that this is simply a large correction or mini-bear market. You can always find arguments that support a bullish view or bearish view at any given time which could sometimes cause you get "analysis paralysis".  I don't have a case of that. When I was bullish in 2009 and 2010 I was always aware of the bear arguments but I was able to dismiss them. Similar to how a judge scores a fight, I would determine who landed the bigger blows -  the bulls or the bears - and then pick who I believed was the winner. This time around though, I can't seem to pick a LT winner because I score the match pretty much even between the bull case and bear case and I have made a few detailed posts highlighting the reasons why it's so tough to pick a side.  If you look at what the market has done in the past few months it seems to reflect my judgement of a draw.

IT wise however, my outlook is not as clouded. Evidence to me suggests we aren't done with
downside even if Santa comes to town next week and the market lifts higher all the way into the new year. Capitalizing on IT market moves has been very tricky for me and in that regard, I think I have indeed been a victim of analysis paralysis to some degree but part of it has to do with the type of insane volatility we are seeing. The market is forcing me to either pick tops and bottoms or else chase a potential turning point after a big gap up/down - things that I refuse to do. When In doubt I stay out.

I'm willing to play IT moves if I get a good enough edge and I'm willing to pick away at some individual names trading at excellent values with solid balance sheets with still good prospects for growth. GDC.to was one I bought into last week...very small position.  I did well with this one last year. Until I can get some LT conviction about these markets, I'm going to be playing tight and that means being very selective about my trades keeping plenty of powder try.

So when someone asks me what's in store for the market in the next year or two I answer  "I have no fucking idea"....at least not right now.

The importance of having the wind at your back

I've said here more than once that this game is not supposed to be easy. If it was, everyone would be playing it and you wouldn't have those dismal statistics that show 90% of traders lose money in the long run. Although the game is not easy, there are things you can do to make is easier. One of those things and in my opinion, the most important thing, is to have the wind at your back and that means trading in the direction of the general trend. You want to be aggressively long stocks when the trend in the general market is on the rise and when economic fundamentals (earnings, leading indicators) are on the rise or stable.  Using the same line of thinking, you want to be primarily short when you see the inverse of the above. When a trend in in place today,  odds are high that it will be in place tomorrow which makes it whole lot easier to make money if you bet with it is as opposed to against it. If your entry happened to be bad and you get caught in counter trend reaction shortly after it, odds are high that you will eventually get "bailed out" by the primary trend.  This is why they say the trend is your friend. Unfortunately, most people follow this adage only when a trend has been in place for a long time and is just about ready to change. Then they fight the new trend not realizing the main trend has changed!

Right now the wind is no longer at the back's of the bulls as it has been since the spring of 2009. The general market has been be flat for the past 6 and 12 months and has been very volatile.  Earnings have remained strong, however leading indicators have rolled over which potentially bodes ill for future earnings. I say potentially because sometimes a roll over in leading indicators may simply be an indication of a mid cycle slow down as opposed to a full blown contraction. ECRI has just reconfirmed their recession call. The latest OECD global leading indicator chart corroborates what the ECRI sees.

Now as you can see by this chart the rollover in the leading indicator doesn't guarantee a recession, it could  simply signal a mid cycle slowdown much like what happened in 2005.  Notice how the leading indicator didn't roll over last summer when there was a lot of worry about a double dip. This time though, that's not the case.  The stock market will often bottom and go back to bull mode a little earlier than leading indicators do, but until we see that behavior you have to be skeptical of the bull side and take it a step further and make a bearish bet if you detect complacency during such conditions of shitty market action and deteriorating leading indicators. Of course, I'm talking about longer term bets here. Those of you who play ST moves need not listen.

I think we will probably have to wait until at least March before we could be in that bullish "sweet spot" again whereby the market is early in a new sustainable uptrend with fundamentals on the rise. During such a phase picking winning stocks is a lot easier as you get the benefit of "the tide lifting all boats". Realizing success going long stocks in bear markets or sideways markets is lot a harder. 2008 was an extreme case of that where practically no stocks in the world went up.

Neither the bulls or bears have the wind at their back at the moment and it shows with the market being flat on multiple time frames. This type of  sideways market is supposed to be ideal for ST trader types but that's hardly been the case thanks to the unpredictable headline driven nature of this volatility and the big gap up and gap down moves that go with it. Overall though, the bears have the edge here because this volatile, broken action we are seeing suggests we are not yet done with the downside and with economic momentum on the down slope, the market has the opportunity to gain traction to the downside making new lows. One possible silver lining to this broken action is, as I've pointed out before in a recent post, we saw similar broken action in the drawn out bottoming formations of the 2 previous big bear markets. So, the bulls could find some solace that if history is any guide, any downside from here will not be catastrophic and will lead to a LT bottom. The way I look at it is this. I'll believe it when I see it.  Given the shitty action we are seeing and the deterioration of fundamentals it's likely there will be another run for the lows sometime in the coming weeks/months. If afterwards the market action and fundamentals suggest a new bull market then I'll be on board long stocks in a major way. In the meantime, there's no sense in loading up on stocks now gritting your teeth hoping that the downdraft in the market you believe is ultimately going to occur, will only end up being part of the bottoming process.  If it ends up being worse than that, you are caught holding the bag and that's a spot you don't want to be in.

So, overall  this where I stand right now - I believe ultimately the market is going to at least make a run for the lows within 6 months. Despite this outlook, I currently don't see enough favorable conditions to make a bearish bet. Discipline trumps conviction. I will only be willing to purchase a limited amount of stocks at this time and such purchases will be very selective and price sensitive. I will also be willing to go net short.  Right now I'm about 95% cash.

Still not out of the woods

From what I've been reading on the blogs I can tell this market has been hurting traders. If and I stress if, we are at the "endgame" and a big bear market is upon us, Mr. Market is preparing the groundwork to allow for a sudden and large slide to take place. He is doing so by whipsawing the bears into an oblivion while conditioning them to cover any profitable short positions quickly before they get taken away in a blink of an eye. That's what happened in the first half of this year as well which set the stage for the big drop in late July early August. Bears were conditioned to not "go for the kill" because anytime they did that it was they who got killed, and so they covered position far too early and missed out on the large portion of the crash. The same type of conditioning could very well be taking place right now if Mr. Market is planning on sending the market back to the October lows or beyond. He can only do so when there's little company.

The market is still broken behaving as it does when bear market conditions are in place. In my view, whether the market is going up or not and by how much,  is not the sole determiner of what constitutes a bear or bull market....it's the way it goes up or down that gives one a better sense in distingushing a correction from a change in trend.  Mechanical trend following systems make no such distinctions as they are based purley on price levels and moving averages.  That to me is like agreeing to go out with a girl only knowing that she has nice measurements. What about her face, her skin, her age, her personality, her intelligence?

The way this market has been behaving on the upside since any of the rally attempts made off of IT lows, namely the early August and October lows, suggested to me that they are not sustainable. They smack of short covering panics and squeezes. It does not matter to me how high the market goes...if it continues to go up erratically with high volatility like what we've been seeing lately, I will continue to be skeptical. That doesn't necessarily mean I'm going to bet against it....I won't unless I see enough weak handed investors/traders embrace the rally while at the same time a lot of bears throw in the towel. I've been around this game long enough to know that the market will do whatever it takes to squeeze every last weak bear into submission while sucking in longs. The bear market rally from  late September 2001 to March 2002 is a perfect example of how long Mr. Market can keep the balls in the air before pulling the rug right from underneath everyone.

Friday's Euro zone meeting was essentially a dud. No definitive and bold action was made to stem the crisis.  At best it was a baby step. The market had sold off sharply the day before and then rallied back to recover all the losses the day after. Bears are pulling their hair out as to how this could be. The reason is probably because there wasn't enough longs to milk while at the same time there were plenty of bears still remaining who figured that the euro zone meeting hype was going to be sold. Thursday revealed that as per NAAIM active managers only had 35% exposed to the long side, no net inflows into equities during the preceding 14 days and AAII sentiment showed a neutral 1.1 bulls vs bears. That to me suggested there wasn't enough suckers for the bears to capitalize on and in the end it was them who were the suckers as they trampled over each other running to the exits.  Compare these numbers  to the latest ST peak in early November when the numbers which were respectively 54%, 1.8 bulls vs bears and about $15 billion of inflows - these number weren't really that extreme either (which is why I didn't pull the trigger on a bear bet) but they were a bit on the high side.

Until I see a strong edge I am going to continue to be patient and just simply watch the action. It's been agonizing doing so for such a long time but when I took at the chart and look at the meat grinder that is this market, for the most part I believe I have made the correct decision. I am still willing though to make some buys in individual names but they gotta be really ripe for the pickings and I'm not going to commit large. Until I'm can feel bullish again about the trend in the general market I can't justify being aggressive long stocks no matter how appealing some of them may be. On the bear side, no matter how skeptical I am about a rally, I will not bet against it if I feel such a trade is "crowded" for I know Mr. Market can squeeze and squeeze and squeeze the bears into submission. In this type of market, doing less is doing more.

Book review: Confessions of a street addict

I just finished reading this book written by Cramer in 2002. In it he tells the stories of his carreer including how he broke into the business along with major ups and downs he went through with his hedge fund and his website thestreet.com. It was an entertaining read for the most part and that along with gaining some insights  into the inner workings of the hedge fund world were the main reasons why I read this book.  There were some nuggets of wisdom that can be gleaned from the book as well. If you weren't trading during the late 90's which featured the Asian contagion, the collapse of LTCM and the dot com mania, this book will give you a "in the trenches" prospective of it. The most interesting part of the book is when Cramer talks about his struggles in 1998 whereby his hedge fund was on the brink of collapse.

Now a days, Cramer is despised and ridiculed by pretty much everyone in the retail trading community who has been trading for at least a few years. While I am certainty aware of his faults and have been critical of him myself at times, but I've always respected him because he is successful. Say what you want about him but you don't get to where he is by being a loser. He made millions for himself and his clients both as a broker with GS and at the helm of his hedge fund which averaged about 24% net of fees over a span of 12 years under his tenure. He is a veteran of the street and has a lot of knowledge of the inner workings of it. He is well connected and comes up with useful ideas and insights now and then.

After reading his book, I had more respect for Cramer in some ways but less respect in other ways. On the positive side, if what Cramer says is true (which I believe is the case), there are very few people on this earth who are more tenacious and hard working than him. It was inspiring to me. He battled through many personal and financial adversities which were brutally agonizing. On the negative side, some of things that Cramer and his fund did to make money bordered on insider trading and market manipulation.  Cramer's firm would generate a lot of commissions for various brokers and as a result they would be able to get access to the important people in the sell side like the big analysts. One particular strategy emphasized by his trader wife, was to talk to analysts gaming them if they were about to upgrade or downgrade a stock and then jumping in with a position if they had good reason to suspect one was coming. If they felt the analyst was warming up to stock they would feed them positive information to give them the "push" they needed to pull the trigger on an upgrade.Another benefit of their "pull" with the brokers was that they were able to know things that the typical retail trader would never be able to know such as if there was a big seller who was putting pressure on a stock and was just about done liquidating their position. When it comes to ST trading individual stocks, which a lot of hedge funds like Cramer's former fund focus on, retail trader's are at a significant disadvantage because of what I discussed above. This is one of the many reasons I don't believe in ST trading.

Cramer also talked about how grueling, cruel but yet ridiculously lucrative it was to have worked for him. Would I have worked for him if given the chance? Yes...the money would be too great to resist. Would I have lasted? Probably not. Aside from his rapid ST trading style which isn't my forte and is incredibly stressful, I would probably not be able to put up with the abuse he inflicts on his subordinates which included getting water bottles thrown at you and having a post-it note stuck to your forehead all day with the stock symbol of the bad trade you made.  I would probably be burned out and stressed having little time and energy for sports, friends or any other kind of life. I realize hard work and sacrifice is essential to success in this game but if attaining success in such a way is going to make you miserable then it's really not success. Perhaps it would have been worth it to put up with the abuse for a few years to build up a good chunk of change then quit and work for yourself.

I've being doing this full time for about 3 years now and my returns have been on par with Cramer's when he was at his fund but I achieved them far more passively, with far less stress never on the brink of collapse and without having the advantage of the inside scoop from the big brokerages at Wallstreet. I've also done it in more difficult market conditions. But 3 years means jack. I could have just as well been lucky rather than good which is similar to the line Cramer ends with in his book.

Weekend Ramblings

Wow, what a crazy market. We went from having one of the worst weeks in history to one of the best! Anyone who has been using a mechanical trend following system has been getting absolutely butchered by this volatility. For me, I haven't been getting butchered but I haven't been making anything either as I continue to remain sidelined. I'm willing to entertain intermediate term trades but the market has been moving  too quickly for me. For instance, coming into this week the risk/reward for such a trade on the long side was looking favorable. The market was deeply oversold and sentiment was bearish enough to give the green light (it wasn't super bearish but bearish enough).  All I needed to see was a little bit of stability to give me the impression that the market had found a bottom. Instead we opened up the week with a big gap up and never looked back. We gaped up big not once, not twice, but trice this week! Now, as I said before, when it comes to bear market rallies vs new bull market rallies, they tend to look the same initially - they are explosive and a gap and run to start either isn't uncommon. What distinguishes them is how the market behaves after the initial thrust is over. But to see 3 gaps like that in one week on flimsy catalysts tells me this is a bear market rally IMO.

Let's look at the reasons for the rally this week. First there was a report  Sunday night that the IMF was going to help Italy, which didn't even end up happening.  Then the big rally on Wednesday was due to the coordinated efforts of central banks around the world to provide liquidity to European banks. Lol! Come on...who actually thinks this is some sort of panacea?   It does fuck all to address the underlying problem of insolvency. We saw similar types of liquidity aid in 2008. Did that mark the end of the crisis? Hell no. If anything it tells you that there's more trouble ahead.  Sure, there was better than expected data out of the US but that was clearly secondary. (And what about the weak data coming out of China?). I don't mean to sound like zerohedge.com here but the reasons  for last week's rally were a joke.

Here's what I think basically happened. Coming into the week a lot of shorts were nervous with their finger on the cover button because they knew the market was very oversold and so any hint of good news would send them running for exits. The IMF rumor did the trick. With the rally on Monday having been done of low volume and Tuesday showing no follow through, the rally looked week and destined to fail the next day and so I bet a lot of these bears put back on those shorts and bears who had missed the recent decline figured this was their chance to make amends. Then the bears  got blind sided again by the central bank news and panicked probably flushing out the more "longer term"  swing trader/mechanical types who had shorted the market after the "triangle breakdown". It was one lemming domino toppling another. I've said recently a few times before that bears are their own worst enemy not the PPT, not Goldman Sachs but their own herd behavior. Remember the motto of this blog folks. The market is not going to easily accommodate the legions of permabears that are still out there even if it were to have terminal cancer and on its way to the end game. The bear will take their money too!

Anyhow, I've decided that it's time for me to take some action. I'm going back to basics by looking for individual small cap/micro cap stocks that are overlooked, trading near or below tangible book, have low debt, turning the corner with earnings (or have stable earnings)  and are not heavily influenced by the behavior of the general market and have promising technical action (base building bottoming formations or gently upward sloping charts). These are hard to find but they are out there and you tend to see more of them out there when you have markets like this. I've put in some orders already for a couple stocks. I have a few others I'm looking at that are promising but need to show another month or two of base building. Once I have exposure to these names I will be much more inclined to hedge unlike before. I will likely use puts on index or sector ETFs.  I will also consider engaging in IT trades on the general market should the opportunity present itself and I will also be keeping a cash reserve of at least 50%. I've been pretty good at picking winning stocks that have outperformed the market big time although I know all too well that in bull markets it's much easier to pick winners. In bull markets everyone is a genius as they say. Although in this bull market there hasn't been many geniuses....in fact there were more dummies than geniuses this time around  because so many were bitter and angry at the market during it's rise.

The Euro crisis has everyone fixated including me (I gotta stop this shit). As a result, I think you'll be able to find some real gems there in the small cap/micro space that have been unduly trashed.  I love this space because not only are the gains more potentially explosive, you have a much higher chance of getting an edge because they tend not be  followed much by analysts and institutional investors until after they make a big move which then creates another upside catalyst. Another thing too is that these stocks can sometimes be slow to react to major trend changes in the market giving you the opportunity to buy or sell before they get pulled in by it. Finally, they are not being whipped around by HFTs and day trader types. Low liquidity can be an issue however and often times these stocks will be dormant for weeks or even months. So, if you crave day to day excitement and use tight stops these stocks are not for you. And just remember, if we get another 2008, very few stocks will be able to withstand being sucked into the carnage including the small cap/micro cap space. But it's not always that way with bear markets. In 2000-2002, small cap value and gold stocks did very well relative the SPX. So, you can find winners out there in a shitty market.....it's just that it will be a lot harder and using a hedge could be the way to go. If however, you have good reason to be very bearish in the IT or LT then you must go at least net neutral...you should optimally be net short though. That's the mindset I'll be having going forward until I have good reason to believe the bull market is back.

As far as the market goes now we're no longer oversold but not overbought yet either. I don't see a huge edge either way although I do see a couple of things that favor the bulls.  There was an outflow last week despite the big rally. That's bullish. Also current NAAIM sentiment shows that active mangers reduced their exposure despite the big rallly and it's only at 30% (it got as high at 50% at the peak a couple weeks ago  and historically that's only neutral). This too is bullish and suggests this rally  still has legs. If however it doesn't and the rally ends up failing soon then it likely that any downside would not be the start of a big bear downleg to new lows.

 Everyone is eyeing when the Euro leaders meet next week (I think it's the 8th)  and it's expected some sort of a "plan" to deal with the crisis will be announced. Barring any major surprises, the market will probably not do much up until that day. Hold on....didn't I just say I gotta stop being so fixated about Europe?

The song remains the same

Hope, despair, hope, despair. Big gap up, big gap down, big gap up, big gap down. That's been the pattern in the market for the past few months. This has been a very frustrating, annoying and dangerous market.

Let's forget about indicators, sentiment, opinions about the bailouts, Merkel and what-not and just try to look at this market using objectivity and common sense. I've said before that bull markets don't have the type of volatility we are seeing. What we are seeing reminds me a lot of  the months that followed the Lehman crash. About a month ago I saw this chart posted on tickersense.com which proves what I'm talking about. This is a very important chart.



The red areas highlight prior instances when the market had the type of volatility we are seeing now. These signals all previously occurred in bear markets. That's the bad news, but there's good news too as you will see.  Whenever we saw such instances of  "high volatility" as per the above chart, it signaled the start of the puke stage of the bear market. Significant and immediate damage lied ahead in the weeks that followed but that ended up marking close to where the bear market had finally bottomed - that's the good news. However, the bottoming process took about half a year to complete the previous 2 times we got the signal. Even last summer's flash crash (arguably a mini-bear) which didn't trigger a high volatility signal, took about about 4 months to complete.

So, let's consider the current situation. Just like with the two previous high volatility triggers, we saw significant and immediate damage occur. The signal was triggered on July 27th.  The good news is that if history repeats, there's a good chance the worst of damage has already taken place. The bad news is that the bottoming process is quite likely not be complete and some sort of retest of the lows, whether it's a higher low or lower low is in the cards. We made the first significant low on August 9th. Therefore, it's quite likely that the bottoming process won't be complete for another 1-4 months - if we are indeed in a bottoming process. But let's be careful not to be dogmatic about this....there's no law that says the market can't bottom sooner.  It's been just under 4 months now since the bottom in August and so I suppose that might be considered long enough time to have completed the bottoming process.  I'm doubtful about that but I'll keep and open mind and be on the lookout for the return of bull market behavior (which is characterized by a upward grinding market with low volatility)..

There's also the possibility for a grim resolution this time around. Bears will argue that massive policy intervention stymied the last 2 bears and if not for that the damage would have been a lot worse. As a result, the heightened volatility could have been an indication of the beginning of the "end game". According to the bears, all the authorities did was delay the end game creating even more imbalances. This time around authorities have largely exhausted their "bullets" to thwart the end game and so that leaves us much more likely to experience it this time around than ever before. It's still an unlikely outcome but IMO, the odds are higher than anytime since about 1996  when many of today's permabears first started calling for it. If this ends up happening I can guarantee you most bears will not even come close to fully capitalizing on it since the market would likely go down in an almost straight line down fashion for months.

A few words on today's rally. The market was quite oversold heading into this week and so it's not surprising to see it go up like this on rumors about the IMF helping Italy or whatever. Anything could serve as a excuse because most shorts by nature are weak and fickle and focus on the ST and they have been clown raped so many times during the past couple of years that they are now conditioned to cover when the market gets oversold. There's room for the market to go higher still even after today's run up but if you bet on it just remember you're likely playing the game of chicken. This seems like yet another hope rally doomed to fail if you ask me.

Bear market strategy

During times like this to keep me focused, I tend to review the principles I believe in....principles that have been forged out of years of experience. Doing so helps me to resist the temptations to do something impulsive instead of patiently waiting for the right opportunities. Let's talk about bear markets because that's what were are in right now. The main "tell" that distinguishes a bear market from a bull market aside from an overall downtrend vs an uptrend is that bear markets have much higher volatility on all time frames: intraday, weekly, monthly. This is how you can tell a bear market rally from a bull market rally. While the initial rally from a bottom in both bear and bull markets often appear the same, (fast and furious) what happens afterwards gives you a better sense of determining if the rally is "real" or not. In bull markets you will see small but relentless upward progress almost daily. If you want in you have to chase because pullbacks are few and are quite shallow. In bear market rallies you tend to see the type of volatility like we've been seeing for the past several weeks - huge up days and down days.

My main philosophy regarding bear market is this. Don' lose money. Making money is secondary and if you want to do so you need to take a trading approach both on the short and long side (emphasis on the short side) as opposed to a long only, buy and hold approach that is optimal in bull market. By trading I'm referring to the intermediate term 1-4 month swings not ST trading and especially not daytrading..... I don't believe in those types of trading.  As a speculator you should be looking to make money in any type of market but I find that with bear market because of the heightened and erratic volatility it is easier said than done. Bear markets tend to destroy bulls AND bears alike.

As a result of the heightened and erratic volatility in bear markets, you need to be able to withstand a lot of noise. If you are convinced that the market is headed a lot lower in the months ahead (and not because you're biased or bitter but because you actually have objective reasons) and want to profit from it,  you need to make yourself a strong holder and ensure that your holding period in line with your beliefs. I chuckle when I visit some of these bear blogs and I read commentary from them about how they believe the economy/market is doomed due some macro argument/facts. Then they go out and make a trade like "Short QQQ at 55 with a  stop at $55.20".  Lol! That's fucking retarded. They are using ST trading tactics to profit from a macro conviction. In bear markets because volatility is so high and erratic, making trades like this will almost certainly result in failure.Your trade has to be aligned with market conditions and your conviction. If you can't comfortably make such a  trade then don't make it!

In my opinion, it's only worth trying to profit on the short side during bear markets when the market is overbought and there is strong evidence of complacency with weak bears throwing in the towel. This is characterized by a VIX in the low 20's, a string of low put/call ratios and AAII sentiment 2:1 bulls vs bears. In such instances, the risk/reward is favorable to make a bearish bet.  In the bear market of 2000-2002 we saw this happen in May of 2001 and March 2002. In the bear market of 2007-2009 we saw this happen in May of 2008. At the peak of this latest rally the above conditions were not met...some were almost met but not quite. As a result I didn't pull the bear trigger. That's fine. Again, protecting capital is the primary objective. The fact that we rolled over so soon also suggests that there's a decent chance we are in a situation similar to December 2008 or August 2010 whereby the roll over in the market was part of the LT bottoming process.

To play the intermediate term swings in the market allowing yourself to be a strong holder able to withstand the day to day noise, I believe that the best strategy is to purchase long dated deep in the money options with an amount of capital that you can afford to lose should you end up being wrong. No stops. By risking only a limited amount of capital, that in effect is your stop. This strategy is especially advantageous when betting on the downside. By using puts as opposed to shorting you will never be forced to cover your position if the price goes against you by a significant amount nor will the fear of "unlimited losses" make you unable to sleep at night and tempt you to make an emotional decision.  By using long dated deep in the money puts, you also don't suffer from the time decay that one would experience holding bear ETFs and short dated OTM puts which is the preferred choice of the  retail  schmucks who try to profit on the downside. When playing the bigger swing it's important to stick with your plan. Don't get tempted by ST market action taking profits too soon in the hopes of getting back in on a counter trend reaction...more often then not you will find yourself on the sidelines missing out.

It's a jungle out there. I'm hearing a lot of market veterans who have trade for over 30 years say that this is the toughest market they have ever seen. It doesn't have to be tough. You can simply not play and wait for things to settle down or wait for those really fat pitches.

Word on the street

There's two things I'm hearing a lot about. The first is the triangle formation in the chart and the second is the notion that the ECB will be end up having to print money to end the crisis once and for all. Let's focus on the second issue first because that's far more important.  I've been saying for a while that ultimately we need to see the entire restructuring of PIIGs debt before all is said and done. The cancer needs to be cut out from the system. For a while, European authorities were in denial about the crisis thinking the problem was one of a lack of confidence as opposed to the grim structural reality which is that these countries have dug themselves in a hole too deep. They figured if they took care of Greece confidence would be restored and all would be well. They tried to pay for the solution as cheaply as possible ...and they got what they payed for. As this crisis has been unfolding the market has been dragging Merkel and others by the collar kicking and screaming forcing them to take further action. It wasn't too long ago whereby a Greek default was considered out of the question and now we've esssentially seen it happen via the 50% haircut. Now the Germans are saying that money printing is out of the question. In fact, a few minutes ago on BNN I saw a quote from Merkel that said she believes the ECB acting as a last resort won't solve the crisis. If she was such as expert as to what will and what won't  solve the crisis why the fuck has she not solved it yet and why does it appear to be getting worse? Merkel has her head up her ass just like she did with Greece a couple months ago.  It's seems to me that it's either print or see messy defaults and a break up of the Euro zone.

As far as the market goes, we are finally starting to see a breakdown from the widely watched triangle which according to textbook t/a should have resulted in an upside breakout. Since everyone is a technician now a days, you can toss the textbook out the window. And who knows, maybe this is a downside head fake to foil the technicians. I wouldn't play that game of chicken though given that we are seeing bond yields blow out in Spain and France. One thing the bulls have in their favor is that the put/call ratio continues to be high day in and day out and the VIX is well above 30. This suggests that if we see the market roll over and make a run for the October lows, there's a good chance it will end up being part of the bottoming process as opposed to a new down leg. It could also mean that the short side is still too crowded and this dip we are seeing today is going to end up being a massive head fake. Either way, I'm still stepping aside. I didn't see enough sentiment indicators give me the green light to make a short bet and so if the market tanks I won't be on board. I don't have a problem with that unlike in early October when there was in fact enough sentiment indicators lining up to give the green light for a trading buy but I never pulled the trigger.

What I haven't liked about this rally since the recent bottom in October has been the high volatility and now the oil spike to $100. The last thing the global economy needs is oil back to $100. I couldn't give a fuck about seasonality and Santa Claus rallies, fundamentals and market action trump and neither suggest this rally from the October lows is the start of new bull run and so if you play the long side you're playing a game of chicken with the bears hoping to that they'll blink before you do. The problem with this game is that once the bears are shaken out the market will likely drop abruptly leaving you the risk of being trapped holding the bag. There's two ways bears tend to get shaken out 1)by a strong rally or 2) covering way too early on the first dip of a major downside move.  

It's been frustrating being on the sidelines for so long. I am however starting to see some emerging bottoming formations on a few small cap stocks I have my eye on that have attractive fundamentals. I'm in the process of making a short list of such stocks.

In these types of volatile, headline driven markets, protecting your capital is paramount. While it may seem likely that this rally from the October lows will fail, there's no telling if it will fail now or a few months from now and so if your betting on the downside you could easily see yourself get stopped out for losses because too many people were in the same trade. After all, the bear case regarding Europe is no a secret and because of that, I believe the bears have been their own worst enemy and the cause of their own frustration these past several weeks and not the "PPT".

Silvio che cazzo fai?

This translates to "Silvio what the fuck are you doing?" In today's National Post it showed a picture of 2 protesters from a Ukranian women's rights group in Rome holding up signs. One of them said this and the other said "Silvio stai scopandi L'Italia" which translates to "Silvio you're screwing Italy". I couldn't help but chuckle when I saw this but at the same time feel a bit sad. Being of Italian decent, I can't help but recognize the decline in the country of my ancestors. Italy's economy has been pretty crumby to say the least for the past several years even during times when the global economy was in expansion. Now it seems like they might be next in line at the barber shop to get a debt haircut. Oh dio.

My previous post did indeed help put things into perspective. I believe it's likely there will be a retest of the October lows in the coming months whether it's due to Europe or other reasons. But I also believe that until the chronic hedging stops (i.e the high put/call ratio), it's not worth making a bet on that outcome. Today's action doesn't change my opinion on this. High put/call ratios like we've been seeing doesn't guarantee there will be no major downside by any means.... nothing in this game is guaranteed....it's all about probabilities and risk/reward. It's just that in my experience, when you're in an uptrend as strong as the one we've been in since October, bear market rally or not, it usually doesn't end untill you see complacency in the options data i.e.  low put/call ratios and a VIX in the low 20s. If that doesn't turn out the be case this time, fair enough. I'll have no regrets if I miss out profiting from the downside because I didn't see what I needed to see to pull the trigger. Nor will I have been burned playing the game of chicken long side. Despite the severity of today's decline it doesn't really look too bad when you look at the chart now does it? The uptrend is still in tact and we could simply be consolidating before another push higher. But what today's decline does tell you is that the market is still headline driven and it's still broken. Bull markets don't behave like this. 

Look people, this market is dangerous for all players on either side of the market and I've been saying that for quite some time now. The only way to have captured today's downside was if you made a bearish bet before yesterday's close gambling that the after hours headlines would be negative. It could have just as well went the other way. The same thing goes for the upside. Most of the upside has been done via gap ups due to favorable headlines. The market is therefore forcing you to gamble at the end of the trading day to capture the big moves the following day. You typically either get instantly rewarded or your nuts chopped off the next morning via the gap. That's not much different that going to a roulette table and betting on red or black. I know not everyday has been like that but a lot of them have been and that's not my kind of market. I know I said I need to be more flexible but I'm not going to play a game that forces me to gamble in a casino-like way....sorry. I'll just remain in cash until things settle down or I see a really good ST edge. You know what? When I first started trading full time in December 2008  it was the same. The market was crazy volatile and I although I was somewhat sure there would be a retest of the November 2008 lows, I couldn't bring myself to bet on it because the market was too nuts and there was too many cross currents and not enough edges. I ended up making very few trades until the summer of 2009. 

Don't force it. Wait for your pitch. You don't have to trade every day, week or even month for that matter. The market is not going away. 

Remember Lester? Here's what he posted last night....no wonder the market is tanking lol!

I fucking give up.  I closed my two remaining IWM Puts near the close today.  They were Dec 66s and sold for 0.98 after paying 1.35 last week.  So this leaves me $200 from the $4000 that I started with in mid-August.  I have taken that $200 and bought a SPY Dec quarterly 133 Call for 1.84.  This will give me the whole month of Dec to catch the Santa rally. 

This guy is gold I tell you!

Who should you believe?

As you know, I've been dazed and confused about where the market and economy is going longer term because there's a strong case to be made for either a bullish or bearish resolution. We're at a major cross road here and if you take the wrong path you're either going to get hurt in a big way or miss out in a big way. It all hinges down to the reccession debate. In this post I'm going to flesh out all of the things running through my mind that is causing me such conflict. Hopefully this catharsis will help me get a better feel for what probably lies ahead. Some of this will sound repetitive given my recent posts.

Last weekend Hussman made a convincing case to support the case for a recession. Here's a crucial except from his lengthy commentary...

Since 1963, when the ECRI Weekly Leading Index growth rate has been below -5 and the ISM Purchasing Managers Index has been below 54, the economy has already been in recession 81% of the time, and the probability of recession within the next 13 weeks was 86%.

If in addition, the S&P 500 was below its level of 6 months earlier, the economy was already in recession 87% of the time, and the probability of recession within the next 13 weeks climbed to 93% (and then to 96% within 26 weeks). Under these conditions, once the PMI fell below 52, the probability of recession within 13 weeks climbed to 97%.

That simple set of conditions (WLI < -5, PMI < 52, SPX < 6 months earlier) has been seen in every postwar recession for which the data is available. Though we've seen recessions without a drop in the WLI much below -5, when a WLI below -7 has been coupled with a PMI below 52 and an S&P 500 below its level of 6 months earlier, the economy has been in recession within 13 weeks, 100% of the time. This is the combination, incidentally, that we observe today.

Now, here's some convincing points from James Stack that totally refute the reccession call

the four-week moving average of weekly jobless claims had hit a six-month low. How often has the economy fallen into recession after such a development? Trick question. It has never happened in 44 years of claims data, he said. The Index of Leading Economic Indicators just hit an all-time high. When has that occurred in the six months prior to or in the early stages of a recession? Never in the 52-year history of the LEI data.

So, you have Hussman arguing that there's a 100% chance of a reccesion according to historical data and Stack who says there's a 100% chance of no reccession according to a different set of historical data! lol! WTF!!!! Well, somebody is going to be wrong....obviously.

Do you see folks why I am so fucking frazzled? Ok, let's get back to the the ECRI recession call. I mentioned how I don't like the fact that they are so popular amongst the masses which in my experience makes it more likely that the guru in question will soon be wrong in a big way.  It's interesting to note that the previous 2 times the ECRI made official recession calls were in March 2001 and March 2008. In both those cases, leading indicators, coincident indicators and reported earnings had all already decidedly turned down from their peaks. That has not happened this time around with their call. Also, when ECRI made the previous 2 recession calls, the stock market had made its peak several months prior and was in a well established downtrend - undeniably in a bear market. Therefore, the ECRI was a little "late" in making their official recession calls from a market timing perspective in 2001 and 2008 (but in their defense, in the months leading to official recession call, ECRI was strongly warning about the negative things brewing in the economy).  This time around, with earnings still elevated, leading indicators still making new highs and the stock market not off it's highs as much relative to when the last 2 recession calls were made, could it be that ECRI is jumping the gun with their recession call?  And isn't it funny how bears love the ECRI now but didn't mention jack shit about ECRI's bullish calls in March of 2009 and November of 2010? In fact, the media mentioned fuck all when ECRI turned bullish. And where was Hussman when ECRI was bullish?  Did he make mention of this? Of course not. He was wallowing in his dogma. That's permabears for you folks and that's why you need to have a balanced approach when reading commentaries from these guys. It's still worth reading what smart guys like Hussman have to say though because they can provide facts and studies that can help you form objective opinions.

Aside from issues with ECRI's latest call, a couple of other things are making me suspicious of a recession and a big bear is forthcoming. I mentioned a couple weeks ago how dumb money thinks one is coming, in particular, a few of  my friends on facebook and the late night talk show hosts making jokes about the economy. You have consumer confidence plunging to early 2009 levels where historically it's a great time to buy LT  and again, all of this is happening in the face of still strong earnings that are poised to make all time highs this year which makes the gloom appear unjustified. If you look at the crash of 1987 and 1998 earnings were still strong and hadn't rolled over thus the crash was simply a severe correction in a bull market (or a short and sweet mini-bear market....whatever tickles your fancy) while many believed it was indeed the start of a big bear market.

The media both mainstreet and financial are quite sour and that bodes well for an eventual bullish resolution to this crisis and we never did see any signs of giddiness from them near the peak either. Sure, you had Wall street strategists bullish and equity inflows were coming in, but that's to be expected in a bull market and those inflows were just a drop in the bucket compared to the outflows that occurred from 2007-2009. And now, those inflows have been completely reversed and then some and so any kind of budding optimism has been completely undone. Bull market tops are usually characterized by giddiness and corporate greed and it's the unwinding of this greed that fuels the bear market that follows. We did not see such greed at the latest peak. The only case where a big bear market occurred under the above circumstance was in 1937 and admittedly, as I pointed out in a recent post, there some important similarities with today's conditions vs. those in 1937.

Lastly, if you look at how severely oversold the market got after the crash in August, the statistics matched what you see towards the end of bear market not the beginning of them and I mentioned  back in early August how we were as oversold as we were in October of 2008. That to me again gives me reason to believe this is just a severe correction and not a new big daddy bear.

Now, let's exam the bear case.  I have concerns aside from Hussman's work that concludes a recession is pretty much guaranteed. My instincts tell me that untill we see a complete restructing of all troubled PIIGs debt this market ain't out of the woods. This situation reminds of me of late 2007 and early 2008 when toxic MBS was really starting to wreck havok. I remember telling my co-worker at the time that in the end the government is going to end up buying all this toxic shit from banks before this is over and that's what ended up happening but not before the markets went down a lot more.  MBS was a cancer to the system just like PIIGs debt is and until this cancer is removed once and for all, at the very least I don't think this market is out of the woods and a major retracement of this latest rally at the least, is inevitable.  Bond markets for PIIGS are saying loud and clear that it does not end with Greece. The potential fallout from this European debt debacle could be just as serious if not worse than  the MBS meltdown. And this time around government authorities have their hands tied a lot more to intervene given already low interest rates and pressure to embrace austerity.

Next you have yield curves in the BRICs - the number one driver of the bull market still flat overall suggesting a serious slow down lies ahead for them. It's likely that they will end up having to cut rates but with oil back to the mid 90's, they may have their hands tied as inflation concerns will remain given that food and energy account for a lager portion of overall inflation compared to developed nations. It seems that the only way for easy monetary conditions to be possible for them  is  if there's a global downturn sharp enough to take the air out of commodities and that translates to lower stock prices.

A rather obscure but historically quite effective indicator that I keep tabs on is OEX option data. Unlike the traditional put/call ratio, the OEX put/call ratio is a smart money indicator, therefore a high put/call  ratios is bearish for the market and low ones are bullish. It doesn't always pinpoint major tops and bottoms to the exact day....it can be early upto a few months, but's effective in signaling an immanent change in  IT/LT market trends in the weeks ahead. It's worth paying attention to only when where there's a bullish or bearish extreme. Look at the chart below and you will see that when the market was close to making it's bear market bottom in March 2009 and during the aftermath of the flash crash, OEX option traders were aggressivly buying calls pushing the 10 DMA below 0.75. OEX traders then became quite bearish during the spring and early summer of 2011. The bearishness unwound only modestly after the crash in August and it's now deep into bear territory again.

Unlike what happened in the months following the flash crash of 2010, wherby OEX traders became aggressivly bullish, they only got so far as being less bearish for a while before going back to deep bearish territory which is where we stand now. This supports the thesis that the market isn't through with this deep correction/bear market. Would I bet the farm on this one indicator? No! There have been some false signals over the years (not evident on this chart) but this indicator clearly favors the bears and suggests at the very least a major retracement, if not a full retest or worse in going the occur in the months ahead.

Next, I want to mention Lester - the worst trader in the world.  I discovered this guy posting on blogs 3 years ago and I kept tabs on him because he is bar none, the worst trader I have ever seen. His major achievements include switching his 401K from equities to cash in November of 2008 and then blowing his entire $300,000+ IRA using option trades in about 18 months wherby practically every single trade he made was the wrong trade! He trades purely on impulse and emotion. Do you know what Lester did this year? He switched half of his 401K back into an SPX equity mutual fund in March when the SPX first hit 1300. Usually he panicks during sell-offs but this time around he actually doubled down on his bet by averaging down into equities about 2 months ago (at around 1200).  He then later went even more aggressive by switching half from the SPX fund to his company stock! This is not a good for the bulls medium/longer term! Bulls need him to flip flop and go back to cash but that's not going to happen until the market goes down in a big way and given Lester's track record that's likely going to happen! I realize you shouldn't base your investment thesis on just one man's behavior but I gotta tell you if I was forced to, I would pick this guy hands down. He is the absolute worst!

Finally, there's the action of the market itself. Although the market rally has been impressive with what still appears to be plenty of doubters via the frequently  high put/call ratio and only modest equity inflows, the rally has been done primarily via gap up behavior. Also, volatility is still high which is not the characteristic of a new sustainable advance coming out of a correction that's going to last several months and make new highs. Take a look at how the market behaved off the July 2009 bottom and the September 2010 bottom. It grinded higher with small but frequent up days temporarily interrupted with sharp but short dips which were few and far in between. That's classic bull market behavior. The upside we've seen so far has been erratic characterized by large gap up and gap down days because most of the movements in the market as of late has been happening after hours or before the bell driven by headlines. That tells me the market is still broken without a solid foundation of true buyers.  It's the chronic shorting/hedging that has been keeping it afloat but that can only go so far. Once the shorts eventually give up (as the always end up doing) the market will  be very vulnerable to an abrupt drop. Admittedly, this short squeezing could potentially last for several more weeks but it can just as well last for a few more days so you better be careful if you try to go long playing the game of chicken with these bagholders.  Look for the VIX to drop to the low 20's to signal  potential true bear capitulation.

So there you have it....a complete info dump from my brain as to my thoughts and observations about this market. I'm going to take some time to review what I just wrote and let it sink in. Hopefully this will help provide me a better understanding as to were this market is headed and what actions I need to take with my account which is still primarily in cash.

Trick or treat?

First off, I'm disgusted with myself. I'm one of the many chumps who missed this entire rally since the bottom in  early Oct. Prior to it I was noting that sentiment was showing extreme pessimism and although bulls had not gained any upside traction at the time it was just a matter of short time before they did. I know I said I would rather wait to see the dust settle and be a buyer early in the new uptrend (should it arise) and that would cause me to miss the bottom, but this was a ST trading opportunity that I missed and should have made a bet on....not a large one (because I have a strict rule of not committing large on top or bottom picking no matter how tempting) but a bet nontheless....something like a bull call spread. Given how oversold we were and the sentiment,  I knew the risk of a V shaped bottom was high whether it was a snap back dead cat bounce or the start of a new sustainable move up. Although I respected the possibility of a September 2008 type waterfall decline whereby oversold and pessimistic conditions were ignored, market conditions this time around were not nearly as bad as they were in late Sept 08  when earnings and credit conditions were in serious deterioration and the financial system was literally imploding. I realize a lot of this looks to be hindsight bias and perhaps it is but I think a lack of balls  to get out my comfort zone explains my mishap best.

Come December, it will be 3 years since I started trading full time (I have been trading "part time" for 9 prior to it). I've done pretty good so far and my success was almost all due to buying and holding individual stocks for months at time. No short term trading, no counter trend trading, no bottom/top  picking. When I was unsure or ST/IT bearish I would go to cash. I'm a large believer in playing the bigger trends and avoiding ST trading but there's usually an exception to a rule. I was too inflexible and not bold enough to get out of my comfort zone. It cost me a missed opportunity in this recent rally and also with TLT calls I was thinking about buying in early July right before the explosive bond rally. And it's not like I was going to risk a lot of money on these trades either....but even despite that I still didn't pull the trigger. Why? I think it's because I'm trying to protect my self confidence from taking a hit should I end up losing on these trades.My thinking was this - I was up pretty good on the year so why risk losing any of that with a non-standard trade? I was playing not to lose instead of playing to win and that's a no no.   Playing the market is a great way to learn about yourself, in particular, your weaknesses. Sooner or later they will be exposed.Back in March is said this


One thing the market will do is expose your weaknesses. If you are ignorant and make decisions based upon data the market doesn't care about or useless indicators, you will get punished. If you don't believe enough in yourself or your convictions you will get punished by not making nearly as much money as you should have or getting shaken out near the end of a dip/correction. If you believe too much in yourself and your convictions the market will eventually humble you for being greedy, stubbornly dogmatic or arrogant. If you're bitter/biased you will not see the market for what it is and you will get punished. If you are disorganized and reckless (don't have guidelines/rules, don't plan your trades) you will get punished. If you are emotional and make snap decisions you will get punished. 


My weakness has tended to be that I'm overly cautious and not confident enough in myself when I should be and it showed again. When I look back at my mistakes, in trading and in life, they have primarily been things I didn't do as opposed to things that I did do. Since I started trading full time, my losing trades have been few and when I did lose I lost small. Although that appears to be a good thing it's not neccessarily so because in my case, it reflects that I'm playing too tight i.e.  folding too many hands as I did with the TLT calls for example. So, despite that I've been doing well, I could have been doing even better..... significantly better if I had more confidence in myself and pulled the trigger more often.

I look at all the tremendously successfull people in the world and they had success by being bold. I need to be more bold - not reckless mind you...but bold...there's a fine line between the two.

Enough about me what about the market. Well, I'll leave it up to the experts and dogmatists to analyze in detail the big news out of the Europe regarding the increase to the EFSF and the 50% Greek haircut. I'll chime in quickly by saying "what about the rest of the PIGs?" I realize this criticism  isn't original but it's just painfully obvious to me given what the bond markets are pricing in, the rest of the PIGs will have to be given haircuts. I mentioned months ago that China would need to step in and help and they are willing. That's good  but what about the dark clowns brewing over China itself? And now we have oil back to the mid 90's which is going to make it difficult for rate cuts from the BRICs which I think is necessary. It's because of these issues I don't think we aren't quite out of the woods even if this relief rally ends up having legs.

Sentiment wise, only AAII is showing somewhat of excessive bullishness. NAAIM exposure has gone up to 40% equity exposure which is neutral sentiment wise indicating more room for the rally to carry on higher or for the market to at least stay afloat for a while. There was minuscule participation from retail via fund inflows and that's bullish and suggests the rally isn't in immanent danger of collapsing (however that could change quickly if we see a spike in inflows this week).

One thing that has stood out is the asinine put buying that has been going on for the past 2 months and even to this day. Despite the fact that the market has rallied 17% the put/call ratio never showed anything resembling mild optimism on any single day. It has been well above 1 most of the days and the lowest it ever got was the high 80's and low 90's a few days. This stubborn and reckless bearishness that the put/call ratio reflects, has been the culprit of this rally in my opinion.  The trading community shorted the rally repeatedly and as result have been clown raped for this group think. This is not the first time I have seen this behavior in the past 2 years. Even the technical types who trade mechanically have been getting murdered.  The so called "death cross" that was triggered in early August has resulted in death alright....for those who followed that signal and went short. The exact same whipsaw happened last summer as well.  Carl who runs the charting service I use decisionpoint.com, issued a bear market signal after the death cross was triggered and is now calling it a bull market again but only after the surge on Thursday. He got chopped up to bits with his mechanical methods. Let's just say I'm a not a fan of using such methods and end it at that.

So what to do now?  Trick or treat? With the market as ST overbought as it is, a pullback/consolidation appears quite likely. How people react to it will be key. If weak types buy the dip then look out below for the market will give a trick. If instead they stay on the sidelines and the asinine put buying continues the market will give a treat and we will probably see this make a run back to the highs of the year.  It's going to be difficult to see major downside traction if so many have their guard up. Ultimately, whether it's this year or next, I think there will be a major retracement of this rally. I'm in the process of hammering out a game plan given my outlook which could involve my typical small cap long plays using a market hedge. However, I feel I need to approach the market with fresh eyes and a clear head and I'm not quite at that point yet. I can call it a year here and walk away with a 22% gain for the year. That's not too shabby considering what's happened this year but I have to learn from recent mistake of playing not to lose instead of playing to win.


Happy Halloween everyone!

Dark days

I've make it no secret that I've been frustrated lately. I've been sidelined not only with the markets but also with the other game I love - soccer and sports in general. I've had this annoying lower abdomen/groin injury for 2 months.  A groin strain is the worst strain you can get because it fucking lingers and when just you think it's healed, as soon as you put it to the test with a hard sprint or 50/50 challenge against another player you realize that it's not and you're back to square 1.  This is  the 3rd time I've had a major groin injury. The first time it happened I was 14 and I was out of action for over a year - I hurt it quite bad whereby just coughing would cause pain.  The 2nd time was the spring of 2010 and it took 6 months to heal. The birth of my daughter that year counter acted the frustration. 

And now here I am again suffering for the 3rd time. Let me tell you some thing about groin injuries. When you first start feeling a bit of pain in that area STOP PLAYING! Also,  DO NOT attempt any rehab until the pain is completely gone because it will only aggravate it. Trust me on this. Only rest and time can heal it. I didn't seem to learn my lesson though this time around because I was so eager to play again.

Although bad luck had a part to do with I really have nobody to blame but myself for this injury. Although I always warm up before games, I don't stretch enough on a regular basis and strength train my abductor area and given how inflexible and injury prone I am, I should have been doing so. Also, I first started feeling the pain in June and if I had stopped playing then I would have been out for probably 2 weeks or so but I "played through the pain" until the point where it was unbearable and by doing so I made the injury a lot worse. 

This brings me to the occupy movements around the world. Although there are some valid reasons for protest, I get the sense that a lot of these people are whiners and complainers and should look in the mirror to see who's really to blame for their lack of success in life. This is going to sound very harsh but losers tend to  blame others, complain and have the "why me?" attitude when they fail. Winners persevere through tough times by learning from mistakes, working hard and believing in themselves. They take control over their destiny as much as they can. They don't mope around and hope politicians or others are going to solve their problems. I know there's been a lot of praise about Steve Jobs and what he has achieved but If you looked at what made him successful in life aside from his outside the box thinking, it was his attitude towards life.... it was a winner's attitude. If you haven't yet done so, go to youtube and search standford speech 2005 and listen to it. It's well worth the 15 minutes.

But here's the cold hard reality of it all. In a capitalistic society such as ours only a small minority are going to be winners while the rest wallow in mediocracy or less. If you do the things that most people are unable or not willing to do you'll maximize your odds of being  a winner....and those things tend to be difficult or unpleasant.

Dazed and Confused

The last few days I've been taking a step back to try and get a clear perspective on things. I've never had such a lack of conviction about where I think this market is headed as I do now. The conflicting cross currents are making my head spin out of control.  Ok where to begin...let's start off with the viagra induced boner run the market has been on. Is it just a bear market rally or was that the bottom and it's upward and onward from here? I've always believed the best rallies are the ones that don't give you much of a chance to get in without having to chase it and that's the kind of rally this has been. Unfortunatley though, often times bear market rallies look likes these types of moves if the majority of the advance has been done via a gap up and run and that's what happened here. Now, it's actually not uncommon to see the first "real" rally out of a bottom start with a gap up...that happened in March '09, July '09 and Sept '10....but after that intial gap and run day you don't see so many follow up gap and run days like we have been seeing.... that's indicative of a bear market rally behavior as weak shorts (and most shorts are indeed weak) cover one after another toppling each other over like dominos. To make a long story short, I think this is indeed a bear market rally and not the beginning of a new bull run and if a LT bottom was made, some sort of major retracement of it is eventually going to happen.

With active fund managers still very underweight equities (current NAAIM shows they are 0% net long)  there is still room for this market to run higher sentiment wise perhaps after the current ST overbought condition is cleared. If earnings continue to come in good, some sort of positive progress is made in Europe and Greece is given their next tranche of bailout funds, we could very well see fear of losing money turn to fear of being on the sidelines missing the boat. Plus you have positive Nov-May seasonality kicking in soon which would give these underweight managers yet another excuse to say "fuck it, I'm getting back in. I can't miss the boat and miss my chance to make up for losses before year end".  Ultimately, such naive emotional based buying would fall flat on it's face.

But forget about sentiment and the ST. What about LT....the thing I care about the most? Well, the issues in Europe have not been resoloved, ECRI has reconfirmed their recession call and China is slowing. It's quite possibile that we may not feel the impact of these potential storm clouds until q4 or q1 of 2012 and the market could stay afloat or go higher till then. You might say "isn't the market supposed to be forward looking?" To that I say yes but it can appear downright dumb and shortsighted at times. Just take a look at what happened in October of 2007 when even though it was crystal clear that subprime had imploded creating ripple effects in the economy and leading indicators had rolled over, the market rebounded from a sharp sell-off in August of that year to make an ALL TIME HIGH! Why? Because just like now, sentiment had become very negative and bears pressed. Then the fed came in and cuts rates. At the time, subprime had only impacted the financial institutions that were directly exposed and so earnings for the broad market were still good. There was this belief by many that subprime would be "contained"  and with the fed to the rescue,  fear of a collapse turned to fear of missing the rally.

So, if the bear case end up being played out, we may very well have to see "proof" in the form of a material decline in earnings before the market breaks down to a significant new lows because as of right now, the European debt crisis, the China slowdown and other storm clouds appear not to have impacted broad based earnings or guidance of future earnings in a material way. Therefore the market still looks "cheap" on a forward p/e basis especially with ultra low interest rates. Call the market stupid or whatever you want for being so naive but that's the way it can be....deal with it.

So the big question is obviously this. Are we going into a big recession or not? You know I have respect for the ECRI but I also don't like how they are becoming so popular these days....but as I said before...I'll give them the benefit of the doubt. I've been talking about the bear case lately so let's talk about the bull case.

To sum of the bull case from my perspective it would be this...the fears/concerns in the market are either not going to come to pass or will turn out to be a lot less damaging  than feared because the dumbest of the dumb money is quite negative about the economy. I've said here before many times that the dumbest of dumb money is the public and mainstreet media. In my opinion they are displaying massive negativity and despair that matches what you see at major market bottoms. On just that basis, it suggests that the recession either is not coming or will be rather muted and so the market has already discounted it and more. I said myself last week that to believe Europe would be handled well with minimal fallout, China to have a soft landing and ECRI to be wrong would mean you'd have to be wearing rose colored glasses and I stand by what I said. However, the thing that's driving me crazy is that there is such overwhealming negativity from the public and media that to bet alongside with the bears means that the dumbest of dumb money is going to be correct and I just can't fathom that happening because they never are. Let me give you some examples of what I'm seeing out there.

I think it was Wednesday night when by fluke I happened to be watching the Jay Leno show. He was making jokes about how bad the economy is. In fact, after doing some googling I noticed that the other talk show hosts like Conan are doing it too and it's been going on since at least September. In the past this has been an excellent LT contrary indicator. I remember these types of jokes in late 2008 and early 2009. I also remember Jay Leno making jokes about the economy in July of 2002 just days before the bear market bottom. Now, keep in mind, these types of anecdotal contrary indicators take time for them to bear fruit. Take for instance what happened near the July 2002 bottom when Jay Leno made jokes. After a big rebound the low was retested twice, once on October and then finally in March of 2003 before the new bull market began. Same thing in late 2008 when the jokes started coming....the market had not yet completed the bottoming process...the market actually still went down quite a bit more but in all of the above instances if you bought stocks and held for at least a year when the talk show hosts make their economy jokes, you would be laughing.....but for a different reason. It should also be noted that in July 2002, October 2008 and just recently, Warren Buffet had been making significant buys into the market. So you had 3 times in the recent past when dumb money was quite negative while one of the best investors of all time was bullish. So far Buffet is winning 2-0....although it should be noted Buffet had been a bit early.

In addition to the talk show indicator, I also noticed a couple of my friends on facebook who never bought a stock in their life say "looks like a reccession in comming".  My soon to be sister in law who never once talked to me about the market asked me how I have been doing given that the market crashed. When you have people who don't even know what p/e means show any kind of attention toward the market or the economy like this, in my experience this has told me the trend was in the late innings. And it's not just main street folks that are gloomy....even the seasoned trader types appear to be. Back in late September I made note of the "Death of Equities" rant I saw on realmoney.com by trader Alan Farley. You can also add me to this list since I've been gloomy as well (but certaintly not to the degree of permabears like Farley and the most others).

Then you have rock bottom consumer confidence numbers that match what we saw in March 2009 and the occupy movements around the globe. If this is not proof of extreme b main street pessimism then I don't know what is. I suppose you can look  at the occupy movements as  having the potential to be the beginning of massive upheaval and social unrest which in that case would suggest we haven't seen anything yet in terms of pessimism.....it  could indicate we're in for a period of sustained, structural pessimsim due to an economy that is terminally sick. While such a thing can certainly happen such a notion would be the complete opposite of the one in late 90's whereby many believed we had entered a "new era" of permanent prosperity.....we all know how that turned out.

The bull case can be summed up as follows. History shows over and over that you will do very well LT in the markets betting against the dumb money when they are are pessimistic as they are now....on some measures pessimism rivals what we saw at the March 2009 lows yet the market is well above those lows - a positive divergence. Meanwhile you have smart money i.e. Buffet, buying and you have bond yields collapsed to lows that were seen during the depths of 2008 which signals extreme risk aversion and therefore a  LT buy signal for equities.  It usually requires a leap of faith to buy in an environment like this because during such times it appears as though things are utterly hopeless but that's what you see at bottoms and that's why most people don't buy low. What ends up happening is that somehow someway things end up turning out much better than what people feared. Maybe it's because fear motivates authorities to find solutions for the issues that are concerning everyone and it motives people to work harder and smarter and some sort of new growth industry comes along as a result. Earnings are still high, corporate balance sheets are solid and there was no greed or reckless behavior near the latest top in the market which is what you typically see at the start of big bear markets. In fact, there was still quite a large amount of skepticism at the latest peak of the market and that to me made me believe that any downturn in the market would not be the start of a serious bear market.  Even if earnings where to decline somewhat, when you compare the alternatives (bonds, money markets) stocks still look compelling. Earnings would have to collapse like in 2008 for the case to be made that stocks have serious downside from here given how low interest rates are. As a result, the market may be able to handle any future negative setbacks in the global economy without making a major breakdown to new lows.

The bear case can be summed up as follows.  The situation in Europe is just getting started. We still have not yet seen all the bankruptcies, restructurings and haircuts that are likely to happen. To believe that the bankruptcy of Dexia will be the only one would be quite very naive. There will be more bankruptcies and they will be larger and like in 2008 they will catch people by surprise.  Prior to the market peak in the summer the yield curves of Emerging markets were inverted signalling a sharp slowdown in growth was immanent for these countries and since Emerging market growth was probably the largest driver of the bull market that began in 2009, the global economy is in big trouble. These economies are only just beginning  to show weakness and so the worst is yet to come.  China, one of the important saviors of 2008 will no longer be in a position of strength because they are showing signs of a debt hangover themselves. The reputable ECRI is confirming a recession will be unavoidable and betting against them in the past was not wise. All bearish sentiment can do at this point is result in bear market rallies. You can't just simply "sentiment your way" out of this. The condition is terminal and the authorities have ran out of the traditional monetary and fiscal bullets to respond to the coming crisis because rate are already at 0% and austerity in now embraced. We have finally reached the "endgame".  Analyst expectations for future earnings are still high and do not reflect the storm clouds brewing. Finally, the market is behaving like bear markets behave - huge volatility with a downward bias.

I think I made a good case for either side of the market and that's why I'm torn as to which side of the market is going to be proven right in the LT. One thing that I'm somewhat sure about is that if the bulls are going to be proven correct, it's still probably going to take more months of base building even if we saw the low last week. The " talk show host joke indicator" and the actions of Warren Buffet (who tends to be a bit early) confirm this. If authorities make a "decisive response" to the crisis, it would be naive to assume everything is going to be hunky dory immediately following it and naive to think that there will be no additional responses required and no more economic fallout. That too would keep a lid on the market's upside. We also likely need to see Emerging market countries slash rates and their yield curves to be upward sloping again before the market is ready for bull market take off.

I have respect for the bear case but only to the point where I'd be inclined to sell longs into strength and remain in cash and not to the point where I'm looking to go short on a longer term basis.  I have a hard time doing that because of where sentiment conditions are right now. But even if you believe the bulls will ultimately prevail, at this point in time, as I pointed out,  I don't believe you are in danger of missing the the next bull run by staying on the sidelines aside from ST market moves. Keep in mind though that the ST moves could end up being quite powerful (for example, after the bottom in July 2002 the market rebounded 25% before giving it all back). So, go ahead and try to catch them if you can but odds are you won't be able to as you'll likely get whipsawed or stopped out prematurely.  There will be a time when the market will be a lot easier to trade/invest in....and that time is not now IMO....at least not for me.

We need to respect the possibility for the "endgame" that bears talk about. I realize bears have been like the boy who cried wolf calling for it over and over throughout the past 15+ years to no avail, but if there was ever a time for it to happen it would be now when you have no potential boost from rate cuts (in developed nations), high government debt levels and little tolerance for increased spending and the type of bailouts we saw in 2008. It's now up to the BRICs to be the world's saviors. Will they or can they do it?

Let's try to keep an open mind about what's going to happen and the most important way to get clues about that is to observe the market itself and not just whether it goes up or down but the way it does so.
I've done a good job protecting gains this year by largely sidestepping the crash but I can't remain in cash forever. For 2 years my strategy was to simply buy and hold small cap stocks for months at a time. That's the way to go in bull markets but until I'm confident to believe the bull is back I  need to change strategies and adapt to these market conditions figuring out a way to make money with an edge because I can't stay in cash forever....but if it turns out I can't find an edge or have any serious doubts I'll remain in cash for as long as it takes.

Defense first offense second.