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!
Monday, October 31, 2011
Wednesday, October 19, 2011
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.
Monday, October 17, 2011
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.
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.
Wednesday, October 12, 2011
Massive short squeeze
Well, it turned out that the bearish extreme in sentiment finally resulted in upside traction. We've seen the market do a 12% boner move from the bottom. The put/call ratio has shown absurd skepticism in the face of this rally which no doubt has helped fuel this move. Yesterday in particular it closed at 1.41 which is what you typically see when the market has been getting slammed. If we close out the day near current levels the market will be fully ST overbought. In the past few months the market has not been able to handle ST ob conditions well....the tell tale sign of a bear market.
I'm pretty frustrated and frazzled right now. Am I too bearish? Am I being too inflexible and should be looking to play these ST moves? It's not what has given me my success and I know forcing trades will backfire but I think I need to start getting involved more with the ST. I know, I know, I said this before but never did anything.
I'm pretty frustrated and frazzled right now. Am I too bearish? Am I being too inflexible and should be looking to play these ST moves? It's not what has given me my success and I know forcing trades will backfire but I think I need to start getting involved more with the ST. I know, I know, I said this before but never did anything.
Sunday, October 9, 2011
Stock Market Purgatory
First off let's talk sentiment. The latest NAAIM sentiment number released Thursday shows that active managers are now actually net short -3.5%. Since 2007 this net short exposure has only happened twice. You can see for yourself in the chart that I posted last week that when this has happened the market was at or very close to a ST bottom with the market eventually rallying about 10% from the low. However, you will also notice that the market was in bear mode the last 2 times it happened and the bottom only turned out to be temporary..
When the market broke 1100 last week and then reversed hard to the upside creating a "bear trap" and "key reversal day" I was quite skeptical about it. Normally, I like to see these kind of days to signal that a capitulation has taken place however this "bear trap" seemed too obvious and by reading the bear blogs out there I got the sense that shorts were covering not pressing into that break. As a result I don't think it was much of a trap at all and that to me says we haven't see the lows yet. I'm also noticing a lot of traders including bear types, are thinking that there's a good chance we've seen the low of the year. How can anyone be so confident about that when the market made 52 week lows just recently especially given the shoes that can still drop out there? It seems like people are trying to will the market into a 4th quarter rally....it usually doesn't work out that way though. Now I realize the market is entitled to a bounce given sentiment but I just do not like the action and apparent bottom picking from weak holders. Maby I'm over analyzing here but something just doesn't feel right. I think there's a very good chance the lows will be retested or broken before the year is over bounce or no bounce and that's what keeps me hesitant from trying to bottom pick.
I realize some of the data has been better than expected last week but doesn't change the overall downward trend in the economic indicators that's been in place since the early summer. Now sure, negativity is high and the market is ripe for some good news to give people the excuse to jump into the market for a 4th quarter rally but the fundamental headwinds are with the bears and in the IT/LT, that matters most and can overrule negative sentiment. We often saw the same thing happen on the upside when bullish sentiment appeared "too high" but the market simply kept chugging higher because earnings were exploding to the upside constantly beating analyst expectations.
There's chatter that the Euro authorities are working on a plan to recapitalize the banks. Even if that were to happen successfully we still have do deal with the potential faltering from China and other emerging market countires. Remember in June when I said that the yield curves were inverted for these countries signaling danger? Well, danger Will Robinson danger! The markets of Emerging markets have been spanked the most aside from European ones, and continue to act poorly. Emerging market growth was probably the largest driver of the bull market that began in March 2009 and so if these horses have stopped running...look out! . The inverted yield curves predicted a serious slowdown for the BRICS and so far we are seeing only early signs of it which means there's plenty of room for more deceleration in the months to come. Some are saying the market has already discounted the bad news. Really? How can you be so sure when fresh 52 week lows just recently made? The truth is these people are hoping the market has discounted all the bad news.
We are just starting to see the economy roll over with the reputable ECRI who called the last 2 recessions and recoveries correctly, on record calling for a new recession. With earnings and margins at record highs there's plenty of room for disappointments. The bulls need ECRI to be wrong, Europe to be handled well with minimal economic fallout, China and emerging markets cut rates and have soft landings, political bickering to stop and austerity toned down. That's a mighty tall order. Do you really want to stick your neck out here and assume that's what's going to happen? You really have to be wearing rose colored glasses to think so. That doesn't mean can't see big rallies when the market gets oversold and bears press but I think that's all we'll be able to see for a while.
I sure hope I'm wrong folks and I hope my negativity marks a LT bottom. Make a fool out me Mr. Market because I don't want to see more misery and hard ship. I'll play the bear side if that's what I have to do to make money but I will only do so "intelligently". I can't justify opening a bearish bet on the market given where sentiment conditions are now but I can't justify a bullish one (even for a trade) given the roll over in fundamentals with shitty market action because in such a situation it's quite possible to see the market go down even more in spite of negative sentiment. That puts me in frustratingly in stock market purgatory as I remain mostly in cash.
When the market broke 1100 last week and then reversed hard to the upside creating a "bear trap" and "key reversal day" I was quite skeptical about it. Normally, I like to see these kind of days to signal that a capitulation has taken place however this "bear trap" seemed too obvious and by reading the bear blogs out there I got the sense that shorts were covering not pressing into that break. As a result I don't think it was much of a trap at all and that to me says we haven't see the lows yet. I'm also noticing a lot of traders including bear types, are thinking that there's a good chance we've seen the low of the year. How can anyone be so confident about that when the market made 52 week lows just recently especially given the shoes that can still drop out there? It seems like people are trying to will the market into a 4th quarter rally....it usually doesn't work out that way though. Now I realize the market is entitled to a bounce given sentiment but I just do not like the action and apparent bottom picking from weak holders. Maby I'm over analyzing here but something just doesn't feel right. I think there's a very good chance the lows will be retested or broken before the year is over bounce or no bounce and that's what keeps me hesitant from trying to bottom pick.
I realize some of the data has been better than expected last week but doesn't change the overall downward trend in the economic indicators that's been in place since the early summer. Now sure, negativity is high and the market is ripe for some good news to give people the excuse to jump into the market for a 4th quarter rally but the fundamental headwinds are with the bears and in the IT/LT, that matters most and can overrule negative sentiment. We often saw the same thing happen on the upside when bullish sentiment appeared "too high" but the market simply kept chugging higher because earnings were exploding to the upside constantly beating analyst expectations.
There's chatter that the Euro authorities are working on a plan to recapitalize the banks. Even if that were to happen successfully we still have do deal with the potential faltering from China and other emerging market countires. Remember in June when I said that the yield curves were inverted for these countries signaling danger? Well, danger Will Robinson danger! The markets of Emerging markets have been spanked the most aside from European ones, and continue to act poorly. Emerging market growth was probably the largest driver of the bull market that began in March 2009 and so if these horses have stopped running...look out! . The inverted yield curves predicted a serious slowdown for the BRICS and so far we are seeing only early signs of it which means there's plenty of room for more deceleration in the months to come. Some are saying the market has already discounted the bad news. Really? How can you be so sure when fresh 52 week lows just recently made? The truth is these people are hoping the market has discounted all the bad news.
We are just starting to see the economy roll over with the reputable ECRI who called the last 2 recessions and recoveries correctly, on record calling for a new recession. With earnings and margins at record highs there's plenty of room for disappointments. The bulls need ECRI to be wrong, Europe to be handled well with minimal economic fallout, China and emerging markets cut rates and have soft landings, political bickering to stop and austerity toned down. That's a mighty tall order. Do you really want to stick your neck out here and assume that's what's going to happen? You really have to be wearing rose colored glasses to think so. That doesn't mean can't see big rallies when the market gets oversold and bears press but I think that's all we'll be able to see for a while.
I sure hope I'm wrong folks and I hope my negativity marks a LT bottom. Make a fool out me Mr. Market because I don't want to see more misery and hard ship. I'll play the bear side if that's what I have to do to make money but I will only do so "intelligently". I can't justify opening a bearish bet on the market given where sentiment conditions are now but I can't justify a bullish one (even for a trade) given the roll over in fundamentals with shitty market action because in such a situation it's quite possible to see the market go down even more in spite of negative sentiment. That puts me in frustratingly in stock market purgatory as I remain mostly in cash.
Tuesday, October 4, 2011
Trying to figure it all out
When I look at what's happening today it makes me wonder if there was ever a time when we saw something similar in the past. If we're indeed heading into a recession we have to assume that there's still significant downside to the market. If this happens it would be the first time in a long, long time that a new recession and bear market had begun when consumer confidence and the mood in general was still one of pessimism at the peak of a bull market. Was there ever a past precedent? I didn't think there was but perhaps I'm wrong. The best historical similarity could be the recession and bear market of 1937-1938. Prior to it, the market had been enjoying a powerful cyclical bull market from the depths of the 1929-1932 collapse. During this recovery, profits had recovered back to pre-depression levels much like what has happened now. However, unemployment was still quite high dropping moderately from the depression peak of 25% to 15% before the market peaked and the recession of 1937-1938 began which was accompanied by a drop of about 47% in the Dow before hitting bottom.
With 15% unemployment at the market peak in 1937, I would speculate that there was probably still a general sense of pessimism from main street. Could the same turn of events be happening again? Well, history doesn't repeat but it can rhyme. The main culprit for the 1937-38 recession was arguable but it coincided with significant spending cuts in the US to balance the budget and an increase in bank reserve requirements. Fast forward to today and we have the entire world embracing government austerity. It's argued by many that back then the government had pulled the economy off life support too early and as a result the economy went sick again as it had not fully recovered from the damage done by the 1929-1932 collapse.
With 15% unemployment at the market peak in 1937, I would speculate that there was probably still a general sense of pessimism from main street. Could the same turn of events be happening again? Well, history doesn't repeat but it can rhyme. The main culprit for the 1937-38 recession was arguable but it coincided with significant spending cuts in the US to balance the budget and an increase in bank reserve requirements. Fast forward to today and we have the entire world embracing government austerity. It's argued by many that back then the government had pulled the economy off life support too early and as a result the economy went sick again as it had not fully recovered from the damage done by the 1929-1932 collapse.
Whatever the real reason for the downturn of 1937-1938 what it proves is that it may be indeed possible to see a recession and big bear market when the public was still feeling sour just prior to it....I say maybe because we didn't have hard data like consumer confidence numbers to verify this and so I used the high unemployment rate at the time as a proxy. Why did contrarian analysis fail? Well, first of all, contrarian theory offers no guarantees, it just gives you an edge just like how being dealt pocket aces gives you an edge but no guarantee you will win....sometimes you have to fold aces to make the correct play. Secondly, contrarian analysis suggested there was potential for further advances since there was still plenty of pessimism to unwind, but that potential went unfulfilled because of policy errors and/or an underlying economy that was still sick and fragile.
Here's what the 1937-38 bear looked like
Here's what the 1937-38 bear looked like
Notice that this bear market did most of the damage in a straight line down fashion without any significant bear market rallies. It was basically 3.5 months of destruction, a brief respite and then a final leg down. It was a short but very painful bear. Do not rule out something like this happening. No two historical charts are alike so forget about thinking that a tit for tat reply of 1937-1938 will happen...all I'm saying is that when the fundamental tide turns for the worse and one thing goes wrong after another you can see a sickening slide in the market that catches even the bears off guard. That's what happened in the fall of 2008 as well.
What about the motto of this blog? At this point how would the market make fools of as many people as possible? There's two ways. 1) The market makes a LT bottom around current levels, we avoid a global recession (or it's very minor) and everything goes right in Europe or 2) the market just keeps sliding and sliding like in 1937-38 and we get no "4th quarter rally" that people are starting to chatter about while bears don't really make nearly as much as they should have as they cover shorts far too early, not making up for the losses they sustained over the past 2 years shorting the market in vain.
What about the motto of this blog? At this point how would the market make fools of as many people as possible? There's two ways. 1) The market makes a LT bottom around current levels, we avoid a global recession (or it's very minor) and everything goes right in Europe or 2) the market just keeps sliding and sliding like in 1937-38 and we get no "4th quarter rally" that people are starting to chatter about while bears don't really make nearly as much as they should have as they cover shorts far too early, not making up for the losses they sustained over the past 2 years shorting the market in vain.
Whatever the case may be, I for one am not going to touch this market until I see a favorable risk/reward set up. I refuse to chase the short side with the market as compressed as it is even though I know we could very well go down a lot more and I'm not going to go long at a fresh 52 week low either especially when the fundamental tide has just turned for the worse only a few months ago, there's continued bickering in Washington and in Europe and there's unresolved issues that pose a major systematic shock if not handled correctly which let's face it, may very well not turn out to be the case given all the clownery (if there's such a word) in Europe
It may turn out to be that I will remain mainly in cash for several months....who knows. If I don't like my starting hand I will fold it over and over and over for as long as it takes. I will not force trades nor will I play the intraday game of chicken with other traders. I don't give a rats ass if I miss the bottom or miss out on a continued crash. I've harvested nice profits over the past soon to be 3 years by being disciplined and patiently awaiting proper set ups and I'm not about to go squandering them chasing sub par set ups for the sake of trying to grow my account....I learned the hard way several years ago that this will backfire more often than not.
I'll end off by saying this....keep an open mind to the possibilities out there. It's easy to listen to the permabears when the market is bad and it's easy to listen to permabulls when the market is good. If all you do is listen to one or the other you will not see the market objectivity and get burned at major turning points from bull to bear markets or vice versa. I know for a fact tons of retail got burned worshiping the permabears over the past few years and now that the market has finally turned they don't have much money left to capitalize. I also realize that I've done a complete 180 turn from just a few months ago but that's what you have to do sometimes...you have to be willing to do a 180 turn from a long held belief in the market immediately if the evidence suggests so. Leave your pride and ego aside.
It may turn out to be that I will remain mainly in cash for several months....who knows. If I don't like my starting hand I will fold it over and over and over for as long as it takes. I will not force trades nor will I play the intraday game of chicken with other traders. I don't give a rats ass if I miss the bottom or miss out on a continued crash. I've harvested nice profits over the past soon to be 3 years by being disciplined and patiently awaiting proper set ups and I'm not about to go squandering them chasing sub par set ups for the sake of trying to grow my account....I learned the hard way several years ago that this will backfire more often than not.
I'll end off by saying this....keep an open mind to the possibilities out there. It's easy to listen to the permabears when the market is bad and it's easy to listen to permabulls when the market is good. If all you do is listen to one or the other you will not see the market objectivity and get burned at major turning points from bull to bear markets or vice versa. I know for a fact tons of retail got burned worshiping the permabears over the past few years and now that the market has finally turned they don't have much money left to capitalize. I also realize that I've done a complete 180 turn from just a few months ago but that's what you have to do sometimes...you have to be willing to do a 180 turn from a long held belief in the market immediately if the evidence suggests so. Leave your pride and ego aside.
Monday, October 3, 2011
Weekend Ramblings
In case you haven't heard yet, ECRI is now on record calling a recession. Check out the interview on cnbc here. I've said it before that these guys have a great track record and the market has certainty been acting as if were are on the way towards a recession. I've noticed the popularity of ECRI has soared. When I first discovered them 10 years ago hardly anyone knew about them and they certainly weren't making all of these TV appearances like now. One thing I've learned over the years is that when a guru becomes popular with the financial media they are on the verge of going from sage to goat. I'm not so sure if ECRI has reached this point and I'm willing to give them the benefit of the doubt with their latest call, but I'd feel a lot more confident in their call if they weren't so damn popular now a days. Anyhow, given the behavior of the markets which are one push away from making new lows, given the rise in credit spreads across the board, given the deterioration in economic gauges and now given the recession call from a firm who correctly foretasted the last 2 recessions, at the very least you have to respect the bear case if not embrace it.
The bear market playbook calls for a trading approach on both sides of the market as opposed to a long only buy and hold investing approach that's optimal in bull markets. The psychology of bear market cycles goes from despair to hope and back to despair over and over. When despair becomes acute, bears press and the market gets oversold, some sort of positive news will come along to trigger a rebound as hope emerges that the "worst is over", "the market has discounted the worst" or whatever. Then of course, that hope turns out to be false and the market heads down again making new lows. Despair, hope, despair, hope over and over until you reach the point where most people given up on all hope and that's when the bottom arrives.
In bear markets I personally like to focus mainly on index trades using long dated deep in the money options. Right now, however, neither side of the market is appealing to me. Despite the likelyhood of a new reccession and new bear market, establishing a bearish bet when the VIX is over 40 and sentiment showing multiple bearish extremes is piggish and not what I call a "sweet spot opportunity" that I look to play. We could very well be at one of those points where despair is acute and we are overdue for a "hope rally" but because the market is not yet fully ST oversold, showing no signs of bullish traction whatsoever and is one push away from making new lows, the long side is not appealing either - you must respect the primary trend in this case and that trend is down. So, in conclusion this argues for staying in cash as neither side of the market is appealing.
Let's talk bigger picture now. If the bull market we've had since 2009 was just one big economic dead cat bounce and we've reached the end game where no more or little can be done by authorities to save the economy then you better watch out because it's going to get really nasty. I sure hope that's not the case and I truly hope that all my bearish talk of late proves to be the ultimate contrary indicator.... I honestly do. I don't wish to see more misery and hardship. As a trader you need to able to play both sides of the market and not be biased towards one side but when you play the short side on an IT/LT basis you are rooting for bad news and profiting from the demise of others. That takes a toll on you....unless you are a miserable SOB who's happy to see more people become miserable too.
Be careful out there no matter what side of the market you are playing. I'm still standing aside.
The bear market playbook calls for a trading approach on both sides of the market as opposed to a long only buy and hold investing approach that's optimal in bull markets. The psychology of bear market cycles goes from despair to hope and back to despair over and over. When despair becomes acute, bears press and the market gets oversold, some sort of positive news will come along to trigger a rebound as hope emerges that the "worst is over", "the market has discounted the worst" or whatever. Then of course, that hope turns out to be false and the market heads down again making new lows. Despair, hope, despair, hope over and over until you reach the point where most people given up on all hope and that's when the bottom arrives.
In bear markets I personally like to focus mainly on index trades using long dated deep in the money options. Right now, however, neither side of the market is appealing to me. Despite the likelyhood of a new reccession and new bear market, establishing a bearish bet when the VIX is over 40 and sentiment showing multiple bearish extremes is piggish and not what I call a "sweet spot opportunity" that I look to play. We could very well be at one of those points where despair is acute and we are overdue for a "hope rally" but because the market is not yet fully ST oversold, showing no signs of bullish traction whatsoever and is one push away from making new lows, the long side is not appealing either - you must respect the primary trend in this case and that trend is down. So, in conclusion this argues for staying in cash as neither side of the market is appealing.
Let's talk bigger picture now. If the bull market we've had since 2009 was just one big economic dead cat bounce and we've reached the end game where no more or little can be done by authorities to save the economy then you better watch out because it's going to get really nasty. I sure hope that's not the case and I truly hope that all my bearish talk of late proves to be the ultimate contrary indicator.... I honestly do. I don't wish to see more misery and hardship. As a trader you need to able to play both sides of the market and not be biased towards one side but when you play the short side on an IT/LT basis you are rooting for bad news and profiting from the demise of others. That takes a toll on you....unless you are a miserable SOB who's happy to see more people become miserable too.
Be careful out there no matter what side of the market you are playing. I'm still standing aside.
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