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.