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?