Mario "Ivan" Draghi says "I must break you" to the bears

Whatever he hits...he destroys!  Ivan Draghi laid the smack down on the bears Thursday and Friday with his "whatever it takes to save the Euro" comment. After Thursday's morning pop, I'm sure a lot traders shorted it thinking "what a bullshit rally this is" and now after today they are being carried out on a stretcher. Like the last 2 summers, the market is extremely headline driven and headlines of importance are those that come out of Europe and since Europe opens before our markets, there is a tendency for large gaps. So, if you want to trade the ST wiggles successfully, you have to be willing to hold overnight positions gambling  hoping that the morning headlines will be favorable to you. The "buy the dips" and "sell the rips" strategy would have been a winner for the past couple of months assuming you would scale into positions not blowing your load on the first dip or rip.

I want to take more of a trader approach to the market at this point. For me that generally means trading the 1-4 week moves in the market but I've been finding that the market has been moving too quickly for me at the turning points. I would have to be forced to pick tops and bottoms, although I suppose that can be mitigated by scaling. I'm also having a problem with conflicting indicators which give me the case of "analysis paralysis". I need to simplify things and just pull the damn trigger. For instance, twice now I failed to pull the trigger on SDS weekly puts.  Last Thursday and again this Wednesday I had them on my radar. I wanted to see how the market would open the following day before pulling the trigger but the market had gaped up big and so the opportunity was lost. Had I attempted to bottom pick - which I would have nailed perfectly - I would have had 200-400% winners in just 1-2 days. Mind you, I would have bet quite small on such risky trades but I would have won instead of just sitting on my hands doing nothing. Doing nothing is what I've been doing for a quite some time and I'm tired of it. I realize though that trading for the sake of trading will usually backfire and I won't do that but for fuck sakes I need to just pull the fucking trigger sometimes and break out of my shell.  There will come a time when my classic "buy and hold" strategy will work again but I don't think that time is now. I'm sure there are some stocks out there that will turn out to be good buy and holds (and I believe my position in hwo.to is one of them) but until bull market conditions return, buying and holding is not the optimal strategy.  Having said that though, I'm not going to resort to daytrading either. To me that's as close to pure gambling as it gets. I'm sure there's some profitable daytraders out there but to me , I see it as far too random.

I could of course, continue to do nothing this summer and wait for the smoke to clear just like I did in the summers of 2010 and 2011 but I want to do better this time. Also, unlike those last 2 years, I don't have a sizeable gain for the year banked which made it easier to just sit and wait. Again, I realize the danger in trying to make something out of nothing so I need to make sure I only play the premium hands...but I need to play the fucking hand when it's dealt and not hesitate so much because in this market if you blink, your opportunity is gone. 

On the sentiment front, once again AAII showed a dominance of bears over bulls while NAAIM and the Rydex ratio are conflicting showing complacency. I mentioned last week, that despite the complacent conditions of other indicators, this extreme bearish AAII reading prevented me from making an IT downside bet. I was wondering how this confliction would be resolved and low and behold the AAII reading ended up signalling correctly that there was indeed too many bears. Perhaps though, this will only result in ST strength (which we now got) which will clear the way for a larger move down later. Another thing that prevented me from making an IT downside bet was the persistent strength in gov't bonds.  ST/IT tops tend to be proceeded by some sort of sell-off in bonds...it doesn't have to be huge....but at least something. Well, we finally got that today although it's a rather small sell-off given the move up they had.

On the fundamentals front, there's some troubling signs in earnings. This earnings season has not been that great. Remember, in the end its all about earnings...that's all that counts. This  article does a good job in highlighting the concerns. We've haven't seen the threat of earnings deceleration like this since the start of the bull market. One positive way to spin this is that expectations for Q3 earnings have been significantly reduced which makes it easier for upside surprises but I would counter that by saying you could see a situation where expectations are correctly lowered but not not lowered enough. Once there's a turning point in the economy, analysts tend to over or under estimate the new trend. I remember in late 2008 bears saying how foolish analysts were in their expectations for a significant rebound in 2009 earnings...well...it turns out they were right to expect a rebound but they weren't optimistic enough! So, it could turn out the be case that analysts are not downgrading earnings nearly enough  if the economy has indeed tipped towards a recession. Of course, if they are wrong and Q2 just turns out to be a slow patch then you will see a rip roaring rally in the last few months of the year...again. 

The" R word" is back

Here we go again. In the past couple of weeks I've noticed the "R word" being used quite a bit in the financial media and by that I'm referring to the word "recession". Talk about dejavu...again! Remember the double dip fears we had in 2010 and then again in 2011? Those turned out to be false and now here we are for the 3rd straight year with summertime recession chatter. You shouldn't however be automatically dismissive of these chicken littles just because they were wrong twice in a row; just like how you shouldn't automatically embrace the views of those who have been right for a while (think Roubini and Whitney in 2009 like I warned about back then).

This morning Spain announced a 3 month short selling ban on all stocks. Historically short selling bans result in even further declines perhaps because it removes liquidity and signals desperation. I don't really care about the whys, I just care about the whats as in what are the results. Remember the short ban on US financials on September 18, 2008? It was followed by a 2 day pop and then disaster for the market especially financials. The was also a short sale ban in September 1931 and what followed was not good for longs either. But, if you also recall, there was a short sale ban of financial stocks in Europe last August and timing wise, it was not too bad a time to go long European equities (only of high quality countries like Germany) intermediate term. That ban was followed by a pop and then a lower lower in September which was significant (about 10% lower) but not severe and then a big multi-month rally took hold. In every case though ,a short selling ban didn't mark the final bottom of the market in question and so I doubt very much that the final bottom in Spain has been reached and perhaps that applies to all of Europe as well even if there's a big ST pop.

During the past 2 summers the markets were what I would technically consider bear markets (albiet small and short lived ones) because the market behaved like how bears do - downwards/sideways trend with high volatility whereby overbought conditions are resolved poorly. We've been in the same condition since May. Overbought conditions have been rejected easily but on the flip side so are oversold conditions so that's the good news which suggest we may end up being in a "sideways, mini-bear" like the last 2 summers as opposed to full blown bear. But I wouldn't get too comfortable with with that notion just yet.  

As far as conditions are right now, what's strange is that despite the market having been strong in the past couple weeks,  AAII sentiment was 2:1 bears vs bulls which is what you normally see after the market has had a significant decline and is near a ST or IT low. On a stand alone basis, this reading suggests we're not ready to go down big just yet and that the rally has more juice in it. Maybe that's going to end up still being the case but most other sentiment indicators, as I pointed out before, are in the opposite condition of what AAII is and do in fact suggest the market is vulnerable to at least a significant pullback.

That AAII reading really psyched me out and prevented me from making the bearish bet I have in mind making. I realize that this AAII  reading could very well end up being a red herring given the condition of the other indicators, but I simply refuse to make a bearish bet with 2:1 bears vs bulls because you'd be a fool so many times in the past if you did so. Perhaps my pickiness will cause me to me miss out capitalizing on the downside.  I have to admit,  I'm a bit pissed off that I missed out on the dip we saw today. When you miss out on a trade it's tempting to want to make a "revenge" trade but this is what the often sadistic Mr. Market wants you to do. He wants you to make hasty, emotionally charged decisions. He wants you to "reach in" to grab the money so that he can give your hand a hard slap and if you overdue do it, chop it right off.

As I type this the market is making a comeback and has erased about half the intraday losses. If you're a bear who's been betting on the big downside break you're probably swearing at your computer pulling out your hair. Again, this is what Mr. Market, the tormentor likes to do. He will make sure that during any major move up or down, the least amount of people are on board to profit from it and so that means plenty of headfake shakeouts. He will often push your convictions to the very limit and beyond.

Summer doldrums

I don't like what I'm seeing here. Friday's bounce not withstanding, we've had a market that has been sliding relentlessly in drip, drop fashion (bear market action) and the disturbing thing about it is that, overall, the key sentiment indicators have remained stubbornly too bullish. The Rydex ratio, which I have been noting for weeks is still too complacent and  became even more complacent as these traders have bought the recent dip. I don't recall a time where these guys have been proven right doing that (although they can be right for a while). The Rydex ratio is now at a level that is outright bearish- it's as low as it was near previous major tops in the past few years.  I know I shouldn't be obsessed about just one indicator especially if most others are giving opposite signals but they aren't. NAAIM barely budged from last weeks reading of 63% net long. AAII sentiment didn't change much either, although it's at neutral. Meanwhile the VIX only got as high at 18 and change during the lows of the sell-off. The only thing that showed wall of worry behavior was the put/call ratio which was a bit on the high side. Overall though, the ST sentiment indicators showed complacency since the market peaked early in the month. I read an article from Hulbert that said insider selling has ramped to dangerous levels as well recently.

I haven't felt this negative about the market's ST/IT prospects since June of last year. I don't know if we'll get the same degree of weakness that followed then, but I'm reasonably sure there will be something significant and I expect to see June's lows retested or broken. We can certaintly bounce a bit more for the next week or 2 but the bottom line is that I think there's unfinished business to the downside. If we get ST overbought again, I intend to make a play on the downside.

I've been heavily in cash (60%) as a defensive measure for a while now, but I'm becoming uncomfortable with this strategy. Given the negative ST/IT conditions I see, it's no longer good enough for me to be in cash like this. Although I will be in good position to capitalize on opportunities should the market have a significant decline, I'd most likely see losses in my core positions in the interim. I need to do better than that. I want to actually thrive if we get a drop and that means getting net short which is why I'm hoping there is some sort of a snap back rally in the next week or so.

Having said all this, there are some things that are potentially encouraging longer term. We are seeing more rate cuts across the board now with Emerging Markets countries with South Korea cutting too. If these rate cuts continue, it will put the global markets in a condition of loose monetary policy which historically has coincided with strong LT returns for equities. However, we need to see more easing and it takes time for monetary policy to gain traction. There also probably needs to be a fiscal push as well. In in interim, we can't be complacent about the weakness we are seeing overseas in China and Europe which now may be starting to  impact the earnings of North American Companies, in particular, tech companies.

It's been a rather frustrating year for me so far. I'm up for the year but only about 5%.  My largest holding hwo.to has pulled back quite a bit while I have taken a beating in fmc.to but my holding in the latter is quite small. I have given my "starter" position in fmc.to as much "wiggle" room as I'm going to give it and I'm now considering pulling the plug on it. Mind you, the stock could go to 0 and I wouldn't be hurt all that bad but as a matter of discipline I have to pull the plug at some point when I'm wrong and I have been. Oh sure, it could turn around the moment I sell but you can't think like that. You have to draw a line at some point. My fate largely depends on hwo.to right now which I'm a strong holder of and can be given my large cash position and my avg cost in the stock. The pull back it has had looks to be profit taking after a big run (along with some general market weakness of course) as opposed to a deterioration in the company's fundamentals. If anything, the fundies are getting even better after my email exchange with the CEO (yes I realize the potential  for bias).

Since 2009 I have been using a buy and hold approach with illiquid small/micro caps like hwo.to. which I believed were undervalued, had explosive potential but were overlooked. I have done quite well dong this but it hasn't been a bed of roses. I tend to have periods where I see solid gains for a 1-3 week periods, followed by nothingness or marginal to moderate drawdowns for several weeks. Dealing with the latter can at times be excruciating but you have to go through it because if you try to get too cute trading in and out you run the high risk of missing the explosive gains when the come. You simply need to have the conviction to stick with your position assuming that you have good reasons to have such conviction. You have the fight the impulse to make hasty trades as you watch the day to day fluctuations.

In the past, when IT general market conditions became too concerning I reduced or eliminated my long holdings and remained largely in cash. I've done it this year and in the summers of 2010 and 2011. I would have done better though  if had hedged my positions instead using index shorts (puts on index ETFs is my preferred choice). I would have done even better still if I took a tactical trading approach with the broad market capturing the ST rallies and declines when it's in "correction mode", although I admit that a lot of times the moves in the market during such times were too random and gap happy to do so intelligently. The bottom line is that I should have done more....I need to do more. I need to get out my 1 trick pony routine especially when macro conditions make a turn for the worse because I know my existing strategy won't work nearly well as buying and holding is only successful in bull markets.

There are signs that macro conditions have indeed turned for the worse but the same could have been said this time last year and the year before and they turned out only to be soft patches. We can't blindly assume that's gonna be the case again though. As usual I will defer to the facts and the indicators.

Still at least one more downside scare left

The market is in a strange place right now. On the one hand, there's plenty of indications that longer term, the market is in position to go substantially higher. Look at the move bonds have had both in the short and long term and how pitiful yields are on an absolute and relative basis (i.e. vs earnings yield of stocks), look at the behavior of long term equity fund flows, look at consumer sentiment, talk to your neighbors about how they feel about the economy and the stock market. All of the above suggests that pessimism is very high - that there's a lot of people on the sidelines, the same people whom by the way, are the dumb money by which history shows over and over are pessimistic/scared near major market lows and optimistic/greedy near major tops. But here's the thing though, these contrary indicators pertain to the long term - they will do you no good in timing the ST moves in the market. Which brings me to the ST/IT. I see some troubling signs.

First, I'm noticing the technically inclined types have turned bullish, you know, the ones that trade based upon momentum indicators, breakouts of "key resistance levels" or moving averages, ect. In the past 2 summers, I've seen such folks turn bullish after a bounce and it ended up marking a ST top or close to one. The "Rev Shark" over at realmoney.com for example is bullish.  These people are weak holders easily shaken out and so when you have a lot of these butt sniffer types long at the same time, the market is vulnerable to a sharp drop as they tend to stampede for the exits at the first hint of weakness. I'm not sure if Friday was the beginning of this stampede but I'm reasonably sure that you'll be able to buy the market at lower prices sometime in the next month or two. Confirming the anecdotal evidence I'm seeing is the latest reading from NAAIM which showed a jump in long exposure to 63%. That number is not alarming on an absolute basis but it's high enough to suggest the market is vulnerable to at least a significant pullback. Next you have the VIX. At 17, it's not exactly the most ideal time to be enthusiastic about the market if you look at recent history. What's more troubling is that the VIX actually closed in the red today despite the market weakness. That's a sign of complacency. Lastly, there was a spike in inflows this week to the same degree which shortly preceded the last ST peak in mid June.

The way the market has been trading reminds me a lot of the flash crash aftermath of 2010 and the period we're in right now reminds me of early August 2010 where the market was forming a ST peak and I noticed pretty much the same conditions.


There's obviously plenty of things that could happen to scare weak longs. The main thing I'd be concerned about are signs that economic weakness is gathering stream in the US. We saw the weakest ISM manufacturing index reading in 3 years registered last week coming in just under 50. Regardless, whatever the catalyst may be, the market is vulnerable in the ST because it's ST overbought and there's weak longs jumping in - a combination that seldom works well in the end. 

Weekend Ramblings

Sad day for me as my beloved Azzuri took a beating by Spain and lost the Euro finals 4-0. It was a great run and nobody expected them to get this far but too bad they couldn't put in a better performance.  Italy played Spain in their first game of the tournament tying them 1-1 and played good enough to win that game. So, how do you figure they get blown away 4-0 the second time around? It looked mainly like fatigue to me, exacerbated by some poor player selection decisions by the coach. Italy had only 2 days rest vs 3 for the Spanish and as a soccer player I can tell you that this one extra day can make a huge difference. Now, don't get me wrong here...Spain is the superior team but if you're going to stand a chance at beating a superior opponent just one time, you need to be playing at your best and the Italians were not and I speculate a large part of that was due to lack of recovery time after their emotional win over Germany. I'll say this though...I don't think I'll even see another team like Spain dominate soccer the way they have been during the past 5 years. 3 major tournament wins in row has never been done before and they will probably have a decent shot at making it 4 in a row at the World cup in 2014.

Anyhow, lets talk markets. I stated that there was potential for fire works with the EU summit in one direction or the other and boy was there ever. Expectations were quite low heading into the summit which caught shorts flat footed. So, were the summit announcements significant enough to warrant that rally? I'm not smart enough to know with a reasonable amount of certainty whether what they proposed is the answer to the problems in Europe. It seems dubious that one meeting could solve everything doesn't it?  It certainty addresses one of the three criteria I outlined recently to make me confident the worst would be over which is bank recapitalizations. From the looks of it though, it seems more like a stop gap measure as opposed to a LT solution but it could at least buy some time or be part of a larger number of steps to finally once and for all put their European fiasco to bed. But again, I'm not even close to being an expert in these kind of things.  What I do know though is that all the EU summit provided was talk and no action, but this talk certainly was significant enough to make the shorts scramble because this summit seemed so hopeless. 

I have my doubts that Friday's rally was the all clear signal that the correction has ran its course even if it goes higher from here. Prior to this ramp, I talked about how the indicators I tracked were a mixed bag with some key holdouts not giving the green light. Heading into Friday though, sentiment improved more in favor of the bulls as AAII showed almost a 2:1 ratio of bears vs bulls which in the past if often followed by at least a ST rally. Also there was a large outflow last week which was about the same size as the inflow at preceded the ST peak the market made about 10 days ago. Of course, you would not have been able to capitalize on this sentiment data much because the market gaped up huge on Friday. On a more larger scale though, I still think that weren't not out of the woods just yet. If this rally is "real" and is the start of another 30% advance like we saw coming out of the correction bottoms of 2010 and 2011, the market should show a change in character and not give you "convenient" entry points if you want to jump back in....i.e. a grinding but relentless uptrend with no sizable dips. 

I suspect this market will still be treacherous for both bulls and bears alike for a while longer. As usual though, I'll take my cue from Mr. Market.