my bad...

Apple's earnings comes out AFTER the bell not before. Blowout earnings again from CAT however which is yet another bellweather stock. Today's a coinflip day...I'm thinking chop.

It's all about expectations

So far about 80% of companies reporting earnings this quarter have exceeded analyst expectations. This is the second consecutive quarter now that this is occurring. Remember back in May how I said that analysts actually lowered expectations for future earnings even though earnings exceeded their 1st quarter expectations. I mentioned how this was a form of anchoring....a psychological trap that investors fall into which occurs when investors/analysts fail to adequately adjust their posture when new information conflicts with it....basically a form of denial. This is no longer occurring. Forward earnings estimates for the S&P have been rising since June but obviously not fast enough because so far earnings reports are blowing past expectations.

There's good and bad news to this. The good news is that even though expectations are now rising analysts may continue to be behind the curve constantly underestimating earnings. They did this on the way down for the entire year of 2008 whereby they constantly overestimated earnings again and again even as they lowered expectations. As expecations get adjusted so do stock prices.

The bad news is that the easy money has now been made on this trade. As a result of Intel and Goldman blowing out numbers, the surprise factor won't be as large and expectations I'm sure are going to be adjusted upward in a big way. This can set the stage for massive disappointment if this economic bounce we are seeing is just an inventory re-stocking blip i.e. a snap back from the standstill the economy was at back in the fall. But the burden of proof is on the bears because the economy has bounced and earnings are on the mend. Can you see now why it has been so difficult for the bears to gain traction on the short side? Yes, jobs are still being lost but that's a lagging indicator. I've read some comments from a few pundits who claim that job losses may now be a leading indicator. This is nonsense if you ask me and just another form of denial from wrong way bears that have egg on their faces.

The question I ask myself now is where will the new jobs be created? In the past this has always been asked by people whenever there was a recession. Nobody really knew but somehow they got created. You had to have faith and guess what...it worked....the jobs came. In the last downturn, housing construction and finance jobs were the source of growth...this time around they won't be....perhaps with infrastructure spending planned they will come from there but is that really a source of job creation that will power the US to regain it's former self of being the leader of innovation? I don't think so. Some other source better be there otherwise it's going to be tough slogging for several years a la Japan post 1990.

Right now we are seeing the tech sector take charge...so perhaps the market is signaling that tech is once again going to lead and so maybe the jobs will be created there again. One very bullish prominent theme that existed just prior to this debacle was the coming explosion of the consumerism from developing countries, China in particular, as the poor transition to the middle class. This was supposed to provide for tremendous growth opportunities for companies all over the world. The problem however, was that the poor was transitioning to middle class by way of providing goods and services to overindulging North American consumers....a trend which was unsustainable. They suffered as we suffered but now with China taking matters into their own hands with their stimulus efforts perhaps they are showing signs of a self-sustaining economy. It's far too early to determine if that's the case though. Anyhow, I digress.

I always take my cue from the market. If I believe a particular theme may play out, I want to see signs that the market is agreeing with me (basing or uptrend price action) and I want to find low risk entry points. I want to make sure that my thesis is not an overcrowded trade because that never works. An example of an overcrowded trade has been the constant failed bottom picking of the Natural Gas sector. Several people are making the argument that the price of Natural Gas is undervalued...it probably is but that hasn't stopped the sector from it's sickening slide and many people have been run over by it. Another example was shorting bonds in the fall last year. Bond bears got ran over big time before bonds topped out early this year.

With the market closing at 951 today it has cleaned out yet another cohort of bears. I don't think there are much left now to squeeze. The market is almost maximum ST overbought....don't get me wrong here....it's already extremely overbought ST and ripe for a pullback...I'm just saying that I have seen it get even more ST overbought...namely early January of this year.

The bottom line is that it would be foolish to be long here for the ST aside from possible intraday scalps. Sure, we can squeeze higher but the potential for profit taking on either a sell on the news reaction or any sliver of a negative surprise is very high and like I said, I don't think there are too many weak bears left to squeeze.

I suppose a break of 960 on the SPX would cause ultimate capitulation of whatever weak bears remain and whatever sidelined money itching to get back in is out there given that this would be a new YTD high for the SPX. The NASDAQ has already made a new YTD high and this has been the leading sector but the fact that is up 9 days in a row is silly...but silly or not, never show a lack of respect for the market because it can and will do the impossible. Anyone who thought 6 days in row was silly and shorted as a result is trapped with losses.

We probably will finally see a down day tomorrow on a "sell the news" reaction to Apple's earnings which will probably be quite good. Will I be suprised if this doesn't happen?...yes and no.

How NOT to trade

Here's a post I just read from a bearish blog site

it broke.1050spx tired of this bearish crap. im LONG from here to 1050. gl

This was a post from a bearish trader who for weeks was short and now threw in the towel and is even going long! He's doing this at a time when the market is extremely ST overbought and at major resistance. You see, in the end so many of these bears that cite fundamentals, p/e ratios and other "logic" to back up their bearish positions end up covering at the worst of times because they can't take the pain and by covering they just add to the "insanity" that they complain about!


I think the market has been very resiliant today because of Apple's earnings slated earnings release tommorow morning. It looks like a lot of burnt bears like the above trader have had enough and can't bear the thought of the market gapping and running tommorow morning like what happened after Intel reported and so they are packing it in.

This is the sort of capitulation that occurs near tops. Obviously this is only 1 trader but I've been seeing similar capituation elsewhere. When enough of these guys are out of the market then you can expect to see at least a ST top, if not an IT top.

Keep in mind a few things...

I mentioned how the market reminds me of March 2002 which afterwards led to a big multi-month decline. Let me be clear that conditions are still NOT ALL yet in place for this notion to be confirmed. Certain things are unfolding the same way but what we also need to see happen is the rydex ratio continue it's collapse, the VIX continue it's decent and bullish sentiment as per AAII show a significant spike to about 2:1 bulls vs. bears. Until these things occur it would be premature to make the comparison complete. If things unfold differently then I will toss this March 2002 replay idea into the garbage. No sweat off my back and no ego damage either. Rather than defend a wrong notion I had to "save face" like so many other blog writers do, I will just try to adapt to the conditions at hand. I have frequently revised my outlooks during the past few months…sometimes significantly so and so far I have been fortunate enough to be right more times than wrong.

It is very important to be flexible and keep and open mind about what the market is going to do. I find way too many traders are biased to one side of the market. Learn to let go. Understand and believe in the motto of this blog. No matter what your convictions are for the end game in the economy you have to realize that it could takes several months, years or even decades for it to come to fruition. The collapse of Rome didn't happen in 2 years....it took about a century.

If you trade according to your personal beliefs of what the economy should or will end up doing, you will get crushed unless you can find the patience and the means to buy and hold the position for a long, long time. And what if you end up being wrong? What a colossal waste of time and money that would be. Ask Robert Prechter who after 1987 crash called for the 2nd depression. This is why I focus more on shorter term time frames....not necessarily day trading mind you.....IMO, most people shouldn't be day trading because it can often be just like gambling on a roulette wheel.

Understand and believe in the motto of this blog. Save your personal opinions and biases to coffee shop conversations. Find out what other people are thinking. If you realize that a lot of market participants share the same view as you that means that either a) the trend is old, is well priced in to the market already and a long term reversal is immanent or b) the market will likely begin a significant move in the opposite direction to shake out the weak holders and johnny-come-latelys before resuming course.

Once you don't care which way the market goes so long as you are on the right side of it then you are in much better frame of mind to make money. You will be able to assess conditions more objectively and realize much quicker when you are wrong. A lot of traders vow to act on this notion but they can't because they can't completely ignore their deep rooted biases.

I can almost guarantee you that over 90% of any bearish retail investor who posts on message boards or blogs have lost money over the past 12 months even though the market is still significantly down from 12 months ago. They likely closed out bearish bets too soon during the collapse and entered them too early since the rally started in March...and probably entered large bets too given the false sense of confidence they gained when they made money during the collapse.

This is starting to look like March 2002

I've said here in the past that the action we've seen in the market since the low in March reminded me of a combination of both the post 911 rally and the March 2003 bear market bottom rally. It's now looking more and more like the post 911 rally which played out as followes...a 3 month rally followed by a 3 month topping process followed by a serious multi-month decline. So far, we’ve had a 3 month rally and 2 months of consolidation.

The 911 debacle was very similar to the debacle we saw last fall in the sense that it was a black swan event....i.e. extremely improbable. In both periods the economy was already weak but the black swan events accelerated the downturn causing the economy to grind to a halt... literally. But an economic recovery and big stock market rally ensued. In fact, the recession was actually over in 2001....but that didn't prevent the last and most brutal down leg of the bear market to occur in the months ahead of 2002.

Right now we are seeing the economy bounce from a very depressed state late last year just like after 911. We've had a big 3 month rally just like after 911 and now we've been going sideways for a couple of months. Before the market rolled over in 2002 there was a massive head fake that occurred in February 2002. Traders went for the kill and aggressively shorted the market in February when it appeared like it was rolling over. How do I know traders were aggressively shorting? Take a look at how the Rydex ratio (adjusted for cash flows) below was behaving along with how the market was behaving. Without going into painful details, basically, the rydex ratio is a measure of trader sentiment. The higher it is the more traders are betting against the market than for it. It is useful as a contrary indicator.




Notice how the Rydex ratio exploded upwards in February 2002 to levels that exceed bearishness seen at the 911 lows. This was unjustified bearish sentiment given that the market had only pulled back moderately. The surge in bearishness created the fuel for a sharp rally back to the highs by early March 2002. That rally really sent the bears packing as sentiment completed reversed. Think about what they just went though...they basically shorted the entire post 911 rally with nothing to show for but losses and then, just like when it seemed like the market was rolling over for good, traders aggresiviely shorted thinking that finally they would be vindicated. But when they go burned again, that was the last straw. They gave up for good this time or if they did decide to go short again, they vowed not to get greedy and take profits quickly. This of course set the stage for the final bear market down leg.

You see, in order for a bear market down leg to occur, markets have to get to the point whereby investors drop their guard thinking that the coast is clear and the bearishly inclined folks have to be humbled to the point where they are too afraid to short or if they did, went small and took profits quickly fearing another upside spike could bushwhack them again at anytime. Regardless of the fundamentals, when the shorts get bold the market spanks them good just like last week.

Now take a look below at the rydex ratio over the past few months. Notice, how just like in February 2002, traders aggressively piled into the short side as the market appeared to have rolled over from a high, in this case the June 2009 high. Now you can see how the rydex ratio is quickly becoming unwound after the big rally we've had. It’s not at the opposite extreme yet, but if we continue to see the rydex ratio collapse from here with the market only making marginal gains then I believe we may have a situation similar to March 2002 which was a major top leading to serious downside.




I'll be keeping a close eye on the rydex ratio and the VIX in the coming days. Next week will probably be choppy. With the NASDAQ up 8 days in a row, it's likely a bit of colling off at the very least is in order.

The Roubini rally?

The boring, choppy action I called for today occured as expected....until about 2pm when suddenly the market got a dose of viagra. Apperently, it was sparked by a comment made by Roubini who claimed the reccession would be over by the end of the year which I suppose people took as a form of capituation from this perma bear. Obviously there is no way to anticipate these sorts of catalysts.

Today's action really stuck it hard to the bears. Capitulation yet again was evident by how the market spiked after it took out 935. That one must of really put the dagger into the heart of all those dogmatic bears out there. In 2 days, the've seen 3 weeks worth of gains get wiped out and then some.

Here's a comment from the SPY message board on yahoo

Do you all think the HYPE machine is finally in full gear? Is this rally going to spx 1000 + ? I was wiped out with my puts ....

When enough bears believe that SPX 1000 is inevidable that's when the bottom of this market may fall out....but then again, like I said yestersday, it seems like anytime we get capituation like the above comment all it takes is a marginal decline to give these lemmings back their convictions....untill they get slapped around again. Eventually, these weak bears will give up permanently and that's when the market will have potential to see serious downside.

The ST outlook is still the same....it just made things even more overbought in the ST. The market will have a very tough time advancing signficiantly from here in the ST. A downside correction or at the very least a tight sideways chop is in store. If we get the latter with a surge in bullishness and collapse in the VIX then look out below.

I'm also prepared for the possibility of a retest of the highs or even break of them after a small dip next week. I seriously doubt the market would have any gas to make it to 1000 if it breaks 950 at this point. It would likely be a serious headfake.

I'm not sure about tommorow....I'm thinking mild pullback or sideways chop again...I'll be playing this by ear and looking to take advantage of cheap option opportunities.

Bottom line: I'm keeping an open mind to possibilities but odds suggest that in due time this rally will fail back to about 915 at the very least even if it means markets go sideways or higher first.
The market is NOT in the position to make a run for 1000 at this point in time.....mabey later on in the year but not now....in my opinion of course.

ST buying climax likely today

As you can see by the chart below, we almost most certaintly hit a ST buying climax today which means tommorow is very likely going to be a flat or down day. Any gap up open will be gift to short but I doubt that's going to happen.





After big rallies like this, it is common to see the market have a boring, choppy day the next day but with a downward bias. I expect this to be the case unless there is some significant bearish surprise in the morning news.

I pointed out just prior to this surge that bearishness was building quite rapidly and to watch out for a snapback rally. We got that big time and I believe we will need to see this bearishness fade away before any sustainable downtrend reasserts itself. That doesn't means there won't be any sharp drops in the market, but rather that untill this bearish sentiment diminishes, any downside will be contained from a longer term picture perspective just like how it has been so far since the rally peaked in June.

There was quite a bit of bear capitulation today, but it seems like anytime the bears capitulate all it takes is a 2% drop in the market to give them back their courage and the moment they get aggressive on the short side they pull a Charlie Brown and fall flat on their backs and the cycle repeats.

I believe strongly that this rally will be retraced completely in due time but before it does I expect to see at least a day or 2 of choppiness. After that I will evaluate again.

The key to successfully trading these markets has been buying the dips and selling the rips...we just got one hell of a rip. But don't be stupid enough to go "all in" on any trade.