Contagion or Hangover

  • The financials are stronger today signaling that today might be more about a post Thanksgiving hangover than about a credit contagion.
  • There is a lot of put buying today. That is a step in the right direction as investors have become complacent recently.
  • Market breadth is bad but not terrible.
  • The dollar is getting stronger throughout the day. An unwinding of the anti dollar trade is likely the largest short term risk for the market.
  • The powers that be will likely not let the market fall out of bed on the last day of the month.

Trapped Longs

I believe a lot of traders were playing the Thanksgiving holiday from the long side when they got blindsided by Dubai. Some of those trapped longs might be weighing on the market.

Commodities Boom

There are likely a lot of reasons to be long commodities but construction demand is not one of them. The global construction boom of the past few years has been a large source of demand for industrial commodities, possibly the largest. The Dubai World default is a reminder that the boom is over and it will take many years before that level of demand is seen again. Large construction projects have long lead times and projects started during the boom years are still being completed. Once those projects are completed demand will diminish further.

Tough Call

While the relative size of the Dubai World default is small, I don't believe it should be dismissed. As Mohammed El Erian of Pimco said, after a 60% run Dubai World could be the catalyst for a correction. The proverbial straw that breaks the camels back. This is also a reminder that the credit cycle is not over, the economy is not healthy and that there are likely more defaults yet to come.

While I am taking the Dubai World default seriously, the shorter term picture is murky. The only time it has paid to bet against the market recenty is when sentiment has been extreme and the market has been maximum overbought. While sentiment is consistent with that seen at tops, the market is only two days away from being maximum oversold. In addition, we are approaching the end of the month and are in a seasonally strong part of the year.

With all these cross currents I would not be surprised if the market went higher or lower in the days ahead. As such, I am not taking a strong directional stance and sticking to my long quality versus short SPY trade.

That Is The Question

As investors throw a temper tantrum for a Dubai bailout, I wanted to pose this question. If banks and investors don't deserve to lose money for lending money to build palm tree shaped islands and ski slopes in the desert, than who deserves to lose money?

Never Admit You Are Wrong

Ben Bernanke has written a shameless oped in this Sunday's Washington Post defending the Fed. In it he never admits that the Fed had any culpability in helping create the bubble but takes most of the credit for saving the world:
"The Fed played a major part in arresting the crisis, and we should be seeking to preserve, not degrade, the institution’s ability to foster financial stability and to promote economic recovery without inflation."
Ben Bernanke uses the "all my friends are doing it" excuse as a leading argument for continuing to let the Fed run wild.
"These measures are very much out of step with the global consensus on the appropriate role of central banks, and they would seriously impair the prospects for economic and financial stability in the United States."
In the remainder of the article he pays lip service to corporations paying for their blunders rather than the taxpayers, even as he continues to funnel money to these corporations by giving them access to free money.

I would much rather keep the focus of this blog on investing and not on pointing out an individual's mistakes but these issue are too important to ignore. I understand that everyone makes mistakes, but a man of character admits his mistakes. Our current leaders are the ones who got us into this mess and they heap praise on themselves. While those who warned ahead of time about this crisis, like Paul Volcker, are ignored.

The Risk Trade

The risk trade seemed pretty riskless, especially with the positive seasonality holiday environment apon us. However, today's action should not have been completely unexpected. With an unhealthy economic and financial backdrop negative surprises tend to happen.

In addition, when a trade is crowded reversals could be ugly. Even if this does not become a contagion it could serve as a catalyst to unwind the risk trade. Have a great weekend.

Covered 1/4 Of My SPY Short

I covered 1/4 of my SPY short. A portion of my long exposure is via short puts. A bunch of premium has been sucked out of those positions, which left me somewhat short. I am just using this opportunity to even out my positions.

I could have added to my longs to achieve the same thing. However, my long cheap, defensive stocks/ short SPY trade has worked out better than I could have imagined and I want to shrink my book a little.

Nobody Knows

Is Dubai World's default more like Lehman Brothers or more like CIT? Lehman Brother's bankruptcy sent shocks through the financial world, while CIT's bankruptcy hardly caused a ripple.

The connections between world financial markets are so complicated that nobody knows the answer and one can only hazard a guess. The size of the default is much smaller than Lehman Brothers, but this is more of a surprise than CIT was.

In and of itself the Dubai World default is not a disaster. However, the jitters seem to be spreading to Greece. It is the contagion effect that is worrying. This could be nothing or it could be a black swan. We will soon find out.

Holiday Surprise

The S&P futures are down 12 points on news that Dubai World has defaulted on its debts, which are estimated to be $40 billion. European markets are down nearly 2%. The fear is that banks have exposure to the debt. In addition, Dubai World has assets across the globe that might need to be sold and could put pressure on asset markets.

Most thought that being long for Thanksgiving was a can't lose situation. Traders are not positioned for bad news and this could potentially get ugly as trading will be thin tomorrow. More likely the S&P will end up 12.

Turkey Time

The only reason to remain in front of my screen is to see if we have record low volume today. That feat will likely be saved for Friday. Have a Happy Thanksgiving.

Intraday Compass

  • Breadth has been the best short term tell for the market and today it is supporting it.
  • The dollar is getting pummeled, which is also supporting the market.
  • Call buying is extreme thus far.
  • The banks are down, while defensive sectors are once again outperforming.

Be Fearful When Others Are Greedy

The number of II bears is the lowest since June 2004. The bull trade is becoming dangerously crowded. This is the time to be fearful.

Speaking Of Extremes

The Investors Intelligence data is out. The bulls are at 50.6%, while the bears are at 17.6%. More evidence that sentiment has become extreme and the bears are an endangered species.

Not So Fast

All the signs were pointing lower yesterday and the bulls still managed to pull the S&P 500 back to the flatline by the end of the day (The Russell 2000 was down 0.5%). After that, I pretty much gave up on the bears for the rest of the week.

However, when I started to go through the statistics of yesterday's rally something jumped out at me. The number of leveraged bears at Rydex fell to an all time low (I have access to 7 years of data at Rydex). In addition, the ratio of leveraged bulls to leveraged bears hit an all time high. While Rydex traders are a small subset of traders, they do give a decent idea of how traders are positioned. Rydex traders are positioned dangerously long.

There was an extreme amount of call buying yesterday on the ISE, but I wrote it off because the CBOE data did not confirm the call buying and it seems that some very large trades might have skewed the data. But now that I have seen the Rydex data, I am not sure I should be so quick to write off the ISE reading.

While most have written off the bears for dead and embraced the positive seasonality, it is possible that they will surprise everyone.

Shiny Happy People Holding Hands

Once again the optimists win, while the evil doing short sellers go home empty handed. It just makes me want to sing:

Meet me in the crowd
People, people
Throw your love around
Love me, love me
Take it into town
Happy, happy
Put it in the ground
Where the flowers grow
Gold and silver shine

Shiny happy people holding hands
Shiny happy people holding hands
Shiny happy people laughing

Everyone around
Love them, love them
Put it in your hands
Take it, take it
There's no time to cry
Happy, happy
Put it in your heart
Where tomorrow shines
Gold and silver shine

Shiny happy people holding hands
Shiny happy people holding hands
Shiny happy people laughing

Have a good night.

Gorillas In Our Midst

There were some extremely large option trades today. A gorilla bought 130,000 GE $22.50 2011 calls and 150,000 BAC 2011 out of the money calls. The timing of these purchases is suspect and is the reason I ultimately chose not to go short today. Its too easy to influence the tape in a holiday thinned market.

Is Gold In The Midst Of A Blowoff

Gold has started to go parabolic in the past few weeks. That usually means that it will either keep going up hard or start going down hard. Rarely does something just meander after moving like that. When an eventual high does arrive, could that cause a rally in the dollar and a move lower in stocks. Could that be the catalyst for a real correction in the markets?

Waiting For Turkey Day

Volume should start drying up this afternoon and by tomorrow should be at a crawl. This likely makes trying to read the tape an exercise in futility, but I will give it a shot.
  • Market breadth is 9:5 negative and is arguing against a turnaround for the bulls today.
  • The option ratios are inconclusive as the CBOE is showing put activity while the ISE is showing the opposite.
  • Defensive sectors are outperforming, while tech and financials are underperforming.
  • The dollar is slightly higher.
All in all I would say the tape slightly favors the bears today, but with thinning volume anything could happen.

Much Ado About Nothing

Yesterday's home sales numbers drummed up a lot of excitement, with call activity zooming to levels not seen in a while. Despite all the hoopla, the rally seemed to lose steam throughout the day. The market is still somewhat overbought, even after last week's decline. It does not appear to me that the market is setup for much upside from here.

The fundamentals underlying yesterday's rally seem shaky to me. Weekly mortgage purchase applications, which are a real time gauge of housing activity, are down to levels not seen in nearly a decade. We are seeing the same type of hangover in housing that we saw after cash for clunkers. In the coming months housing numbers will once again show deterioration. I believe the December numbers will be a disaster, but those will not come out until January.

I am tempted to move to a net short position this morning. However, I realize that anything could happen in a holiday thinned trading environment. A gorilla with an agenda could really push things around and I believe that most agendas these days have an upward bias.

One Day Wonder

I believe that today will prove to be a one day wonder rather than the beginning of a new leg up. I will have more in the morning. Have a good night.

The Missing Link

If stocks are rallying based on dollar devaluation why are treasury yields staying so low? This divergence will not be able to continue indefinitely. If rates do go higher there will be implications for stocks.

Rolled My Amgen Position

My Amgen position was called away at option expiration. I sold the Amgen December 55 puts naked on Friday.

Bah Humbug

The market is rallying because a Fed official is endorsing printing more money and Existing Home Sales came in better than expected. I outlined earlier why I believe the existing home sales numbers are rear view and misleading.

The Fed continues its irresponsible policies, by going down the same path that got us into this mess. If a country headed full speed in the wrong direction is a reason to buy stocks, than the stock market is a strong buy.

I am seeing heavy call buying in a market that is still overbought. Were we not headed into the seasonally strongest part of the year, I would be moving back to a net short position today. Instead I will just shake my head in disappointment and hold onto my cheap, "defensive" stocks versus an SPY short.

Existing Home Sales and More

The best thing the market has going is seasonality, as we are entering the strongest part of the year. In addition, the complacency disappeared from the options gauges late in the week.

On the negative side the correction has been on the short side thus far in terms of time. All things being equal. I would expect the correction to last another week. However, the days around Thanksgiving have a strong positive bias. We are seeing more and more divergences, which argues for the possibility of a stronger correction than what we have been seeing recently. Sentiment has not yet shifted back to pessimism as Rydex traders are still pretty heavily long. This mix of factors makes the shorter term a tougher call.

I expect the existing home sales numbers released today to surprise to the upside. Existing home sales represents closings, for which contracts were likely signed during the Summer. We know that housing activity was brisk during the Summer, as first time buyers rushed in order to receive the tax credit.

Currently, weekly mortgage purchase applications are hitting multi-year lows. This is a much better forward indicator of housing activity while existing home sales are rear view. Housing numbers have been surprising to the downside, so a positive surprise from existing home sales has the potential to spark a small rally even though the number does not mean much.

I will be traveling today and resume posting in the afternoon.

Supply Hitting The Market

During the latest week we have seen a number of IPOs and secondary offerings. A large new supply of stock in the market is a negative. There is reason to believe that we will be seeing more supply in the months ahead. The following quote is from a banker quoted in yesterday's Wall Street Journal speaking about new offerings:
"As far as pipelines go, everyone is busier than they have ever been. ... I personally have been on 30 pitches over the last 10 days, which is very busy."
This is another headwind for a market that is starting to look shaky. Have a great weekend.

The Correction Has Begun

The correction that I had been looking for has finally begun. If this follows the path of previous corrections we should expect it to last through next week. However, seasonality turns very positive after Thanksgiving so we could see a low going into the holiday.

While seasonality will turn positive after Thanksigiving, I am not expecting a year end rally. Despite the positive seasonality I expect a decline into year end, but not a collapse. The divergences during the latest rally and the complacent sentiment ("fundamentals don't matter") make me believe that the market is tired and in need of an intermediate term correction. However, it is tough to see a total collapse with seasonality so strong.

Many readers have asked or are likely wondering why I lowered my net short exposure into yesterday's plunge if I am negative on the market. There are two reasons. The first is that I want to respect the seasonality, even though I don't believe it will hold this year. The second is that I am short the SPY, but long cheap, "defensive" stocks. These stocks have been outperforming the market for a while now and I expect them to continue to do so. I expect to make money in a down market, even if I am not net short.

One From The Road

I am traveling today but wanted to give a quick update. I have sold December covered puts on my short SPY position ( the 100 strike). In addittion I have sold the EXC January 45 Puts naked. This brings me closer to neutral.

Expecting A Move Lower

The conditions are continuing to line up for a move lower:
  • Market is overbought.
  • Rydex traders finally became aggressively long yesterday. They held out this entire rally, until now.
  • We had a second day in a row where breadth lagged the market.
  • Sentiment surveys (Investors Intelligence bears at 21%) and anecdotal sentiment are showing complacency.
My best guess is that we see a down day today. However, it is possible that option expiration will delay the move lower until next week.

Same As Yesterday

Today's trading looked a lot like yesterday's. A flattish day with negative market breadth. The best chance for a break either way in the market is likely tomorrow. Otherwise we might need to wait until after expiration to find out which way the market is going. I am traveling again tonight and will return on Tuesday. I will try to post at least once a day. Have a good night.

Phase Two

My thesis in entering my pharmaceutical trade was that pharmaceutical stocks would make a move in two phases. The first phase would come with the closing of the Pfizer/Wyeth and Merck/Schering Plough mergers. I believed that would lead to an initial move higher. More than 6% of pharma's market cap disappeared when those mergers closed and indeed it did lead to a move higher in the group.

Pharmaceuticals have underperformed for a decade and managers are underweight the group. The second phase would come from these managers starting to chase pharma as it outperforms. While I was very confident that phase one would materialize, phase two was more of a leap of faith. It appears that phase two is now materializing.

CNBC Nonsense

I don't watch CNBC but have heard that numerous pundits have come on the past few days and said that the fundamentals don't matter and that they are bullish. While its true that the fundamentals haven't mattered, the fact that people are so complacent is a red flag in my opinion.


The hardest thing for me is to just hold onto stocks that are doing well for me. My pharmaceutical positions continue to march higher and I have to fight off the urge to book profits every day. I own Merck, Pfizer and Eli Lilly and all seem to have broken out over the past few days. I sold covered call earlier in the month and partial positions will likely be taken away from me on expiration.

Opposite Day

  • We are seeing very heavy call buying today.
  • Investors who missed the rally seem to be buying the pullback. Its funny how investors were uncomfortable "chasing" the market as it rose 7%, but a .2% pullback is enough to generate extreme call buying.
  • Breadth is once again negative but not to an extreme.
  • This continues to look like topping action to me.
  • For the past few weeks tech has been rallying while financials have been struggling. Today, is the exact opposite with the financials leading the way and tech bringing up the rear. Normally I would say positive financials are a good thing but tech has been leading the market.

If They Can't Take It Down

It looks like they will try to take the market higher today, after they couldn't take it down yesterday. Sometimes the market is that simple, even though I'm sure the major news outlets will assign some news based reason for the move higher this morning.

The action yesterday was not that different from what we saw at previous tops in the past few months. Milling around at the highs before a sharp break lower. The chart below is of the S&P 500 and shows the last 3 corrections. I marked the milling around period with a red line followed by a sharp move lower.

Chart from Yahoo Finance

Sentiment is in place for a top as talk about a year end rally is getting loud. The market has rallied 7% in two weeks, yet two weeks ago there was only put buying and little year end rally talk. The divergences continued yesterday as decliners handily outpaced advancers even though the market ended higher on the day.

If we get a move higher today, it will be very tempting to add to my net short position. However, I will try to resist as I don't want my short position to get too large at this time of year.

The Money Quote

  • The money quote from Target's conference call "In our view, sell-side analysts are somewhat more optimistic across most of our industry than we believe is warranted in light of the harsh realities of the current environment."
  • Some readers have asked about shorting retail stocks in the past few months. Even though I believe retail will be one of the worst sectors in the years to come, I was against shorting them because retail stocks are typically strong this time of the year. The strong seasonality weakens after Thanksgiving and turns negative after Christmas.
  • Is retail ever a good business? The retailers that were around thirty years ago are mostly gone or have restructured through bankruptcy and the same will likely be true thirty years from now.
  • When will the terrible economic situation just be bad news? Without all this reverse psychology, that if everyone knows its bad than its really good.

John Mack Tells Ben, Hank and Timmy To Stuff It

All In Bet On America

  • Why is my net short position small? I have been burned too many times being short during this time of year.
  • Where do I expect this correction to go to? I don't know, but I want to move to a more neutral position by Thanksgiving.
  • Warren Buffett said his recent purchase of BNI was an all in bet on America. Looking at his portfolio he bought more Wal Mart and Nestle, while trimming more economically sensitive stocks. Seems pretty defensive to me.
  • Warren Buffett tried teaming up with Goldman Sachs to buy tax credits from Fannie Mae in an effort to find a loophole and avoid paying taxes. I suppose that was an act of patriotism as well.
  • China lectured the US about health care reform and how it will be paid for, as well as monetary policy. Say hello to our new masters.
  • The sad thing is they are right to be worried.

Pavlov's Traders

I have just arrived from the airport and am not yet oriented but wanted to make two quick observations. The knee jerk reaction has been to buy the dip and investors are doing so. Call buying is extremely heavy and the market has not managed much of a rally. In addition, breadth is quite negative for a flattish day. Based on those two observations I don't believe the buyers will be successful today.

Thats All Folks

I believe we are late enough in this rally that when a correction does arrive I will be able to pick up stocks at better prices than at the current juncture. As such, I moved to a slightly net short position today. I will be arriving on the Red Eye tomorrow morning and posts will begin a little late. Have a good night.

Endangered Species

Intraday reversals are an endangered species and happen less often than at any other time I could remember. As such, I don't expect the market to turn today. I believe the reason is all the levered ETFs. They are reweighted towards the end of the day in the direction of the market.

Drugs Breaking Out

Both Merck and Eli Lilly are breaking out today on heavy volume. They are core longs for me.

The Paulson Pop

Shares of Citigroup are higher on news that John Paulson has amassed a position. Those who followed Paulson into Bank of America after his last 13-F are sitting on a loss while the broader market is up 10%.

Net Short

I have sold down my shares in Exelon for a small gain. The position has been a disappointment as the shares have gained 1%, while the market is up 4% in the same period. I still believe the shares are a value and will look to buy again at lower prices. The sale makes me slightly net short.

Random Thoughts From Hungary

  • I am currently in Hungary for the first time. In the late nineteenth century and early twentieth century Hungary was among the most advanced societies. While Hungary is now a democracy again the effects of their Communist experiment are still being felt as the country is visibly run down and poor.
  • Which makes me think of our socialist experiment. Is printing money to bail out failed institutions and promote larger government the answer to our problems?
  • Are Alan Greenspan and Ben Bernanke geniuses? Why didn't other central bankers throughout history think of the novel idea of lowering rates to zero in order to solve every problem?
  • The headlines from Obama's trip to China is that he is urging the Chinese to allow uncensored access to the Internet. Who gives a rats @$! ? With all the trade imbalances his biggest concern is if the Chinese can watch porn online?

The Missing Ingredient

There are two things I like to see when entering a short position on the broader market. The first is that the market is maximum overbought or nearing it. After today, the market will be maximum overbought. The second thing I like to see is that sentiment is lopsided towards the bullish camp. That is not yet evident as it seems that investors are still reluctant to embrace the rally. I am hoping that we will see more exuberance today. If so, I will move to a net short position in time for Turnaround Tuesday.

The caveats are that option expiration could drag this rally out to the end of the week. And the period heading into Thanksgiving is seasonally strong. As such any short exposure I take on will be relatively small.

Bears On Offense

I view the market as being similar to a game of football. Sometimes the bulls are on offense and sometimes the bears are on offense. For the past two weeks the bulls have been on offense but the market is nearing maximum overbought and it is time for the bears to go on offense.

It is possible that when the bears are on offense they will not score or even fumble. However, the odds favor the bears putting points on the board when the market is maximum overbought.

There is still time for another push higher by the bulls but it would likely be a climax rather than the start of another move higher. The market is reaching maximum overbought and its time for the bears to go on offense. Have a great weekend.

On The Road Again

I am headed out to the airport tonight and will be traveling until Tuesday, when I return on the Red Eye. I will try to post once a day tomorrow and Monday. The current rally is long in the tooth and while I could see another attempt higher tomorrow or Monday, it would likely be a selling opportunity. Have a good night.

Large Drop In Short Interest

There was a large drop in short interest on the NYSE in late October . That was due to the closing of the Pfizer/Wyeth deal. Arbs were short Pfizer until the deal closed. Some are citing the drop in short interest as a bearish factor. There are a lot of reasons to be bearish but that is not one of them.

Not Much To Like

  • Market breadth is terrible with the Russell 2000 leading to the downside.
  • There is too much call buying for a down day.
  • The dollar is exploding higher, while commodities are tanking.
  • Market can't rally despite good unemployment numbers.

Musical Chairs

I have spoken to many people that know that the economy is poor and that stocks are not cheap but are long because they don't think the market will go down with all the "liquidity". The same people believe that there will be a comeuppance one day as a result of our "kick the can down the road" mentality. If everyone is planning to get out before the comeuppance, who will be left holding the bag?

Cash For Clunkers: Part Two

Mortgage purchase applications hit a 9 year low. We are now witnessing what happens when demand is brought forward. This is similar to what happened to car sales after "Clunkers".

I'm certain many will point out that the government has extended the tax credits. However, when Macy's throws a "limited time" sale and then a week later throws another "limited time" sale, the second sale is not nearly as effective. When will the government learn that gimmicks are not going to fix the economy?

Waiting For The Fat Pitch

While a strong case could be made for a move lower, there is also the possibility of one last push higher. The market is not yet maximum overbought and we have not yet seen the throw caution to the wind attitude of investors during the latest rally.

While the current setup probably warrants a slightly short posture, I am waiting for the fat pitch. If we get that last push higher, I will move to a short posture. I shoud do fine in a down market as I am long defensive stocks (healthcare, utilities) versus a short in the SPY.


The market appears increasingly vulnerable to me and I am tempted to make my move on the short side. However, I will be travelling from Friday through Monday and I could see one more push higher. I am yet undecided.

Trading Range

I believe the market will remain in a trading range for the remainder of the year and that we are likely bumping along the top of that range. We could see a move down of 10% but the seasonality does not support a total collapse. That is likely 2010's business.

On The Other Hand

To be fair and balanced I will point out that some factors are supporting a reversal today. The turnaround in the dollar and the fact that the rally is pretty miniscule despite a good amount of call buying.

Turnaround Odds

Market breadth has held in very well during this attempt lower. That and the strong financials means we will not likely see a turnaround today. However, if we rally into the close I would consider moving into a net short posture.

Sold Down Some Longs

I have sold down some of my longs. I am now market neutral.

Ingredients For A Top

Two weeks ago I wrote a piece, Ingredients For A Bounce. I believe we are approaching the opposite extreme and the ingredients are beginning to line up for a top.
  • Most rallies don't end until they suck in the majority of traders. We finally saw a move to the bull side by Rydex traders yesterday. While not at the extreme seen at the end of previous rallies, they have finally moved to the bull camp.
  • There has been a decent amount of call buying the past two days further showing that investors have finally bought into the rally.
  • The market is no longer oversold and will be maximum overbought by the end of the week or early next week.
  • There are numerous divergences.
The caveats are that the market can still go a few more days before it is maximum overbought, which would lead to a better selling opportunity. In addition, the days leading up to Thanksgiving are seasonally strong. Tactically, I will look to reduce long exposure and add to the short side gradually in the coming days. However, because of the seasonality I will likely not move to a very aggressive short posture.

Getting Technical

The technical term for what I mentioned in my last post is divergences. Divergences tend to lead to market tops. While the major averages are doing well, the average stock is not. Among the divergences are:
  • The Russell 2000 is well off its highs.
  • Momentum is waning. The last two highs have occurred with lower overbought readings.
  • Market leaders like semiconductors and financials are not making new highs while the major averages are.
The evidence is lining up to push me towards a net short position at the end of the week.

Lack Of Enthusiasm

Maybe the reason we are not seeing the enthusiasm with the current rally that we have seen with previous rallies is that the hot sectors are under performing. Small caps and financials were the stocks that were getting everyone excited and they are both well off their highs. Maybe the lack of enthusiasm is justified? I am considering dropping my requirement that we see enthusiasm as a prerequisite for this rally to end.

The current rally is being led by high quality stocks that are underowned. Healthcare stocks are leading the way. My portfolio is made up almost entirely of healthcare stocks and a utility. It has performed very well in the recent rally.

Call Buying

There is a lot of call buying thus far today. Investors are finally embracing the rally, which brings it one step closer to the end.


Fred Mishkin, a former Federal Reserve Board member, wrote an op-ed in the FT stating that its okay if the Fed allows an asset bubble. His credentials are that he helped create two of the most destructive asset bubbles in the history of mankind and like his co conspiritor Alan Greenspan never owned up to his mistakes. The article belongs in Mad Magazine.

The Last Hoorah

Good Morning. The good news for the market is that Rydex traders are still fighting the rally and the market will not be maximum overbought until the end of the week. The bad news is that we finally saw some call buying yesterday as traders began to embrace the rally and the market is no longer oversold.

I believe the most likely scenario is that the rally lasts through the end of the week. I have noticed that Rydex traders like to buy pullbacks and they seem to be a decent barometer for other traders. We should see a pullback sometime this week that traders buy into with a final top at the end of the week or early next week. As the week wears on we should start hearing chatter about a year end rally. That should mark the top for 2009.

Low Frequency Trading

Today had to be one of the most listless, unemotional 2% rises I have ever seen in the market. We are finally seeing some call buying and it is possible to start thinking about a pullback. While I believe the most likely scenario is that the rally lasts through the end of the week, it will likely not be straight up. Have a good night.


There have been some comments about the low volume. There is a saying that volume is the fuel of a bull market, which makes sense intuitively. However, I have never been able to make any market trading decisions based on volume.

Volume has been of some help in individual stocks. When a stock is plunging on heavy volume and I want to try and pick a bottom, I look for a slowdown in the volume. A short term bottom usually comes shortly after the slowdown in volume.

Seeing Through The Rhetoric

Pharmaceutical stocks are outpacing the broader market today. This is despite the fact that the House of Representatives health care bill is tougher on pharmaceutical companies than was originally expected.

The Senate bill will likely be a lot kinder to pharmaceutical companies and a compromise will probably look a lot more like the Senate bill. The government is embarking on a trillion dollar spending program. The pharmaceutical sector, which is the largest lobbyist, will get their pound of flesh from the taxpayers and the stock market knows it. While politicians might not understand much about macroeconomics, they do understand who butters their bread.

Bizarro Land

While in Bizarro Land the market goes up every day, in the real world Rome continues to burn.
  • Tishman Speyer and Blackrock essentially defaulted on Stuyvesant Town.
  • We are about to enter the second wave of defaults for ALT-A mortgages.
  • Free government sponsored healthcare and government sponsored mortgages for all. Paid for with printed money because we live beyond our means.
  • And record unemployment at the same time as record bonuses.
So where does that put me? Unfortunately, I trade in Bizarro Land and not the real world so I am bullish for the coming week. My net long position is getting smaller as I use the strength. I will look to be market neutral to net short by the end of the week.

The Week Of Embrace

Last week the S&P 500 rallied 3% even as investors fought the rally. Puts were bought all week, while Rydex traders have sold the rally every step of the way. I suspect that this will be the week when everybody finally embraces the rally. The market will not be maximum overbought until the end of the week and it is likely we will get there.

The market remains overvalued and the economy remains weak but a number of events have come together to give the market one more shot in the arm. While I will be looking for chinks in the armor I believe that fighting the market this week will be futile. Next week is a different story. By the end of the week we should see some giddy bullishness just as the rally nears its end.

Fundamental Concern

While I believe it is best to stay out of the market's way for the next few days my fundamental concern is large enough that I don't want to add to longs. The fundamentals will eventually catch up with this market. Have a great weekend.

Jobs Report Will Matter

The horrendous Jobs Report will matter in the long term but in the short term the fact that traders are positioned the wrong way is the most important fact. I suspect that over the coming week market participans will once again mover from pessimism to optimism. That will be the time to remember the horrendous report.

Why The Market Is Rising

Charles Biderman, founder of Trim Tabs, has done extensive studies on liquidity. When a company is bought out in a cash takeover, investors holding the shares are likely to take the cash they receive and buy other stock. His models show that half of the cash infusion is realized the week the deal is announced as arbs buy stock from shareholders. The other half is realized the week of closing.

In the past week, the Merck/Schering Plough deal closed, which had an $18 billion cash component. At the same time the takeover of Burlington Northern and IMS Health were announced this week which had combined cash components of $18 billion. According to Biderman's work those deals amounted to a whopping $18 billion inflow.

Many will dismiss Biderman's work because he had a horrible call. The reason Biderman went wrong was that he only focuses on corporate liquidity and ignores what market participants are doing. In most cases that is fine but when participants have record amounts of cash to deploy, that is a mistake. However, that does not mean his work does not have value.

Too Much Pessimism

I was quite surprised to see so much put buying yesterday on a day when the S&P 500 was up 20 points. I though that it must be an anomaly. However, when I looked at the Rydex data this morning I found that Rydex traders added to their short positions yesterday. That seems to confirm the notion that there is too much pessimism in the short run.

Rallies typically end when everyone embraces the rally. That is clearly not the case at present and the rally likely has more to go. A sell off on the NFP data would likely be a short term buying opportunity.

Healthcare Takeover

Another cash takeover was announced in the healthcare sector today. IMS Health is being taken private in a $4 billion transaction. A disproportionate amount of cash takeovers this year were in the healthcare sector. Investors seem to be more interested in sectors that are issuing stock like cyclicals and financials. I am following the real money buyers rather than the speculators.

Put Buying

There seems to be a lot of put buying for a day when the market is up so much. Rydex traders are positioned pretty bearishly. All this argues for a continuation of the rally.

Shifting Positions.

I have sold covered calls on some of my healthcare positions as they have run very hard in the past few days. I replaced that exposure by buying shares of Exelon. I outlined my thinking on the shares last week.

Trading Against Myself :Part Two

I am bearish on the long term prospects of the economy and the stock market. Despite my feelings about the long term, I went net long a few days ago and have caught a very nice trade. A few years ago I would not have been able to do that. The possibility that I would be correct in my long term view and lose money at the same time would have been more than I could handle.

It took me nine years of trading until I was able to trade against my long term view. Since then my results have improved dramatically. I am not sure if this has been the only factor but I am confident it has been one of them.

Buy Program

By my rough calculation, there will be a $1.5 billion buy program at the end of the day today relating to the S&P 500 changes of the Merck/Schering Plough merger.

Sold Covered Calls On AMGN

I sold November 55 covered calls on my AMGN position. I am now sitting on a profit as I added to the position at lower levels over the past few days.

Time Is The Most Important Element

The S&P 500 rose 30 points from its low on Monday to its high yesterday. An argument could be made that the 30 point rise was the oversold bounce and that the market will now head lower. An upside trade in the S&P 500 does not have as much support as it did earlier in the week.

However, I believe it is too early to get negative. Working off an oversold condition is as much a function of time as it is of price. It has been less than three days since the market started bouncing and is still oversold. I would give the market until early next week to prove itself. If it continues to chop around without making progress a stronger case can be made for it working off its oversold reading by going sideways.

For now I believe the market deserves the benefit of the doubt, especially because it seems that nobody trusts this rally. By the time this move is over everyone should be calling for new highs. That said I am only modestly net long after trimming my exposure into yesterday's ramp.

Need To Sleep On It

When I lowered my exposure to stocks this morning I did not think a turnaround was in the cards. The truth is I wanted to press my bets but discipline dictated taking a bunch of chips off into a 25 point S&P 500 rally. Luckily, I followed my discipline instead of my gut.

The action in the bank stocks is troubling. I need to sleep on my call for a rally in light of the continued carnage in the bank stocks. I will give you my updated thoughts in the morning.

Pharma On Fire

My pharma positions are on fire today. MRK is up over 5%. LLY and PFE are up 2%. This is likely the result of the Schering Plough money being put to work in other pharma stocks.

Amgen Horror Show

I bought Amgen last week because I thought the biotech sector was due for a rally. While biotech stocks have rallied by 4%, Amgen is down by 5% since my purchase. I believe Amgen is the most reasonably priced biotech stock. It trades at nine times earnings net of cash and is expected to grow earnings at nearly 10% a year over the next 4 years.

Amgen was hit with two scary sounding headlines over the past week that don't amount to much. The first is that they are being sued for their sales practices by 21 states. At most this will amount to a one time settlement of a few cents a share. The second was a study that confirmed the risks of one of their drugs, Aranesp. The risks of this drug are well known and well chronicled. They released the results of the study with their earnings two weeks ago but the official press release seems to have generated another round of selling. Analysts tooks down Amgen's numbers a meager 1% based on the results of the study.

Amgen is now down 17% since releasing earnings. The stock likely had some hot money in it as it has outperformed for the past few years. Biotech is a classic momentum group with momentum investors and Amgen clearly does not have that momentum right now. The fact that it is down in an up tape with the health care sector on fire is not lost on me. However, I believe there are a few dollars of downside and $25 of upside. They are supposed to earn $7 in 2013.

A possible catalyst would be that they use their $7 in net cash to buy back stock. They have a history of repurchasing stock but it is somewhat erratic and hard to predict but the cash is there.

Trimmed Long exposure

After a 25 point S&P 500 rally I have trimmed my long exposure. I don't think the market is headed lower but a 25 point rally begs for some profit taking.

What Was Warren Thinking

Warren Buffet's buy of Burlington Northern is somewhat perplexing. The price he paid was not cheap at twenty times earnings. That is generally not the type of price that value investors like to pay. Warren Buffet has stated that he believes the value of the dollar will fall. That would help explain why he would overpay for a company. However, he used Berkshire stock to help pay for the deal as well. Unless he believes his stock is overvalued as well it is hard for me to make sense of this deal.

Trading Against My Long Term Opinion

Good morning. I believe that the market remains overvalued and that it will take many years for the economy to heal. However, a confluence of factors have lined up for a short term market rally.

The market has become oversold and sentiment has become too bearish in the short run. The bearish sentiment is evident from the put buying for a string of days. This has laid the foundation for a rally. The closing of the Merck/Schering Plough deal, which had an $18 billion cash component, and Berkshire Hathaway's part cash buyout of Burlington Northern have given the market the push it needs. I would expect a rally to last a few more days at least.

Relief Rally

The Russell 2000 is actually outperforming today for the first time in forever. Another sign that the market might be ready for a relief rally.

Mark To Make Believe

In its latest 10-Q GE said the difference between fair value and where they are marking their assets is a whopping $18.8 billion. They are paying a dividend and not raising capital. Pretty hard to believe.

S&P 500 Changes To Happen Thursday

The S&P 500 changes will not occur until Thursday relating to the Merck/Schering Plough merger. There should be a $1.5 billion buy program at the end of the day Thursday by my rough calculation.

Covered 1/4 Of My Short Positions

Merck announced it is closing its takeover of Schering Plough today. I covered 1/4 of my short positions making me a little net longer.

On Notice

Schering Plough notified the NYSE they are about to close. This likely means the deal will close this week. This should give the market and the healthcare sector a boost in the coming days.

Good Feel, Bad Positions

While my market feel has been decent the past few days, my longer term healthcare positions have been absolutely killing me. A few weeks ago when my healthcare positions were soaring it made up for my bad feel. I will take lucky over smart any day of the week.

The Early Tells

The early tells are negative. There is heavy call buying and market breadth is two to one negative. This is definitely not a positive.

Market Floor

There are some negative factors that argue for a sloppy market, not the least of which is the meltdown in financial stocks that is spreading around the world. However, I believe the following three factors will put a floor under the market in the near term:
  • The Berkshire takeover of Burlington Northern.
  • The impending closing of Merck/Schering Plough. They are still waiting on Chinese approval.
  • The oversold condition of the market.

Now That's Positive

Berkshire Hathaway is acquiring the shares of Burlington Northern Santa Fe it does not already own in a part cash part stock deal. That is an undeniable market positive.

Oversold Enough To Bounce

In the medium term the market has a lot of strikes against it. Important groups like the small caps and financials have been severely underperforming. The market has been able to become deeply oversold, something that it has not done since the March lows. Despite the oversold condition and the positive seasonality the market has not been able to rally. This all points to a market that has more work to do on the downside at some point.

In the shorter run the deeply oversold condition argues for a relief rally. It is also possible that the market can work off its oversold condition by going sideways and chopping around. If it does so for the next few days the best course of action would be to just step out of the way. For now it still has a chance to rally.

No Cash, No Care

A big deal was made last night because Stanley Works is acquiring Black & Decker. The deal is a stock for stock deal and is meaningless in my opinion. Cash deals are bullish because holders of the takeover target receive cash and are likely to put that cash to use in other parts of the market. In a stock for stock transaction holders of the target receive a different stock and the market effect is neutral.

Looming Positive

A looming positive for the market is the closing of the Merck/Schering Plough deal. The deal has an $18 bilion cash component and should give the market a small boost. China is the only country that has not given them an approval. They do a miniscule amount of business in China and there is no reason they should be holding them up. But they are China so they can do what they want. Get used to it.

Bullish For A Trade

I am bullish for a short term trade and am slightly net long. I am still bearish in the medium term but believe the market is oversold enough to bounce. The caveat is that the market can work off the oversold condition by going sideways for a few days but that is still a few days away. I believe a large secondary from a financial company also have the ability to cut a rally short.

The Pullback

This is the pullback I was looking for. I am using this pullback to modestly add to my long positions.

Gap Up

Good Morning. The market is gapping up this morning. While I expect a short term market rally to start some time early this week, I would be loathe to chase a gap up opening. If we get a pullback I will take the temperature of the market and consider adding to my longs at that point. I will be paying attention to market breadth and the put/call ratio on a pullback.

Reaching Maximium Oversold

I did not think that the market would get maximum oversold because of the end of the month markups, but it looks like we are heading there. The market will be maximum oversold at the end of the day on Monday. Once the market is maximum oversold it becomes increasingly difficult for the market to make progress on the downside. The market should see support through the latter part of the week and a down day on Monday should lead to a decent short term long side opportunity. This is corroborated by the large jump in the VIX.

In the medium term the oversold reading is a market negative. The above chart shows that the market is the most oversold it has been since the March low. This means the market has gained downside momentum and that any short term rally is likely to ultimately fail. Any low made this week is likely to be retested in the weeks ahead.

Normalized Earnings

An explanation of why banks are cheap based on "normalized earnings".