The Case For Gilead

I have rebuilt my stake in Gilead during its most recent decline. Aside from the attractive valuation, I believe there might be some short term catalysts to help the stock and the recent pressure on the stock might soon lift:
  • After a two year roaring bull market Gilead is one of the few stocks where investors might still have tax losses. The stock is down over 15% for the year and over 30% from its all time high. If there has been tax loss selling in the stock it should soon abate.
  • Gilead is a former growth darling. While most of the growth investor base is now gone, there were still some growth funds with stakes at the end of the third quarter. I believe that many of the remaining growth funds want this name off their sheets for the new year.
  • Gilead saw some pressure after the most recent S&P 500 rebalancing. Its weighting in the index was reduced because the company has bought back a large amount of shares. That supply should have been digested by now.
  • I believe a Genzyme deal is a high likelihood in the next few weeks, which should be good for the entire biotech sector.
Have a happy, healthy and prosperous New Year.

Small Caps Vs. Large Caps

Small cap outperformance over large caps has lasted for over a decade now. It is atypical for outperformance of one group to last this long. I believe the main reason this trend has been going on  longer than usual is that in the last cycle leverage got a lot of large cap companies into trouble. Small cap companies were less leveraged going into the cycle and came out in much better shape, having to raise a lot less equity.

More recently I believe two factors are have been contributing to small cap outperformance. Large cap companies continue to buy small cap companies even though their own stocks trade at much lower valuations. Additionally, the government has added to the supply of large cap stocks by selling huge stakes in Citigroup and GM.

I prefer large cap stocks because of the liquidity and the better valuations but am not quite ready to make a large cap over small cap bet. The government will still be selling a huge AIG stake into the market as well as the rest of their stake in GM and possibly GMAC, all large cap stocks. With that type of overhead supply in the large cap space I will wait. Once that supply is out of the way I might consider a large cap over small cap bet as the valuation gap is ridiculously large.

My List For 2011

The past year was a breakthrough year for me. It was not nearly my best year percentage-wise, but a year when I was disciplined at almost all times. While that may seem like a small feat, I have been trading since 1996 and it took me 14 years to reach this point. Here is my list of trading goals for 2011:
  • I hope to continue to be patient and disciplined in 2011. When sitting in front of a screen all day, it is natural to want to do something. Waiting for the best opportunities is difficult and that is why it is so rewarding.
  • I caught every major low in 2010. However, I sold a good chunk of my exposure into the initial strong thrusts higher. In each case I thought we made a low but was worried about a pullback and thought I would be able to reload into one. While I believe that taking some profits after a nice move is a good idea, I want to try not to worry as much about the wiggles if I believe we are in an intermediate move higher.
  • I believe its better to put one's eggs in a few baskets and watch those baskets like a hawk, than have eggs all over the place that one cannot possibly watch. Too much diversification leads to mediocrity as one can only keep up with so many companies. That said, I would like to try and diversify a little more this year. I have a natural desire to put more and more money into my best ideas, but there is a benefit to a little bit more diversification. That means doubling down on research and buying in smaller increments. This is especially challenging right now as fewer companies meet my value criteria. 
  • I hope to keep an open mind. So many things I strongly believed in a few years ago, I now believe wrong. There is no place for absolutes in investing. 
 I believe this blog was a big factor in improving my trading. It forces me to clearly explain what I am doing and why. Readers question me if I don't do so. Thank you to all the readers.

Last Day of Trading

There was a very sharp drop last year in the final minutes of trading. Additionally, the final day of trading has had a negative bias. Year end influences will likely effect trading today more than any other factors. I remember year end being slow but not quite as slow as what we have seen the past couple of week. I am looking forward to a little more volatility.

Slow Day Discussion

I want to bring to the forefront a discussion that has been going on in the comment section of the blog on an ongoing basis. I am of the belief that money flows move the market. Looking at recent data:
  • There has been a steep rise in margin debt.
  • According to every survey I have seen equity allocations have been rising.
  • Short interest has declined to levels not seen since 2007.
  • Put/call data and the VIX point to a very unusually large proportion of money going into calls.
All the data that I look at point to money flowing to the long side and it is no surprise to see that the markets are higher. The reason I believe tracking this data is important is because once the crowd is already positioned aggressively in either direction, than there is little left to fuel a continued move. It is this data that had me aggressively long this Summer and this data that now makes me cautious.

There are assumptions that I am making. I assume that surveys roughly reflect what people are really doing. I assume that a preponderance of calls being bought means that people are bullish, even though some call purchases can be paired with a non-bullish position. There are other assumptions that go into this method. But that is the reason I use a lot of data and when it is all pointing in the same direction I have found it to be correct. Nothing is perfect.

Some readers in the comment section are suggesting that the "aggressiveness of buyers" is what moves markets and that money flows do not matter. They offer no definition of "aggressiveness of buyers" and no way to measure it.

Sometimes Simple Is Best

I try not to go short during the last few months of the year unless one of the two following things happen:
  1. The sentiment indicators I look at are clearly at an extreme.
  2. There is a bubble bursting like in 2007 and 2000. 
This does not mean that I must go long or cannot be hedged but it means that I try to avoid being net short. In general, I am willing to go both long and short and am a mean reversion trader. The fact that a four month straight up rally did not run over me is surprising. A few years ago it likely would have. Not only have the past four months been not bad, but they have actually been good.

I changed my posture to net short about two weeks ago once sentiment was very clearly at an extreme and I have gotten nicked for about 15 points on the S&P 500. During the past few months some readers commented that my unwillingness to go short because of the calendar was simplistic. I would rather be simple and avoid losing money than sophisticated with large losses.

Seasonality Update

The second to last trading day of the year is typically the strongest day of the Santa Claus Rally. That works out to tomorrow.

No More Rainy Days

As long as the crowd is right about 2011 being a fabulous year than there is not much to worry about. How prepared are investors if something does go wrong?
  • Margin debt is at $299 billion which is pre-September 2008 levels. NYSE net cash balances are negative $35 billion.
  • The VIX and put/call ratios point to a market that is not well insured. 
  • Short interest is at levels not seen since 2007. The shorts will not provide much support for the market.
An unforeseen event combined with these facts are a recipe for disaster. But we all know that doesn't happen when all the pundits are saying that 2011 will be rosy.

Investing is not only about preparing for the most likely scenario, but preparing for all possible scenarios. Few are prepared for anything to go wrong.

One More Sentiment Extreme

According to Bespoke Investment Group short interest as a percent of float of the S&P 500 is at a level not seen since 2007. Yet another piece of sentiment data that will not matter until it does.

Beware The Lockups

Tesla Motors, which had its IPO about a half a year ago, has been rocketing higher for months burning short sellers along the way. Yesterday, it fell 15% as the lockup to sell shares expired. When a company goes public typically only a small portion of the company starts trading while the remaining shares held by company insiders or outside investors are locked up and cannot be sold until the lockup expiration.

Lockup expirations were very important during the Internet bubble. Many companies losing money would have market caps in the tens of billions of dollars while less than 20% of their shares were trading. Suddenly the lockup expiration would hit and the stock would melt as a wave of sellers hit the market.

I stopped paying attention to lockup expirations a long time ago because they only tend to matter with very overvalued companies. However, with all these China IPOs that few know anything about (replace .com with China) it could start to matter again. If you hold a recent China IPO highflying stock it might make sense to pay attention to the lockup expiration. There is a free calendar each week in the Wall Street Journal.

Commodities In Lock Step

The fact that commodities are moving higher in lock step with stocks will pose a problem for markets at some point. I view this as a problem for a number of reasons:
  • Higher costs for basic items like food, clothes and energy act as a tax on the lower and middle class. This will be a headwind to growth.
  • The Chinese have an inflation problem, in large part stemming from the rise in commodity prices. Prices for goods coming out of China are rising rapidly. For years we have been importing deflation from China. If this continues we will be importing inflation.
  • Eventually these price increases will show up in government statistics. At that point Ben Bernanke will haveto back off QE II and rates can potentially go a lot higher. 
This is not something that will happen in a day and will likely be a prolonged process if it does occur.  However, the point of recognition for markets does not necessarily need to be a prolonged process. In markets things tend not to matter, until they do.

My Framework For 2011

A few readers have asked me for predictions for 2011. I don't come into a year making predictions but rather with a framework on how I view the economy and the markets. During the year I use this framework in addition to short term considerations such as sentiment, seasonality, technicals(overbought and oversold) and valuation among other things to make investment decisions.

I believe we are currently in a cyclical recovery within a secular bear market. Normally, it is too early to look for a major turn less than two years into a cyclical recovery. However, given the unprecedented imbalances and stimulus we are seeing, I believe there is a much higher chance of the recovery being derailed than in a normal cycle.

 Among the largest risks I see are:
  • Unprecedented liquidity in the form of money printing leads to inflation or inflation is imported from countries like China. That leads central bankers to hit the brakes and results in higher rates.
  • China is trying to fight inflation and perform a "soft landing". The last time we heard the phrase "soft landing" was 2007 and before that was 2000. We all know how those worked out for markets. 
  •  European banking and/or sovereign crisis.
  • US municipal crisis or fiscal crisis. 
The economy is like a supertanker and rarely turns on a dime. In order to see a major turnaround I believe that a crisis will need to hit. But a crisis is a larger than average potential outcome, given the state of the World. I don't believe valuations are pricing in many problems and investors cannot afford to have anything go wrong.

To summarize my framework for 2011: the economy is unlikely to turn on a dime given that we are slightly less than two years into a recovery but an event that can derail it is a higher than normal potential outcome. Some were probably looking for a simpler answer like the market will be + or - 12%, but the market is not that simple.

Overall Market

The near term call on the market is tough but looking out a few weeks my bent is still on the bearish side. We are seeing record breaking sentiment levels which typically lead to corrections. However, we are also in a very seasonally strong part of the year. To make things tougher the strong seasonality usually works best in good years such as the one we just had.

In hindsight, when we look back at this week the outcome will seem obvious. If we go lower everybody will point to the nosebleed sentiment levels and if we are higher everybody will point to the seasonality. So why am I bearish on what seems like a coin toss? Because when I look out further, even if the market does make its way higher in the next week or so I believe it will be a last gasp. I believe there is a couple of percent reward on the upside with a lot more downside potential.

The Liquidity Is Outside

I have spent the entire morning digging out and am only about 50% done. While the news reports try to sensationalize every snow fall as the storm of the century, this one is really bad. That means that those traders that are not on vacation will have a difficult time getting to their desks. Liquidity will be thin.

I believe the best way to take advantage of this illiquid market is to be a liquidity provider. If an individual stock one owns seems to be up a lot for no reason, paring back the position with an eye on rebuilding it on a dip is a viable strategy. By the same token buying a stock that is having an outsized move lower for no apparent reason is also a good strategy as long as one would not mind owning the stock. Under and over reactions to news are other ways to try and take advantage of the situation.

We're Not Printing Money

Here is Jon Stewart speaking about  Ben Bernanke not printing money.

The Daily Show With Jon StewartMon - Thurs 11p / 10c
The Big Bank Theory
www.thedailyshow.com
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Have a very Merry Christmas and a great weekend.

Who Do You Trust

Other than pointing out the seasonality, trying to analyze the market right now  is an exercise in futility. Instead, I thought we could play a game. Who do you trust?




 I had to give Bill Clinton two spots. Both were classic. Ben Bernanke almost received a second spot for his 100% certainty that he can control inflation.

Ben Bernanke Is Coming To Town

Merry Christmas from the bearded man at the Fed. I have little to add. Have a good night.

Further Added To Gilead

I have further added to my position in Gilead. Gilead is a former growth darling that is now a leper in the growth community. While most of the ownership has changed hands already there are  a couple of growth funds still paring down the position. For instance, as of September 30 Janus was able to cut about half its position in the stock, but still had a 20 million share position.

I suspect that the remaining growth funds in the stock want the position off their sheets for the New Year. Gilead was the only stock I follow that traded above average volume yesterday. These funds are selling into a very illiquid market. I am willing to give them the liquidity they are seeking and believe I will be able to sell for higher prices in the New Year.

Sunny Day

Sunny Day
Sweepin' the clouds away
On my way to where the air is sweet

Can you tell me how to get,

How to get to Sesame Street

Come and play

Everything's A-OK
Friendly neighbors there
That's where we meet

Can you tell me how to get

How to get to Sesame Street


-My proposed new theme song to Squawk Box
I am at a loss for words at this point. The market has gone up unabated for four straight months. Nearly every sentiment indicator I look at is sitting at multi-year extremes, yet has not mattered. Everybody is forecasting a great year in 2011 except for a few perma-bears. None of this seems to matter as the market is just not reacting to any extreme other than a brief pause here and there.

This is not the type of market I prosper in as I am more of a mean reversion trader than a trend follower. Surprisingly, I have been able to pick my spots in the past four months and have navigated this market pretty well. This is the first time I have been caught short since the rally started and even if my puts expire worthless it will only be a small pimple. That said, going forward it will be increasingly difficult for me to perform if we do not get a correction as the pockets of value I have been able to find are disappearing and my uncomfortableness is growing.

Inflationary Pressures Heating Up

Commodities have been moving up in lock step with equities. Eventually, that will disrupt the virtuous cycle I described this morning of cheap money leading to buybacks and M&A. Evidence is gathering that inflationary pressures are heating up:
  • China has been a source of deflation but there are daily stories of inflation and price increases coming from China. Most notably, a contact of mine received a 30% price increase in the cost of clothing from their Chinese manufacturers.
  • Depending on which commodity index one looks at, commodities are up between 15% and 25% this year. Were it not for the brief 2008 spike in energy prices indexes would be at all time highs.
  • The newspapers are rife with stories about less discounting this holiday season. 
  • Con Agra has been one of the latest food companies to complain about rising input costs. They are raising prices and reducing the size of packages. 
  • The price at the pump is rising and brent crude trades at $93. Once oil crosses the psychologically important $100 level it will be hard for Ben Bernanke to maintain there is no inflation.

    Beating The Dead Mutual Fund Horse

    Every week there are mounds of articles about how retail investors are bearish because of the outflows from equity mutual funds. When was the last time you heard anybody who wanted to invest looking at equity mutual funds? Fifteen  years ago institutions and retail investors alike flocked to equity mutual funds. A number of shifts have made investors look elsewhere when investing money.

    Technology in the form of indexing, ETFs and cheap online trading have made mutual fund investing less attractive. Data showing that indexing consistently beats mutual funds is widely known. On the institutional side alternative investments such as hedge funds have provided even more competition for mutual funds. Some investment advisers push mutual funds because of the fees they receive but other than that mutual fund investing is in decline.

    Bond mutual funds have held up well because it is much tougher for retail investors to buy bonds. The bond market is still a dealer market and bonds rarely come in bite sizes. Add to that the declining risk profile of aging baby boomers and the increase in assets in bond mutual funds makes a lot more sense.

    The resounding bullishness in the individual investor sentiment survey, the meteoric rise in margin borrowing and the increase in option trading are probably a better gauge of retail investor sentiment than mutual fund flows.

    Memories of 2006

    There was an article in the Wall Street Journal yesterday showing that there were nearly $100 billion in buybacks during the third quarter. While the dollar amount was not as high as before the credit bubble burst, as a percentage of market cap of the S&P 500 buyback activity was at similar levels. Buyback activity is much more bullish than investor buying because corporations don't turn around and take profits (at least not until there is trouble).

    I have been thinking for weeks about how much the current rally reminded me of the rally from late 2006. But  did not realize how similar the situation actually was. The bad news for the bears is that there was no real pullback of greater than 2%-3% until there were rumblings from the subprime market.

    There are some differences between the current market and 2006. Back then we would get $10 billion - $20 billion a week in LBO announcements. While M&A has picked up it is nowhere near that type of activity. Additionally, in the past few months we have seen a lot more supply with the largest deals being GM, Citigroup and Blackrock. Next year the government will be selling AIG and the remainder of GM. Private equity firms are also trying to unload the LBOs of yesteryear.

    I believe we will see corrections of greater than 2%-3% because buyback and M&A activity are not quite as strong as they were in the comparable period before the credit bubble burst. However, in order to see a larger move lower something will need to go wrong. A move up in borrowing costs would likely be the catalyst whether it be because of a move up in interest rates as a result of inflation or spreads widening because of a sovereign or municipal crisis.

    Don't Worry, Be Happy

    Yet another day when caution did not pay. Maybe when I finally get the hang of it the market will finally correct. It feels like people are shutting down for the year as stocks are trading well below average volume.

    For those focused on seasonality the strongest days are between Christmas and New Years, so there is some room in the next couple of days for a down day. We might even see a dodo bird. Have a good night.

    The Ticking Time Bomb

    Sentiment continues to hover at dangerous levels as we enter this seasonally strong time of the year. Many are willing to ignore sentiment data because it has not mattered to this point. That is akin to standing next to a ticking time bomb because it has been ticking for a while but has not gone off yet.

    It is certainly possible that the strong seasonality may delay any correction until January. However, it seems that is what everybody is banking on. By definition not everybody will get out safely. I understand the desire to play the strong seasonality but with the VIX at 15 there is little excuse not to take some protection along for the ride.

    Last Thing

    The S&P additions today will have a minor negative effect on the S&P 500 in the last half hour.

    Things That Make Me Say Hmmm

    Why did the VIX go down so much today on expiration? Are Johnny Come Lately investors now selling vol? How does that end?

    Calling It A Week

    The VIX is imploding once again as caution has become a fool's game. This fool is taking his SPY Puts home for the weekend. Have a great weekend.

    Change Of Plans

    I am completely out of TLT. While I think treasuries are good for the next couple of weeks, its not a position I want to get stuck with. Better early than late.

    Out Of Visa

    I sold Visa for a gain.

    Catch The Knife

    Visa is down for a second day in a row and I am attempting to catch the knife.

    US Outperformance

    A recent Bank of America-Merrill Lynch survey shows that a net 16% of fund managers are overweight US equities, while a net 4% are underweight European Equities. In November the same survey showed managers with a net 1% overweight in the US and a 15% overweight in Europe.

    Global fund managers were positioned entirely wrong at the beginning of November and I believe that is the case once again. The strong overweight in US equities leaves little room for increasing allocations to the US and is a headwind to continued outperformance of US equities in my opinion.

    Bond Bottom

    I will likely be out of the TLT I bought Wednesday afternoon today but am letting my original position ride.

    Tops Are Processes

    Bottoms are events and tops are processes. A good example of a bottom was on September 1 when the S&P 500 shot up by 30 points and never looked back. A good example of a top was April when we saw a market that started trading sideways in mid April and did not crack until late April, nearly two weeks later.By the time a top is formed even the bears have given up.

    The fact that options expiration is today did not help the bears. Expiration often serves to help a trend persist, only to see the market come down the following week (as a few readers pointed out). I believe the market is topping but what worries me is that Christmas is coming along with the positive seasonal tendency. That may serve to extend the topping process or even bring a marginal new high. If we do get an expiration hangover early next week I might be more inclined to cover my net short but I will likely stay tightly hedged.

    Vicious Cycle

    Treasuries have been in a self reinforcing cycle for the past few days where selling has begot more selling. They seem to have stabilized, which hopefully has stopped the process.

    Bulls On Defense

    The bulls have successfully defended 1134 on the S&P 500 for two days now. Given recent history it would not be surprising to see the bulls mount a rally from that level. However, they have expended so much energy buying calls at this level  that I would be surprised to see a rally with any oomph. A solid break of 1234 would likely cause some weak hands to fold and might set up a better bounce.

    DOES NOT COMPUTE

    Despite the fact that the market was lower yesterday investors enthusiasm for stocks did not wane. Put/call ratios show continued call buying, albeit slightly below the record breaking pace we have seen recently. Rydex traders actually increased their already extreme bullish positioning.

    This morning we are looking at a gap up as enthusiastic investors bid up prices. This is not what sentiment looks like after a healthy correction. The market has traded in a fashion that makes corrections feel like an impossibility but I can assure you they are still possible. The momentum trading robots will swing the other way if the markets start heading lower, even if right now they are saying "Two down days in a row. DOES NOT COMPUTE"

    Just Call Me

    Thus far the market is responding to a sentiment extreme much in the same way it has been recently. We are seeing a pullback, but the market is not falling apart. 

    I added to my treasury position this afternoon and am going home long Treasuries and short stocks. You can call me dumb, deaf and stupid. But don't call me consensus. Have a good night.

    Long TLT

    While I think treasuries are a terrible long term investment I am long TLT for a trade.

    Net Short

    I have used today's strength to move to a net short position via January SPY Puts.

    Overbought

    The market is now overbought as seen in the chart below. However, the current overbought reading is weaker than the ones we saw earlier in the rally. This points to a loss in momentum, otherwise known as a negative divergence. A strong overbought reading has positive medium term implications as it speaks of a market with a lot of underlying strength.

    There is also a negative divergence in the number of new highs. On November 4 there were 569 new 52 week highs on the NYSE. During the current rally the highest reading was 431. Even though the market has made a higher high, the number of stocks participating has decreased.
    The reason I say the market is overbought is that we are dropping high numbers from the 10 day moving average of the advance-decline line. The numbers we are dropping are shown below. Today, we are dropping 1727, meaning that a number below 1727 will start taking the line lower. We would need a monster rally today to get a reading higher than 1727. Over the next eight days we will only be dropping a single negative number of any size, meaning that the line on the chart will likely be heading lower.


    In addition to the sentiment extremes we now have an overbought market with negative divergences. While this is the season to be jolly everything else is in the bears favor.

    Nothing Done

    That was one of the least volatile post FOMC reactions I have ever seen. We did indeed make a high shortly after the decision but one had to squint to see it. Unfortunately, it was not enough to get me a fill on my order. I remain very tightly hedged (likely slightly over hedged) but not meaningfully net short.

    The ball is now in the bears court. We are overbought and sentiment is extreme. If the bears are going to make a move it should happen in the coming days. Have a good night.

    Locked and Loaded

    My orders are in. I will likely get filled on my order to buy SPY Puts if the S&P 500 approaches 1250.

    Victim Of The Internet

    The electronics retailer, Best Buy, missed badly and I believe the disappointments will likely continue into the future. As more people become comfortable shopping online it makes little sense to shop at a brick and mortar electronics retailer. There is simply no way for Best Buy to compete with online merchants who have little overhead and sell for razor thin margins. I believe Best Buy is a company in secular decline and while it may look like a value, I believe it is a value trap.

    The View From The Top

    At market tops the bullish arguments always sound best. There are always great reasons why the market should continue higher. But once everybody is convinced by the bullish arguments there is little money left to propel the market higher. Looking at a chart of the 10 day moving average of the CBOE put/call ratio it is quite clear that the crowd has been convinced that it's up, up and away. This is about as bullish as they get.

      
    Adding to the sentiment extreme, the market will be overbought at the end of the day today. I have written at length about how I loathe going short at the end of the year and thus far it has been a very good decision not to go net short. However, one out of four times the market does go down at the end of the year. Given all the extremes we are seeing I believe we are in year four. I plan to use the volatility surrounding the Fed meeting to establish a net short position.

    I See A Bad Moon Rising

    Despite another day of call buying for the record books, the semis and small caps are now down on the day. They have been the leaders of the rally. I see a bad moon rising. Have a good night

    Hard To Contain

    I am having a very hard time stopping myself from buying more SPY Puts. I have rarely seen such unbridled bullishness. I am trying to save the bulk of my buying for after the Fed meeting tomorrow.

    Roll Out

    I have rolled my long SPY Puts from December to January. I also rolled the strike up. This makes me ever so slightly shorter.

    What To Be Long

    John Hussman has some excellent charts this morning showing valuations of Cyclicals compared to Consumer Staples. Consumer Staples are at historically cheap valuation extremes when compared to Cyclicals. If one wants to be long it makes a lot more sense to be buying Consumer Staples. From Hussman Funds:

    Fun Fact

    Margin loans outstanding are not a short or even intermediate term market timing tool but they do tell a story. At the beginning of the Summer margin loans outstanding were approximately $230 billion. At the end of November margin loans outstanding were close to $300 billion. I am not going out on much of a limb by saying they are probably even higher now since we rallied by over 4% since then.

    Breaking The Rules

    As I outlined on Friday every sentiment indicator I look at is sitting at an extreme. In addition, the Fed meeting tomorrow will coincide with the market becoming maximum overbought. We often see a lot of two way volatility following a Fed meeting. I will likely attempt to use that volatility in order to establish a net short position.

    I try not to go net short at this time of year as I am not a glutton for punishment but the current setup on the short side cannot be ignored. With the VIX sitting close to 17 I believe that put options are a low cost way of establishing short exposure with defined risk.

    Doorbuster Markups

    The stock market works in an opposite manner to department stores. Investors are excited to buy stocks when they are marked up rather than when they are on sale. This week we have seen a markup on some of the hottest merchandise, the low dollar financial stocks. That will likely entice eager retail buyers over the weekend.

    At the end of the day on Tuesday we will be maximum overbought. With all the sentiment indicators lined up maybe we will finally see some downside following that. Have a great weekend.

    Please note: I previously said we will be maximum overbought at the end of the day on Monday in error.

    Seems Wrong

    It seems wrong to me that NFLX and FFIV are not up more on their addition to the S&P 500. If I were not so scared of stocks trading at close to 100 P/Es I would probably trade them from the long side.

    More Of The Same

    We are seeing continued heavy call buying this morning yet the market remains resilient. I would note that it always feels like the market can't go down at tops.

    Sentiment Is Extreme

    There are three areas that I look at to gauge sentiment and all three are singing the same tune.
    • Survey Says- All sentiment surveys are pointing to a bullish sentiment extreme. My favorite survey for intermediate term sentiment is the Investors Intelligence survey. The number of bulls are at a new high for the bull market and the bears are at 21%. I prefer it when the bears are under 20% but this is close enough.
    • Rydex- Rydex traders are positioned about as bullishly as they get.
    • Put/Call Ratios- The two put/call ratios that have worked best in the past year have fired off sell signals.
     Were this not the time of the year when sentiment can get to an extreme and stay at an extreme I would be aggressively short. As it stands I am tightly hedged. The timing of a correction is tricky because we will not be maximum overbought until the end of the day on Monday. Than we are bumping up against option expiration, which often serves to extend  a rally. Than we are bumping up against Santa Claus rally time. Even so, if there were a gun to my head and I had to be long or short for the next two weeks, I would be short.

    Party Continues

    Since today is Put/Call ratio day I will note that a sell signal was triggered by the 10 day moving average of the CBOE total at the close. However, we will not be maximum overbought until the close on Monday and I suspect the bears will have to wait until then. The strong move in the banks will likely keep the animal spirits raging long enough to suck in the weekend money. No stock sparks the imagination of the retail crowd like Citigroup and the stock has had a nice move.

    While it now looks like this rally has a little more time I am remaining tightly hedged. It is difficult to watch a party like this from the sidelines but at least I won't have a hangover in the morning. Have a good night.

    Reviewing The Put/Calls

    After reviewing four put/call ratios and their performance this year in picking tops, the two clear winners are the CBOE Total put/call and the dollar weighted equity put/call. The CBOE total gave three signals and all were good. The dollar weighted gave the same three signals plus caught the top in early August that the CBOE total missed. However, it did give two additional signals that were more like resting points.

    The dollar weighted equity put/call gave a sell signal at the close yesterday and the CBOE total will likely give one today at the close or in the coming few days. In most instances when these sell signals occurred the market was maximum overbought. That will not happen until the close on Monday. Still, it does not seem like a time when one should throw caution to the wind like most are doing.

    The ISE Equity

    Once upon a time the ISE Equity was my favorite indicator. It was like putting my hand on the pulse of the market. The chart is shown below.

    In the past year it has given two false signals. Like the CBOE equity it gave a false signal earlier in the year. The signal came in early April, so it was a little better than the CBOE Equity. However, it now gave off another false signal. This is directly attributable to the options trades in stocks like Citigroup and Bank of America.

    CBOE Equity Only

    I know the CBOE Equity Only is a favorite of many readers of the blog. The chart is shown below.

     

    The chart has basically given the same signals as the CBOE Total, except for a huge false/very early signal in early March. That is likely because there was a lot of speculation happening in small bank stocks at the time that were skewing the ratios.  Currently, the CBOE equity only triggered a sell signal at the close yesterday.

    Buying Puts

    There is insane call buying wherever I look. I purchased SPY Puts and am very tightly hedged. I would get more aggressive but the market will not be maximum  overbought until the end of the day on Monday. I want to save the bulk of my powder in case we are able to rally until then.

    The CBOE Put/ Call

    The CBOE Put/Call has been the best this year at identifying tops. As the chart below shows the 10 day moving average pierced the 0.8 level on three occasions. All three occasions led to moves of at least 50 points lower on the S&P 500. There were no false signals.


    While it may appear that we are not yet close to a sell signal that is not the case. A low reading today would get us one as we are dropping a very high number.

    Dollar Weighted Put/Call

    I purchased some very expensive put/call data yesterday to help alleviate my concerns about how Citigroup and Bank of America options may be skewing the put/call ratios. The data I purchased is dollar weighted put/call data, hence cheapie options have little effect on the data. Unfortunately, I am not certain if I am allowed to share a graph based on that data so I will err on the side of caution and not show the graph. However, I will describe the results.

    Using a 10 day moving average we are currently getting a sell signal triggered only six other times this year. On 4 occasions we had pullbacks of at least 50 points on the S&P 500 and on two occasions we had smaller pullbacks of a couple of percent, but the market did pause for a while during those two other occasions. I will post a few more columns today looking at the other put/call ratios and evaluate how they worked this year and what they are saying now.

    I spend thousands of dollars a year on research which benefits all readers. You can give back to the blog at no cost to yourself by simply using one of the Amazon links on the side of the page when shopping at Amazon. Thank you to all the readers who have already been doing so.

    Skewed Put/Call Ratios

    At times during the past year we have been seeing very extreme readings on the put/call ratios. In April the ISE equity only reached levels never seen before. I believe the data may be distorted due to low dollar stocks like Citigroup and Bank of America. A call on Citigroup likely costs pennies and does not deserve the same consideration as a call on a stock such as JPMorgan but it is afforded the same consideration.

    According to ISE data about 110,000 call options were bought today on Bank of America and Citigroup combined, while only 5000 Puts were bought. That tremendously skews the data even though there was likely not as large a cash outlay on those options as there would be with higher dollar value stocks.  I am looking for a way to get a better reading. Do any readers know where to find one?

    Defensives Outperforming

    For the first time in forever defensive stocks are outperforming today. Is the rotation into economically sensitive stocks finally over? Semiconductor and industrial stocks trade at high teen multiples to what is likely close to peak earnings, yet Kimberly Clark languished at twelve times. Maybe a recovery is already priced into the economically sensitive stocks?

    Unrelenting Bullishness

    I do not use chart patterns in my trading but even I know that yesterday was a classic bearish reversal day. One would think that would make market participants a little less bullish. One would be wrong as there is hand over fist call buying today. This is not a positive for the market.

    The Year End Pile On

    All the evidence I see, both anecdotal and statistical, tell me that investors are at an extreme level of bullishness. It seems everybody is geared up for a year end rally and the bears are non-existent. Normally, under these circumstances I would be aggressively shorting the market. However, experience has taught me that this is the time of the year when sentiment often gets extreme and stays extreme.

    Statistically, the only thing the bulls have going for them is that the market is not overbought. The S&P 500 is roughly in the same place it was a month ago. Additionally, the Ireland crisis is still showing up in the shorter term statistics. That said , the bulls are close to all in long and its tough to see where the fuel for a continued rally will come from. But the Grinch doesn't usually get paid much at this time of year.

    The best of the gains are likely behind us and there is room for a small correction in the next couple of weeks but a bigger correction will probably have to wait until January. As such my shorting is largely to hedge my longs and I am not net short.

    Bears Turn

    I believe the bears will be in the driver's seat for at least a few days. Barring a shock I am not expecting a huge move down, mainly due to the calendar. Have a good night.

    The Highs Are In

    I believe today will mark the highs for the next couple of weeks. The news is as good as it gets, there is extreme call buying, extreme sentiment and heavy supply of new issuance is hitting the markets.

    Who Are You Going To Believe

    The CRB is breaking out to a new 2 year high this morning. Chairman Bernanke says there is a 0% chance of inflation. Who are you going to believe, Ben Bernanke or your lying eyes?

    From INO.com

    Where Does This End

    In late 2007 the market did not look pricey based on expected earnings. However, those earnings expectations were based on a continued real estate and debt bubble. As we now know those earnings never materialized once the bubbles bursted. We are in a similar situation now where stocks are not historically expensive versus expected earnings but the economy is being held together by many unsustainable influences.

    Current earnings are based on an economy where the US government is running a trillion dollar deficit, municipalities are spending well beyond their means, the Fed is printing money, insolvent banks are being propped up as are sovereign nations etc..

    This does not mean we are headed lower as the same could have been said in 2005 and 2006, yet the market continued higher. The question to ask is how will we know when when this unsustainable situation will end? I believe the answer is higher inflation and higher interest rates. Current policies will eventually lead to higher inflation. That will force the Fed to step off the gas at which point higher interest rates will start to choke the economy. Oil above $100 a barrel or food price hikes being passed through in earnest would put serious pressure on the Fed and eventually on the stock market.

    I believe the market is currently overvalued based on the level of sustainable economic activity. I understand that many people want to go along for the ride. The key is to understand that one is playing a game of musical chairs  and the day will come when the music stops.

    Small Short

    I was sitting on the fence deciding whether to put on some shorts but the Citigroup offering nudged me over. I shorted some SPY in the after hours.

    Citigroup Offering

    The government is going to do an offering of their final 2.25 billion shares of Citigroup, which should yield them roughly $10 billion. Additionally, there are roughly $4 billion worth of other offerings scheduled for this week. I believe this heavy supply increases the chances that the market heads lower this week.

    Advantage Bears

    I believe the bears have the advantage for the balance of the week. We have weaker seasonality ahead and bullish sentiment is too widespread. Additionally, a lot of call buying today was not able to do much for the bulls. Have a good night.

    Bought Back SPY Puts

    Early last week during the Ireland scare, I shorted SPY Puts. I bought back those puts back for pennies on the dollar. With the VIX at 18 there is no need to be short way out of the money puts.

    Put Him In The Bathroom

    "Well, this fear of inflation is way overstated. One myth that's out there is we're printing money. We're not printing money. "
    - Ben Bernake in his 60 Minutes interview

    Bernanke said he is “100 percent” confident that, when necessary, the central bank can control inflation and reverse its accommodative monetary policy. 
    -Bloomberg News
    After being wrong about every major macroeconomic forecast he has made since becoming head of the Fed, Ben Bernanke has not lost much confidence in his forecasting abilities. He is 100% certain that inflation won't be a problem. He must believe he is due to be right after saying that housing wasn't a bubble, that subprime was contained, that the credit crisis was contained, etc. After all nobody can be that wrong, that often.

     Ben Bernanke reminds me of that gambler in A Bronx Tale, who always loses. Right now those betting on Treasuries might want to put Ben Bernanke in the bathroom.

    The Monday Bounce

    Late Friday it looked like we were setting up for what has become a weekly ritual, the Monday Bounce. But those pesky Europeans have thus far  put the kibosh on a rally. If we get a typical Monday bounce I will be looking at the short side.
    • Sentiment is at an extreme level where we have typically seen a negative risk/reward profile for the market. Sentiment moderated a little with the European scare but there has been very heavy call buying the past 3 days.
    • Who does not expect a year end rally at this point?
    • Seasonality is less of an issue for the next couple of weeks as we have passed the beginning of the month. As we approach Christmas seasonality will favor the bulls again but for now its neutral. 
    • Although not a great reading, we are slightly overbought.
    Any shorts I add today would likely just neutralize my modest long exposure. I see little reason to remain long given the factors outlined above. I will likely use options in going short as insurance has become cheap with the VIX at 18.

      Bulled Up

      There is nothing like bad news not driving the market lower to get everybody bulled up. The pattern in these situations has been to see money come in over the weekend followed by a Turnaround Tuesday to the downside. Also, please note the large move up in commodities today and higher rates despite the weaker economic numbers. Will the vigilantes be knocking on our door soon? Have a great weekend.

      Sleeping With The Enemy

      It is becoming increasingly clear that that all the tax cuts will be passed and extended unemployment benefits will continue. President Obama wants a strong economy for his re-election so he is willing to sleep with the enemy in order to ensure it. The deficit will remain close to 10% of GDP and that is before an onslaught of baby boomers retire and start collecting Social Security and Medicare.

      While the problems in Europe might seem foreign, it is only a matter of time before the bond vigilantes come for us. Politicians will not make hard choices unless they are forced to. I am not certain the bond vigilantes will give Obama until his re-election. At that point the adjustments that we have fought tooth and nail for the past two decades will finally happen.

      The Short Term Bear Case

      I am considering shorting into a gap up on the employment report for the following reasons:
      • Sentiment surveys are still at bullish extremes.
      • After pulling back a little during the recent correction, Rydex traders are back in an extreme bullish position.
      • There has been extreme call buying for two days in a row.
      • The beginning of the month has passed.
      • The short term oversold condition that existed at the beginning of the week is gone.
       But the following are making me have second thoughts:
      •  I hate being short at this time of year.
      • While the market is slightly overbought now, it is not at an extreme.
      • Other than the ISE Equity, the 10 day moving averages of the put/call ratios are not at an extreme.
      I am still considering if and how to play a gap up this morning (if we get one). 

      Rates and Commodities

      With oil at a new 2 year high and interest rates starting to rise, at some point good news could become bad news. If oil surpasses the $100 level the Fed will have an awful hard time making the case for deflation and a continuation of QE II.

      Getting Silly

      The optimism is getting a little silly but seasonality is stopping me from trying to fight this move quite yet. If we gap up on the payrolls number tomorrow I may venture over to the short side.

      Standing Up For Seasonality

      There was a widely discussed article last week about how seasonality has not been working. That could not be farther from the truth, especially when one considers that seasonality is only a single factor and that there are other factors that drive the market.

      2010 started off with a rally followed by a correction right after January options expiration. That is about as typical as it gets. We rallied right through the seasonally strong period at the end of April, even though many other indicators were pointing to a top at the end of March. Seasonality trumped them all. Many claim that "Sell In May and Go Away" did not work. Sure, if you measure from the end of April to the end of October than the gains were small. But there was a 200 point draw down on the S&P 500 in the interim.

      Seasonality did not stop me from going long in early July and late September when every other indicator was at a bearish extreme. It did not stop me from shorting a couple of weeks back when we were at bullish extremes. But it definitely deserves to be a factor in one's decision making process. I used the recent correction to tiptoe in on the long side even though the market was nowhere close to bearish extremes. While many factors were involved, a large consideration was seasonality. Had it been Summer I would have waited longer. There is no single indicator that will always work but in my experience seasonality is an indicator worth giving some consideration to in the context of many other factors.

      Hit & Run

      I am out of Bank of America.

      What Makes This Market Hard

      The current market is tough to invest in for both longs and short. While there are overvalued companies, many companies seem to be priced reasonably relative to earnings estimates. The problem is that the economy and credit markets are being artificially propped up by governments and central banks around the World. Without this assistance it is doubtful that earnings prospects would be nearly as high.

      As the past decade and economic history has taught us markets and economies will eventually go to where they want to and government tinkering can only work for so long. What would the current economic environment look like if governments and municipalities were not spending well in excess of what is sustainable? What would credit markets look like if governments were not artificially supporting them? How does one evaluate an economically sensitive company or a financial whose book value is highly dependent on credit markets?

      For the short side the environment is just as tough. An unsustainable environment based on leverage lasted from 2003 through 2007. Who is to say the same thing could not happen again? What if money printing leads to inflation and the market is down in real terms but not in nominal terms?

      I am finding it more and more difficult to find investment ideas and am in hit and run mode. I know it must be frustrating for readers with longer time frames seeing me making the bear case one week and the bull case the next. Unfortunately, it looks like the current environment is here to stay for a while.

      Overbullish

      It looks like market participants are turning too bullish again, but the oversold reading and seasonality might be able to keep the bulls going a bit longer. Have a good night.

      Bailout.gov

      By extending loans to Greece and Ireland all the EMU and IMF are doing is kicking the can down the road. They are not getting rid of debt, only helping roll out the maturities and adding to the total level of indebtedness. Ireland and Greece will now have even more debt that they cannot afford to service.

      Greece will have debt at 150% of GDP in a couple of years by the most generous projections. If one assumes that Greece's interest costs are 5%, they will need to pay 7.5% of GDP a year just to service debt. There is not a chance that is going to happen. But it does look like the bailout machine has succeeded in saving the day for now.

      Renting Bank Of America

      I am renting a small long in Bank of America. I believe this "Wiki Leaks" story is much ado about nothing. The stock would probably be trading closer to $12 than $11 were it not for the story. I am keeping the position very small as I have little faith in the company. This is a pure trade.

      M&A Activity

      Private equity groups raised large funds in the heyday before the credit collapse. Time is running out to spend that money and they either use it or lose it. I doubt that these "Masters of the Universe" are going to let those fees get away from them, whether there are bargains to be had or not.

      Recently we have seen a pickup in LBO activity and M&A activity. I believe this puts a floor under the market for as long as it continues. As long as the junk bond market supports this activity I don't believe it will end.The sovereign and municipal debt issues are starting to spill over into the junk market, but rates are still very supportive.

      The Red Eye

      I am back in town on the Red Eye and have a lot to discuss, but it will probably take a few posts. As I wrote on Monday I believe there is room for a little more downside but barring a default in Europe its hard to see a complete collapse. I believe a default is inevitable but the Europeans will likely be able to kick the can a little further down the road as they are following the script of the Federal Reserve.

      The reason I believe there is room for a little more downside is that while the S&P 500 corrected by 50 points from the top, sentiment has not corrected much. We have seen some fear the past couple of days and I guess one can say we have done the minimum in terms of sentiment correcting. But this is not typically the sentiment seen at the kickoff to strong rallies. It would be nice to get one more move lower that breaks 1175. That should get sentiment lined up for a strong year end rally.

      I sold a  decent amount of SPY puts when the S&P 500 was testing 1175 as I don't see that much more downside from those levels. If we get a break of 1175 I will get more aggressive.

      Capital Update

      I used today's weakness to sell a decent amount of December 116 SPY puts. I respect the possibility of some further weakness but am not expecting a complete meltdown. I will return December 1.

      Capital Observer Is On Vacation

      I am on vacation and will return on December 1. Have a Happy Thanksgiving.

      Thank you to all the readers who have been going to Amazon from my site, when making a purchase. Remember, if you shop at Amazon you could support the blog at no cost to yourself. There is an Amazon banner all the way at the bottom of the page or a number of links on the side. If you go to Amazon through any of those links when you make a purchase, the blog will receive a small percentage. The item will not cost you a penny more.

      The Last Post

      A break on the S&P 500 below last weeks low would likely generate enough fear to get us  a swoosh lower. I believe that swoosh lower could be bought for a trade through the beginning of December. The market is oversold and heading into a strong seasonal period. One last push down would likely get sentiment into neutral territory allowing for a modest rally.

      I don't believe this is a great opportunity but I likely would put on a small trade were I not headed on vacation.

      Good News and Bad News

      The good news is that the market is now oversold heading into a seasonally strong period. The bad news is that sentiment is not yet in place. The CBOE is showing put activity but the ISE is showing call buying. In other words the oversold readings are lining up, seasonality is lining up but sentiment is iffy. It would be nice if we broke last weeks low. That would likely get sentiment in place for a rally.

      Health Care Austerity

      A wave of austerity has swept across the globe as debt markets no longer want to fund ever increasing government deficits. I believe that the austerity trend is here to stay. One of the first things that every country undergoing austerity has done was to cut the amount they pay for drugs to bio-pharma companies.

      Bio-pharma companies are easy targets as there is no love lost between them and the public. The knee jerk reaction is to think "good for them, those crooks deserve it". But looking at the facts might yield a different conclusion.

      The bio-pharma industry has been consolidating as the low hanging fruits have been picked and finding new drugs is extremely costly. R&D costs have been rising and new blockbuster drugs have been few and far between. Companies like Pfizer have wasted tens of billions of dollars on R&D with little to show for it. There are far  fewer biotech and pharma companies than there were 3, 5 and 10 years ago. If companies are paid less for new drugs than there will be even less R&D and fewer new drugs.

      While I believe this is the wrong place to cut costs, I see the writing on the wall. Many bio-pharma companies are cheap enough that further price cuts are more than priced in. But when the time comes that more austerity measures are announced the stocks will likely not react kindly, especially when it happens in the US.

      I have drastically cut my exposure to bio-pharma companies for the reasons cited above and because my largest holding, Gilead, had reached my target. I still believe the sector is attractively priced and still hold some positions but the dangers of austerity are large enough that I don't want as large an overweight in the sector.

      Broken Record

      I feel like a broken record repeating the same arguments day after day but my outlook has not changed. There is a very high level of complacency as many are banking on seasonal factors to carry us through the year. If anything goes wrong in our unbalanced global economy, market participants are ill prepared.

      At the same time, I learned the hard way that it is very difficult to go short at this time of year. In addition, we are seeing a continued M&A bid with private equity going after J. Crew. All in all its tough to have much conviction in either direction.

      I am heading on a much needed vacation tomorrow and my appetite for any type of risk is diminished. There will be better opportunities.

      Cuidado

      One of my favorite market scribes, Doug Kass, takes a shot at those who are going long strictly based on seasonal strength. I agree that seasonal strength in and of itself is not a reason to go long. However, based on the fact that 80% of the past 20 years saw the market up into year end it does make sense to be extra careful on the short side.

      Hangover City

      The day is starting off with a severe expiration hangover. I wrote last week that I believe that a hangover can be bought for a trade through the seasonally strong Thanksgiving holiday and the turn of the month.

      I am not planning on opening any new positions as I am going on vacation on Wednesday. However, if I were to play the long side I would wait until there was put buying, which I am not seeing yet.

      Hedge Trimming

      I have used the pre-market weakness to remove my hedges completely. During expiration a bunch of my longs were called away and I am left with very modest long exposure. In addition, I have already written covered calls against all my remaining longs. In other words there is little left to hedge. If the market were to fall 10% I believe I would take less than a 3% draw down. I still believe an expiration hangover is possible.

      Tis The Season

      There is a lot not to like about this market. Most notably, while the market corrected sentiment stayed way too bullish.  The ten day moving average of the ISE equity did not even dip below 200 during the recent 4% correction. Readings above 200 are usually seen at tops.

      However, seasonality is simply too strong to commit much money to the short side. According to data from SentimenTrader.com the last two weeks of November through year end have been positive in 80% of the past twenty years. The four down years all happened during major crisises. This is not the first time sentiment has been extreme at this time of year. I would argue that sentiment is extreme at this time of year almost every year.

      I am not sounding the all clear as much of the data I look at is bothersome. But with such a strong seasonal tailwind the short side is even tougher than usual.

      Out

      I will be out today. Have a great weekend.

      Tough Call

      The widespread belief that the correction is over and its up, up and away into year end bothers me. I also believe that expiration exacerbated yesterday's move. Thirdly, the market is digesting a lot of supply as there was well over $30 billion in stock issuance the past couple of weeks. All this leads me to believe that we should see an expiration hangover early next week.

      Until I think of all the positives the market has going for it. The market will be oversold early next week and we are heading into some of the strongest seasonality of the year. Strong seasonality tends to work best during times when the animal spirits are strong such as now.

      All this leads me to conclude that an expiration hangover could probably be bought for a trade. However, chasing the market here might not be that great of an idea.

      A Good Deal

      The government did a good job with GM. Had the stock gone up 20% today it would have appeared like the taxpayers were stiffed. The modest rise allowed the buyers to make a small profit and the seller to exit at a fair price.

      No Soup For You

      It looks like extended unemployment benefits will expire December 1. This will have  a minor negative effect on the economy going forward.  From the AP:
      Republicans in the House have blocked a bill that would have extended jobless benefits for the long-term unemployed beyond the holiday season.
      The most recent extension of jobless benefits expires Dec. 1. Two million people will lose benefits averaging $310 a week nationwide by the end of the year.
      With a divided Congress there will likely be a lot more of this. In the long term it is what is needed but in the short term it can lead to some pain.

      Expiration Influences

      The market is just another commodity in the risk on/ risk off trade and I suspect that expiration has exacerbated today's move higher.

      The Situation

      Knowing that there was a tech bubble or a real estate bubble was the easy part. Many people lost massive amounts of money with this knowledge as these bubbles continued much longer than anybody could have imagined. In the process they ran over most of the skeptics. There is now a similar unsustainable situation in sovereign and municipal debt levels that will eventually not end well.

      While I don't take the situation lightly and constantly monitor the developments, I try not to let it effect my short term trading. I am willing to go long for a trade when my indicators are lining up, despite these festering issues. Might I get hurt when the excrement finally hits the fan? Hopefully, I will be able to recognize when we are at that point but its possible that I will get nicked. But its unlikely to take away all the gains from all the other times when the indicators lined up.

      I would much prefer if we were in a healthy environment with more reasonable valuations. That would allow me to concentrate more on investing and less on trading but that is not what we are dealing with right now.

      Pros And Cons

      The largest negative factor in the market is sentiment. The number of bulls has reached multi year highs on both the Investors Intelligence and AAII survey. Even with the recent large pullback, there has only been a slight decrease in bullishness. Secondly, there has been a lot of stock issuance in the past two weeks totaling well over $30 billion.

      On the positive side the market will be oversold next week and we are heading into a seasonally strong period. Thanksgiving followed by the turn of the month will give the bulls a seasonal tailwind. Additionally, there has been a pickup in M&A activity.

      I believe this means that if we do get one more move lower in the next few days it can be bought through early December. But its unlikely to be a great rally given the high level of bullishness.

      GM

      I cannot help but laugh when the GM IPO is cited as a reason the market should rally. Markets are about supply and demand and $20 billion of supply is a clear negative. Maybe a lot of the selling we saw this week was to make room for the GM IPO, but its also possible that there will be more selling tomorrow. We will find out soon enough. Have a good night.

      My Bad

      In my last post I erroneously wrote that munis are trading higher as I looked at a bunch of closed end muni funds. Muni funds are rallying but muni bonds are actually trading lower.

      Munis Rallying

      After a gut wrenching decline municipal bonds are finally rallying today. There will be tears in the municipal bond market, its only a question of when. As we have learned from past imbalances they can persist for longer than anybody believes possible. However, at the end what is not sustainable comes to an end.

      A Reason To Sell

      We have not seen much fear or capitulation yet because market participants don't have a reason to sell. It would be nice if there was a news story that scared market participants this way we could get a better short term bottom.

      Out Of Longs

      I am out of my longs from yesterday. The put buying has subsided and we might see some GM related selling late in the day.

      Giving It Some Room

      I am giving my longs from yesterday a little more room as the market is holding steady despite heavy put buying this morning. I am still looking to exit today but am in a little less of a rush.

      Finally Extreme

      The Investors Intelligence survey has finally reached an extreme with 56% bulls and 20% bears. The poll is probably a little dated but still will not give bulls the warm and fuzzies.

      Change Of Heart

      Yesterday, at midday I stated that there was a decent chance of a bounce and took a very modest long position. Some events since then have led me to reconsider my stance. I will look to take profits into strength today as I no longer believe the bounce is worth playing.

      What has changed? GM has upsized their equity offering which will now be around $20 billion, including preferred shares.That is an awful lot of supply to digest, not even considering the other $5 billion in IPOs and secondaries on the docket for the week.

      Secondly, when I went long around midday there was a decent amount of put buying. By the end of the day there was call buying at the ISE and very little put activity at the CBOE. This is especially surprising considering the magnitude of the decline.

      Sentiment is not in place for a good low as most believe this is a normal correction and are showing it in the options market. There is heavy supply about to hit the market and we won't be maximum oversold until early next week. I am going to give this correction  a couple more days before venturing to the long side.

      They Never Learn

      I was surprised that the "Don't Fight The Fed" rallying cry worked so well in the past few weeks given how miserably it failed the whole way down in 2008. I am less surprised that the end result is the same.

      The difference between a normal correction and something more sinister will be if these sovereign and municipal issues subside or if there is a crisis. The powers that be clearly want a bailout as Ireland is being offered help it has not even asked for. Have a good night.

      Just A Little Bit

      I sold some more SPY puts and am leaning a little long here.

      Fear Here

      We are finally starting to see some signs of fear and not the fear of missing. Stocks are probably good for a short term trade but a much better setup would emerge early next week if stocks remained under pressure.

      Fire Drill

      Are today's rumbling in the sovereign debt and muni markets a fire drill or the real thing?

      Worth Repeating

      I quoted John Hussman a couple of weeks back as to the type of market we were in.
      As of last week, the Market Climate for stocks remained characterized by an overvalued, overbought, overbullish condition. This has been historically associated with a poor return-risk profile and "negative skew" - a tendency for the market to establish a string of marginal new highs, and for occasional 2-3 day pullbacks to be followed by sharp recoveries. The pattern is for little overall progress, but repeated slight highs, terminating with a steep, abrupt decline that can wipe out weeks or months of gains in a matter of days.
      Nice call Dr. Hussman.

      Sold Puts

      I sold the SPY 118 Puts expiring this Friday against my hedges.

      Something Is Rotten

      In the short term I still believe the bulls should stay out of the bears way for the balance of the week. We had a two and a half month run higher so a ten day correction should not be much of  a surprise. The bulls were still buying calls yesterday showing that from a sentiment perspective the correction has not yet run its course either.

      Nobody wants to miss a good rally even if it is built on a faulty foundation. The problem is that the issues facing the market are real. The US will not be able to run a deficit of 10% of GDP forever, many municipalities have no way of fulfilling their obligations and sovereign countries like Greece are essentially bankrupt and will default. So when these issues crop up how does one know if its just a fire drill or if its the real thing?

      For the past few weeks sovereign spreads have been blowing out and municipal bonds have plummeted. Is this a false alarm or is it the point of recognition? It probably is a false alarm but eventually it will be the real thing. And at that point everybody will be accustomed to the false alarms.

      Under The Weather

      I am feeling a little under the weather today. I will return tomorrow. Have  a good night.

      Both Sides

      The two cash deals announced today do help the bulls but are still outweighed by the share issuance this week and the officially broken Potash deal. Overall today's deal news helps the bulls as M&A is an important component of the bull case but I still think the bulls have their work cut out for them this week.

      Its Raining Supply

      There are about $20 billion in IPOs and secondaries scheduled for this week. In addition, we are coming off a sentiment extreme. I believe that means that the upside will be extremely challenging for the bulls this week. Under normal circumstances I would expect a few more attempts at the high, as tops are usually a process. But with that much supply on deck, I cannot see the bulls making much progress.

      The good news is that if we get another down week than next week the market would be oversold heading into Thanksgiving. That would be a good setup for the bulls, but until than I believe the bears are in charge.

      Insiders Continue To Sell

      Insider's are not being persuaded by the Bernanke Put and continue to sell stock at a record pace. From Barrons:

      Beware Blanket Statements

      It is no coincidence that just as the "Don't Fight The Tape/Fed" chatter grew to a deafening roar that the tape has finally had a decent sized pullback. I am not a big fan of blanket statements like "Don't Fight The Tape". There is a time to fight the tape and there is a time to go with the flow.

      The time to fight the tape is when the crowd has given up fighting the tape. Heading into QE II sentiment was bullish but many were looking for a "sell the news" reaction, so there was a contingency that was still fighting the tape. After QE II a stampede ensued and financial media and the blogosphere were lit up with the "Don't Fight The Tape" meme.

      Part of knowing when to fight the tape is anecdotal, like paying attention to the fact that many were looking for a "sell the news" reaction to QE II. But one must also have some quantitative measures as well. I like to use sentiment surveys, put/call ratios and the Rydex ratio to make sure that my biases are not coloring my view of sentiment. In addition, I always look at the same indicators so I cannot pick and choose the ones that agree with my view.

      All the indicators I look at were at or close to a bullish extremes at the beginning of this week, signaling that it was probably a decent time to fight the tape. Trading slogans like "Don't Fight The Tape/Fed" are a dime a dozen and when everybody's chanting the same one they are worth even less.

      Great American Heroes

      If you go to the gas station this weekend and realize you need to shell out a couple more bucks to fill your tank or go to the grocery store and come back with less change than you expected, just know that it is for the greater good. The capitalist system only works if great capitalists are allowed to thrive such as the ones highlighted in a Wall Street Journal article:

      In the latest sign, HCA Inc., one of the nation's largest hospital operators, plans to use a specially formed company as part of a plan to pay a $2 billion dividend to its private-equity owners.

      The payout plan is another indication of the dizzying heights in this year's junk-bond sales boom. Companies have raced to issue a record number of junk bonds and in some cases have provided less protection for investors than in the past.
      The dividend, HCA's third this year, will go to private-equity investors including Kohlberg Kravis Roberts & Co., which trades as KKR & Co., and Bain Capital LLC. It will be financed through the sale of $1.5 billion in junk debt maturing in 2021 and the use of HCA credit lines.
      Thank you Ben Bernanke. You are correct, QE II is already working.

      Mind The Gap

      After Ben Bernanke's Washington Post article, where he admitted to trying to juice the stock market and destroyed any credibility the Fed had left, the SPY gapped up from 119.95. It looks like we might get  a gap fill today as we already did so in the overnight session. That area should be good for a bounce if we get there. That said, I think it eventually gives way before this correction is over.

      Smarter Than Seth

      The greatest value investor of our time, Seth Klarman, is returning money to investors as he cannot find enough opportunities. If you are wildly bullish here, what are you seeing that Seth Klarman cannot?

      Too Much Call Buying

      There is too much call buying at the ISE for such a large down day. I don't think the bulls will be able to make it two turnarounds in a row today.

      Insiders Selling

      According to InsiderScore.com via Sentimentrader.com insiders at S&P 500 companies sold $4.9 billion worth of stock last week, the most ever since they began reporting in 2004. At the same time retail investors were buying calls hand over fist.

      Bulls Unprepared

      Sovereign spreads in Europe are blowing out again. Chances are the ECB throws them a lifeline but how ill prepared are investors if that turns out not to be the case?

      Tech Issues

      I was hoping that in the next couple of days the market would make a marginal new high that would really get investors excited. At that point a short position would have been a very high probability trade. Unfortunately, there were some disappointments in tech land that may not allow that scenario to play out.

      Tech is the sector which managers are most overweight and the news last night was not good from Cisco or Kulicke & Sofa. That combination will make it very hard for tech to get off the mat. Its possible we will just see some sector rotation and I might still get my setup but I'm not holding my breath.

      Lay Off The Shorts

      My opinion remains the same as it was this morning. I don't believe this market has much upside, but I did not see the type of enthusiasm today that makes me want to go short again quite yet. Have a good night.

      Bad Auction

      Long term treasuries are tanking on a bad auction. I already hear the QE 3 helicopters revving up. Too bad oil just broke out to a two year high. Collateral damage.

      II Sentiment

      The jump in bulls and drop in bears in the Investors Intelligence survey was smaller than I expected. It is only a single indicator but according to it there is still a little more room before sentiment becomes extreme. I think sentiment is pretty extreme but would feel better going short if this indicator lined up.

      Mixed Signals

      The CBOE is showing call activity while the ISE is showing put buying. I like it much better when they are both saying the same thing.

      More Inflation

      Yesterday, a Chinese credit agency downgraded US Treasuries. It is pretty clear that the agency would not do so without the consent of the government. I believe this means the Chinese are planning on buying less treasuries and hence US Dollars. That is likely the reason treasuries performed so poorly yesterday.

      In order to purchase less treasuries China will either need to allow the yuan to rise or use the dollars to buy natural resources or a combination of both. Either way, this should lead to higher inflation in the US.

      Not Going Anywhere

      While we could see some sideways trading, I don't believe this market is going anywhere on the upside anytime soon for the following reasons:
      • Bullish sentiment became too extreme and it will take some time to work off that condition.
      • There has been quite a bit of activity in the secondary market this week, with the $8 billion Blackrock offering being the largest. The GM IPO is scheduled for next week and will likely be about $13 billion. That is  a lot of supply for the bulls to digest.
      • The upside momentum has been broken and that should give the mo-mo traders pause, which seems to be everybody these days.
      If the bulls come out of the gate today buying calls I will look to build up a short position again. The reasons I am being careful on the short side are as follows:
      • Seasonality- This is the time of the year when I have seen extended markets become more extended.
      • Artificially low rates are greasing the wheels and are leading companies to borrow to buy back stock and encouraging M&A activity. In a few years when companies have to roll this debt it might spell trouble for them but in the short run it is  a positive for the market.
      • Tops are often range bound affairs before the bottom falls out so we might see some more rally attempts.

      Losing My Religion

      Just as  everybody found religion and the chorus of "Don't Fight The Tape" reached a deafening roar the market finally decided to pull back. A little. If you think that is a coincidence than you don't understand how markets work. Have a good night.

      Covered The Balance

      I covered the balance of my net short position.

      Further Covering Shorts

      I have further covered shorts. I now have a very small net short position remaining.

      Broken Correlation

      At some point higher commodities will be bad for stock prices as it will mean the Fed has to lay off the QE or heaven forbid tighten. I find it interesting that commodities and stocks have decoupled today with commodities higher and stocks lower. I don't think we are at the point where higher commodity prices will be seen as bad but I do not think we are that far away either.

      Covered Yesterday's Shorts

      I also covered the shorts I put on late yesterday. Often times at tops we see some range bound trading before the bottom falls out so I am trying to take advantage by buying and selling on a scale. I now have a modest net short position.

      Covered Morning Shorts

      I covered my shorts from this morning for a modest profit. I still have a medium size short position.

      Turnaround Tuesday

      I am looking for a turnaround today. I have added to my shorts even though I shorted yesterday close to current levels. I am stepping it up.

      White Lies, Deceptions and Government Statistics

      Commodities are up about 15% for the year. Would anybody be surprised if the CPI came in at a core rate of 0.1%? If you believe that, there is a nice bridge for sale crossing the East River with a great IRR.

      To Infinity And Beyond

      Commodities are taking off and oil is challenging a two year high. If it breaks out from here than it might be to infinity and beyond. The only thing saving the US dollar is that the Chinese accept it as payment for their goods, otherwise we will have already seen a run on the dollar.

      There is a perception around the World that the US dollar is a joke. Nobody other than central banks are buying and it seems that many are having second thoughts. So while the markets are going up in US Dollars, those dollars are worth a commensurate amount less. I asked yesterday, how long it would take before everybody figured out whats going on. At this pace, not very long.

      Endless Appetite

      We had a third day in a row of ferocious call buying. The "weekend warriors" had their chance to buy into the market today. Maybe we will finally get a Turnaround Tuesday tomorrow. I remain short straw hats in Summer. Have a good night.

      I'm Reloaded

      I reloaded on my SPY short on the latest spike.

      One Sided

      Judging by what I am reading nobody is fighting this move. If an unforeseen event happens a lot of people will be caught offsides. I am not saying something is going to happen but the potential for a nasty reaction is there if it does happen.

      Late Day Weakness

      The Blackrock secondary is supposed to price tonight and will likely be well over $7 billion. We might see some late day selling if portfolio managers need to make some room for the position.

      Lay Off The Calls

      There is an awful lot of call buying for a down day. This is not what the bulls want to see.

      More On Tops

      We often see some choppy range bound trading while a top is being formed. Thus I will slowly put out shorts as we rise and slowly cover as we fall. This strategy can make decent money in a choppy range bound market.

      Covered Friday's Shorts

      I covered the shorts I put out on Friday. I remain modestly net short. I will look to put them out again on a bounce.

      The Tipping Point

      At what point will the public ask for Bernanke's head on a platter?
      • Oil at $100 a barrel? Gas at $3 a gallon? Gas at $4 a gallon?
      • Would it be a rise in food prices?
      • Another commodity?
       What do readers think the tipping point would be if commodities continue to rise?

      The Bull's Siren Song

      Late last week we finally saw sentiment that is consistent with an intermediate term top. I want to remind readers that the bull case always sounds best at the tops and the bear case always sounds best at bottoms.  At times like these I try to close my ears to all the great arguments and concentrate on what has been the result of one sided sentiment in the past.

      There are two items that make the current juncture a little tricky. The first is that tops are always tricky. Bottoms are a lot easier because once sentiment turns extremely bearish one can usually grit their teeth, take the pain and before you know it the market turns higher. Tops can wear on and on and really test one's resolve.

      The second tricky item is that it is very rare to see a good intermediate term top at this time of year. In extreme cases it does happen, when there is  a major shift in fundamentals like the bursting of the tech or housing bubble. Currently, I don't see a major fundamental shift but that does not mean we will not have a correction. If my memory serves me correctly we had a 6% correction last November followed by a year end rally. I am expecting something similar.

      Weekend Reading

      During the last two trading days of the week we finally saw unadulterated, hand over fist call buying. In my reading this weekend I have also noticed some signs that sentiment might have become too extreme.
      • There was a large amount of chatter in the blogosphere about why one should not try and fight the trend. While that point is debatable, my contrarian antennae go up when suddenly everybody is singing the same tune.
      • There is a bull/bear survey every weekend on TheStreet.com. I do not ever recall seeing it as lopsided as it is right now with 70% bulls and 20% bears.
      • I always check out the Insider Transactions in Barron's and it has been a long time since I have seen such large stock sales by insiders. Please note I am not talking about the ratio but the size of the insider sales.

      I Need A Miracle

      I am signing off for the day. I have an order in to cover my short from this morning in case a miracle happens and we reverse lower. Have a great weekend.

      Extra Froth Please

      The put/call ratios are at rarefied levels. As of now it doesn't seem to matter.

      The Right Move For Bank of America

      Mark this day in your calendar as the day I complimented Bank of America. After surviving the subprime debacle they then went out and bought Countrywide and Merrill Lynch. They saved the taxpayers a lot of money at the expense of their shareholders.

      Bank of America is selling their stake in Blackrock. There is no reason to hold this non core position and they are getting out at a good price. If they do suffer large losses from mortgages this might mitigate the need to raise capital at distressed prices. They are doing the right thing.

      Added To Shorts

      I have added to my short positions on the spike following the Jobs data.

      Some Supply

      Next week we will see a Blackrock secondary of greater than $7 billion. The following week we will see a GM IPO of $13 billion. Plus their is a decent sized IPO calendar. Supply will be heavier than usual in the coming two weeks.

      Darn Calendar

      We saw extreme call buying yesterday at both the ISE and CBOE. Both the ISE and CBOE equity showed the most call activity since the rally started. Anecdotally, it seems everybody thinks buying stocks is easy money after the S&P 500 has already risen 16%. Everybody who was looking for a "sell the news" pullback has thrown in the towel. This is what the end of a rally feels like.

      Normally, I would feel very comfortable shorting into this type of activity. However, the time of the year makes me a little nervous with my short position. Its the time of the year when rallies often go further than they should. In late March sentiment was at an extreme but the positive seasonality in April allowed the rally to extend. If it were May instead of November I would probably have a short position double the size that I am currently carrying.

      QE II Already Working

      In Bernake's Washington Post piece he claims that QE II is already working and offers the rise in the stock market as evidence. I guess that means that the Tech Bubble was proof that the Fed's policies were working and the Real Estate bubble was proof that the Fed's policies were working because after all the market rose both times. If the stock market likes it than it must be good for the economy.

      Throwing Caution To The Wind

      Investors are clearly throwing caution to the wind. The only question is how long it lasts.

      Added To Short

      I have further expanded my SPY short.

      Paying The Piper

      Bernanke actually admitted that he was targeting stock prices in a Washington Post piece yesterday. Bernanke can print money but he cannot control where it ultimately ends up. A lot of it is ending up in commodities as commodity indexes are making fresh two year highs.

      If stocks do indeed rise the benefit will only be felt by a small segment of the population and all we are doing is borrowing gains from the future. The rise in commodity prices will be felt by everyone. Inflating asset prices has led to disaster after disaster. I don't expect a different outcome this time around. The only question is the timing.

      Shorting The SPY

      I shorted the SPY this morning at roughly $121. For the past few weeks sentiment has refused to go to a bullish extreme as many were looking for a "sell the news" reaction to the Fed. Now that the Fed decision has come and gone it seems those who were looking for a pullback are throwing in the towel, meaning we will finally reach a bullish extreme. My short position is small and I have plenty of room to add.

      Potash Decision Shortly

      The Canadian government is supposed to rule on their decision regarding BHP's hostile bid for Potash. This could be a market mover if the government rejects the deal.

      Pulled My Orders

      I have pulled my orders to go short for now. I think this "larger than expected" QE II will do the trick of getting optimism to an extreme and lead to an even better opportunity to go short. It is crystal clear that the way the $600 billion figure was chosen was to look at expectations and beat them. Straight out of the GE "beat by a penny" playbook. Sickening.