Deflation Watch

The price deflator in the GDP report rose 2.3% and that was before the recent rise in commodities. What deflation is Mr. Bernanke fighting?

The Hidden Big Event

The window dressing period is now over as I don't believe many funds are brazen enough to try and mark up stocks on the last day of the fiscal year.  The seasonally strong period is not over as we still might see monthly inflows early next week.

Everybody is focused on the elections and QEII but there is another very important event next week. On November 2 the Canadian government will rule on whether they will allow BHP to proceed with its hostile bid for Potash. I believe there is a decent chance that the Canadian government rules against the bid. Potash is a greater than $40 billion company and there are a lot of arbs in the stock. If the Canadian government rules against a takeover there will be a lot of selling. That would be a double whammy of more supply and would also hurt sentiment.

Lie To Me

I almost fell off my chair when I saw this quote from Steven Schwarzman in a Bloomberg article:

Stephen Schwarzman, chief executive officer of Blackstone Group LP, the world’s biggest buyout firm, said another round of asset purchases by the U.S. Federal Reserve won’t have much of an impact on companies.
“It’s not an enormous incentive to do something different with your businesses because rates are down a few basis points,” 

I would like to see him say that with a lie detector on and I would like to place  a leveraged bet on the outcome.

Dog Theory

A few days ago I noted the tendency of stocks trading near 52 week lows to outperform from November to January. The worst performing stocks, like financials, have done well in the past few days. It could be that some have been trying to front run the effect.

Party Pooper

I must admit that the prospect of another bubble makes me quite unhappy. Its not something I am comfortable participating in so I would likely end up watching the festivities from the sidelines. I would try to grind out some trades at the extremes but I don't see myself prospering in that type of environment.

I believe that at the end this will fail as I don't believe there is such a thing as something for nothing. For selfish reasons and for the long term health of the country, I hope the Fed's attempt to create another bubble fails sooner rather than later.

Neither Here Nor There

Once the market rallies as hard as it has and as long as it has we usually reach a state of intermediate term extreme bullishness. The Investors Intelligence survey is not there yet, the put/call ratios are not there yet and Rydex is not there yet. To add to it we are in a time of the year where the market usually does well. Until I see at least a couple of those indicators at an extreme, I am not interested in the short side other than for quick trades.

I would love nothing more than to take risk as that is the only way I can make money. Being patient is a difficult part of investing. But coming back from losses is even more difficult.

Sitting It Out

As I wrote yesterday, the very slight oversold condition and the positive seasonality tilt the short term odds in the bulls favor. But the fact that the consensus now believes that QE II will be a sell the news event might prompt people to sell ahead of the news.

We have a market that has not had a real correction in two months, but there are some short term positives. I have a difficult time buying into this type of setup but it usually does work out for the bulls. I was bidding for some stock yesterday but I was never filled as the bulls pulled it together. I am sitting it out for now.

A Lot To Think About

Stocks are now very slightly oversold heading into a strong seasonal period. In a vacuum those two factors should give the market a bullish bias over the next few days. But its not that simple as the elections and QE II are just around the corner as well.

It is becoming somewhat conventional wisdom that QE II will be a sell the news event. Does that mean they try to sell ahead of it or does that make it a self fulfilling prophecy? Have a good night.

Call Buying

There is a relatively large amount of call buying for a down day. This decreases the chance of a turnaround today.

Strong Seasonals

The market has been acting like it wants to correct but I suspect that fiscal year end for mutual funds and the approaching elections and QE II have not allowed the market to do so. The window for a correction is closing fast for the bears. At the end of the day today the market will sort of be short term oversold, although it won't be a great reading. We will have essentially gone sideways for ten days. We are also entering one of the seasonally strongest periods of the year.

If the market does manage to sell off today it could probably be bought for a trade into QEII. I would be much more comfortable with this trade if sentiment were not so stretched and we had a better correction. If this scenario does play out than we should finally see a correction shortly after the QE II announcement.

The Problem With QE: The Final Chapter

Yesterday, I clumsily tried to explain that QE II was not a win-win. Jeremy Grantham does so much more eloquently in his Q3 investment letter. Here are some gems from the letter:
Given the mysteries of momentum and professional investing, when coming down from a great height, markets are likely to develop such force that they overcorrect.Thus, all of the beneficial effects to the real economy caused by rising stock or house prices will be repaid with interest. And this will happen at a time of maximum vulnerability, like some version of Murphy’s Law. What a pact with the devil! (Or is it between devils?)
....Any plunder to be had from the booms and busts went, of course, to the more nimble members of the financial community!
...When rates are artificially low, income is moved away from savers, or holders of government and other debt, toward borrowers. Today, this means less income for retirees and near-retirees with conservative portfolios, and more profit opportunities for the financial industry; hedge funds can leverage cheaply and banks can borrow from the government and lend out at higher prices or even, perish the thought, pay out higher bonuses. This is the problem: there are more retirees and near-retirees now than ever before, and they tend to consume all of their investment income.With artificially low rates, their consumption really drops. The offsetting benefits, mainly shown in dramatically recovered financial profits despite low levels of economic activity, flow to a considerable degree to rich individuals with much lower propensities to consume.

The Problem With QE: Part Two

The prospect of QE is sending the CRB index to a new two year high today.  Kimberly Clark is down nearly 6% today as they faced higher input costs. Many other corporations are singing the same tune such as Mcdonalds, General Mills, Starbucks, Goodyear Tire and many retailers.

The government claims that there is no inflation but most non-government statistics say otherwise. A basket of 31 items from Wal Mart are are up 5% from the beginning of the year. The ISM, which is not a government entity shows the prices component rising rapidly. Who do you trust?

The poor and middle class are getting squeezed with higher prices while the rich benefit from asset inflation. This does not make for a healthy society.

The Problem With QE

The problem with QE is that it gives incentives to engage in financial engineering and distorts the economy. Borrow at close to zero and buy an asset that yields a little bit more. Nothing productive is created. Why go out and create stuff when you can make more money doing  a carry trade backed by the government?

Over the past decade low rates by the Fed gave people incentives to enter professions like mortgage brokers, real estate brokers, real estate speculators and finance professionals. It created over capacity throughout real estate and finance related sectors. Many of those people likely would have gone into professions that were more productive, were it not for artificially low rates. Now many of those people are out of work and its not their fault. Why do something productive when one can take make more money shuffling money from one place to the other? In the long run this will hurt the country.

Opposite Day

For the past few weeks the banks led by Bank of America have been hindering the markets attempt to break out of the range. Today, when the bears tried to make their move, Bank of America has led the troops back. 

I was actually hoping that Bank of America would go lower this week. The Credit Suisse research I referred to earlier lists Bank of America as a bounce candidate as it is trading close to a 52 week low heading into mutual fund year end. The stock is so oversold that when it finally bounces it should be hard. This would be a small position as it would be a pure trade.

Window UnDressing

This month end has added importance as it is also the fiscal year end for most mutual funds. Since mutual funds are generally long only it is unambiguous which way they want to see the market go. In a vacuum that is a positive for the market.

It seemed too obvious to me that the market would go up into QEII without a correction but sometimes the obvious becomes a self fulfilling prophecy. The chances of a sell the news reaction would be extremely high if that turns out to be the case.

There is also an effect known as Window (Un)Dressing where mutual funds dump their losers before year end. Some say it is to receive the tax loss and the more skeptical might say that they don't want to show that they were caught in a dog.  Regardless of the reason stocks near 52 week lows tend to outperform from November to January according to a nice piece of research put out by the quantitative group at Credit Suisse. The end of this week might be the time to buy the dogs.

My Fundamental Process: Part Three

The final step in my fundamental process is to take into consideration my macro outlook. For instance, if I think the economy will get worse I am less likely to buy shares in companies whose cash flow will suffer in a weaker economic environment, unless I believe its already priced in.

Once I finally emerge with a buy candidate using fundamentals I might use my (non fundamental) indicators to decide on the timing of a purchase or if I should hedge the position with a short on the S&P 500 or another index.

Tomorrow, Tomorrow

There is too much put buying for an up day. This reduces the odds of a turnaround today. The bears might need to wait for tomorrow.

Short By Default

My holdings continue to ramp but unfortunately I have written covered calls and am benefiting less and less as all the calls are now in the money. I should adjust my hedges lower if I want to maintain a slight net long posture but I won't. I am slowly allowing my portfolio to move to net short.

My Fundamental Process: Part Two

My investment process usually starts with the cash flow statement as I look at free cash flow. That is the cash a business throws off less anything they spend on capital expenditures (Capex). Why eliminate the cash they spend on Capex? Because it is difficult for me to tell the difference between Capex that is necessary to maintain the business and Capex that is truly a new investment. For instance, Fedex needs to keep buying new trucks so its not an optional expenditure.

Another reason I heavily rely on free cash flow is that it is quite easy to manipulate earnings per share. It is a lot harder to fake cash flow over the course of many years. Cash does not lie.

There is usually a reason why a company trades cheaply and one must make sure that the cash flow will continue. Such questions that must be asked are as follows
  • Is the company in secular decline? If the company has a product that might be made obsolete or is in an industry that is in decline than the low multiple might be justified. 
  • Is the industry the company is in cyclical? How bad would a downturn in the economy hurt free cash flow?
  • Does the company have a strong enough capital structure to withstand a rough period?
  • Can the management be trusted to return the cash to shareholders or invest it wisely? Or will they burn the cash on bad acquisitions and the likes?
  • Are the cash flows unsustainable for any other reason?
  • Is there a catalyst to bring out the value? Do I get paid a dividend while I wait? Are they buying back shares?
Anybody running a screen can identify companies with a low price to free cash flow ratio. The harder part is answering the above questions.

My Fundamental Process

In Friday's post Fundamentals Vs. Indicators I attempted to explain how I use both fundamentals and  indicators (sentiment and technical) in my investment process. A reader asked me to elaborate further on my fundamental process and I will attempt to do so in the next few posts.  Most value investors fall into one of two categories. There are value investors whose main  focus is the balance sheet and there are those whose main focus is the cash flow.

Seth Klarman is probably the best value investor right now and he is what I refer to as a "balance sheet"  investor.  He looks for situations where he can buy $1 of assets for 50 cents, even if its uncertain how or when that value will be unlocked.

The other type of value investor is a "cash flow" investor, the most famous being Warren Buffet. Warren Buffet is more interested in buying companies that generate and will likely continue to generate good cash flow at a reasonable multiple than buying assets on the cheap. In his earlier years Buffet was more like Klarman but he slowly shifted to a cash flow investor. That might be because it gets more difficult with size to be a "balance sheet" investor as many of the assets are illiquid and hard to accumulate in Buffett size quantities. Also, reinvestment of assets is much more of an issue as well.

I fall into the category of a "cash flow" investor. Balance sheet investing makes perfect sense to me but requires a greater leap of faith. The assets are usually less liquid and the how and when value will be recognized is often an unknown. Taking that leap of faith is why investors like Seth Klarman get paid but there is money to be be made in value investing based on "cash flow" as well.


Hussman Says It Best

"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. In statistical terms, the mode of the distribution is positive, the mean is negative, and the skew is downright wicked. "
-John Hussman in his always excellent weekly missive
I think John Hussman wrote an excellent description of where the market is right now. As I outlined last week sentiment has a little more room before becoming extreme enough to push me to the short side. But as Mr. Hussman wrote this rally is likely to end with an abrupt, sharp fall, which could happen at any time.

I am scratching my head as to why the futures are up so much this morning. It seems to be part of a risk on trade as commodities are also making new highs for the move.

Patiently Waiting

I have not made a single trade since Monday as I wait for better opportunities. There are no called strikes in the stock market. Have a great weekend.

Fundamentals Vs. Indicators

I think of myself as a value investor that tries to time the market. Value investors think its heretic to try and time the market and technicians think its heretic to talk about fundamentals or funnymentals as they like to call it.

My style is a combination of both and it works for me. My stock selection is based mainly on valuations and fundamentals although I do pay attention to liquidity factors. For instance, I chose Gilead Sciences as a long because of the ridiculously cheap valuation but I made it an outsized position because Gilead was aggressively buying back shares and there was a lot of cash M&A activity in the healthcare sector.

I don't pay much attention to fundamentals when I am trying to time the market. At the end of August the bears had great arguments about why the market should go lower. But the fact was that every sentiment indicator was pointing to extreme bearishness and the market was oversold. Under those circumstances the market usually goes higher and this time was no different. If the market as a whole were cheap than I would likely shy away from timing the market, but in my opinion it is not.

It annoys me to no end when I read articles or books with investing or trading rules because different strokes work for different folks. There is no right way. If I would have listened to those trading rules I would have never come up with my style, which works very well for me.

Hoping For A Correction

If we get a move lower through Wednesday the market would be short term oversold. That would come right in time for the turn of the month and ahead of QEII. Maybe sentiment could even turn a little bearish if people start talking about QEII as a sell the news event. A decline through Wednesday would actually make a decent setup for a long trade.

I am still hoping for a correction because I am uncomfortable buying at current levels with sentiment too bullish for my tastes. Otherwise I will continue to sit on my hands with little risk.

Au Contraire

Jeffrey Cooper of points out that the Daily Sentiment Index of S&P futures traders is at 93%, the highest reading in 3 1/2 years. That is extreme, but I am not familiar with the indicator.I like to stick to the indicators I always follow because one can always mine for data to confirm their bias and my bias is to want to be bearish. Does anybody follow this indicator or have any thoughts?

Crusie Control

Many of my holding's are nearing my targets and I am running out of ideas. If the market doesn't serve up new opportunities, I will be looking at a very boring year end. I am very hesitant to go short during the seasonally strong year end unless sentiment reaches an unambiguous extreme. Truth be told, I would not be so upset with a relaxing end of the year with little risk.

Canary In the Coal Mine

The canary in the coal mine for today's rally was the high level of put buying yesterday. The CBOE closed above 1.0 even though the market was sharply higher. Let's see if today's rally gets the crowd excited.

The Bigger Sentiment Picture

I wanted to take a step back today and look at intermediate term sentiment. Unless there is a major economic event most large moves lower tend to occur from a state of extreme intermediate term sentiment.

The Investors Intelligence survey is an excellent intermediate term sentiment indicator. Below is  a graph from Bespoke Investment Group, with my labels, showing the level of bears on the Investors Intelligence survey. The danger zone seems to be when the bears are below 20%. We are not quite there yet. As an aside please note the high level of bears we saw in late August right before this rally kicked off.

The next chart I want to look at is the Rydex Total Bull/Bear assets below from We are nowhere near the upper band but I would note that pre-2009 the current level was considered pretty extreme. This indicator is inconclusive. I would once again point out that at the kick off to the current rally at the end of August we were sitting at the lower band.
The next chart is the 30 day moving of the CBOE Put Call Ratio. As you can see below there is little amiguity to this chart. It is not at levels seen at previous tops.
The 10 day moving average of the ISE Equity put/call ratio shown below tells a different story and is consistent with other intermediate term tops. Please note: The label October 08 High should read October 2009 High.

Overall what we are seeing is that sentiment is not quite at an extreme in the intermediate term. That does not mean we should not see corrections. But it does mean that it is unlikely we see a move lower similar to the one in April, short of a systematic event.

A Big One

I am working on a post with a lot of charts and graphs so my first post will be late today.

Was That It

Can the market continue higher without more of a correction? I don't believe the market is currently in a position to  rally well. The Investors Intelligence bears chimed in at 22% today. That is close to the 20% level that signals intermediate term danger. A further rally would likely get us there right in time for QEII. Have a good night.

Eyes On The Exit

My very conservative fair value estimate for Gilead is $40, with quite negative assumptions. I wrote covered calls on the shares.

Holy Gilead Batman

My largest holding, Gilead, is rocking and rolling after earnings.

Not One and Done

It is unlikely that the excesses of a two month uptrend have been corrected in a single day. At best I believe the bulls are looking at sideways trading for the next few days and at worst we might see a meaty correction.

The reason this rally has been so strong is that in late August portfolio managers were de-risked and had a lot of room to buy. That is no longer the case as I believe they are now overweight equities. At this point increased risk appetite will only take us so far.

The market will need something else if it is going to push much higher into year end. I don't believe individuals will drive the next leg of the rally although I have underestimated their risk appetites (or tolerance for pain) before. The most likely source of a continued rally would be cash M&A, LBO  activity and share buybacks. While we have heard many rumors there has been only a little action thus far.

Sharp Moves

Sharp moves like today happen when a trade becomes extremely one sided. Two months of straight up have caused a lot of complacency and its not likely that a single down day has undone all that. I expect the bulls to be tested further. Have a good night.

Timing A Correction

Ideally a correction would last a few days, which would bring us to month end and a few days before QEII. At that point I would expect a rally attempt into QEII.

Writing Puts

I am writing some deep out of the money January SPY 108 Puts against my hedges.While I believe this correction can go longer I am not looking for a complete collapse.

No Fear

We are once again seeing a high ISE reading, signaling call buying, despite a lower market. This indicates a complete lack of fear. Some healthy skepticism would be a positive. I remain cautious.


I wrote a bunch of covered calls which at the time were a good deal out of the money but are now near or in the money due to the fact that my positions have performed well. That serves to reduce my long exposure. As such I used today's pre-market weakness to remove some hedges as I was becoming a little over hedged.

Bear Hug

The knee jerk reaction is to think that the selling will not stick as has been the case for nearly two months. But the bulls have their hands full this morning. The market is overbought in the short and intermediate term, sentiment is excessively bullish and a bunch of tech darlings did not meet investors lofty expectations. I believe it is too much for the bulls to handle.

The bulls will argue that strong rallies tend to end on good news, not bad and they would be correct. If it were not for the fact that the market was already set up for a correction than I would side with the bulls. However, as I wrote at the end of the day yesterday the environment was about as good as it gets. If we do get a move lower it could be sharp as the short base has been decimated and I suspect that the crowd is leaning the wrong way.

Bears Learn Murphy's Law

Everything that can go wrong for the bears has. Bank of America announced it is continuing foreclosures which set off yet another rally. Now Apple will come out and blow the lights out. Is this as good as it gets? Have a good night.

Scaredy Cat

I covered my SPY short for a miniscule gain. With the financials in a well deserved oversold rally it will be hard for the market to gain downside traction.

Can't Get A Date

I believe that private equity shops are dying to do deals but after walking away from deals in 2007 and 2008 many don't want to do business with them. If the economy heads south they just might try to wiggle out of the deal. Why bother doing business with somebody like that?

Gone Short

I am now moderately short via the SPY.

Interesting Stat posts this morning that small options traders have turned extremely bullish. Every time bullishness of small options traders has reached this level since the bull market kicked off in March 2009 a correction was not too far behind.

The Case For A Correction

The market was set up for a correction last week as it was overbought on both a short and intermediate term basis. However, the bears were not able to do anything with it as is often the case in a strong trending market during expiration week. Often times a correction must wait until the week after expiration which is where we are now. Sentiment is somewhat supportive of a correction as we are nearing extreme optimism but are not quite there yet.

There was a change of character in the market on Friday. Every time in the past month the market looked like it was going to start correcting, the put buyers would come in as everybody wanted protection. During the dip on Friday the crowd was still buying calls as they finally learned that even the smallest dips are buying opportunities. Normally I would view this as a significant event but I don't like to make too much of option activity on expiration as the activity might be expiration related.

The market is stretched from a time, price and sentiment perspective. These are not conditions under which I am comfortable buying. I am admittedly hoping for a lower market as to allow for better opportunities.

Sign Off

Corporate earnings are strong, the economy is recovering, Bernanke is printing money and World peace is right around the corner. I don't believe this will end well but as I alluded to in my opener, timing is key. I believe the chances of a post expiration hangover next week are pretty decent but I believe the downside will be limited to a few percent. I am signing off for the week. Have a great weekend.


The move in financials is astonishing especially following yesterday's move.

Gilead Ramping

My largest holding, Gilead, is ramping. It reports earnings on Tuesday.


I will be completely out of American Express at the end of the day today.

Selling SPY 118 Puts

I have sold the SPY 118 Puts expiring today. If we close below 118 I will be out of my net short position with an itty bitty profit. I still think we are likely headed lower in the near term but don't have the conviction to fight the good fight.

By The Way

In unrelated news Social Security benefits will not increase next year due to the fact that the CPI is not showing inflation and holders of TIPS will receive next to bubkus but their purchasing power is is uneffected as long as they stay away from anything in the CRB.

No Inflation

Apparently, the CRB is lying. There is no inflation to speak of.

An Expensive Lesson

In late 2006 and early 2007 I payed a dear price for a very important lesson. The market was going up in a straight line and overbought and extreme sentiment did not matter. We were in the middle of an LBO and stock buyback boom where nearly every week had new announcements of LBOs and buybacks.

I was certain that the real estate boom would turn to bust but I failed to appreciate that when there was well over $10 billion a week being injected to the market via buybacks and LBOs the market was going to go up. I was nicked pretty badly and was having second thoughts about if I were any good at investing.

Two lessons emerged from this experience for me. The first was that one cannot be so focused on the long term as to ignore what is in front of them. The second was that LBO activity, cash M&A and buybacks are very bullish for the market in the short run. Eventually, I bought LEAP SPY Puts with the VIX at 10 figuring that they gave enough time for my thesis to play out. That turned out to be my personal Greatest Trade Ever. That trade recovered my losses and soon after I had enough money to trade full time.

The reason I bring up this story now is that we learned that Seagate received a bid yesterday from private equity groups. Earlier in the week Pfizer announced a deal to buy King Pharmaceuticals. Deal making is clearly heating up as is buyback activity. We are nowhere near the point where we were in the heyday but this is worth monitoring and will likely have me taking profits very quickly on the short side.


I slightly reduced my short exposure into that last whoosh lower.

Who Is Benefitting

I read an article in the Wall Street Journal about private equity using low rates in order to borrow and pay themselves dividends. So private equity shops who are relevaraging the financial system benefit from QEII as do hedge funds riding the liquidity wave while Joe Sixpack pays more for his six pack due to inflation. And more jobs at momentum following quant funds are created.

Point of Recognition

A hot CPI tomorrow after a hot PPI today might give the win/win crowd something to ponder. QEII is likely to result in higher inflation with little added jobs. The question is when will be the point of recognition?

Funky Financials

The financials are trading like hell today and CDS are blowing out. I am not certain what the cause is. There doesn't seem to be any major news out but the news may be forthcoming.

Materially Out Of AXP

I now have materially less exposure to American Express after a very strong rally. I was looking for a relief rally after an overreaction last week to news of a skirmish with the DOJ and we got it.


The best thing the market has going for it is that sentiment is still not extreme even though I believe there is now too much bullishness. The Investors Intelligence survey is a great example of this. The bears in the survey stand at 24%, which is a low reading. However, a reading in the area of 20% has been a much better sell signal. The possibility that sentiment will reach an extreme is what keeps me from getting aggressive on the short side and has me only modesty short.

While I am not pressing too hard, there is a decent chance of swift move lower. I believe the short base has been all but destroyed. If participants ever find a reason to sell there will be few shorts to soften the decline. The market remains overbought and there is too much bullishness. I believe the market is vulnerable in the short term.

Extra Foam

For what its worth, the market is starting to feel frothy. Tops are a lot tougher than bottoms and the fact that this Friday is expiration does not help matters. I bought back some deep out of the money November SPY Puts that I was short. This is a baby step and makes me very slightly shorter.

Net Short

I am now net short due to the fact that I had shorted SPY Calls expiring Friday that are now in the money. I am strongly considering shorting more SPY.

The Comfortable Consensus

Intel's earnings and outlook were pretty much inline, which normally would be a disappointment. However, sentiment surrounding the PC space has become so negative recently that PC stocks might actually be able to stage a relief rally.

I believe that any resulting strength in equities can be sold as I still expect a correction in the near term, although bears might have to wait until after expiration for their honey. There is a comfortable consensus that stocks can be bought in front of QEII and the elections. A little too comfortable for my tastes.

One Less Tool

For the past few weeks I have been a seller of out of the money puts and calls as I was of the view that we would not have a great move either way. This strategy has worked nicely for me but is a lot less attractive now. With the VIX below 19 it might be time to buy options rather than sell them.

Why Medtronic

Medtronic is down nearly 30% from its April high as a weaker economy has hit the medical device sector. Medtronic is the leader in the space and is facing tough competitors who are taking share in some of its businesses.

Even after factoring in all of Medtronic's woes the stock trades at nine times forward estimates. Medtronic trades at a multiple that is lower than many pharmaceutical stocks who face patent cliffs and have much higher profit margins that the government might try and cut into. Medtronic's business is steadier and should trade at a higher multiple. As usual the analysts who loved the stock 30% higher now hate it as it has suffered a raft of downgrades.

I believe the secular trend is for higher healthcare consumption as the baby boomers age. There is a cyclical aspect to the business but only to a point as only so much of healthcare spending is discretionary. Medtronic does face competition but they always did. At nine times forward earnings there is a lot of room for error and a lot of upside potential if they meet their modest goals.

Back In The Saddle

I am back in the saddle after the Red Eye. I believe today's action is par for the course. We should continue to see attempts lower in the near term. The dip lower today was bought as the first dip after a strong run usually is.

Pfizer agreed to buy King Pharmaceuticals for over $3 billion in cash, which substantiates two of my beliefs. Healthcare should continue to benefit from strong price/free cash flow via buybacks and M&A. Secondly, Pfizer's management cannot be trusted. They said they were going to buy back shares and lay off the acquisitions after Wyeth. The good news is that Pfizer shares are pretty cheap so management will have a tough time messing that up.

A Buy And A Good bye

I took a bullish position in Medtronic today and shorted the SPY against it. I am short of time and will explain my Medtronic trade at a later time. I will be traveling overnight so posts tomorrow will be sparse. Have a good night.

The Bigger Picture

While there is a decent possibility that we see a move lower that lasts a few weeks, I still don't see a market collapse. As long as easy money fuels buybacks and cash M&A the market should be able to limit its losses. I wrote a column about what it would take for me to believe that we will see a much larger move lower last week.


Does anybody out there know if there is a technical reason for the drop in the VIX to 19.24? That is not something the bulls want to see as it speaks of complacency. A low VIX can often persist and is not an immediate signal of danger. But its not comforting either.

Heads Up

This Friday the CPI will be released. Few are focusing on this report but it has the potential to throw a wrench into the bulls equation. In the past few months we have seen:
  • Rising commodities.
  • Rising import prices.
  • Rising rents according to REIS.
  • Various companies pushing through price increases.
There is the potential for a hot number. I am pretty certain that Helicopter Ben will find a way to rationalize it as he seems hell bent on printing money. But it might cause some debate and make the bulls take a step back. If not for the coming Fed meeting than for the following ones.


The rally is now a full 30 trading days old and we are overbought in the intermediate term.
I know the chart above looks like there is still room. However, since this is a 30 day moving average in order for the line to continue higher we must get readings higher than 30 days ago. The readings that kicked off this rally were high and its quite unlikely that we will be able to do so. Especially considering that an up day today would make us overbought in the short term as well.

The American Association of Individual Investors survey is showing extreme optimism. The ISE Equity 10 day moving average is consistent with previous intermediate term tops as seen below.
However, some sentiment indicators are not there yet. Those include the Investor's Intelligence survey and Rydex. The CBOE 10 day moving average is not consistent with previous tops as seen below.
To sum it all up, an up day today would make us overbought in both the short and intermediate term. Some sentiment indicators are consistent with an intermediate term top while others are not. Overall the weight of the evidence is pointing to a market with more potential risk than reward, especially if we are up again today.

Looking Toppy

Below is a screen shot from of just some of the many unintended consequences of QEII. Who wants to be a Turkish Millionaire?

 I believe the market will make a high early next week after which we will finally see a correction that lasts more than a day. There is the possibility that expiration holds the market up and that a correction will need to wait until after expiration. Even in that case I think the market will not make progress in the latter part of the week. Have a great weekend.


I cannot help but wonder what would have happened if David Tepper never went on CNBC a few weeks back. Would stock prices be going up on bad news? He planted the idea that all news is good news because the Fed will print money. Investors have taken the ball and run.

George Soros  introduced the idea of reflexivity where one's actions in markets can change the course of events. I highly doubt Tepper intended to have such a large effect but I cannot help but think that the course of the market might have been different had he not appeared on TV.

Its All Good: Part Two

If the CRB closes at the current level it will mark a new 2 year high, joining other commodity indexes. Americans are losing more jobs and paying higher prices. Maybe nobody needs to work and we can all do carry trades to cover our rising costs. Is there such a thing as a free lunch? Is believing that printing money solves problems the equivalent of believing in a free lunch?

Its All Good

I am not sure if the bulls want a good jobs report, a bad jobs report or if its all good as David Tepper believes.  I believe the number is noise. I am patiently waiting for the bulls or bears to push this market too far in one direction or the other. I continue to believe that this market can be bought when its oversold, and sold when its overbought.

One Tough Market

It looked like we were finally headed for an overbought reading this morning when the market turned south. It seems like every time the market is about to get oversold or overbought it turns around and goes the other way. Those looking for a low risk entry point are simply not being given an opportunity.

I am short a decent amount of out of the money puts and calls, so this choppy action is benefiting those positions but not allowing me to take more aggressive positions. Have a good night.

Second Thoughts

Secondary offerings have not been faring well recently. Petrobras is now trading below the offering price as is M&T Bank. I cannot decide if this is bullish or bearish? What could be bullish about it? Less secondary offerings and IPOs.

Bullish on AXP

I took a bullish position on American Express.


We are seeing a reversal in commodities. Let's see if the macro trade works both ways and stocks follow.

The Last Dance

As the US peso continues to devalue, the futures are up yet again. Americans are getting less and less for their pesos while David Tepper gets richer. Atta boy Bernanke. I believe the current rally will be the final rally before a correction that lasts more than a day. We are setting up for an overbought reading in both the short and intermediate term. Hopefully, we will also see sentiment become extreme as well.

I expect a decent short term top in the coming days. My lone hesitation is that expiration often serves to help elongate a trend. There is a chance that the bears will have to wait until after expiration. What is clear is that we are late in the game.

Not My Game

I have been willing to buy when we were oversold and bearish sentiment was extreme. But given that:
  • Valuations are not attractive except when compared with worse crap (aka bonds).
  • We are in an all out currency war.
  • The economy is slowing and the only hope is that money printing and asset bubbles will create jobs. 
  • Sentiment is now bullish and we are overbought.
I am going to sit on my hands with my conservative positioning and wait for better opportunities. Yes, we could see participants continue to buy in anticipation of QEII but I am happy to sit the game of musical chairs out. Have a good night

Be Careful What You Wish For: Part Two

The CRB Index is testing a two year high now. Americans will soon be paying more for everything, but don't worry this is a good thing. While Ben Bernanke has yet to be right about anything, he is due.

One Time

Mortgage applications for purchase soared last week. A large reason for that was that FHA's new requirements went into effect this week and the deadline for getting a mortgage under the old requirements was last week.

My understanding is that the LEI uses mortgage applications as a large input, so we should see a pop this week. But we will not know the real level of mortgage demand until we see how mortgage applications do in the coming weeks.

A Little Room

A single up day has not made the market overbought in the short term, as one can see below.
There is still room in the short term for the market to get overbought but this Friday will mark day 30 of the rally which will make us overbought in the intermediate term. If we continue to go up until then we will also be overbought in the short term. At that point I think we could expect a correction that lasts more than one session.

Sentiment has definitely improved but it does not seem to be extreme enough for me to get aggressively short on an overbought reading:
  • The II survey is showing 46% bulls. At better tops since the March 2009 lows we have seen that number above 50% and bears closer to 20%. Bears currently stand at 28%.
  • The 10 day moving averages of the put/call ratios still have room before they reach an extreme.
  • Rydex traders are not nearly as bullish as they were at previous tops.
While I have seen some studies indicating extreme sentiment, I try to stick to the indicators that I always follow in order to avoid confirmation bias. None of the indicators that I look at are showing extreme optimism in the intermediate term. That could change if the market rallies a bit more, as I sensed some giddiness yesterday.

For now I think we are late in the game but with sentiment still not extreme I am not looking to take an aggressive short stance. That could change if the facts change.


Today's trading is giving me flashbacks to Charles Prince's famous quote, "But as long as the music is playing, you've got to get up and dance". That is essentially what market participants are saying. I sure hope those buying have better luck than Chuck did. Have a good night.


The ISEE Sentiment Index is at europhic levels today.

Do You Believe In Magic

I read Fed officials commentary and am dumbstruck that they want to print more money because unemployment is too high. Since when does printing money cure unemployment? We have been printing money for the past 15 years and unemployment is at Depression levels. What do you call somebody who does the same thing over and over and expects a different outcome?

I don't believe this will end well but the key is not to be too early in fighting it. I am short the SPY 117 Calls expiring next Friday. If they are exercised that would put me in a slightly net short position and I am fine with that. I am starting to see giddiness.

Be Careful What You Wish For

Central banks around the World can print money but they cannot ultimately control where that money goes. It seems a lot of that money has been finding its way into commodities recently. The effect on the economy of higher inflation and higher interest rates will be very real but the effect of the euphoria causing investors to buy stocks because of "liquidity" will be fleeting.

What It Would Take To Get A Sustained Move Higher

The strong rally of the past month has been a relieving of the oversold condition and the extreme pessimism that prevailed at the end of August. I will be the first to admit that I have underestimated animal spirits in the past but I don't believe that the rally can continue in the same fashion without something more than continued performance chasing.

We could slowly work our way higher on performance chasing and positive seasonality but I would envision more see-saw type action where the up moves are slightly larger than the down moves. There is only one scenario under which I could imagine a strong thrust higher and that is an M&A/LBO boom. There has been a lot of talk about deals in the pipeline but precious little action.

The ingredients for an M&A/LBO boom are in place. The corporate debt markets could not be more accommodating and valuations in many parts of the market are reasonable. Its just not happening yet. Large one time dividends or buybacks from the likes of Google and Apple would serve a similar purpose.

What It Would Take To Get A Sustained Move Lower

As readers know I am not expecting an outsized move in either direction in the near term. I envision a market that might get oversold or overbought but then revert back to the other direction. In this post I will look at what I believe it would take to get a sustainable move lower. In a later post I will examine what it would take to get a sustainable move higher.

Here are some scenarios where I could envision a large move lower:
  • A lot of the current bullish factors are dependent on low interest rates. Companies are borrowing at record low rates to buy back shares, lower interest expense and to finance buyouts. The 2.5% dividend yield on stocks looks downright generous compared to bond yields. Consumers and home buyers take advantage of the low rates as well. If QEII or the threat of QEII sends the dollar lower and stokes inflation than rates are likely to go higher. Higher rates caused by stagflation would destroy the market. This is a huge risk that I believe the Fed is completely ignoring. 
  • While the economy has been slowing down at the pace I expected, I must admit that corporate profits have held up better than I expected under these conditions. If the slowdown starts to hit corporate profits and cash flows in a much larger way than the market would likely go significantly lower. Currently profit estimates for the S&P 500 for 2011 are approximately $95. It would take a 20% drop in profit expectations before valuations were seriously challenged.
  • In a slowing global economy with many imbalances the "unexpected" happens more frequently. There clearly is higher than normal risk of an "unexpected" event.

Waiting Is The Hardest Part

I still don't see a very high probability setup and am not interested in taking a stand on the long or short side. Waiting is the hardest part of investing. Tomorrow I will look at what I believe it would take for us to get an outsized move, up or down. Have a good night.

Writing Naked SPY Puts

I used the strength last week to write naked out of the money SPY Calls. I am using today's weakness to write naked out of the money SPY Puts. I believe in options parlance that is called a short strangle. This reflects my opinion that we will not see an outsized move in either direction. I am waiting for the market to become oversold before making outright purchases.

Perfect Vision

Using 20/20 hindsight the call buying last week and this morning, combined with the inability of the bulls to make any headway was the proverbial "canary in the coalmine" that the market needed a rest.

Buy Oversold, Sell Overbought

During the month of September the market became overbought and never pulled back much. The reason I believe the market was able to do so was that market participants were "de-risked" at the end of August as pessimism was extreme. That gave participants a lot of room to buy.

Over the month of September sentiment has normalized and it stands to reason that equity allocations are higher as the chatter is growing louder that the market is a win/win. One can even make a case that short term sentiment has turned too bullish. Now that equity allocations are at normal levels, I believe that we will see more two way action. That means I will look to sell when we are overbought and look to buy when we are oversold.

We have gone sideways for the past two weeks making us neither overbought nor oversold at the current juncture. I am waiting for the bulls or bears to push things too far before making any strong directional bets.

Not So Sure About That Deflation

If the bull case revolves around QEII and low rates, than inflation is a threat to the bull case. The ISM Prices paid component came out above 70, which is very hot. The recent surge in commodity prices does not help either. The study below from Bespoke shows that spikes in commodity prices have generally been followed by higher CPI inflation.
It seems the only time that higher inflation has not followed a surge in commodities was in 2008 when we were seeing a blow off top and commodity prices completely collapsed afterward. Unless commodity prices collapse odds are that we will see a higher CPI in the coming months.

I have also been seeing some anecdotal cases of higher prices in my readings recently and when booking airfare: From the AP:
The heavy freight division of UPS says it will raise rates by 5.9 percent on Oct. 18.
...On Wednesday, FedEx Corp. said its freight and national less-than-truckload units would raise rates 6.9 percent starting Nov. 1.
Caterpillar is raising prices. From the AP:
Heavy-equipment maker Caterpillar says it will raise prices up to 2 percent worldwide starting in January... The company has already announced its first emissions-related price increases of 2 percent to 6 percent. Those also take effect in January.
Prices are rising at Wal Mart as well. From Bloomberg:
The cost of a 31-item basket of goods at a Wal-Mart in Virginia was $95.75, a 2.7 percent increase from August and a 5 percent gain from the start of 2010, analyst Charles Grom said today in a report. The price is the most since the New York- based analyst began the survey in January 2009.