The Good And The Not So Good

The good news is that the market is now maximum oversold as shown in the chart below. Maximum oversold does not mean that the market must rally but it should be more difficult for the market to make much headway on the downside.



The not so good news is that sentiment does not yet seem to have swung back to excess bearishness although the extreme bullishness is certainly gone. The chart below is the 10 day moving average of the CBOE put call ratio.

I have marked previous peaks in put buying with arrows. As you can see, the current level of put buying has increased but is not yet at levels seen at prior troughs. The same is true for the Rydex data and sentiment surveys. Anecdotally, I do see some people starting to worry and have been hearing some pretty dire predictions.

In summary, I would love to see another down day or two that moved sentiment inline with the maximum oversold condition. I believe at that point a rally would be a very high probability event.

Disclaimer

Couldn't Pull The Trigger

I believe we will get a very tradeable rally starting some time next week as opposed to the occasional bounces we had this week. However, the end of the decline could be the sharpest and scariest part. My plan was to force myself to do some buying at the end of the day if there was an ugly close, similar to the one we just had. But something stopped me that I can't put my finger on. Maybe it was that the decline felt too orderly or maybe it just feels too good to not have much risk on. That said,  it is hard to imagine that a decline on Monday would not lead to a Turnaround Tuesday. Have a great weekend.

Who's The Monopolist

In the past Apple often accused Microsoft of using their monopoly power to hurt consumers but it seems to me that Apple is not doing too bad a job of hurting their own customers. Apple forces applications for the iPad and iPhone to be bought through the iStore. They try to make it as difficult as possible for iPod users not to buy music from the iStore. They don't make much of their hardware compatible with SD Cards or other standard devices so that they could sell their own branded hardware for many times the cost. Who is The Real Evil Empire?

Waiting For Capitulation

While we wait for Capitulation, here is something entertaining to watch.

Come On Steve

I owned Microsoft for a brief period at the beginning of 2009 with the stock in the teens. I remeber listening in on a conference call where Steve Ballmer said that he wants to preserve cash for opportunities and not buy back stock, even though Microsoft had 10's of billions of cash on their balance sheet. The stock went as low as $15 and Steve Ballmer preserved his cash. This quarter when the stock averaged about $28 Microsoft spent nearly $4 billion on buybacks.

I'm not saying that the stock is not worth $28 because I actually think the current price is reasonable. But why does he think its a buy now and it wasn't at nearly half the price? The skills necessary to operate a company and manage money are completely different. But CEOs are given the power to do both.

Shopping At The Gap

Since my market view is somewhat neutral I decided to put on a pair trade. I am long Gap Stores and short XRT calls, which is the retail equal weighted index, as a pair trade. Gap trades at 10 times 2010 estimates net of cash. They are a retailer that actually returns cash to shareholders via dividends and buybacks. The merchandise has gotten much better. I have recently been at the Gap a few times since my son was born and I actually walked out with something for myself. There has been a large improvement since the last time I was there many years back.

I am interested to hear what readers think about shopping at the Gap?

Call Buying Is Disturbing

The continued call buying is disturbing. But we are also oversold so I am doing little. My Amgen position is disappearing as I sold the 57.50 covered calls a few weeks ago and the stock is well above the strike. Combined with the sale of Berkshire that reduces my long exposure and gives me leeway whichever way the market goes.

The Market Puzzle

Last night we closed just above a bunch of support levels. Breaking them this morning would have led to a really good shakeout and I was looking forward to buying into such a shakeout. So what does the market do? Gap up. I will not consider getting short at this point because we are very oversold and the cost of being wrong is high. The market does not like to make it easy.

Selling Berkshire

Berkshire Hathaway is ramping in the pre-market and I have sold the remainder of my position. I remain short Berkshire puts.

Short Term Trades

The purpose of posting my trades is to show how I put my thought process into action. However, recently I have had to post dozens of times a day as the market has become hectic. I believe posting so many times alienates a large group of readers who are not so interested in the short term and likely read the posts too late anyway. As such, I will no longer be posting my short term trades, although I will still post my short term strategy and thoughts.

The Checklist

It seems like a good time to make a list of the short term positives and negatives. The positives are:
  • Rydex traders stayed stubbornly long through last Friday's decline. This week they have finally taken down their longs to low levels. While they have increased their shorts, they are nowhere close to extreme levels yet.
  • The market will be maximum oversold at the end of the day today. The oversold reading will be very good if we could manage an ugly day today. 
  • The 10 day moving average of the put call ratios are off their lows and are reaching the high end of readings we have seen since the March low.
  • Sentiment surveys have all shown large drops in bullishness although there is plenty of room before we reach maximum bearishness
The negatives are:
  • The momentum and intermediate term trends are downward.
  • There was way too much call buying yesterday.
  • While the bulls have definitely backed down, we have not yet seen capitulation or the shorts get aggressive.
  • Fundamentals and valuation do not support the market.
  • The market went straight up 70% so straight down cannot be ruled out.

    Asked and Answered

    I apologize for the lack of posts but my meetings ran over. Today's action has not yet had the chance to sink in as I was away from the computer but here are my initial thoughts:
    • Yesterday's late day rally was likely the result of leaks about Obama's speech. Its always better when the market bottoms on no news or even bad news.
    • The call buying today was disturbing. 
    • I would not be surprised if today's decline has something to do with Greece, with Greek bonds widening out to record levels.
    • I was hoping to buy Goldman in the 140 area. Does today's rally mean I need to change my plans?
    • My longs were actually up nicely today (Amgen and Berkshire). It was pure luck that I had such a good day because I was clearly wrong about the direction of the market. I have been on the other side of luck plenty of times so I will take it when I can get it.
    • The million dollar question is "Will I be buying weakness tomorrow as planned"?
    • Its likely that I will buy weakness but I would want to see some fear and put buying. If call buying stays at today's level I might just take a pass.
    • Have a good night.

    The Obama Takes It Back Rally

    Part of the reason the market rallied at the end of the day yesterday was because there were leaks that Obama was going to soften his language on the banks. While I would prefer that the market bottom on exhaustion with no news, I believe that the odds favor the bulls for the coming week.

    Even if the market were to fall through tomorrow we would be maximum oversold heading into the seasonally strong beginning of the month. Therefore I believe it is best to get ot of the bulls way and even buy if we do get another scare this week.

    As an aside, trading on Barack Obama or any other politician's rhetoric is silly. Politicians huff and puff and say what the public wants to hear, but there is rarely ever any action. The only thing worse is trading on what Jim Cramer says. At midday yesterday he declared the banks dead. They promptly rallied and are gapping up this morning. I will be at meetings all day and will try to post.

    Have We Seen A Short Term Low

    I suspect that we might have seen a short term low that could carry us through the seasonally strong beginning of the month. I was hoping to build up more longs but I am sure everyone else was as well. Have a good night.

    Sold SPY

    I sold my SPY position for a quick profit. I will be looking to buy dips through the end of the week.

    Picked Up Some SPY

    I picked up some SPY @ 108.4. I will likely flip it quickly if we get a rally into the close.

    Capitulation

    We are starting to see the capitulation I wrote about in my opening piece. Commodities are getting sloppy. If the market initially sells off on the FOMC announcement I will likely start the process of bulking up on longs. I want to leave room for additions because this phase could last a few days.

    Apple News Should Get Sold

    The Apple is scheduled to reveal the tablet today. Highly telegraphed pieces of news like that are usually sold. I have no skin in the game.

    Economist's Surprise Is Surprising

    Economists simply don't get it. The new home buyer incentive artificially boosted home sales. Fix your models already.

    Biotech Is Underowned

    Biotech has been holding up well during this recent correction. I believe the sector is underowned and that this could be the catalyst that gets people back into the sector. Amgen is my largest long position.

    Sold Berkshire Puts

    Last night I sold half of my Berkshire Hathaway position. I sold the February 72 Puts naked to make up for the shares I sold.

    Not So Positive

    We saw a big drop in the Investors Intelligence bulls today. Sentiments Edge describes why a drop in sentiment from high levels might not be a good thing.

    Oracle Closes On Sun

    Oracle has closed its deal to buy Sun Microsystems. The deal is all cash and some of that cash should find its way into other stocks.

    Leaving Room

    My sole long positions are Amgen and Berkshire Hathaway. I am leaving plenty of room to add to positions if we do get a disconnect through the end of the week.

    Unhedged

    I have covered my SPY short in the pre-market. I am long.

    The Easy Trade

    There are generally three phases to a short term decline. The first phase is the initial thrust lower. We saw that initial thrust lower with the 60 point drop in the S&P 500 that ended last Friday. The second phase is a reprieve, where the market bounces back somewhat. We had a reprieve from Monday morning through most of the day yesterday, although I was expecting a little more. The third phase is the final capitulation lower, which we have not seen yet.

    Except for the decline in June, none of the declines we have seen since the March low have met this textbook definition. The current decline looks like a textbook decline thus far. If the market capitulates into the end of the week we should see a very playable rally start from there. In addition, if the market went down into the end of the week the market would be maximum oversold. That would offer a very high probability long side trade.

    While I believe that the intermediate term trend is lower, we are getting late in this down leg. If the market starts to break down I plan on legging into longs through the end of the week. When a rally finally arrives, I expect that any further losses that the market suffers will be recaptured.

    Sold Half Of My Berkshire Position

    I sold half of my Berkshire Hathaway position. It is up 8% in after hours as it is being added to the S&P 500. When it rains it pours.

    Calling It A Day

    The past week of trading has been profitable but grueling. I am going to enjoy the rest of the afternoon with very little risk on my books. I will be back bright and early.

    Hedged Again

    I have used this rally towards 1105 to hedge my portfolio. My portfolio is now market neutral. I suspect the S&P 500 will reach 1115. However, because I believe the intermediate term trend is lower I will err on the side of caution.

    Reason For My Flip Flop

    As soon as I put my trade through to short SPY, I realized that hedging myself was an emotional decision. I became scared that the market would go down and I let that fear control me rather than logic. I walked away from the computer for a few minutes and thought about my decision. Then I checked the put/call ratio and saw that there was put buying. That cemented my decision to reverse myself. I ate my ten cent loss and covered my short.

    I make a living largely on the bad emotional decisions of others, so it might seem odd that I can make the same mistakes. I am just human and that realization allows me to correct myself quickly. I'm just a primate typing on a keyboard that can act emotionally.

    Audible On Audible

    I have unhedged myself again. I am net long again. My indecision cost me a dime on my SPY position.

    Audible

    I have called an audible and rehedged myself. I am now market neutral. This likely means that a rally will start promptly.

    Alcoa Pays In Stock

    Alcoa put $600 million worth of its stock into its employee pension plan.  After the carnage of the past decade many pension plans are underfunded and companies are increasingly donating stock. This type of behavior is a longer term headwind for stocks.

    Swapped Into Buffett

    Berkshire Hathaway B shares will likely be added to the S&P 500 in a little over 2 weeks, when the Burlington Northern deal closes. I swapped out of my SPY long and into the Berkshire B shares. I wanted to buy Berkshire this morning but the stock gapped up. It later came down and gave me the opportunity to buy.

    Bought SPY

    I have started a long position in the SPY @109.09.

    Let's Break Friday's Low

    In the pre-market the SPY is sitting right on Friday's low. We should  get a nice shakeout if those lows are broken. I plan on using such a shakeout to start beefing up my long book.

    Getting Closer To A Rally

    Most market observers were not happy with yesterday's action. Many expected a stronger bounce after the three day, 60 point plunge on the S&P 500, as did I. What I liked about yesterday's action is that it seemed to have turned many people negative and that is a step in the right direction.

    Rallies start when markets are oversold and most participants don't like the market. Rallies end when the market is overbought and the crowd is bullish.  The market will be maximum oversold by the end of this week. I believe a gap lower this morning would be an opportunity to start beefing up long positions in anticipation of the oversold reading.

    Little Conviction

    I don't have much conviction but am remaining unhedged. My only remaining long position is Amgen so there is not that much to hedge anyway. We have seen a lot of put buying in the past two days and therefore I think that any break below Friday's low would be regained pretty quickly. The bears can argue that the near term oversold condition is being relieved by going sideways. This market does not like to make anything easy.

    Now Thats An Offering

    The Bank of China is considering a $30 billion stock offering according to the Wall Street Journal. That can't be good for the Chinese stock market. Many are saying that China is a bubble. I don't know if that is true but that is the type of event that could burst a bubble.

    Ideal Situation

    An ideal situation would be an Apple beat tonight that gets everyone excited. I would likely use that opportunity to put my hedge back on and might even consider getting short again.

    Sold Exelon

    I sold Exelon at a loss. I took a harder look at the stock over the weekend and realized that I missed something. Namely, that free cash flow will fall off a cliff starting in 2010. I only buy into companies with strong free cash flow. I had assumed that because earnings and free cash flow were roughly equal for the past 5 years that would remain the case. I was mistaken and I should have noticed this earlier. I am taking my lumps.

    Another Minus

    Another item that favors the bears is market breadth. Breadth has turned negative on both the NYSE and Nasdaq even though the market is actually higher.

    Hoping For A More Normal Market

    Since the March lows the up moves have occurred in a straight line.  Even though the corrections have been few and far between, they have also been very sharp. That is not how the market normally trades. There is usually more give and take. I am hoping that the bulls make a stand because I am long and also because I am hoping for a return to a more normal market.

    Pluses and Minuses

    The positives are:
    • We are seeing heavy put buying and the market is holding in relatively well.
    • We are oversold in the short term (but not by my favorite measure) 
    • We are sitting right above Friday's lows, which should act as support.
    The negatives are
    • The market has until the end of the week before it is maximum oversold by my favorite measure(10 Day moving average of NYSE Advancers - Decliners)
    • There were no major cash M&A deals announced over the weekend
    • The insider selling window opens up at many companies this week.
    • Most people believe this is just a correction.

    Existing Home Sales Plummet

    Existing home sales plummet. The economists are shocked!!!

    I was entertaining the idea of rehedging ahead of the number but I was not convinced that the number would matter. It looks like I made a mistake.

    Existing Home Sales

    The existing home sales number is coming out at 10:00 AM. I expect the number to come in low as many rushed to close by November, in order to qualify for the first time buyer tax credit. The effect should be similar to the aftermath of Cash For Clunkers. I am aware of the fact that the tax credit was extended but the sense of urgency that buyers had is now gone.

    Not So Brave Bulls

    The bulls, who came into 2010 thumping their chests are in need of diapers. Normally, I would be very comfortable relieving them of their positions after three nasty days in a row. However,  the media has a bearish story for the weekend that is easily understood by the public. OBAMA WANTS TO KILL BIG BANKS.

    The public has been on a buying orgy so they have some merchandise to sell. We could see that selling on Monday but that would make the odds of a rally on Tuesday extremely high. I am long, nervous and ready to add late Monday if necessary.

    I actually thought I was going to have  a peaceful weekend after covering my shorts yesterday. Some things never change. Have a great weekend.

    Lifted My Hedges

    I have lifted my hedges and I am long for a trade.

    The Missing Ingredient

    We are starting to see the ingredients necessary for a bounce as complacency has left the building. The missing ingredient for a larger rally is that the market will not be maximum oversold until the end of next week. I expect a bounce sometime before that but it will likely be rejected pretty quickly.

    I am still maintaining a market neutral portfolio but I did sell puts against my hedge, so I will not be hedged if the S&P 500 goes below 1040 by February expiration. I might take stabs early next week and play for a bounce but will wait until late next week before making a stand on the long side. If we do get a bounce shortly, I will look to put some of my short exposure back on.

    The Goldman Trade

    I scaled into Goldman with my best purchase being pretty close to the lows of the day. Now that it has bounced I have been scaling out. It is pointless to talk about such short term trades so this will be my last update. I want to be out of the stock by the end of the day as the insider selling window opens next week and some might want to monetize their bonuses. I will revisit the stock after next week.

    Finally Some Fear

    We are finally starting to see some fear and panic. In my opinion this is a good thing and an important ingredient for a bounce.

    Sold SPY 105 Puts

    I sold the SPY 105 February Puts against my SPY short position. Including the premium I receive that would be a 10% correction. At that point I would be willing to remove my hedges.

    Adding To GS

    GS is down another $1.30 and I am slowly adding to the position. The stock is moving quickly and I will be trading around my position. I can't guarantee updates.

    Bought GS For A Trade

    I bought Goldman Sachs for a trade again at 157.50.

    Not Maximum Oversold

    I hope that we are returning to a more normal market, where the market is once again a two way street. In that type of market oversold and overbought readings should be much more valuable.

    In the ultra short term the market is oversold, as 3 of the past 4 days have been down pretty hard. My favorite measure of oversold is the 10 day moving average of the NYSE A/D Line. On that basis the market will not be maximum oversold until late next week. If we were to head lower over the next week we would be maximum oversold  right at the turn of the month.That setup would offer  offer a decent long side opportunity.

    The Fat Lady Is Not Singing

    I don't believe that two down days have gotten rid of all the excess bullish sentiment in the market. To summarize:
    • The Investor's Intelligence survey showed the lowest number of bears in decades.
    • The American Association of Individual Investors showed the least amount of bears in years as well as extremely low cash allocations.
    • Fund manager surveys showed widespread bullishness and low cash allocations.
    • There was a level of call buying that had not been seen since the Internet bubble.
    • Rydex traders were heavily invested.
    This type of extreme will take time to work off. So why have I covered my shorts?  The S&P 500 has gone down 40 points in a straight line right into support. Most markets don't move in straight lines (recent experience not withstanding) and there is give and take. I don't believe we have seen a durable bottom, but that doesn't mean we can't bounce.

    Googling

    I used the dip in the futures from Google's disappointing earnings to cover the balance of my net short position. I am long AMGN and EXC and short SPY against them. I am now market neutral.

    Who Woulda Thunk It

    I further trimmed my shorts into the closing bell. My net short position is now quite small. I would have much rather seen a sloppy close. While the market has the potential to bounce, I don't expect a very strong bounce.

    What has been the strongest asset class this year? Treasuries. Who woulda thunk it?

    Another Kick Save

    Will Barney Frank's comments prove to be another kick save for the market and lead to an end of day rally? I believe the market is much better off with capitulation into the close rather than another late day save. It would increase the odds of a decent bounce.

    Money Well Spent

    The rally in the banks was because Barney Frank said that any regulations would be phased in over 3 to 5 years. The banks lobbying dollars hard at work. That was even quicker than I expected. Maybe regulations in 3 to 5 years?

    Sold Goldman

    Goldman has bounced $4 and I am gone from the trade.

    Fading Obama

    I have been fooled by Obama's rhetoric once too often. If he thinks the health care lobby is strong he has not yet been introduced to the banking lobby.  I am taking a trading long in Goldman Sachs.

    Disclaimer

    I do not offer investment advice on this site. Under no circumstances does this information represent a recommendation to buy, sell or hold any security. Positions may change at any time without notice.

    Further Picking

    I am further picking away at my shorts.

    Close Enough

    As we are pretty close to 1120 I have started to cover my SPY short. I will cover more on a 5 point scale.

    My Biggest Fear

    My biggest fear from the short side is a large cash deal on Merger Monday. The analysis that led me to short was that pretty much everybody was bullish and that there was no marginal buyer. If corporations lay out cash to buy other corporations we would have  a marginal buyer. I am looking to cover a chunk of my short exposure in the 1110 to 1120 area on the S&P 500. However, as the weekend approaches my trigger finger will get itchier as I don't want to hold a large short position over the weekend.

    This Is Different

    The selloff today looks different in that we are seeing two days in a row of selling. I can't remember the last time that happened. I am not declaring victory but just pointing out that we are finally seeing a change.

    Why Exelon

    Yesterday, I purchased shares of Exelon, the electric utility. I believe the shares are reasonably priced at 12 times earnings given the stability of the utilities business. There is also a lot of upside to earnings if natural gas prices ever do pick up. They are especially reasonably priced compared to the broader market and offer a nice dividend that has room to grow. The reasons for the timing of my purchase are as follows:
    • We have seen a giant game of sector rotation in the market over the past few months. Utilities have been on the skids for over a month. If past is prologue we should see them come back into favor shortly. 
    • I foresee a tougher period ahead for the market. Utility shares tend to outperform in those circumstances.
    • Exelon disappointed last earnings season. I believe this has set the bar extremely low for their report tomorrow. I like low bars.

    Gimme That

    Goldman's earnings beat was largely because they clawed back compensation from previous quarters. The businesses largely performed in line with expectations this quarter.

    Covered XHB and XRT shorts

    I covered my shorts late in the day of the homebuilders and retailers (XRT and XHB). Late in 2009, I shifted some of my short exposure from SPY to a combination of SPG, QQQQ, XRT and XHB. Rotating my shorts was a good idea as I actually made money on them as a group, even though SPY is higher (mostly thanks to SPG). This was the last of them and now I am only short the SPY.

    On net, I have slightly lowered my short exposure today by covering some shorts and buying shares of Exelon. My net short exposure is somewhere between medium and high.

    Of Late Day Rallies

    Typically, weak days such as this one end in a weak manner. But this is not a typical market. Last week, we saw similar selloffs that just dried up at the end of the day. It will be interesting to see how today ends. I have no strong feeling.

    Warren Buffett On CNBC

    Warren Buffett is the greatest investor of all time but he is still human and hypocritical at times. This morning on CNBC Warren Buffett's double standard was on display.
    • Buffett complains that the economy and banks were over levered and needed government help but would not say that forcing the banks to raise capital was a good thing. He even hinted that it was unnecessary. He is sour about the fact that Wells Fargo had to dilute shareholders. 
    • Buffet diluted shareholders in the Burlington Northern acquisition but was complaining that Kraft is doing the same. The deals don't look very different to me.  
    • Buffett thinks the rich should pay a higher share of taxes yet lauded Kraft for selling their pizza unit in a way that did not avoid taxes.
    One of the better Warren Buffett books out there is Pilgrimage to Warren Buffet's Omaha.  The author looks at what makes Buffett great but also looks at some of his flaws and inconsistencies.

    Dollar Rally

    The dollar is rallying hard while gold and the Euro are getting beat down. Is the Republican victory the cause for this as government spending is more likely to get curtailed? Or are the problems in Greece growing?

    Bought Exelon

    I used today's downdraft to purchase shares of Exelon, the electric utility.

    Lock Up Period

    Banks have given out a record amount of compensation in the form of shares. Usually employees are locked up from selling until three days after earnings. If some of these bankers want to convert their shares into hard currency, we could see some selling over the coming weeks. By tomorrow most of the major banks will have reported and by next week the lock up periods should pass and bankers will be free to sell.

    Forward Looking Investors

    Despite worse than expected earnings and revenue, Bank of America is trading higher. This is because investors are patient and are looking towards earnings two and three years out. Or is it because they are momentum junkies?

    Shot Across The Bough

    Last night's election was a shot across the bough for Democrats and the Obama Administration. The Republicans took one of the strongest Democratic seats in the Senate. The American people have voted and they are not happy.

    The American people are sick of bailouts and money printing and they want to see real financial reform. If the Democrats finally listen to the people it will be good for the country in the long run and lead to a healthier economy. However, in the short run it is likely to slow down the economy and the stock market.

    Sticking Martha Stewart in jail won't do the trick this time around. Even if the Democrats continue to be toothless in regards to financial reform, the bulls better hope that the recovery is self sustaining because the Obama Administration's hands are now tied with regards to further bailouts and stimulus.

    The Law of Large Numbers

    Apple and Google are approaching market caps of $200 billion. Once that type of size is reached it is a lot harder to move in the manner they have been. Especially, because they don't pay dividends and therefore are excluded from many portfolios.

    The Marginal Buyer

    I keep asking myself who is left to buy? Fund manager surveys show that cash weightings are extremely low. Sentiment surveys show the lowest levels of bearishness among both investors large and small in many years. Option activity is as skewed towards call buying as I have ever seen it. The conclusion I come to is that there is nobody left to buy. But I thought that on Friday as well and here we are up another percent?

    Sold Treasury Long

    I sold my treasury long by covering my TBT short. I am very happy with the outcome of the trade even though it was far from a homerun. The trade worked in an up market, which theoretically it should not have.

    Moved To Large SPY Short Position

    I have moved to as large of a short position as I am willing to go to.

    Healthcare Is On Fire

    Healthcare is on fire today, a continuation of last week's move. While I still own Amgen, I disposed of my pharma longs over the past couple of weeks, thinking I could buy them back cheaper during a correction. Even if we do get a correction it looks unlikely that I will be able to get my positions back.

    I will not trade out of longer term positions.
    I will not trade out of longer term positions.
    I will not trade out of longer term positions.
    I will not trade out of longer term positions.
    I will not trade out of longer term positions.
    .......

    Exuberance Continued

    We are seeing continued exuberance and call buying at the open. I have added to my SPY short and will add again at the end of the day if the market continues higher.

    Merger Arbitrage

    I put some of my free cash balances in the Exxon Mobil/ XTO Energy arbitrage.

    Expiration Hangover or Mutual Fund Monday

    We often see an "expiration hangover" the trading day after expiration, where the market has a large down day. This is especially true when the weeks heading into expiration have been strong. In recent months we have seen another phenomenon known as "Mutual Fund Monday", where money flows into the market over the weekend and Monday is very strong. Both of these opposing forces will be at work today.

    I believe this market is headed for a correction.We are seeing levels of bullishness that has not been seen in years and has led to corrections in the past. In addition, the market is now overbought. I don't know if this is a bull market, bear market, cat or dog. What I do believe is that this market is headed lower in the near term.

    The Greatest Trade Ever

    I spent the past few nights reading the book about how John Paulson made his billions, The Greatest Trade Ever. What amazed me the most was how little he had to lose. The CDS insurance he was buying was only costing him 8% of the funds assets a year. Had the trade not worked out all he would have lost was 8% a year.

    The other thing I learned was that the reason he bought CDS protection on the banks the following year was because he realized the major banks were his counterparties and they were losing what he was winning. The major banks did not lose money lending. They lost money in a casino, betting against John Paulson and the likes. That is why they had to be bailed out and that is what took down the system.

    The book is pretty entertaining and an easy read but there is not much one can learn from it, except how screwed up the system is.

    Expirations

    Expirations are tough to game because the options are in control of the market. Normally, if a market has not rebounded by 3:00 PM on a Friday the chances of a rebound are very low. The only move I made today was to sell the AMGN February 55 Puts naked. I am short the January 55's and they are expiring worthless today.

    Too Slow

    I came into the day with a medium sized net short position and was planning on materially adding to the position. The market opened down and I wanted to wait until the first options readings came out before adding to the position. However, by the time the reading came out the market was already down hard.

    Traders are still buying calls today. While expiration days are very hard to predict I believe a significant correction has begun. I would be surprised if we did not go somewhere between 5% and 10% lower over the coming weeks. I am off to meetings for the next few hours.

    As Good As It Gets

    Earnings did not disappoint. I was bracing for strong numbers and still Intel's numbers impressed me. However, the way stocks react to the news is more important than the news itself. Thus far the futures are sagging in reaction to the blowout earnings. I was expecting the news to be sold but not this quickly.

    It was almost six months ago that Intel positively surprised and the market took off on what was one of the most powerful rallies I had ever seen. At the time there were many doubters, shorts and under invested market participants. Six months later we are seeing off the charts bullishness, with the number of bears at levels not seen in decades.

    Be Careful What You Wish For.

    It looks like I will get my chance to short the market tomorrow. Have a good night.

    Your Friendly Reminder

    • The news is always best at the top and worst at the bottom.
    • Williams Sonoma beat handily and raised and is selling off.
    • Powerful rallies tend to end on good news, not bad.

    Earnings Setup

    • The treasury auction went fine and now treasury bears have no more major events until the month of February. I am in no rush to sell my position.
    • Intel will blow out earnings as by all accounts Windows 7 is selling well. The only question is will the news get sold?
    • I will likely move to a large short position some time tomorrow as long as the market holds up.
    • Since the VIX is at 17.5, should I use options for my bearish bets?
    • If the TBT is such a horrible vehicle, why is there over $4 billion of the security outstanding?

    Pressing My Treasury Long

    Even though I see interest rates higher in the longer term, I remain long treasuries for the following reasons:
    • Every time I have seen the consensus this bearish on treasuries there has been a rally.
    • I don't believe the economy could withstand much higher rates. If rates go much higher the rest of my portfolio should do very well as I am not positioned for a strong economy.
    • I am long treasuries via a short of the TBT. The TBT is a levered ETF that has lost  over 30% of its value in the past 18 months even though treasuries (TLT) have done nothing.
    Today is the auction of the 30 year bond, which is always scary for treasury investors. However, this will be the last auction for the month of January. It will be a few weeks before treasury investors will be faced with any more scary events.

    I will be out at meetings for the next few hours.

    Weekly Jobless Claims

    The weekly jobless claims will be coming out shortly. Last week, a sell side analysts put out a note saying that jobless claims might be less than expected because of seasonal adjustments. Many seasonal workers are laid off after Christmas every year, so the government seasonally adjusts the number downwards. The analyst surmises that since there was less seasonal hiring this year there will be less seasonal firings and this week's number should come in better than expected.

    This logic seems sound to me although I am not familiar with the data. Therefore I would take any improvement in the reported numbers with an even larger grain of salt than other government figures.

    Bears Honey Stolen

    The dip buyers showed up in force today and the bears have completely given up yesterday's gains. It is looking increasingly likely that the bears will have to wait until after expiration to get their hands on the honey pot. For an indication of how I am positioned watch the following video.

    That Didn't Take Long

    • The call buyers are back at the ISE after taking the morning off. They learned their lesson rather quickly.
    • The pharmaceutical sector has broken out today. I sold down my exposure over the past week looking to buy it back cheaper on a correction.
    • A mistake that I keep repeating is trading out of longer term positions.
    • The question is not if Intel and JPMorgan will beat earnings. The question is what will be the market's reaction once they beat estimates?
    • If anybody out there believes that either of these companies will not beat earnings handily please say so on the message board.

    Cash for Bloggers

    Wilbur Ross is out calling for a new cash for clunkers program. Of course he owns a boatload of auto parts companies. I am calling for a cash for bloggers program to stimulate the economy.

    Nasdaq 100 Showing Strength

    The Nasdaq 100 is showing strength today, despite the bad news out of Google. It has been underperforming all year. This likely means its underperformance is coming to an end.

    No Euphoria

    The bulls have finally backed off the calls today and defended yesterday's lows. I am staying put and not adding to shorts today.

    II Survey and Rydex Traders

    The Investors Intelligence survey is out and has reached a new extreme with 53.4% bulls and 15.9% bears. In addition, Rydex traders are holding the largest ratio of long positions to short positions in over seven years. I am very tempted to add to my shorts but am debating waiting until after Intel reports. We could see a final gasp higher. That said, risk is very high and I will let readers know what I am doing once I decide.

    Expiration And Changes In Trend

    There are two factors that are in the bulls favor over the next few days. The first factor favoring the bulls is that during previous corrections since the March lows the market did not head straight down but rather chopped around the highs for a while before heading down. The second factor is that this week is option expiration.

    The first factor is self explanatory but I wanted to elaborate on option expiration. Strong trends tend to persist through option expiration. Often the day after option expiration will serve as a turning point. I have some pet theories on why this occurs but nobody knows for sure. Some say that the market will only go down after people's downside protection expires. I theorize that expiration might serve as a capitulation point for those fighting the trend through options. As expiration approaches one is forced to make a decision whether to throw more money into a losing trade or to capitulate.

    So why am I persisting in betting against the market and not waiting until expiration? I believe there is some meaty downside, whether it occurs before or after expiration. I don't want to lose a position that I believe will eventually make a good profit trying to be cute. In addition, for a down day yesterday had a lot of call buying. Had we seen put buying yesterday I would have been more willing to take off the position temporarily.

    Are You Scared

    While call buying tapered off a little into the end of the day, there is still not much fear out there. Most people are still more concerned with catching the bottom, than with losing money. While I took some profits on my treasury long, I did not cover any shorts. Have a good night.

    Amgen Guidedown No Biggie

    My largest long position is Amgen, which guided down earnings today. They said revenue will come in at the middle of the range while earnings will come in at the low end. The main culprit was a $60 million diabetes investment they made. The company trades at less than ten times earnings, net of cash and has good growth ahead of it. A miss of a few cents doesn't change the fact that the stock is cheap.

    Clean Up Time

    I took profits on a part of my long treasury position by buying back naked TBT calls that I was short. I was short the 50 strike calls expiring this Friday. No need to keep cheapie options hanging around that could bight me in the arse. I remain short shares of TBT.

    Overwrote My Amgen Position

    I wrote the Amgen Feb 57.50 calls against my long position. I am already short the January 57.50 calls. I doubt it will surpass that level by the end of the week.

    Gap Fill

    It seems like a gap fill is a no brainer today. It is the first chance for anxious buyers to buy a pullback as pullbacks have been very shallow since the new year started. The problem is that it almost seems too easy. It has not paid to over think anything recently but I am going to press my shorts anyway.

    Secondary Off Season

    A bunch of secondary offerings were announced yesterday. Not enough to have an effect on the overall market but a lot for this time of year. Most companies can't sell their shares because they are in a lock up period until they report earnings. If this much stock is being sold during the off season, this raises the chances that we will see increased stock issuance once companies report earnings.

    Alcoa Doesn't Matter

    Despite my bearish positioning, I will be the first to admit that Alcoa does not matter. Rarely do their results have any predictive value for the rest of earnings season. However, it could serve as an excuse for the market to correct if the market is already inclined to do so.

    Regular readers know my belief that the news matters less than most believe. By most accounts the employment report on Friday was bad. However, the market was not ready for a correction. Had the market gone down the media would have said that the employment report was the reason. If the market corrects today, Alcoa will be the reason. The truth is that the market will go down today if it is ready to correct and that has little to do with Alcoa.

    The VIX Bleeds

    The VIX continues to bleed today. I have been a seller of premium for the past year but at these prices the strategy no longer makes sense. As much as I hate to pay up for options, at these prices it is becoming hard to justify not replacing stock positions with options.

    Sold Down Pfizer

    I sold down my Pfizer position. I will be looking to buy it back during the correction I envision. Maybe I'm being too cute, but that's what I did.

    Pavlov's Traders

    Dip buying has paid off in spades and the first dip lower this morning has been bought. Every correction in the past few months started out with a dip that was initially bought. It will be tough to squeeze the shorts today as the gap higher this morning gave the bears very good prices to get short at.

    Fading Momentum

    The high beta stocks of the Nasdaq 100 and the Russell 2000 have been very weak out of the gate despite heavy call buying. Could this be a  signal of fading momentum? The indicators are favoring the bears in the early going.

    Mind The Gap

    Today's gap higher feels like a knee jerk reaction to the fact that its a Monday. If that is the case the bears might actually be getting good field position to mount a move lower. I am expecting a move lower to start today or tomorrow.

    The fact that this week is expiration somewhat tempers my enthusiasm for a move lower. Expiration week has a way of stretching trends. That said, conditions are so extreme that I believe sales at these levels will be rewarded whether a move lower starts this week or next.

    A Catchy Slogan

    Every good rally needs a catchy slogan to suck in the masses. The slogan for this rally is, "If you put your money in the bank you get 0%". The beauty of such a slogan is that it can't be argued with because it is true. It also allows one to pay any price for a stock. The statement is true whether the Dow is at 10,000 or 20,000.

    During the housing bubble the slogan was "They aren't making anymore land" or "real estate always goes up in the long run". During the Internet bubble it was "the Internet is the future". All those statements were and are true and allowed investors to pay any price for an investment. However, that did not stop people from losing fortunes. The fact that the Internet was the future did not stop the Nasdaq from falling from 5,000 to 2,300 a decade later. They certainly aren't making anymore land and I am certain real estate will be higher 100 years from now. However, those that invested two years ago are likely sitting on large losses.

    Interest rates are indeed 0% but that does not mean stocks must go up. Interest rates were 0% between September 08' and March 09', yet investors had no problem selling. Now that stocks are 70% higher, the slogan gives people the intellectual excuse to follow their primal instinct of chasing the herd.

    Warren Buffet said that in the short run the market is a voting machine and in the long run is a weighing machine. I am not knocking the slogan, as a catchy slogan is more powerful than the fundamentals in short run. But recognize the argument for what it is.

    Bears Dread Mondays

    Monday's have been an absolute killer for bears recently, as money pours in over the weekend. Not to mention the risk of a Merger Monday. Even though Tuesday is likely the bears best chance to turn the market around, I am going to stick with my medium sized net short position.  The VIX is plummeting, calls are being bought and fear is non existent. Have a great weekend.

    Treasuries Turn

    Treasuries broke down earlier this morning but instead of following through to the downside they have turned around and are now rallying. Is this a precursor to an equity turnaround? It certainly doesn't hurt the case.

    Miami House Prices

    I went to Miami thinking that I would be able to buy my dream house for pennies on the dollar and was sorely disappointed. In parts of Florida that are less popular than Miami house prices are way down. In Miami prices are down somewhat, but from really inflated levels. Owners are asking for prices that are unrealistic and little inventory is moving. It seems the only way to get a deal is to buy a short sale or foreclosure where the bank is taking the loss. There is a lot of that as many got in over their head but the foreclosure process takes years and it usually takes three months to get an answer back from a bank on a short sale offer.

    No Fear

    There is absolutely no fear out there. Investors were buying calls right out of the gate despite the negative payrolls report. They did not even pause for breath. This brings to mind the Buffett saying "Be fearful when others are greedy and greedy when others are fearful".

    Fundamentals, Shmundamentals

    It never ceases to amaze me how the media tries to explain every wiggle in the market based on fundamentals and never attribute any movement to psychology.When the payrolls number came out the media reported it as terrible. Now that the market is rebounding they are grasping at straws trying to explain why the numbers are good. The fact is that people want in and they don't care about no stinkin' fundamentals. Greed has taken over.

    The Miami Condo Market:: Ground Zero

    I was in Miami this past week house hunting. I was primarily looking for a house but I did look into a condo as I wanted to see if it made sense. Many development projects were built in less desirable locations like the Miami business district, where condos should probably not have been built in the first place. In those areas prices are down as much as 50% or greater.

    In the prime locations prices are probably down a third to forty percent. After a 40% drop, do Miami condos make sense? A three bedroom apartment in the new Trump building, which is in a prime location, sells for roughly $900,000.

    In Florida property tax is roughly 2% of the purchase price and maintenance is about $1,300 a month in a luxury building. The monthly costs are roughly $2,800 a month not including insurance, which is a significant cost in the hurricane prone area.

    The same fully furnished apartment could be rented out for $3,600 a month. Including brokers fees and vacancy costs one would be lucky to cover their maintenance and taxes and have to carry a $900,000 apartment. For the people who bought at the height of the market the economics make even less sense. Never mind the fact that if enough people decide to walk away from their apartments and not pay maintenance other owners will need to cover the shortfall.

    Many hold on to the apartments as they don't want to take a loss. I spoke to someone on the plane ride home who moved from Florida to New York and did not sell their house in Florida because they didn't want to take a loss. They are renting out the house and paying money out of their pocket in order to cover the mortgage.

    More to come later on the Miami area housing market.

    One Last Thing

     I am tempted to get shorter but want to save some fire power in case we get a better than expected number tomorrow morning. At that point I would be willing to move from a medium to large net short position.

    Minor Manicuring

    I have done some minor manicuring of positions. Last week, I switched a portion of my short exposure to the QQQQ. I thought we might see some tax related selling early in the year as the QQQQ was up nearly 50% last year. The QQQQ has indeed underperformed the past few days and I decided to switch my short exposure back to the SPY.

    In addition, I sold the AMGN 57.50 calls against my long position. They had some news that I believe caps the stock in the short term.

    I am about to board a plane out of Miami where I was house hunting. I will let readers know what I saw down here when I settle back in tomorrow.

    On The Road Again

    I will be on the road for the remainder of the day. I will try to get out another post on how I am positioned at the end of the day. For now, I have a medium sized net short position.

    20/20 Hindsight

    In hindsight, it was obvious that the market would start the year off strongly. We heard many stories of how hedge funds took down risk towards the end of the year in order to lock in their performance fees. Since sentiment was so bullish it was likely that when the new year started they would be back taking up risk. That was the reason I waited until the second day of the year to move to a net short position. But I am left asking myself why I didn't go long for a trade?

    Looking forward a few weeks from now, what will be the trade that is obvious in hindsight? I think the trade will be that we finally get a significant correction. Extreme sentiment like the type we have seen over the past few weeks almost always leads to a correction.

    Underlying Weakness

    I believe today's trading has bearish implications. We are seeing call buying that is about as heavy as could be. However, it is coming on a day where the S&P 500 is flat and the Nasdaq 100 is down. If the bulls can't manage a rally with all this call buying and positive sentiment, what will it take to get a rally?

    Ouch

    I return from my travels to find the market mixed. My portfolio is taking it on the chin as there is a rotation out of defensive stocks and into more cyclical stocks. At the same time treasuries are getting pummeled. That is the opposite of how I am positioned.

    There are some chinks in the armour. The QQQQ, which has been outperforming the whole rally, is lagging pretty badly today. In addition, there is an awful lot of call buying for a flattish day. I know it has not mattered but that doesn't mean it won't.

    Taking The Under

    The Unemployment Report this Friday is likely to be the highlight of the week. Last months number surprised to the upside and has likely raised expectations for the report this Friday. I believe market participants will be disappointed.

    The government reported figures are estimates and have a decent size margin of error. I believe last months report overstated the strength in jobs. There are three other methods of estimating job losses and all showed weaker numbers.
    • Last month ADP showed a job loss of over 100,000. ADP is the largest payroll processor in the country and has reliable data.
    • TrimTabs uses tax receipts to estimate job losses and they also estimated a much higher number.
    • Lastly, flat jobs growth is correlated with a 4 week moving average of 400,000 new unemployment claims. The 4 week moving average of unemployment claims was well above 450,000 last month.
     

    Still Don't Like Simon

    I believe Simon Property Group is a horrible long term investment. It is overpriced, it faces the secular headwinds of a move towards shopping online and consumer deleveraging. However, it has moved down strongly in recent days and in the short term the case for underperformance is a little weaker. That is why I covered my short and shorted SPY instead.

    Added To Shorts

    I covered my Simon Property Group short. The stock is down nearly 7% since I shorted it even though the market is actually higher. I shorted the SPY in its place and then some. I am now in a medium sized net short position.

    Sold Down Merck

    I have sold down my long position in Merck after a greater than 20% gain on the position. This moves me to a net short position.  In addition, my longs are defensive while my shorts are in higher beta sectors. I also have a long treasury position (short TBT) that should do well in a corrective market. Please note: I will be on the road for much of the day.

    Lying In Wait

    Today, is seasonally the strongest day of the year. After today seasonality will be less of an issue as we are passing the strongest part of the month. Nine months of the market going straight up has led many market participants to forget that the market is not a one way street.

    I am not going to rehash all the signs of froth but yesterday only added to it. There was call buying all day and breathless media coverage. I will be looking for an entry point today to move to a net short position.

    I don't mention the emerging markets often because I like to stick to my knitting, which is US stocks. But I can't help but notice that every pundit is positive on emerging market stocks. Usually that means stay as far away as you can.

    Bull Fever

    I am on the road but wanted to get out a quick post.Traders are back from vacation in a bullish mood. They are buying calls hand over fist. I am itching to move to a net short position but will hold myself back until late tomorrow.

    Extreme Sentiment Vs. Seasonality

    Please Note: I will be on the road this week so posting will be light

    Sentiment is stretched to levels where we should see a correction, even in the context of a bull market. The Investors Intelligence bears are at multi-decade lows while the AAII bears are at multi year lows. Option activity has been skewed heavily towards call purchases and Rydex traders are positioned long. It is rare to get such a confluence of extreme readings and this should lead to a correction starting sometime in January.

    There are factors that could lead to one last push higher.
    • Traders returning from vacation are more likely to put on bullish positions since most are bullish right now.
    • The second trading day of the year (tomorrow) is seasonally the strongest day of the year.
    • This month is earnings and most companies have a lockup on selling shares until after earnings are reported. There will be few secondaries and little insider selling until later this month.
    • Money comes into the market at the beginning of the year.
    Last week, I raised the beta of my short portfolio as a first step towards trying to play a correction. Since the first few days of January are seasonally strong I will wait a couple of days before considering a more aggressive bearish posture.

    While some of the seasonal arguments are persuasive I would caution against relying too heavily upon them. Last year a 25%+ plunge started very early in January and "Sell In may and Go Away" was more like "Sell In May and Get Smacked". I pay attention to seasonality but like any other indicator, it is only one of many clues.