Binary Event

Traders are probably reluctant to carry large positions into the long weekend and for good reason. Europe will be trading on Monday even though our markets will be closed. There is potential for a very large gap when we return on Tuesday either way. My best guess is that Europe trades just fine.

While I am positioned long, I made some sales yesterday of stocks I bought when the market was melting down earlier in the week. In addition, I sold some covered calls. No matter what happens when we return on Tuesday I will be able to manage.

Today is a tough call as it is the last day of the month and there is no business like monkey business. There is a little more call buying than I would like to see given that the market is trading slightly lower. I am signing off for the weekend unless something big happens between now and the close. Have a great weekend.

Don't Fight It

The market is oversold, momentum has shifted in the bulls favor, sentiment is negative and we are approaching the turn of the month. Could the market retest yesterday's breakout? Could new problems emerge in Europe over the weekend? Sure, but the odds are in the bulls favor. Once the market is overbought and everybody is talking about liquidity, recovery and puppy dogs it will be the time to go short again. For now, bears should just stand aside.

Hoping For A Quiet Day Tomorrow

I am already looking forward to the long weekend. It has been an exhausting few weeks. Usually the day before a holiday is quiet and I am hoping that is the case tomorrow. Have a good night.

The Most Crowded Trade

The most crowded trade right now is the long dollar trade primarily versus the Pound or Euro.

Europe Closes Strong

European equity markets have closed strong, up 3.6%. If they have put in a bottom they will likely drag us higher.

Long For Now

I am still long for now and think the market should be fine over the next few weeks but just want to reiterate why I am not bullish on the market through the Fall:
  • The government is trying to unload $20 billion worth of Citigroup stock.
  • The government is also trying to unload GM and Chrysler wants to come back as well.
  • Private equity shops are lining up to sell the companies they bought in the last cycle.
  • The economy is slowing and more stimulus might be not be possible as the deficit has become a political issue.
  • Europe is slowing and will have a negative short term effect even though they are taking necessary steps.
  • Comps are getting tougher
  • Seasonality will be negative for the next few months
In the short run their has been too much fear and negativity but after a respite I am getting out of dodge.

Call Buying Not Necessarily Bad

After a long downtrend a lot of call buying is not necessarily a bad thing. It might indicate a change in sentiment so I would be careful shorting here. I would prefer to see put buying into this rally as that would really be indicative of a strong market. That said, most rallies after strong downtrends kick off with call buying.

Pared Back Vodafone

I pared back my Vodafone position.

Sold Covered Calls On SPY

I sold covered calls on SPY again.

Sold Microsoft

I sold Microsoft.

Individuals Finally Throw In the Towel

Individual investors have finally thrown in the towel after staying stubbornly bullish during this correction. AAII Bulls are 30% and bears are at 51%. This is a positive.

Nervous Markets

It is amazing how nervous market participants are. Yesterday, the S&P 500 took a 25 point dive on fears that China would sell its Eurozone debt holdings. As I pointed out yesterday, that simply is not going to happen and I believe it was pretty obvious. Overnight the Chinese affirmed that they are not selling and the markets are trading back at yesterdays highs.

Microsoft's CEO made some macroeconomic comments saying that its possible that Europe's problems could spread. Microsoft's stock was promptly hit up for 4%. Reactive traders are getting punished while those who stay calm are seeing opportunities. This is the opposite of the momentum market we have been in. Could we finally be seeing a two way market or is the market just trying to shake out the renters before another momentum move?

More Thoughts On Citigroup

  • We are in the midst of a crisis. The government really should have waited until the crisis passed before selling additional shares of Citigroup. This supply does not help matters.
  • News hit that Bill Ackman bought 150 million shares of Citigroup. So now Ackman, Paulson and Berkowitz among other savvy investors own large positions. Who is left to buy the next $20 billion?
  • Do I like being on the other side of these savvy investors trade? No, but I like being on the other side of a $20 billion sell order even less.

Shorted Citigroup

The government just announced they are selling another 20% of their Citigroup shares. I have reshorted the shares at slightly better prices than where I covered a few weeks back.

Fat Finger

The huge decline in Microsoft seems wrong with Intel and Dell being barely down. I bought shares at $25.

By The Way

China revaluing the yuan would be the worst for the US Dollar and treasuries as those are their largest holdings.

China Worried But I'm Not

Part of the afternoon selloff was due to the fact that news hit that China has been reviewing its Eurozone debt holdings. China is not going to exarcebate this crisis by dumping European debt on the market. As a giant exporter they have more at stake than anyone else. However, they are realizing that if they continue to accumulate mountains of sovereign debt the day will come when they won't get paid back. This will likely push China towards revaluing the yuan once markets calm down. This tidbit is worth remembering once the markets calm down and nobody is worried.

Audible

I bought back the covered SPY calls I sold earlier today for a negligible profit. I think we are likely seeing margin calls. I expect this pressure to abate over the coming days.

Constructive

I think today's action is constructive. There was too much call buying and excitement this morning but the call buyers have backed off, the excitement has died down and the market is closing in on the days highs. The 119.4 level on the SPY has been holding the market back. I believe there is an above average chance that the market will make it through on the next attempt.

Breadth A Positive

This morning when the market was a lot higher I pointed out the negatives. With the market close to the lows of the day I would point out that breadth is better than 5 to 1 positive, even in the face of a meaty pullback and the call buyers have backed off.

Sold Covered Calls

I sold covered calls against my SPY position. There is a little too much excitement out there today and this will give me flexibility to add to positions if we get a pullback. I remain constructive in the medium term.

Too Much Excitement

I think there is a little too much excitement this morning. Call buying is very high. I am sticking with my positions but am less excited about them.

Goldman Struggling

Goldman is struggling today. This might be just some give back from the huge move yesterday but Goldman signaled the low yesterday by going green in the morning so its worth a mention.

Also, keep an eye on the Euro. If it gets going we could see another round of short covering.

Europe Doing The Right Thing

Yesterday, Italy joined other EU countries and announced $30 billion in austerity measures. As an aside, Italy's deficit as a % of GDP is approximately half that of the US. All the while another stimulus package is being discussed over here. The Europeans are dealing with the root of the problem and cutting out of control spending instead of kicking the can down the road.

There are many critics who say that the Europeans are clueless and now is not the right time to cut spending. The problem is that it is never the right time and that is the reason we are where we are. Alan Greenspan and Ben Bernanke have tried to avoid recessions at any cost. It is only getting harder to make the cuts that will eventually be needed. Had they allowed recessions to naturally occur instead of fighting it tooth and nail imbalances would have never reached the current state.

These critics of cutting deficits seem smart because the market agrees with them. Whenever there is a bailout or a spending bill the market rallies. But the market liked the Long Term Capital bailout, The Internet Bubble and The Housing Bubble. Maybe its time we stop looking to markets for advice and use common sense. The answer to debt problems is not more debt and the answer to deficits is not more deficits. Acting responsibly will hurt and markets will likely go down but at least a foundation for a real recovery will be built.

Expiration Window

I believe that the bias will be to the upside until June expiration. While we might not go straight up and there will be bumps along away I believe the trend will be higher. My reasons are as follows:
  • The market is very oversold on a 10 day basis and will soon be oversold on a 30 day basis.
  • There has been a lot of put buying in the past few weeks. Market players have adequate downside protection.
  • Rydex traders are positioned bearishly.
  • The VIX spiked to levels seen at previous major crisises, after which there was a market rebound. The one exception was the Fall of 2008.
  • We are starting to hear extreme downside targets and the bears are getting too loud.
Even if we are in a new bear market there will be rallies. The quality of the current rally will offer hints as to  the type of market we are in.

Why So Bearish

Just a couple of weeks ago, these market timers were on average recommending that their clients allocate 80% of their Nasdaq-oriented portfolios to stocks. That was the highest level for this average since 2000, and was a contrarian warning signal that trouble laid directly ahead.
Today, in contrast, the comparable average recommended exposure level is minus 45% (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). This negative level for the HNNSI means that these market timers on average are recommending that their clients allocate nearly half their Nasdaq-oriented portfolios to going short -- an aggressive bet that the market will continue declining.
-Mark Hulbert, Marketwatch
Market timers are uber bearish as seen in the above article. As an aside, I have been hearing recommendations to buy SDS left and right recently.  I thought these leveraged ETFs were put to bed already after the losses they inflicted.

The Two Wildcards

There are two wildcards in the market today. One positive and one negative.
  • The ECB is rumored to be cutting rates by 50 bps. This might make participants hesitant to stay short overnight and we could see a short covering rally.
  • Margin calls happen late in the day and might have been the culprit yesterday. We could see more today.

Citigroup Might Get A Reprieve

The government gave Morgan stanly 20% of its Citigroup stake to sell. I estimate that they are likely close to disposing of it. Under current market conditions I doubt that they will sell additional shares. I would not buy Citigroup based on this but at least they might stop underperforming. The problem is that the better the stock does the more likely the government is to sell. Its a catch 22.

The Good and The Bad

  • On the positive side I was very scared this morning and I do not scare easily. High levels of fear occur at market bottoms. 
  • Goldman turning positive doesn't hurt either.
  • On the negative side the ISE Equity only reading is showing call buying. This does not jibe with what it feels like out there but is a cautionary sign.
  • Doug Kass at RealMoneySilver.com says he is hearing rumors of an ECB rate cut. Rates are 1% over there so they have some room.

Settle With Goldman

The democrats do not want the market to tank before the elections. One way the government might be able to buoy the market is to settle with Goldman

Goldman Is Up

The fact that Goldman is trading higher bodes well for the market.

A New World

There is a lot of fear out there this morning and we are testing the years lows. Combined with the oversold nature of the market and the built up pessimism that would typically be an ingredient for at least some sort of bounce. While the odds favor the upside this market has shown tremendous momentum to both the upside and downside so it would not be that surprising if we continued lower.

The economy and market are both unhealthy. Without government intervention both would be massively lower and you can only fool the market for so long. However, that did not stop the market from rallying 80%. I believe this experiment will end in tears but the question is how we get there.

Expiration Hangover

Some random thoughts at the close as I have not yet fully digested today's action
  • In the early going there was a lot of call buying, the financials were lagging and the market was struggling. I chalked it up to the day after expiration but in hindsight these were warning sign that the bounce would fail.
  • I turned on CNBC today and there was a lot of talk of how scary Europe is and about another possible flash crash. This is quite the opposite of all the happy talk we were hearing a few weeks back.
  • The one missing ingredient in this correction has been time. It has been a little short from a duration perspective. 
  • Could margin calls have contributed to some of the late day weakness?
  • What will happen tommorow?
Have a good night.

The Technical Bear Case

Of the 3257 issues traded on the NYSE last week, 2955 declined and just 275 advanced. The S&P 500 has now abruptly erased nearly 8 months of progress. Moreover, we observed a "leadership reversal" with new 52-week lows flipping above the number of new 52-week highs. Our broader measures of market action deteriorated to a negative position as well. Historically, we can identify 19 instances in the past 50 years where the weekly data featured broadly negative internals, coupled with at least 3-to-1 negative breadth, and a leadership reversal. On average, the S&P 500 lost another 7% within the next 12 weeks (based on weekly closing data), widening to an average loss of nearly 20% within the next 12 months - often substantially more when the Aunt Minnie occurred with rich valuations and elevated bullish sentiment.
-John Hussman of Hussman Funds
This morning and yesterday I posted statistics that argue for a rally. The always thought provoking John Hussman brings up equally impressive statistics calling for a decline. I would point out that we are not necessarily at odds. My statistics are shorter term in nature. Hussman's look out a few months.  I believe we will see a second half slowdown so its possible we will both be right.

European Shopping Trip

Many European multinational companies have been hit very hard because they happen to trade in Europe. I have purchased shares of Vodafone this morning trying to take advantage of the bargains. Their Verizon Wireless stake is worth $10 a share conservatively. In the meantime their earnings without Verizon Wireless supports a nearly 7% dividend.

More Sentimental Evidence

Yesterday I posted a chart showing Rydex traders positioned very bearishly. Below is a chart of the CBOE 10 day moving average. As you can see put activity has been running very high. Once market players have already become this pessimistic it is usually too late to sell. I believe there will be a tradeable rally in the coming weeks.

Rydex Traders Very Bearish

Below is a chart of Rydex traders positioning courtesy of SentimenTrader.com






Rydex traders are positioned more bearishly than at any time since July 2009. July 2009 kicked off a 25% rally in the S&P 500. While I don't expect anywhere near that type of rally I believe the odds favor the upside.

No News Is Good News

I believe the bulls have cleared some important hurdles today. One month ago there was record call buying. Today, a lot of the options that leveraged speculators purchased are expiring worthless. The deterioration of those options have likely contributed to the recent slide and that pressure should now abate. In the past few weeks investors have been de-risking and buying protection. That should put a floor under the market for the next expiration cycle.

Additionally, today's higher close might mean that the vicious cycle of liquidations has ended. While the day after options expiration is often weak I believe next week should be good barring any major developments. Have a great weekend.

The Biggest Risk Going Forward

Germany voted today to back the bailout. I believe that Europe is now throwing enough money at the problem to kick the can down the road. While many are focused on Europe I believe an economic slowdown is now the largest risk to the market. I am fairly confident that we will see a second half slowdown but am less certain about when the market will realize this.

Stability Would Be Nice

The market has likely been suffering from some forced liquidations and margin calls the past few days. A stable close would go a long way in staunching the vicious cycles of lower prices forcing more liquidation forcing lower prices ...

Seth Klarman's Margin of Safety

I have been wanting to read Seth Klarman's book Margin of Safety for years. I believe he is the best value investor of our time and is better than Buffett. However, the near $1,000 price tag has kept me from it. There is a free .pdf version online and I plan on reading it this weekend.

Somebody Knows Something

Goldman Sachs is trading like a settlement with the SEC is imminent. This makes sense as Obama has won the PR war and financial reform has passed. At the end of the day the government does not want a meltdown and that would go a long way towards calming markets.

The Increased Herding/Momentum Effect

I am still not able to get used to the way the market has been moving in recent months. When the market goes up it does so in a straight line and when it goes down it does so in an even straighter line. Most markets I have traded have taken two steps forward then one step back or vice versa. But this market takes two steps forward than another 10 steps forward before falling back 14.  Momentum and the herding effect are more powerful than at any time that I have traded. I believe there are a number of reasons this is occurring:
  • Hedge funds are increasingly short term oriented. When the market is rising everyone is piling in on the long side for fear of being left behind and when it is declining they are very quick to cut risk.
  • Many quant programs have a large momentum component and the growth of quant investing is exacerbating moves. 
  • Momentum investing has been working and investors are always chasing performance.
  • Retail investors have always herded and they simply cannot fight these massive moves.

Flashbacks

We have been hearing the words risk reduction in the past few days which brings back memories of the credit crisis of 2008. While there is still too much leverage in the system there are many differences between 2008 and today.
  • Investment banks have raised a lot of capital and reduced positions. The chances of them becoming forced sellers is a lot smaller than during the previous crisis. 
  • Many of the major losses were seen in CDSs and CDOs and financing leveraged transactions. There has been almost no CDO and leveraged finance transactions. I would be shocked if banks took on large CDS risk again. It will take a few years before banks make the same mistake again although I'm sure they will make others.
  • Many over leveraged companies have raised capital or rolled forward debt maturities.
  • While hedge funds have been reducing risk they are not as leveraged as they were coming into the 2007 crisis. The biggest risk takers were wiped out and are no longer in existence.
While the economy still has too much leverage, any credit crisis is likely to take on a different shape this time around.

Still Looking For A Rally

As readers know I expect a second half slowdown, so any buying I do is inherently a trade. There were many powerful counter trend rallies during the bear market that began in 2007 and even if we are entering another bear market there will be trading opportunities from the long side. This type of trading is not for everyone because it requires extreme nimbleness.

I believe that in the short run the pessimism has become too thick:
  • Yesterday, we saw put buying that was only matched once during the 2007-2009 bear market. In addittion, the 10 day moving averages of the put/call ratios are in extreme territory.
  • Rydex traders are at levels of high pessimism.
  • Yesterday, many of the hiding places that have held up well during the decline were pummeled. That typically occurs near the end of moves.
The following are my concerns:
  • These type of moves tend to last about six weeks which would measure to the beginning of June. However, we could see a throwback rally now and a retest at the beginning of June before a better rally develops.
  • Sentiment surveys are not extreme yet. That likely has to do with the duration of the decline as well. By early June the crowd should be in the bear camp.
  • The global economy is unbalanced and something can snap at any time.
  • Given how much the market has fallen margin calls can become an issue.

Blame The Short Sell Ban

It was not the short selling ban in 2008 that took down Lehman Brothers or created the financial debacle. It was too much leverage and bad lending. The short selling ban is just something that happened along the way. Blaming the financial crisis on the short selling ban is like saying that the market goes up when I clap my hands because the last time I clapped my hands the market went up.

The blame for the market action of the past few days has been largely laid on the short selling ban from Germany. Germany's short selling ban changes nothing. These imbalances have been building for years and the day of reckoning was a matter of if not when. It gives people who can't take the pain of their positions anymore an excuse to sell and blame it on someone else. My trade was good but stupid Germany tripped me up.

Travel Day

I am traveling today and will return Friday.

What A Difference A Few Weeks Make

A few short weeks we saw record call buying while this morning we were seeing put buying that was almost at the opposite extreme. A few weeks ago Greece did not matter, while yesterday Germany banning short selling convinced everyone that another crash is coming. For as long as markets exist there will be over reactions and participants will get caught up in the emotion.

I am not belittling the problems out there as I see many hard years ahead for an over levered global economy. However, there will still be rallies and selloffs. With sentiment so negative I think we could see a rally and am positioned for one.

Went Long SPY

We had very extreme put buying today. Combined with how oversold the market is, I decided to take an SPY long.

I Will Be Out This Morning

I will be out this morning and return in the afternoon.

Over And Out

Indicators, Shmindicators. Nothing matters right now but the Euro. I will be out for the remainder of the day. Have a good night.

Spinning My Wheels

After a very good start to the year I have been spinning my wheels since March. The main culprit has been the fact that my core longs have been in healthcare and the sector has absolutely stunk up the joint. I have had some good trades during that time like shorting Citigroup but all it has done is negate the damage that my core longs have inflicted.

My thesis on pharma/biotech stocks were that many were so cheap that even if they never came up with another drug, the current price of the stocks was still too low. As an example, a Citigroup analyst came up with a $70 discounted cash flow valuation on Amgen assuming they never find another successful drug.

Then I heard news that Greece and Spain decided they were going to pay drug/biotech companies over 20% less for their drugs.  Even with that news the stocks are cheap as the earnings effect is marginal. But if their customers can come to them any day and say we are paying you less then who is to say it won't keep happening. Right now the US can run a 10% deficit but the bond market might not allow that forever. The bottom line is that the stocks are still probably too cheap but I can wake up one day and find out that their customers decided to pay them less and all my earnings estimates were wrong.

I cleared my portfolio of healthcare stocks yesterday as I just cannot live with that type of uncertainty. I am bearish on the economy and it has been difficult for me to find  reasonable valuations in non economically sensitive stocks other than in healthcare.  I will double up on research and hopefully be able to identify other longer term opportunities. Until then everything is a trade.

Weekly Chain Store Sales Weak

Weekly chain store sales came in at -2.5%. Is the economy suddenly slowing? I think the largest factor is that comps are getting harder as the economy started recovering this time last year. Everyone was heralding the US consumer in March when we were comparing against the depths of the recession. The measuring stick is what has changed. I continue to expect a second half slowdown as comps get tougher and stimulus begins to decline. A renewed credit crisis is also a possibility.

Financial Reform

The democrats want to pass a financial reform bill by the end of the week. Healthcare stocks have gone in a straight line down since healthcare reform was passed. That fact will not be lost on traders even if it was a coincidence. The knee jerk reaction might be to sell financial stocks if reform passes.

Market Should Continue Higher

Yesterday's action was bullish. We saw put buying and the market still managed to close slightly higher. The market remains very oversold and the 10 day moving averages of the put/call ratios are at levels that have previously led to rallies. I expect this rally to continue until we see call buying and the bulls bragging about a successful retest. In addition, the Euro looks like it is sold out and the Euro has been leading the markets.

Euro Is Stabilizing

The Euro is stabilizing and is only down slightly now. It has led the markets down ...

Covered Citigroup Short

I covered my Citigroup short. My reason for being short was the government selling. If the price goes much lower the government might not sell additional shares. If the stock bounces I will look to short again.

Where Does It End

I gave up on all my healthcare positions. Spain decided that it was paying the pharma/biotech companies 22% less for drugs in order to help close their deficit. Where does it end? What will the US do when they are in the same position a few days or years down the road? The stocks are still dirt cheap but I cant live with that type of uncertainty.

Market Should Bounce This Week

I believe the market should see a bounce this week. We have had two full weeks of very negative trading with a lot of put buying. This brings all the 10 day moving averages into oversold territory and generally that means the market has a tough time making downside progress.

While everyone seems negative right now if we manage a bounce I could already see everybody talking about a successful retest. At that time it would pay to reconsider the short side. But for this week my call is higher.

The wild card is that this week is expiration. Four weeks ago we saw record bullish positioning in the options market and that is a wild card.

Point Of Recognition Or Healthy Retest

Europe tried to kick the can down the road but the market is not buying it. Solving a debt crisis with more debt does not work. The question is when the market notices this. The US did the same thing nearly 18 months ago and the market has still not called out the US. Is this a healthy retest of last weeks low or is the end game here? I believe the market will bounce  but am less sure when the market will choke on the mountain of debt. Have a great weekend.

Watch The Euro

The Euro is very heavily shorted. It is common to see short covering rallies on Fridays as traders flatten out for the weekend. That is where we should look for signs of stabilization in Europe and possibly a rally over here.

Thats A Knee Slapper

I have been reading many articles saying that the US is in a much better situation than the EU. Really? The EU as a group will have a 6% deficit this year. The US is projected to run a 10% deficit. Right now foreigners are happy to fund the US deficit but that can change in an instant.

Market Should Hold Up

The market is quite oversold and sentiment has been pretty negative for the past couple of weeks. Barring a worsening of the crisis in Europe I believe the downside will be contained in the near term. Dips, including this mornings, could probably be bought for quick flips. Monday's lows, around 1150 on the S&P 500 should serve as support.It looks like we are right there in the pre-market.

Retest

After such a strong run a retest usually occurs. While I was expecting a retest at some point I must admit that I  was starting to think it would be after options expiration. In hindsight the call buying this morning combined with the inability of the market to rally was the clue that the market was going to have a tough time. 1150 should serve as strong support for the bulls tomorrow if the bears wish to test their resolve. Have a good night.

Cash Money

I mentioned this morning that we were seeing some takeovers and buybacks. The bulk of the takeovers and buybacks this year have been in tech and healthcare. Historically, that has meant those sectors should outperform.

More Optimism

For the first time since this rally began this week we are seeing optimism in the options market. It seems that investors are finally beginning to embrace this rally. That is not what the bulls want to see.

Will Gold Now Become A Bubble

Will the ECB printing $1 trillion dollars in EUROS be the catalyst to take gold to bubble status? In order for something to become a bubble it needs to appeal to the masses and has to be catchy and easily understood like "The Internet Is The Future". I could just see people saying "You can't print gold". This is something that the masses can understand and I would not be surprised to see a fabulous rise in Gold. But for some reason I can't bring myself to buy any.

Second Half Slowdown

I believe the economy will start weakening in the second half of the year. Stimulus spending will be lower on a year over year basis in the second half of the year and many municipalities are still cutting budgets. Comps will be tougher as the economy started recovering in the second half of last year. Housing will be especially pressured as the housing tax credit will have expired, the FHA has tightened guidelines recently and many mortgages are going to reset. I think all this adds up to a second half slowdown.

At the same time there are some positive developments in the stock market. We have seen a recent pickup in M&A and LBO activity. Last night SAP announced they will acquire Sybase for nearly $6 billion and private equity buyers want to pay $12 billion for FIS.There has also been a pickup in stock buyback activity.

I still believe that we will see a stock market slide happen in concert with a second half slowdown. However, the positive developments I mentioned make timing a drop a lot trickier. As such I am going to take my cues from my short term indicators and right now they are not pointing to a drop.

What Is Good

There are a few good things going for the market
  • There have  been quite a few buyback announcements in the past few weeks.
  • It appears a very large LBO transaction will be announced shortly.
  • Sentiment is no longer exuberant.
  • The market is still oversold.

Bought GS

I am still short the GS 140 puts and I have now bought a long position in the stock as well.

More Constructive Short Term

The action this week has been constructive. The market is acting well even though participants have been distrustful of the rally. Overall we have seen put buying and Rydex traders about as bearish as they have been all year. This makes me believe that any downside will be limited and that the lows of last week will hold. I still think the market will run into problems in the intermediate term but now doesn't seem to be the time.

Everybody Else Was Doing It

Last night the Wall Street Journal reported that Morgan Stanley is being investigated for its mortgage derivative sales practices. This is very good news for Goldman Sachs as they can now use the "all my friends were doing it" excuse. I doubt the government is looking to take down the last two remaining independent investment banks. More likely they are waging a public relations war to get financial reform passed and look like they are doing something before the election.

Goldman's market cap has taken a $25 billion hit since news of the investigation broke. This increasingly seems like an exaggerated amount. Any government penalty is likely to be a fraction of that. The fact that others were allegedly knowingly selling crap to their customers makes it less likely that customers will defect to other firms. While this does not make Goldman's behavior right it does make their stock look cheap.

Round Trip

The market spit out both the bulls and bears today. Could we see a choppy range bound market into expiration? I have little conviction either way currently. Have a good night.

Back In Neutral

I believe the easy upside has been seen and the market will be a lot trickier now.

Market Looks Good

The short term picture for the market looks good. We are still seeing put buying this morning. The market will likely rally for a few days until everybody forgets what happened last week and the crowd is scared to miss the rally. At that point I believe we will retest Friday's lows

Goldman's Trading Record Is Less Than Meets The Eye

Goldman Sachs did not have a losing day last quarter in its trading operation. I have read many conspiracy theories around the blogosphere about how Goldman achieved this feat. Most either say Goldman knows where the market is going because they get to see all the customer's orders or that they manipulate the market. The truth is a lot less impressive.

A lot of what Goldman classifies as trading is just customer order facilitation. For instance, if a customer wants to buy a large number of options they can't go directly to the exchange, so they go to the Goldman derivatives trading desk. Goldman then sells them the options and hedges out the risk. Goldman makes a small spread on the trade and that counts as trading revenue.

Goldman is also a bond dealer and that is a license to print money. The corporate bond market is a dealer market. A buyer and seller cannot come together as there is no corporate bond market so they have to go through a dealer. It is inexplicable why in this day and age of technology there is no corporate bond market that bypasses the middle man but that is the case.

With a steady stream of income from these and other customer trade facilitation businesses the company gets a huge head start every day on trading revenue. I am certain that the pure prop desks have a much lumpier record.

The Short Term Tea Leaves

Yesterday we saw heavy put buying even though the market was up strongly. In addition, Rydex traders moved to their most bearish positioning since the February low. Both data points are quite bullish and argue for further short term upside. Given the events of the past week I am putting less weight on these data points but they are enough to keep me away from the short side for now.

If you are not scared after the events of the past week than you simply don't understand. The market crashed 10% in a matter of minutes and it was impossible to get out while it was happening. There were no bids. In addition, a number of sovereign nations would have defaulted had numerous extraordinary measures not been taken. It is abundantly clear that markets of the World are being held up by governments. On their own they would be a lot lower. The music might still be playing but not everyone will have a seat if the music stops. Last week, almost nobody did. Having a strong commitment to this market is more like a game of musical chairs than investing.

Doing Little

I am not planning on making any big moves as this market scares the hell out of me. While everything is not fine it is difficult to know when problems will arise again. It could be a day or it could be a year. Barring any major news the market should continue to make more upside attempts over the next few days before testing the downside again. Have a good night.

Put Buying

We are seeing put buying today despite a strong move higher. That is a positive for the market.

Confidence or Confidence Game

These wild swings are not confidence building from where I sit. It is very difficult for me to picture a sustained rally from these levels. I would expect the rally to peter out over the next few days although I have underestimated the effect of quantitative easing before. As such I will be running a pretty balanced portfolio of longs and shorts. Healthcare is still the cheapest sector out there.

Winner, Winner Chicken Dinner

As I write the S&P futures are up by over 50 points. I don't believe that the S&P 500 will make much headway this Summer and that this is a chance to lighten up. I was short the morning of the crash and switched to a net long posture for a trade a couple of hours before the crash. It looks like I am being bailed out of my bad trade and I will be making sales at the open.

It is beginning to look like the goldbugs are right. All roads are leading to the printing of money and debasement of fiat currencies.

The Quants

The Quants is a good primer on the world of quant investing. While not quite as exciting as The Girl With The Dragon Tatoo, it explains the evolution of quant investing and identifies many of the major players. While I read it a few weeks out of curiosity, it helped me better understand what was going on this past week.

Signing Off

I am signing off for the week. Have a great weekend.

A Necessary Ingredient

I think today's panic was a necessary ingredient. Many people were shaken yesterday but did not take action because they were so shocked. Today's capitulation should setup a rally for a few days barring anything major from Europe.

Humanoids Capitulating

Yesterday's trading was scary and many people just want out. I can't say I blame them. This morning the humanoids are capitulating. This is a necessary step toward an oversold rally.

Question For Readers

Now that everyone has had the night to sleep on it, what are readers feelings about what happened yesterday? Ramifications for the market in the near and longer term?

Sold SPY 115 Calls

I sold the SPY 115 calls in an attempt to reshort the SPY I covered yesterday. This would put me in short on the SPY at slightly better levels than where I covered if we are above 115 at expiration. However, if the market crashes before expiration this hedge will likely be a band aid on a bullet wound.

Thoughts On The Market

  • The textbook reaction to the type of drop we saw yesterday is an oversold rally followed by a retest of the lows. However, the market has not been trading according to the textbook for the past few months and if a quant program or some sort of outside factor caused the decline yesterday I am not sure if yesterday is comparable to previous instances. 
  • We are very oversold in the short term and have had three solid days of put buying. All those factors argue for a short term rally.
  • It is hard to believe that yesterday's trading will make people feel better about holding stocks. Many became bullish over the past few weeks and the pendulum might swing the other way now. 
  • From the perspective of time this correction has been very short and it will likely take until the end of May before we get a good intermediate term oversold reading and a complete sentiment shift. Bounces and relief rallies not withstanding.

Colocate This

I felt like I was watching the Transformers versus the Decepticons yesterday, with us humans being mere collateral damage. The decline was completely emotionless and I have little doubt that quant driven trading was the culprit.

Yesterday was unlike the steep declines seen in October and Novemebr of 2008. Those declines were filled with emotion and fear. Yesterday, most people I spoke to were confused and shocked and the ones that were trading were trying to buy. The speed with which the market collapsed points a finger at the quants as humans simply don't react that fast. Additionally, many of the quant programs have a momentum input and it is undeniable which way the momentum was going yesterday.

We are stuck in a bad sci-fi movie where the computers have taken over. Unfortunately, we do not choose which market we trade in and need to adjust to the environment. This means allowing room for more momentum and being more cautious. In chaos there is opportunity. I will have a column up before the open on the current market outlook.

Some Explanation

I have been asked to clarify some of my posts from yesterday.
  • In the post where I tried to explain what happened yesterday by writing 0100101010111010010101010, I meant that the computer programs took down the market. Computers basic language is binary which is just a series of zeroes and ones. That in turn gets interpreted to what you see on your screen.
  • The reason I suggested Cliff Asness should stay home is that he was a major proponent of adding momentum factors to quant programs. He also runs one of the largest quant funds in the World and does not like to keep a low profile. 

Hulcer Attack

The action for the past few months has had an extremely unnatural feel to it. There were no pullbacks on the way up. Nobody complained because everybody was making money but this is the end result. I almost had a heart attack and an ulcer combined as option prices were wacky and I thought I lost a very large percentage of my money. If I were Cliff Asness I would stay in my house for the next few days. Have a good night.

What Just Happened

0100101010111010010101010 just happened.

Amazing Momentum

The momentum does not cease to amaze me. When this market goes up it goes straight up and when it goes down it goes straight down. There is no in between. Quants?

Covered More SPY Short

Punk Retail Sales

Same store sales numbers released today were disappointing. Comps will only be getting tougher for the remainder of the year. Is now a good time to ask why so many consumer discretionary names are trading at well over twenty time forward numbers? It now looks like the move in retail was just a massive short squeeze and not the return of the US consumer.

Disturbing Action

In the early going we are seeing call buying and the market is sinking to the lows of the day. In a vacuum that is disturbing.

Covered Some Shorts

I covered some of my SPY short which makes me slightly net long.

Bullish In The Very Short Term, Intermediate Term Bearish

The Greek situation is scary. If Greece were the only country that was borrowing  money at an unsustainable pace I would say that this represents a buying opportunity. However, there are a large number of countries, including our own, that are operating in an unsustainable fashion. One must respect the possibility of contagion especially given the recent complacency, negative seasonality and following an 80% rally.

With respect to all the risks we are approaching support at 1150 on the S&P 500. The market is very oversold on a short term basis and we had two days of heavy put buying and some panic. I think we could get a counter trend bounce here in the short term. There is binary risk in the market. If Greece defaults support will not mean much. As such, I will likely play small if I decide to play for a bounce.

Uber Support

I believe further dowside tomorrow can be bought for a trade as we are nearing uber support at 1150 and we will be deeply oversold. That said, if Greece goes oversold will likely not mean much, so I will play it small if I decide to. Have a good night.

Doug Kass On Quants

I referenced Doug Kass' article yesterday on how quants are likely amplifying the momentum. Here is the link.

Quick Flip

I took a quick flip on some of the merchandise I bought in the hole this morning.  I think the S&P 500 should be able to bounce another 10 points but with the trend being lower I will err on the side of caution. The Pfizer trade is longer term in nature and I will hold it.

More Agressive On Pfizer

I became more aggressive on Pfizer this morning. The following comment from the conference call (courtesy of SeekingAlpha.com) caught my attention
And finally, given the prevailing market conditions, we believe that share buybacks represent an attractive investment opportunity for the company and a prudent use of our capital. And to punctuate what Jeff mentioned earlier, we intend to buy back shares opportunistically as market conditions warrant.
This statement tells me that Pfizer believe their shares are cheap and they are likely buying back shares. The combination of this and negative sentiment towards healthcare shares  makes me believe Pfizer will outperform going forward.

A Bit Panicky

We definitely saw some panic at the open. I believe we put in a short term low. I am still bearish in the intermediate term.

UsingThe Gap

I have been using this gap down to build up some longs.

Status Of The Bounce

After a vicious sell off like yesterday, a bounce would not be a surprise. However, due to the fact that I believe the trend is lower, I am being more discriminating in playing bounces. If we get some more panic selling today that would greatly increase the chances of a bounce and I might take a shot from the long side.

More Bulls

The bulls in the Investors Intelligence survey increased to 56%. Had the survey been conducted yesterday I am sure the number would be lower. Even so, this is yet another sentiment data point suggesting an intermediate move lower.

Not My Problem: Part II

Is Greece a buying opportunity or an omen? Or both? From the New York Times:
The bursting of the real estate bubble and the ensuing recession have hurt jobs, home prices and now Social Security.
This year, the system will pay out more in benefits than it receives in payroll taxes, an important threshold it was not expected to cross until at least 2016, according to the Congressional Budget Office. 

What A Day

Looking back, the record call buying two weeks back was a clear signal to get out of dodge. I believe we have begun an intermediate term decline. It will not be straight down but its the bears turn now. Have a good night.

Not Playing For A Bounce Yet

While there will surely be bounces I believe that the trend is now lower. I am not going to play for a bounce here, even though I love playing counter trend moves. Counter trend moves are the sharpest moves and one can make money very quickly. It seems too early time wise in the decline to play for a high probability bounce. As I mentioned in my opener, momentum seems to carry moves much further these days so I will give moves more room.

I never had a chance to get as short as I would have liked to. Had I been very short I would be picking away at the position now.

Europe Is Ugly

European stocks as measured by the STOXX 50 closed down 3.74%. 

How Do You Say "Mission Accomplished" In Greek

Looking at the markets it seems that there is some doubt that the Greek rescue package will pass/work. Buying the dip has been easy money but if Greece fails this could be the big dip.

Pfizer Earns

Pfizer's earnings look solid. The stock is so cheap that a cent here or there would not have bothered me. But this number should make the "beat the number" crowd happy.

I'm Not Worthy

Doug Kass, of RealMoney Silver, has written an excellent piece this morning on quants. He points out that while these quant programs are driving markets ever higher at some point these momentum driven strategies will make the market go a lot lower than it should. Currently, the article is on the paid site. I will provide a link later if they move it to the free site.

Late in The Momentum Game

Momentum strategies in the stock market tend to work because they take advantage of the human tendency to herd. When a stock goes up it creates a buzz, which attracts more people and the stock goes yet higher. After reading The Quants, a book about the growing number of funds that employ quantitative strategies,  I realized that most quant strategies employ a combination of momentum and value. As increasing amounts of trading occurs through black boxes, momentum seems to be getting amplified.

While the market and stocks always go farther than anyone thinks possible, the recent tendency for momentum to persist is greater than anything I have seen. The momentum occurs to the upside and downside. The correction in January was extremely sharp and offered few bounces.

Morningstar recently has decided to add momentum as one of the factors it looks at. Many like to believe that the stock market moves solely on fundamentals, which is why it likely took people so long to accept that herding has an effect on the stock market. But it appears that momentum is finally having its day in the sun.

Those who embraced momentum strategies have had an absolute fiasco in the past year and have printed money. However, the death knell for every strategy is its acceptance by the broader public. I am not going to change my strategy and will stick to what I know. Mean reversion strategies will have their day in the sun again as well. However, I am aware of the tremendous momentum and have adjusted my trading to cope with it.

The Upside Is Limited

I believe that the majority of the upside for the week has been seen and that the market will turn lower by the end of the week. I will likely position myself more bearishly upon further strength tomorrow. Please note that Citigroup was barely able to gain any ground today on a big up day for the market. I am maintaining my very large short position in the name. Have a good night.

Analysts and Healthcare Stocks

Most pharmaceutical and large cap biotech stocks were hit hard once the impact of healthcare reform was announced. The pharmaceutical industry agreed to sell drugs to the government at lower prices and in return will receive a lot of new customers. On net this will benefit the drug companies. However, they are giving the discounts now and healthcare for everyone will not start for a few years.

This was laid out in the reform bill and yet analysts were shocked when companies announced the impact. Not only that but many analysts capitalized the charges. For instance, if a company were taking a 20 cent hit from healthcare reform and the analysts target P/E was ten they lowered their price target by $2. But in a couple of years these healthcare reform charges will turn into gains. These are one time charges and the effect of them should not be capitalized.

Analysts are supposed to use common sense in what gets capitalized and what is on time in nature. Most financial companies took huge write downs last year and are now writing up those assets. Analysts are happy to capitalize those earnings even though they are low quality and likely one time in nature. And they are happy to capitalize losses that are one time in nature for the drug companies. Reminding me once again that you can't teach a spreadsheet jockey common sense.

Observation Mode

I am in observation mode today as I let the beginning of the month and Greece relief rally play out. I will start looking at positioning my portfolio more bearishly tomorrow. Pfizer, a large holding of mine ( via short 17 Puts) , reports earnings tomorrow. If Pfizer does well it will give me more wiggle room to take on market risk tomorrow.

Supply of Stock Increasing

This week looks to be a busy week in term of IPOs, as the calendar is pretty heavy. Additionally, the government is in the market every day selling shares of Citigroup. This new supply adds to my desire to short a rally early in the week, if we get one.

We will be entering the seasonally weak part of the year on Wednesday. While sentiment has moderated in the past week it is still extreme on an intermediate term basis. The second half of the year will see a decline year over year in stimulus and tougher comps. If this market is going to turn down or if this market is going to have a meaty correction this seems to be the time when it should do so.