Wire To Wire Put Buying

There was put buying all day today and despite that the bears could not keep the market down. Tomorrow is the first of the month and if by some miracle the market gets some inflows we might get a nice up day. Have a good night.

Can Everybody Be Right: Part Two

The ISE Equity is a low 126. This is surprising on an up day. The CBOE equity is confirming the pessimism. I believe this bodes well for the balance of the day.

Audible

I have decided to remove my hedges. The strength in the Euro combined with the early put buying leads me to believe that I will be able to re-hedge later today at better prices.

Can Everybody Be Right

It appears hedge fund managers are very gloomy. From Marketwatch:
Hedge-fund managers have become more bearish on equities because they're concerned about slowing economic growth, according to results of a recent survey released Monday by TrimTabs Investment Research and BarclayHedge. 
 
The firms surveyed 104 hedge fund managers over the past week and found that 47.1% of them are bearish on the Standard & Poor's 500 Index. That's up from 33.1% a month earlier.
Just over 17% of those surveyed were bullish on the S&P 500, down from 33.9% a month ago, TrimTabs and BarclayHedge reported. 
In my experience betting with the crowd when there is such a strong consensus is not a good risk/reward proposition. If there is a bright side for the bears it is that many were burned being short off of the March 2009 lows, so I doubt that they are aggressively shorting.

Looking At the Bear Case

The gloom is palpable this morning and typically we have seen bounces when this has occurred in the past few months. Additionally, the Euro is steady so we should not see much pressure from sovereign issues today.

The most convincing argument the bears have right now is that the market is not oversold in the intermediate term. Today, is the sixteenth trading day since the market made its high on August ninth. Intermediate term trends tend to tire after six weeks or 30 trading days. That would work out to a few days after September expiration.

The market went sideways for a few days before the actual August ninth top, so an argument can be made that the market will be oversold a few days before expiration. All in all, the market will be oversold in the intermediate term at expiration give or take a few days. Even if one believes this will occur that does not mean we can't rally now for a few days as we are still short term oversold. That said, I will likely wait until the market is oversold in the intermediate term before getting aggressive on the long side again.

Ready For Anything

I remain of the belief that the downside should be limited. But am aware of the possibility that I am wrong due to a slowing economy, sovereign issues etc. Luckily, I was disciplined and hedged a little after I caught the easy trade. Have a good night.

Encouraging

Some backing and filling, combined with some put buying is constructive after Friday's big turnaround.

How's The Mood

Every Monday I make sure to read Jeff Saut's weekly commentary. He is one of the few strategists on Wall Street worth listening to. The following stuck out in this mornings' commentary as it relates to investor sentiment
The state of mind at the conference was particularly glum where prior to my presentation I was asked numerous times if I had a-n-y-t-h-i-n-g positive to say.  Accordingly, I began my discussion by stating that if one more person asked me about the Hindenburg Omen I was going to get sick.

Egoiste

Henri A. Termeer, the Genzyme CEO, has overseen Genzyme through their manufacturing debacle. In Sanofi's letter it was revealed that when Sanofi called Mr. Termeer to offer a buyout, Mr. Termeer said that Genzyme was not interested without even asking a price.

I understand the rejection of the $69 offer as it does seem a little low. But how does a CEO who oversaw the destruction of so much shareholder value not even listen to an offer because selling out would likely hurt is ego? Who does he serve, shareholders or his ego?

Buybacks Are Bullish

In the long run a buyback may or may not make sense for a company, depending on their valuation and their  level of financial leverage. In the medium term buybacks are bullish for the stock market as a whole as cash is put into investors hands.

This morning HP announced a $10 billion buyback. If other companies follow their lead and follow through this would be bullish for the market.

Where To Now?

Typically when the market is as oversold as it was last week and sentiment is extreme, the market has a one to three day bounce at minimum. More often a bounce lasts closer to two weeks. So which is the case now?

I have a hard time believing that the market will head much lower right now. The market rarely goes down when everybody wants it to go down. Last week we saw individual investors as gloomy as they were at the March 2009 lows, according to the AAII survey. Hedge funds de-risked at the beginning of the Summer and there is little reason to believe that has changed. Both hedge funds and individuals would look like heroes if the market crashed right now.

I believe the most likely outcome is that we stay in a trading range, with the possibility of expanding the upside of the range if there is enough cash M&A. That said, I took the precaution of partially rehedging my portfolio at the end of the day Friday, after catching the easy trade (some sort of rally off the deeply oversold condition and extreme sentiment). We are still in a secular bear market and the economy is deteriorating so I will not press my luck too hard on the long side even if I believe it is the right trade in the short term.

Sanofi Going Hostile

Sanofi has sent a bear hug letter to Genzyme. Here is the link.This paves the way for a hostile offer and should be positive for all of biotech and health care tomorrow.

Clearing the Gloom

The bulls have now done the minimum. The market is no longer deeply oversold and some of the negative sentiment has likely been cleared. However, we are nowhere near overbought and sentiment is still quite negative. I would expect the market to first dispose of all the new found doom and gloomers, even if it will eventually head lower. Have a great weekend.

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Partially Rehedged

After catching a 25 point S&P 500 rally, I have partially rehedged by selling the November 107 SPY Calls naked. I remain net long and think we will continue to rally but don't want to be a pig.

Why I Would Not Hold Short Over The Weekend

There is a good chance we see a Merger Monday as :
  • Top M&A lawyers have publicly stated in the press that they have been really busy and there is a robust pipeline. Whether agreements get reached is a separate issue but the potential is there.
  • It has never been easier and cheaper to borrow for large companies
  • Many companies are sitting on a lot of cash, especially in tech and healthcare.
  • A number of mega cap companies have publicly stated that they are on the hunt. Nestle, Sanofi and BHP come to mind immediately.
I believe that M&A would have a compounded effect at this point. Not only would the cash entering the market help, but it could have the addittional effect of getting the extremely negative sentiment to swing back towards optimism. If I were a bear I would wait until Monday to see if a merger materializes before going short.

Understanding The Market

I always find it amazing how few people understand how the market really works. If one were not involved in markets and turned on the news tonight they will probably hear that stocks went up because of Ben Bernanke's speech. Or better yet on the GDP revision, ignoring the fact that the S&P 500 was down 10 handles after the report. A nice and simple sound bite.

The real reason the market is up is more complex. Most don't have the attention span to watch a TV segment about it and would just tune out. Nobody really knows why the market is higher for sure and one can only guess why millions of market participants do what they do. I believe the main reason we are up is because negativity has been building up for weeks and we finally saw a capitulatory bottom this morning on the Intel news. In simple terms everybody who wanted to sell did, leaving no more sellers.

I have a tip for Ben Bernanke. Only give speeches when the market is oversold and sentiment is extremely negative. You will be a national hero and everybody will say what a genius you are, even if you just mumble some nonsense like Greenspan did.

Closing On the Highs

I think the market will close on the highs today.

Data Mining

The ISE equity looks high once again but 16% of the calls being bought are on Citigroup and don't amount to much in dollar terms. If Citigroup were a $30 stock  the reading would be around 170, which is not high for an up day. Call activity is also subdued on the CBOE.

Asset Alligators

Are the asset allocators at work? We have had a huge move up in Treasuries coupled with a huge move down in stocks. A rebalancing would mean selling bonds to buy stocks.

Reversal In Treasuries

Pleas also note the huge reversal in treasuries. I believe that is equity positive.

Friendly Reminder

Semiconductors topped when Intel announced its great news. They are notorious for topping on good news and bottoming on bad news. Keep that in mind.

Dummy Discount: Part Two

I would probably be buying Intel right here had they not acquired Mcafee. I don't believe they are good stewards of capital so I require a larger discount.

Panic

The action is starting to feel a bit panicky on an Intel profit warning. I believe that is a good thing.

Quick On The Uptake

Investors were very quick to learn that all rallies should be sold so they are loading up on Puts this morning.I believe this is bullish

Opposing View

John Roque has been right more often than he has been wrong. I always pay attention to what he has to see even if it does not jibe with my opinion.

Better Odds

Today's bounce has a better chance of holding. Those who were looking for a bounce to sell into likely did so yesterday.

Cisco Looks Like A Bargain

Cisco's market cap is $90 billion once taking out net cash.  Even in the worst year of the financial crisis Cisco had $9 billion in free cash flow. Free cash flow is projected to grow to $13 billion by 2013. That leaves a lot of room for error.

I believe we are entering a weak economic environment but the inventory and overbuilding issues that were pervasive during the last recession will be less of an issue this time around as companies stayed disciplined. I especially like that Cisco has been a consistent buyer of their own shares. When the market is falling it is nice to have a buyer of last resort and Cisco should outperform, even if the market does poorly.

Yet More Sentimental Evidence

From Marketwatch:
Consider the average recommended domestic equity exposure among a subset of short-term stock market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). This average currently stands at minus 6.6%, which means that the average short-term stock market timer is actually recommending that his clients allocate 7% of their equity portfolios to shorting stocks.


...In addition, market timers who focus on the Nasdaq market in particular -- and who tend to be an especially volatile bunch -- are even more bearish right now. Their average exposure now stands at minus 50%, which means that they're now allocating half their equity portfolios to an aggressive bet that the market will continue declining.

Could everybody be right? It has happened, but betting with the crowd when there is such a strong consensus will lose one money over time.

He Shoots, He Scores

The hype surrounding today's economic release is just plain silly. It is  a revision to a backward looking GDP figure. Who cares if the number comes in at .8 or 1.5? We already know what corporations earned in the second quarter. Tell me the GDP for the second half of the year and I might trade on it. Anybody who trades based on such a meaningless number deserves to have their money taken away.

The second most hyped inconsequential event of the day is Ben Bernanke's speech. Everybody is blaming him for the market route because he is not showing faith in the economy. After Ben Bernanke used the phrase "unusual uncertainty" the market continued to rally. The market only went down after the FOMC meeting. Unfortunately for Bernanke that meeting happened to be at a time when the market was overbought on both an intermediate and short term basis and sentiment was bullish.

What if instead of saying the economy was "unusually uncertain" Bernanke said the recovery is on track. Would the market be higher now? Would the market have ignored the atrocious economic data? The financial media likes to hype these events as they want ratings and want to make investing feel exciting. See it for what it is. Keep your wits and take advantage of those who don't.

Dumb and Dumber

Watching HP and Dell outbid each other for 3Par is like watching Dumb and Dumber. Only the sequel without Jim Carrey.

Canary In the Coalmine

The canary in the coal mine this morning was the heavy call buying at the ISE, the traction in Treasuries and the anemic response to the jobless claims numbers. It is very difficult to get a read on sentiment these days as the put/call ratio has lost some of its effectiveness but the numbers this morning at the ISE were high enough to raise eyebrows.

The majority of the evidence still points to excess pessimism and the market usually has a tough time going lower under these conditions. But it is the time of the year when anything could happen.

The late day weakness might have been due to Tyco being added to the S&P 500 as there was a $2 billion sell order in order to accommodate the stock. Have a good night.

Cash Takeovers Are Positive

There have been a lot of articles recently saying that M&A is negative for the market. Most cite the AOL/Time Warner merger pretty close to the top of the tech bubble and the LBOs in 2007. Before I refute these arguments, I want to remind readers why I believe cash M&A is bullish.

When a company is bought out for cash shareholders receive cash for their shares. A lot of that cash finds its way back into other stocks. A lot of the cash finds its way into other stocks right after the announcement of the deal as arbitrageurs buy the stock from investors. The balance hits the market at closing.

The AOL/Time Warner merger was an all stock deal. I agree that all stock deals are not bullish as one companies stock is being exchanged for newly created stock of another company. I do not recall much cash merger activity at the top of the tech bubble. Probably because valuations were too high to allow any.

LBOs picked up steam during the 2003-2007 Bull Market. They reached a fever pitch in late 2006 and the first half of 2007 as financing became ridiculously easy. I believe the blow off run in the S&P 500 from around 1225 to 1525 was a direct result of these LBOs. It was the reason the market kept going up until October 2007 even though the credit troubles started a lot sooner and the economy was clearly slowing. It was only when some of the deals started to break that the market picked up steam on the downside as arbitrageurs started dumping shares on the market.

Maybe the LBO activity in 2007 was a sign of the excesses in the credit markets.But while the deals were happening it was extremely bullish for the market. If cash M&A picks up I believe it will be bullish for the market once again.

Individuals Very Negative

The American Association of Individual Investors survey is showing 21% bulls. That is about as low as it got during the credit crisis. According to SentimenTrader.com there have been 48 other weeks since 1987 where investors were this non bullish. The market was higher 3 months later 47 out of 48 times. Take that Hindenburg Omen.

Oversold Rally

Even the bulls think that this is just an oversold rally and it seems everybody is eager to sell into it. The number of shorts at Rydex finally started jumping yesterday and the level of pessimism at Rydex is now approaching the levels seen in early July. I cannot even count the number of pundits I have heard say that we will reach 950 on the S&P 500 in the coming months.

I was in the camp that thought we would see an oversold rally and that we would likely head lower into the Fall but I am now questioning that belief. These are not the conditions under we which we normally see a big move lower in the markets. Its certainly possible that a rally turns the crowd bullish again as I have rarely seen investors so fickle.

Credible sources have said that there is a lot of activity in the M&A pipeline. If some of those deals come to fruition in the coming weeks I believe that the opposite could happen. With the crowd leaning bearish, we could be one big deal from a decent move higher in the markets.

Slow Motion Bottoms

The slow motion bottoms we have been seeing recently are tough because they give you too long to doubt yourself. I remember the good old days when I used to be able to buy into a scary panic, take a walk around the block and come back to see that the S&P 500 rallied 20 points. Now that we finally got our slow motion bottom I think the market could rally through the end of the week.

I wanted to address something a reader said on the message board today:
I find it amusing that you emphasize any positives when you are trading long. Then, when you sell or short you immediately flip and emphasize why the markets will drop.
There are a lot of valid critiques that could be made about me but this simply isn't one of them. I always point out the bull case and the bear case regardless of which way I am trading. I have been one of the biggest economic bears regardless which way my portfolio was positioned. Have a good night.

Why Citigroup

Citigroup is  a stock widely loved by both professional and retail investors. I have read countless positive recommendations on Citigroup in the past year and cannot remember reading anything negative. Retail sentiment can be summed up in something that an acquaintance said to me: "If I had any money to invest I would buy Citigroup because it has to be worth more than $3".

It is very possible that everybody is right about Citigroup. But as long as the government is in the market selling shares every day I see no reason to buy. Talk to me when they are done or almost done.

Buy, Buy, Buy

Jim Cramer has a tendency to be bullish, so it is not much of a tell when he is bullish. When he turns bearish it is worth taking notice.

Too Much Call Buying

After buying puts out of the gate this morning, there has been a lot of call buying at the ISE. Anecdotally, I am not seeing anybody bullish so I don't know what to make of it.

Nice Call

Medtronic, the medical device maker,  has fallen by nearly a third since its April high. Yesterday's 10% drop was due to an earnings guide down of a whopping 2%. Medtronic now trades at nine times earnings. Medtronic's growth is slowing as people cut back on doctor's visits and elective surgery.

Times are bad enough that copays are stopping people from visiting the doctor. In my opinion, the more dominant trend is the aging baby boomers and the greater need there will be for healthcare in the future.

After the huge drop Wall Street's Finest, Jeff Mathews term for analysts, are coming out and downgrading Medtronic. Now, after it dropped by a third. At this price it is difficult for me to see how long term holders lose money on this stock.

All The Negatives Are True

All the negatives that everybody is focusing on are true.
  • Their are pension issues.
  • There are municipal issues.
  • There are sovereign issues.
  • There are commercial and residential real estate issues.
  • I can go on but you get the point
But these issues have been around for a long time, including through an 80% rally. In the bigger picture I believe these issues will keep us in a secular bear market. In the short run these issues tell us nothing.

Rally Caps On

I think we will get a higher close today.

Long Only

I have gotten rid of my hedges. I am long only.

II Bulls At New Recovery Lows

The bulls in the Investors Intelligence survey are at lows not seen since before the March 2009 lows. I am assuming the ranks of bulls further thinned in the past couple of days and is likely not yet reflected in the number.

Doom And Gloom

Everybody is all doom and gloom. I remain bullish for a trade. Apologies for the late start. More coming.

The Price Target Indicator

I am hearing a lot of price targets on the S&P 500 and they are all south of here. That is usually a pretty good sign that the market is ripe for a bounce. Although it would be nice to get the Biggs Indicator, which called the most recent bottom and top.

The Endangered Species

The rare bird, better known as the intra day reversal, was nowhere to be found today. Recent bottoms have not been of the whoosh variety but rather a cessation of downward momentum followed by attempts higher by the market.

I think expectations regarding economic reports are about as bad as it gets and it will be difficult to negatively surprise investors at this point. The market is oversold and sentiment is very negative. I believe it is best to buy under these conditions even though it is difficult. I don't believe the market pays people to be comfortable.

I do have my reservations which include the fact that we are not oversold on an intermediate term basis, the economy is getting worse and we are at the time of the year when bad things are known to happen. That said, I think at this point the risk/reward favors the upside for the next few days and possibly into Labor Day.

Widespread Pain

In the past couple of weeks , the 13-Fs for the second quarter came out.The most widely held stock by hedge funds was Apple. There is widespread pain in hedge fund land the past few days as the stock has been very weak. Hedge funds are not known to stick around when there is trouble, which is why I avoid stocks widely held by hedge funds at all costs. The stock should bounce with the rest of the market but I would look elsewhere.

Common Sense Not So Common

I took micro and macro economics and that is the extent of my formal economics education. Yet by noticing that mortgage applications for purchase fell off a cliff and that we were in the period after the expiration of the tax credit, I was able to ascertain that the Existing Home Sales numbers would be UGLY. There were no spreadsheets, no formulas and no calculus. PHDs in economics need to attend a course in common sense, especially those working on Wall Street and at an unnamed "independent" government institution.

Major Homebuilders Higher

Most major homebuilders are now higher on the day, showing these numbers were not much of a surprise for those who actually follow the industry.

Put/Call Ratio Supportive Of The Market

We are seeing put buying at both the ISE and CBOE. Despite that the market has started to rebound. I believe this augurs well for the balance of the week.

Increased Longs

As per plan I increased my longs into the post Existing Home sales swoon.

Intra Day Reversals

Major intra day reversals have become an endangered species. Markets that open down big tend to stay down big and vice versa. As readers know I believe that the aftermath of the Existing Home Sales data should mark some kind of low. The question I am debating is if an intra day reversal is possible or if the sun will come out tomorrow?

Oversold In Pictures

For the first time since early July the market is oversold as you can see in the chart below.
Here is a look at the raw data that makes up this indicator below. As you can see for the next four days we will be dropping negative numbers which I highlighted in red. That is the reason I am looking for the market to rally through the end of the week.
Sentiment is mostly negative as surveys, Rydex data and the sudden awakening of Wall Street analysts to a second half slowdown all point to a gloomy investment community. My only reservation is that the put/call ratio showed a little too much enthusiasm yesterday. But with the oversold reading and the majority of evidence pointing to negative sentiment, I believe a buy on the bad housing data will yield a profit by the end of the week.

Oversold

The market is now oversold ( I will post a chart in the morning). Sentiment is negative but not at an extreme. As I have mentioned numerous times the Existing Home Sales number tomorrow should be a disaster. If we dip after the number I believe the market is good for a bounce through the end of the week. Have a good night.

A Secular Change

Over the coming decade baby boomers will be retiring en masse. Many will be pulling money from their retirement accounts or receiving payments from their pension plans. This will mean selling assets and should be a headwind for valuations over the coming decade.

This will be a benefit to those who are currently saving money for retirement and investing for the longer term as it is better to be able to buy assets at lower prices. However, those who are investing for the shorter term  and expect to return to the valuations of the past two decades might be in for a surprise.

Expiration Hangover

There is often a hangover the morning after expiration and there is also the possibility of a dip tomorrow morning based on the horrible housing data I expect. For those that want to use weakness to play an oversold rally, the Nasdaq appears to be the most fertile ground. The Nasdaq is a lot more oversold than the NYSE, there have been recent takeovers in the space and the Nasdaq showed nice relative strength on Friday.

Seemingly Inconsistent

At the beginning of the year I was in a small minority that was looking for a double dip and am still in that camp although it has grown. Yet, here we are and I am constructive on the stock market in the short term. I know that many readers must find this seeming inconsistency hard to understand. Hopefully the following two points will help explain:
  • What everybody knows is not worth knowing. Everybody is in agreement that the economy is slowing so what is the edge of making negative bets based on that fact?
  • The stock market is not the economy. Yes the stock market correlates to the economy most of the time. But sometimes it leads, sometimes it lags and sometimes it does neither. 
Believe it or not when I started investing I mostly traded  based on my long term thesis. It took me nearly a decade of constantly giving back gains because of short term fluctuations before I stopped being stubborn.

I started by taking off my long term trades when the markets reached extremes. Once I realized I  was pretty good at picking out the extremes, I started placing short term trades that went against my longer term beliefs. That was my breakthrough and my profitability shot through the roof to the point that I eventually built up enough money to trade and invest full time.

Looking At The Coming Week

There is room for some weakness in the early part of next week but it would probably be a buying opportunity as the market would be quite oversold. As such, I believe it is better to give the bulls the benefit of the doubt next week. Have a great weekend.

Exsqueeze Me

When there is a large short base we tend to see squeezes heading into the weekend.

Paolo and Paulson

Paolo Pelligrini, the man who came up with the idea of shorting subprime for John Paulson, is shuttering his hedge fund after taking a loss on a Treasury short. Reminding all us mere mortals that identifying a bubble is a lot easier than profiting from one because they usually go further than anybody expects.

His ex-boss does not seem to be far behind as he has concentrated his bets in the financial sector and that sector is severely underperforming. His largest common stock holding, Bank of America, is performing miserably.

Man Of The Week

My hat is off to the investment banker who sold Intel on the idea of buying Mcafee.  That banker could probably sell ice to an Eskimo. As far as I am concerned he has earned his bonus. 

Color Me Positive

With the majority having turned negative further evidenced by a huge outflow from equity funds this week, color me more positive.

M&A Pipeline Heavy

A Bloomberg article quotes M&A lawyers saying that the M&A pipeline is heavy. That does not mean that the deals will come to fruition but if they do and they are cash deals it would be a huge boost for the bulls. Barring a complete financial collapse I believe the market would hold up and possibly even rally if a cash merger boom comes to fruition.

Delusional

Today marks day nine of the decline that started the day of the Fed meeting. Even if we are headed a lot lower we are not likely to go down in a straight line. There should be bounces along the way. The day after expiration is typically weak and if we go down Monday we will be maximum oversold.

Existing Home Sales come out Tuesday morning at 10 AM. The expectations are for sales of 5.1 million homes at an annual rate. Those estimates are delusional and I expect a sharply lower number. I could envision a scenario where the release of those numbers take us lower and we end the day sharply higher as the market would be extremely oversold at that point and Turnaround Tuesday lives up to its name.

The Bull Case: Part Three

I was perusing this evenings headlines on Marketwatch and found the following headlines:
  •  Gap unveils new $750 mln buyback plan
  •  Intuit approves new $2 bln share buyback program
  •  Marvell Tech to buy back up to $500 mln in shares
  •  Nordstrom to buy back up to $500 mln in shares
  •  Rambus to buy back $90 mln in common shares
We are clearly headed into a major economic slowdown and this should be the time when the bears make hay. But if we continue to see this type of buyback and cash takeover activity the bulls might be able to hold the fort . At least until the slowdown weighs on the bottom line and effects companies cash generation abilities. 

Time Is on The Bull's Side

Earlier this week when the market began to rebound many argued that the market was a buy because sentiment was too pessimistic. I reminded readers that time is an important aspect of a decline as well as the level of sentiment. At the time not enough time had passed for participants to act on their bearish feelings.

Today is day eight since the market took a sharp move south and the more days pass the more people capitulate to the negativity. Monday would be day ten of the decline and that would make us maximum oversold. In other words we are late in this decline and the time is approaching where one should try and see the positive, for a trade.

Biotech Is A Bargain

After a very long drought the biotech sector became hot for a few days following the announcement that Sanofi wanted to acquire Genzyme. The deal would be huge as 10% of the sector would disappear overnight, for cash. Recently it has been reported that talks are on hold due to the fact that the Sanofi board is on a month long vacation (its good to be a European in August).

Arbs still think there is a good chance a deal will happen as Genzyme trades at a large premium to where it would be without a bid. However, the sector has completely given up its gains as investors cannot look past the end of the day. I believe a deal is likely to happen next month and the whole sector will benefit. In the worst case the deal does not happen and one is left with very reasonable valuations, many companies that are buying back stock aggressively and businesses that should do well even in a downturn.

Waiting For Bad News

Housing data for July will be coming out next week. If mortgage applications are any indication, and they are usually the best leading indicator for housing, than the data should be worse than terrible. The only question is how will the market react? If we get a sell off leading to the data than the initial reaction will likely mark a low. However, if we bounce before then we could see a second dip.

What If

The day after expiration is typically weak. If we were to head down through Monday we would be maximum oversold and headed into Turnaround Tuesday.

The Dummie Discount

The biggest risk in buying value stocks is that the companies squander the cash they are generating. I was getting close to buying Intel based on the fact that they were trading at eight times earnings when taking out net cash. I would now need a larger discount to buy the shares of Intel as the management might squander the cash.

Buyable Dip

I believe this dip is buyable. I have already acted between my sale of puts yesterday and my buy of Gilead this morning.

Added To Gilead

I have added to my Gilead position. The addition is a short term position.

Proving My Point

The news this morning highlights the tug of war in the market. Jobless claims jumped as the deterioration continues but Intel buys Mcafee for $7 billion in cash. Eventually a bad economy will effect the ability of corporations to buy back shares and do cash takeovers but in trading the journey is more important the destination.

Another Cash Deal

Intel is acquiring Mcafee for cash. I'm still scratching my head to figure out why a semiconductor company is buying a software company, but that doesn't change the fact that its bullish for the market.

Going Nowhere Fast

The market seems to be going nowhere fast. The bears argue that the economy is deteriorating at a rapid clip and they are correct. While the bulls argue that participants are already negative and holding small equity positions, leaving few to sell. Additionally, companies are buying back shares and there is the potential for quite a few cash deals.

If the Genzyme and Potash deals get done than I believe that the market will hold and possibly even rally despite the poor fundamentals. However, both situations are unlikely to be resolved until after Labor Day. I would also note that there is a lot of supply in the waiting as the IPO pipeline is quite full with GM joining the fray.

All in all the picture is quite confusing. In the short term I still plan to buy a break if it happens between now and early next week.

The Elusive Setup

After another late day knock down it appears that there is still a chance I will get another dip lower to buy. Have a good night.

Druckenmiller Calls It Quits

Legendary investor Stanley Druckenmiller is shutting down his $12 billion hedge fund and calling it quits. His fund is down 5% for the year. With a fortune estimated at well over $2 billion he is sick of grappling with the markets. I cant say I blame him. Here is the story from Bloomberg.

Cash Over Psychology

I have heard numerous pundits say that takeovers are bullish because they change the psychology of the market. That might be true but I would rather buy when psychology is negative. The reason I believe cash takeovers are bullish is because it puts cash in the hands of investors who in turn take that cash and put it in other stocks. I will take cash over psychology any day.

Baby Steps

As I have written, I would buy into a sell off that lasted through expiration. As such I sold the SPY 107 Puts naked expiring this Friday.

Good News, Bad News

Mortgage applications surged as homeowners used lower rates to refi. But applications for purchase dropped and are down over 38% year over year. The good news is that lower rates will allow some homeowners to save money but the lower rates are not helping the housing market yet.

Bad News For Bears

The Investors Intelligence data is out and the bulls dropped to 36.7% while the bears jumped to 31.1%.  The II data, in conjunction with the Rydex data shows that it did not take long for investors to become pessimistic again. This leads me to believe that the downside will be limited in the near term and that it will take a financial accident to take the market significantly lower in the near term.

This increases my conviction that a move lower over the next couple of days should be bought. It just seems less likely that we will get a meaningful move lower. This is a tough situation as sentiment indicators are supporting the market but the economy is deteriorating and stocks are not cheap.

Bullish Fodder

Rydex traders moved to an extreme level of pessimism yesterday. It has not paid to bet with Rydex traders when they are at an extreme. This is a positive for the bulls.

Wrap Up

I had expected a bounce sometime this week but did not expect it to be nearly 30 S&P 500 points from bottom to top (thus far). Had I expected that big of a bounce I would have done some buying. The M&A news this morning would truly be good for the market if it comes to fruition. I believe a lot of cash M&A activity is the only thing that could take this market significantly higher.

We have now had a reflexive bounce so the risk/reward for short term longs is not great. If we get another move lower over the coming week I believe it will be buyable for a trade. Have a good night.

The View From 10,000 Feet

Many large cap stocks trade at reasonable prices compared to cash flow and earnings. The problem is that the economy is slowing and it is very difficult to forecast how slow the economy will eventually get and what effect that will have on earnings.

Reported earnings are backward looking and forecasts are always way off at economic turning points. In 2007 nearly $100 in S&P 500 earnings was being forecast for 2008. Reported earnings for 2008 ended up being negative. I don't believe that will happen again but I do believe that forecasts could be way off if the economy continues to deteriorate.

There is also the possibility of a tail event due to numerous global imbalances and a slowing global economy. Valuations are not at a point where one does not have to worry about the economy and until we get to that point everything is a trade.

Bounce

Traders have been looking for a bounce the past few sessions after the market came down in an abrupt manner earlier last week. Today, we are finally seeing that bounce which should last a session or two. If the market were to come down again after this bounce into early next week the market would be maximum oversold. That would create a low risk setup for a multi day rally.

Now Thats Bullish

Potash has rejected a nearly $40 billion cash bid from BHP Billiton. A cash deal that large would be bullish for markets. A nearly $20 billion Genzyme transaction is on hold as Sanofi's management cannot be bothered to negotiate during their month long vacation. Talks will resume in September and I believe a deal will eventually get done. If both these deals go through it is difficult for me to see much downside.

Carry Trade For Dummies

There is an interesting Interactive Brokers ad I have heard on Bloomberg radio numerous times recently. They start out by telling listeners that they offer margin rates as low as 1.5% or something like that. They then go on to say that they have a list of hundreds of stocks that pay a dividend of over 5%. They let the listener put two and two together and feel quite smart about themselves. After planting the idea they go ahead and warn about how these stocks might go down in a much less interesting manner.

The Bull Case: Part Two

The bull case that I have heard repeatedly recently is that market participants are too dire, with talk of a Hindenburg omen and a double dip. Contrarily that means the market will not go down. That is exactly the type of argument that I like to make but there are a number of things bothering me about this argument:
  • There are too many people making this argument. In early July I was screaming this argument from the rooftops and nobody wanted to hear it. Now suddenly everybody is a contrarian. 
  • It takes time for people to actually sell their stocks even if the mood has suddenly changed and that is why I like to use the oversold readings. Not enough time has passed for people to act on their new found bearish feelings. I would feel comfortable with this argument if more time had passed.
  • The economy is bad and getting worse. While it is better that people recognize this and price it in, a bad economy in and of itself is not a good thing.
  • We are at the time of the year that sentiment often reaches an extreme and this is not extreme. 
While I respect this argument enough not to short the market, the bulls have not convinced me.

Dumb Things Companies Do

News is out that Bank of America might cut its nearly $10 billion stake in Blackrock, to which I say its about time. In the Summer of 2009, Bank of America did a roughly $10 billion secondary, selling their own shares for a little over $10. Back then shares of Blackrock were trading higher yet they chose to hold onto that stake and sell their own shares.

Treasuries Are Surging

Treasuries are surging this morning. Does anybody know the reason?

Mark To Model

Deutsche Bank initiated Gilead at Buy and Amgen at Hold. I hold both stocks although my position in Gilead is significantly larger. The analyst put a $42 price target on GILD and a $57 price target on AMGN using a discounted cash flow analysis.

For some odd reason the analyst used an 8.5% discount rate on Gilead and a 9.4% discount rate on Amgen even though Amgen is the larger company with a more diversified revenue stream. This is a glaring inconsistency where the analyst tweaks his/her spreadsheet in order to back their view. I find most analysts do this.

Time Frames

I tend to think of the market in four time frames. The longest time frame I think in is secular, which is a multi year time frame. I believe we are in a secular bear market which means we are likely in a wide trading range or worse. Please note that the market can go up by 20% from here and we would still be in a large trading range. This time frame has little effect on my trading except that I err on the side of caution with my long trades and don't try to catch every last dollar. This also leads me to be more patient in buying.

The second time frame I think in is the intermediate term which is generally a six week period but can be anywhere from four weeks to a few months.  I believe that an intermediate term rise that started in early July and lasted five weeks ended last week and we have just begun an intermediate term decline. Because I believe we are in an intermediate term decline that has just begun I am even more careful than usual in going long.

The third time frame I think in is the short term, which is generally about two weeks. If the market were to decline through this week and and was followed by post expiration weakness than we would be maximum oversold in the short term . That would set us up a nice risk/reward trade for a very playable multi-day rally, still likely within an intermediate term decline. This short term time frame combined with the intermediate term has the largest effect on my trading.

The fourth time frame is a "very short term" time frame, or day to day. For instance even if the market becomes maximum oversold by next week as I laid out above it is very unlikely that we will go straight down and we will probably see a relief rally at some point this week. We did go straight down into the early July low but that decline was fairly uncommon. My current very short term view is that if we have a down day today we should rally tomorrow. This is the time frame I trade least on and keep those trades small.

Take A Seat

The bears have made it four in a row, as it seems that many were caught by surprise by the bad economic data and are looking to lighten up on rallies. While I thought we would see better rally attempts than we have in the past couple of days, I have held on to my wallet. With the economy weak and seasonality weak I want to wait until the market is maximum oversold before making any purchases. Have a good night.

The Shmindenburg Death Cross

Helene Meisler of RealMoney.com , the best technical analyst out there, points out that only 5 of the 92 new highs on the NYSE are common stocks. Most are preferred shares or bond funds. Looking at common stocks only there is nowhere near enough new highs for a Hindenburg omen. Not that I would invest a penny based on it anyway.

No Replacement For Common Sense

The hottest investment strategy is to buy stocks with high dividends. This strategy makes a lot more sense than other strategies that investors embraced in the past like buying Munder Net Net Net. But a dose of common sense needs to be used with this strategy as well.

For instance Eli Lilly pays the highest dividend in the large cap pharma/biotech space. But when looking under the hood it is also the most expensive stock in that space. By 2014 Eli Lilly's earnings are expected to fall to under $3 as patents expire, meaning Eli Lilly trades at 12 times 2014 earnings. Most large cap pharma/ biotech stocks trade well into the single digit multiples of 2014 earnings. Most trade under 7 times. Its possible that Eli Lilly will discover new drugs and those earnings will go up, but the same holds true for the rest of the companies.

I suspect the stock has outperformed because these dividend strategies have grown in popularity and Eli Lilly's dividend is among the highest of S&P 500 companies. I believe it is better to own stocks that pay less or no dividends that are a lot cheaper like Gilead, Amgen or even Pfizer.

Encouraging Sign

The ISE Equity is showing a lot of put buying today for the first time since this decline started. At the same time the market is holding in fairly well. This market may have some rally in it.

Process More Important Than Being Right

I thought that chances were we would rally into next week and possibly into expiration, followed by a move lower into the Fall. I could not have been more wrong as the market has tanked. However, I hedged myself and lightened up positions right around the highs of the market. The reason being that I rarely try to catch the last bit of a move, whether it be on the upside or downside.

The rally was already five weeks old and while many intermediate term rallies tend to stumble at the six week mark, the market no longer had the cushion it had at the beginning of July. Sentiment, while not extreme had improved a lot and the market was somewhat overbought. I especially did not want to reach on the long side in what I perceived to be a weak economic environment.

Had the rally lasted to expiration I would have taken a stab on the short side as I expected the economic data to take a turn for the worse. Am I upset that I missed the move lower? When I started trading I might have been but trading is a lot like deal making. If you are not willing to walk away from a deal than you will not be a good deal maker. In the same way one must be willing to wait for the ducks to line up and be willing to miss moves.

Calling For A Summer Friday

The fact that we have come down so far, so fast and that it is a Summer Friday make me think we should drift higher today. My only apprehension is that everybody seems to want to short a rally. I will be waiting for a better oversold reading before doing any buying and will pass on playing small bounces for now. 

CPI came in a little high, even with hedonic adjustments. The data doesn't jibe with deflation unless one is looking at the stock market. Retail sales are the most useless economic report as retailers already reported the more accurate data for July. JC Penny lowering estimates might be the more relevant data point.

No Bull Case

The most bullish and bearish thing out there is that nobody can even state the bull case. Will tomorrow be a Summer Friday or will it be much more exciting? Have a good night.

Healthcare Shines

Healthcare companies are facing many issues. From sovereign countries strong arming them, to less people visiting doctors and pipeline issues. But many of the stocks trade at single digit multiples and the stock prices reflect the risks.

At the same time many industrial, retail and material shares trade at twice the multiples of healthcare, even though there are clearly risks to the economy. Financials trade on "normalized" earnings which is a whole other ballgame. Recently, healthcare has started to outperform. I expect the trend to continue.

Back To The Economy

A question for the bullish readers out there, if there are any. Now that GDP is around 1%, what gets the economy going again?

I Used To Roll the Dice

I used to roll the dice
Feel the fear in my enemy's eyes
Listen as the crowd would sing:
"Now the old king is dead! Long live the king!"

One minute I held the key

Next the walls were closed on me
And I discovered that my castles stand
Upon pillars of salt and pillars of sand

-Coldplay
Thus far it has paid to remain conservative and I believe that will remain the case. Better to wait for the market to become oversold before making a stand on the long side. However, with the S&P 500 now down a quick 55 points from the highs a few days ago it would not be surprising to see some sort of bounce. I am likely to just remain on the sidelines but will consider a very small purchase. I believe a buy here will prove profitable when a bounce does arrive.

Bulls Not Dead Yet

Many were belittling the European crisis and the signs of a slowdown because earnings were fine. As I previously mentioned earnings are a backwards looking indicator. The fact that earning reports were fine in July does not speak to the current state of the economy or the future state of earnings.

When final demand slows it takes a while for the companies further down the supply chain to notice that. Retail sales, auto sales and mortgage applications have slowed markedly in recent months but many were happy to ignore that because earnings were fine. With Cisco's earnings report the myth that earnings can buck the economy will be laid to rest.

This does not mean that the bulls are now dead meat. Cisco trades at 11 times this years earnings ex net cash. Intel trades at eight times ex net cash so a case can be made that a lot is already priced in. Additionally, not many jumped aboard this rally so there might not be that many people to sell.  A reasonable case can be made for a trading range.

The ball is now in the bears court. The oversold condition has been relieved and the bears can now show what they are made of. They can use this overbought reading to take the market sharply lower or we could see them waste it chopping around.

Cisco Disappoints

Cisco disappoints on earnings as  a slowing economy is slowly making its way to earnings. The bulls should be tested again tomorrow morning. Have a good night.

Bounce Potential

I am not looking to play a bounce, but if I were I would be looking in tech land, specifically at the Microsoft/ Intel duo. They are down strongly on news that PC demand has softened. Two brokers had notes out about it yesterday so the news is likely now in the stocks.

Back To Their Old Ways

In their earnings conference call a little over 3 months ago Pfizer said that they would be buying back shares as they thought their stock was a bargain. At the time their shares were trading around $17. During the quarter their shares traded nearly 20% lower to $14. One would think at that price they really thought their shares were a bargain. Pfizer, which has $20 billion a year in free cash flow spent a whopping half a billion dollars on buybacks during the quarter.

When discussing buybacks on their most recent earnings conference call they spoke about the potential for "bolt on" acquisitions and downplayed buybacks. It seems a zebra cannot change their stripes. At current prices and with management reneging on their word there are better opportunities in healthcare.

Not Buying It

With the economy in such dire straits, I am only taking the lowest risk long setups. That would happen once the market is approaching maximum oversold. We are a long ways from that. That does not mean we won't get bounces or even that we wont rally to a higher high. It just means that I don't like the risk/reward setup so I won't be participating.

Deflation Watch: Part Two

A friend in the manufacturing biz received the following email yesterday:

Good morning valued XXXX customers!

We have received word of an imminent price increase on glass as announced by the glass manufacturers. The increase in pricing to the glass fabricators such as XXXXXX, will be in the 8 to 14% range, depending upon the product. We will have no choice but to pass a portion of the increase, approximately 7 to 8%, on to our customers. There is a ‘window of opportunity’ for you to place new orders at this time, before the increase takes effect, which, we are told, will be on or about August 16, 2010.

Please check your inventories, upcoming requirements, etc. and let us know as quickly as possible what items you will be needing so as to beat the price increase deadline. If you have any questions, please let us know.

Kind regards.

Late In The Game

Timing indicators point to a top early next week or possibly at expiration, as trends have the tendency to use expiration as a turning point. However, we are late enough in this rally that caution is warranted. I don't typically try to catch the last bits of a rally and that is especially the case now.

Speaking to people in the real world, the chorus has been getting louder that business is miserable and people are cutting back. While I often like to use the phrase "The stock market is not the economy", the disconnect can only go so far as they are connected in the long run.

There is a global slowdown, people are hurting and the stock market has relieved the extreme negative sentiment and oversold condition. The time to be aggressive was when Barton Biggs turned bearish, Robert Prechter was featured in the New York Times and Nouriel Roubini hosted Squawk Box all in the same week. Not now.

A Reason To Give In To Desire

When the market is rising participants want to find an "intellectual" reason to join the herd. Sentiment has stayed neutral to slightly positive as the horrendous data has not allowed participants to turn bullish to an extreme. QE 2 could give those fence sitters the intellectual excuse to follow their primal instinct of joining the herd. A rally that lasts into expiration with extreme sentiment would be an excellent short setup.

No Backbone

The Fed continues down the same path that has led the country to ruin. More easy money. Fire the bums.

Roll Out

I was hedged via a short of the August SPY 108 Call. I rolled the position out to September.

Deflation Watch

I found the following from Reuters rather telling about our deflation problem:
A check by J.P. Morgan Securities said average prices at the Wal-Mart Supercenter in Virginia were upped by 5.8 percent, the most significant sequential increase since it started the study in January 2009.
Ben Bernanke is on the job so don't worry your little head off about deflation.

Slow Down

Investors have been breathing a sigh of relief in recent weeks as European data has been coming out fine despite the crisis. It now appears that the crisis might not have had enough time to trickle into the data as this mornings releases are showing renewed weakness. In general, data from around the World shows a global economy that is stalling. When the economy is slow, the economy becomes accident prone as the weak spots are exposed.

The global imbalances will not go away and will eventually need to be dealt with. That does not mean that we cannot ignore them for extended periods of time as the 80% rally has shown. But do not forget that they are there. That is the reason that I err on the side of caution and turn market neutral once the pessimism has cleared.  If we were in a bull market in a healthy economy I would press my longs until we saw extreme optimism.

Nothing To Write About

I have written fewer and fewer columns the past few days because there is simply nothing happening in the market. Most of the stocks I follow are on track to trade a fraction of their daily volume and barely move all day. It seems the bulls want to test the upside of the recent range after the bears couldn't get it done on Friday.

As an aside its amusing how the crowd could not find an economic reason to get bullish so they are using QE 2.0 as an excuse. They always find an excuse to get bullish after the market is already up. They think they are "investing" but in reality they are following their primal instinct to be part of the herd. Have a good night.

Go Figure

Even though Simon Property Group's stock price is off its high seen during the largest US real estate bubble ever, it trades at close to a record market cap because of all the shares it issued. How is it possible that retailers are having such a tough time and a landlord to retailers is at bubble levels? Beats the hell out of me.

Genzyme Deal Should Happen Eventually

I believe a Genzyme deal will happen for a number of reasons:
  1.  The amount Sanofi is offering is a very good price for Genzyme's shareholders. Sanofi bid $69 but it is clear they would move up to the mid seventies. The only reason Genzyme even traded above $50 was because people were speculating that they might be taken over.  Genzyme shareholders holding out for more are being greedy. They want the price for the company assuming the manufacturing problems will be resolved quickly and on multiples paid during times when biotech as a group traded for much higher multiples.In addition, they are assuming that there will not be price pressures on Genzyme's drugs from sovereign countries.
  2.  Genzyme was in the middle of a $1 billion accelerated stock  repurchase plan when Sanofi made a bid. Genzyme's stock price was in the forties when they initiated this plan so Sanofi's bid is forcing them to pay a lot more for their stock than they intended, as one must continue buying shares in an accelerated repurchase plan. If they walk away from a deal they will have no deal for shareholders plus they will have paid by my estimation $200 million more for their share repurchase than they intended.
  3. Genzyme is quite clearly up for sale to the highest bidder. If nobody emerges now and Genzyme rejects Sanofi's bids it will be a long time before Genzyme shareholders see these prices again. 

Timing A Top

Many of the indicators I like to look at are showing a muddled picture. As long time readers know I like to use time rather than price as an indicator for when a rally has exhausted itself. The reason being that most market participants can only fight the pull of the crowd for so long when the market is rallying.

Six weeks is the period of time when an intermediate term move often runs into problems. Early next week is when this move will be six weeks old. However, option expiration is very often a turning point for the market, especially recently. Expiration is next Friday.

I prefer when all the indicators line up for a turn in the market. Time indicators point to a post expiration swoon. It is also possible that by that point the sentiment indicators will come around as well. At that point it is likely that the faltering economy will matter again.

Why The Market Won't Go Down

GDP came in worse than expected, as did employment and retail sales. So why won't the market go down? The answer is quite simply that hedge funds have de-risked. The evidence is that hedge funds as a group gained less than 2% in July even though the S&P 500 was up 7% while corporate and junk bonds were up as well. All they had to do was own something and they would have done much better. Their returns imply very low levels of stock exposure.

Mutual funds don't change their cash levels drastically and individuals are losing interest in the market leaving hedge funds as the most active participants in the market. When they de-risk the market goes down and when they re-risk the market goes up. Right now they are re-risking and trying to get in on dips. As soon as they are done re-risking the market will promptly fall. The million dollar question is when?

Masterpiece

Jeff Mathews has an excellent piece on Hewlett Packard and Wall Street analysts.

Trader Toss

On days like today everybody tries to dissect the movements of the market as if the market is some sort of perfect discounting mechanism. "The temporary workers this. The hours worked that blah blah blah". What was the market discounting at the April highs? What was the market discounting at the lows a month ago? Has the value of all US businesses gone up by 11% over the  past 5 weeks? In reality markets are made up by humans with emotions that have mood swings from optimism to pessimism and back. Right now we are closer to optimism but might still have more to go. Have a great weekend.

The Bullish Wild Card

I am very tempted to start moving to a net short position as the market has now retraced almost all of the mornings losses. But we know that Genzyme and Sanofi are in friendly merger talks and there could be an announcement when we wake up Monday morning. For that reason I will maintain my neutral stance. If this rally somehow managed to carry through option expiration that would be an exquisite short opportunity.

Not Buying The Dip

I am once again not buying this dip. The bulls will certainly put up a fight around the lows of the past few days but sentiment is now positive and there is room for a move to the downside.

Risk Is High

Risk is now high in the market. For the past month the negative sentiment has buoyed the market and buffeted declines. But sentiment has now turned positive, which means the market no longer has a buffer on the downside. Sentiment is not extreme so the market can keep going higher but a big move lower is no longer out of the question either. It is difficult to call a change in momentum especially in the market of the past couple of years, but there is a few percent of possible upside and a lot more potential downside.

The Bear Case

I am constantly debating the bull and bear case in my head. While I have gotten bullish when sentiment has turned too negative, I cannot bring myself to get bullish for a longer term move. The argument I keep coming back to is how bad business is in the real world. Almost every business owner I speak to is struggling and the job market is brutal for those seeking jobs.

Can corporate America flourish while the rest of the country goes to shit? If valuations were great I would say that it is priced in but the market is not cheap. Can the Fed create another bubble? Its not out of the question, but that is not something I am willing to base an investment decision on.

The other bear argument I keep coming back to is that there is a lot of supply lurking. The government still has over $15 billion of Citigroup that it wishes to sell. General Motors wants to come to market with a nearly $20 billion IPO. There is over $30 billion in the the IPO pipelines as private equity buyers look to bring companies public again. There are eager sellers waiting if a rally does materialize, which should limit the upside.

Ofcourse these arguments do not even take into consideration the slowing economy and the above average chance of an economic accident as a result of the slow economy and the many imbalances.

No Conviction

The market has traded in an extremely tight range since Monday afternoon. I would not be going out on a limb by saying we should expand that range tomorrow. I don't have a very strong feel on the market and wish I could offer more in the way of an opinion. Luckily healthcare has been shining led by Gilead so my lack of conviction on the overall market has not mattered. Have a good night.

Taking Profits

After a very good run I have cut my gross exposure by a third, meaning I cut both longs and their related hedges. I remain market neutral.

Dip Buyers

The crowd does not seem to be scared by the unemployment data. They are buying calls this morning pretty aggressively. I would much rather see them buying puts and am not inclined to buy this dip.

Diverging Data

Economic data has been deteriorating in the past few months. Indicators of final demand have been deteriorating more quickly such as mortgage applications, car sales and same store sales. At the same time employment and manufacturing have only slightly deteriorated. The question is which is the carriage and which is the horse?

Today unemployment data came in weak and same store sales came in fine, which is the opposite of what we have seen in the past few months. I am in the camp that believes that the economy is slowing and when the economy is slow the chance of some sort of accident becomes higher. The data has given hopes to both the bulls and bears but by the end of September we should know who is correct.

Will They Ever Learn

It appears that market participants are on their way to swinging to extreme optimism. Will they ever learn? I hope not because that will make it harder for those that do learn. While I don't want to participate in this, I am not looking to make a move to the short side until the optimism becomes extreme. Have a good night.

More Rejiggering

I sold some XLV and moved the money into Teva Pharmaceuticals.

Wrote Gilead Covered Calls

Gilead is up nearly 10% since the morning after earnings where I purchased it. I wrote the August 36 covered calls. I would be very happy to walk away with over 13% in less than an options cycle.

Call Buying

We saw some heavy call buying in the first hour of trading, further evidence that market participants are warming up to the market and a cause for some concern.

Getting Sentimental

I find that measuring sentiment is an excellent guidepost to where we are in a rally. At the July lows almost every indicator and most anecdotal evidence was pointing to excessive pessimism. So where do we stand today?

Yesterday, Rydex traders finally capitulated and turned slightly positive after fighting this rally tooth and nail for four weeks. They are nowhere near extreme optimism but this does tell us that the vast majority of the gains are likely behind us.

In a strong market sentiment will get to excessive optimism and might even stay there for a while. In weaker markets it may never get there. This market has now done the minimum and the most ardent bears might want to take a shot from the short side here but the risk/reward setup is not great.

There is also a time aspect to sentiment. This move higher has lasted about four weeks. I would prefer if six weeks had past as most market participants will capitulate to a trend after six weeks. The bottom line is that for a better risk/reward setup on the short side sentiment will need to become more positive and more time needs to pass. However, if the market is truly weak than this rally has now done the minimum.

Newsletter Writers Cautiously Optimistic

It has been difficult to get a clean read on sentiment lately but my sense is that market participants are now leaning bullish. The HNSNI sentiment indicator shows market timers are recommending a 35% exposure to stocks. At the July lows they were recommending a -15% exposure.  So while sentiment has improved greatly it has not yet reached an extreme where one can confidently fade the crowd.

Tweaking

I sold some XLV and moved the money into Amgen. This does not change my relatively market neutral positioning.

Repeated Warning

We are seeing call buying at the ISE today despite the fact that the market is struggling. Add to that the fact that seasonality will turn negative tomorrow and that we are overbought. There is reason for caution heading into the back half of the week.

Tough Times

You know the economy is bad when defensive companies like Colgate, Kellogs and Procter & Gamble miss earnings due to people switching to cheaper Brand X. Don't let the rise in the stock market fool you into thinking that the economy is anything but weak.

Another Reason Not To Go Short

In my previous post I mentioned that I am not interested in going short until more ducks line up. Another reason not to go short is that the Wall Street Journal reported Sanofi and Genzyme are in friendly merger talks. A deal can be announced any day now and should give the market a small adrenaline shot if announced.

The Fakeout Breakout

The market should pull back in the coming days as it is overbought and heading into weak seasonality. I believe a large portion of the short base covered yesterday as we cleared obvious "resistance", leaving less cushion for the market if we do manage a move lower. Although "de-risked" hedge funds should provide some cushion on a move lower.

For the past couple of years the market has overshot to both the upside and downside as momentum players carry the market much further than it should go. For that reason I am not interested in going short until all the ducks line up. I still would like to see evidence that hedge funds have re-risked and sentiment to get more positive before initiating a short position.

The Low Hanging Fruit

The low hanging fruit for this week and the rally that started in early July have been had. While there might be some upside in the next couple of days I believe we will end the week at lower levels than where we currently stand. Have a good night.

That Sucking Sound

That sucking sound is the market sucking in all the hedge funds that de-risked. For hedge funds the pain trade is higher. Like when they de-risked, the market could go much further than it should.

Equity Offering Calendar

MetLife announced a $3 billion secondary this morning. There are about $1 billion worth of IPOs on the calendar for this week and the government sells nearly $1 billion worth of Citigroup every week. Most of this supply will not hit until later in the week giving further support to the thesis that the market might struggle later in the week.

Neutral, Not Bearish

I am market neutral but not bearish for a number of reasons:
  • Hedge funds are largely still de-risked and there are few over leveraged market participants out there.
  • Seasonality is still positive.
  • Sentiment is not yet extreme but I suspect we will get there pretty soon if the market keeps going up.
In order to break the early July lows I think there will need to be an economic accident. With equity weightings pretty low I don't think the market can fall that far on its own weight. 

Early Bird

I have used the early strength to tighten up my hedges and am now market neutral after leaning long for the past few weeks. While I could see some further strength I am not one to hold out for the last bits of a rally.

The Last Dance

There are a number of reasons why I believe strength early in the week could lead to weakness later in the week.
  • Investors have warmed up to the market in the past couple of weeks but are still hesitant. A further rally, especially one that takes the market over resistance, could get sentiment into the extreme territory that typically leads to a pullback.
  • Seasonality is strong today and tomorrow but turns weaker on Wednesday.
  • The market is overbought so I would be surprised if the market could rally uninterrupted for the entire week.
The market's first test will be the ISM report today at 10. I expect a dissapointment so it will be imperative for the market to shake off that disappointment after the number.