Europe Matters Again
It seems that Europe once again matters. Without intervention European sovereign spreads will continue to blow out. We are essentially in the hands of the ECB as they are the only ones with the power to step in. The ECB is unlikely to let the EU go up in smoke. The only question is how long they wait. Have a good night.
Its Good To Be The King
From the Wall Street Journal:
I couldn't help but think of Mel Brooks when I read this article
In one of the largest executive paydays in recent years, Nabors Industries Ltd. is giving its chairman $100 million in cash in a severance-style deal, even though he isn't leaving the company.
... The stock of Nabors has fallen 19% this year, and has underperformed the S&P 500-stock index for the prior one-year, five-year and 10-year periods.
I couldn't help but think of Mel Brooks when I read this article
Crisis Not Over
The chart below is a one month chart of Italian bond yields. It does not include today's move up to 6.14%, a new one month high. According to Italian bond yields the crisis is not only not over, but getting worse. From Bloomberg:
It is certainly possible that our markets will ignore Europe as they did for much of the past year, until June. We had a year end rally last year as the situation in Europe worsened. However, it will be more difficult as a recession in Europe is all but guaranteed and the effects will be felt by US businesses.
The excess pessimism that has buffered the market is now gone. The fear of missing out on a rally has replaced the fear of losing money, although we are not yet at extreme optimism. The direction of the market is a difficult call, which is why I have reduced longs into recent strength. I prefer cheap, defensive stocks over the high beta cyclicals that have recently skyrocketed.
It is certainly possible that our markets will ignore Europe as they did for much of the past year, until June. We had a year end rally last year as the situation in Europe worsened. However, it will be more difficult as a recession in Europe is all but guaranteed and the effects will be felt by US businesses.
The excess pessimism that has buffered the market is now gone. The fear of missing out on a rally has replaced the fear of losing money, although we are not yet at extreme optimism. The direction of the market is a difficult call, which is why I have reduced longs into recent strength. I prefer cheap, defensive stocks over the high beta cyclicals that have recently skyrocketed.
CA Hanging In
CA was downgraded yesterday following earnings and four analysts reduced their price targets. Despite this there has been no selling in the stock as it has barely budged. I have been following CA for a while and this is the first time it has refused to go down on bad news.
Wounded Animals
We have been seeing a huge move out of defensive stocks and into more cyclical and higher beta stocks. This is likely because people are trying to play catch up with the market, as many missed this move. I believe this is a huge mistake.
The economy is still likely to slow even if the stock market holds up. Spreads in peripheral Europe have not improved and they are about to undergo severe austerity measures. With Europe in recession and government spending about to decline in the US, we will be lucky to get muddle through growth.
I expect defensive value names to outperform. It is entirely possible that these wounded animals, fighting for their professional careers will continue to pile in to high beta stocks for a while, but I believe it will end in tears.
The economy is still likely to slow even if the stock market holds up. Spreads in peripheral Europe have not improved and they are about to undergo severe austerity measures. With Europe in recession and government spending about to decline in the US, we will be lucky to get muddle through growth.
I expect defensive value names to outperform. It is entirely possible that these wounded animals, fighting for their professional careers will continue to pile in to high beta stocks for a while, but I believe it will end in tears.
Taking A Moderate Stance
I believe the risk/reward in stocks has tilted back to a neutral level. The only thing that has changed in Europe is perception. Italian bonds are trading worse than they were before the summit. Sentiment is starting to lean to the overly bullish camp, although some large investors seem to be under-invested. Seasonality is a positive. While I have reduced my long exposure, I am maintaining moderate net long exposure. This is due to the fact that I have confidence in some individual stocks rather than the broader market.
On a personal note, it feels so much better to have lowered my equity exposure. The last few months have been brutal in terms of stress and lack of sleep. Not to mention twenty trips to the bathroom a day. I wish I were exaggerating. This business is not easy, even when one is doing well.
On a personal note, it feels so much better to have lowered my equity exposure. The last few months have been brutal in terms of stress and lack of sleep. Not to mention twenty trips to the bathroom a day. I wish I were exaggerating. This business is not easy, even when one is doing well.
Some Extreme Bullishness
Last night I posted an article showing how wrong footed hedge funds have been recently and highlighted that they were far away from being at a bullish extreme. It seems that individuals and market timers are reaching extreme bullishness. According to SentimenTrader.com AAII data shows individuals are the least pessimistic they have been all year.
Mark Hulbert writes that market timers have turned very bullish as well. From Marketwatch:
Mark Hulbert writes that market timers have turned very bullish as well. From Marketwatch:
This water being thrown on the stock market’s parade comes from contrarian analysis. The wall of worry that existed at the correction low in early October has given way to a significant amount of enthusiasm and excitement — which does not bode well for the rally’s sustainability.
...In fact, the HNNSI is now nearly as high as where it stood in May, soon after the bull market hit what so far has been its high-water mark.
One More Thing
I came across an astounding article in Bloomberg that I had to share. According the ISI survey hedge funds were at their lowest exposure since 2009 heading into the European Summit this week. From Bloomberg:
If this survey is representative of hedge fund exposure and they decide to bring exposure to normal levels this rally could have a way to go.
Hedge funds reduced bets that stocks will rise to almost the lowest level since 2009 this week, according to International Strategy & Investment Group.
ISI’s index of “net exposure” to stocks slipped to 44.7 yesterday, compared with its 2011 high of 54.2 in February, according to a note sent to clients. The measure climbed to 45.5 on Oct. 12 after declining to 44 on Sept. 21, the lowest level since April 2009.
If this survey is representative of hedge fund exposure and they decide to bring exposure to normal levels this rally could have a way to go.
Reduced Exposure
I have greatly reduced my net long exposure. I am usually early so by that measure the rally probably has more to go. Have a good night.
Slowly Selling
I am slowly selling into this rally by selling covered calls. Sold covered CALLs against CVS.
CA Management On The Right Track
We believe the cash generation of CA’s mainframe software and maintenance-like revenue will remain stable, and the net present value of this alone is around $33. The value of that cash flow is being discounted today, and we assume this has to do with investors’ assumptions of how that cash will be allocated.
- John Diffucci, JPMorgan Software Analyst
One of the best software analysts, John Diffucci of JPMorgan, believes that CA's mainframe business alone is worth $33. In addition, CA has $2 in net cash per share, a cloud computing business, a security business and a virtualization business. On a sum of the parts basis CA Technologies is worth over $40.
Mr. Diffucci believes that the reason CA trades at a discount is that investors fear a misallocation of capital. CA has embarked on an acquisition spree over the years that has yielded little, eroding investors confidence. What good is earnings if it is squandered away? I believe that management has found God and is finally on the right path. This should bring CA closer to its fair value over time.
At an Investors Day in late July CA management said that they were done with large acquisitions and that they will return more cash to shareholders. In the latest quarter CA Management delivered on that promise. They spent $200 million on repurchasing shares during the quarter, which works out to 8% of the shares outstanding on an annualized basis. Including the 1% dividend, they are returning cash to shareholders at a 9% annualized rate. CA announced that they repurchased nearly $50 million worth of additional shares since the quarter ended and the management once again stressed returning cash to shareholders on the conference call.
CA has been a value trap for a decade so investors are conditioned to expect little out of the stock. There has been a major change as management is now returning capital to shareholders. As long management continues to deliver on their promise the stock should go much higher.
Added To CA
I have slightly added to my already large position in CA. I believe earnings are being interpreted in the wrong way and they are on the right track. I will have more later.
Wow
I don't know what is more amazing. The fact that we are gapping up by 30 points or the fact that so many people are turning bullish now, after a 20% move in the market.
I now believe the market is in its fair value range. We are trading at roughly 13 times next years earnings. That is on the low side but we are in a very high risk environment, so some sort of discount is justifiable.
While I believe the market is roughly fairly valued, the market often over shoots and will likely do so again. We had extreme negative sentiment a few weeks back. That is generally followed by extreme positive sentiment, which we have not seen yet. Market participants are underweight and we are headed into the strongest part of the year.
I have greatly reduced my long exposure into this 20% move but am remaining moderately long. The main reasons are that I believe there are stocks trading cheaply even though the market as a whole is not and the odds still favor more upside.
I now believe the market is in its fair value range. We are trading at roughly 13 times next years earnings. That is on the low side but we are in a very high risk environment, so some sort of discount is justifiable.
While I believe the market is roughly fairly valued, the market often over shoots and will likely do so again. We had extreme negative sentiment a few weeks back. That is generally followed by extreme positive sentiment, which we have not seen yet. Market participants are underweight and we are headed into the strongest part of the year.
I have greatly reduced my long exposure into this 20% move but am remaining moderately long. The main reasons are that I believe there are stocks trading cheaply even though the market as a whole is not and the odds still favor more upside.
Reduced Net Long
I have used the strength in the pre-market to reduce my net long exposure by shorting SPY. My net long exposure is now moderate.
The Constant Debate
I don't know if it is apparent in my writing but there is a constant debate going on in my head. There are times, like in early October, where its not much of a debate as I was convinced that the market was a great risk/reward trade. I was scared shitless, but I knew what the right thing to do was. Currently, it is not as clear to me.
The bear case is quite simple. The bailout package is very unlikely to work in its current form because it requires trillions of dollars in funding from private investors. I don't believe they will get it. The EU will likely adjust the bailout package, but if history is a guide they will need to get hit over the head first.
The bull case is that even if this solution stops things from getting dramatically worse we should see a rally. We are entering the strongest part of the year with large investors underweight and underperforming. The recent pullback looks healthy in that it has caused much handwringing but not much damage was done.
I have decided to remain net long but am nowhere as long as I was in early October. The deciding factor in remaining long is the valuation of my longs. I am able to buy some great companies at very reasonable multiples of free cash flow, that have limited economic sensitivity.
The bear case is quite simple. The bailout package is very unlikely to work in its current form because it requires trillions of dollars in funding from private investors. I don't believe they will get it. The EU will likely adjust the bailout package, but if history is a guide they will need to get hit over the head first.
The bull case is that even if this solution stops things from getting dramatically worse we should see a rally. We are entering the strongest part of the year with large investors underweight and underperforming. The recent pullback looks healthy in that it has caused much handwringing but not much damage was done.
I have decided to remain net long but am nowhere as long as I was in early October. The deciding factor in remaining long is the valuation of my longs. I am able to buy some great companies at very reasonable multiples of free cash flow, that have limited economic sensitivity.
Sold Some Vodafone
I sold a small portion of my Vodafone position. The stock remains my largest holding, even after the sale. I still think its a great stock but if I want to reduce my long exposure I have to sell something.
An Incremental Negative
Another incremental negative is that the Federal Reserve is not allowing Met Life to return cash to shareholders until the stress tests next year. Met Life is in relatively good shape and if the Fed is not letting them return capital to shareholders its likely that nobody will be allowed. This is especially bad for the financials.
Tempering My Enthusiasm
My enthusiasm for the market has been tempered in recent days for two reasons. The European rescue package is weaker than I had hoped for. I believe that the EU will eventually rectify the situation, but there is the risk that the market needs to have a fit first. The second reason is that sentiment is no longer as supportive of the market.
While I still believe that hedge funds and larger investors are under-invested, I now believe that shorter term traders are long again. The latest Rydex data shows that traders have positioned themselves more aggressively.
Seasonality will be turning very positive in the coming days. With $100 in S&P 500 earnings projected for next year, current valuations (12.3 times 2012 earnings) are decent even if earnings come in slightly lower. Levels of share repurchases and cash M&A remain high. I still believe the market has more positives than negatives but I am less enthusiastic than I have been to this point.
While I still believe that hedge funds and larger investors are under-invested, I now believe that shorter term traders are long again. The latest Rydex data shows that traders have positioned themselves more aggressively.
Seasonality will be turning very positive in the coming days. With $100 in S&P 500 earnings projected for next year, current valuations (12.3 times 2012 earnings) are decent even if earnings come in slightly lower. Levels of share repurchases and cash M&A remain high. I still believe the market has more positives than negatives but I am less enthusiastic than I have been to this point.
The EU Catch-22
The EU has slowly leaked its agreement, which will come as little surprise when it is officially released tomorrow. It is a positive that the EU countries are seeing eye to eye on the need to leverage the EFSF. It is also positive that the numbers they are discussing are north of a trillion Euros, which is likely enough to stem the crisis. The problem is that there is no way this thing will get funded as it is designed.
The EU is planning to fund the leveraging of the EFSF through private investors. They refuse to allow the ECB to help in the funding. There is no way on Earth that private investors will put up a trillion Euros to fund this thing. There is a deleveraging occurring across the World, which is a large reason for the crisis in the first place. Funding the EFSF through private investors is a Catch-22.
The most likely outcome is that once EU leaders realize that the EFSF will not get funded they will find a way, which will likely include the ECB. This makes taking a stance on the market tougher. The market can be 10% higher by the time the EU figures out that the EFSF wont get funded. At which point they will likely use the ECB anyway. That said, I would feel much better if a proper mechanism was already in place. Overall, the agreement makes me slightly less bullish and I will likely reduce positions more aggressively than I was planning to.
The EU is planning to fund the leveraging of the EFSF through private investors. They refuse to allow the ECB to help in the funding. There is no way on Earth that private investors will put up a trillion Euros to fund this thing. There is a deleveraging occurring across the World, which is a large reason for the crisis in the first place. Funding the EFSF through private investors is a Catch-22.
The most likely outcome is that once EU leaders realize that the EFSF will not get funded they will find a way, which will likely include the ECB. This makes taking a stance on the market tougher. The market can be 10% higher by the time the EU figures out that the EFSF wont get funded. At which point they will likely use the ECB anyway. That said, I would feel much better if a proper mechanism was already in place. Overall, the agreement makes me slightly less bullish and I will likely reduce positions more aggressively than I was planning to.
Risk Management = Momentum Strategy
There has been a lot of head scratching recently at the steep ascent of the market. Historically, this type of straight line movement is unusual but it has become common in recent years. The S&P 500 crashed 225 points lower in a little over two weeks, starting in late July. I believe the reason such abrupt movements have become common is the proliferation of momentum strategies.
Most hedge funds market themselves as having a value strategy when in reality they have a momentum strategy. They have "risk management" tools in place whereby they do not allow losses to grow and reduce exposure when they are losing money. In isolation this strategy works fine, but when everybody is employing the same strategy selling begets more selling. As markets move lower more hedge fund are forced to "manage risk", which causes markets to move even lower until everybody is de-risked. Once the market starts moving higher the opposite occurs, as we are currently seeing.
Many quant strategies use momentum as vital inputs. Twitter and the blogosphere are dominated by those who employ momentum strategies. With all these momentum strategies in place it is no wonder that we see these straight line movements. I have greatly adjusted my trading strategy to allow for this type of movement. As somebody who is value focused this means being more patient with both buys and sells. The good news is that for those that can keep their heads these awesome moves provide great opportunities.
Most hedge funds market themselves as having a value strategy when in reality they have a momentum strategy. They have "risk management" tools in place whereby they do not allow losses to grow and reduce exposure when they are losing money. In isolation this strategy works fine, but when everybody is employing the same strategy selling begets more selling. As markets move lower more hedge fund are forced to "manage risk", which causes markets to move even lower until everybody is de-risked. Once the market starts moving higher the opposite occurs, as we are currently seeing.
Many quant strategies use momentum as vital inputs. Twitter and the blogosphere are dominated by those who employ momentum strategies. With all these momentum strategies in place it is no wonder that we see these straight line movements. I have greatly adjusted my trading strategy to allow for this type of movement. As somebody who is value focused this means being more patient with both buys and sells. The good news is that for those that can keep their heads these awesome moves provide great opportunities.
Nothing Done
I did not make any sales today but am growing a bit nervous about the market. There has been a big change in sentiment in recent days, as investors are suddenly in the holiday spirits. This is a very tricky juncture as the rally is likely to continue but the risks are now greater.
This rally started with investors at very low exposure levels so they likely have plenty of room to add. Seasonality is also very supportive of the market as are the high levels of repurchases and cash M&A. However, sentiment is now on the bullish side and the easy gains have been seen. I will be looking to start reducing positions in the days ahead. Have a good night.
This rally started with investors at very low exposure levels so they likely have plenty of room to add. Seasonality is also very supportive of the market as are the high levels of repurchases and cash M&A. However, sentiment is now on the bullish side and the easy gains have been seen. I will be looking to start reducing positions in the days ahead. Have a good night.
Making It Hard
My plan coming into this week was to hold on to longs into the turn of the month and pull back a bit in the early part of November. However, the market is starting to get a bit frothy in the short term and I am getting very tempted to pull back a bit. I am still undecided.
Rally Maturing
There is increasing evidence that this rally is no longer in its nascent stages. Last week, I laid out a few changes in investor sentiment showing investors moving away from their state of extreme pessimism. Since then more evidence has piled up that the conversion of the masses from bears to bulls continues. Insiders have turned sellers and the put/call ratio showed a big increase in call activity on Friday. I still favor the long side as we are a long way from extreme optimism and seasonality is turning positive but it is time to be more vigilant.
The chart below is from Thomson Reuters via Barrons:
Since August insiders have been "backing up the truck" but last week they began to "feed the ducks" in earnest. The CBOE equity put/call ratio dropped to 0.50 on Friday which is a level that signifies extreme call activity. This might have been expiration related but we certainly were not seeing those type of numbers a month ago on any day.
I believe that the strong seasonality and the still under invested hedge funds should keep this rally going. However, sentiment is now less of a positive for this market and gains will be harder to come by. Typically rallies that begin with extreme pessimism end with extreme optimism. By that measure we are not at the end of this rally but we are certainly closer.
The chart below is from Thomson Reuters via Barrons:
Since August insiders have been "backing up the truck" but last week they began to "feed the ducks" in earnest. The CBOE equity put/call ratio dropped to 0.50 on Friday which is a level that signifies extreme call activity. This might have been expiration related but we certainly were not seeing those type of numbers a month ago on any day.I believe that the strong seasonality and the still under invested hedge funds should keep this rally going. However, sentiment is now less of a positive for this market and gains will be harder to come by. Typically rallies that begin with extreme pessimism end with extreme optimism. By that measure we are not at the end of this rally but we are certainly closer.
Setting Up For A Rally
The market has now gone sideways for six trading days. Slowly but surely the overbought reading is being worked off. I remain of the belief that when push comes to shove the EU will do what is necessary to avoid a cataclysmic event and that the market will be higher by Thanksgiving. Have a good night.
Get These Traders Some Ritalin
A generation that has grown up on Ritalin is now trading the markets so its no wonder the market acts like it has ADHD. We go from "the end of the world" to "infinty and beyond" and back in a matter of minutes.
News that Sarkozy is headed to Germany to try and iron out an agreement on a rescue plan has the market tanking. I remain of the belief that an agreement is too important not to happen, so it will.
News that Sarkozy is headed to Germany to try and iron out an agreement on a rescue plan has the market tanking. I remain of the belief that an agreement is too important not to happen, so it will.
The Hurdles and The Hope
The bulls will be facing some hurdles today. The market remains overbought, which makes further upside difficult but not impossible. The most important stock in the world, Apple, disappointed. European sovereign spreads continue to blow out and the ECB continues to twiddle their thumbs.
On the positive side it is very likely that a deal will be reached soon regarding the EFSF. The EU is on the edge of the abyss, but I do not believe they will throw themselves in . German politicians are talking tough because Germans are against the bailouts and this is a negotiation but in the end I believe they will do what is necessary to prevent a cataclysmic event. Market participants remain underinvested as we head into the seasonally strongest part of the year. Additionally, option expiration often serves to prolong a rally and might provide a positive surprise for the bulls this week.
On the positive side it is very likely that a deal will be reached soon regarding the EFSF. The EU is on the edge of the abyss, but I do not believe they will throw themselves in . German politicians are talking tough because Germans are against the bailouts and this is a negotiation but in the end I believe they will do what is necessary to prevent a cataclysmic event. Market participants remain underinvested as we head into the seasonally strongest part of the year. Additionally, option expiration often serves to prolong a rally and might provide a positive surprise for the bulls this week.
What I Said
Rather than try to capture a couple percent in a pullback and risk losing my longs I am willing to endure this pullback.
I wrote this statement last night, feeling that playing a correction was too tricky. Timing the correction was even trickier than I imagined it would be as the market turned on a dime this morning and did not look back. I have traded my way out of too many good intermediate term moves looking for a pullback and did not want to make the same mistake again. Have a good night
Some Changes In Sentiment
A few weeks ago I was pointing out many of the the multi-year extremes in sentiment. Its only fair that I now point out some sentiment indicators that have come off extremes and are now in neutral territory:
The sentiment extremes we saw a couple of weeks ago are no longer present. However, we have not yet reached bullish extremes and many intermediate term measures are still showing excess levels of bearishness.
- Rydex traders are still positioned slightly on the bearish side (almost neutral) but there has been a big move off of the extremes.
- Newsletter writers tracked by Hulbert are 25% long the Nasdaq, which is a neutral reading
- The AAII survey shows individuals on the bullish side.
- The option ratios are still showing a lot of activity in puts but the put activity has backed off levels we were seeing two weeks ago.
The sentiment extremes we saw a couple of weeks ago are no longer present. However, we have not yet reached bullish extremes and many intermediate term measures are still showing excess levels of bearishness.
The Great Humbler
The stock market is truly The Great Humbler. The consensus coming into the week was that we would see a pullback, but the market gapped down Monday and gave very few any time to position for it. This morning, just as the consensus became that we would see a deeper pullback we turned around and have not stopped rallying. The markets moves this week remind me of a bull at a rodeo that does not let anybody ride for more than a few seconds.
The Chances Of Another Lehman Moment
I believe we are headed higher in the intermediate term unless there is a systemic event a la Lehman Brothers. At the current juncture a systemic event seems like a low probability outcome. Every politician remembers Lehman Brothers, which makes a disorderly default scenario highly unlikely. As much as voters hate bailouts, they hate deep recessions even worse and politicians around the World know this.
In the EU the ECB is buying bonds, while the IMF has various lending programs. The nearly $600 billion EFSF fund has been approved and there is now talk about leveraging it 3 to 5 times via loan guarantees. While countries like Germany have talked tough regarding bailouts, when push has come to shove they have not let us fall into the abyss.
Trillions of dollars of unspent bailout funds are a kick of the can at minimum. It is highly unlikely that we will exhaust those funds in the next few months. The doom and gloomers might be proven right, but further down the road.
In the EU the ECB is buying bonds, while the IMF has various lending programs. The nearly $600 billion EFSF fund has been approved and there is now talk about leveraging it 3 to 5 times via loan guarantees. While countries like Germany have talked tough regarding bailouts, when push has come to shove they have not let us fall into the abyss.
Trillions of dollars of unspent bailout funds are a kick of the can at minimum. It is highly unlikely that we will exhaust those funds in the next few months. The doom and gloomers might be proven right, but further down the road.
Overbought Pullback
I believe today's decline was the start of an overbought pullback and not the beginning of a new leg down in the market. I do not know how deep this pullback will be but believe there is a very high probability that the market will rally again once the pullback is over and score new highs (relative to this past week's). Markets tend to re-rally after strong overbought readings are worked off and I believe that will be the case again this time.
Rather than try to capture a couple percent in a pullback and risk losing my longs I am willing to endure this pullback. Have a good night.
Rather than try to capture a couple percent in a pullback and risk losing my longs I am willing to endure this pullback. Have a good night.
Merger Monday Strikes Again
We saw about $15 billion in cash deals announced over this weekend, with El Paso and Brigham Exploration being the largest. Many have been scratching their heads over the recent strength in the markets. Hedge funds have been de-risking, investment advisers have gone into defensive mode and individuals have been redeeming mutual funds. All that selling has been offset by corporations repurchasing their own shares and buying other companies for cash at a torrid pace.
Finally Overbought
The market will finally be short term overbought at the end of the day on Monday. Many are likely wondering how it is that we are not overbought already. I measure overbought as a function of time rather than price. Monday will be the tenth trading day of this rally and strong moves tend to get exhausted after ten trading days.
A textbook scenario would be to see a strong day on Monday followed by a Turnaround Tuesday and more corrective action for the balance of the week. However, in recent years we have seen strong overbought readings like the one we are experiencing get worked off with sideways action. Additionally, the coming week is option expiration and expiration often serves to perpetuate a strong bullish trend. Regardless, the market should have a more difficult time with the upside by Tuesday.
A strong overbought reading like the one we are experiencing has bullish intermediate term implications. Even if we do correct for a few days we are likely to rally again afterwards. There is a lot of fuel for a rally as most market participants are still positioned conservatively if not outright bearishly. If market participants decide to turn bullish for some reason we will be a lot higher by Thanksgiving.
A textbook scenario would be to see a strong day on Monday followed by a Turnaround Tuesday and more corrective action for the balance of the week. However, in recent years we have seen strong overbought readings like the one we are experiencing get worked off with sideways action. Additionally, the coming week is option expiration and expiration often serves to perpetuate a strong bullish trend. Regardless, the market should have a more difficult time with the upside by Tuesday.
A strong overbought reading like the one we are experiencing has bullish intermediate term implications. Even if we do correct for a few days we are likely to rally again afterwards. There is a lot of fuel for a rally as most market participants are still positioned conservatively if not outright bearishly. If market participants decide to turn bullish for some reason we will be a lot higher by Thanksgiving.
Thats All Folks
I reduced my long exposure modestly today as I wanted to lock in some gains after a 14% run in the S&P 500. I believe sentiment still favors the bulls as does seasonality. We will soon be headed into year end and performance anxiety might serve to accentuate any advance.
My main fundamental worry is that the ECB has been allowing Italian spreads to blow out as they have greatly reduced their bond buying. There is an Italian bond auction tomorrow. They will likely take a bigger stand if spreads blow out further but it would be nice to see them a little more proactive. I will be out until Monday. Have a great weekend.
My main fundamental worry is that the ECB has been allowing Italian spreads to blow out as they have greatly reduced their bond buying. There is an Italian bond auction tomorrow. They will likely take a bigger stand if spreads blow out further but it would be nice to see them a little more proactive. I will be out until Monday. Have a great weekend.
Scratch That
The call buying I pointed out earlier has leveled off and is now more neutral. If people ever decide to turn bullish for some reason this market will fly.
A Minor Difference
A minor difference is that we are finally seeing call buying today in the equity only readings of both the CBOE and ISE. Up until now traders were fighting this rally tooth and nail buying puts. One day of call buying is not bearish but after a 13% run in a straight line it makes me a little more cautious.
Reduced Net Long
I have slightly reduced my net long exposure by shorting some SPY. I just don't want to be a pig.
Hard To Believe: Part Two
Here is more evidence that the crowd remains extremely bearish even after this enormous rally. From Marketwatch:
Consider the average recommended equity exposure among those short-term market timers monitored by the Hulbert Financial Digest who focus on the Nasdaq market (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). This average currently stands at minus 43.8%, which means that the typical Nasdaq market timer is currently recommending that his clients allocate nearly half of their equity portfolios to going short.
That would be noteworthy at any time, since rarely has the HNNSI been this low. But it’s especially so right now, since the stock market is coming off such a strong rally. After all, from its intraday low a week ago, the S&P 500 index is now 11% higher.
Hard To Believe
In the latest week the number of bears in the Investors Intelligence survey actually increased to 46.3%, while the number of bulls remained the same. This survey is likely dated by a few days but the sustained level of bearishness despite this rally is quite amazing.
There is some evidence that the bears are pulling back. Rydex data is the most up to date as it is updated every night. At Rydex the leveraged bears have largely given up in the past week. Overall positioning of Rydex traders is still on the bearish side. The put/call ratios have showed sustained put buying throughout this rally as well. The majority of the evidence points to bearish sentiment.
It seems we are gapping up again and the risks of a short term pullback are increasing. However, with so much bearishness out there and strong seasonality a couple of weeks away I believe the bulls still deserve the benefit of the doubt in the intermediate term.
There is some evidence that the bears are pulling back. Rydex data is the most up to date as it is updated every night. At Rydex the leveraged bears have largely given up in the past week. Overall positioning of Rydex traders is still on the bearish side. The put/call ratios have showed sustained put buying throughout this rally as well. The majority of the evidence points to bearish sentiment.
It seems we are gapping up again and the risks of a short term pullback are increasing. However, with so much bearishness out there and strong seasonality a couple of weeks away I believe the bulls still deserve the benefit of the doubt in the intermediate term.
Crystal Ball
My crystal ball worked quite well this morning as I wrote that I had no idea what this market would do in the short term. The market did not seem to know where it was going either as it stumbled around all day and closed pretty close to unchanged.
While we could see some more of consolidation or even a bit of a correction the market is not yet overbought and sentiment still supports the bulls. We saw a decent amount of put activity today even though the market went sideways. Have a good night.
While we could see some more of consolidation or even a bit of a correction the market is not yet overbought and sentiment still supports the bulls. We saw a decent amount of put activity today even though the market went sideways. Have a good night.
On The Other Hand
The short run is a tough call as the S&P 500 has shot up by 11% in a little over four trading days. A correction of this move would not be surprising but is not yet a high probability trade. A good overbought reading is still a week away.
I prefer to measure overbought based on time rather than price. It takes about ten trading days for a strong move to exhaust itself and this move is only a little over four days old. If we continue to rally through next Tuesday we would have a good overbought reading. At that point we would be bumping up against options expiration, which can often serve to extend moves.
In the past few months rallies have been failing well before the market has become fully overbought. However, if this move is the real deal this rally can continue into next week before exhausting itself. That does not preclude corrections along the way. In the short term I don't see a high probability trade either way.
I prefer to measure overbought based on time rather than price. It takes about ten trading days for a strong move to exhaust itself and this move is only a little over four days old. If we continue to rally through next Tuesday we would have a good overbought reading. At that point we would be bumping up against options expiration, which can often serve to extend moves.
In the past few months rallies have been failing well before the market has become fully overbought. However, if this move is the real deal this rally can continue into next week before exhausting itself. That does not preclude corrections along the way. In the short term I don't see a high probability trade either way.
Getting Interesting
The S&P 500 (including dividends) is now down less than 4% for the year. The average hedge fund was down about 7% or 8% at the end of September according to the popular hedge fund indexes. We are nearing the point where performance anxiety might start to kick in as managers look to make up performance into year end.
In the short run the market is once again extended and a pause or correction would not be surprising. However, equity allocations remain low and the potential for further upside is there. Have a good night.
In the short run the market is once again extended and a pause or correction would not be surprising. However, equity allocations remain low and the potential for further upside is there. Have a good night.
The Risk To Annaly
I believe that Annaly Capital Management is attractively valued as it currently trades below book value. However, there are risks due to prepayments. Prepayments rise when people refinance their homes. Recently, we have seen a wave of refinances due to record low rates. If President Obama institutes a refinance program that allows underwater homeowners to refinance, prepayments are likely to rise much further. From the WSJ:
The risk to Annaly is that bonds they are holding that trade above par will be redeemed at par. From the Annaly 10-K
Some homeowners are beginning to refinance their residential mortgages faster than expected in response to falling long-term interest rates, causing a chunk of the $5 trillion in mortgage-backed securities to slump in secondary markets.
Prepayments on 30-year fixed-rate loans, the return of principal when a loan is refinanced or withdrawn from the MBS, jumped nearly 30% last month, Fannie Mae and Freddie Mac said late Thursday. That was well above forecasts of a 20% rise, though was focused on newer loans with lower interest rates to borrowers with better credit, according to strategists at Morgan Stanley and Credit Suisse.
The risk to Annaly is that bonds they are holding that trade above par will be redeemed at par. From the Annaly 10-K
An increase in prepayment rates may adversely affect our profitability....when borrowers prepay their mortgage loans at rates that are faster-than-expected, this results in prepayments on mortgage-backed securities that are faster than expected. These faster than expected prepayments may adversely affect our profitability....While we seek to minimize prepayment risk to the extent practical, in selecting investments we must balance prepayment risk against other risks and the potential returns of each investment. No strategy can completely insulate us from prepayment risk.
I believe the discount to book value gives one a margin of safety in Annaly. I currently don't own the shares but would likely repurchase the shares if they dipped to last week's lows. I look forward to hearing more about Annaly's prepayment risk on the earnings conference call.
Three Reasons To Be Bullish
There are three reasons to be bullish and none have anything to do with a robust economy. Valuations are very reasonable, sentiment is extremely negative and we are about to enter the seasonally strongest months of the year.
Even with lowered estimates the S&P 500 trades at its lowest multiple to trailing twelve months and forward earnings in decades. We are currently trading at less than twelve times next year's lowered estimates. Almost every sentiment indicator is pointing to extreme pessimism. Historically, it has paid to buck the crowd when they have been this negative. Thirdly, we are entering the strongest six months of the year.
There are certainly risks as imbalances that have grown over decades are coming home to roost. However, with Lehman Brothers so fresh in the minds of policy makers it seems likely that they will kick the can at a minimum. While I respect the risks, I believe the odds favor a higher market. That said, the imbalances keep me from being as aggressive as I would like to be.
Even with lowered estimates the S&P 500 trades at its lowest multiple to trailing twelve months and forward earnings in decades. We are currently trading at less than twelve times next year's lowered estimates. Almost every sentiment indicator is pointing to extreme pessimism. Historically, it has paid to buck the crowd when they have been this negative. Thirdly, we are entering the strongest six months of the year.
There are certainly risks as imbalances that have grown over decades are coming home to roost. However, with Lehman Brothers so fresh in the minds of policy makers it seems likely that they will kick the can at a minimum. While I respect the risks, I believe the odds favor a higher market. That said, the imbalances keep me from being as aggressive as I would like to be.
A Good Week
There are a few things that the bulls can feel a little better about at the end of this week. It seems that the vicious cycle of liquidations leading to more liquidations is over for now. After a nice move we have pulled back without completely falling apart, which is different from what we have been seeing recently. In a couple of weeks seasonality turns positive. Sell in May sure seemed to work this year. Have a great weekend.
Antsy
I am getting a little antsy over the speed of this ascent. The S&P 500 is now up 9% in a little over 2 trading days. The biggest positive is that few are properly positioned for this.
The S&P 500 (incl. dividends) is down a little over 5% for the year. The average hedge fund is down 7% to 8% depending on which hedge fund index you look at. If the S&P 500 gets closer to break even its unlikely hedge funds will catch up because they are largely risk off. This would cause a lot of anxiety. In addition, people start looking for a year end rally towards the end of October which is not that far away.
On the negative side the market has had a steep climb and sovereign spreads are blowing out again today in Europe. I am considering writing covered calls against partial positions.
The S&P 500 (incl. dividends) is down a little over 5% for the year. The average hedge fund is down 7% to 8% depending on which hedge fund index you look at. If the S&P 500 gets closer to break even its unlikely hedge funds will catch up because they are largely risk off. This would cause a lot of anxiety. In addition, people start looking for a year end rally towards the end of October which is not that far away.
On the negative side the market has had a steep climb and sovereign spreads are blowing out again today in Europe. I am considering writing covered calls against partial positions.
Sitting Tight
The S&P 500 is now up well over 80 points from its lows in a pretty straight line, but I am still not seeing many signs of over exuberance. With sentiment having been stretched so negatively the rubber band has a long way to go in the other direction. As I wrote this morning, I have largely sold out of my trading longs but am holding on to my core positions.
I suspect that at some point the bulls will be tested. The key will be for us to see a minor correction without completely spitting the bit as we have been recently. The fear of losing money can quickly morph into the fear of missing a year end rally. I am headed out early. Have a good night.
I suspect that at some point the bulls will be tested. The key will be for us to see a minor correction without completely spitting the bit as we have been recently. The fear of losing money can quickly morph into the fear of missing a year end rally. I am headed out early. Have a good night.
Both Sides
The short term bull and bear cases are quite simple and both have merit. The bears will say the S&P 500 has shot up a very quick 70+ points. Even in the context of an uptrend we could see a pullback of a couple of percent, never mind if this is just a dead cat bounce.
The bulls will counter that despite this huge rally bearish sentiment is still extreme and most are still fighting this rally. In past years strong uptrends have kicked off with tremendous rallies. Most prominent is the rally that started off 666 in the S&P 500 and last Summers rally that started in late August. In both instances the rally was as sharp as this one and the market never looked back.
I see both sides of this argument which is why I am largely out of my shorter term longs but holding on to my core positions.
The bulls will counter that despite this huge rally bearish sentiment is still extreme and most are still fighting this rally. In past years strong uptrends have kicked off with tremendous rallies. Most prominent is the rally that started off 666 in the S&P 500 and last Summers rally that started in late August. In both instances the rally was as sharp as this one and the market never looked back.
I see both sides of this argument which is why I am largely out of my shorter term longs but holding on to my core positions.
Home On The Range
We are largely back in the middle of the range we have been in since early August. Considering how negative everybody has become during this 8 week period of sideways trading, this can be viewed as a positive. That said, I am now positioned nearly in the same way I was coming into this week. I remain net long but am no longer as aggressively long as I was when we plunged into the depths. Have a good night.
Sold Annaly
I sold my position in Annaly. I am looking to reduce my long exposure as we rise. I believe the stock is still undervalued but something had to go.
You Cannot Be Serious
Bill Ackman made comments to the effect that he would not invest in HP because the company is too complicated, even though it appears cheap. JCPenney is a second rate retailer in a recession. To make matters worse the secular trend is towards online and JCPenney does not even seem cheap. I would buy HP over JCPenney any day of the week. I own neither.
Repatriation Tax Holiday
There is news of a possible repatriation tax holiday. Many large US companies have cash stuck overseas. A tax holiday would allow them to bring it back to repurchase shares or do US based acquisitions. The best way to play it would likely be the QQQ or the OEX (S&P 100).
The QQQ has tech and biotech companies, which do a lot of their business overseas. The OEX has most of the large multinationals. There will likely be a buying opportunity further down the road as people have been piling into these names since the announcement.
The QQQ has tech and biotech companies, which do a lot of their business overseas. The OEX has most of the large multinationals. There will likely be a buying opportunity further down the road as people have been piling into these names since the announcement.
Capitulation
There are numerous reasons to believe that the lows made yesterday will be durable lows. There was a great amount of fear and panic seen once the S&P 500 broke 1120 on Monday. To my eyes it looked like capitulation and almost all of the indicators I look at show that bearishness is about as extreme as it gets.
We also had some positive divergences yesterday in that we made lower lows but the number of new lows on the NYSE was lower than those seen in early August. Additionally, the market is not as oversold as it was in early August. This type of action is typically seen at good lows as the downside momentum is slowing.
When we broke below 1120 on the S&P 500 I started buying on a scale lower until I was aggressively positioned. While I believe we have bottomed I am now starting to reduce my position. I f we rally through the end of the week I hope to get rid of all of my adds. That would leave me net long but not as aggressively so.
We also had some positive divergences yesterday in that we made lower lows but the number of new lows on the NYSE was lower than those seen in early August. Additionally, the market is not as oversold as it was in early August. This type of action is typically seen at good lows as the downside momentum is slowing.
When we broke below 1120 on the S&P 500 I started buying on a scale lower until I was aggressively positioned. While I believe we have bottomed I am now starting to reduce my position. I f we rally through the end of the week I hope to get rid of all of my adds. That would leave me net long but not as aggressively so.
Discipline Over Conviction
I wrote the weekly SPY CALLs as a means of reestablishing partial hedges. I believe we have finally put in a durable bottom but discipline trumps conviction. Have a good night.
An Oldie But A Goodie: Part II
During the financial crisis of 2008 buying Annaly Capital Management below book value was my bread and butter trade. Every time Annaly would drop below book value I would build a position and when it popped above I would either write calls or sell the shares. I was able to pull this trade off numerous times during the crisis and the profits were a big help in getting me through the crisis.
My thesis was simple. There is no reason why a portfolio of agency bonds, which have implicit government backing, should trade below book. In the meantime I was being paid nearly 20% to wait for the shares to pop back above book. I was able to execute this trade over and over during the 08' crisis. Am I not worried about the financial crisis? If we get to the point where agency securities cannot be repo'd than every bank in the World will go down.
My thesis was simple. There is no reason why a portfolio of agency bonds, which have implicit government backing, should trade below book. In the meantime I was being paid nearly 20% to wait for the shares to pop back above book. I was able to execute this trade over and over during the 08' crisis. Am I not worried about the financial crisis? If we get to the point where agency securities cannot be repo'd than every bank in the World will go down.
Turnaround Tuesday
Since the S&P 500 broke 1120 late yesterday afternoon we have seen an acceleration to the downside. Breaking important technical levels is helping us get capitulation as many of the remaining bulls are now tossing their towels. In my experience these are the best times to buy.
Most of the indicators I look at are at historic extremes that almost always lead to upside. Unless we get another Lehman Brothers I believe that this will once again prove to be true. I believe the odds of another Lehman Brothers are extremely low. While officials are talking tough there are massive rescue facilities being put in place. Lehman Brothers happened over the course of a weekend with nobody prepared.
The last bit of a decline is generally the scariest and this is no different. I believe the odds of a whoosh and a rebound today are very high. it is always darkest before dawn and it is pitch black right now.
Most of the indicators I look at are at historic extremes that almost always lead to upside. Unless we get another Lehman Brothers I believe that this will once again prove to be true. I believe the odds of another Lehman Brothers are extremely low. While officials are talking tough there are massive rescue facilities being put in place. Lehman Brothers happened over the course of a weekend with nobody prepared.
The last bit of a decline is generally the scariest and this is no different. I believe the odds of a whoosh and a rebound today are very high. it is always darkest before dawn and it is pitch black right now.
Baby Steps : Part Three
I have further removed hedges in the pre-market. Since we broke 1120 on the S&P 500 I have removed 3/4 of my hedges. I am now aggressively long.
Fun Times
The market meltdown continues as liquidations lead to more liquidations. It feels like it will be one of those sleepless nights. Hopefully we will get a a solid washout tomorrow. Have a good night.
Baby Steps : Part Two
I have further removed some hedges. I am saving the rest of my ammo if we break 1100 on the S&P 500.
Baby Steps
I moved to a slightly longer posture by removing some of my hedges. I am planning on going slow and on a scale.
Bring It
Sentiment is about as negative as it gets. I can lay out dozens of indicators pointing to this but I don't believe many would argue with this statement. While sentiment is supportive of the market there are risks. The major downside risks are continued redemptions and liquidations and/or a systemic event.
I view a systemic event as unlikely in the near term. The EFSF is 400 billion Euros or about $550 billion dollars. There are also IMF bailout funds in place as well as asset purchases by the ECB and other liquidity facilities available. At minimum, the $550 billion EFSF is a large kick of the can. I would point out that for months the market thought TARP would not be enough, yet TARP was more than enough as most of it went unused.
I believe the cycle of redemptions and liquidations is the bigger risk to the market. There are news stories of redemptions and liquidations and the price action seems to support this. Last week a group of momentum stocks fell 10% on no real news. Where there is smoke there is fire.
While it is difficult to know when this vicious cycle will end I believe that it will provide opportunity as we should see a snapback when it does. As such I will be adding exposure on a scale if we melt lower. While I have been trading around a net long position,I have held myself back from becoming aggressive on the long side. Further meltage would get me aggressive.
I view a systemic event as unlikely in the near term. The EFSF is 400 billion Euros or about $550 billion dollars. There are also IMF bailout funds in place as well as asset purchases by the ECB and other liquidity facilities available. At minimum, the $550 billion EFSF is a large kick of the can. I would point out that for months the market thought TARP would not be enough, yet TARP was more than enough as most of it went unused.
I believe the cycle of redemptions and liquidations is the bigger risk to the market. There are news stories of redemptions and liquidations and the price action seems to support this. Last week a group of momentum stocks fell 10% on no real news. Where there is smoke there is fire.
While it is difficult to know when this vicious cycle will end I believe that it will provide opportunity as we should see a snapback when it does. As such I will be adding exposure on a scale if we melt lower. While I have been trading around a net long position,I have held myself back from becoming aggressive on the long side. Further meltage would get me aggressive.
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