Bulls Not Done Yet

The bulls have come a long way since Thursday. However, I would still not bet against them quite yet. If we get another up day tomorrow than the scales might start tipping in the bears favor. Have a good night.

Commodities Rally

The most common theme in earnings conference calls this quarter was the desire to raise prices. The recent rebound in commodity prices will not help ease these inflationary pressures. These pressures are occurring in a slowing economy. Imagine what would happen if the economy actually did well.

It is very difficult for me to see the upside in this market. Valuations are fair at best, if one accepts that profit margins will stay at record levels. If the economy does better we will likely have an inflation problem. If the economy slows corporate profits will likely suffer. It seems to me like the upside is a few percent, while the downside is sizable.

Please don't confuse my long term view with my short term bias. Even though I am negative longer term I am still leaning long and will likely remain so through tomorrow. That said, if my long term view were more positive I would likely be significantly longer.

 

 

Going Up?

While I believe we can rally for a few more days, I don't believe this is the beginning of a new leg higher in the market. Often after a crisis is resolved we see a strong move higher, as the fear subsides. However, I don't believe many were worried about the European crisis so the relief should be short lived.

Happy Bailout

According to news reports Germany has agreed to another Greek bailout even though Greece has missed every target of the previous bailout and will only make symbolic further concessions. This has not been confirmed but it seems markets believe it as the Euro is surging as are equity markets around the World.

I took a moderate trading long position last week as we were oversold, seasonality was positive and sentiment was negative. Even though we did not see much panic or fear, the conditions likely called for a slightly more aggressive posture but I was worried about the situation in Europe. I was surprised that few showed much concern about the situation in Europe but it appears the majority was correct.

As a reminder we are still oversold until the end of the day tomorrow and seasonality is positive through Thursday. I am likely to continue giving the bulls the benefit of the doubt through tomorrow at minimum.

Friendly Reminder

I want to remind readers that while we will enjoy a three day weekend, Europe is open for business on Monday. There will be two days worth of news out of Europe when we return on Tuesday. This means that there is greater than usual gap risk with positions carried over the weekend. Have a great weekend.

The Minimum


  • The market has now done the minimum, given the oversold conditions and sentiment readings. We typically see at least a bounce and we have bounced.

  • There is extreme call buying today. That is not necessarily a bad thing as it takes a long string of days with call buying before it becomes bearish. It does tell us that we are no longer in the early innings of this rally.

  • It has paid to buy weakness and sell strength for the past few weeks. Rallies and declines have not gone very far recently.

  • I rolled my short SPY put position to next week using the weekly options this morning in order to maintain my modest trading long.

  • If the market continues to rally next week I will likely move to a more neutral posture.

Siding With The Bulls


  • Most sentiment indicators show too much bearishness but not extreme bearishness

  • Seasonality is positive as we are now in the turn of the month.

  • The market is oversold and will remain oversold until the end of the day on Wednesday.


These three arguments have me giving the bulls the benefit of the doubt until the middle of next week. There are two factors that have been keeping me only modestly bullish:

  • We never saw much fear or panic during the latest downturn.

  • Events in Europe seem to be coming to a head. There is a chance Greece will not get its next round of bailout money and the Greek government only has enough cash to go until mid-July.


 

Working For The Weekend

The weekend cannot come soon enough. As long as there are not fireworks out of Europe I expect trading to slow to a drip tomorrow ahead of the long weekend. Have a good night.

The Right Move

In a market that is oversold, seasonality is positive and sentiment is negative; the correct move is generally to buy the dip. Most of the time I ignore the headline or economic number of the day and instead watch the people watching the news. Had I done that today I would have added to my longs.

Instead I focused on the headlines coming out of Europe and stuck with my modest bullish positions but did not add to them. While I wish I had added, I believe that I made the correct decision. As I have written numerous times I believe market participants are treating news about Greece like "The Boy Who Cried Wolf". Except this time the wolf is actually in the hen house. Even if my assessment of Greece is wrong and the infinite bailouts continue I believe I am still better off sticking with my small positions. If I am worried about Greece I am more likely to make bad decisions with my long positions. Better to keep positions small and manage them with a level head.

Out Of MSFT

I bought back the MSFT Puts that I was short.

Scary Headlines

There are scary headlines coming out of Europe regarding Greece. Bloomberg has reported and the IMF has confirmed that unless the IMF receives more guarantees from the EU it will not release the next round of financing to Greece next month.With the EU divided on how to deal with Greece its hard to see the EU making new guarantees.

Its possible that this is great political posturing to scare Greece. It definitely has me scared. This doesn't mean people wont whistle past the graveyard and we cant rally until then, but there is a landmine out there. My trades are likely to remain small until there is a resolution to Europe or we see some real panic.

Talking Bottoms

We opened lower and closed higher yesterday but the turnaround was neither dramatic nor powerful. The reason being because we never had a really good washout. That does not mean that we can't rally, only that it will likely occur in fits and starts if we do rally.

I prefer panic bottoms because they are easier for me to trade. I buy when I sense panic and try to hold on tight. As long as I don't get shaken out, before I know it the market is zooming higher and I caught the bottom. The type of bottom we saw yesterday takes longer to form and often gives me too much time to think and second guess myself.

While there might be bumps along the way I believe the market should have a positive bias through the middle of next week. I don't believe the upside potential is great and Europe is a wild card.

 

How Long Will It Last

It appears that the market is finally bouncing. The oversold reading will last through Wednesday of next week and the positive seasonality will last through Thursday of next week. While I am not expecting major fireworks the bulls should be  given the benefit of the doubt for the next few days. Have a good night.

Void Of Humanoids

I was just thinking about how strange it was the way the market bottomed this morning. There was a complete lack of emotion. Its almost as if the algorithms realized that seasonality was turning positive (turn of the month) and the market was oversold and just bought.

This is not sour grapes. Kudos to the algos. It just means that one needs to adjust their trading style to the new realities of the market. Anyway, if every bottom looked the same trading would be easy and we all know that is not the case.

Mixed Signals

The CBOE put/call ratio is showing extreme optimism while the ISE is showing extreme pessimism. This was the case to a lesser extent yesterday as well. The drop in the VIX leads me to believe that the CBOE is probably more accurate but I prefer it when they are singing the same tune. All in all there is not much to read into this.

Oversold

The chart below from Bespoke is a slight variation of what I normally post as it only looks at S&P 500 stocks and I look at all NYSE stocks. It shows that on a short term basis stocks are nearly as oversold as they were after the Japanese nuclear disaster. As I have written, this should produce a rally soon but I don't expect it to look anything like the one we saw in March. Back then everybody was talking about the end of the World while today people are talking about the oversold reading.

 

No Easy Trade

We got the lower open but instead of scaring people it was quickly bought and the VIX is actually lower once again. I believe my slightly bullish bias is appropriate given the oversold reading but I want to see more fear before getting more aggressive.

Boo

The S&P futures dropped 10 points overnight but have recovered most of those losses. I believe that type of drop during the regular session would probably produce enough fear so that we can finally rally for more than an hour.

To summarize, we are oversold and the 10 day moving average of the put/call ratios are consistent with what we generally see before a bounce. However, we have not seen much fear or panic and there has been very heavy stock issuance this week, including the re-IPO of AIG. While the bulk of the stock issuance is behind us it might take a few more days to digest.

Tactically, I am short some SPY puts and only have a single core long, CA Inc.. I would be willing to get more aggressive on the SPY if we finally see some fear in the market. However, even in that case it would likely just be a trade where I am looking for a percent or two.

Turn Of The Month

The turn of the month is almost upon us, which tends to have a positive bias. This is yet another reason to expect some sort of a bounce to develop soon. As I wrote this morning, we are now just about oversold and sentiment is pretty negative.  It would be nice if we could get one more spike in the VIX as a better washout would lead to a better rally, but it might not be in the cards. Have a good night.

Best Case Scenario

Higher commodity prices are clearly starting to  have a negative effect on corporate profits and the economy. The rise in commodity prices has likely not been completely passed through because many companies hedge their production. I believe that a continued rise in commodities would be quite negative for the markets and economy, even though they have been positively correlated until now.

The best case scenario for the market might be that we see a continued drop in the stock market and commodities followed by a rebound in stocks while commodities lag. If stocks and commodities bottom here and take off together I believe it will lead to a lot more trouble down the road.

Financials Lagging


  • I suspect the financials are lagging because of the AIG re-IPO tonight. Some managers are likely making room in their portfolio.

  • Another explanation for the lagging  financials might be because the market is open, as it seems to be a daily occurrence.

  • I have been hearing the words "moving average" and "critical support" a lot in the past two days. I would like it if we broke these "critical levels", stop losses get hit and maybe fear will get reintroduced into the market. Then maybe we could see more than a weak bounce.

  • The VIX is actually down today. It would be nice to get one more spike.

Dialing Back

I have sold my SPY long and instead have sold the weekly SPY Puts naked. This is still a bullish posture but less so.

Partly Sunny

We saw a decent amount of put buying yesterday, which leads me to believe that some of the risk from Europe is being priced in. While I don't believe a default is being priced in to stocks, I believe it will now take more concrete evidence of an impending default to shake the market.

Even if the market gives up its gains today we will have a decent oversold reading at the end of the day today. Starting tomorrow we will be dropping negative numbers for 4 out of the next 5 days from the 10 day moving average of the NYSE Advance-Decline line. The put/call ratios are consistent with those seen at the beginning of a rally as well.

Somewhat tempering my enthusiasm is the fact that we have a very heavy week of stock issuance, we never really saw much panic and intermediate term sentiment still has room to become more bearish.

Feeble Rally

The extreme put buying has only led to a feeble rally from the lows this morning. I am sticking with the trading long that I bought in the pre-market today.

Bad news from Europe is starting to be recognized so barring a worsening of news overnight the market should attempt to rally soon. The heavy issuance calendar and the weak oversold reading is tempering my enthusiasm for much more than an oversold bounce. Have a good night.

Get Used To It

This is clearly not the market we have gotten used to since September. For months sentiment would swing between euphoria and just plain bullishness. A few hours of put buying was enough to produce a rally. That is no longer the case.

We are now in a market where it pays to wait for extremes. I believe we will see bouts of extreme pessimism this Summer and those will be the best entry points. Today's put buying is pretty extreme no matter which ratio one looks at. A few months ago it would be enough for a month long rally. I believe it should be good for at least a bounce.

You Can't Be Serious

Deloitte & Touche resigned as the auditors of Longtop Financial, which appears to be yet another US listed Chinese company that turned out to be a complete scam. I found this disclosure to be most shocking:
(1) the recently identified falsity of the Company's financial records in relation to cash at bank and loan balances (and possibly in sales revenue)

What I found shocking is that it appears that auditors don't even know how to verify something as simple as cash in bank accounts in China. And this is not a fly by night auditor. An investment in any Chinese company requires a giant leap of faith if something as simple as cash in the bank cannot be verified properly.

Supply Problems: Part II

An advantage that the bears have this week is that the stock issuance calendar is quite heavy. Aside from the re-IPO of AIG, there are quite a few other large IPO's. The issuance schedule for this week can be seen here.

Some Steps In The Right Direction


  • On Thursday the VIX closed at around 15.5 and this morning spiked above 19.5. I believe this is another step in the right direction.

  • In the early going we are seeing heavy put buying.

  • European markets are not getting worse and seem to have stabilized at lower levels.

Emerging Positives

This post is going to focus on some emerging positives for the market. However, I want to emphasize that everything on the long side is a trade for me right now. I don't see valuations as being attractive, I believe the crisis in Europe will get worse before it gets better and QEII is ending.

  • Rydex traders have stayed begrudgingly bullish, even as many other sentiment indicators showed a move to bearishness. Late last week Rydex traders finally started backing off. They are not overly bearish but at least they have moved into neutral territory.

  • The Investors Intelligence survey also finally showed a large drop in bulls. I prefer when all the sentiment indicators I look at are in unison and we are getting closer.

  • We will once again have a weak oversold reading at the close tomorrow. The last weak oversold reading led to a 25 point bounce in the S&P 500.

  • The put/call ratios have been giving a buy signal and continue to do so.


If the market struggles today and tomorrow I can imagine that sentiment will turn pretty gloomy and we might even see a pop in the VIX. Combined with the oversold reading that could lead to a decent rally. However, if the ticking time bomb known as Europe goes off than all bets are off.

Trading Long

I have taken a trading long in the SPY on the large gap lower.

Dear Abby

One of the people I follow on Twitter tweeted:
Dear @cnbc, no one cares about Greece.

I believe that this is a good representation of investor sentiment towards what I believe to be a very serious and worrisome issue. I plan on remaining in a very defensive position until we see more extreme sentiment or there is  a resolution/default to the situation in Europe. Have a great weekend.

Cash

I am likely to remain in a large cash position. The short side is not attractive to me because too many sentiment indicators are showing pessimism. I prefer to be short when there is excess optimism, which I don't believe to be the case.

I do not want to go long because I am not finding many stocks with attractive valuations. Earlier in the year many defensive stocks traded at attractive valuations but that is no longer the case. From a trading perspective we are not seeing extreme pessimism either.

My recent strategy of buying weakness and selling strength is likely to continue working but the situation in Europe is worrying me. It seems we are reaching the end of the road. Investors have been conditioned to use rumblings in Europe as buying opportunities. This has worked because there always has been a bailout. Europe is no longer united and without a united Europe there cannot be another bailout. I don't believe markets are prepared for a default which is an outcome I now expect.

Even if I am wrong about Europe, the fact that I am worried about it puts me at a disadvantage as I will get scared out of my positions every time there are rumblings. For these reasons I am choosing to remain largely in cash.

Bounced Check

According to news reports Norway is no longer willing to write Greece checks as they claim Greece has not fulfilled its obligations.

Sold SPY Long

I was long the SPY and short the 134 Calls. I decided to unwind the position. I am no longer long SPY. My sole remaining long position is CA Inc. I am short some out of the money Puts on MSFT and SPY as well but I am about 90% cash and my overall exposure is low.

Inflation Experience

It has been thirty years since inflation has been an issue in this country. One would have to be at least 60 years old and have been investing from their early twenties in order to have experienced of investing through the onset of inflation. As a group current investors have little experience dealing with the onset of an inflationary period.

Last night we got a clue as to what inflation could look like. Both Gap and Aeropostale were hit by lower spending and higher costs. Both lowered earnings estimates by greater than 20% and are trading  more than 15% lower.

Supply Issues

We have seen a large supply of new stock in recent days, which gives the bears an advantage. Mosaic did a $6.5 billion secondary and Glencore did an $11 billion IPO. AIG is scheduled to do a $9 billion re-IPO next week. The good news is that the AIG offering was reduced by more than half and the government will not be selling their remaining stake in GM until August. This means that once the current round of supply is digested, supply should not be an issue for a few months.

The Situation In Europe

Futures are lower as sovereign spreads are blowing out yet again. I believe that we are likely to see a Greek default in the months ahead. There is now widespread disagreement in Europe with regards to Greece. Without unity there cannot be another bailout, unless there is a restructuring (aka default).

A Greek default would pose problems for other PIIGS as they also require bailouts. It will be a lot harder to sell the idea of more bailouts to taxpayers around Europe when they just lost a lot of money to Greece. Why should taxpayers in one nation pay for profligate spending in other countries?

The issue does not end there as European banks are up to their eyeballs in sovereign debt and would require huge recapitalizations. Huge bank recapitalizations would stress European markets in addition to slowing markets because of the lower government spending that defaults would result in.

Few seem to be concerned about Europe because we have had so many fire drills that have turned out to be buying opportunities. The same occurred in 2007 with regards to the subprime crisis. We had warnings all year yet they turned out to be buying opportunities as the market climbed through October of 2007. I suspect that one day the fire will be real and that it is not that far away.

I Don't Get It

Recent sentiment numbers can only be construed as bullish. We have been seeing continued put buying and individuals are as bearish as they have been since August. The reason this is bewildering is because the S&P 500 is only about 2% off its highs. I have pared back my longs as I am having a hard time finding much to buy from a valuation perspective and have many fundamental worries. But these numbers make me want to stay far away from the short side. Have a good night.

Not Bearish

I would like to emphasize that while I have cut back my positions I am not bearish. We are seeing put buying again today and a decline in commodities yet the market holds up well.

Trimming Trading Longs

As the market has risen I have been trimming back my trading longs. I have bought back the Google puts I sold earlier in the week as well as the vast majority of my Microsoft puts. I am now only very modestly long.

China Remains Uninvestable

I hesitated to write this post because my last post on China led to personal attacks, but I have decided that it is wrong to allow that to influence me.

Yet another US listed Chinese company appears to be a fraud. Shares in Longtop Financial have been halted for two days now. What makes this different is that they were brought public by Goldman Sachs and had some of the smartest hedge funds as major shareholders. Billions of dollars will be lost as a result of these Chinese frauds but it is manageable. The real risk is that this halts foreign investment in Chinese companies.

Chinese banks have market caps in the hundreds of billions of dollars. In free markets banks tend to do poorly so one can imagine what happens when loans are  a result of political influence, as they often are in China. These banks show profits but if these profits come into question capital markets can become shut down to these banks.

It is likely that the recent frauds in China will halt the flood of Chinese companies listed in the US. The bigger risk is that investors start to question the validity of Hong Kong listed Chinese companies, which might lead to more serious issues. I continue to believe that Chinese stocks are uninvestable.

 

Be Careful What You Wish For

The most bearish possible longer term outcome is stagflation. We have been on the road to stagflation as commodity prices have been rising and economic growth is slowing. While in the short run a continued drop in commodities would likely take the stock market lower it is probably the better longer term outcome. If stocks and commodities shoot off on another leg higher stagflation will almost certainly become a serious issue.

The Bull Case

Recently, it has paid to buy weakness and sell strength. But a decent case can be made for a continuation higher:

  • The American Association of Individual Investor's survey is showing that individuals are extremely pessimistic with bears outnumbering bulls by 14%. It is even more staggering that this is occurring as the S&P 500 is a mere 2% from its highs.

  • The put/call ratios are throwing off buy signals. Despite the 20 point bounce in the S&P 500 we saw a continuation of put activity yesterday.

  • The market is still slightly oversold and has a long way to go before it becomes overbought.

  • Bullishness on the Investors Intelligence survey has fallen by 10% recently.


I want the market to go down because I don't like the valuations I am seeing. Earlier in the year I was able to buy defensive stocks cheaply but those stocks have moved to a fair valuation, leaving me with slim pickings. I will likely be moving to the sidelines shortly but I see little reason to short the market with the current bearish sentiment.

Whos The Sucker Now

At midday I wrote that too many people were calling this a suckers bounce. It seems that we now have a few more believers. One can say that the market has now done the minimum, with the S&P 500 bouncing over 20 points since yesterday morning. I am now more cautious but still believe the bulls deserve the benefit of the doubt. Have a good night.

Sold Covered Calls

I have sold covered calls against my SPY trading long.

Bought Back SPY Puts

I have bought back the SPY Puts that I sold naked  last week for a small profit.

Suckers Bounce

This is purely anecdotal. I have read in a few places that today's action represents a suckers bounce and was thinking the same thing myself. But generally a good suckers bounce gives people hope that the bottom is in and does not have everybody calling it a suckers bounce. This leads me to believe that the market will first need to suck a few more people in even if this indeed is a sucker's bounce.

Divergent Readings

We are seeing call buying at the ISE and put activity at the CBOE. This is making it difficult to get a reading on sentiment today. With commodities bouncing, Europe holding up, a slight oversold reading and the put/call ratio giving a buy signal I still favor the long side.

Survey Says

The bulls on the Investors Intelligence survey have dropped to 45% but the bears are still under 20%. The bulls were over 55% at one point so on margin this is an improvement, but still more bearish than bullish.

The Politics of Bailout

According to a Bloomberg story EU officials are fighting hard to keep the top IMF job in the EU. In doing so they have tipped their hand. They are looking to distribute the sovereign losses to taxpayers around the World via more IMF bailouts.

I failed to understand why the arrest of DSK was such a big deal to markets, but it is now making sense to me. If the IMF does not pitch in than the EU is left alone to bail out their own countries. It is becoming politically difficult to sell bailouts in many EU countries. On balance the risks of a default in Europe have increased.

Citigroup Options

Citigroup has recently done a 10-1 reverse split. This has reduced the volume on the stock by nearly 90% and the effect on options has likely been similar. I have written many times about how I was worried that Citigroup options were skewing the put/call ratios. Its possible that we will now get better readings out of the put/call ratios, but also that the range of readings will differ.

When Citigroup traded under $5 many times hundreds of thousands of Citigroup options would trade in a day and the trading was often  biased to the call side. Those options were worth pennies so they did not represent large commitments, but this had a large effect on the entire put/call ratio. I have found the put/call ratios to be less useful after the financial crisis than I did before.

The reason I write this is because I was thinking about my earlier piece and the charts I posted along with them. On the ISE equity we are seeing more put buying than we did during the Japanese disaster and on the CBOE equity we are seeing nearly as much. But the panic back then was palpable. This is not the case now and I am wondering if the difference is the Citigroup options.

In the long run I believe the elimination of massive volume in Citigroup options will make the put/call ratios much more useful. In the short run the range that the put/call ratio trades in might change and using the put/call ratios will be a little trickier.

Put/Call Ratios Saying Buy

In addition to the moderate oversold readings, the put/call ratios are now giving a buy signal. The 10 day moving average of the CBOE put/call ratio is posted below. While we are not seeing the same amount of put buying that we did during the Japanese nuclear crisis, this is the second most amount of put activity we have seen since September.

The CBOE equity only 10 day moving average is nearly where it was after the Japanese nuclear crisis.

The ISE equity only is actually showing more put buying than during the Japanese nuclear crisis.

There does not seem to be that much fear and we have not seen a scary decline, so I would take these readings with a grain of salt. I would be very surprised if we saw a rally anywhere approaching the one we saw after the Japanese nuclear crisis. I don't believe this is a great buying opportunity but these readings should at least be good for a bounce and will keep me biased to the long side.

I Messed Up

Under Mark Hurd, HP always seemed to best analyst consensus by a penny. The new CEO of HP is essentially saying Mark Hurd played accounting shenanigans, which has led to a lower outlook. If HP has indeed come clean and all the dirty laundry has been aired than the stock is stupid cheap, but who is to say that this is the end of the accounting issues. I have sold HP and taken a large loss on the position.

There are times when I lose money and it is not my fault. Sometimes one can bet on the higher probability outcome and shit happens. However, I believe that in this case I made a mistake. I was aware that Mark Hurd was that type of CEO and chose to ignore it. Have a good night.

A Ray of Hope

The ISE is now showing put buying as well. The 10 day moving average of the put/call ratios will be giving a decent buy signal at the close today. We have seen a good amount of activity in puts for the past ten trading days.

Crime and Punishment

It doesn't seem to me that HP's punishment matches the crime. Expectations were low coming in but in this market momentum rules. When a company does poorly no valuation is too low and when it does well no price is too high. Needless to say, I am in a world of pain.

Turnaround

We have seen the indices open down and reverse higher. In addition, we saw extreme put readings at the CBOE. This is typically a good sign for the remainder of the day. The ISE is not corroborating the extreme put buying. I would feel more confident if the put buying were occurring at both exchanges.

HP Spits The Bit

HP has spit the bit in after hours. I have added to my position. I was not expecting a beat and raise out of HP and was bracing for a nasty quarter. That is why it trades at seven times earnings. A lot is priced in.

Weighing The Short and Intermediate Term

At the close the indicators have not changed much from this morning except that the put/call ratios have gotten a little closer to a buy signal. As I wrote this morning the indicators are mildly bullish in the short term but not table pounding bullish. From an anecdotal standpoint it doesn't seem anybody out there is bullish. In the short run that may be the best argument for a rally.

From an intermediate term perspective the weight of the evidence shows that investors are still positioned in an excessively bullish manner. The Investor's Intelligence survey has the number of bears below 20%. Short interest is hovering at multi year lows while margin lending is at multi year highs. Many famous managers have practically thrown in the towel on short selling. Portfolio manager and advisor surveys show that managers as a group are overweight stocks.

With intermediate term sentiment excessively bullish and seasonality negative it might take more to produce a rally than we recently have gotten used to. What we have not seen yet is a scary day with very heavy put buying and a lot of fear. We started seeing that late today and more of that tomorrow might finally get us lined up for a rally. Have a good night.

Sector Herding

Even though the S&P 500  has pulled back less than 3% from its highs, many stocks are 10% to 20% off their highs. Investors have been flocking to defensive stocks and away from energy and technology stocks.

The herding effect in this market is unlike any I can recall seeing. Even when the top line indices don't show momentum, the sectors show extreme momentum. I am taking advantage of this by building positions in technology stocks, which investors are stampeding out of. They are becoming cheap on an absolute basis even if we assume that we are headed for another recession.

 

Shifting Exposure

Defensive stocks have been outperforming since late February yet it seems that everybody just realized it. I have read numerous articles in the past few days about how defensive stocks are outperforming in the major newspapers. Once a trend is written about in every major newspaper it is generally late in the game.

I am shifting my exposure to technology names as they have been sold hard in the past couple of days from the SPY. I have written Puts on Google and Microsoft and reduced my exposure to SPY. In addition, if there are sovereign issues technology profits should hold up relatively well as they did through the subprime crisis.

The Case For A Bullish Short Term Bias

The market is finally oversold but it is not a great reading as you can see in the chart below.

Below is the raw data that goes into this indicator. We will be dropping moderately negative readings for the next 4 days and for 6 out of the next 10 days. At a good oversold reading we generally drop a lot of large negative numbers, which we do not see here.

The put/call ratios are not giving a strong signal either but are closer to buy signals than sell signals. Below is the 10 day moving average of the CBOE put/call ratio. All the put/call ratios look similar, whether one looks at equity only or the ISE readings.

All in all the data I presented does not make  a table pounding case for stocks. But it is enough to leave me with a short term bullish bias for the next few days.

Long For A Trade

The trading in the past few weeks has differed from what investors, including myself, have gotten used to. From September until the Japanese nuclear disaster, sentiment ranged between euphoric and just plain bullish. It was necessary to step in pretty quickly to buy. Waiting patiently for the market to be become oversold was a  fruitless endeavor. Recently, that has changed and patience has paid.

The market is currently oversold, as the S&P 500 has spent most of the past two weeks going lower. It is not a great reading but enough to keep me biased to the upside. I am positioned long heading into next week but will be pretty quick to lighten up on strength. Have a great weekend.

Writing SPY Puts

I have used the early weakness to write  the SPY 133 Puts expiring next week naked.

Repurchased CA, Inc

I have repurchased my position in CA Inc. The results were slightly disappointing but I am very happy with the larger share repurchase program. I believe this is an over reaction.

China Is Not For Investing

Chinese internet company, Alibaba, removed its crown jewel, Alipay, and transferred it to a company owned by its founder. Western investors in Alibaba are now at the mercy of the whims of the Chinese. Many Chinese companies listed in the US have recently turned out to be complete frauds. Chinese banks lend money for projects that end up looking like ghost towns, yet the same Chinese banks have some of the highest market caps in the World.

I would not put a penny into a Chinese company. I do not trust the accounting and politicians can make up the laws as they go along. It is culturally acceptable to rip off foreigners. Invest in China at your  own risk.

Slightly Bullish

The market will be oversold at the end of the day today, but it will not be a great reading. On net, the market has gone down slightly over the past two weeks but the action has been choppy and has not led to extreme sentiment.

The S&P 500 has already rallied 20 points from the lows yesterday morning. Recently, it has not paid to chase weakness or strength and I do not intend to do so. While I would rather be long than short, I prefer to buy on weakness.

I have a moderate trading long in the SPY and am short SPY puts that will likely expire worthless today. I had intended to add to my trading long today but I am unwilling to chase this strength. If the strength continues I will likely sell covered calls against my trading long.

Don't Chase

This is not a  market in which to chase stocks higher or lower. I continue to believe that the best course of action is to buy weakness and sell strength. I am trying to grind out returns by following this plan. This is not the time to swing for the fences. Have a good night.

Buy The Dip

It appears that we saw a short term bottom this morning, that I believe should last a couple of weeks. I believe a move lower tomorrow would be an opportunity as we will then be oversold, even though we are unlikely to make a fresh low.

Murky Sentiment

In today's AAII survey the bears actually outnumber the bulls. Sentiment readings are very murky as we are seeing disparate readings from different indicators.  There is no clear extreme in either direction.

Mr. Market Smells Blood

There were numerous articles this week about hedge funds that had large drawdowns as a result of the commodity crash. What was missing from those articles were stories of liquidations. In one of the articles I read a hedge fund manager with a nearly 20% drawdown stood firmly by his beliefs that commodities would go higher.

Markets generally don't allow wounded animals to live, especially the leveraged ones, and the market smells blood. The commodity plunge has continued overnight and this feels like the liquidation stage. This should lead to a better bounce in commodities but there can be a lot of damage before that bounce begins. I would expect a bounce to begin by early next week. Commodity stocks should be the first to find stability followed by the commodities themselves.

 

The Year Of The Trader

2010 was the Year Of The Trend Follower, as it payed to buy strength and sell weakness. 2011 is shaping up to be the Year Of The Trader. Buying on a scale into weakness and selling on a scale into strength has been the best strategy. I believe this strategy will continue to outperform. Have a good night.

Building Towards A Rally

It is good to see that there is some put buying today. I believe this increases the odds that we see a rally next week, if we sell off through the end of this week. I am treating this market as a trading market where I buy oversold and sell overbought.

Writing SPY Puts

I wrote the just out of the money weekly SPY Puts naked. If we go down through the end of the week we will be oversold and I would not mind the position being put to me.

No Easy Trade

At the beginning of the week I noted we were likely to see a reprieve as we saw a string of down days with lots of put buying . We have now seen that reprieve, which makes for tougher trading. We are neither overbought nor oversold, but closer to being oversold. Sentiment is not at a bullish extreme or a bearish extreme, but closer to a bullish extreme.

I believe that we are in a trading market and that it will pay to fade the extremes. Unfortunately, there are none to speak of right now. If we sold off through the end of the week the long side would be interesting for a trade.

What's Wrong With This Picture

The Greeks are out in the streets protesting austerity measures and the citizens of other European countries are in an uproar over bailing out profligate countries. Yet the European politicians continue to insist that the bailouts and austerity measures will continue. Our politicians continue to make soundbites while our deficit sits at 10% of GDP. Right now our deficit does not matter but most imbalances do not matter until they do. Add to this that we are in the seasonally weak part of the year and QEII is ending. I believe this argues for a more cautious stance.

While I could see the market making a marginal new high by a couple of percent, there is also the chance that one of the imbalances will finally matter. I don't believe there is a lot of money to be made in a buy and hold strategy and considerable risk. I am in trading mode.  I am currently holding a small core long portfolio and some trading longs. I will likely sell out of my trading longs as we approach the year's highs.

 

Hanging On

After taking some profits at midday, I am going to hang on to my remaining trading longs. If the market heads lower over the next three days we will be oversold, hence I believe the downside is limited. I have ample cash to take advantage of a move lower if it occurs. Have a good night.

Sold Some SPY

There is a lot of call buying today. I was going to wait until the end of the day before selling but I decided to peel off some of my SPY long a little earlier.

Money To Burn

I thought it strange that Microsoft all but stopped repurchasing shares last quarter and surmised they might be saving up to buy Yahoo!. My idea was right but the target was wrong as they purchased Skype for over $8 billion.

This highlights the danger of owning companies that produce strong cash flows but don't commit to how they will spend the money. I doubt Microsoft's shareholder base is the type to like expensive acquisitions with little synergies. I also believe this to be a reason why mega caps have underperformed. Instead of buying back their own cheap stock they make expensive acquisitions.

What Makes A Good Oversold Reading

A good oversold reading is reached when there are a string of ten trading days where most of the action is to the downside. Generally, we do not see ten straight down days. More often we see a decline, followed by a reprieve, followed by another decline. We have been following this script and are now in the reprieve stage. If we then declined through the end of the day Friday we would get a good oversold reading.

I am not predicting that we will go down through Friday. Only that if we do that it would likely be a good entry point as the market will be oversold. Tactically, I will look to trim my trading longs today in order to make room in case we do get oversold.

It All Hinges On Europe

We will likely gap up tomorrow as long as nothing new emerges out of Europe. That is a considerable  asterisks as the problems in Europe are real but the timing of the realization is a mystery.

While this potential crisis does make me nervous, I am sticking with my modest core holdings and my trading longs. If we get a day where Europe is on the back burner and we see some call buying I would likely ditch my trading longs. Have a good night.

The Question Of Europe

It is clear that European officials don't want to deal with the sovereign issues right now. There are enough bailouts in place to buy them at least until the end of the Summer before determining the next step. If these sovereign issues could be swept under the rug for now than I believe markets could rally.

Unfortunately, if markets sense that a default is imminent they will not wait until that point before starting to price it in. The market may have dodged a bullet as Greece has no plans to leave the Eurozone. But that does not mean that Friday's news does not turn into the point of recognition for markets that a default is imminent.

This is a very tricky juncture as an investor and trader. It was obvious a year ago that Greece would need to default at some point. However, staying out of the market or even worse, shorting it would not have been a profitable decision. As somebody who anticipated the collapse of the real estate bubble way too early I am aware how long these imbalances can persist.

I believe that if the market could put Europe on the back burner it can probably score a marginal new high by a couple of percent over the next few weeks. After that I would expect a bumpier Summer. I believe the most likely outcome is that the day of reckoning is delayed yet again. But the possibility of a crisis will keep me more conservative than I otherwise might be and have me taking profits on the long side quicker than I otherwise might.

Reprieve Interrupted

The market has been heading lower since Monday of last week. It appears we were seeing a reprieve on Friday when news of a possible Greek default hit and interrupted it. Typically, when a market becomes oversold we see a decline, followed by a reprieve and followed by another decline. Is the reprieve over?

The put/call ratios showed a third day in a row of put activity on Friday. Additionally, commodities are rallying strongly today and commodity stocks were the culprits that dragged the averages lower. This leads me to believe that the market should rally today.

The caveat is that there seems to be something amiss in Europe. On Friday I noted that where there is smoke, there is fire. While the Greeks issued harsh denials, there indeed was  a meeting regarding Greece. Greece is seeking more lenient terms and a further bailout. How much of a stretch is it to believe that they at least hinted at the possibility of leaving the Euro as a bargaining tactic?

The infinite bailouts can delay the day of reckoning but eventually there will be restructuring, aka defaults. The size of Greece's debt is simply too large and I don't want to be long when a default happens unless the market is prepared. I don't believe the market is prepared but it seems that all the parties involved are trying to give the can another kick.

Moving Back In

Greece is denying that they want to abandon the Euro. Where there is smoke there is fire, but I take this to mean that there is nothing imminent this weekend. Eventually, Greece will default but one could have said that a a year ago and missed out on a lot of gains.

From a trading perspective I believe the market is set up for gains barring a Greek default. As such, I have decided to buy back the SPY I sold, but am not repurchasing the other positions I sold. Have a great weekend.

Sold SPY

I am not generally one to panic or sell into weakness but I sold my SPY long. If  this is a fire drill I will feel like a jackass but a jackass with money in his account.

Sold CVS

I sold my position in CVS as a means of reducing risk.

Sold SLV

I sold SLV for a small gain. I want to reduce my risk in case these headlines turn out to be true.

Most News Is Noise

I view most financial news as just being noise, which is why you will rarely see me discussing the headlines of the day on the site. The headline that has taken the market down about Greece leaving the EU could be big if it turns out to be true.

This scares me. We saw similar headlines with the S&P 500 at lower levels that did not pan out. It is costly to be spooked but I am being cautious and not adding into this downturn as I would be if we were down on some other headline.

Pressing Longs

I am pressing my longs. The put/call ratios are showing put/buying despite the higher market. This is bullish.

AIG Gives Market A Reprieve

It appears that the AIG re-IPO will not be happenings until the final days of May. I was concerned that this large block of stock might hurt the market. On the margin this makes me a little more constructive over the next couple of weeks. For now, I believe the downside is limited and that we should see a bounce in conjunction with an oversold bounce in commodities.

Momentum Strategies

There are so many trend following and momentum strategies out there that when the fire alarm is rung they cannot all fit out the door at the same time. That is why we have seen a 30% crash in silver and and severe declines in other commodities.

Momentum strategies have worked in the past as investors tend to herd. However, when any strategy becomes too popular it tends to blow up.

I have picked up some silver looking for a dead cat bounce. Even if the cat falls further I should be able to get out at a profit once it bounces as it has fallen off a very high floor. Have a good night.

 

Flashy Crashy

I am long SLV for a pure trade.

Sold SPY From Pre-Market

I sold the SPY I picked up in the pre-market.

Follow The Leader

The energy etf, OIH, has been a leader to the downside in the past few days. It is now trading higher despite a lower S&P 500 and lower oil prices. I believe this bodes well for the market for the remainder of the day.

Low Expectations

Given today's terrible weekly jobless claims number and yesterday's terrible service ISM number expectations are likely very low for tomorrow's Payrolls number. I view this as a positive as it will be difficult to disappoint.

Adding To SPY

I have added to my SPY long into the pre-market beating.

CVS Earnings Assessment

CVS earnings beat estimates and guidance was inline. They repurchased $467 million worth of shares during the quarter which is roughly inline with guidance of $2 billion in share repurchases for the year.

I would have liked to see them more aggressive on the share repurchase as their cash balance now sits at over $2 billion, a gain of over $700 million for the quarter. Overall my investment thesis has not changed and I believe the shares represent good value at current levels.

The Topping Process

While I have longer term concerns I believe the market is ripe for a short term bounce. Sentiment has turned very negative in a relatively short amount of time and I expect we will get some sort of bounce to keep the bears honest. Tops are often processes and rarely a straight line down. Have a good night.

Little Conviction

I wrote Monday that I had little conviction either way but apparently nobody else has conviction either. On Monday morning there was hand over fist call buying with the S&P 500 nearly 30 points higher than today's lows. We are now seeing hand over fist put buying.

Too Little, Too Late

There are a lot of puts being bought this morning. This is coming on the third day of the decline. The put buying is likely too late and makes it more likely we will see a  short term bounce starting soon. I have taken a short term SPY long.

What I Look For In Earnings

CVS is reporting earnings before the bell tomorrow. There will be two things I will be looking for:

  • That the business outlook is more or less unchanged. I could not care less about beating by a penny or missing by a penny. The stock is cheap enough that a penny here or there does not matter. Only a large change downward in their outlook would effect my valuation of the company.

  • That the management is following through on its promise to repurchase shares and their repurchase plan going forward.


 

Merger Wednesday

There is news of two large cash deals this morning of around $5 billion each. Applied Materials is buying Vareant and Conagra has made a bid for Ralcorp. This is precisely what the bulls need.

Institutional investors as a group are just about fully invested and the fuel to drive this market higher needs to come from somewhere. Continued cash M&A would be a boon to the market. It has been a very active week for cash deals thus far. I believe this will help limit the decline. As such, I am removing my hedges. While I am still worried about stocks over the next few months my long portfolio is not very large.

Run From Conventional Wisdom

In 2009 they heralded "The Death Of Buy and Hold" right before one of the greatest bull runs of all time. At the beginning of 2011 we were bombarded with "Don't Fight The Trend" momentum preaching right before a slow motion collapse of many momentum names and strategies. Beware the conventional wisdom of the day. Have a good night.

Bifurcated Market

It is strange to see the S&P 500 down so much while certain sectors are holding up well. Financials, staples and large cap tech are actually higher on the day. Small caps, commodity names, energy and pharmaceuticals are sharply lower.

As I have mentioned numerous times, today is the last day of seasonal strength. Seasonality has worked remarkably well and its possible that many algos are selling and rotating ahead of the weaker months.

Creating A Put Spread

I sold out of the money SPY Puts. As I am already long in the money SPY Puts, I am now long a put spread.

The Hardest Trade

One of the hardest lessons for me to learn was to trade small when I had low conviction. There was a recurring pattern in my trading earlier in my career. I would do well on high conviction trades. The money would burn a hole in my pocket and I would blow it on low conviction trades.

I have since become a lot more disciplined but it still a struggle. I am having a very good year and the temptation to let it roll is strong.  I have taken down my exposure to match my low conviction, but the temptation is there every day to take risk. The blog helps me a lot in forcing me to explain my rationale as does my experience of having been through the grinder.

Playing Devil's Advocate

In this post I want to play devil's advocate and look at the case for a continuation higher in the market. Most good tops show extreme bullish sentiment. However, the put/call ratios are pointing to neutral sentiment at the current juncture. Below is a chart of the 10 day moving average of the put/call ratio. At most good tops the line is at the bottom of the page. Currently, we are nowhere near the bottom and unlikely to get there soon.

This is somewhat surprising given that the Investor's Intelligence survey is showing extreme bullish sentiment and Rydex traders are at their most bullish positioning ever. However, the American Association of Individual Investors survey is also showing neutral sentiment.

The announcement of cash takeovers and large share repurchases on an almost daily basis furthers the bull case. At the same time the secondary offering calendar has been light given how high the market has climbed. The government is planning to sell its stakes in AIG, GM and Ally this Summer. That could add up to over $40 billion in new supply. Until that happens the supply/demand equation still favors the bulls.

A good case can be made for the bulls, which is why I have only decided to move to a market neutral posture rather than a short posture. I would be willing to go net short if more of the sentiment indicators lined up to show extreme bullish sentiment or if we get closer to the AIG re-IPO, which should introduce $20 billion in new supply to the market.

 

 

In The Nick Of Time

My plan coming into the day was to stay long until the end of the day tomorrow. When I saw the voracious call buying I decided it was time to get out of Dodge. I hedged my long exposure by buying SPY Puts just in the nick of time. I plan on remaining hedged at least until the market becomes oversold. Have a good night.

CVS and Hewlett Packard

I remain long both CVS and Hewlett Packard, despite the fact that I am no longer bullish on the overall market. In their own way both stocks typify the types of value stocks I am willing to own.

CVS is probably the best example of the type of stock I like to own:

  • CVS operates in the drugstore and pharmacy benefit management business, which has little economic sensitivity. I worry about the economy because of the imbalances that were not dealt with during the last recession and prefer stocks with little economic sensitivity.

  • CVS trades at less than twelve times 2012 estimates.

  • CVS is returning cash to shareholders. CVS has committed to $2 billion in share repurchases in 2011 and even more next year in addition to paying a dividend.


Hewlett Packard has some hair but falls in the too cheap to ignore category:

  • While HP does have economic sensitivity, it also has some steadiness due to its consulting and software business where contracts are generally longer term.

  • HP trades at less than 8 times 2011 estimates and a little over 7 times 2012 estimates.

  • The management has not committed to returning cash to shareholders and its possible that they will continue to do value destructive acquisitions.


In contrast to CVS's management, I don't believe HP's management is acting in the best interest of shareholders. HP's management can destroy shareholder value at any time without notice. However, at 7 times 2012 earnings estimates there is a big buffer. I would not be holding HP if it traded at a similar multiple to CVS.

In summary, both HP and CVS are representative of the types of stocks I like to own. CVS is trading at a very good valuation and management is taking the right steps. At HP management is a wild card but the ridiculously cheap valuation makes up for management.

Finally Call Buying

One of my complaints about the bear case has been that there is little exuberance being shown from the put/call ratios. At good tops market participants are generally buying calls. We are finally seeing extreme call buying today. It is still early but if this continues the odds of seeing a top this week are greatly increased.

Not Waiting

While the market has room to get more overbought through tomorrow and seasonality is still positive I have decided to hedge my portfolio.  I bought August SPY Puts to offset my long positions.

Upon Further Review

The largest cash deal this morning was TEVA's $6 billion buy of Cephalon. However, Cephalon was already in the middle of a hostile bid by Valeant. This makes the deal less important in that many arbs were already speculating on a takeover. Viewed in that light, today's Merger Monday is less impressive.

Merger Monday

There were two decent sized cash deals announced this morning. This is an incremental positive for stocks as it reduces the supply of stock. These cash deals make it less likely that I will take a net short position this week. More likely, I will move to the sidelines and look for clear signs of extreme sentiment.

A Trading Market

During the six months from September through February the market became oversold only once. It was a remarkable period where there was barely any weakness. I boxed that period in green in the chart below. More recently, the market has oscillated between overbought and oversold. I boxed that period in yellow.

I believe that we are now in a market where we will continue to see two way trading. It will pay to sell when we are overbought and buy when we are oversold. The one way trading we saw that started in September is over.

Heading into September the buzzwords were "risk off" and "de-risk". Equity allocations were low. These low allocations in a rising market forced managers to chase equities higher and resulted in a one way market. Currently, institutional surveys show high equity allocations and hardly any bearishness or short selling. In September we were heading into the strong part of the year. We are now entering the seasonally weak part of the year. I believe we are in a different market than many have become used to.

I believe there is a decent risk of a decline this Summer. However, even if the market manages to work its way higher I expect it will do so in more of a stair step manner rather than straight up. This will lead to trading opportunities both ways.

At the current juncture the market is overbought but has room to get more overbought through tomorrow. At the same time seasonality is strong the first couple of days of the month but then turns weaker. If we are in more of a two way market than the bears should have the upper hand starting Wednesday.