The David Tepper Interview

The majority of the discussion surrounding David Tepper's appearance on CNBC had to do with his bullish outlook. The part I found most fascinating was when he said that it would not be a big deal if we went off the fiscal cliff and the market took a 5% dive. He is long so extrapolating further that would mean that his fund would take a hit. Most hedge fund managers use jargon like "risk control" and would never say something to the effect of, "So what if we lose some money. It happens."

It is common sense that 30% a year returns cannot be achieved without taking risk. Obviously those risks need to be intelligent and David Tepper believes his upside is much greater than his downside.  But he realizes there will be times when hes wrong and will lose money. Many hedge funds are so focused on avoiding losses that they do not allow themselves to make any money. Hedge funds worry that if they suffer a draw down investors will redeem. So they play not to lose and end up suffering losses by a thousand paper cuts. I believe that this behavior has played a large role in the underperformance of the hedge fund industry in recent years. Many hedge funds would be wise to take something from the David Tepper interview other than the fact that they can now buy with reckless abandon.

The Difficult Period

The seasonally strong period that begins in November and continues through most of  January is a difficult period for me to navigate.  Many of the sentiment indicators I rely on simply do not work during this period. Often times excess bullishness can persist during this seasonally strong period without effecting the market.

We saw the highest reading in years on the NAAIM survey last week. Yesterday we saw the most call buying in over a year on the ISE. We also saw extreme call activity at the CBOE. During any other time of year these kind of extreme readings would almost guarantee poor performance going forward. But I have seen numerous occasions where these extremes don't effect the market at year end.

I have mentioned numerous times in recent months that I like to give the market the benefit of the doubt during these seasonally strong periods. Despite this I found myself a little more hedged than I wanted to be for yesterday's strong rally but still moderately net long. I do not plan to add to my hedges despite the negative signals my sentiment indicators are giving off.

Tax Selling

In the past couple of weeks we have seen a steady stream of secondary offerings and insider selling. Much of this is likely due to the tax increases going into effect in January. Over $14 billion of secondaries have been announced this week alone. This additional supply of stock will make it  difficult for the market to make much headway.

I was hoping for a decline this week that would dampen sentiment. Instead the modest advance  has sent sentiment towards excess bullishness. The AAII bears, Investors Intelligence bears, Hulbert newsletter writers & the NAAIM are all approaching levels of excess optimism.

I believe that the risk in the near term is to the downside and have added to hedges as the market has climbed. The market has laughed at my plans for a decline and then a rally into year end. I still believe this can occur but the timetable has been pushed out a bit.

The Second Half Of The Month Should Be Better

The bears have not done much with the overbought reading this week  but still have another week to try and send the market lower before the overbought reading is completely worked off. Other dynamics such as seasonality and insider selling allow for further downside into the middle of the month. I believe that a move lower into the middle of the month would be a buying opportunity as many of these same factors will turn positive at the end of the month. is reporting extreme amounts of insider selling, especially among founders who own large stakes in companies. This is likely due to capital gains tax rising next year. While this selling is likely not related to fundamentals the additional supply of stock does not help. Towards the end of the month many company insiders will be in a blackout period as we approach quarter end so the selling from insiders should lessen.

The special dividend announcements have been coming in fast and furious. Most of these special dividends are scheduled to be paid in the latter part of the month. If  a portion of these dividends is reinvested it should be an incremental positive for the market.

A move lower into the middle of the month would make the market oversold, with seasonality turning positive in the latter part of the month and a slew of special dividends scheduled to arrive. The short term outlook remains iffy but it should get better once we get past mid month.


Rest At A Minimum

The current rally has taken the S&P 500 up over 70 points from the lows in a period of two weeks. That makes the market short term overbought. Seasonality is strong for the first couple of days of December month but turns negative later this week. I expect the market to make a short term high in the next few days. At a minimum the market should trade sideways if not lower.

While I am cautious about the very short term, the intermediate term picture is not as clear. Sentiment indicators show that investors remain on the bearish side despite the recent rally and intermediate term seasonality favors the bulls. Normally I would say that this combination is enough to make me very bullish in the intermediate term.  But it is difficult to know what effect a change in capital gains rates will have in the last few weeks of the year. There is also the possibility that all the special dividends have  a positive effect on the market.

My plan is to use strength early this week to put on some hedges but to remain net long. It takes extreme optimism for me to get neutral or bearish at this time of year and we certainly are not seeing that.