Musings On The Quarter That Was

It is the end of the quarter today and I have been spending some time today reflecting on what I have done right and wrong. It was a very successful quarter for me so there has been more right than wrong. I wrongly turned cautious when the S&P 500 reached 1340 but have traded my hedges well so that the cost has been modest. I'm not convinced that given the input I had at the time that I did anything wrong. I generally miss the end of rallies but I rarely get caught long at the top. That is a trade off I am willing to make.

More than market timing, my stock selection has been the reason for my success this year. My largest sector weighting coming into the year was software. My largest core positions in software were CA and BMC. They rallied 35% and 20% respectively before I sold out of them completely. I replaced them with Symantec, Comverse and Amdocs, which have done well since.

I have never done a scientific study of my returns but I believe the vast majority of my returns in recent years (post 2008-2009 bear market) have been generated through individual stock selection rather than through predicting the market. It certainly did not hurt that I was in a position to buy the past two Summers as I turned cautious ahead of the big drops, although I was early turning cautious both times. But I believe stock selection has been much more important.

I spend a lot more time on the blog discussing the market rather than my individual positions. The reason is that there is simply more to say on a daily basis. Once I write up a stock idea, there is not much to say unless there has been a major change in the price or the fundamentals. However, most of my day is spent searching for individual ideas and that is where I believe most of my returns are generated.

Cross Dressing Bear

I used yesterday's weakness to reduce my hedges and would now describe myself as a bear dressed up as a bull, albeit a very conservative one. Rydex traders became even longer last night and we are gapping up. I am trying to become more bullish for the next three weeks of very strong seasonality but the market is making it very difficult for me.

I have found that excess bullishness heading into strong seasonality generally leads to gains, albeit modest ones. Most of April's strength is seen in the first couple of days of the month and then in the middle of the month. If we rally early next week I will likely raise the strikes of my long SPY puts. Protection is cheap and I am happy to pay for it given the excess bullishness.

I would not be surprised to see today's early strength fade and am considering fading it for a trade. The biggest negative is that if I am wrong I will need to cover at the end of the day as we head into strong seasonality next week.

Can't Always Get What You Want

A nasty close would have made us oversold just as we are heading into strong seasonality. The risk/reward for a bounce would have been rather favorable. Unfortunately, the market had other plans and has started its bounce earlier than I was hoping for. I am happy I used the opportunity earlier in the day to reduce my hedges and am now in a position to benefit from strong seasonality. If we see a down day tomorrow I would still consider buying some SPY calls but its possible we have put in a  bottom for the week.

Shifting Positioning

I have moved my hedges from in the money puts back to put spreads. This is a less defensive posture that leaves me somewhat protected but gives me more upside exposure for the strongest three weeks of the year. With the VIX so low there is no need to go without protection, even if one is bullish. If we get a nasty close I will buy some out of the money SPY calls to play the strong April seasonality. That said, the stretched sentiment is keeping me from being aggressive and I would characterize my long exposure as moderate/medium.

Not Much Has Changed

Not much has changed over the past 24 hours. While prices corrected a bit, the level of universal bullishness is virtually unchanged. If we do get a nasty day today I plan on moving my hedges from in the money puts back to put spreads. We are heading into the seasonally strongest three week period of the year next week. I originally envisioned myself getting rid of my protection in the case where we had a correction this week. With the VIX so low and sentiment still jubilant I have decided that buying some cheap put spreads for protection is well worth the money. I might buy some out of the money April SPY calls as a way of playing the seasonally strong period as they trade with an implied volatility below 13 in some cases.

Looking For Weakness

Rydex traders took their net long position to a new record yesterday just as we are entering a seasonally soft three day period. For some reason the last three days of March have shown consistent weakness, which on average have been down 1.1% since 1990. I suspect that we will see additional attempts to the downside this week given the backdrop of extreme bullishness and poor seasonality. It is also possible we see a quarter end rebalancing of portfolios. Given the big move higher in stocks and the move lower in bonds, this would mean rebalancers would have to sell stocks to buy bonds.

Covering The SPY

I covered my SPY short from yesterday's after hours session. I will be looking to put it back out on any strength as I believe the bears are not done for the week.

Walgreen's Risk Reversal

Walgreen's reported earnings today that were not as bad as feared. Many thought that Walgreen's earnings estimates were too high without Express Scripts. That does not seem to be the case and the worst case scenario seems to be off the table.

Walgreen's trades at a lower valuation than CVS, even assuming that Walgreen's and Express Scripts never make up. That is unlikely given that it is in both their interests to come to an agreement. I admit to having been wrong about this for a long time but my opinion has not changed. It makes sense for them to make up before the PBM selling season is over as Express Scripts and Medco are likely to lose a lot of business without Walgreen's and have to price more aggressively on the contracts they keep.

I have added to my Walgreen's position through April risk reversals. I have sold the 33 Puts in order to buy the 36 calls for even money. It makes sense for Walgreen's and Express Scripts to come to an agreement sooner rather than later. I believe we can see an agreement in the next few weeks. At the same time with results being less worse than feared, I believe the downside is limited.

Market Doesn't Care

The market did not oblige me and instead of correcting further it blasted off. This makes for tougher decisions as we have an even more extended market with strong seasonality right around the corner. I decided to err on the side of caution and move closer to a market neutral stance by shorting SPY in the after hours session yesterday.

There is a nearly unanimous consensus that it simply does not pay to fight the tape and anybody who does is in denial. There is tremendous pressure for managers to keep up with the Dow Joneses. Retail investors need to hear their friends and family say "I own Apple from X dollars". All this adds up to the straight up, performance chase we have been witnessing. This is not the type of mentality that is present during good buying opportunities. I remain patient and willing to miss out until a better opportunity presents itself.

Phil Falcone's Other Big Bet: Spectrum Brands

The subject of billionaire hedge fund manager Philip Falcone elicits strong feelings. He is best known for his big bet on Lightsquared but lesser known for his other big bet: Spectrum Brands (SPB). Phil Falcone controls over 50% of the $1.65 billion company ...

Read the rest on MarketFolly

Tightening The Hedges

I have tightened up my hedges by rolling up the strikes of my long SPY Puts.

Tricky Juncture

The market is at a tricky juncture. Sentiment is excessively bullish and we have not had a real gut check for the bulls in months. However, we are a week away from the seasonally strongest three week period of the year. Often during these seasonally strong periods we see extreme optimism become even more extreme. This makes for a difficult decision as both the bulls and bears can make a good short term case.

There is still room this week for a correction. If we were to see some corrective action this week I would be willing to add moderately to my long exposure heading into strong seasonality. However, if the market keeps zooming ahead I would likely tighten my hedges up. Under normal circumstances I would be market neutral or net short right now but as a result of the positive seasonality I have medium sized long exposure with some April SPY puts for protection.

Shallow Correction

The market did see a post-expiration correction this week although it has been on the very shallow side thus far. I believe that there is still potential for a further correction next week. If we do see one it could likely be bought for the very seasonally strong first few weeks of April. Seasonality is strong early next week but very negative for the last few days of the week. Have a great weekend.

 

Not Ideal

The swoosh lower that we saw earlier in the morning is a good thing for the bulls looking for a bottom. Unfortunately the wave of extreme call buying that we are seeing following that is not. The pullbacks in the past few months have been shallow so one can argue the market has done the minimum for this correction but I would much prefer to see more downside and the bulls get shaken up a bit more.

Top Of The Morning

A correction serves to wring out the excess bullishness in the market. I wrote late yesterday that my sense was that people were not giving up on their bullish stance, despite the market decline. This was confirmed by the Rydex numbers from last night as traders actually increased their net long stance into yesterday's decline. I strongly suspect that the correction is not yet over.

Italian and Spanish spreads are widening once again after months of tightening. There are no longer any significant programs in place to aid spreads. It will take a significant worsening of the situation before the Germans agree to do more. Unless spreads start tightening on their own we could be in for the next chapter of the Euro crisis soon.

Not Over

My best guess is that this correction is not over as I believe a lot of people have been caught leaning the wrong way. I saw few signs today of people giving up. This market has constantly surprised to the upside so I shifted my exposure to allow for  a shallow correction in case I'm wrong, but I would be very surprised if it were up, up and away from here. Have a good night.

Shift To Defense

Last year during the March correction we saw a major shift towards defensive stocks and sectors that lasted throughout most of the year. This happened despite the fact that the market rallied until early May. We are seeing a similar  phenomenon this year as defensive stocks and sectors have lagged badly all year.

I am noticing that defensive stocks are holding up rather well today. During the few other dips we saw this year they basically moved with the market and did not offer protection. This might be a clue that defensive stock are set to outperform again. My longs tend to be of the conservative variety, not high octane, so this should benefit me if I am correct about this shift.

The Tradeoff

The tradeoff that I received from my shift in positioning today (described in the previous post) is that I will now be able to participate in a rally as if I were medium net long but am no longer protected in the case of a complete collapse. I am still protected in the case of a normal correction. My best guess is that this correction has not yet run its course, but I did not want to wait too long before making this shift.

Shifting Positioning

I have covered my SPY short and sold my deep in the money SPY puts. Instead, I bought April SPY139-134 put spreads. This protects me from a further correction but not from a complete collapse below 1340 on the S&P 500. I believe that the market should at least manage not to collapse during this seasonally strong period. On the upside I would be able to participate in a rally, should it occur in April.

Buy The Dip or Holding The Bag

The "buy the dip" crowd seemed to run out of steam yesterday and I believe the majority of traders are leaning long. Rydex traders are sitting on near record longs. We saw a big drop in the VIX yesterday despite the lower market, leading me to believe that a big long vol trade blew up yesterday or somebody put on a big short vol trade. Either way it does not seem that the crowd is positioned well for a decline.

We are in a seasonally strong time that tends to see heavy inflows into the market so its possible that inflows save the day. That is the only positive I see right now and not enough to make me want to take on a large amount of market exposure. I would use a correction in the next few days, if it occurs, to take me back to medium exposure levels.

I See Stupid Things

There are stupid things going on left and right. This reeks of excess speculation:

  • Zynga is up 7.5% because they announced a press conference.

  • Barton Biggs just announced that he is 90% long.

  • Goldman and Citigroup put out reports today related to new eras in investing

  • LinkedIn is up 9% on a Goldman upgrade. Goldman put a $135 price target on LinkedIn on $1 in 2013 earnings. The $1 in earnings ignores stock option grants.

  • Apple goes up $10 a day as investors pile into call options.


I know. I just don't get it.

Get Your Kool-Aid Here

Goldman put out a breathless piece this morning about how cheap equities are relative to treasuries, calling this a rare buying opportunity. Where were they 6 months ago before stocks rose 30%? I would note that treasury yields were lower at that time as well. One thing that never changes in the market is that people get bullish higher and bearish lower.

These type of calls after a long rally are cautionary as they tell you that everybody is drinking the Kool-Aid. This is yet another sign that sentiment is overheated and that caution is warranted. I continue to expect more corrective action this week.

My Newest Position

My column at MarketFolly is up explaining why I purchased my newest position, Amdocs.

Is the Hangover Finally Here

We are in a very seasonally strong time of the year but I believe there is still a window for some sort of a pullback this week. The first dip is being bought today but I expect there will be more attempts on the downside this week. Market participants have been conditioned to buy every dip and that is what they are doing.

The number of options trading in Apple is disturbing. Yesterday over 278,000 AAPL contracts traded, the underlying value of which is nearly $17 billion dollars. This tells me people are using extreme leverage to own Apple and these things don't tend to end well. With Apple being a large part of the major indices it will likely have  abroad effect if/when it does unravel.

Record Breaking Rally

The current rally has been record breaking as the Nasdaq 100 is up for 11 weeks in a row for the first time since 1999. As a mean reversion trader and investor I don't expect to catch the tail end of record breaking moves. Im just happy when I don't find myself on the wrong side of them. Luckily I have managed to stay very modestly net long but today made some moves to get me closer to neutral. I strongly feel we will see a correction this week. Have a good night.

Tiptoeing To The Dark Side

I have rolled up the strikes on my SPY Puts as I slowly tiptoe to a more defensive position.

Looking For A Pullback

I expect a pullback at minimum this week, despite the Apple hoopla. Last year the market topped out on news that Osama Bin Laden was killed as the news is always the best at the top and worst at the bottom. There are quite a few reasons to expect weakness:

  • The put/call readings late last week at both the ISE and CBOE showed the type of exuberance not seen in a year.

  • Option expiration often serves to perpetuate a strong rally and then we see a hangover. I have seen many market turning points right after option expiration.

  • The IPO and secondary offering calendar are pretty heavy already for this week and we are likely to see more secondaries announced. Insiders have been selling aggressively and there's no reason to believe that will stop.

  • Quarter end rebalancing will be negative for stocks as stocks soared this quarter and bonds plunged.

  • A host of indicators are at extremes such as Rydex and Consensus.

Nothing Done

The crowd would be ill prepared if the market went down as most would be positioned the wrong way. But this type of crazy bullishness often persists through seasonally strong periods. I'm too scared to buy or sell at this point. Luckily, this has stopped me from doing anything thus far. Have a great weekend.

 

Expiration Hangover

We are seeing extreme call activity for a second day in a  row. This is not bullish but the caveat is that it might be expiration related. Expiration often serves to extend a rally and we often see a turn down following option expiration. This extreme call buying, the fact that the market is extended make me think we are likely to see an expiration hangover next week.

Momentum Rules

My best guess on how the next few weeks unfold is as follows. We should see some sort of a correction next week in the 2%-4% range after which we should rally again. A bigger correction is not likely in the cards until after the seasonally strong period is over. I have not yet decided if I am going to position myself more aggressively for a correction next week.

I must admit to struggling with the market recently. Luckily it has been more of a case of missing out rather than capital loss. The size and duration of the rally we are seeing without a corrective move in between has been with little precedent. Hedge funds dominate the market and their risk on/risk off mentality is creating tremendous moves. I have made adjustments to account for this but it simply has not been enough. Luckily, my understanding of this dynamic has been enough to keep me out of trouble and away from a net short position.

Expiration Related

I don't know if its expiration related but we are seeing extreme call activity this morning at both the ISE and CBOE. This is definitely not  a positive, especially if it continues all day.

Caution To The Wind

I am seeing abundant signs that investors are throwing caution to the wind. This type of behavior would normally take me to a net short posture but the very strong seasonality has me torn. I have seen this type of behavior persist through seasonally strong periods. In 2010 the market came into this same seasonally strong period very extended but did not correct until late April. That said, the signs of excess are so great that I am strongly considering moving to a market neutral posture or getting net short:

  • Rydex traders are at record long positions.

  • Consensus bulls are at 78%

  • The VIX is at a post-crisis low.

  • Many technical pundits who were looking for a  correction threw in the towel in recent days.

  • The pace of secondary offerings has reached a fever pitch as corporations are rushing to sell stocks.

  • Apple gaps up by $5 a day every day than keeps running. This pace cannot persist until late April. This type of behavior is often seen in the later phases of a rally.

  • We are likely to see a big asset allocation out of stocks and into bonds later in the month due to quaterly rebalancing. Stocks are up big for the quarter and bonds are down big.


I am sitting on my hands for now but as we get closer to expiration I will be more likely to move closer to the dark side.

 

Shifted Some Exposure

I shifted around some exposure today. I completely sold out of my position in CA Technologies. I now own Symantec, Amdocs and  Comverse in software. I could not help myself and I added to my already large Vodafone position.

On Shorting Apple

The retail folks I speak to all love Apple, while people who manage money for a living either love it or are dying to short it but are too scared. I see both sides of the argument as in many ways it encapsulates the entire market. The bulls will argue that the valuation is reasonable, while the bears will argue that the earnings are not sustainable in the long run and that it has gone too far too fast.

If I were going to short Apple I would wait until late April. In the coming month a lot of money will be entering the market. The pension/IRA/401K contribution deadlines are rolling around and tax refunds often get put into the market as well. A large chunk of this money is likely to find its way into Apple as it is the most loved stock out there. I would wait until everybody gets in before trying to short it. Its possible that it will pull back before then or even top out. But the best risk/reward on the short side would be if it is still soaring in late April. By the same token I would be very careful with longs at that point.

Banks Buying Themselves

On the margin the large number of share repurchases announced yesterday is bullish. It is especially bullish for the financial sector, where the repurchases are set to occur. Many  investors are underweight financials, so the potential for outperformance is there. The other side of the argument is that these stocks have run a long way in anticipation and in reaction to the news, so a decent pullback is a possibility even inan intermediate term bullish scenario.

While I acknowledge that yesterday's news was an incremental positive, my view of the market has not changed because the market is now even more stretched. I try to always point out both the good and the bad even if it does not jibe with my positioning. I don't want to fall into the trap that many do of only looking for data that supports my view. My style is not to chase extended moves and i don't want to veer from that either.

Respecting The Bull Case

The level of complacency in the market is about as high as it gets. The VIX is about as low as its been since before the crisis in 2008 and anecdotally it seems worry has been banished. I am very tempted to move from my very modest net long and become more defensive but I am stopping myself for the following reasons:

  • We are headed into a very seasonally strong period. In seasonally strong periods extended markets often become more extended. A lesson I have learned the hard way numerous times.

  • The backdrop of corporations aggressively repurchasing shares remains.

  • The S&P 500 trades at 13.5 times expected earnings for 2012, which is reasonable.


Given the market backdrop I am very comfortable with my positioning. I am finding some very attractive stocks that have been discarded as investors chase beta. I believe these should outperform my hedges over time regardless of market direction.

Share Repurchases Are Bullish

I have been pointing to share repurchases as a big positive for equities since the Summer. Bloomberg Business Week quantifies the effect of this:
Stocks are getting scarcer in the U.S. for the first time since the bull market began as companies cut share sales to the lowest level since 2006 and buy back equity at the fastest pace in four years.

Amgen Inc., Hewlett-Packard Co. and 1,971 other U.S. companies repurchased $397 billion of stock last year, while they issued $169 billion of new equity, data compiled by Birinyi Associates Inc. and Bloomberg show. The combination reduced the Standard & Poor’s 500 Index divisor, a measure of outstanding shares, by 0.6 percent last quarter, the first drop since March 2009.

Stock Of The Week

My stock of the week is up at Market Folly. Here is an excerpt:
Comverse Technology (CMVT) was involved in an accounting saga that dragged on for years and cost well over a billion dollars to untangle. During that period, a who's who of hedge funds tried to catch the CMVT falling knife unsuccessfully. Currently, Soros Fund Management and Barry Rosenstein's Jana Partners own major stakes in Comverse.

No Edge

The market is set up such that I don't believe I have much of an edge. Friday's jobs report made everybody feel that all is well with the world. Unfortunately, those are not typically ideal times to invest as a lot of good news gets priced into the market. At the same time the market is entering a very seasonally strong period later this week. I have very often seen extended markets like the current one become more extended during seasonally strong periods.

While I am not willing to take on much market exposure I do believe there are individual bargains in corners of the market. Some defensive stocks like Vodafone are being discarded in favor of more economically sensitive stocks. A handful of steady, boring software companies trade at single digit price to free cash flow ratios. My current stance is to be long cheap, steady companies with some market hedges.

Taking Another Look At Vodafone

Vodafone is my largest position and has been a big underperformer for me this year. The stock is down 5% year to date while the S&P 500 up nearly 10%. While nobody can know for certain why the stock is performing so poorly I can hazard some guesses. Telecom stocks in general are performing poorly this year as they are defensive in nature and this is a "risk on" rally. In addition, European telecoms are performing particularly poorly as a weak economy and regulation are hurting profits.

When I purchased the stock I had no illusions that the European wireless telecom market was strong. Vodafone is a geographically diversified telecom company and over time wireless telecom should grow as a cellphone is not a luxury item. Vodafone trades at a massive discount to the broader market and to US telecom stocks. When a position goes against me I look at it again to see if anything has changed. In the case of Vodafone I believe the value is still there and the stock is even more attractive than it was a few months ago.

Unwinding 1/2 of Lowe's Trade

I unwound half of my long Lowe's / short Home Depot trade as the trade has had quite a run. I allowed this trade to go from a big gain to a decent loss previously. Now that I have  a nice gain again I'm not letting it go. This likely means it keeps running.

What If

If the market corrects into the middle of next week, heading into a very seasonally strong part of the year I will gladly increase my long exposure. The tougher decision becomes what to do if it rallies into that period.

I try not to sell short into seasonally strong periods unless every indicator is lining up or I have a very definable catalyst. That is currently not the case so I know that I will likely not be looking to add to shorts aggressively. If anything I might remove some hedges and write covered calls against some longs instead.

I am hoping for at least a consolidation in the next few days. If it does not happen I will try to be patient and wait for a better opportunity. As Warren Buffet says, "What’s nice about investing is you don’t have to swing at pitches". And as his partner Charlie Munger says, "I didn’t become a billionaire by chasing after mediocre opportunities."

Out For The Day

I will be out of the office for the balance of the day.

By The Book

Trying to trade this market based on past experience has been difficult, as the market has set all sorts of records with the persistence of the most recent rally. With that caveat, it would be quite unusual if the correction were already over. As a result I have used the pre-market strength to put back on the hedges I removed when the market was 1% lower.

There are two reasons that I believe this correction is not over, time and sentiment. Ideally a correction would last 10 trading days, at which point the correction would become exhausted. If the correction is already over than it lasted all of 3 trading days, maybe 4 depending on how you mark the beginning of the correction. A correction is supposed to move sentiment closer to neutral territory and I don't believe three down days were enough to accomplish that. At a minimum I would expect a few more days of choppy action.

 

Hedges Back On

I have used the pre-market strength to put some hedges back on.

AIG Coming To Market

The government is coming to market with $6 billion of its AIG position. AIG will buy half the shares. This is a minor negative as it is additional supply in the market. Today's rally is exactly what was to be expected with the market oversold. Unfortunately, the correction is not likely over yet. Have a good night.

Small Cap Nonsense

There is a very annoying notion in parts of the money management community that managers can only add value in the small cap sector. The theory goes that large caps are analyzed by so many people that there is simply no way to outperform, while small caps lack coverage and a manger can add value. A decade long run of small cap outperformance gives the people who espouse this theory even more confidence in their assertion even though it should give them pause.

Like with any other asset class, at a certain price it makes sense to own large cap stocks and at a certain price it makes sense to own small cap stocks. Am I supposed to buy a less liquid small cap stock at a far more expensive valuation because there is a theory that I can only outperform in small cap stocks? No thank you. John Hempton at Bronte Capital has two articles where he pulls no punches that I would highly recommend on the subject.

Article 1

Article 2

Correction, Not A Top

The S&P 500 has fallen a quick 40 points from last week's highs and the market is oversold, so we are seeing a bounce this morning. I don't believe the bounce will carry very far as there are too many trapped longs that will look to sell a bounce. Corrections are as much a function of time as price. It is too soon to get a good rally, but another week of corrective action should produce a better rally.

I believe we are seeing a correction and not a market top for a number of reasons:

  • We continue to see very aggressive share repurchases being announced. Last night Quallcom announced a $4 billion repurchase and the previous night Applied Materials announced a $3 billion repurchase. This comes after a very strong month of share repurchase announcements.

  • Mid-March to mid-April is an extremely seasonally strong period.

  • There have been no buyable dips this year. The first buyable dip is likely to be bought by underinvested managers who didn't want to chase and sold out bulls.


 

Big Down Day Random Thoughts


  • We are finally seeing unadulterated selling today. I believe this needed to happen and is a good thing in the long run. A market that sets all sorts of records for being extended is not somewhere I want to invest.

  • If the market were to remain corrective for another week this would likely get sentiment closer to neutral right in time for a very seasonally strong month long period.

  • I believe the reason for the seasonal strength from mid-March to mid-April is that people receive tax refunds and there is the IRA deadline. Regardless of the reason there is a clear seasonal tendency.

  • It might be hard to believe but the market is already oversold. Most stocks have been declining as the Russell 2000 is now at levels first seen on January 24. That said, its not a great oversold reading.

  • The first dip in the market usually gets bought. Underinvested managers like myself are likely to use the first real dip of the year to add to longs.

  • I expect that the market will retest the recent highs by April option expiration, although I would not be surprised to see a couple more percent downside before that journey begins.

  • I am looking for one of two things before adding to longs. 1. A clear sign of fear, panic or excess negativity 2. More time to pass as this is only Day 3 of the correction. The closer to 10 days the better.

Stock Of The Week

My stock of the week is now up at Market Folly.

A Method To My Madness

Many are likely wondering why I was so quick to remove my hedges if I am cautious at current levels. I believe that we are at risk of a correction of 5% or so but don't believe we are at  a longer term top. Coming into the day I was pretty close to market neutral, which was a little aggressive given my outlook.

I believe there is still risk of a further correction as sentiment remains stretched. In the past few weeks I both sold down longs and added hedges. I am going to wait for a deeper correction before adding back longs. Seasonality turns positive next Thursday according to the trading calendar I shared last week. Ideally, I would like to see a decline through the middle of next week that moderates the excessive bullish sentiment in order to add back longs.

 

Using The Weakness

I am using this morning's weakness in order to take modest profits in my hedges. I am now back to a moderate net long. In the past few weeks I have both sold down longs and added hedges. I am waiting for a larger correction before adding back longs.

Under The Hood

Most of my stocks have been slowly dripping lately and are now down a few percent while the major averages are still within spitting distance of their highs. Megacap stocks like IBM and ExxonMobil are chugging along while most stocks have been lagging. What does all this mean? That I'm annoyed. Have a good night.

Added To Symantec

I have used today's weakness to add to my Symantec position.

Market Pros and Cons

The Pros

  • Valuations are still reasonable. We are trading at about 13 times expected S&P 500 earnings for 2012.

  • Corporations continue to return cash to shareholders via repurchases and cash takeovers. While share repurchases have dropped off the level they were running at late last year, they are still at a level supportive of the market.

  • Corporate debt markets remain supportive of the market.

  • We still have nearly two months before seasonality turns negative ("Sell in May")

  • The market is nearing a short term oversold reading, albeit not a great one. How's that possible? The Russell 2000 is at a 1 month low. Most stocks have been declining, while the largest stocks have been rallying.


The Cons

  • Rydex traders are record long

  • Consensus bullish sentiment is 77%. That's about as high as that reading ever gets.

  • Market Vane bullish consensus is at 67%, which is about as high as it has gotten post 2008.

  • Corporate profit margins are at a record. It will be difficult for corporations to continue growing earnings more than revenue.

  • The excess debt that has caused several accidents and near accidents in recent years is still present.

  • Insiders have been selling aggressively and there has been a pickup in secondaries.


There are times when I lose money and I know that I made a mistake. Those are the toughest losses to deal with and the ones that linger in my memory. There are other times when I lose money and am able to look back and say that I would do everything the same way, given the facts at the time. When deciding on taking on an individual stock position or taking market risk I ask myself a question. If I end up losing money on this trade, will I look back and regret the decision.

If the market were to correct by 5%, or worse, if one of the many global imbalances were to creep up and cause a larger drop, would I look back and kick myself for taking a lot of market risk right now? The answer is yes. So many sentiment indicators are at dangerous levels after a 28% rally that it would be impossible to look back and say the warning signs were not there. Hence, I am pretty certain that I don't want to take  a lot of market risk right now. At the same time the bull case is not completely without merit, so I do not see a case for a short position. I continue to wait with little market exposure for better opportunities.

Frustration

I am not a big fan of buying into extended markets so I continue to sit the party out. The bears have their best chance to take this market down in the next two weeks before seasonality turns very strong. I really hope that they do so that I can feel comfortable taking on more exposure. Have a great weekend.

Stock Of The Day Update

I have received very positive feedback on the "stock of the day" feature from readers. I believe it worthwhile to continue but have come to the realization that it will be nearly impossible to keep up after a while at the same level of quality. I have decided instead to write up two stocks a week. Some write ups will be posted here and others will be at MarketFolly.com, an excellent site  that follows hedge fund activity. Here is a list of some of the previous write ups:

Why David Tepper owns Boston Scientific

Why Dan Loeb owns Yahoo!

Why Vodafone is my largest position

Why Lowe's Should outperform Home Depot

Why David Einhorn owns Xerox

 

A Secular Shift

The Russell 2000 is lower since the day before the February employment report, while the S&P 500 is nearly 4% higher. That is  a large margin of outperformance considering the market has gone higher. I think this may be part of a larger secular shift to large cap outperformance. Large caps have now outperformed over a one year period as well.

Small cap stocks have outperformed large cap stocks since the year 2000. Large caps now trade at a large valuation discount to small caps and seem poised to outperform. I think that this change is being driven by the fact that large cap companies are spending a lot more of their cash repurchasing their own stock or acquiring other large cap companies versus acquiring small cap companies.

Large cap outperformance makes sense to me as I would prefer to own cheaper companies with better liquidity. After several false starts over the past decade large caps may finally be having their day in the sun.

Taking Some Profits On Lowe's Pair Trade

After a nice run I unwound the portion of my long Lowe's/ short Home Depot trade that I added at the beginning of the week. I am back in the black on this trade and I am sticking with my original position.

Call Me Switzerland

Spending a day away from the market was not enough for me to regain my senses as I remain cautious on the near term prospects of the market. Many of the things I am reading and hearing are the polar opposite of the end of the world stories I was hearing during the Fall. Valuations are reasonable and a very strong seasonal period starts in two weeks so I am not willing to bet against the market. However, I am not willing to take market risk as I believe the risk/reward is poor.

One of the most twisted pieces of logic I have been hearing is that the market won't correct or pull back because we are in a bull market. While I have only been investing for three market cycles I have yet to experience a bull market or studied one where there have been no pullbacks or corrections.

In a flashback to 1999, the news that Zynga is opening a website sent the stock up by 15%. Retail investors keep buying Apple because of the hot tip that an iPad 3 is coming out. Imagine their jubilation when they realize its certain to be followed by an iPad 4. Strategists are once again raising their price targets on the S&P 500 after lowering them during the Fall. All the while insiders are dumping stock hand over fist and bankers are pushing out as much supply as people will buy. No thank you.