Special Dividends

The market is getting a little frothy in the very short term and its possible that we see a dip in the early to middle part of December. In the intermediate term sentiment is nowhere near extreme and we are still in the seasonally strongest few months of the year. While I have used strength to trim some positions and wrote covered calls against others I am maintaining a medium to moderately net long posture. I prefer to give the market the benefit of the doubt during this time of year.

A few companies have announced special dividends for the latter part of December. If this trend picks up and an abnormally large amount of dividends are paid out in late December it could give the market  a lift as some investors reinvest these dividends. The ideal setup would be for us to see a correction into mid December, all the while many more special dividends are announced. That would make for an excellent risk/reward long setup.

The Easy Trade Is Over

It was highly likely that we would see a bounce from the extreme oversold condition and excess pessimism of a week ago. Now that we have seen that bounce the future direction is more difficult to predict. We are not yet overbought and sentiment is muddled.

Normally, I would expect to see a retest of the recent lows at some point but in recent years we have seen numerous instances where the market moves in a single direction with nary a correction. In the past week I have sold my trading longs and written covered calls against some of my core positions. I would now describe my posture as a medium sized net long position. Have  great weekend and a belated Happy Thanksgiving.

Too Much Pessimism

I have been using weakness in the past week to further expand my longs. I thought that we would see a turn in the early part of last week but it took until Friday for that turn to occur. There are even more  indicators pointing to excessive pessimism than there were a week ago:

  • Rydex traders are positioned nearly as bearishly as they have been all year.

  • Hulbert newsletter writers are recommending an outright short in the S&P 500, which is not seen very often.

  • Both Investors Intelligence and AAII bears are at the highest levels in a  year.

  • The market is deeply oversold


The oversold reading, the excessive pessimism and the very strong seasonality help make  a very strong case for the long side. I am positioned aggressively long.

Chimera At a Discount: Part 3

A few weeks ago I wrote up why I thought Chimera was undervalued (Part 1 & Part 2). The stock is up 8% today on news that Annaly(NLY) offered to buy its other subsidiary, Crexus (CXS), for a 5% premium to book. I believe that Annaly will eventually buy Chimera and believe that book value is over $3.20.

Annaly invests in agency securities. It subsidiary Crexus invests in CMBS. Chimera, Annaly's other subsidiary invests in non-agency RMBS. Annaly said on its latest conference call that the opportunities in agency securities are not attractive because the Fed has distorted the market. Now that Obama has been re-elected for a second term it makes it likely that these distortions will not end any time soon. It makes sense for Annaly to diversify into other markets.

The reason I believe that Annaly has offered to buy Crexus but not Chimera is because Chimera is not current on its financials.  It is a matter of time before Chimera becomes current and when they are I believe they will be bought by Annaly. The type of assets that Chimera holds had a tremendous rally in the third quarter. Chimera last reported economic book value of $2.87 as of the end of June. I estimate that current economic book value is over $3.20. If Annaly pays the same premium that it paid for Crexus that would equal roughly $3.35

Calling For a Rally

I believe that the risk/reward is starting to shape up very favorably for a rally. I have been complaining recently that sentiment refuses to tilt into excess bearishness. I believe that all that changed on Friday. Following Obama's speech all I heard was dire talk. Anecdotally, this was the most bearishness I have seen since June. We are also seeing some empirical evidence that there is excess bearishness as well:

  • The assets in Rydex bear funds as compared to Rydex bull funds reached their highest level since June. This applies to the leveraged funds as well.

  • The CBOE put/call ratio has been above 1.10 for three days in a row. That is extreme put activity.

  • The volume in SDS, the Ultra short S&P 500, was the highest in over a year on Friday, per sentimenTrader.com.


We have often seen follow through selling on Monday's after a nasty week followed by a Turnaround Tuesday. I am already positioned long but if we do see a decline on Monday I plan to expand my long position. I believe a rally is in the cards.

Signs Of A Bottom

We are seeing some signs of a short term bottom today:

  • We saw panic in the most important stock in the market, Apple. It seems to me that we finally saw panic in Apple today after weeks of people trying to call a bottom. Volume is tracking higher than anytime in over six months. This more of  one of those "you know it when you see it" type of calls as its difficult to measure panic in an individual stock.

  • Put buying is high for  a second day in a row.

  • New 52 week lows have contracted from yesterday even though the market has made a lower low. this is a positive divergence.

  • We saw several extreme readings yesterday that typically lead to a rally within a few days. Today's carnage only adds to those odds.


I have taken some trading longs in anticipation of some sort of a bounce.

Bounce Likely

A nasty day like yesterday typically leads to a short term bounce. While the short term conditions are ripe for a bounce the intermediate term conditions remain foggy. The sentiment indicators remain mixed as market participants have backed off their bullishness but refuse to turn excessively bearish. It seems as if market participants have been punished so many times in recent years for being excessively bearish that they refuse to make the same mistake. The result is a longer, more drawn out correction.

Two sentiment indicators I look at typify current investor psychology. The leveraged  bull funds at Rydex have close to the lowest amount of assets seen all year. This is a big drop from a few weeks ago and shows that many of  the bulls have given up. At the same time the bear funds also have close to the lowest asset levels seen all year. While investors have backed off their bullishness they refuse to get bearish. The same can be seen with the Investors Intelligence bears, which refuse to climb as well, while the bulls have backed off.

I am continuing to give the market the benefit of the doubt in this typically strong seasonal period. I added to my net long positioning yesterday but not by as much as I planned to because the sentiment indicators have yet to line up.

 

Seasonality Works

Many sophisticated investors look down at seasonality and view it as voodoo. I believe it is a very valuable tool. History has proven that seasonality works more times than not. The following table is from Mark Hulbert at Marketwatch showing market performance in the stronger months versus the weaker months.

 




























Dow’s “summer” gain — over the six months beginning on 5/1Dow’s “winter” gain — over the six months beginning on 11/1
20101.0%15.2%
2011-6.7%10.5%
2012-0.9%???
Average since 18961.7%5.1%


I learned the hard way that seasonality works by fighting the market at the strongest parts of the year earlier in my investment career. Seasonality is not a be all and end all. It is one of many indicators I use to form a market opinion.