Hi there, and welcome back to CRI's S&P 500 blog.
For those new to investing, this is a very dangerous market to learn the ropes. Making a bet long or short during these 'clean-up' phases can be profitable but it also can be very costly. We always want to look at any trade from a risk perspective and given the volatility seen lately, one has to appreciate the associated risk. Talk about volatility - over a three week period (through the end of the summer) the market fell 18% (133.89-109.7/133.89) and now in just three weeks it has rallied 15% (123.97-107.43/107.43). Could another double digit percentage swing be far off? Only time will tell but one thing is for sure - expect more volatility.
While the fundamental backdrop has been relatively good over the past year or so, things aren't looking so rosy going forward. Two factors drive stock valuations - earnings and Interest rates. We have been confident of earnings but one can't help but get concerned when 2009-2011 market darlings like RIMM/AAPL/NFLX have either completely fallen apart or are starting to miss expectations. Corporate short term interest rates (as measured by Eurodollars futures contracts) are now trending higher not lower. This means that the credit squeeze that started the meltdown back in 2007-2008 is back on. At the same time, longer term government bonds have moved violently higher pushing their yields down. While not inverted, the yield curve is flattening which suggests that the broader economy is starting to slow. Weather it be the effects of Europe's indecisiveness over its' Sovereign debt or Chinese Central bank tightening economies are slowing and as savvy market participants we must listen to what the market is telling us. We talked a while ago on WCTS Spotlight blog about HG Copper and how it is called The Professor of Economics. Read our comments re. copper and you will further see validation to the notion of a slowing global economy.
So with all that said, how ought smart market participants to be positioned?
Investors: In our last blog entry (10/07) we suggested 'Investors' ought to be sitting in cash and doing nothing and have been advocating that stance for some time. I would re-iterate that mantra today. While our time tested trending indicator (that being the relationship between the weekly 13 EMA and the 30 SMA) remains negative, one ought to just sit on the sidelines and wait it all out. Considering the extreme volatility of the market right now, as investors we don't want to be looking at the screen every five minutes. Should that moving average relationship change (at current levels that isn't likely for some time) we will change our stance. While you won't make a pile of money sitting in short term government paper, this is a time not to be greedy.
Traders: In these kind of trading environments, fortunes can be made and lost in a matter of minutes and it is not for the faint-of-heart. Ironically, this kind of trading pattern is very common after prices have corrected to the 50% level. The 'trade' was to short up top and take profits at the 50% level, what we are seeing now is the clean-up from the trade. Quite often a market will break lower, consolidate, then break lower again (as was the case three trading weeks ago) but the last break lower turns out to be a trap. The market quickly reverses and heads right up to the top of the range. This is exactly what happened here. The 110 level was taken out three weeks ago which suggested we were going lower. The market then reversed and took out the trading range high of 122.87. In essence, the market ran out of sellers on the push through 110. When the floor traders saw this, they ran the market back up looking for any sellers and for the 'stops' on existing short positions. In summary - they got the shorts on the run.
Since we have left a rather large gap right at the 50% level (117.715), I personally wouldn't be inclinded to chase the market here. It looks to me like we will take a serious run at the origional breakdown point of 125.05 and then the 127.50 area (trend line resistance) after that. Considering how close we are to those levels now (123.97) the associated risk of going long doesn't make the trade justifiable. Those that were able to switch long on the pivot through 120 (congrats on a smooth trade) ought to look to those upside targets as areas to exit. This may happen in the coming days or may take a few weeks to develop. Keep in mind, the market is once again getting overbought on a daily basis and we are still bearishly trending on a weekly basis so at best one ought to be looking for a seasonal top over the next eight week to sell into.
That's all for this week,
Brian Beamish FCSI
The Canadian Rational Investor
the_rational_investor@yahoo.com
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