Current Market Outlook - Final Thoughts Ahead of my Vacation

I am off for a well deserved vacation starting this Thursday. I will be out of the country (trekking in Nepal and India) and will not likely trade or even check my portfolio often. In my real account I positioned myself more or less defensively, raised some cash, and sold some low conviction stuff and a bunch of June calls to protect against a possibility of a nasty correction. Having said that, if I wasn’t going on vacation, I would still be pretty invested now. But I am putting my portfolio on autopilot and you will not see any transactions until I get back on June 1st.

As far the market outlook, here is my take:

Just like everyone else I believe a mild correction is way overdue, and like many others I am disappointed that we really didn't get one. Unless you want to call a shallow pullback we got last week a correction. Having said that, it’s not about how I feel. The market doesn't really care how I feel, or how you feel, or how much some of us wish for the market to move exactly as we expect.

Right now, the market action is telling us that it’s just not yet ready to go down. Why? Let’s examine a few things:

We ended last week with a decidedly bearish bias. This was a first down week after multiple UP weeks. We exhausted all the positive catalysts related to earnings and green shoots. We witnessed an incredible increase in supply, as secondary offering and money raises by financial and non-financial companies alike hit the market. We are also approaching a seasonally weak market time. The economic data continues to show further weakness and question a potential of recovery anytime soon. So, it is totally sensible to expect a market correction. However, let's keep out minds open and not let micro vision take over.

On a second look, we had a shallow sell off, which was aborted at 20 day ma for SPX. We had a reversal day on Monday, (opened lower and made a new low, then reversed and closed above the previous day's high. This is positive, especially when bouncing off of a support and following options expirations. The market is continuously shrugging of poor eco-data (crappy retail sales, crappy housing starts, crappy gov't policies, etc). Short interest is down in May and has not been increasing with the rising market. Shorts seem to be clearly humbled by the resilience of this market and don’t have much resolve to fight the tape. As far as the sentiment, I think there are still plenty of bears and cautious investors, with many HF still under invested on the long side and with little incentive to short.

The trading range remains 875 to 940 on SPX.f we break above 950, I think the buying panic fueled by under performance anxiety will kick in and get the market higher...1000?. If we fail to break above 940, and in the absence of a major negative catalyst, we may just drift back down to 875. If we continue to buy pullbacks, I think another rebound; even more powerful than we are seeing now will follow. My focus remains on areas I have been bullish for some time: energy and materials, China and Brazil, and select special situations. Good luck!

WH - Remains My Top Pick

Despite many cautionary red flags and signs that we might be in a beginning of a corrective phase, I believe the next pullback will present a good buying opportunity for stock pickers. This is the time when you can create alpha for your portfolio not by buying or shorting the market, but by finding the gems that will outperform the market both during correction and when the market rebounds. This is not an easy exercise.

One of my top picks and largest holdings is WH, a third largest manufacturer of Oil County Tubular Goods (OCTG) in China. Their products are casing and tubing equipment for oil and gas exploration and extraction industry. This company has a number of things I look for in good investment.

1- It has exposure to energy and is a play on a rebound in oil and gas exploration and extraction.

2- Its a play on one of the best performing emerging economies - China. WH is also a supplier to the state sponsored industry which is in a sweet spot of government's stimulus.

3-It recently adopted a generous dividend policy, a payout between 30%-50% of profits. Just recently it paid $.30/share and declared a special dividend of $.45/share payable to holders as of June 30, 2009.

4- It has a strong cash-rich balance sheet and experienced, investor-friendly management.

5- Valuation is extremely reasonable - trading at a P/E of just 4x 2010 consensus estimate of $1.02. I believe these estimates are conservative, as they proved to in Q1, and will be going up.

This morning they announced Q1 results, beating street estimates by 50%, despite a difficult environment. I remain extremely positive on this company and will keep you posted. The stock has not really participated in the most recent rally in Chinese names, and is up 13% today, but I believe it has more room to run. This remains one of my largest positions.

The Red Flags of Impending Correction

Here is a good summary of why the correction I described in my previous post is very likely.

Following a week where the market has been churning at the highs and struggling to make any headway, a big gap down such as we saw this morning on a poor Retail number tends to concentrate the mind on some of the reasons for caution out there. Simply put, during March and April the market could afford to gloss over the negatives as long as stock prices kept marching higher due to some big catalysts that turned out to be better than feared: the Stress Test, earnings season, and economic data. Yet with these catalysts now largely out of the way, investors have been noticeably more aggressive in booking profits than they had been in the recent past, and shorts have finally had some success in taking down overextended stocks. Given this new sense of uncertainty that is starting to permeate the market after such a powerful rally, I thought it would be useful to summarize some of the possible warning signs that cautious investors are now citing as reasons for a near-term correction:

-- With the S&P now trading at 16x 2009 estimated EPS and 13x 2010 EPS, there are very few stocks that are legitimately "cheap" these days.
-- Along the same lines, the recent rally has already priced in expectations for continued better than expected economic and corporate news, suggesting that: a) disappointing data such as this morning's poor Retail Sales number has the capacity to negatively surprise the market, and b) that good news, such as INTC's "Q2 going better than expected" guidance last night, will show diminishing returns in terms of its capacity to surprise on the upside.
-- Companies have been rushing to bring debt and stock offerings to market over the past week. Beyond the simple matter of increased supply, this flood of offerings has the added implication that companies believe that now is the time to cash in on the rally in their stock prices.
-- The "garbage stock" rally we experineced over the past week or two, was a clear sign of froth in the market.
-- While substantial inflows of money into the market have lent a persistent bid to stocks in March and April, the other side of the recent rally has been the fact that short-covering has been a major source of upside fuel. This morning, Credit Suisse noted that the month-end data for April showed a solid drop in short interest across all market caps, suggesting that short-covering could become less of a supportive factor for stocks than it has been.
-- With the Stress Test and earnings season behind us, there is a distinct lack of catalysts entering the slow summer months.
-- On a technical basis the major averages are still overextended, although the recent selling has alleviated this somewhat, with the S&P 500 facing formidable resistance near 940-950 (its Jan high and 200-day sma).
-- More broadly, the trauma inflicted on the credit markets, the global economy, and particularly the U.S. consumer over the past 9 months, when combined with a degree of government intervention in the economy that we have not seen since the 1970s (many would argue the 1930s), does not augur for a V-shaped economic recovery. In other words, those 2010 estimates are still too high and need to come down.

Of course, the bulls will continue to argue that recent economic data suggests that the economy has bottomed, or is in the process of bottoming. The idea is that 2009 has already been written off, and that you have to be fully invested for when the real recovery begins in 2010. This argument implies that any correction will be of a short-term nature, and any declines will be bought.

The major averages were overdue for some profit-taking after running 30-40% off the lows in an almost straight line, so this week's minor sell-off should not be blown out of proportion. Yet the bottom line is that correcting stock prices no longer allow investors to ignore bad news such as this morning's Retail data, so in terms of understanding where current market sentiment lies, it's worth knowing what the arguments for caution are as we head into the summer. Selling in May and going away may not be such a bad idea.

Is much awaited correction finally here?

For weeks now, I have made a decision to sell in May. I've been correctly positioned for this rally and capitalized on it pushing the beta and the alpha, while still maintaining my sell discipline. So after 6+ weeks of pushing the envelope and pressing my bets, I've become a lot more cautious. During the past week or two, I have been getting more and more defensive, selling some extended stocks, after my trailing stops got hit, trading more pairs, and selling covered calls. The idea was to drastically reduce my equity exposure (which has increased from roughly 30% to over 50%)by the end of May.

Currently, I am seeing more red flags of an impending correction, than during the May Day parade in Moscow. More on that in my next post. I would be surprised and frankly, disappointed if we don’t get a pullback soon, as I would consider it not only healthy, but also an opportunity to finally end the debate whether this is a bull or a bear market rally.

So, after a few days of tag of war, it looks like the fear is winning today. As I am writing this, we finally broke below 890 on SPX, the first line of defense. The next support to watch is 875. An ideal pullback would be around 10% or so, from the recent high of 930, roughly down to 825, where we also have a pretty good technical support. I still believe the odds favor that we have put in a bottom in March, but we may get to test my theory soon.

In my next post, I will discuss some of the reasons my gut is telling me to duck.

On Retail Sales - should we be surprised?

The retail sales that came out this morning were disappointing to some and shocking to others. They were not surprising to me. If anyone has been paying attention, it should be clear that sales at major retailers still remain subdued. The comps have not really recovered in April and traffic and sales are still mostly driven by aggressive price discounting. Consumers remain fickle and few are spending frivolously, but good deals still get customers into the stores. Speaking of deals, if you walk around your local mall, you will see the discounting has become less prevalent, as retailers have aggressively paired their inventory. Most stores look much cleaner in terms of merchandise and retailers are slowly moving back to full price selling. Does this hurt retailers? Some are clearly going to be affected more than others, but in general, many retailers took a tremendous amount of cost out, pairing their SG&A expenses significantly. This helped earnings in Q1, so despite weak comps and top line results, many were able to meet or exceed EPS expectations. While many retailers stillhave little visibility into sales in the second half, many are comforatble with thier earninsg guidance, which in some cases assumes no recovery in sales. The next level of contribution should come from the decrease in raw materials and improved pricing from suppliers. Think how much more negotiating power retailers have with Chinese factories struggling to remain open. Other input costs like energy, transportaton and logistcs, etc have also come down relative to where they were last year. This should provide some lift to gross margins in the 2H. Combining lower cost of goods and lower SG&A should provide a tremendous operating leverage for some of this retailers when sales rebound even a little bit. How much of these savings will they pass on to consumers? Having this flexibility to drive sales without completely detroying thier profitability, provides retailers with a lever to offer more discounting. Well, if the push comes to shove, expect to see more discounting and promotional activity to drive salesBut for now, I think the retail sales will remain a volitle metric and one difficult to predict.

TBT - Update

The $14B 30-yr auction was not very pretty, the demand was there in that the 2.14 cover was solid, and the 33% indirect bidder participation rate decent, but the demand for more yield for 30-yrs of risk pushed it to 4.288%. Treasuries got crushed in the wake of the results with the 30-yr hitting the worst levels since mid-Nov, dropping to add 8.3 basis points since they hit. The 10-yr has been slammed as well but saw only 4.5 bps in yield, running off to hit the 3.3% point.

The TBT trade has now achieved my near term target of $51-$52, broke above 200 dma and on its way to close the November gap to $56.

On Bulls, Bears, and Opportunistic Traders

I have been in several discussions that involved some pretty polarized views about what to expect in the equity markets.

On Bears: The bears position is generally anchored in their belief that we will continue to see a significant deterioration of the macro environment and economic conditions, combined with an extremely overheated technical picture. This is not an entirely new or novel position, so I am not going to list every point in detail. Most of these points are pretty valid and you can read about them on many blogs, community websites or in the mainstream media. The bears also seem to be convinced that bullishness is back in vogue and the masses are back calling for a new bull market.


I have no beef with it, other than the magnitude of the decline the bears expect.
Many are calling for new lows, which would imply a move back into mid 600's or lower on the SPX. I disagree. Below is a summary of my post on Marketguru, where this discussion took place.


I am not so sure, we will revisit the lows. Look, there is always a possibility, but I think that barring a major systemic shock, along the lines of a 'Black Swan', we are not likely to crash to new lows. Obviously, one can not predict 'black swan' event, by definition, but we can account for it with some sort of probabilistic outcome. Yes, the patient (our state of the economy) is still very sick and is in ICU, but off of life support. As far as Black Swan, it could be anything - economic, geopolitical, or some kind of pandemic type situation (a bit more severe than swine).

If you are not familiar with black swan, just fucking google it.

On sentiment: In the circles I run, there are plenty of bears. In the media - there are still plenty of negativity. Blogs - many are still going over the same points. So from a sentiment standpoint I think it may be more of a push.

On Bulls: The 'bullishness' I do come across generally expressed as a) equities may have put in a bottom in March and b) the signs of economic recovery may signal that the most severe economic contraction has already taken place. I have not heard too many declarations of a new bull market, or return to the glory days of early 2005-2007. There are still plenty of scared investors, sitting up to their ears in cash, and I am talking about professionals.

We can have a correction at any time, a 5-10%, perfectly plausible. It will likely get some frothy money out and help technicals get back to neutral, or maybe even dip into an oversold territory. I am not at all comfortable with what the second quarter earnings reports will bring. I think it will be a bit more challenging to deliver 'surprises' we saw in Q1. Lastly, seasonality, (sell in May adage) is another thing that will likely help provide some type of pause, but if we DO hold 800-825 on SPX, I think more money will be come back into the market.

I don't see 30-40% decline as likely, right now. We just don't have the same factors in the equation that caused a 50% plunge from 14,000. The near death of the US financial system, massive, massive hedge fund deleveraging, the collapse of Bear, Lehman, AIG, and disappearance of Merill, Wachovia, Wash Mutual, trillions of $ from buy and hold crowd trying to get out all at the same time as the HF were getting massive redemptions and margin calls.

How can you you trump this unless we get a 'black swan'?

Here is what I see: 5-10% correction, pause, and then we grind our way back into the 900-1100 range on the SPX, where we will likely mark some time until we get a definitive recovery. I don't really consider this to be an overly bullish scenario, but the one that I view as most likely.

For the record, I do not consider myself either a bear or a bull. I am an opportunistic trader, and I can generally make a case for many different outcomes. I then invest based on the the one I consider to be the most likely one.

You can now follow my trades on Twitter

If you want to follow my trades in real time, maven100 is now tweeting MarketGuru trades. Or you can use the marketguru.com.

SPX - on the path to 950? What to do now?

My previous post, "SPX at the Crossroads" looked at a possibility of a breakout above 875 resistance and a 6-week trending channel on SPX. We got it today. Unfortunately, volume remained weak, but this has not stopped the market, since the last 100 points on the SPX were achieved on below average volume. This will likely change if we continue to march forward and onward, as the ensuing buying panic may pull more money in.

The technicals remain stretched, but every pullback continues to be bought. Banks are acting strong, despite looming stress test results on Thursday. They just don't act like the sector facing the most difficult time in decades. I think the bad news for the time being is understood and to a certain extent, Thursday may be anticlimactic. Commodities, energy, materials, and emerging markets continue to see a lot of $$$ inflows.

Having said that, the macro backdrop remains pretty dismal. There is no question about it. We will continue to face many economic headwinds over the next 12 months+, but thanks to the FED and Treasury, we were able to kick this football up the field, to deal with them in another time. So what investor to do?

Accuse me in not being original, but I plan to sell in May and go away. Specifically, sometime around the end of May (going on vaca on 5/21 so will likely do some selling before I go) or when we get to 950, which is my near term UPSIDE target on SPX.

The way I see it, the question really boils down to the one of strategy. Investor has several basic choices:

1)Continue to play in the sandbox with the bulls. Make some money by being in the right sectors, but emphasis on very strict discipline/money mgmt (tight trailing stops), or using options(either covered calls, buying some calls with no equity exposure, or buying puts, to limit downside). Easy money has likely been made.

2) Wait it out in cash or high quality bonds...until the tape turns and you jump on board and join the merry ride downhill. It's OK to miss some money here, being late is better than being wrong.

3) Invest in some specific sectors you know well...perhaps some health care names or other defensive, which did not participate in the recent rally...or some commodities like Natural Gas which is not likely to go much lower even in major selloff.

4)Do nothing. Make some popcorn and watch the action. Fun for the whole family.

It really becomes a matter of one's comfort with one of these choices. I am not advocating shorting at this time. Timing is everything and until the sentiment changes, shorting will remain a very risky play. In this one-directional tape, the old adage is spot on: being early=being wrong.

My personal choice involves a slightly more complex strategy, known as Barbell. I will describe it in detail in the next post.

In a meantime good luck. Would love to hear comments on this one...