Getting Serious and Getting Seriously Defensive - 10 Reasons To Be Seriously Concerned

Today's action underscores our near term concerns about the impending market selloff. We are finally beginning to see some fear in the marker, as VIX has moved above 30, which in the past had signaled a difficult period for the equities. Although we can easily make a bullish case for staying long, simply put, the risk reward of being in equities is no longer attractive at the moment. Period.


Having correctly positioned our portfolios in March, we took full advantage of the oversold markets and what appears to be generational lows on some of the high quality stocks being dumped by liquidating hedge funds and scared retail investors. We remained long, completely unperturbed by a debate of whether this was a bear or bull market rally, and only turned mildly cautious at the end of May, mostly because of somewhat overextended indexes and approaching seasonally weak time for the markets. With a week to go in May, while heading out of the country on vacation and unable to monitor the market, we sold marginal and low conviction positions and wrote June calls on just about everything else, with few exceptions.

Today's action continues to ring some serious warning bells. Here is a summary of what we have been posting for the last few weeks and how we currently view the market. We doubt anyone will find any of these 10 revelations shocking, but would hope that most investors and traders would agree with us that these are really valid reasons for near term concern.

1)Every child knows by now that major indexes moved too much too fast, up 40-50%, clearly outpacing economic progress, which has only shown a few sparse "green shoots". The recent economic data remains subdued and recent testimony from the FED about economic recovery is very sobering.

2)During the same time, investor expectations have risen dramatically, making it much more difficult to deliver any kind of upside surprises.

3)Technical picture has become very troublesome with divergences galore; many individual stock charts continue to make new highs, while momentum indicators such as stochastic and RSI are not confirming the continuation of the up move. Additionally, last week we hit technical resistance on SPX at 950 and NDX at 1506 (50% Fib retracement) and COMP 1875 (50% Fib retracement)and were unable to break out. SPX continued to churn around its 200 day ma, but failed to repeat the heroics of Nasdaq which earned the "Golden Cross" (50 day moving average crossing above 200 day moving average). This is generally considered a bullish sign, but it requires for other indexes to follow suit.

4)The approaching second quarter earnings will likely be uninspiring. With most of the cost cutting already done and less of an impact from lower energy costs, margins are not likely to continue the same degree of improvement we saw in Q1. In some cases such expectations are now embedded in Q2 guidance or street consensus. Even if Q2 earnings will be OK, the Q3 visibility remains cloudy, so we are not likely to hear many upbeat conference calls with management sticking their necks out.

5)Consumer confidence and spending will likely take another dive; consistent with higher gasoline prices and higher mortgage rates - two recent sources of an increase in disposable income. This could very well start a negative feedback loop with markets declining on a sentiment turning negative and sentiment turning even more negative from declining equity markets.

6) Investors are not going to get any help from Obama and his administration - only promises of higher taxes, mounting pile of debt, skyrocketing deficit and more and more government running interference in every aspect of the American enterprise. This is hardly a confidence builder for investors to put more money into markets.

7) Seasonality - everyone who reads our blog should be aware by now that July-Sept has been historically a very difficult period for the equities. I recently saw some research that this negative market performance is exacerbated during the 1st Presidential year.

8)Everyone is expecting a pullback. This has been almost a 100% consensus view from bulls and bears, from professional investors to speculating dentists and landscapers. As much as we like to fade consensus trades, we have to admit that the new money is very reluctant to make its way into the market right now, making it much more difficult to move it higher. This sentiment is not lost on short sellers that are becoming more active and less fearful every day the market is failing to decisively move ahead.

9)Recent leadership from commodities and materials stocks looks to be tested here, as US dollar continues to strengthen (most recently due to comments from Russian Finance Minister Alexei Kudrin, who said that he has confidence in the dollar and no immediate plans to switch reserve currencies). With Tech investors having second thoughts after QCOM lowered its guidance last week and the Healthcare still under pressure, there are very few places to rotate into. Utilities?? Maybe. Mortgage Backed securities and Munis?. Possibly.

10) Lastly, with high hopes that the world has placed on China to lead us out of this recession, we should not forget that once China is done stockpiling commodities (that have become dirt cheap)it has very few means to stimulate the economic growth outside of its own borders. Chinese domestic consumption will not be enough to generate global economic revival, since most of China's economy still depends on the export trade. There have been few, if any signs, that this part of their economy is getting any traction. Having said that I still feel investors should allocate part of their risk capital to China.

So what does our portfolio look like now?

Maven's 10 largest positions, by market value(excluding positions completely hedged with in-the-money or at-the-money June calls, which expire this Friday): DNDN,WH,ATN, DZZ,RIG,UNG,USB,NE,SDTH,SLB.

So we maintain a few positions, but continue to raise cash over the past few weeks. At this point, we are looking for 5-10% pullback. which could take a few days or a few weeks. Frankly we have no idea if this pullback will happen this week, next week or over the next few months. But we do believe, as we stated above, that the risk/reward of being in equities right now is no longer attractive. While we are waiting for the pullback to run its coarse, we will be busy finalizing our buy "wish" list and will scale in aggressively when the time is right. As long as the primary uptrend remains intact, we will likely have a lot of company buying the dip.

WH- Top Pick, Up 25%

WH-one of my top picks finished up 25% today. I believe the stock was recommended by Robert Hsu, a publisher of a well-regarded china focused investment strategy service. Although, I generally tend to ignore slef promoting stock pickers, I do know WH pretty well, and happy that it was profiled. If you want to catch up on this pick, see my post here:

http://themrktma​ven.blogspot.com/​2009/05/wh-remain​s-my-top-pick.html

Since I first profiled WH this post on May 14th, the stock is up more than 75%.
Over the past few days the volume has been very strong, exceeding a million shares in three of the last four days. Today, the stock traded over 2.5 million.

Although, these recommendations always present a great opportunity to take some profits, I will likely hold on a bit longer, in order to capture a special $.45/adr dividend, payable to holders of stock as of June 30th.

The Impending Earnings Season

AA generally kicks off the earnings season. They report on July 8th. As I have posted several times in the past few weeks, I see Q2 earnings seasonas a possible catalyst for a market selloff. It could start a bit earlier, if we get some negative preannouncements (or nervous investors selling ahaed of actual results). Over the next few weeks we will likely continue to churn here, but be CAREFUL going into the July 4th weekend.

I still believe the earnings will be generally OK, but the EXPECTATIONS have risen dramatically. What was viewed as positive (meeting lowered guidance and severely cut selllside estimates) in Q1, will be a huge dissappointment to impatient investors expecting a real and not just second derivative improvement. Most management teams will provide mildly upbeat outlook, but visibility still remains very cloudy into 2H. Historically, the second part of the summer is when the pain of "Sell in May" adage becomes painfully obvious.

So what if we do get the pullback off of the earnings disappointment?
I still think investors should buy the pulback, as long as the pirmary upternd remains intact. Potentially, some sector rotation could soften the overall market decline, as cash will flow from overbought sectors such as energy, commodities and tech into some of the underperforming secotrs such as Healthcare (still pressured by impending HC reform), utilities and some other defensive consumer staples. You can rotate as well, but I would also watch for opportunities to reenter trades in your favorite Energy, Commodities, Emerging Markets and Tech stocks. Stock picking and not broad based bets on the market will be key to the successful 2H performance. Easy rewards from shorting the market (that worked in Jan - March) or buying the market (that worked in March-May) will likely dissappear.

Closing my Oil short position, for now

In my rush to judgement, I shorted some oil, via DUG. I am now closing my position. My reasons for shoting oil were straightforward and still stand: 1) hedging my long UNG position 2) staying with a long US dollar trend which is pputting pressure on all dollar-denominated commodities, 3) USO chart, a proxy for OIL looks overbought and vulnerable to pullback, and 4) recently widening contanga ha been putting some pressure on the spot oil prices.

The main reason I decided to go to the sidelines here and clsoe my short is the unstability in Nigeria, one of the main oil producing countries. Unrest in the Niger Delta has reduced the country's daily oil output to 1.76 million barrels compared with 2.6 million barrels in January 2006. Nigeria's main armed group on Sunday intensified its threat to attack the oil industry in the coming days, warning that it will stand firm on a 72-hour ultimatum issued earlier. "The ultimatum (to local and foreign oil workers) expires about midnight (Monday).

Although, there should be no problems increasing supply from other places, given the luckluster demand, I still don't want to be exposed to the headline risk over the next few days. Stay tuned.

Trading US dollar, Gold, Bonds and Energy

TBT has reached my secondary objective of 56, and I would recommend to take some prfits on this trade. The run was spectacular, but with stronger US dollar, I would wait for a better entry point into TBT, perhaps around 51-52. I closed my UDN position, and going long US dollar via UUP. I am also shorting gold via DZZ, which is one of the most overbought commodities at the moment. Lastly, I am going neutral on energy, by selling calls against my every energy position, with the exception of a few coal names.

My longer term views are pretty much just the opposite of the trades I listed above, but for now, I feel, that the path of least resitance is in the direction of these trades.

Market Outlook and Portfolio Strategy For the Next Few Weeks

After a two week hiatus (travelling in India and Nepal) and not having a luxury of watching this market on a tick by tick basis as I normally do, I finally had a few minutes to put some my thoughts together. As usual, I try to examine the market action trough a prism of sentiment, fundamentals, and technicals.

Sentiment: Money inflows continue at a decent pace.

The rally has propelled the markets to a very interesting inflection point. Fueled by 'green shoots' and improving sentiment among the investors, mainstream media, and blogosphere - what started as a traders’ rally has now a potential to mature into a broader, investors' rally. For the second month in the row, the latest data shows continuation of the flow of money into stock funds, showing the biggest sequential inflow of funds into mutual funds assets on a percentage basis and on an absolute basis since at least February 1998. I have repeatedly made this point over the past few weeks, that with trillions of idle cash ($3.8T by some estimates) on the sidelines, the underperformance anxiety will eventually cause a buying panic. The bears and skeptics will throw in the towel and will join the rally, providing the second phase thrust to this bullish move. Even a small portion of this money finding its way into the market, let say $400-$500 billion, could be the catalyst to start a buying frenzy.

Technicals: Consolidation near key resistance levels, but the uptrends are all intact.

During the last few days the market's advance have stalled near the key levels (see more on this below) and we will likely see buyers and sellers duke it out here prior to seeing any kind of resolution. The major indexes reached their respective resistance levels, pinning the action right below these levels, as the market consolidates and digest its recent gains. Volume is still pretty average, despite the additional inflows, although Nasdaq outperformance signals wider participation. However, in the absence of fundamental or major economic catalysts over the next few weeks, we should pay attention to technical’s, since a breakout above key levels may be the start of another leg. But for now, ah, we are stuck in the good old trading range.

So let's examine the charts on the two key indexes DOW and SPX.

The Dow, after replacing two of its underperforming components C and GM, with CSCO and TRV, now has the weapons to push through a major resistance at 200 MA on a monthly chart (~8756). At the same time the 200 day MA, is in the sights, at 8817, but it has some major work to do here, especially considering that the near term indicators are overbought. The monthly stochastic, however, is in a great shape, just crossing from the severely oversold levels. On a down drift, we can lose 400-500 points on the Dow without causing a major technical damage. For the

The key levels for DOW: Support - 8225-8275. Resistance - 8817-8850


The SPX, has already poked its head above the 200 day ma, and seems to be in a well defined daily channel. But it too, is approaching a lot of overhead resistance at around 940, so expect a battle here with at least a few attempts to tag this level before a real breakout. The near term momentum indicators are also losing steam and no surprise if we see some more consolidation before a breakout.

The key levels for SPX: Support - 900-910 , Resistance- 940-950


Fundamentals: Maintain caution as we approach the Independence Day!

From the fundamental perspective, as I posted before, we are approaching a seasonally difficult time for the market. I am concerned that the Q2 results and Q3 guidance will be disappointing, given higher expectations of economic recovery and lack of favorable factors that helped Q1 results. The positive reactions to Q1 results were all about low expectations, contributions from lower energy and raw materials costs, plus the impact of significantly lower SG&A expenses. With rising energy costs and investor expectations that are now discounting some topline growth driven by economic recovery, we could see some disappointment following the Q2 results. Also, many companies have already severely reduced their operating expenses, so broadly speaking, we should not expect much more in terms of operating leverage from additional SG&A cuts. Smarter investors will likely start bailing ahead of the results, so ideally you want to be careful going into the July 4th holiday weekend.

Portfolio Moves and Strategy:


Currently, I maintain positions in a number of commodities and energy stocks, all of which have been hedged by selling June calls. If my stocks don’t get called away on the 18th, I will likely start selling at the end of June and to reenter sometime in September or October. In the mean time I will maintain a few long term positions and trade around some of the positions I know well.

TBT – will be adding additional short Treasuries position on a pullback, as concerns about fiscal deficit, never-ending supply of paper dwarfing any purchases by the FED, and re-allocation into riskier assets all putting pressure on the bonds. I am not chasing the move now, as I do hope to see bonds bounce during a market pullback, providing a better entry point. At $50-$52, I will put a much larger position.

KEY- bought shares of KEY, although I am not really focusing on financials, I wanted to pick up some shares here for a trade. Trading at less than 1/2 its book value, the valuation more than compensates for deteriorating credit quality and capital raise concerns. Stock is oversold and was upgraded by RBC today, which is helping my cause.

UDN – reluctantly added a little more to short US dollar position, I think there may be better levels to enter this trade.

BTU, WLT, CNX – put small coal position back on. China has been buying record levels of met coal from Australia. Given how much production has been take out lately, this should provide some pricing support to major US met coal companies.

OIL – I am not chasing oil here, and turning a bit cautious as contango has widened again. I think after Goldman’s $85 oil forecast is digested the shorts that scrambled to cover today will put it on again. I am an OIL bull, and would look for a pullback to add aggressively, but for now, most of my positions have June calls written against them.

GOLD – I maintain CEF, and the only exposure both gold and silver. I continue to favor Silver, because of much cheaper valuation, but Gold seems to have more interest here. I think gold is overbought and will crack if the USD moves gets stronger.

SVR – sold position, as the stock has lost momentum and seems a bit ahead of itself.

Final thought: My portfolio is prepared for a pullback and although I still maintain a decent exposure to equities, I am compiling a list of top ideas that I want to aggressively add on weakness, as long as we don’t violate the uptrend. I will be publishing my Buy Wish List later this week.

Happy Trading!