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.