The Line in the Sand - 1050, The Battle Between Dip Buyers and Bounce Sellers is On

So my strategy paid off, as I used the 1100 level on SPX to raise cash and reduce beta last week. Still, it hurt like hell yesterday, and I did take a few positions down a bit and bought a small piece of TWM insurance, in case the GDP numbers were ugly. Prudency is a virtue.

Having said that, it was clear to me that yesterday’s selling was irrational, but not unexpected. My two or three previous posts provided specific reasons why the odds of a selloff have risen dramatically over the past few weeks.

Contrary to many other bloggers and posters, I DO NOT BELIEVE THIS IS THE BEGINNING OF MAJOR SELLOFF. I am sticking to my earlier prediction that the rally will continue through the end of the year, although a correction/pullback right now is perfectly normal market reaction. Let me say it again - NORMAL REACTION.

As the title of this post says, I think the battle around the 1050 level on the SP will determine the extent of the pullback. I would not be surprised to see it get taken out and the index to revisit the 1020-1030 level, but I do believe we will be marginally higher by the end of the year. I expect to end 2009 near 1100 level.

My focus is not really to figure out what happens to the SPX. Although I use it as an overall market barometer, I think the research focus should be on stock and sector specific dynamics. This will be the key to outperformance in the next 6-12 months. If you spend your energy on trying to guess where the market is going - you will realize that it is futile. The long term economic picture will remain murky for some time and it will keep enough pessimists out of the market, so there is no complacency among investors that we witnessed in the past.

Today I am doing some trading. I am not really establishing new positions, but revisiting some of my old favorites and either reestablishing recently sold positions or adding to some of the existing ones that got crushed in the 'beta' trashing of the past few days.

Stay cautious as NOBODY really knows how violent the correction is going to be if we break below 1050. The battle between dip buyers and bounce sellers is on. Take advantage and use the overreaction to add to your high conviction ideas when they get oversold. This is the best advice I can give you.

My trades: Sold AMSC for a nice trade. Bought DVN. Added to SNDA, DNDN, NE, ANR, JRCC. Looking to buy SWN, SLB.

Thoughts On The Recent Market Action, part II

I wanted to add, to my fundamental rationale stated in earlier post, that the technicals are also indicating that the odds of a pullback now exceed the odds of continued rally. The short term indicators are both ovebought and show divergence with momentum indicators like RSI and Stochastics. While we witnessed a 52 week highs on the broader indicies, these indicators clearly failed to confirm.

Additionally, the last few days, we have seen a lot of rotation and on UP days (some stocks were up, while others were down), while on DOWN days,it seems to be more uniformly red.

Lastly, the intraday volatility has picked up, which is indicative of a nervous market. More reason to be cautious.

Don't panic. Stay long your high conviction ideas, sell covered calls, but dont short this market. Not yet. There is still a wall of worry and plenty of pessimism out there.

Thoughts On The Recent Market Action

My intermediate SPX target has been achieved as the index touched 1100. Although, I can make a case for it to move higher to 1150-1200 by year end, I think the risk reward of this scenario is not very attractive. We are now more likely to see an organized pullback, perhaps back to 1050 or even 1030 level.

While the earnings continue to surprise both on the EPS as well as the revenue line, the clear pattern is emerging. The sellers are moving out post the earnings surprise. Nothing to do with fundamental prospects, but traders are not sticking around to find out how the long term thesis will play out. With oil also reaching the top of my near term $80 range and the US$ attempting to rebound, the easy money has been made. The strategy now is to tread water, wait for the pullback or the sideways action to come down the nerves and get the overbought readings reset. We will see how willing and courageous are the buy the dip guys. I am not shorting the market, but it’s clearly saying: “Don’t chase, stay nimble, don’t speculate without having a very strong conviction in the trade”. I am listening, since I learned a long time ago to respect it. I will let the amateurs chase it here…but will remain vigilant in case I think it gets overdone in some of the names I don’t mind holding through even a more serious correction.

A few weeks ago, I started implementing my 'barbell' rotation strategy. Basically, reducing risk by lowering beta and selling some of the extended commodity, materials, china, and energy holdings. See the post here: 'Barbell' Your Portfolio to Reduce Risk.

My net cash is higher this week than it has been in the last 3-4weeks (~65% net long), but more importantly, the aggregate portfolio beta is now .55,following the aggressive rotation into Healthcare. I am also layering some shorts positions, but most are earnings specific or company specific ideas, and not a bet on the market weakness.

Main recent portfolio changes: Sold/Reduced - ANR,SWN,CELG,NE, IPI,MWE,DVN
Bought/Added - ALGN, OMPI,SNDA.

Intermidiate/longer term I remain bullish on multinationals (US$ play), agriculture, healthcare, and select energy, materials, industrials and infrastructure.

A few thoughts on a first week of earnings results

As the third quarter earnings reports are rolling in, I feel vindicated. My scenario for jobless recovery seems to be playing out. The tech sector is reporting very sold numbers, not only on the bottom line, but revenue as well. AMD, GOOG, IBM - all seem to be living up to lofty expectations. The bottom line continues to benefit from cost cutting, efficiencies and productivity gains (yes, productivity gains). The revenues are benefitting from pent up demand, depleted inventories, and improving fundamentals. Now let's hope that the stocks can continue to perform, as expectations are racing to even loftier levels.

The main themes that I outlined in my post a few weeks ago
http://themrktmaven.blogspot.com/2009/10/what-to-expect-from-third-quarter.html

are working out: semis (SMH), apparel manufacturers, oil/gas, china, multinationals. I have been adding some more exposure to other Asian emerging markets with ETFs: Malaysia (EWM), Hong Kong (EWH) and Singapore (EWS). Lastly, have been adding some of the best of breed biotechs: CELG, GILD, CEPH, more for risk diversification. See this post for more details: http://themrktmaven.blogspot.com/2009/10/barbell-your-portfolio-to-reduce-risk.html

Lastly, I wanted to comment on two stocks in my portfolio. I am taking a beating in SNDA and AMED, and usually, I sell my losers once the loss threshold is achieved (7%-10%). I am sticking with both for now. The reason I am is because I clearly understand why these stocks are down and I am comfortable with this risk. SNDA is a victim of two China's regulatory agencies infighting and potentially new restrictions that can somewhat change the landscape for the Chinese online games. I am sticking with this trade, because the stock is cheap, generates tons of cash, has $43 in cash + recently spun off GAME equity on the balance sheet, and a total control over GAME. AMED is a victim of a short seller newsletter (that in my opinion is basing their short thesis on highly questionable information) and the HC reform overhang. At 10x 2010 PE, I think I am fairly compensated for this risk.

Please send me a message on marketguru.com or use comments on my blog to contact me with questions.

'Barbell' Your Portfolio to Reduce Risk

So we have been here before..in 1999, then again at the end of 2003 and now once again. Dow at 10,000.

The prognostications of Tice, Farber, Roubini, back in March and April about Dow heading to 3,000-5,000 are no longer a very realistic scenario...although some hard core bears may disagree. Personally, I never dismiss any scenario, to me it’s just a matter of odds and probabilities. These odds and probabilities are always shifting, depending on what I see, read, hear and feel. At Dow 10,000 and with SPX approaching 1100/1150 we are near the upper end of the trading range. Although we can clearly get a breakout-fueled rally as more towels get thrown in, the risk is also increasing.

I am dealing with this risk by creating a Barbell Portfolio. It is a technique borrowed from bond managers, to create a portfolio using bonds with short term and long term duration. In simple terms, it reduces bond portfolio risk in an uncertain interest rate environment. Similarly, I am rebalancing my portfolio by adding some of the ‘safer’, lower beta healthcare stocks, while also keeping some of high beta, volatile materials, industrials, energy, and emerging markets stocks.

I think this is a sane approach given where we are and how far we come from. Here is my thought process.

If the market tanks from here, the healthcare holdings in my portfolio should outperform. Yes, they may still decline in absolute terms, but given that most of them lagged the market because of the HC reform overhang, it remains one of the least overbought sectors.

Conversely, if the market keeps going, my high octane stocks should continue do well, and hopefully outperform the market, while the resolution of the Obama's HC plan (whatever the final outcome) should drive stocks higher as well. Despite a defensive nature of this group, we may see a pretty rapid ‘catching up’ as investors bid up the shares of the best of the breed biotechs, managed care, and hospital stocks. I am not including smaller, riskier, biotechs with binary outcomes as part of this strategy, but will add them on a case by case basis to the “risky” part of the barbell.

The barbell portfolio will allow you to still participate in the market advance, while protecting you on the downside, should momentum turn. Of course, as any insurance/protection, it has it cost. Should the market move aggressively from here, the healthcare will continue to lag.

My top picks for the HC are : AET, UNH, CEPH, CELG, GILD, AMGN. Another name that I like and have a lot of confidence in is DNDN.

5 reasons Why The Rally Could Continue Through the End of the Year

In response to lot of financial blogs calling for a market top, I wanted to offer some of rationale why I think its not likely to happen until the end of the year.
So here are my five simple reasons.

1) Last week, we could not take this market down more that 3.5%. I recently read that someone called this decline horrendous. I can't help but laugh. C'mon now, 3.5% after a 55%rally, is not really horrendous. This 3.5% ‘horrendous’ decline was in a face of one the worst weeks in terms of economic headlines (recall- weaker ISM data, higher non farm unemployment, bad auto sales, bad housing data...etc) and just ahead of unpredictable 3Q earnings season. Still - only down 3.5%. Let’s not get overly dramatic here people.

2)The fundamentals are getting better, slowly. Sure, bring on the boos...Recovery, has been a dirty word lately and a source of heated discussions on financial blogs. well, yesterday AA had decent numbers and retail sales came in better. Jobless claims - again better. Are these numbers good? Not really. But they are better than expected. Perception is what drives the markets. Always. Don't ignore it.

3) I can't argue, however, that we seem to be clearly ahead of fundamentals now as far as the stock market is concerned, but if we get a 10% sell-off to the bottom of the range,(950/1000 on the SP)the market will be trading at below 13x 2010.....and guess what, in a few months the analysts will unveil their 2011 estimates, making the market look even cheaper. And the smarter guys understand it.

4) We are through the worst of seasonality - a spooky September and the first half of October. Thus far, anyone betting on seasonal weakness, was proven wrong. Again, we had plenty of excuses to push this market through support and toward the lower end of the trading range last week, but thus far - another victory for the dip buyers. Viva la dip buyers.

5) Finally, don't forget, most of the money managers didn't get paid last year..not the traders, nor the investment managers. The HF guys are finally sitting on some profits, but many are still below the water mark (the level they need to achieve in order to get paid). Getting killed last year and in Q1 was bad, but they had a lot company. Not showing anything better than 10% YTD return -that's horrible. Try to explain this under-performance to your institutional clients that stuck with you when you lost 30% last year. My point is that unless they are sitting on a 25% gain, they will stay long and will participate in this momentum driven market. Every pullback will likely be bought through the end of the year. And yeah...the shorts are exasperated...just ask them.

I do not advocate chasing this momentum unless you have very good discipline and can trade quickly with tight stops. We are just at the beginning of the earnings season, and more volatility is expected, so stay nimble and patient. My take is that this market remains in a 15% trading range with an upward bias and my strategy remains to be a swing trader through the end of the year and to rotate into weaker, underperforming sectors as the market approaches the top of the trading range and becomes overbought. We are still 30-60 points away on SPX from there, so there is some room.

Struggling with Myself

I struggle with myself on days like today..as every bone in my body tells me to sell and not chase this momentum. So I am not chasing, but I am not convinced that shorting this market is the right strategy and has been pretty vocal about the reasons why on a number of financial sites and in my blog.

Unfortunately, this also precludes me from being involved in some very interesting situations, as they all moved without getting down to entry points that I identified as low risk. So alas, I am watching some of my favorite names soar today…without me. As luck has it, I was travelling yesterday, otherwise I probably would have taken the advantage of yesterday’s rally, but over the two days the move is just above my threshold. So I will have to be patient. This market will continue to be volatile and over the next few weeks we will be rewarded with a better entry point.

So for now, the strategy that worked for me is to rotate constantly from overbought to oversold sectors, especially those that got crushed for reasons I don’t agree with fundamentally. My techno-fundamental discipline is paying dividends in this market…and I feel comfortable with my risk adjusted performance. I will never be the highest return guru, as my risk discipline will not allow me to pyramid my trades, chase latest M&A rumors, or do smilar things that amateurs do.

To revisit some of the areas I am focusing on right now, as we get ready to kick off the earnings season:

1) Oil at $65 a few days ago, was pretty close to the bottom of $60-$80 band that I believe to be a decent and realistic range for crude over the next 6 months. My US$ bear bet continues to play out, although I am long oil/nat gas and other commodities as a proxy for the US$ short.
2) I continue to believe that the right way to play Nat Gas rebound, is via exposure to Coal and Nat Gas E&P companies, rather than commodity itself, but one could take a small position in natty straight up.
3) Looking to take a few positions in semis and apparel manufacturers ahead of earnings (see my post from last weekend What To Expect From Third Quarter Earnings ). Semis is now becoming a bit of a consensus trade, so be careful!
4) I am seriously looking at Healthcare today, and over the next few days, I will be making a number of trades...I am going to overweight HC, and plan to dedicate a separate post to it later this week.
5) China and Brazil – again, in the next week or so I will outline my favorite picks.

What To Expect From Third Quarter Earnings

Next week the third quarter earnings reports will start in earnest, as Alcoa (AA), kicks it off on Wednesday. Before we focus on Q3, let us quickly recall the Q1 and Q2 results.

The first quarter was all about very low expectations as the "sell-siders" and corporate CFOs have really reigned in their forecasts and it took just a small marginal improvement from a horrendous Q408, to beat the numbers. The Q2 was a bit more challenging, as both investor expectations and market dynamics have changed. Investors were looking to see a bit more than just 'small beats' we saw in April. The skeptics among us in July (myself including), were prepared for at least weak guidance, if not outright missed estimates. We were once again proven wrong. Well, not really wrong - most reports came above still pretty conservative earnings projections, but many companies did miss the topline expectations.

Now we wait with anticipation for what the third quarter results will bring. So if the Q1 was all about earnings and Q2 was all about future guidance, than what should we be looking for in Q3? In one word - topline growth.

Topline, also known as revenue or sales, is what the companies lacked during the last several quarters and investors gave them a pass. Now we expect a lot more. We want to see still strong margins that resulted from almost twelve months of aggressive purging of any excess expenses(bonuses and salary cuts, delaying maintenance and equipment upgrades, personnel, T&A, productivity improvements etc, etc, etc). This was how they made Q1 and Q2 numbers. Now, we expect to see the businesses to show an ability to generate sales. Those that did, will have not only see their revenues expand, but the leverage in the business models should deliver very strong operating results.

Is this even a possibility? I think so. Not for all companies of course. But lets take a look at a few places where we might see some surprises.

I think apparel manufacturers can do well, for example. Like everyone else they had a very difficult year, but the retailers are beginning to place orders again. Department stores have reduced their inventories by 12% YoY. Many retailers are beginning to sell full price items again, and not only sale items. The apparel manufacturers will not only enjoy savings from becoming mean and lean over the past several quarters by getting better sourcing from their own suppliers, cheaper cost of raw materials, etc, but potentially stronger orders from retailers. And I don't really want to hear that consumer is not shopping. After almost a year of being very prudent, we are clearly seeing traffic improve and shoppers are coming back. Maybe not the 10% that are now unemployed, but the other 90% that are still working, like yours truly.

Another example - semiconductors. The overcapacity in the industry has hurt many of the semi and semi cap companies. Many have rationalized their production and many have merged or just out of business. At the same time, we are nearing the upgrade cycle for many PC and laptops. Many are still running on 1 GB or 2GB of RAM. With $400-$500 machines that can have 3x as much power and hard disk space, we should see stronger consumers demand not only in US, but also in emerging markets. And don't forget Windows 7, that comes out at the end of the month. How about other electronics that now require more and better and faster chips? Even printers are now wireless. What about Netbooks and digital picture frames? Soon we will have chips in our new set of kitchen knives.

One of my favorite industries is Oil and Gas. This one is a bit trickier to call. I think we may see a mixed bag of results. Generally, I would expect to see production cuts to continue to pressure results. Having said that, I am looking for those that were able to hedge their production at higher prices, paid down their debt (reducing interest expense) and Capex (capital expenditure). As the prices of Oil and Nat Gas continue to recover, we should see them beat results, as most analysts and investors are basing their forecasts on $60-65 oil and $3.50 natty. This will not last much longer, as I am a firm believer that these prices are much closer to the bottom than to the top.

Lastly, a few select Chinese companies should have decent top- and bottom-line results. Chinese economy has really led the global recovery. Their domestic consumption is at levels that exceed 2007. They have access to cheap labor, tons of government subsidies, and cheap and abundant access to loans (this door is now getting somewhat closed, as Chinese govt decided to limit lending, and cool things off a bit as well as to prevent bad debt from becoming a real problem). At the same time, the several hundred Chinese companies listed in US, can still access fairly cheap equity capital. And lets not forget the $586 billion in government stimulus, which was not wasted on transfer payments or bailouts. It was focused on key strategic industries and had a much better impact than the ones in US or European Union. Expect to see much better topline and bottom line results from some of these companies. I have done a lot of work on some of them, and would urge you to do the same before investing. Emerging markets are not for lazy or complacent investors.

Finally, I would look for US multinationals that have a large part of their revenues coming from Europe or China. A combination of a weak US currency and demand coming from still growing Chinese economy could really help these companies deliver solid Q3 results.

On Economic Recovery and More Frustrated Mavening

There are plenty of reasons now for a pullback..as economic recovery and green shoots are finally being questioned. Meredith Whitney, a self professed market guru, credited with predicting financial meltdown, is once again in WSJ. She writes "Anyone counting on a meaningful economic recovery will be greatly disappointed...SHOCKER!!!! Are you serious, woman? WHO IS STILL EXPECTING A ROBUST ECONOMIC RECOVERY?. C'mon...anyone that still does, is not likely to be a WSJ reader, so perhaps she should really Op-Ed in New York Post instead. She should get a bit more ‘shock’ capital that way. Dougie Kass is also rehashing his 10 bearish points….again and again. And did Goldman Sachs had the actual foresight to increase their jobless claims estimate by 25%, on Thursday afternoon, a day before the release? Not sure how tough of a stretch it was in light of all the negative economic data we saw over the past week or so. And yes, having Mr. Paulson on a speed dial helps.

So, October started with a bang. BANG BANG, that is. Hey, why should anyone be surprised? Plenty of excuses for a sell off, just pick one, or two, or three. But let’s get real people! Let’s stop the nonsense of arguing if we are in recovery. This is not a question anymore. We have recovered greatly from the abyss of 2008.

Why should anyone expect anything more than a subdued, shallow slope improvement? The weekly/monthly data will be mixed and volatile. You can bet on it. No V-shape, baby. Think about it. We are attempting to dig ourselves out of the worst economic and financial crisis in modern history, of course it will be choppy! Unemployment will continue to rise for at least 6 more months – deal with it and don’t act all shocked when it gets above 10%. I see absolutely no way for the job growth to come back, until the revenue growth resumes. So let’s get real. Let’s not expect miracles. Let’s not confuse hope with reality. Let’s be patient. But there is no reason, really, to be a doomsayer either, even though fear mongering has become quite fashionable now days. And yes, let stop freaking out, every time the market goes down 3% and we get an ugly economic stat. Unless there is a trend developing, don’t use one month’s data to justify your bullish or bearish stance. Yes, Meredith and Dougie, you said your piece, now shut the hell up and let see what happens.

Diatribe aside, the market held up OK again, after a scary day or two. Will the slide continue, I really can’t tell. The issue is whether the greed (of dip buyers) and sidelined cash, can overcome the bearish arguments. Will the sentiment turn completely negative? I don't know. But the fact that the cash and bond yields are still crappy, there is little reason for institutional money managers to dump their equities. This was once again pretty obvious on Friday, as we witnessed outflows from bonds into equities, providing an army of dip buyers with some aerial support. And as I discussed in my previous post, the technicals suffered some damage, but overall held up OK, bouncing from a 50 day ma.

For now, I am comfortable with my long positions, beta exposure , and cash levels. Perhaps we can finally get the correction out of the way, in a more meaningful way that the last few we had (ranged 3%-4%). For now, I am still operating under scenario that the market will remain range bound between 950/1000 and 1100/1150. But let see what the next few weeks of earnings will bring. More on earnings and what to look for in my next post.

Quick take on today's action

Let’s take a quick look at the recent market action . Overall, the as I am writing this on Friday, midday, the indexes are holding up OK. Although some technical damage was done as we broke below 1040, we are holding the 50 day moving average. Given a plethora of excuses to take profits, including bad economic headlines and obsession with October's reputation for market weakness...the markets seems to be taking it all in stride. Even the morning choppy trading, right after the jobless numbers came out, seemed pretty organized and panic-free. The breadth seems pretty narrow. If we close this week in a positive territory, give the dip buyers yet another victory to celebrate.

Although the market averages appear to stabilize, be careful…watch for signs of rotation out of cyclicals into defensives. This rotation could kill your portfolio, even with only a mild pullback in the indexes. This is an important point for a casual market observer, as averages often obscure this little, ugly reality.