Technically speaking, we're in a box

Yesterday's reversal was impressive, especially in a face of a number of very negative macro headlines. The day could have turned out very ugly. But the S&P index held a very important 1044 level, bouncing nicely off of it. Today's follow through is nice to see, but its premature call it an 'all clear' signal. As I said in my previous post, the 1010 level on SP is beckoning and I think the odds are that we will revisit this level.

For now it appears the market is in a 'box' 1040/44 - 1085/90 on SPX. If you want to trade for a quick profit, these levels are pretty good.

In order for me to get a bit more constructive on the market, I need to see the SP to either break down and hold the 1000/1010 support (also 32% Fib retracement on a weekly chart) OR to break above its recently violated 200 day MA at 1108.

So we have two sandboxes to play in: 1040-1090 (50 point range) and 1010-1110 (100pt range). So overall, don't get suckered in in chasing rallies...I think buying dips near 1040 is a more conservative strategy in this market

Good luck.

A look at Technicals - A Picture + 1000 Words

The markets are trying to stage the early morning rebound following a very negative open. Although, I don't agree with some of the 'the world is ending scenarios' every bone in my body tells me that we will see the rally fade into the close. I hope I am wrong and everything will be rosy from here, but the technicals are plain ugly and the buyers are still scarce. The activity seems to be again concentrated among some nervous shorts covering, options expiration position squaring and high freq guys doing what they normally do - trading the daily trend.

I have been spending some more time with charts, since fundamentals don't seem to matter now. The 1150 was a very negative break with multiple long term trendlines broken. Everyone seems to be talking about revisiting the 1050, so it becomes a self fulfilling prophecy.

The short term trade seems is to buy 1050 for a bounce..but sell 1075-1085 resistance. The intermediate technical picture is still pointing to more pain. The possibility of revisiting 1010 is now real scenario in my book. This is where I would start putting money to work. If we break 1000, the 933-950 support comes into play and I would be there with really big shopping bag and its my 'back up the truck' level.

Of course, the Dow 10,000 is psychologically important as well.

For now this crazy volatility has relegated us to small trades to capture a few points here and there...and keeping a few longs in the portfolio that have already gotten beaten to a pulp and probably too late to sell now. With plenty of cash and some VXX to offset these losses, I can think constructively and get caught up in the emotion of the day

Searching for Positive Catalysts and Silver Lining

My earlier post outlined the reasons I believe this tape is irrational. This correction is focused on events outside of US, as opposed to the last major sell off when there were legitimate concerns about the economic and monetary crisis happening right here.

We are now unquestionably in a DOWN TREND...and it could be just as powerful as a bull market trend. If you are uncomfortable analyzing these type of markets, just change the red color to green on your quote screen and turn the charts upside down. Seriously speaking, this market is clearly not responding to any good news and takes any kind of negative news as a reason to sell. This is a classic example of a correcting market.

After outlining some risks and concerns, let's focus on the positives and possible catalytic events that can stop this downtrend and provide some stability to this tape.

First of all some silver lining.

The stronger dollar is not bad. No longer do we have questions whether the world will chose another currency to replace the dollar. Are you kidding me? Euro? Yun? Yen? Ruble?

Secondly, we can now once again consider traveling to Europe. Yes, you will still pay $5 for espresso, but its better than paying $8. Of course, it also puts the pressure on our trade with Europe and we will likely see fewer Europeans leaving with suitcases of Saks and Tiffany's stuff. At the same time, European economies may benefit from the weaker dollar.

Thirdly, the US economy and the economies in Asia and Latam are healthier than last year and are unlikely to get pulled into the economic crisis because of the debt problems affecting Europe. Despite the fact that only ~5% of our GDP is tied to Europe, our markets are taking a full blow, as if the problems in Europe are guaranteed to spill over here. The probability adjusted scenario has clearly more than priced this risk in with a 10% correction.

The interest rates in US will likely remain low longer than I originally thought. Given the turmoil, I don't see how the FED will find the will to raise rates. This is positive for corporate and municipal borrowers as well as real estate.

Chinese are now beginning to realize that they really need to be careful in terms of new policies. Hopefully, they are realize that there are many eyes on them (and i am not talking about 2.8 billion of Chinese eyes)as the world looking for any signs of slow down in China. I hope that they will remain responsible and find a way not to overshoot when trying to slow down its economic expansion.

Finally, corrections are generally healthy. They are painful reminders that one can't be complacent and can't lose perspective when either making or losing money. Risk control rules in both bull and bear markets. A valuable lesson, that is

Now, about potential positive catalysts.

1)Its all about Euro now - so any kind of intervention or political resolution in Europe that provides the reversal of EURO trend would be positive for commodities and should prop up this market.

2)Corporate buybacks - many companies have rebuild their week balance sheets and streamlined they operations to generate cash. They will likely start using this cash to initiate buybacks.

3)M&A - as valuations becoming much more attractive in a hurry, the savvy corporate and private equity buyers might start stepping in. We have seen a trickle of mergers over the past few weeks, but given that fundamentally most companies are still doing pretty well, we could see a number of high profile M&A transactions. Having said that, do not fall for daily rumors of takeovers. Eight or nine of ten will prove to be false, so don't chase the stock that are up on takeover rumors.

4)Oversold bounce + one of the catalysts listed above - keep your eyes open, a severely oversold market combined with a positive catalyst could provide some hope or at least send the shorts covering.

I was hoping to find at least five potentially positive catalysts, but can't think of any more at the moment. Of course, this market could simply continue to ignore good news and over react to bad news.

Full Out Beta Assault

No one really knows where the bottom is and we could just as easily be 10 points or 200 points away from it. There are just too many crosswinds to have a reliable prediction. But the exercise could still be important, so diligently plan for various outcomes, adjusting your exposure based on probabilities of each outcome.

When you start hearing the words from the late 2008 like de-risking and de-leveraging portfolios, etc..its time to pay attention, as the herd has been clearly on the move and the exits are getting crowded. The stink of fear is abundant. Everyone was looking for correction and voila.

So for now - no real answers, just sharing some of my thoughts and observations:

1)This is an irrational market - we are once again in the market environment where the technicals seem to matter little (at least as predictors, although still have some explanatory value)and fundamentals matter even less. When a company reports a stellar quarter, provides robust guidance, and trades at a highly attractive valuation on both historical and relative basis, one would expect this stock to go up 5-10%. Well, we are seeing just the opposite. That's irrational. When key technical supports are broken without a pause, and oversold indicators provide little if any relief, to me this indicates that technicals are no longer reliable way to gauge the market bottom. This is clearly, once again, an irrational market, driven by emotions, controlled by fear, uncertainty and the lack of confidence. Feel free to disagree. Of course some stocks deserve to be sold...overvalued, over-levered, or just trash that went up with the overall market, etc...but we are not seeing much differentiation in selling. By the way, the institutions seem to be on mostly on the sidelines, refusing to get caught in this whiplash market and its mostly the retail lemmings that are getting caught in the crossfire.

2)Emotions aside(panicky selling is just a response, not the cause)So what is really happening fundamentally? Fundamentally, we are basically done with earnings reporting and we have seen mostly decent results. Until the the next reporting period, we are in the information vacuum, and the market seems to be at the mercy of the quant traders, high frequency traders (aka bandits) and volatility hedge funds. The balance sheets, for many companies are in good shape, and companies seem to have more confidence in their outlook than they had in the last 12-18 months. The economy seems to be humming OK, with manufacturing, services, and even retail sales holding up better that anyone thought possible in the jobless recovery. Hardly justifies the puking we've seen. The valuations are coming down hard, as P's are getting hit, but we are not seeing corresponding earnings revisions. Just the opposite.

Techncially - the downside volume has increased and we witnessed many key supports broken. Briefly. I am watching 1100 support to provide a relief bounce, with 1150, a former key support is now a tough overhead resistance, where I expect a lot of selling from both longs and shorts to once again pressure the market, assuming we will even get there near term. The most critical support below 1100 is 1060, which would undercut the May 6th 'flash crash' low, and really scare some folks.

2) So what works in this type of emotional market? This is a sentiment driven tape, and the sentiment is decidedly bearish..what a change from few weeks ago! The investors are very skittish and the we are seeing a total bloodbath among the high beta stocks. Of course for a long term investor that has plenty of cash in reserve, this is might be a fantastic opportunity to buy/add. After all, its much easier to invest when so many quality names are selling at garage sale prices! But yes, such an investor should have two things in addition to cash, patience and a good supply of Valium or other nerve numbing meds. If you choose to buy here, you should stay nimble and stick to quality names, as they will be the first to rebound when the sentiment changes and market turns.

3)On Europe and Euro - personally, I believe the whole European drama is a bit overdone, but it matters less what I think, but what the other mass of investors perceives. To use the very appropriate Wall Street adage, 'markets can remain irrational much longer than I can remain solvent". But....There are definitely legitimate concerns about the risk of PIIGS defaulting or at least the contagion to spread beyond the European banks. The short sellers are pressuring the EURO trade, and predictions of parity could become a self fulfilling prophecy. Although I won't discount Euro getting down to 100, I see this outcome as improbable. The Euro might see 120, or even 117 or so, but I think we will see an intervention that could stem this decline from getting more ridiculous. I would not be surprised to see some type of massive intervention by G20. Recall, that it was the G20 global stimulus plan that marked the turning point in March of 09. Could we see something like this but focused on supporting Euro? Thoughts?


Other risks to consider - the US fiscal policies and potential monetary tightening in US (ie higher rates, although everyone believes that this day will never come), Obama's reckless politics and economic policies, and one risk that remains incalculable - a risk of a major terrorist attack or a serious military action in the Middle East! Having said that, we have seen these crises come and go, and most of them did present a good investment opportunity to those that acted contrary to the crowd.


4) Many quality names are getting crushed only because they have a high beta. Its a lot easier to short the higher beta stocks (like commodity producers, small cap emerging market stocks)to get more bang for the buck to take advantage of a rapidly falling tape. The SPX most recent decline of ~9% masks the double digit percent selloffs in some of the high beta stocks, so many portfolios got hurt even if they only had a few volatile stocks in it. Right now, its probably prudent to be careful with emerging market stocks, especially China and Russia, as the money clearly moving out of this space, and I have also have several losses to show for. Additionally, I am weary of multinationals, especially those that have a lot of unhedged revenues in Europe, as you have a combination of weak Euro and economic and political problems griping the continent...so staying away for now.

5) Right now is the time to take a rational look at your portfolio, reduce some exposure to highly volatile stocks and start working on a shopping list of high quality, cash rich/cash generating companies that will likely be the first ones to recover when the turmoil dies. No reason to be a hero, no reason to try to pick up a falling knife or try to outmaneuver the market. I think that things will get really interesting near 1000 on the SPX. Technically you will be at 32% Fib retracement support and the valuation of around 11x 2011 projected earnings for the SPX. This is where the brave ones and those that horded cash should start putting it to work.

Brief thoughts in the midst of the market rout

We seem to be in the midst of a correction that should take 4-6% off the SPX. Hopefully, you were following my advice and raised cash into the strength. My portfolio now has more than 50% cash, but even a few stocks I own hurt on the days like today. The sentiment is changing, we are not seeing as much buy on the dip mentality, especially in some of the more riskier equities, emerging markets, or commodities names. At the same time, the negative news flow is mostly coming from the outside of US, while the economic data here is decent, and actually is neutral to positive. But the market is nervous after a big move and consolidation is not surprising. The earnings and guidance from most companies was good and economic news have been steadily improving. The first support on SPX is at 1170,near 50 day moving average and we are only 6 points away a I write this. The momentum indicators are getting close to oversold levels too, and it would be interesting to see if we turn there. If the 50 day ma doesn't hold (many stocks already broke that level)we should see the support at 1150, which would be roughly a 6% correction from the recent highs.

European events still dominate the investors psyche, concerns about overheated China other emerging markets, and corresponding run to the safety of the USD, all of this needs to be considered. What must be understood as well, is that with a skittish markets and the path of least resistance being down, any catalyst could really be blown out of proportion. If you are fully invested, its won't hurt to tighten your stops and raise some cash, only if to deploy it it aggressively when the markets stabilize. Its easy to get caught in the emotions of the day, but trying to maintain some perspective and having a strategy would get you through the craziness.

My strategy is to start looking for names that are being thrown out with the proverbial 'bath water', while at the same time to be mindful that not all sectors will be back hitting new highs in the near term. Generally, for now, I plan to focus on defensive names, avoiding controversial names like GS, BP, RIG, CAM, etc, although I may buy some stocks that unfortunately got caught in these highly publicized events and were sold in sympathy.