Let's recap, shall we?

A brief review of the facts:

1. Most forward-looking indicators (e.g. PMI, durable goods, etc) are showing that the economy has slowed dramatically over the past 2 months
2. The housing situation, while difficult to say whether it has become worse, has certainly not become any better.
3. The labour market is weak. Payroll numbers have help up OK (though their accuracy is debateable) but the 4 week MA of initial jobless claims continues to increase, and is approaching worrisome levels. A rise past 350k would be a strong signal that a recession is underway.
4. Consumer confidence is plummeting, particularly future expectations. Surveys show that a large percentage of Americans believe the economy is already in a recession.
5. Energy prices remain punatively high, despite the retreat from recent highs
6. Despite 100 bps of cuts from the Fed (plus BoC and BoE cuts), LIBOR remains high, the credit markets are glued up, and the stock market is 5% below it highs (as I write this SPX is 1490).

Is this a pretty picture? One that points towards a return to healthy growth and profits next year? I think not. So I must continue to stay short, wait and be patient. The market will come over eventually.

Speaking of patience, once again I rushed the trade last week to increase my short position. Although I wanted to increase around 1500, and saw that as a reasonable place to enter, I jumped the gun and made the trade before the market was able to get there. It was not an outright stupid move (I still believe that next year selling at 1465 will look pretty smart) but I could have got much better execution if I had been patient.

With less than 3 weeks left in the year, it's difficult to foresee how things will develop. It is possible we will get the usual Santa Claus rally and could even see SPX back close to its high. But if that were to happen, I would expect January to be pretty ugly.

MARKET POSITION: EQUITIES - SHORT (9 units); GOLD - LONG (1 unit)

Market offers more opportunities

The market continues to offer opportunities to increase my short position. After a hard and fast rally last week, the market seems to be weakening again. No surprise, given the events in the credit markets these days. A growing number of people are starting to say that a recession may be just around the corner. Housing, employment, consumer confidence, profits are all weakening. And the market is only 6% off its highs! A testament to human optimism and trend following.

I think by the middle of next year, now will be seen as an incredible opportunity to go short. Last week's oversold condition has been rectified, and the market is ready to start declining again. So I am taking this opportunity to increase my short position by two more units. I was hoping to be able to do it closer to 1500 on the SPX, but I am not sure we are going to get there with all the negativity these days.

MARKET POSITION: EQUITIES - SHORT (9 units); GOLD - LONG (1 unit)

(Short) Bear Market Rally

According to Richard Russell of the Dow Theory Letters, last week's price action confirmed the existence of a bear market in US equities. While I think it is too early to say for certain that we are in a bear market (bear markets, like recessions, can only be identified after the fact), it does appear that way. The market has gradually ground lower, without panicking, some days down more, some less. Importantly, despite a lot of negative data (housing, consumer confidence, financial sector) there is still a lot of optimism around. That is a necessary ingredient in a bear market. Once that is all gone, it is time to start looking for a bottom.

So the markets did fall over the past week as I expected, but the sharp drop that I was anticipating did not occur. That is both good and bad. Bad because I am impatient (though I am trying to work on that) and I want at least a 20% decline NOW, but good because it means that the market has yet to capitulate, and the bear is still alive and well.

Yesterday and today suggest that we may be experience a short bear market rally. This is totally normal after 3 weeks of almost continuous declines. I would not be surprised to see the markets rally 3-6% over the next 1-2 weeks. Not enough to trim positions (my ideal holding period is longer than that) but I may add to the short position if the rally is large enough. The key will probably be the data coming out of the US over the next few days. If it is OK, then the rally should hold. If it is terrible, the markets will probably return to the downside. I do not forecast monthly variables, instead trying to look for trends, so I am not too concerned about one month's data point. For now the economic trend is slowing, the data looks bad, and I expect that to continue for some time.

Gold has turned lower again, and I am starting to get the feeling that it could be some time before we see it over $800 again. I remain a long-term gold bull, but as long as the credit situation is detetiorating and the other asset markets falling hard, it will be difficult for gold to rally. The turning point should come once the Fed reduces rates much further and pumps a lot more liquidity into the system, and the US dollar really starts to take it on the chin. So I will continue to hold the 1 unit for now.

MARKET POSITION: EQUITIES - SHORT (7 units); GOLD - LONG (1 unit)

Situation continues to deteriorate

The market situation continues to deteriorate. I was expecting some market strength today folowing on Friday, but instead we have declines. This suggests that the decline could be more steep than I expected, and there may not be multi-day or multi-week rallies (at least in the short-run). To this end I have increased the short position by one unit. I do not want to materially increase my short position after a few weeks of declines, but the greater risk seems to be that the market will fall more quickly than anticipated.

MARKET POSITION: EQUITIES - SHORT (7 units); GOLD - LONG (1 unit)

Patience finally pays

It has been a difficult few months, but it seems that my patience is finally paying off. I have been convinced that this credit crunch was not over. Everyone wanted it to be over in October -- risky assets were up, the Fed had eased, banks had taken the necessary write-downs, credit spreads were coming in -- but I was certain the crisis had much farther to go. The current problems in the credit markets will likely take years to work out. That is not to say that financial markets will remain in "crisis" for years, but the short panic in August just seemed too short, too small and too easy a payment given the size of this problem. Sub-prime is only one facet -- there has been a very large increase in household debt over the past 5-10 years, and the re-adjustment will have serious implications for the financial sector and the economy in general.

So my short positions are finally making some real money as the equity markets start to decline. I expect this will be a relatively severe bear market that could last 12-18 months, but it is tough to know. Right now the short-term direction is down. That is not to say the market will fall every day, or every week. Some days the market may rally significantly, and some weeks the market may gain. But overall, equities are headed lower. At this point I am going to leave my position alone. I may trim slightly if there is a particularly sharp fall, and I may add a bit if there is a particularly large rally, but overall I plan to keep the size roughly constant.

I continue to be bullish on gold, but in the short-term gold may fall further as investors reduce exposure to risky assets. This is a healthy correction in a long-term bull market. In fact, I have been waiting for this -- it is the reason that I did not add to my position earlier. So I will keep a close eye on the situation, and may add to the position on a sharp fall.

On agricultural equipment, I am still bullish, and view the recent correction in AG and CNH as returning the stocks to more reasonable levels. The sell-off is undoubtedly linked to the decline in the broader marker, and should not be construed as negative for the companies. I still plan to add these companies to the trading portfolio, but I will watch for either 1) a particularly sharp decline indicating the companies are oversold, or 2) strength in the stocks when the overall market is weak, indicating that the stocks have started to buck the broader trend. I need to try to avoid the temptation to buy too soon. Patience.

MARKET POSITION: EQUITIES - SHORT (6 units); GOLD - LONG (1 unit)

Still waiting

The situation has improved slightly from my perspective over the past 1-2 weeks. As I forecast, international equities are noticeably weaker. Indeed, the US market is displaying many of the signs of an early bear market. Gold is considerably higher and the USD is much lower. The problem is that I have made little money. Cdn equities, while off their recent peak, have not fallen as much as US equities. Moreover, the gains on my short US equity position have been negated by the large increase in the CDN/USD rate. Gold is significantly higher but gold equities have not rallied nearly as much. AG is 10% higher but I have not yet taken a position (though I still intend to). Clearly I need to work on structuring my portfolio better -- if one cannot make money when one is right, when can one make money?

Despite the strong fundamentals I am wary of entering AG and increasing my gold position at present. The equity market is drifting sideways today after yesterday's sharp fall, indicating that investors remain wary. I think it is best to keep some powder dry for when the (inevitable?) break comes, and hopefully I can pick up some at more attractive prices. I am also seriously considering taking a long energy position. Energy stocks have not increased very much despite the large increase in oil prices over the past few months. Perhaps most investors do not believe that the current period of high prices is sustainable. I am not sure if $95 oil is sustainble, but I think $70 oil is easily sustainable, and this is probably not yet priced into oil stocks.

MARKET POSITION: EQUITIES - SHORT (6 units); GOLD - LONG (1 unit)

AGCO Confirmation

Agco reported Q3 revenues and profits today far above last year's level and analyst estimates, and guided full-year earnings estimates higher. I take this as confirmation of my assertion that higher food prices will lead to stronger sales of farm equipment. Agco is up 42% since my discussion here in August, CNH is up 35%. I plan to take positions in both sometime in the next 1-2 weeks. I am not jumping into the trade as still think equity markets will trend lower in response to weaker economic news this week, and this may allow me to get a slightly better price. That said, I may set a stop buy in case I am wrong and the market jumps higher.

MARKET POSITION: EQUITIES - SHORT (6 units); GOLD - LONG (1 unit)

No trading this week

I have decided not to trade this week. There are too many important data releases, and this will probably cause the markets to be especially volatile. I am not good at trading volatile markets. This week we have consumer confidence, the Fed, ISM, GDP and non-farm payrolls, to name a few. If I am correct, some (most) of this data should confirm the slowdown in the economy that I think is beginning. If I am wrong, then I need to seriously re-think my macro outlook.

MARKET POSITION: EQUITIES - SHORT (6 units); GOLD - LONG (1 unit)

Back to insanity?

Seems that the return to sanity was relatively brief. I did not expect the large fall last Friday to continue, but this week has been bizarre. People on both sides (short and long) are clearly nervous, given the large intraday swings in the equity markets. The bears are nervous that the Fed easing will allow the economy to hold up OK and therefore boost stock prices. The bulls are nervous that corporate profits and the economic data are both weak, and therefore the economic picture might not be as rosy as they imagine. The result is pure noise, very difficult if not impossible to read from a technical perspective.

In such a situation I think it is important to return to the fundamentals. Three factors are key here: 1) the housing market is imploding, and shows no sign of bottoming in the near future; 2) the credit crunch in August has made it more difficult for many households, corporations and investors to borrow; it has also shaken their confidence in the future and made them less inclined to spend and invest; 3) oil has been making historic highs - (even though gasoline is not making new highs, it is still very expensive byt historical standards, as are other oil derivatives). The data also seems to confirm the economy is slowing -- today we had durable goods orders weak and initial unemployment claims moving up (4 week moving average).

The risk is that rapid money growth props up the economy and financial markets for a little while longer. Such a scenario could lead to an upwards "pop" in equity prices that could severely damage my bottom line. I think what is more likely is that rapid money growth will flow into other assets such as gold, commodities, and maybe emerging markets. It is notable that gold is once again testing its highs at $770, despite everyone saying last week that gold was overbought and due for a correction. Could be short covering of course and the correction may still happen, but it is notable nonetheless.

In this situation it is best to wait and practice being patient. In time, the market will reveal its direction, and this will cause me to either add to or reduce my positions.

MARKET POSITION: EQUITIES - SHORT (6 units); GOLD - LONG (1 unit)

Is sanity returning to the financial markets?

What a change from a little over 24 hours ago. Then, the major European indices were up 0.5%-1%, apparently on the news that Heineken and Carlsberg were interesting in buying rival brewer S&N. The US markets then opened higher following the news that housing starts had declined by a very large number, and inflation was slightly higher than expected.

Now, the european indices are down considerably, bonds are trading much higher, and the yen is rising. What happened to the no-brainer risk trade? Have people finally realised that the Fed cannot save the day? Is sanity finally returning to the financial markets?

It will take several weeks, if not months to answer that question. In the meantime, I hope to start seeing some positive returns from my short position. During the collapse in the US markets yesterday I added to my short position, buying 2 units of SDS at 50.40. After the rally at the end of the day yesterday I thought maybe I was a little hasty, but it looks like today's open will redeem my decision. This sell-off/correction (call it what you will) is starting to feel as if it has some legs, and may continue for some time.

MARKET POSITION: SHORT - EQUITIES (6 units); LONG - GOLD (1 unit)

Some short and longer-term thoughts on the markets

The market is (so far) down about 0.5% today and is farther off its peak last Thursday. I would like to think that this may be the start of a longer-term trend but I have learned to be more careful in my short-term predictions. What I can say with a fair degree of certainty is that all of the elements for a large correction remain in place. The economy is definitely slowing, the credit markets remain glued up (though less so than a few weeks ago) and corporate profits are hurting. The general sentiment is that the situation is not that bad and the Fed is cutting so the economy will be back on its feet in no time. I continue to believe that this looks more like the end of the cycle than a mid-cycle slowdown. Anything else is probably wishful thinking.

I cannot say with any degree of certainty when the correction will take place, but when it takes place it will be rapid and it may not seem that serious at the start. People will believe that it is just another small reversal after a period of large gains. This makes it better to stay short and wait for the correction to come to me.

It is also difficult to know how large the correction will be. There has not been a significant correction (over 10%) in many years, making one long overdue. But whether it will be 10%, 15%, 25% or even 40%, depends on the evolution of the economy.

So in the short-term, I remain short equities, and I think bonds could also do well in the initial stages of the stock market correction. Looking farther out, once the correction looks like it is ending, I think the global inflation trade will be the best bet. Emphasis on 4 areas: 1) commodies / natural resouces (gold, energy, mining, etc.). These have done well over the past five years but there is still a long way to go; 2) emerging markets, especially those that produce a lot of commodities; 3) companies that produce products for commodity producers (e.g. I mentioned the agricultural equipment makers last month); 4) Japan - the return of global inflation should finally cause Japanese prices to rise, and Japanese assets will also reflate in price.

MARKET POSITION: EQUITIES - SHORT (4 units); GOLD - LONG (1 unit)

Slaying a Bull is a Long Process

Anyone who has ever witnessed a bull fight knows that slaying a bull is a long process. Especially a large and strong bull such as the one currently in existence in the global equity markets. Clearly I was too hasty to declare the start of a bear market in August. Instead of increasing my short position, I should have covered and gone long. I made the wrong move.

But I do not think now is the time to cover. Despite an extremely bullish sentiment, the market is exhibiting signs of getting tired. The rally is being driven by a small number of stocks. Other than the DJIA, other indices remain well below their June/July highs. The Nikkei is still down considerably. Gold is $100 higher, yet the US 10 year is 60 bps lower than its peak.

Similar news on the economic front. It is not as weak as I previously thought. Yet a serious slowdown is evident. Employment, manufacturing and spending are all well down. House prices continue to decline as inventories rise. As I keep saying, I can't imagine people are going to continue spending as they become concerned about keeping their house and their job. But most economic commentators think the economy will avoid a recession. From my perspective, this would be incredibly lucky indeed.

Of course, the economy has not entered a recession yet. Leading indicators such as the ISM and initial unemployment claims are still holding up OK. But once it becomes obvious the economy is in recession, it will be too late from a trading perspective. One must look out and anticipate what will happen. And it appears that the balance of risks is to the downside. The situation is clearly weaker than July, yet the equity markets are at about the same level. I would rather be short than long.

MARKET POSITION: EQUITIES - SHORT (4 units); GOLD - LONG (1 unit)

Sitting Tight

That's right, I have decided to sit tight. The market continues to move higher against me. It is now clearly through my pre-planned stops. Proper risk management states that I should sell down my position. Am I a deer in the headlights? I sure hope not.

The fundamentals continue to suggest the market is past its peak. The housing market keeps getting worse. This has got to start affecting consumer spending at some point soon. Initial unemployment claims so far show the job market is fine, but that cannot carry on forever once spending starts to slow. The credit markets are making good progress at returning to normality, but overall interest rates have not yet returned to where they were a few months ago, even after the Fed easing. The volume of CP outstanding is still shrinking, and apparently some banks are still shut out of the interbank market. Banks have started to unload some of the leveraged loans but the process is only starting and apparently the amount on their books from the big spending spree earlier this year ($300+ billion) is almost as much as the total amount of leveraged loans held by asset managers, etc. It is going to be difficult for all this to be absorbed, and until then, the banks are not going to want to fund new LBOs, hence no more takeover premiums on stocks (despite all the hype about Bear and Sallie Mae today).

Of course this is only speculation but I wonder about the effect of quarter-end tomorrow. Are lots of investors clamouring to get back into the market before they close their books? What other effects might be at work here? Next Monday also marks the start of October, a traditionally difficult month for stocks.

On gold, my entry was clearly timed poorly (I seem to have a knack for poorly timed entries) but I knew this might be the case -- this is why I only started with one unit. Gold continues to hold up well. It has received a lot of media attention recently and everyone seems to like gold, so that is not good from a contrarian standpoint. But I think being a contrarian is more important towards the end of cycles / trends when the consensus has been right for a long time and it cannot get beyond this -- like the case in equities currently. So I am staying long and looking for an opportunity to increase my position on further strength.

I am slightly concerned about the possible tracking error between the TSX and S&P500 indices. I think the present economic environment is more similar to the 1970s then the 1980s or 1990s (the comparisons people are always making). In the late 1970s the TSX performed very well due to the concentration of natural resource stocks, while the S&P went nowhere. If something similar happens again I could end up being right (in that the S&P500 performs poorly) but I lose money. Not the desired objective. I need to keep a close eye on this, and maybe consider diversifying into other short ETFs (e.g. SDS) even if it means taking on some currency risk.

One last point: I took a look at the start of the bear market in 2000 again to see how it played out and if I could relearn anything. One thing that struck me: even though the market peak was reached in March, it was not until late September / October that the S&P decisively moved lower -- 6 months later! In contrast, it has only been 6 weeks since the recent market peak in July. So I am going to wait at least until next week to see how things play out.

MARKET POSITION: EQUITIES - SHORT (4 units); GOLD - LONG (1 unit)

Patience is a virtue

Patience is a virtue in trading. One needs to have patience when entering trades, and patience when exiting. I could do with more patience. I tend to rush into trades, then bail when they do not go my way immediately. I was reflecting on how many of my big ideas over the past 18 months (long DJIA in early '06, long China in mid '06, long gold in late '06, short equities in spring '07) I abondoned then subsequently performed well.

I also rushed to replace the one unit of HXD that I sold Wednesday. After holding it as it fell $5, I did not want to watch it recover. My stop-buy was filled yesterday at 20.65.

Relatively quiet day today. Equity market is up again erasing yesterday's losses. So I sit and practice being patient.

MARKET POSITION: EQUITIES - SHORT (4 units); GOLD - LONG (1 unit)

Unconvinced

As I keep stating, I am unconvinced. Unconvinced that the credit crunch is over, unconvinced that the Fed lowering rates by 50 bps will solve the housing problem (which is at the root of the crisis), and unconvinced that the recent rally in the equity markets has legs. Perhaps I am stubborn, or wedded to my short position, but I don't think so. The more I think about it, the more unconvinced I become.

For risk management purposes, I entered 2 stop losses yesterday on my HXD position, for 1 unit at 19.90, and one unit at 19.80. The market gyrated between about 19.85 and 20.00 for the first 90 minutes. I thought I had outwaited the volatility, but not quite. My 19.90 stop was hit on the last move down through 19.90, then the stock subsequently rallied by about 50 cents (2nd stop was not hit).

Gold continued to rally so later in the day I placed a stop buy for one unit on HGU at 25.05 but this was not hit. Neither was my "re-enter" stop buy on one unit of HXD at 20.50.

Gold is through $730 today so I am a buyer of one unit of HGU at market (25.39). I also re-placed my re-entry stop buy for HXD at 20.65. CDN market continues to be quite weak and has fallen below my 13,900 upper target that I kept re-emphasising earlier this month. I think this may signal the final top of the rebound rally that began mid-August. Sentiment turned noticeably over-bullish after the Fed announcement. Most bears seemed to throw in the towel and assume risky assets were once again a safe bet. Reminds me of last June.

MARKET POSITION: SHORT EQUITIES (3 units); LONG GOLD (1 unit)

So Who's Right?

So who's right? The stock market or the Fed? The Fed cut rates by 50 bps yesterday due to concerns the recent credit crunch would adversly impact the real economy, and the stock market jumps over 2%. Does the stock market think that easy money is about to return? Or that inflation will be good for firm's pricing power? Or was it just caught up in the moment, and reality will soon bring it back to earth?

Either way, my upward bound for the TSX was breached yesterday, so I must seriously consider reducing my short position. However, as I have been burned many times entering and liquidating positions near turning points, I plan to wait until at least one hour after the open today to decide. Housing starts this morning were down more than estimates, and Morgan Stanley reported a 17% fall in earnings due to the credit crunch. Maybe these might remind investors what's really going on.

I also wish to establish an initial position in gold through HGU. Gold has gained strongly since I first mentioned it about a week ago. If the stock is up strongly more than one hour into trading, I will probably take a small position. I am slightly concerned about a small correction after the large gains of the past month, so I plan to enter this trade gradually.

MARKET POSITION: SHORT (4 units)

Testing Times

These are certainly testing times for anyone on the short side, such as myself. I think a lot of shorts have been shaken out over the past 2 weeks. I have held on due to my firm beliefs in the fundamentals, but good risk management practices dictate that I should consider reducing my position if the markets continue to rise from here. My sense is that we are probably near the end of this rebound rally, but I said that last week too. But rallies and declines usually end with a bang (I certainly re-learned that lesson when I sold additional units at almost the bottom of August's decline), and today's sharp rally certainly has that feel to it. I have continually said that my target range for the TSX rebound was 13,550 - 13,900. Today we reached 13,895.

Tomorrow will be a major test. Retail sales data for August will give a hint as to whether the American consumer still has some spending power up his/her sleeve, and whether people were spooked at all by the credit turmoil.

MARKET POSITION: SHORT (4 units)

Short Side Lining Up Nicely

The TSX appears to have spent the past four days forming a top to its pullback and the short side is now lining up nicely. Last week I mentioned that my level of uncertainty seemed greater than usual but I can safely say that I no longer feel that way. I would cite the following five factors:

1) Economy: last Friday's NFP report confirms what I have been saying for a while -- the economy is weak. The US housing market is very slowly falling off the edge of a cliff, and this will have major implications for households and the financial sector. The odds of a recession are now high -- certainly above 50%. Hell, there may be a recession underway already. A cut in the Fed Funds is now gauranteed, but as I said last week, it will be too late.
2) Market Sentiment: has shifted from overconfidence to hope. Everyone is now hoping that the Fed will save the market and the economy. That is the classic sign of the early stages of a bear market. Nevertheless, the bears remain wary. They are scared that the Fed will cut and the market will rally strongly. My investigations (admittedly anecdotal) are that there are not a lot of net shorts out there. That is a good sign from a contrarian perspective.
3) Financial Flows: The first week back after the summer was not good from a financial flow perspective. It seems that few deals were done. Everyone is edgy, and investors are not committing new money. The M&A market is quiet. Banks are stuck with lots of PE loans that they cannot unload and will have to carry on their balance sheets. LIBOR is ticking up as the financial system is icing over, despite all the money injected by central banks
4) Treasuries: Treasuries are rallying strongly. I was worried last week that the longer end of the curve was not coming down. Since then, the US 10 year yield has fallen by 15 bps. Impressive.
5) Gold: Over the past 8 months or so, gold has been stuck in a band between about $640 and $700. In general, it fell when risky assets fell, as investors treated it like other risky assets. But over the past couple of weeks, gold has increased sharply, and it breached $700 last Friday. And this despite the fact that the economy appears weak and commodities are not very strong, so inflation should not be a big concern. This may indicate that investors are becoming worried about the US financial system, and believe that the Fed is going to have to create LOTS of money to bail it out, putting more downward pressure on the USD.

If the market continues to fall I may add to my short position in the near future, keeping in mind rule #2. I will also considering taking a long position in gold, using the Horizons Betapro Gold Bull fund (HGU).

MARKET POSTIION: SHORT (4 units)

Fed Shmed

A couple of weeks ago I speculated that we may come to a point where the Fed cuts rates but then the market realises that the economic outlook is poor, leading to further market declines. The probability of this scenario occurring appears to be rising. The Fed looks like it will cut later this month but it will cut because it is concerned about the economy, not because it wants to prop up asset prices. In fact, from the snippets of Bernanke’s speech I have read, the Fed is becoming very concerned about the economy. It realises that falling housing prices will probably impact consumer spending. It also realises that credit conditions are tightening, and lower interest rates are needed to neutralise that impact, and possibly reverse it.

But all of this does not really matter. Why? Because the Fed is behind the curve. If there is going to be a recession later this year, or early next year, the Fed is already too late. Monetary policy operates with long and variable lags. All the Fed can do is try to ensure that any upcoming recession is not too long or too severe. I think the Fed knows this too.

MARKET POSITION: SHORT (4 units)

Conflicting Signals

Of course, there are almost always conflicting signals in trading -- that's why it is so difficult to do it successfully. But it seems that the signals are more conflicting than usual now. On the negative side are all the economic fundamantals that I have mentioned many times since starting this journal, so I will not repeat them here. On the positive side are several more ephemeral factors: 1) the yield curve has moved from flat/slightly inverted to upward sloping. This usually foreshadows stronger economic growth. 2) Sentiment seems to be midly bearish (though not overwhelmingly so). Its tough to know how many others out there are net shorts, but I certainly don't get the impression either that everyone is heavily long either. 3) Ed Hyman of ISI is calling for higher stock prices, based on moderate GDP growth (no recession) and falling interest rates. Ed is a highly respected economist and knows his stuff. But I wonder if the corporate connnections he usually relies on to guage the economy are poorly suited to predicting a consumer spending induced slowdown.

Despite yesterday's rally, the TSX still remains below my target up-bounce range of 13,550 to 13,900. So I would not be surprised to see some additional upside from here. But as I keep mentioning, it is important to stay on one's toes and not get wedded to one side or the other.

MARKET POSITION: SHORT (4 units)

Massing in the wings

I get the feeling that there are a large number of investors massing in the wings, waiting to buy the next dip. Everyone seems to know that the fundamentals warrant more pain, but they do not believe (or do not want to believe) that the bull market may be over. The US economy will soldier on.

I have trouble with this version of events. I do not see how the unraveling of what was probably the greatest bubble in American history --yes, far greater than the tech bubble of the 1990s -- can not have serious negative implications for consumption, and therefore the economy. Toll Brothers' recent conference call highlighted how bad things really are, and the economy probably has not hit bottom. If no one wants to buy a house now, what about when people really start to lose their jobs?

Many people in the investment community have pointed out that investors probably overestimate the impact of Wall St. events on Main St. This is probably true. But they are also underestimating the impact of Main St. on Wall St.

The market appears to be rolling over and it will probably re-test the recent lows. As of now, my positions are showing losses so I will not be adding to them. However, the TSX remains below my upper risk level of 13,900 so I will also not be reducing my position. It is a case of sitting tight and waiting to be proved right (or wrong, as the case may be).

MARKET POSITION: SHORT (4 units)

Profiting from the long-term increase in food prices

A few well-known, savvy, long-term strategic investors have mentioned farmland as a good investment. I assume this is a play on food prices. As far as I know (I admit I need to do some research on this), food prices have been falling in real terms since the advent of the green revolution in the 1960s. Improved chemicals, fertilisers, seeds and machinery have all kept food prices down. Most farmers are still notoriously poor.

However, there seems to be several forces now working against this trend, including: 1) population growth. Although the growth rate is declining, the earth is still expected to add about another 3 billions inhabitans over the next 40-odd years. That is a lot of mouths to feed. 2) There are diminishing returns to the above inputs. 3) Lack of land and water. Growing populations, desertification, falling water tables, disappearing rivers, etc. are all placing pressure on marginal farmland. 4) Climate change. This may open up new farmland in Canada and Russia but my guess is that more fertile land will be lost in the warmer climes than gained in the north.

There have been many stories on increasing food prices over the past 6 months or so. With all of the above factors working together, this could be the start of a long-term, structural increase in food prices around the world. The proportion of total household spending on food has been on a long-term decline, especially if you strip out the increasing spending at restaurants. The proportion should climb back up.

So, how to profit from this trend? Farmland is difficult to purchase for a small-time investor. Too much money, too much hassle, little diversification. My big idea: if food prices increases, farm incomes should also increase. This should translate into higher capital expenditures by farmers, ergo companies that manufacture farm equipment should also prosper.

A brief investigation shows that the largest farm equipment manufacturers are: John Deere (DE), CNH Global (CNH), Kubota (KUB) and Agco (AG). I would like to purchase a broad basket of shares to reduce company-specific risk, plus this is not supposed to be a stock-picking exercise. However, DE, CNH and KUB are also exposed to the construction equipment industry, making them less of a pure play. Whether this will be a help or hindrance over the long-term is tough to say. The slowdown in global economic growth may hurt, but the global infrastructure construction boom is probably still in its early stages.

I will return to this topic in the near future.

Let me take that back

In yesterday's post, I said that investors were starting to hope that the worst is over. I think traders / investors are starting to fear that the worst is over. The smart money seems to think that, although things are fine medium-term, we are due for some more short-term pain. In Macro Man's lingo, this is the "W" correction. There will be another leg down, and it should be bought. But investors are worried there may not be another leg down, and so they are trying to decide if they should jump back in or wait.

It is tough to know how to play this knowledge. I am a contrarian by nature, which gives two possible options: 1) there will not be another leg down, and this rally should be bought, or 2) the next leg down should be sold.

The fundamentals (as discussed in past posts) point towards option (2), and the fundamentals should rarely be ignored. But, as always, it is important to remain aware that I might be wrong, and I may need to change my mind. For now, the TSX is below the target range for the upward retracement, and I will watch and wait.

MARKET POSITION: SHORT (4 units)

Wait for it...

The upward bounce continues and investors are starting to hope that the worst is over. I am having trouble believing that everyone could have gotten off so lightly. Sure, the credit markets took it on the chin, and some hedge funds blew up. But given the scale of the sub-prime problem, the amount of leverage in the system, the level of take-no-prisoners risk-taking, it seems naieve to think that the whole problem would be solved by some minor Fed easing and limited asset transfers. The equity markets were down about 10% from their peaks -- hardly a crisis!

The TSX is still below its target "up-bounce" range (TSX currently at about 13,400, target range 13,550 - 13,900). So it would not be unreasonable to expect some more upside. But it is times like these a trader needs to stay vigilant and ready to change his mind if he is proved wrong. If the TSX moves above 13,900 I will be forced to reduce my short position.

MARKET POSITION: SHORT (4 units)

Bounce Begins

Asian and European markets higher after the Fed's 'surprise' (depending on whom one speaks to) cut in the discount rate Friday. Yen is lower and the usual carry-trade suspects (NZD, AUD, etc) are higher. It seems that some calm has returned and traders/investors are tentatively taking some risk.

However, the reduction in the discount rate does not change the fundamentals. Monetary policy in the US remains tight given the economic situation. I think the markets are starting to realise that all is not as rosy on Main St. as the bulls/economists would have us believe.

There is speculation whether the reduction in the discount rate is a signal that the Fed will cut at its next meeting, or whether it was merely a sop to the markets to try to calm the situation. I don't think the Fed knows for certain what it will do at the next meeting. If markets continue to fall and the situation morphs into a true crisis, the Fed will probably cut. But if markets recover, the Fed will probably not. The strange logic is that the market is more likely to rally if it thinks that the Fed is going to cut....you can run yourself in circles here.

When the Fed finally does cut, it will probably be greeted with great joy. But as the markets see that it is having limited effect on the real economy, they will dispair. The first cuts never seem to have any impact, just as the first increases never seem to have any impact.

MARKET POSITION: SHORT (4 units)

Guess who's back from holidays?

A few of the Dipbuyers returned from summer holidays yesterday, and immediately got to work trying to re-start the party. The music was started, some other guests came back, and they even danced for a few hours. The problem is that the booze (AKA credit) is all gone, and all of the stores (AKA banks) are closed for the night. Thus it seems that the party is unlikely to last.

Indeed, despite the dramatic recovery in NY yesterday, Asian markets tumbled pretty strongly overnight. The Nikkei fell over 5%, to a level that was last seen 12 months ago. European markets are currently giving up early gains. Currency markets remain volatile (the Yen is jumping around like a kangaroo). Given how long the liquidity lasted, there must be a lot of traders / funds out there hoping (please) that they are not forced to exit positions at severe losses. The pain is getting bad, but I don't think we are there just yet. Usually markets go vertical when they are near turning points, both on the upside and downside.

Looking out a few weeks / months, the big question is whether this is just a credit crunch, or something worse. The general opinion seems to be that this is like 1998 -- we just need liquidity conditions to return to normal (preferably with a little help from the Fed), and everything will be fine i.e. the bull run can resume. The major problem with this theory is that it ignores the fact that there is also a severe housing market downturn going on at the same time. This could continue for another 12 months, maybe longer. Manufacturing is also weak. This has already placed a lot of pressure on consumer spending, one of the major drivers of economic growth the past 5 years. Banks are also tightening lending and this will not help the situation. Thus we could have a situation where the market is "saved" by Fed easing, but then belatedly realises that the economy is in pretty bad shape.

Looking at yesterday's trade in retrospect, the timing was poor, and it cost me money. The trade was definitely impetuous, and perhaps I need to consider introducing some sort of "cooling off" policy whereby I must wait an hour or two following the decision to trade. This would allow the circumstances to be evaluated in a calmer manner.

MARKET POSITION: SHORT (4 units)

The great shakedown

Markets declining sharply again today. I bought 2 more units of HXD at 24.85. I was a bit impatient and rushed the trade -- it traded down to as low as 24.11 shortly afterwards. But now it is around 25.00.

Starting to see some signs of capitulation out there. US 10 year broke throught its resistence around 4.70 and is now trading around 4.63. Yen is down more than another point to 113. I think a lot of people are getting shaken out of dodgy, overleveraged trades.

MARKET POSITION: SHORT (4 units)

Watching the dominoes fall

Contagion is a good word to describe current events. Dominoes keep falling in the great contraction of global liquidity. Investors/traders are bailing out of positions because they are losing money in one market or another, and are trying to curb losses / reduce risk. Banks are severely reducing their lending to funds and forcing funds to mark-to-market collateral. The most recent victim is the global carry trade (mentioned yesterday). Today we see the Yen up significantly while the AUD and NZD are down 3-4 cents in ONE DAY. Emerging markets are starting to feel heat; yields on gov. bonds such as Hungary and Turkey are rising.

There seems to be no turning back now. This will get worse. Selling is begetting more selling. The fundamental problem is that there is such a large amount of leverage in the financial system at present. Everyone is playing with borrowed money. The most likely scenario is that this will continue for a while, then the central banks will be forced to step in. The central banks do not want to bail everyone out -- they are concerned about moral hazard, certainly. But they also do not want this to spread to the real economy. Most importantly, perhaps, they do not want this to cause a collapse of the banking system. Bernanke is, after all, the expert on the Great Depression.

I am seriously considering adding to the short position sometime today.

MARKET POSITION: SHORT (2 units)

More damage needed?

Looks like my call on a short-term bottom was a little pre-mature. We continue to witness a very large reduction in risk/leverage. Asian markets fell sharply again last night. Nikkei closed below its March low, which is bearish. Europe down - FTSE is approaching March lows, though DAX remains far above. The USD is strengthening against the Euro and C$. The Yen is up sharply the past few days while the NZD is down, indicating that the global carry-trade is unwinding.

It's tough to make a short-term call here. The declines over the past few days were large, and a technical bounce would be normal. At the same time, the negative news is starting to become overwhelming. The Bulls' rhetoric seems to be waning. The mainstream media is starting to discuss the possibility of a recession. Wal-Mart (the US and world's #1 retailer) went out of its way yesterday to highlight the difficult economic environment.

There has also been a lot of talk about the Aug. 15 deadline for redemption requests at hedge funds (given a 45 days to quarter-end notice period). Many investors at losing funds are likely to throw in the towel and ask for their money back. This would prompt more de-leveraging / selling. There has been a massive move into quantitative trading / investing over the past few years. For a while, it must have seemed like free money. But as with all great things in the markets, it cannot last. Goldman is unlikely to support ALL of its hedge funds.

Medium-term trend remains down based on poor economic outlook and negative sentiment / technicals.

MARKET POSITION: SHORT (2 units)

Short-term bottom forming?

Yesterday's rally did not turn out as well as expected. After opening up, N. American markets drifted downwards all day, culminating with a sharp slide that caused a negative return by end-of-day. Asian markets were mixed overnight. Europe opened down but has been rallying this morning. Perhaps we may be working through the sellers and forming a short-term bottom. Again, I do not expect it to last. Despite all the rhetoric coming out of the traditional bullish camps, I don't get the impression that everyone is waiting to jump back in with two feet and increase risk/leverage. The opposite, in fact -- people seem wary. And how long are investors going to tolerate large losses from these funds before they bail-out?

A recent report by Lehman Brothers on the quant-fund massacre last week http://www.dealbreaker.com/images/pdf/quant.pdf provides a few interesting lessons:

1) Language it important: your model did not blow up, it "misbehaved"
2) Turns out everyone is running the same model (more or less). Oops! How did that happen? (hint: everyone is using the same dataset and techniques to build their models)
3) The market has acted in unexpected ways. Funny that -- I always thought the market was predictable, as long as your computer programme was big enough
4) When things go really wrong, blame the asset class, not the manager!

MARKET POSITION: SHORT (2 UNITS)

Whew! Am I glad that's over....

Asian and European markets up this morning, some very strongly. I am assuming that this is a "relief" rally, as in "Whew! Am I glad that's over..." Uncertain how long this rally will last, but I guess anywhere from 2-6 days. As mentioned last week, the economic fundamentals do not look good (in the US - globally it looks OK for now). The liquidity tap, if not off, is down to a trickle, and this should prevent any meaningful rally in the markets. That is what makes this "correction" different from the past few. People were frightened. It seems unlikely that hedge funds will be wanting to increase leverage again quickly, and private equity firms will probably be wary of big new deals in this environment. Similarly, I don't see the banks lining up to throw money at these guys like they did only a few months ago.

The "crash" is probably over, however, I do expect this market to gradually grind lower for the next several months, at a minimum, maybe longer.

MARKET POSITION: SHORT (2 units)

Knowledge & Confidence

My suspicion was 'correct' -- NY and Toronto rallied throughout the day yesterday after opening sharply down. In the end, TSX closed down only a few points, while SPX closed flat. Short covering was probably a factor, but two other factors may also have played a role: 1) there seems to be a growing sense that the world is not coming to an end (despite all the crazy talk on Thursday). Maybe all the money the global central banks pushed into the system is having a soothing effect. 2) There has been a lot of speculation that all the quant traders are running the same models (more or less), and as the credit markets crashed they have been forced to reduce risk/leverage wherever possible. This probably has some truth to it -- how many different strategies (real differences, not superficial) can be employed with the same backward-looking dataset? Anyways, perhaps this selling has come to a halt, at least temporarily.

This sets us up for the rally to continue into the first half of this week. However, it seems unlikely to last. Economic fundamentals are still poor. Central banks may be willing to provide emergency liquidity, but I doubt they are willing to cut rates to save the credit markets. Things would have to get REALLY bad before that happened e.g. equity markets down 20-30% in a very short time period. At this point they could justify the cut to themselves by pointing to the likely effects on the real economy.

After reading more of "The Black Swan" over the past few days, I am reminded of the dangers surrounding knowledge and confidence. It is probably impossible to consistently forecast the markets, especially the short-term day-to-day movements. Anyone who claims they can do so is either lying, lucky, or, most likely, never checks their own record.

It is important to keep the limitations of one's knowledge in check and not become overconfident. In the markets, being over-confident is worse than being stupid.

MARKET POSITION: SHORT (2 units)

Initial Thoughts

Trading started several months ago but, for some reason (?), I did not start the journal until today.

Coming back from holidays on Monday 6 August (4 days ago), I had the strong feeling that the markets were ready for a technical bounce. In fact, I had tried to buy HXU at the last moment last Friday afternoon, but was too late in entering the order by a few seconds. Toronto was closed Monday but NY rallied. On Tuesday at the opening, I was surprised to find Toronto trading flat from Friday's close. Being quite certain that the markets would rally following the Fed statement later (no matter what they said -- any old excuse would do), I bought HXU at 28.37. Stop loss was set at 27.95. I thought there might be a dip before or after the statement, but thought the spread would be sufficient to take account of any market 'noise'.

I was away from the computer from before the Fed announcement until after the close. I was slightly annoyed by the outcome. Markets did indeed rally, and there was a dip first. But the dip was large, and my stop loss was hit. In fact, my stop loss was hit at 27.88, and the low was 27.83. Close was 28.60. There must be a lesson to be learnt there, but I am not really sure what it is. For now, I am taking it to be: "be sure in your trades and set stop losses wide". If you are not sure, then don't trade!

Wednesday: market rallied again but I decided to stand on the sidelines. I did not expect the rally to last very long -- this was a technical bounce, after all, so it was a matter of waiting for it to peter out.

Thursday: European markets tank after more bad news on sub-prime. Turns out the problem is spreading to Europe. Amazing where this junk is turning up. In retrospect, not too surprising though. Considering that China, Japan, India, Russia, Saudia Arabia, etc. have been buying all the US Treasuries over the past few years, what has everyone else been buying? Securitised and structured products. And why not? They have a AAA rating, and the yields are certainly better. But ratings do not say anything about liquidity risk. And right now, it seems that no one wants anything without a government name. The technical bounce is over.

Toronto gaps sharply lower at the open and I am a buyer of HXD at 21.78 (no stops set after Tuesday's experience...for now). Market subsequently rallies for the next few hours. I know this cannot last, but I am annoyed at my impatience. I could have entered the trade at a much better price. Try to tell myself that it is the big moves that matter, not the intraday. In the end, market gives up all its gains and more.

Friday (am: London): Asia down sharply overnight. Nikkei is down a lot but the March lows held (so far). Europe also down. US$ up. Everyone is worried. Apparently the central banks are injecting liquidity into the markets. But I have a strong feeling it won't be enough to prevent a bear market. It may prevent a seizure of the credit markets, but the damage to the American household has already been done. People are worried about their homes and jobs. Spending will slow, dragging the economy down with it. In the financial markets, the global buyout binge is finished. finito. This has been driving the market up for the past 6 months, and now it is gone.

This all said, I have a sneaking suspicion there will be some short covering today before the weekend. The selling will continue next week.

MARKET POSTIION: SHORT (2 units)