(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)