Everyone's confused (me too)

There is a sense of confusion in the markets. You see it in the indices, and you read about it in blogs and in the media. There seems to be 3 distinct groups emerging. The first see the indices as very over-bought, the fundamentals are terrible, and therefore the markets must be heading down in the near future. The second group is the complete opposite, arguing that the trend is up, it is strong, the data has all been better than expected, and the markets are heading higher. The third group falls somewhere in the middle and may be the largest. It sees the markets as overbought and the data as poor. It sees that the markets are probably due for a short-term correction. But it also recognises that the uptrend has been pretty strong, and if anything, the technicals are starting to look better. It also recognises that there are still a lot of people on the sidelines, and these people may need to get sucked into buying before we see a real reversal. That would send equity indices another 3-5% higher (approx.).

I fall into the last group somewhere. I already went out on a limb and called a top and was wrong. I am not going to try that again. But the data this week continued to be on the weak side, despite the fact that the market thought it “better than expectations”. That may be true, but to me it just showed that the underlying economic momentum was strong so it is taking the economy a little longer to slide. In fact, this is not new. In past recessions, there was often a period of mild weakness before the recession really got underway. And I really do not see how the economy is going to have a mild downturn with a sharp recovery when house prices are crashing and oil is at $125.

So I continue to believe that the downside risk to equities is much, much greater than the upside potential, and therefore I am keeping my short position. There is some evidence that market sentiment is getting very bullish, which is probably necessary before we can have a sustained downturn in equity prices. But there are still a lot of bears out there, hanging in (like me). So I am not going to rule out a pop as some more cover their shorts.