Wile E. Coyote moment

Global equity markets are markedly lower this week, but the slide so far has been rather orderly. The situation reminds me of last July or early January. The other, larger financial markets (FX, bonds, credit, commodities, etc) are signalling major problems, yet the equity markets are only just beginning to cotton on. USD/EUR is much lower, short-term government bond yields have collapsed, credit spreads (swaps, LIBOR, corporates, munis, agencies -- you name it) are blowing out, gold is pushing $1,000 and oil is well over $100. Banks are short capital, risk aversion is high, and liquidity is tight. 5 year TIPS real yields are now less than zero! The response? SPX is still above its January lows, and VIX is at 26.5. It's like the equity market has run off a cliff, but is only just realising it now....

Just to throw in one more issue: inflation expectations appear to be rising in the US treasury market. No wonder -- surprising it took so long. This is negative for earnings multiples. And I am not going to discuss the monolines.

As for the economy -- it's not looking good. Not terrible, mind you, but not good either. Both ISM surveys were below 50 this month. As the 4 week moving average of initial unemployment claims remained above 350k for the 3rd week in a row today, I feel comfortably declaring that the US is officially in recession. The ISM and unemployment numbers were not as bad as the market feared, but that does not mean the recession will be short or easy. This is only the beginning. It is natural that the indicators will be mild at the start. It's really the trend that matters. And the trend is not good.

As mentioned above, gold and oil continue to power higher. I am wary of jumping in here. No need to be greedy. Patience will be rewarded on the commodity trade. I think commodity prices will take a big hit sometime soon as people re-equate the US slowdown with lower demand for commodities. They will probably also be affected by the tightening of liquidity and falls in other asset prices. But that will set-up a good buying opportunity. This commodity bull market is far from over -- it's just gotten too far ahead of itself at this point.

MARKET POSITION: EQUITIES - SHORT (11 units); GOLD - LONG (1 unit)

Getting close....to meltdown?

Yesterday the 4 week moving average of initial unemployment claims was above 350k for the second week in a row. This is a bad sign for the economy. Other data out the past week has been awful -- home sales, durable goods, home prices, consumer confidence, inflation. On Monday the ISM manufacturing will be released, and it should show that manufacturing contracted in February, confirming the start of a US recession. Financials continue to disclose major losses while corporations have started to anounce layoffs. Mortgage rates and spreads for much corporate lending have ticked higher over the past month even though the Fed cut rates by 125 bps.

Despite the abysmal news, the equity markets performed fairly well the past week, rallying higher on several days. I admit this made me uneasy -- a market that can rally on bad news may be a market that had already priced in the bad news, and is now ready to move higher. I am more than willing to admit this is a possibility. But the more likely scenario is that it was a short-covering rally / bull-trap. It seems that I misjudged the level of short interest out there (there is a lot), and probably some people were forced to reduce positions into the rally. My primary rationale for this belief is that the bond / credit / FX markets are not confirming the equity rally. TIP yields are still very weak, treasuries seem to have plateaued, credit spreads are going ever higher, and USD keeps sinking. If equities were really going to mount a sustainable rally, I would expect at least some of these markets to provide some support.

So the million question is: how long can the market hold up in the current barrage of negative economic, financial and corporate news? The answer is: probably not very long. In fact, there are some signs that the rangebound nature of the past few weeks is coming to an end. US equities faltered late-Wednesday of this week then were down about 1% yesterday. European equities are down over 1% this morning. More importantly, JPY/USD has moved downwards by an incredible 4 yen over the past week, including about 2 yen in the past 24 hours. JPY/EUR has moved by 2 yen in the past few hours. Could this signal the start of the next phase of meltdown?

As mentioned last week, gold and oil continue to power higher, and I think this may continue for a while longer. It is instructive that there seem to be no "serious" analysts predicting $120 oil. Everyone seems convinced that the price is so high due to "speculators". Are all the hedge funds in the world long? Perhaps, but the real money investors do not appear to be, setting up the possibility of much more upside to come. I am rather annoyed that I did not get long energy shares in mid-January when I looked at them closely. Oh well, there will be another time -- this is a long-term story and patience is neccesary. What is much more annoying is that the TSX continues to strongly outpeform SPX on the upside, causing immense pain to my holdings of HXD. Given the expected strong performance of commodities for the foreseeable future, I will take advantage of any future weakness in the TSX to exit my HXD positions. Heretofore I will focus the short trades on other markets / sectors.

MARKET POSITION: SHORT - EQUITIES (11 units); GOLD - LONG (1 unit)

One down, one to go...

I have said that I am looking for 2 things to confirm the start of a US recession: 1) the 4 week moving average of initial unemployment claims above 350k, and 2) the PMI below 50. Number 1 was confirmed today. Number 2 is not quite there. Although the PMI dipped to 48.4 in December, it rebounded to 50.7 in January. But I think it will be below 50 for Feb. Today's Philly Fed index was terrible. Manufacturers seems to be getting dragged down by all the gloom. There is a spreading malaise. Although many companies still have strong sales, they are getting worried about the future, reducing investment and stopping hiring. This is recessionary behaviour.

The big question is whether this will be short-lived, or whether it will morph into something long and severe. There are some good reasons for both. I have not yet decided, though I am leaning towards short-lived. TIPS have ticked up a bit over the past few sessions -- I am going to watch this closely to see if it might be indicating a return of econ. growth later this year.

As I predicted a couple of weeks ago, US equity markets have remained range bound. There seems to be some consolidation going on. I still believe that the next major move is more likely to be downward. The market has not yet fully discounted a recession. VIX is still only 24.5. When it happens, it will be time to cover my shorts and wait for the rally.

The Cdn equity market, on the other hand, has been rather strong over the past couple of weeks, and the divergence between Toronto and NYC is quite large. This is atypical, though perhaps not for this point in the cycle. I mentioned this was a possibility many months ago as I was worried that a strong commodity performance would hold up Cdn equities as US equities fell. It was the major reason I bought some SDS. But I am feeling a bit frustrated now. I am seriously considering two options: 1) reduce my HXD exposure in favour of SDS, or 2) increasing my holdings of gold plus adding energy to provide a sort of hedge. Ideally, the two positions would both perform well. The problem is timing...I am not sure if now is the best time. The one month return difference is quite large, and should narrow.

Gold and energy are up nicely over the past week, prompting me to review my position that they would fall further before moving up again. Gold has reached new highs in the past few days, and $1,000 now seems easily within reach (this seemed ridiculous not so long ago). The most interesting part is that gold cos. seem to be valued at a long-term price of $600-700. Oil related cos. are similarly valued at an oil price of $60-$70. Oil recently reached $100. Everyone thinks the price is crazy and must fall -- few people are predicting $120. This looks like a good contrarian bet from my perspective.

MARKET POSITION: EQUITIES - SHORT (11 units); GOLD - LONG (1 unit)

Rangebound

First, I think it necessary to address my last post, where I changed my mind about the direction of the market and decided that it was headed lower. In retrospect, this was not a terrible call (the market is currently about where it was that day), but again I was a bit impatient and rushed the trade. I previously had stated that I thought SPX would go to 1380, and I was waiting for some more optimism to return. Well, SPX reached 1396 on Feb. 1st, and again there were stories suggesting that a recession was not certain. Vix also retreated nicely. That would have been the best time to re-establish the short. C'est la vie...

On to today. The market seems to be slightly rangebound, awaiting direction. US equities were up yesterday on no real news, and European bourses are rallying strongly today on fumes. There is a possibility that this could turn into something bigger. Markets are down considerably over the past 2.5 months so a rally is not impossible. A recession still does not appear to have started yet in the US (my two criteria -- initial unemployment claims 4 week moving average above 350k and PMI below 50 -- have not yet been breached), allowing for some optimism that the bullet might be dodged. The Fed reduced rates by a silly 125 bps in one week.

But that does not seem to be the most likely scenario. A bear market rally may come soon, but I think there needs to be a real intermediate washout before it can be sustained. The Fed's inter-meeting cut prevented this from happening in January, but it needs to happen at some point. It is normal. It could happen when investors finally realise that a recession has started, and they can then comfort themselves by hoping that at least it will be short and shallow.

Gold still seems very overbought given conditions in bond markets. There is a good chance that it could fall sharply back to the $650-$700 range. But long-term I remain bullish so I will continue to hold my unit, hoping to add at better prices.

MARKET POSITION: EQUITIES - SHORT (1 unit); GOLD - LONG (11 units)

I changed my mind

I changed my mind about the market. I changed it several times, in fact, but I have settled on the reverse of my position last week. I now think that the market is more likely to go lower. There are several reasons for the change. First, because US markets were closed last Monday and the Fed made it's dramatic 75 bps announcement Tuesday morning, the markets never had the big, fast drop that slides usually end with. Last Tuesday's and Wednesday's lows were ultimately unsatisfying in that they did not shake out enough longs, and emboldened many (including myself) to gamble on some upside. Indeed, too many people have been saying that last Tues/Wed marked intermediate lows, and the market is poised for a good rebound before falling lower again. This suggests that too many people have assumed the worst is over for the time being and put risk back on the table.

Last Friday's slide was also indicative of a weak market. The high was at the open, (and slightly short of my 1380 target for SPX), and the market did not see it again all day. Despite a bit of a rally today, we are still far below Friday's high. This is not the sharp rebound that I was expecting.

Finally, today's new home sales data was aweful, providing another reminder how bad the economic situation is likely to get. I am not sure what Bernanke and co. are going to deliver on Wed, and I don't really care, but I don't think the market is going to be happy whatever it gets.

I returned to my previous short level earlier today, purchasing 3 units of HXD and 2 units of SDS.

MARKET POSITION: EQUITIES - SHORT (11 units); GOLD - LONG (1 unit)

Chill-Out time

It's Chill-Out time for the equity markets. It got a little heated at the beginning of the week, but the scene is a bit calmer now. VIX is down to 28, the US 10 yr is up a whopping 22 bps as I write this, and the global equity markets have bounced off their lows. The tone of the media has also changed. Although it is impossible to measure this scientifically, it seemed that ALL of the stories on Tuesday / Wednesday were doom and gloom, whereas the mix is much more balanced today. Positive stories today included the bail-out of the monolines and progress on the fiscal stimulus package. This will be important to watch as it could have a strong impact on the markets when it finally goes through Congress, though I am sceptical about the final impact on the economy.

Light week data-wise. Initial unemployment claims were surprisingly low again today. This also needs to be carefully watched. If this remains at such a low level, it will be a major hole in the recession story, which has now become mainstream. Existing home sales were very poor today, however. Lower interest rates seem to be having an impact on refi applications, but the banks and consumer credit companies see rising losses on the horizon and they are scared. Anecdotal evidence suggests a BIG decline in new auto loans, for example.

I expect the market to bounce around a bit here but ultimately move slightly higher over the short term. Not surprisingly, the chatter is still somewhat negative, and I will wait for some optimism to return before re-establishing my full short position. This is a risk management exercise more than an attempt to goose returns. I am looking for SPX to reach about 1380, maybe higher.

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

The end of the beginning?

Was today the end of the beginning of the bear market? Only time will tell for certain, but there were a few prominent signs. After Asian stocks fell hard for two days running, the international media were screaming about a stock market crash when NY opened today. After the Fed cut rates 75 bps in a surprise inter-meeting move, the market only opened down about 4%, then rallied through the day to close down 1%. This is the first market move greater than 3% in some time. In response, VIX hit 35 this morning (see last Friday's post re: VIX).

These facts led me to close out 5 units of my short position near today's close. I waited through most of the day to see if the market might collapse (as it has done several times recently) but it held up OK. This was a sign the market might finally be finding some support, though it also meant that my price was not great. In particular, I gave up all of yesterday's gain in HXD. Well, one should try to be as dispassionate as possible.

I am thinking there may be a short rally from here as the market finally clears its oversold position. Could last anything from a few days to a few weeks. I plan to re-establish the shorts, hopefully at better prices. I am hoping that I am not attempting to time the market too closely here....

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