Orderly slide

This recent slide in the equity markets has been perfect. Fairly steep, but orderly, gradual. No large gaps or sudden slides. I suspect this is because many participants are a bit shell-shocked. They thought that the economy avoided a recession, or they thought that it was going to be short and shallow, and therefore the bottom in the market was already in.

There is a large and growing bear contingent on the web, and this worries me a bit. But many of them were talking about a bounce last Friday, and it never came, so maybe they were as surprised as everyone else by the markets over the past 2 days.

I think that as long as the decline remains fairly orderly and VIX stays at reasonable levels (say, below 32/33), we could have an acceleration of the decline over the next few weeks. I am looking for about 1100 on SPX. And if concerns about global growth continue to rise, then commodities should fall, and the TSX could fall pretty hard and fast with them. I am going to watch VIX for a sign to cover, plus for a large downside gap on the open.

MARKET POSITION: SHORT EQUITIES (10 units); SHORT REAL ESTATE (3 units); SHORT ENERGY (1 unit)

Quick update

Equities have been trending downwards the past two weeks, and today we had the first really big down day in a while (almost 3% on SPX) and the Dow made a new low for the year. Credit spreads have jumped out, the TED spread has turned up again, USD is soft, gold spiked up and oil prices are hitting new highs. The big question, of course, is whether this represents a tradeable bottom, or at least are we near to one i.e. should I be covering my shorts?

Sentiment is getting pretty bearish. I hear a lot of talk about SPX re-testing the March lows. Short interest is high and rising. The economic news has continued to be bad, and I get the feeling that the consensus may swing towards a 2008 recession again. On the flip side are a number of other factors: VIX is still pretty low (23.9 today), treasuries are still well above their lows earlier this year -- and the curve is still pricing in a hike this year; stocks are not cheap, commodity prices are still very high (I expect these to break down before the market bottoms), EUR/JPY -- a great crisis indicator -- is high (167/168), and there are few people talking about a serious breakdown in the equity indices -- most are just talking about a re-test of March lows.

So unless we have a major breakdown over the next few days, I think I am going to stay put for now. In 2002, the market fell through June, and then SPX lost another 190 points in the first few weeks of July. Goes to show that when the market really collapses, it can move far. I think the real bottom will come in August or September. A large gap-down on the opening Monday might change my mind over the short-term, however.

Portfolio Performance

I am late posting May performance as I have been traveling the past few weeks. I will not say much here -- the charts speak for themselves. Disappointing. Returns have improved the past couple of weeks but have a long way to go to make up for the carnage in April and May.

The US markets have been pretty weak the past few weeks but Canada remains pretty strong. US economic data has been weaker than expected, for the most part, though it is still inconsistent. My base case is still that as concerns about global growth increase, commodity prices will weaken (gradually at first, then more quickly), and the TSX should also fall. Although there are a few holdouts, consensus seems to be that high commodity prices are here to stay. I never feel comfortable agreeing with the consensus (although this sometimes gets me into trouble).

Sentiment is interesting again. My greatest concern is short interest on the NYSE, which is at all-time highs. Hopefully this does not indicate a generally bearish disposition, as this would mean that the market is close to a bottom. However, other indicators suggest that the market is still not overly concerned. VIX is in the low 20s, many people still seem to think that the US has dodged a recession, and there is little panic talk. Price movements may have become short-term over-sold, but so far the action has been relatively calm, indicating that we are not at a panic bottom. However, if there are a large number of shorts out there, the market could rebound pretty quickly after a bottom is formed. We should get more confirmation this week with the FOMC meeting plus several key data releases.

I sold my remaining unit of gold last week on moderate strength. I took a loss on this position after haveing a sizeable gain at one point. I will not try and give a lesson right now, but needless to say, I see the downside as greater than the upside over the short-term.

MARKET POSITION: SHORT EQUITIES (10 units); SHORT REAL ESTATE (3 units); SHORT ENERGY (1 unit)

The end is nigh

I have a strong feeling that the end is nigh for equities. All equities. Let me be clear. I am not saying that equities will crash and never recover -- I am talking about a rather quick and messy slide that takes 15%-20%+ off of the major indices from current levels. It will probably also be a "V" shaped bottom, with a fairly quick bounce up from the lows. This is also not a prediction for the next week, but rather what I expect over the next 3 months.

My rationale is based mostly on current oil prices, which are having a severe impact on consumers and businesses in most countries at current levels. The liquidity cruch of 07/08 appears to have passed (the worse of it, anyways), but it has left economies weakened and vulnerable, and the big jump in oil prices is a kick in the head that will be impossible to dodge. The hawkish rhetoric coming out of some central banks does not help either. The UK and German yield curves are now inverted, pointing to recessions there within about 12 months. The US yield curve has also flattened as yields have risen -- definitively NOT what is needed to get the US economy and financial sector back in shape.

The slowing in global growth will inevitably impact commodities prices as everyone remembers about the laws of supply and demand. This will impact the TSE and many other indices that have been supported by commodity producers.

I would like to exit my remaining gold position at a decent price if possible -- unfortunately I missed the latest uptick but it is a relatively small position so I am not overly concerned. So far, the short energy position has worked well and I may add to that position in future. Other positions, such as short real estate and short EAFE equities, are also starting to do better. The one major loser in my portfolio is my short CDN equities position, though I feel comfortable with it given my comments above.

My fundamental analysis is supported by sentiment. As of last week the consensus was that the US had dodged a recession, but that is starting to change. This is now the best time to be short -- as the consensus slowly moves from one extreme to the other.

Bonds have been big losers over the past few months but I think the worst is past. Bonds yields also spiked up at about the same time last year, then dropped with equities in the summer/fall. I expect the same to happen again this year, as concerns about the economy return over the next month or so. However, I expect inflation to remain troublesome so it is very possible that the previous lows may hold.

MARKET POSITION: SHORT EQUITIES (10 units); SHORT REAL ESTATE (3 units); LONG GOLD (1 unit); SHORT ENERGY (1 unit)
Posted by CDN Trader

Couldn't resist

I could not resist shorting energy shares. After buying and then quickly selling HEU at about $18.00 only about 2 months ago, I was forced to watch it march to almost $30 today. I have been patiently watching oil prices and waiting for the right time to enter on the short side. I think that time is now. Sentiment has changed dramatically over the past couple of months. When oil was at $90, no one thought it would sustainably break $100. Now the media is full of reports about oil going to $150 or even $200, and there is less talk about speculation -- it's all about the long-term fundamentals. I believe in the long-term fundamentals. Oil may go to $150 or $200.....but not right now. Not with the global economy slowing. Not with the US consumer suffering with higher food and gas prices.

Of course, I am taking a gamble here. I am going against an established trend, which is generally not a good idea from a trading perspective. And prices can sometimes go vertical at the top. The problem is that when commodities turn, they can sometimes do so very quickly, especially when one side of a trade has become very popular. I am not a very fast trader, so sometimes I must be a bit early. I have taken a small position, and entered tight stops.

I funded the trade by selling one unit of HGU (gold). Gold has had a nice run over the last month, but I fear it too is getting near its top. A return to $1,000 is looking unlikely (in the short-run). I will probably look to exit my other gold position over the next 1-2 months, depending on price action.

MARKET POSITION: SHORT EQUITIES (10 units); SHORT REAL ESTATE (3 units); LONG GOLD (1 unit); SHORT ENERGY (1 unit)

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.

Rangebound (again)

It seems that the equity markets are probably rangebound again as everyone awaits a bit more clarity on the economic picture. Data over the past few weeks has generally been better than expected, showing that expectations had been set pretty low. But now people are starting to talk as if there is no recession at all, or it will be very mild. The data do not support this conclusion, either. Employment (including initial claims), consumer confidence, housing starts and the ISM manufacturing index are all signalling a weak economy, one that is probably mildly contracting.

Looking forward, there are few good reasons for optimism. The consumer is suffering from the powerful one-two combination of falling house prices and very high gas prices. The financial crisis, which may or may not be over (I am somewhat ambivalent here), has had a severe impact on consumer and business confidence. Interest rates have been lowered significantly but the full impact has not been passed through to the end-users due to the problems in the financial sector (mortage rates remain above 5%) and loan officers are reporting a tightening of lending standards.

What is obvious is that there has been a major shift in investor perceptions since the March lows, and most are now much more bullish and trading the recovery. This is good from a contrarian perspective. I assume that the recent peak around 1420 on SPX will hold and we will ultimately see the index around 1150 (though I dislike hard predictions like that). Any strong gains above 1420 would be a serious concern and force me to re-evaluate my positioning.

HXD continues to be a major loser in the portfolio and is a strong argument for the introduction of a stop-loss rule (which I abandoned soon after trading). However, I am becoming much more bearish on commodities after recent spikes and therefore am more comfortable with the HXD position. In some ways, this is shaping up to be a classic cycle where the Cdn market lags the US into a bear market by about 6-12 months due to the tendancy of commodity prices to increase sharply towards the end of the business cycle. I remain a long-term commodity bull but think that we have seen most of the gains this cycle as prices have moved too far too fast and the fundamentals cannot catch up. I was an oil bull at $90 but at $125 the effects on consumption will be gradual but strong. I will probably sell gold into any near-term strength.

MARKET POSITION: SHORT EQUITIES (10 units); LONG GOLD VS. SHORT REAL ESTATE (2 units)