Sunday, January 22, 2012

Trading Thoughts for Week of January 23

Equity rally is long in the tooth. I think that longs need to prepare to bail and shorts should be ready to go to work very soon, even though there is nothing on the charts that says it is time to do so, yet.
Here are my technical and fundamental reasons for being cautious:

1. SPX is overbought. This can continue as long as daily stoch is in embedded mode (and it currently is). It has traded straight up in rising wedge (bearish reversal pattern) since 12/20, with no meaningful pullbacks. As the matter of fact, there have been no closes below 8 ema on daily since then. Once the gaps above get filled, there are 6 gaps on SPX futures below current level to shoot for, all the way down to 1153. When weakness develops, many longs will bail and shorts will initiate new  positions. Have to wait for a signal!!

2. Increased dissemination of bull(ishness) by fund managers, appearing on business alphabet soup network, about how "everyone is missing the train" - is ludicrous and contrarian in nature. They sing the same song over and over: "stay invested", "you can't time the market",  "don't fight the Fed", "stocks are undervalued". S&P 500 earnings are projected to be roughly $100 per share this year. Apply a 13 P/E multiple to that - you get 1300 for SPX. Let's assume the best case scenario -  $105 (EPS) x 13 (P/E) = 1365. So we go up another 50 points, and then what? S&P 500 is at or just slightly below its fair value, considering U.S. GDP projected growth of 2 - 3% this year. What train are we missing? Train to nowhere...

3. Same fund managers say that "market deserves a higher multiple". I am tired of this argument, and do not get their main thesis behind it - "interest rates are at historic lows". There are many reasons for rates to stay this low, the main being that bond market does not believe liquidity-driven recovery in equities. Stocks do not trade in a vacuum. Expansion of P/E multiple can not happen until possible external macro shocks have been removed, some of which are:

a) Greek debt haircut talks could collapse, Spanish and Italian bond yields could spike to unsustainable levels - resulting in EU debt crisis spiraling out of control.
b) Eurozone recession could be deeper and last longer - resulting in much lower earnings by S&P 500 multinationals.
c) China could slow down tremendously - thus pulling the entire world economy down with it.
d) U.S. GDP could be revised downward due to that world-wide economic slowdown.

If that worrisome cocktail is not enough, let's add a few more important developments:

e) fresh Portugal default fears, as that country's debt is now rated junk by all three main credit rating agencies.
f) Iran's sabre-rattling in Strait of Hormuz threatening to block a flow of crude oil.
g) Absolutely no clarity on GOP candidate yet (with Santorum and Gingrich dealing a blow to Romney in primaries), not even talking about who will win U.S. presidential election in November.

Way too many uncertainties for market to advance without a meaningful pullback.
Taking all of the above into consideration, combined with the fact that SPX is up 22% from October 4th low, I am staying flat equities now and will be ready to short on a signal.

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