Sunday, February 19, 2012

Trading Thoughts for Week of February 20

Virtually uninterrupted stock market ascent from December 20th continues. Shorting this bull move on the premise of market being overbought seems to be a fool's game. I carefully waited for credible selling levels, identifying them as confluence zones of resistance. Combined with momentum divergence and pattern studies I pulled a trigger a few times. While a few scaleouts got filled, the remainders got stopped out. One has to be patient and let the market do its punishing, only to reverse in the face of those exuberant and unsuspecting ones. I will be less defiant if SPX can get above 1370 and stay there. Above that level reward to risk is greatly diminished, as the next resistance level is way above. Continuing to be wrong on the short-term direction of the market is both frustrating and humbling. Perhaps I am completely out of touch. I expected SPX to stay inside the wedge for the first part of 2012 and break out in the second. This said, it can return back into the wedge just like in October. S&P 500 is now trading at 13 times 2012 projected earnings.

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Chinese rulers (for the lack of better word) cut RRR again, even as CPI has climbed back up in January. Scared politburo is now ignoring its 4% consumer inflation target, while its is trying to revive slowing Chinese economy. With $3 trillion in their coffers, we have an absolute respect for Chinese leaders, as we expect them to save our Western civilization from all of our financial perils. I think it is likely that they will end up spending most of that money on domestic stimulus, to make sure less people die of hunger and neglect inside of their own country.
Let's look at what happened after the first cut of RRR on Nov 30, 2011. Shanghai Composite rejoiced the next trading session making a high at 2423 on Dec 1. It has not seen that price ever since. Even with a 10% rally from January 5th low, index closed at 2357 on Friday. The rally was in anticipation of second RRR cut. How long will investors celebrate this time? One is to be cautious, knowing what happened after the first time.

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European leaders are once again outdoing themselves with shenanigans of epic proportions. I talked about ECB bond swap previously, it finally came. Supreme institution is going to escape the bond carnage without a scar, at the same time as private investors are taking a 70% haircut. Investor outcry should be starting about now!! Furthermore, we are learning that over the weekend EU leaders are feverishly searching for new ways to restructure Greek debt in order to bring it to 120% of GDP in 2020. If this is not the most ludicrous condition of Greek bailout, then I do not know what is. What will these geniuses think of next? Perhaps European Union can suspend the principles of economics altogether by 2020? I suggest they finally think about how Greece is supposed to grow its GDP after a harsh austerity has been imposed on it.
Look for market to start punishing "me too" EZ struggling peripheral countries' debt not a minute later after the Greek bailout is announced. Euro short-covering rally (on the bailout announcement) will be brief and will be met with new wave of selling. There are way too many shorts now though, so the rally is much needed to reduce that amount. Use 20 dma as a guide and be patient.

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Based on last quarter's disappointing results and its weak forward outlook, I am wondering how AMZN is still trading at current level. It is known as a premium operation with innovative leader, the pioneer of online retailing. But declining growth rate and margins are going to hunt the stock going forward. It has underperformed in this recent tech rally (along with GOOG).  My conviction on the downward direction will get a boost if the long-term trendline breaks, which also happens to be at head and shoulders neckline. One is not to overreact, this trendline has to break first.

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So I saved the best for last today. Bear with me through this last part, as there will be a trade of the year (related to this) at the end. And no, it is not to short U.S. Treasuries. We know what happened to that last year. Save your hard-earned money and stop fighting the Fed.
A few months ago I had a heated discussion (at a local bar) with another gentleman (not an investor) about America's sources of oil imports. While seemingly smart individual, he was completely ignorant to my arguments. So I finally pulled out my iPhone4 and showed him the facts, which immediately quieted him down (thank Gore for wireless internet). He was astonished to find out that U.S. gets more than half of its oil from Western Hemisphere, and a much smaller share from the Middle East. It is mind-boggling how misinformed the public is about this subject. So next time you want to win a bar bet, bring this subject up. Or better yet, the next time your elected politician says how "America relies on its enemies for oil", send him/her this chart.

But now on more serious note. With the above in mind, you have to wonder what Mr. Obama was thinking when he axed the Keystone XL pipeline. Canada is our closest ally, the friendliest of all oil sources. How many American jobs were not created because of the lost project? And finally the most important, what will we do when our gasoline possibly hits $4 and $5 per gallon this summer? Granted, that pipeline would have not helped this year, as it would take a while to complete, but the time to start was in 2010, when it was on the President's desk first! Endless delays are finally prompting Canada to ink the oil deal with China. Great!! Speaking of China, it is getting most of its oil from the Middle East and other "hot spots" around the world. It is recognizing the stability of Canadian oil supply and is ceasing the opportunity.

Today newswires are reporting that Iran is suspending its oil exports to UK and France. This will put even more strain on crude oil and gasoline supplies and boost the prices, just as Saudi Arabia reportedly reduced its oil exports.

So let's discuss the trade. I believe that this may become the best trade of the year. It actually already started for me, on December 29th, as I discussed in my post that day. But it gets better, or worse, depending on whether you are a trader or the consumer, which I am both. As the price of the gasoline hits $4 and $5 per gallon, retail sales are going to take a serious hit. So adding XRT short, as the price of gasoline continues to rise, makes this a more powerful trade. Interestingly, the two are usually moving opposite to each other, but have correlated in the same direction since depressed levels at the end of 2008. Look for that to break down as we near the $4 mark on retail gasoline. Obviously, the U.S. economy is going to slow down tremendously due to that development, because consumer spending is 70% of U.S. GDP. Hence SPX short would also work in this case. One important thing to remember is that at above $4 and surely at $5 per gallon the demand destraction will take care of gasoline price, and it will eventually start heading down, like in July of 2008 - by then retail sales were toast. So as soon as I start riding my bicycle and not my SUV to the grocery store, I will immediately announce the end of long RBOB trade here.

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