Friday, August 2, 2013

The Morning Call--Trust me, I know that I am on the wrong side of this trade

The Morning Call


The Market

            The indices (DJIA 15628, S&P 1706) smoked everything is sight yesterday.  The Dow blew through the upper boundary of its short term trading range, re-starting the clock on the time element of our time and distance discipline.  The S&P closed within its short term uptrend (1601-1762) and above the former upper boundary of its short term trading range (1687).

Both of the Averages finished within their intermediate term (14498-19498, 1538-2126) and long term uptrends (4918-17000, 715-1800).

Volume actually dropped though breadth improved.  The VIX declined but remained with its short term trading range and its intermediate term downtrend.

GLD fell, confirming the break of its very short term uptrend (not good) while finishing within its short and intermediate term downtrends.

Bottom line: the bulls were out in force yesterday and, at the end of the day, left the impression that a new moon shot may be in the offing---even though the lower volume raises nagging doubt.  If the Dow closes above  15550 though the end of trading Monday, the break of its short term trading range will be confirmed.

While the Averages will be out of sync through Monday, the magnitude of yesterday’s advance returns our focus to the upside; to wit, the upper boundaries of the short (16000, 1762), intermediate (19498, 2126) and long term (17000, 1800) uptrends.

As I noted before, assuming 16000/1762. 17000/1800 are the likely upside technical limits, there is not all that much reward left when compared to the technical downsides S&P 1601, 1538, 715).

            Intra stock correlations are declining Medium):



            Yesterday was a gangbusters day economic data-wise, both here and abroad.  In the US, weekly jobless claims were down, the July Market PMI reading was up more than expected as was the July ISM manufacturing index.  The only disappointing stat was June construction spending which was weaker than forecast.

            Overseas, the Chinese and Eurozone PMI were improved and the ECB left interest rates unchanged.

            Meanwhile on the political front, Boehner admitted that there would be no appropriations bill by the end of September indicating the Washington remains as paralyzed as ever.

            Equity investors clearly loved the above; and frankly, I agree.  While this week’s economic data has by no means been all upbeat, the primary indicators showed the kind of strength that supports an environment of economic growth.  In addition, worse things can happen than gridlock in DC.

            However, the issue remains, is good news good news (an improving economy) or bad news (the end of Fed easing) and visa versa.  Yesterday was a clear indication that good news is good news, implying that there is no worry about the end of QEInfinity.  However, I am not going to rely on one day’s pin action to provide the answer (1) because it is too short a time frame and (2) I don’t think that the prevailing confusion on Fed policy gets clarified in just one day.

            That said, a one day read of the tea leaves is that equity investors love a strong economy even if it means higher interest rates (which we got yesterday) and a more hawkish Fed.  Of course that followed a day (Wednesday) in which the Fed was more dovish and interest rates rose.

            I had sought to cut through investor confusion over Fed policy by concentrating more on interest rates than all the speculation around what the Fed was going to do and why.  But Wednesday and Thursday’s inverse pin action of the stock and bond markets suggest that investors are just as confused about the implications of higher interest rates as anything else.

            Bottom line: the only way that I can explain yesterday’s Market performance is that investors believe that (1) the economy is getting stronger, (2) it is only logical that interest rates will to up as a result, (3) and the Fed will either err by delaying any tightening, even in the face of a better economy or if it does tighten, if will have a marginal impact on interest rates.

            Let me say, that I know that I am on the wrong side of this trade at the moment.  But I can’t help but have a problem with (3) above.  To be sure, it may, in fact, happen exactly as outlined.  But I think that it makes no sense to have no downside protection  (cash) when (1) Fed policy is in uncharted waters and it has historically never been successful in transitioning from easy to tight money and (2) much of the appeal of stocks has been a superior yield to bonds and that all seems to be changing.

            When our stocks’ prices are pushed into historically absolute and relative high valuations, our Portfolios will continue to lighten up on those holdings.

            Assuming the Dow confirms its break to the upside, anyone wanting to push out on the risk curve may consider a good multi asset class ETF (IYLD) or a high yield US dividend ETF (SPHD) which would be a less risky way to participate; the Russell 2000 ETF (IWO) would be the more risky alternative.  A purchase of any of these alternatives should be accompanied by very tight stops.
            Update on valuations (short):

            Why everyone hates this market (medium):

            Advice for underperforming money managers (like moi):

Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at

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