"I'm not going to waste my time arguing with a man who's lining up to be a hot lunch."
-Hooper to Quint in Jaws (1975)
When I study real Bear markets, the Baby Bear that I first taught myself to trade in from 2000 to 2003, just doesn't measure up. The Bear of the early 1970's, however, was the real horror film thriller. She gave birth to all sorts of nasty stuff - like sharks.
Steven Spielberg capitalized on the horrors associated with an American nerve system wired to sky rocketing inflation, and released Jaws in 1975. The movie was based on a book by Peter Benchley, but the societal impact was transcending - fear what you can't see - and the movie absolutely nailed that all so elusive Holy Grail of relevance - timing.
We have coined a term here at Research Edge called "The Shark Line". Quite simply, that's the marked-to-market line in a stock, ETF, etc. that market participants should have a heightened sense of risk management around. What you can't see coming up from underneath the waters of consensus negativity can really bite.
Yesterday, after the SP500 broke out through its Shark Line of 762, I put up a real-time note to our Macro clients alerting them of Jaws - as Quint would say, "this shark, swallow you whole"...
The ONLY times that I will buy or cover a security that is UP on the day are when A) we cross the Shark Line or B) one of my analysts gives me an incremental piece of Research Edge. Boiled down to its bare bones, those two factors get priority focus in my real-time risk management process.
After the SP500 broke out through 762, the chase out of the water was on. This market doesn't trade on valuation right now. It trades on price momentum. What they call the "benchmark huggers" in the mutual fund community know this better than most. After we crossed the Shark Line, one of our more prolific mutual fund Portfolio Manager clients sent me the following note:
"Long-only investors, and particularly long only benchmark huggers whom we compete with start to panic when the market moves. So many of these funds are holding record cash levels, and even if you are at a modest 5-10% cash position, an index move can really hurt your performance. Consultants/pension funds may be a little more tolerant on the way down, but if a manger subsequently underperforms his/her index on the way up, the pressure can be excruciating. This is different for total return/absolute-return oriented managers (you, I believe belong to this category), as good total return managers do not panic as much because they have the advantage of pure beta. Relative to an index, this is mitigated. As such, benchmark huggers do panic because they hide behind index returns on the way down, but cannot hide if they are underperforming on the way up."
When this mother load of "cash on the sidelines" in the mutual fund community is married up with a bunch of underperforming "hedgies" who have no idea how to manage short exposure on the way up, what you end up with is exactly what you saw out there yesterday - bloody waters - and as Hooper explained "the height and weight of the victims can only be estimated from the partial remains"...
In the hedge fund community, I have worked with people who call this a "corn cobbing", "getting your face ripped off", and sometimes plain old "getting squeezed." It's all the same, and it can be painful, particularly if you haven't proactively prepared for it. You see, most people in this market still think that market crashes only happen on the way down - that's not how I think about it. To me, a crash is what happens on the opposite side of consensus expectations, on the order of a 12-18% move.
One week ago, I'd written that I had covered ALL of my short positions other than the US Dollar (UUP), Short Term Treasuries (SHY), and Corporate Bonds (LQD). I also noted that I have NEVER done that before in my career. While many people called that being a lot of things - now I can simply look back at the scoreboard and call that being right. NOT being eaten by a Shark that you have been studying every morning seems like a reasonable expectation you should have for a risk manager.
There are a lot o ways to look at yesterday's SP500 closing price of 778. It was a healthy +2% above the Shark Line, which incidentally was immediate term TRADE resistance (3 weeks or less). Now that resistance becomes support. It was +15.1% trough-to-peak from the manic media sponsored Great Depression low made on March 9, 2009 (I wrote a note then titled "The Great Recession: Why I'm Not Depressed...). And 778 SP500 was also +12% higher from where that silly community organizing wanna be USS Navy Captain, Barack Obama, suggested that the market looked "like a bargain."
So where to from here? Well, looking back at where Jaws came from is always crystal clear. As Captain Quint said "cage goes in the water, you go in the water. Shark's in the water"... and now we have to deal with the prices that remain.
I have immediate term TRADE resistance up at the 795 line. This puts us in a balanced position of risk versus reward (upside/downside is +/- 2%). I was first given the shark hunting gun at hedge fund in the year 2000. In that Baby Bear market of 2000-2003 the average trough-to-peak squeeze rally in stocks was just north of +17%. If we see that 795 print, that will have been a +17.6% move, trough-to-peak. I have seen this scary movie before.
My Partner, Howard Penney illustrates a TREND line breakout in Technology in his US Sector View report this morning. While there are now 6 out of 9 SP500 Sectors in positive TRADE territory, breaking out on a TREND basis is much more relevant/sustainable price action. Intermediate term TREND (3 months or more) resistance for the SP500 is up at the 830 line.
This time around, if you so choose to get back in these waters, my advice would be to keep your head on a swivel... trading and treading around the Shark Lines very carefully...
Best of luck out there today,
EWZ - iShares Brazil- The Bovespa is up 5.2% YTD. President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil cut its benchmark interest rate 150bps to 11.25% on 3/11 and will likely cut again next month to spur growth. Brazil is a major producer of commodities. We believe the country's profile matches up well with our reflation theme: as the USD breaks down global equities and commodity prices will inflate.
EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months. With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.
USO - Oil Fund- We bought oil on Friday (3/6) with the US dollar breaking down and the S&P500 rallying to the upside. With declining contango in the futures curve and evidence that OPEC cuts are beginning to work, we believe the oil trade may have fundamental legs from this level.
CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +22.1% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.
GLD - SPDR Gold- We bought gold on a down day. We believe gold will re-find its bullish trend.
TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price. The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.
DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.
EWJ - iShares Japan - Into the strength associated with the recent market squeeze, we re-shorted the Japanese equity market rally via EWJ. This is a tactical short; we expect the market there to pull back when reality sinks in over the coming weeks. Japan has experienced major GDP contraction-it dropped 3.2% in Q4 '08 on a quarterly basis, and we see no catalyst for growth to return this year. We believe the BOJ's recent program to provide $10 Billion in loans to repair banks' capital ratios and a plan to combat rising yields by buying treasuries are at best a "band aid".
EWU - iShares UK -The UK economy is in its deepest recession since WWII. We're bearish on the country because of a number of macro factors. From a monetary standpoint we believe the Central Bank has done "too little too late" to manage the interest rate and now it is running out of room to cut. The benchmark currently stands at 0.50% after a 50bps reduction on 3/5. While the Central Bank is printing money and buying government Treasuries to help capitalize its increasingly nationalized banks, the country has a considerable ways to go in the face of severe deflation. Unemployment is on the rise, housing prices continue to fall, and the trade deficit continues to steepen month-over-month, which will hurt the export-dependent economy.
XLI - SPDR Industrials - This group underperformed yesterday and remains broken on a TREND and TRADE duration. From a fundamental perspective, industrials are typically later cycle stocks and so should continue to underperform their early cycle counterparts.
DIA -Diamonds Trust-We re-shorted the DJIA on Friday (3/13) on an up move as we believe on a Trade basis, the risk / reward for the market favors the downside.
EWW - iShares Mexico- We're short Mexico due in part to the country's dependence on export revenues from one monopolistic oil company, PEMEX. Mexican oil exports contribute significantly to the country's total export revenue and PEMEX pays a sizable percentage of taxes and royalties to the federal government's budget. This relationship is unstable due to the volatility of oil prices, the inability of PEMEX to pay down its debt, and the fact that PEMEX's crude oil production has been in decline since 2004 and is down 10% YTD. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.
IFN -The India Fund- We have had a consistently negative bias on Indian equities since we launched the firm early last year. We believe the growth story of "Chindia" is dead. We contest that the Indian population, grappling with rampant poverty, a class divide, and poor health and education services, will not be able to sustain internal consumption levels sufficient to meet targeted growth level. Other negative trends we've followed include: the reversal of foreign investment, the decrease in equity issuance, and a massive national deficit. Trade data for February paints a grim picture with exports declining by 15.87% Y/Y and imports sliding by 18.22%.
XLP -SPDR Consumer Staples- It underperformed the market again yesterday. We're positive on consumer staples for a TRADE, and negative on a TREND basis.
SHY -iShares 1-3 Year Treasury Bonds- On 2/26 we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.
UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is up versus the USD at $1.3030. The USD is up versus the Yen at 98.6740 and up versus the Pound at $1.3906 as of 6am today