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“At the same time I realize that the best of all tipsters, the most persuasive of all salesmen, is the tape.”

-Jesse Livermore

Before someone indoctrinates your children into a “buy and hold” strategy for this stage of their life, make sure you have them read Edwin Lefevre’s ‘Reminiscences Of A Stock Operator.’ While the business of being bullish or bearish is cyclical, some of Jesse Livermore’s risk management teachings are timeless.

My move to sell my exposure to the SP500 (SPY) into yesterday’s market strength raised the predictable response from some of our subscribers that ‘hey, you trade too much.’ I understand that perspective. After all, I had only held the position for a day. That said, I don’t agree with the conclusion. It’s the equivalent of telling me I manage risk too much.

The last time I held a long position for less than 2 days was at least 3 months ago. So I’m not submitting that one needs to be in and out of markets maniacally all of the time. I am simply suggesting that one needs to respect the price momentum of the tape. Mr. Macro Market’s prices don’t lie; people do.

The last 6 days of US stock market trading have unearthed some obvious warning signals. No, I am not suggesting that the stock market is going to crash. However, I am saying that the benefit of the doubt no longer goes to the bulls. This is new.

Here are some risk management factors to consider:

1.       The immediate term TRADE lines for the SP500 (1025), Nasdaq (2271), and Russell 2000 (630) have been broken

2.       The intermediate term TREND line for the SP500 (1096) is being tested

3.       The Range in my immediate term probability model for the SP500 has blown out to 83 points wide (it averaged 24 points 3 weeks ago)

4.       The Volatility Index (VIX) has broken out above both my immediate and intermediate term lines of 20.12 and 22.51

5.       The S&P Sector risk management model that we run only has 1 out of 9 sectors in a bullish immediate term TRADE position (Healthcare)

6.       The US Dollar continues to breakout to the upside on both immediate and intermediate term durations

Directionally, all of these moves have been confirmed by bearish volume signals. Yesterday’s volume signal was one of the driving factors behind my decision to sell my long position in the SP500. The market was rallying, unconvincingly, on a down -19% day-over-day move in volume.

Down markets on accelerating volume are explicitly bearish. The during the -5.1% three-day down move from last Wednesday to Friday, that’s exactly what Mr. Macro Market registered. Additionally, Volatility (VIX) had a massive melt-up of +53% on a week-over-week basis. All in, I don’t get paid to ignore these 3 risk management factors (price, volume, and volatility); particularly when they occur simultaneously. I don’t think you do either.

So now what? I sit on my hands, and I watch, and I wait. I don’t have to justify being long the SP500 because I don’t have to justify a buy and hold strategy. Will the SP500’s intermediate term TREND line of 1096 hold? I think the probabilities are mounting that the answer to that question is no, but Mr. Macro Market works in mysterious ways. I’ll let him persuade me in the coming days as to which side of this line I need to be positioned on.

Globally, the risk complex doesn’t look any prettier. We have been calling for a correction in Chinese stocks, so this isn’t a surprise, but it certainly appears to be to the masses. One of the top read headlines on Bloomberg this morning is “Bank of China, Construction Bank Start Curbing Credit.”

This isn’t new. The Chinese government has been explicitly signaling a reduction in speculative loan growth for the last 6 weeks. What’s new is Mr. Macro Market making people pay attention to it.

China’s Shanghai Composite Exchange got tagged for another -2.4% down session overnight, taking it’s YTD losses to -7.9%. For the more institutionally traded “H-Shares” listed in Hong Kong, the news is no different. The Hang Seng lost another -2.4% last night as well, taking it’s YTD loss to -8.1%. Both the immediate term TRADE and intermediate term TREND lines in these very important Asian bellwether tapes remain broken.

If our Macro Themes continue to be right and the Buck Breakout continues alongside the Chinese Ox being in a Box, commodity prices will continue to weaken. We re-shorted Gold (GLD) in the Hedgeye Virtual Portfolio yesterday and we maintained a zero percent allocation to Commodities as an asset class.

In addition to respecting the tape, Jess Livermore taught me that “the game” teaches you this game. Trading is risk management. Risk management is trading.

My immediate term TRADE lines of support and resistance for the SP500 are 1080 and 1126, respectively.

Best of luck out there today.

KM

LONG ETFS

 

XLV – SPDR Healthcare — We bought back our bullish intermediate term view on Healthcare on 1/22/10.

EWC – iShares Canada — We remain bullish on the intermediate term TREND for Canada. With a pullback in the ETF, we bought Canada on 1/15/10 and 1/21/10.

XLK – SPDR Technology — We bought back Tech after a healthy 2-day pullback on 1/7/10.

 

UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

EWG - iShares Germany —Buying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.


EWZ - iShares Brazil — As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

CYB - WisdomTree Dreyfus Chinese Yuan — The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.

 
SHORT ETFS

 

GLD – SPDR Gold Shares We re-shorted Gold on a bounce on 1/25/10. We remain bullish on the US Dollar and bearish on the intermediate term TREND for the gold price as a result.

 

IEF – iShares 7-10 Year Treasury One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.
 
RSX – Market Vectors Russia
We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.

EWJ - iShares JapanWhile a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY - iShares 1-3 Year Treasury Bonds 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. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.