Wednesday Roundup: FOMC Minutes Cast a Shadow on the Green Shoots

Posted on May 20, 2009 by BMWFan

The equity market s

finished the day with small losses after a roller-coaster ride.

As I had alluded to yesterday, I expected ano ther

day without a large change in closing prices. Though I did not bargain for a big gap-up followed by a major sell-off, the lack of conviction among both the bulls and bears was very visible.

Pump and Dump
The S&P500 gapped up at the open, above the 916 level it had a hard time getting over yesterday.

This seems to beget more buying as the markets rallied well above the R2 pivot level, without a pause.

The rally was driven by financials with the bulls cheering Bank of America’s successful equity issue, and the energy sector which was anticipating a large draw-down in oil and distillate inventory.

The market internals were lop-sided on the bullish side on both the Nadaq and the NYSE, indicating a true trend up day.

However around 10:25AM, five minutes before the release of the oil inventory report, traders started taking profit.

I had alluded to this in a post on twitter earlier in the day. The oil report did not disappoint but the market continued to move lower. What was surprising was that the market continued to sell-off through the R1 pivot level, all the way down to the daily pivot level.

FOMC Minutes Show the True Economic Picture
Over the past few weeks, I have been alluding to the fact that the sentiment in the market seems to be manufactured. The Fed statement at the conclusion of the Fed meeting did not have any mention of quantitative easing. This was interpreted by the bulls as a message that the economy was better than expected sending long bond yields high, and cheering the equity markets.

However the FOMC meeting minutes showed that some member of the Fed are considering increasing the amount of debt the Fed will purchase from the market to support asset prices.

The Fed members reduced their projections for economic growth in their quarterly forecasts, though they saw a slowdown in the rate of contraction; the second derivative as the financial press calls is.

It seems the ambiguity in the Fed message after the meeting was deliberately designed to improve sentiment to allow banks to raise capital after the Stress Test results.

The FOMC minutes seem to convey a different message than what the market interpreted from the policy statement released after the meeting.

The equity markets added to their losses after the FOMC minutes were released with the SPX trading below the R1 pivot level before finding support near 900. The equity indices finished close to the low of the day, though the net change in closing prices was less than 1% across the board.

My Portfolio
The bipolar nature of the market has precluded me from adding any long or short positions.

I continued to trade intra-day using set-ups I often share on twitter.

I added some puts on the IYR during the early morning rally, and continue to hold my TSO position. Bond prices rallied after FOMC minutes and I will be looking to exit the last lot of my TLT position on any continued strength.

Thursday’s Outlook: Lack of Conviction Likely to Continue
Since we are heading in to the Memorial Day weekend, trading volume is likely to decline, and the market is unlikely to make any sustainable move either way. Based on the nature of the U-Turn today, I expect a bearish bias. It is very rare for the SPX to breach the R2 pivot level but then reverse and go back to breach the S1 pivot level.

It seems the SPX has now found a new trading range between 875 and 930, and will churn in between. We seem to be in a mean-reversion environment, with no broad-based strength or weakness. As long as Washington DC continues to be the financial capital of the US expect this treacherous market to continue. We will continue to see vicious sector rotations. The better performing energy, agriculture, materials, and the gold sectors seem to be next in line for profit-taking within a week or two.

Even if the SPX is able to break out of

the trading range, it is not clear whe

ther that new trend will sustain. Neither the bulls nor the bears have the conviction to hold on to positions for too long. One approach is to buy options to trade the move out of this range; i.e. if SPX breaks 930 buy calls and if it falls below 875 buy puts. This limits the risk you take in case the move reverses, as it has happened so often in this market

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Tuesday Roundup: Housing Starts Temper the Enthusiasm

Posted on May 19, 2009 by BMWFan

The equity markets finished mixed on Tuesday, as lower than expected numbers on housing starts tempered enthusiasm about a housing market recovery.

The S&P500 and the Dow30 finished slightly negative, while the Nasdaq and the small cap Russell2000 finished slightly positive.

The SPX spent much of the day bouncing between the levels of 910 and 916, before selling off in the last half hour and close at 908.

There was a lack of conviction from both the bulls and the bears

and it showed today.

Finance and Real Estate Lags

The financial sector lost some of yesterday’s gains as the Senate passed legislation to control Credit Card charges and interest rates. Th is

is likely to reduce the profitability of banks issuing credit cards. There is continuing uncertainty about the fate of commercial real estate, with Moody’s saying that commercial property values have plunged and the WSJ reporting that smaller regional banks may incur losses up to $100B as a result of their lending to finance construction and other CRE related activity.

I personally feel that the fall in new construction permits is necessary for

the system to flush out existing inventory. This is likely to put a downward pressure on the job situation. However the bigger challenge facing our financial system is the decline in asset prices and reducing supply of new homes is perhaps the single most effective method of maintaining price stability.

Capital Raising and Market Indecision

As I have alluded to, there has been a concerted effort to provide support to the market as banks and RE

ITs have tapped the private markets to raise new equity capital.

Bank of America, which has to raise the largest amount of new capital

as the result of the Stress Tests, issued 825 million shares at $10/share to raise $8.25B in new capital.

The support provided to enable these capital raises distorts the markets and reduces the conviction of participants.

The bulls are not sure whether the higher prices will last once the secondary offerings are done; the bears are worried of being squeezed as big money provides support.

My Portfolio

I am still unable to find convincing buy or sell setups in this market, and am simply day-trading.

Energy: OIH and Refiners (TSO)

The oil services sector continues to do well and the OIH is up almost 5% in the past two days.

It has not pulled back enough for me to open a position.

The refiners continue to do well, with TSO breaching last Thursday’s highs today.

There is expectation that tomorrow’s Oil report is going to be bullish for refiners and it is being reflected across the oil sector. I continue to hold my TSO calls, though I may take some profits if we get a spike tomorrow.

IYR: Choppy Action but Signs of Topping

IYR continues to have wild intra-day swings. In spite of all the negative reports about CRE, IYR managed to take out yesterday’s highs before closing in the red by 1.59%. It failed to cross the lower trend line of the channel I have referred to in my previous posts. The choppy action today also suggests that the current up-swing is possibly done, and the downtrend is likely to resume.

Tomorrow’s Preview

Hewlett Packard’s financial results were not received well by the market and the stock is down more than $2 after hours. This is likely to put the technology sector under some pressure tomorrow.

Though the market has welcomed the capital raises by banks so far, investors may also start questioning the amount of dilution equity holders are being forced to undergo.

Though I have been more wrong than right on this, I expect a day with a bearish bias tomorrow. This does not necessarily mean a big sell-off. Today the market had a bullish bias most of the day, threatening to take out the 915 level on the SPX and rip higher.

However, we ended the day almost flat. Tomorrow may also be a day similar to today where we churn with a bearish bias but end the day mixed.

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Monday Review: The Bulls are Back with a Vengeance

Posted on May 18, 2009 by BMWFan

Contrary to my opinion, the equity markets opened the week with a massive rally which took the SPX well above the 900 level. The market internals were one of the most bullish I have seen in a long time; the A/D r ati

o was at 12.75:1 on the NYSE and 3.88:1 on the Nasdaq.

The small cap Russell2000 outpaced all other indices, up 3.35% and showing that risk appetite was back with a vengeance.

The rally was led by financial and real estate stocks, especially Bank of America. The bullish news from the Indian stock markets, where the circuit breakers were hit on the upside, seems to have helped improve sentiment, with CNBC reporting that traders on the NYSE were also acknowledging the fact.

The Capital Raising Shenanigans Continue

Citigroup reported that that BAC may have raised $4B in new capital by sell

ing equity in the open market. As if on a queue, Goldman Sachs placed BAC on their conviction buy list. To complete the bull parade, Dick Bove, an analyst respected by the Street came out with very positive recommendations on financial stocks, including a $48 price target on BAC in five years (4x returns). The news that Goldman Sachs, JPMorgan and Morgan Stanley will likely return TARP funds help improve the sentiment.

I was hoping that the capital-raises by the banks, and support the market shenanigans that went with it were done after the Stress Tests.

But clearly I was wrong.

Unlike Meredith Whitney, Dick Bove has been bullish on banks stocks throughout the decimation they endured during the past 18 months. However, he is still able to add fuel to the fire sparked by Goldman.

Real Estate Joins the Party

Another factor contributing to the rally was the usual better than expected results from Lowe’s which was peppered with some positive comments about high margins sales of potted plants and patio furniture.

The home-maker’s Housing Market Index showed a 2 point improvement from April, primarily driven by optimism among home-makers themselves that the current and future sales will improve; while the customer traffic component was flat. This lead to a big rally in the homebuilders (XHB).

My Portfolio

The stock market typically rallies in the options expiry week and then corrects in the week after. This month the action was reversed, with the stock market testing key levels during the Options expiration week, and then rallying strongly the next Monday.

The stocks I was waiting to buy on a pullback (OIH, GDX) did not come to the levels I was comfortable buying at. As a result I did not open any new long positions, but day-traded index futures.

IYR Puts

A rising tide lifts all boats, and even the commercial REITs rallied hard, with the IYR up 7.5%. More importantly, the charts of many of IYR components which were on the verge of a technical breakdown, seemed to have stepped back from the edge of a cliff.

As I have noted earlier, the IYR has been excellent trading vehicle often seeing 5-10% movements within a day or two.

I have been trading IYR puts; buying them on major rally, and selling them

on a decline.

I added to my IYR put position today.

IYR Channel

IYR is challenging, the lower trend-line of the channel it fell out off again.

My expectation is that it will fail at this trend line and pull back. The wild-card of course is the chance that another REIT lines up with a secondary offering resulting in the street providing support to the sector.

Luckily the June expiration cycle is very long (5 weeks) leaving ample time for IYR to correct and the puts to make a profit.



Treasury Bonds: TLT Decision Pays Off

Last Friday, I had decided to wind-up my long position on the TLT by not rolling over in the money call options, and allowing my stock to be called out. Today the spread between the TYX and TNX (30Year and 10Year yield) further widened by 2 bps to 97 basis points. The TLT fell by $1.52, as risk appetite returned and treasuries were sold.

Oil Services Rally

I had been waiting for the OIH to pull back a bit more before I enter a long position. However, I did not get a chance as it rallied closed to 5% today. OIH continues to be in a downward channel so I am not going to chase this rally.

Closing Note

I do understand the thesis that the bank’s regular lending business is very profitable now. However, the questions about the assets formerly known as toxic assets (aka legacy assets) still remain. But it seems that the establishment (the government and Wall Street) wants the investing public to forget about them and instead focus on the positives.

As an American I do want our financial system to heal and the recession to end. But I get scared when the establishment uses its power to control information flow and sway investor sentiment.

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Weekend Roundup: The Standoff Continues but Sentiment Shifting

Posted on May 17, 2009 by BMWFan

On option expiration Friday, the equity markets followed a pattern very similar to what seen on Thursday. The market challenged the 900 level on the SPX but was sold off hard even before it reached Thursday’s highs just below 900. The sell-off was brutal with the SPX falling almost 18 points from its intra-day highs before finding its feet.

However, the key technical levels around 875-880, corresponding to the 20 day SMA

The bears can take heart from the fact that for almost three days, the SPX was rejected at the 900 level. The bulls can take comfort from the fact that the 875-880 level has held during the same period.

Sentiment Shifting?

Of greater importance was the sentiment shift visible on Friday where better than expected consumer sentiment number and steady inflation numbers could not ignite a sustainable rally. The sell-off on Tuesday following the poorer retail sales number showed that the market is no longer ignoring bad news.

The inability of the market to rally on good news on Friday further confirmed that the current bullish run is showing signs of exhaustion.

The longer the market stays in this 875-900 range, the greater the likelihood of a more significant correction. During the past month better than expected earnings and economics news, and the relatively benign stress-test results provided the bulls with the ammunition to charge higher. Going forward the catalyst to drive the markets higher are likely to be harder to find.

I expect a downward bias, with the probability of a correction down to low 800s on the SPX increasing.

Global Events: Europe weakens but India Pleases

The bad news from Europe continues with the GDP contracting at a rate of 2.5% in the 16-member Euro region,

the highest ever since data was first compiled in 1995. Germany’s GDP fell 3.8% the largest drop since 1970 when the data compilation started, showing how even the strongest Euro-zone economy is getting weaker.

On the brighter side, elections in India led to a convincing win for the ruling Congress party, raising hope that economic reforms will accelerate as the pesky Communists are sidelined.

Expectations of growth from China and India are one of the pillars holding up global growth story, and the election result is a welcome sign. There are expectations that both the Indian Rupee, and the Indian stock markets will jump up to catch up with the rest of the emerging markets, now that the political uncertainty has been resolved in a positive manner; futures on the Indian stock market are up 11.25%. Some ETFs which US based investors can use to add exposure to India are EPI, PIN, and the INP.

Re-Assessing Treasury Bond Risk Across the Yield Curve

On Thursday, I had written that I planned to roll any in the money call option on my TLT holdings. However, the inflation data for April, released on Friday, showed that though prices declined, deflation risk is remote forced me to re-assess the risk associated with the long bond holdings.

A key metric I am following is that the spread between the 10 year treasury yield and the 30 year treasury yield has continued even during the February sell-off.

The spread hit a high right after the Fed’s Quantitative Easing announcement in March, and has continued to bounce of its 50 DMA since early 2009.

There are several underlying factors contributing to this wide spread. The focus of the Fed’s Quantitative easing policy is likely to be in the 10 year bond, since most long term consumer and industrial debt tends to be priced off this duration. The critical 30 year mortgages key off the 10 year treasury yields.

There is also the fear that the Quantitative Easing and high Treasury issuance is likely to put a pressure on the US Dollar over the long term. As a result longer term bonds are likely to price in a higher currency risk premium, especially when it comes to foreign buyers of bonds. In summary, bond investors are recovering from the panic of the past year, and recognizing the risk of locking the rate for 30 years.

The only likelihood I see of the 30 year yields pulling back sharply is a major economic shock, which forces the world markets to completely overhaul the prospects of global growth.

However, governments world-wide have signaled, with strong conviction, that they will not allow the failure of any institution of systemic importance. As a result, with each passing week,

the likelihood of such an event goes down.

Based on the above, I decided to allow a portion of my TLT position to be called-out by not rolling over the

call options I had written. I plan to exit the remaining positions gradually over the next few weeks, on any spike in risk aversion.

I feel that the shorter term bonds, which can be traded by using the IEF (7-10 yr) and the TLH (10-20yr) are relatively a safer bet, and more likely to benefit from any Fed action.

For bond investors, the junk bond (high-yield: JNK, HYG) and corporate bonds (investment grade: LQD) are also attractively priced relative to their long term spreads against treasuries. Assuming that the economic recovery story does not prove to be a complete illusion, the spreads are unlikely to widen in the same catastrophic manner as they did last fall. Though these bonds have rallied a long way from the depth they had fallen too, buying these bonds on bouts of risk aversion is likely to provide good long term gains.

My Portfolio: Trading Plan

I expect a bearish bias going into next week. Some of the sectors I am watching carefully are the commercial REITS (IYR), Energy and Precious Metals.

IYR has broken out of its channel and is likely to break the support level

of $30 it has been testing over the past few days.

Potential price targets are in the $28 and $26 level. I plan to take profits on my puts at these price levels.

Energy is likely to continue to pull back after its strong run, as the market re-assesses the green shoots. I am looking forward to establishing a long position in the Oil Services Holder (OIH) in the mid 80s, around the level of prior resistance which should prove to be a strong support level.

The other leg of the commodity reflation/weak dollar trade is precious metals. Precious metal and mining stocks have had a strong run, thanks to the weaker dollar during the bull-run.

It is likely that any strength in the dollar is likely to put a halt on this rally and lead to retracement.

I am hoping to establish long positions when the GDX reaches the $32-33 level, which is close to a supporting trend line stretching from early January. The $33 level corresponds to the 62% retracement of the rally from the March lows ($29.16) to the April highs ($39.55) Establishing a position near a trend line provides a good stop out level allowing you to cut losses on a trade.

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Global Decoupling: Distinguishing between Economies and Markets

Posted on May 17, 2009 by BMWFan

Seeking Alpha has an interesting article by Geoff Considine, on the performance of equities in emerging markets over the past three years
Geoff’s article made the following observations:
1. The hypothesis that emerging market economies were self-sustaining and hence their markets will be decoupled from developed markets was proven to be egregiously wrong.
2. Emerging markets are likely to continue

to be strongly correlated with developed markets, with correlations increasing.
3. The Beta (a measure comparing the magnitude of moves) is likely to come down from the historical levels.

The decoupling hypothesis was put to test last year and it failed miserably. However there were distinct divergences when it came to decoupling of the markets versus decoupling of economies, especially when it came to India and China. In this article I explore some of the underlying dynamics which drove that behavior and what investors should be conscious of when making investments outside the US.

When Economic Decoupling does not translate to Market Decoupling?

The major Asian economies of China and India continued to post positive growth. India benefited since it is not an export driven economy; the Chinese government put its vast hoard of cash to work to increase focus on domestic consumption when exports were crashing.

These Asian giants now have domestic markets of a size large enough to dampen the effects of a global slowdown. As a result these economies continued to outperform the developed economies by the 4-8% margin observed in the last decade. Their performance during this period is a vindication of the decoupling theory; but only on the economic side.

When it came to the equity markets, both the Chinese and Indian equity markets suffered major losses, often exceeding those of the developed markets. This divergence in relative performance between the economies and markets was a direct result of reduced risk appetite from investors in developed economies.

The Marginal Buyer: Foreign versus Domestic

The run-up in the equities of emerging markets was driven by investors in developed economies rushing in to cash on the growth in the emerging markets. Apart from the increased risk appetite during

the period of low volatility in the middle of the decade, many foreign investors invested in the emerging markets because traditionally these markets were seen as less correlated to the their domestic markets.

However, thanks to the size of the foreign investment, they increasingly became the marginal buyer of equities, overtaking domestic investments from the emerging markets. Geoff writes:

From 1990 through 2000, only 20% of funds flowing into mutual funds went into foreign-focused

mutual funds. By 2007, the flow of money into foreign funds was twenty times higher than the flow into domestic funds (John Bogle provides these stats in Enough (2009)).

The same foreign investors who could not get enough of the emerging markets in the middle of the decade ran for the exits as risk appetite started waning about 18 months ago.

As a result the equity markets of these countries showed high correlation (and no decoupling), with a higher Beta magnifying the losses.

Future Trends

Investors seeking diversification in their equity portfolio should realize that emerging markets no longer remain the undiscovered, uncorrelated class, which help diversify a portfolio. Even when their economies continue to grow and become less dependent on exports, the markets will continue to attract capital from the developed world. Hence any change in risk appetite in the developed world will continue to affect the performance of these markets.

Outperformance: Perhaps Yes

There is a case to be made of relative outperformance of these markets compared to the developed world. Part of the reason is going to be the painful lesson learnt by investors that even developed markets are not averse to systemic r

isk whether it is the sub-prime crisis in the US or the Eastern-European loan crisis in Europe. The persistence of economic growth illustrated by India and China during the past year, will also increases the confidence level in these economies’ ability to tolerate shocks.

This is likely to result in a gre

ater in-flow of buy and hold investors into these markets instead of the hot money investors. The appetite for risk of the local investors will also grow as these economies recover their growth rates. This is likely to reduce the Beta or the volatility of returns from these markets.

Market Decoupling Ever Possible

?
Any change in correlation (the true decoupling) between these markets will have to wait till their economies grow to a size:
1. Where domestic investors dwarf out foreign

investors as new investors in the equity markets.
2. Domestic consumption dominates export as driver of economic growth

At that point these markets will follow the lead of their local economic conditions (which are likely to be influenced by the global situation), and not just the risk appetite of investors in the developing world.

This is unlikely to happen in the near term in the more popular emerging markets.

Frontier Markets: Best Bet for Decoupling
Investors looking for equity markets which are decoupled from the developed world will have to step-out of the comfort zone of the popular emerging markets and into undiscovered emerging markets, the so called frontier markets. These markets include countries all over the world.

These markets are yet undiscovered by main-stream investors in developed markets. So for at least in the short term, these markets may not be affected by a rush for the exits by foreigners.

Many of these markets have the same characteristics of the major BRIC emerging markets in terms of potential for organic growth and the ability to benefit from rising commodity prices.

If risk appetite does return, it is likely that the frontier markets will act like the emerging markets of the last decade.

Since the size of these markets is small, they are likely to show higher Beta, and outsized returns initially. But they will carry extreme down-side risks; similar to the down-side illustrated by the equity markets of the major emerging markets over the past 18 months.

Seeking Alpha has several articles on investing in frontier markets via ETFs, Close End Funds, and ADRs. Right now I would avoid investment in Eastern Europe and focus on countries which will benefit from growth in commodities and raw-materials. However, investors should keep in mind that except for the most aggressive, risk-taking investors these small markets should be a small part of your equity portfolio (< 5%).

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Thursday Review: Risk Appetite Return

Posted on May 14, 2009 by BMWFan

The US equity markets bounced back after the large losses registered on Wednesday.

The equity markets shook off a slightly worse than expected job-loss data with across the board gains. Stocks sold off at the open, and tested yesterday’s low on the SPX.

However like yesterday the ES futures bounced off the 880 level, forming a double bottom. This set the stage for a bounce which lasted most of the day.

The rally was led by the financials, technology and agricultural stocks. The Russell2000 Small caps led the indices with a 1.40% gain, showing an increased risk appetite among investors. On the fixed income side, treasury bonds were bought today

and the yields slipped further.

Rally Stalls at SPX 900

After forming a double-bottom at ES 880 level, the markets had a strong run reaching a high point near 897 corresponding to the 900 level in the cash SPX index. Market internals continued to improve all day long, with the rally. However the indices seem to hit a brick wall around the 900 level on the SPX cash index and pulled back sharply in the last hour of trading. The indices finished in the middle of their range today.

Lack of Conviction: Range Bound Action?

The price action suggests a lack of conviction among both the bulls and the bears. The bulls defended the 880 level on the ES but the bears responded with conviction near the 900 level on the SPX. Though the buy-the-dip mentality is intact, there is also some fear of a sharp pullback, resulting in shorter holding periods and a trigger-happy towards profit taking.

Insurers Get TARP Funds:

The market is likely to welcome the news that a number of insurers will now get access to TARP funds to help bolster their balance sheets.

Insurance plays a critical part in the functioning of an advanced economy, and better capitalized insurers is likely to help boost confidence, not only for investors, but also the consumers and businesses who rely on them to manage risks.

Friday’s Outlook

Tomorrow is expiration Friday, and it is likely to be a volatile day with a bullish bias.

There is some economic news related to inflation and consumer sentiment which may move the market a bit. However, if the reaction to today’s Job Loss number was any indication, these indicators are unlikely to move the market in a big way.

There is some expectation that the SPY will pin around the 90 strike because of the large open interest in options near that strike.

I do not expect the indices to break to new highs tomorrow; I also do not expect them to breach the support levels put in yesterday.

My Portfolio: Reviewing the IYR Chart

I used the morning weakness to book profits on my remaining puts on the IYR. After the market rallied into the day, I bought back some of the puts back.

I expect IYR to trade in a choppy manner but with a bearish bias. The ETF has broken its upward sloping channel and after a pullback is now testing the trend-line from the downside. A failure to break above the trend-line and back into the channel is likely to result in a stronger downward move. Most of the commercial REITs have already raised a lot of capital via secondary equity offerings, and any support provided to them by the underwriters is likely going to dissipate.
IYR Channel

From a trading perspective the large intra-day range of the IYR provides ample opportunity to swing trade.

An active trader can increase their leverage by either using the ultra-ETFs (URE and SRS) or by using options.

Trading Intra-Day Patterns: Goldman Sachs

I also traded Goldman Sachs on the short side late in the day. Goldman was forming a wedge pattern which broke leading to a large spike down. I had posted the setup via twitter well before the entry-signal was generated. The trade was to short Goldman (either outright or by buying a put) when it broke the lower trend-line of

the wedge. The break of the wedge resulted in a $1.0 move in a few minutes.
GS Wedge Break

My Portfolio: Independent Refiners

My out of the money June calls on TSO did very well today as the refiner jumped up 7% today. TSO found support at the rising trend-line from the M

arch low, and continues to trade in a rising channel.

With the summer driving season coming at a time of rising consumer sentiment and moderate oil prices, the refiners are likely to perform well.

By some estimates, the refiners are trading at a discount to the replacement value of the physical refineries, and are attractive takeover targets for integrated oil companies.

My Portfolio: Plan for Tomorrow

I do not plan to initiate any core positions tomorrow, unless we get a big spike up which I will use to initiate some put positions. I will roll over any of the in the money May calls I have written on the TLT to the June expiry. Though I will not be surprised if this rally continues, I feel the risk of a significant pullback is becoming higher and the rewards do not justify chasing this rally.

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Green Shoots get a Reality Check

Posted on May 13, 2009 by BMWFan

After almost two months of bullish action, the equity markets finally got a reality check with the announcement of lower than expected retail sale data, and sharp rise in the number of home-owners facing foreclosure. The market gapped down at open, and did not make any attempt to fill the gap.

All rally attempts were feeble and met with further selling. The markets closed near the low of the day, with the decline being led by the Russell 2000 small cap index, showing a decreasing risk appetite. Bonds got a bid and yields continue to decline across the curve.

Prudence Pays Off, Finally
Yesterday, I had written that though I had been waiting for a pullback to buy, I was too chicken to buy when the opportunity showed up with the S&P500 below the 900 level. Though at the back of my mind, I was afraid that the S&P500 will make a run towards its 200 day MA, my prudence in not chasing the rally paid off today.

S&P 500 Finds Support
Though the indices finished close to the lows of the day, the SPX found support in the low 880s and did not break that level in spite of multiple tests.

The market internals were heavily bearish with both the market breadth and advance-decline lines at extremely negative levels throughout the day.

However, the ES futures did not break below 880 in spite of being at a striking distance much of the afternoon, ignoring the horrible market internals.

To me the price action today showed two things:

(1) The Bears were delighted to make a profit today but were reluctant to press their luck too far.

This also means that there is a greater risk of a vicious sell-off since short covering is unlikely to provide any meaningful buying support.

(2) The Bulls have not lost hope, and the buy on the dip mentality is still alive.

If the S&P500 can hold the 875-880 level tomorrow, we are likely to see another bullish run before this rally ends.

However, I do not see anything which suggests that the new high price level will hold.

My Portfolio: Taking Profits on Puts
I used the drop today to book profits on my put positions in IYR and FIG.

Though I was a bit early in selling calls on my TLT positions, the high volatility premium and the rapid time decay for options expiring this Friday still made them worthwhile.

Day-Trading Options
I also traded options today, primarily selling calls and puts, for intra-day trades.

Though selling options left me with a negative gamma and limited upside, the rapid intra-day time decay helps cushion any position which moves against me.

This was very useful during the afternoon where the market chopped around the lows of the day without making a big move either way. This strategy requires careful position management since your downside risk is not limited when you are short the option, unlike the long option position. However it allows you to make a profit even if the underlying moves against you to some extent.

The other strategy of course is to buy calls and puts, with the hope that the high gamma of options near expiration will help you profit from a big move.

However, I did not see that strategy work today with the big gap down having done most of the work already. Though there were some trending periods, most of the afternoon was spent in range bound churning where the time-decay of long option positions would have hurt profits.

Trading Plan: Fade the Bounce, but Buy Precious Metals on Dips
I believe that this rally has run out of positive catalysts to make a sustainable move forward. I intend to open new bearish put positions on any significant bounce as we move into expiration Friday. The June Expiry cycle is long (5 weeks) and provides ample time for the underlying equity to make a move with limited

time decay.

If we do break through the 875 level with conviction, I plan to add outright short positions.

My focus would be on sectors which have made a run in the later part of this rally and have not yet corrected significantly. The sectors which led the early part of the rally, like Tech, financials and home builders have already corrected. The most appealing candidates seem to be in the energy, materials and the industrial space.

As a hedge, I may consider opening long positions in the precious metal sector, especially silver and the miners on any pullback. Precious metals are in a sweet spot now, since they not only benefit from the reflation trade inspired by the green-shoots, but will also do well in the flight to safety trade.

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Rounded Bottom: Nice Set Up for the March to the 200 Day Moving Average

Posted on May 12, 2009 by BMWFan

The equity markets continued where they left yesterday, continuing the sell-off which started after Meredith Whitney’s bearish interview Unlike yesterday the selling was across the board with no divergence between exchanges or between the market breadth and advance/decline statistics. The decline was led by the riskiest class, the small cap Russell 2000 index and the growth stocks as represented by large cap tech. Bonds got a bid and yields continued to creep down.

The bearish momentum gathered steam as the S&P500 cash index broke the 900 mark, a crucial psychological level. However, this was just a set-up for a bear-hunt. The sell-off had been orderly and the equity markets formed a nice rounded bottom, before blasting off after 1:00PM. The S&P500 wiped out most of its losses, while the Nasdaq and the Russell 2000 finished well of their intra-day lows.

Is the Correction Is Over?

On an intra-day basis, the S&P500 has declined 3.6% from the high reached Friday of 930.17. Similar declines for the Russell2000, the Nasdaq Composite and the Nasdaq100 stand at 4.73%, 4.36% and 5.15% respectively. These numbers are right in line with the earlier pullbacks seen in this rally and with the nice round bottom put in today, it is likely this correction is over.

Another key factor to observe is that the VIX closed down today showing growing risk appetite. Even when the SPX went below 900, the VIX did not see any big spike, indicating that investors are increasingly confident that a major price collapse is unlikely.

Opex Week: The 200 Day Moving Average
The 200 Day Moving Average is a very important market indicator used to determine long

term trends.

A market trading above an upward sloping 200 Day Moving average is considered Bullish; one trading below a downward sloping it considered bearish. During bear markets, this average often represents a line in the sand,

where rally often reverse; in a bull market it is often the last line of defense where a pull-back stops and reverses.

The 200DMA for the SPX is at 951.12 (4.7% away); for the Russell2000 it is at 523.56 (5.7% away). The Nasdaq Composite and the Nasdaq100 have already reached this mark and have been straddling it for the past week. Since this is the week of Options Expiration, which is typically bullish, we are likely to see the S&P500 and the Russell2000 make an assault towards their respective levels.

It is very likely that this level is going to form a formidable resistance for the equity markets and likely setting the stage for a stronger pull-back.

My Portfolio: The Capital One Price Action
The price action in Capital One (COF) is a great example of how Big Money is helping support the market to allow banks to raise additional capital.

I have been using puts and puts spread to trade COF on the bearish side with some success.

Last week the price of COF moved up 80% as a result of a massive short squeeze following the news that the stress test results for COF were positive. There were murmurs on chat boards that both Goldman Sachs and Merrill-Lynch (Bank of America) were supporting the stock. This is typically a sign of an upcoming secondary offering.


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Monday Mid Day Update: Divergence Galore

Posted on May 11, 2009 by BMWFan

As I had anticipated the equity markets gapped down at the open today.

There is strong divergence all along, with large cap tech getting a bid while energy and financials being sold off.

This is the reverse of the sector rotation we were seeing last week.

Market Internals Diverge
The market breadth

is negative on the NYSE by a 4.4:1 ratio while it is positive on the Nasdaq with a 1.58:1 ratio. However Nasdaq A/D ratio is negative -1.65:1 while the NYSE A/D ratio is negative -3.25:1 consistent with the breadth.

This divergence suggests across exch

anges, and even within the exchange suggests a confused market.

The strength is the Nasdaq seems to be driven by big Tech stocks like Apple and Google, while the broad market is being sold.

Treasuries Getting a Bid
After the quick climb last week, treasury yields are going down and treasuries are getting a bid.

There is increasing talk of Fed intervention to limit the yields and with reduced supply from

the treasury, shorts are closing their positions. There is also some portfolio reallocation going on, as

some managers move out from equities to bonds.

My Portfolio

As I had anticip ated COF took a big dip

at the open after the announcement of the secondary offering. It easily made my downside target of $28.54. The secondary is likely to be priced today or tomorrow and the underwriter (Barclays) is likely to support the offering till at least

the end of the day. COF seems to be having strong support at $28.
I have closed out most of my put positions, while keeping a small amount. I converted that portion into a bearish put spread by re-opening the short put leg I had bought back on Friday. This allows me to profit even if the price goes up

a bit into the secondary, while time-decay works in my favor.

Some Other Stocks I am Watching: Gold Miners

Based on the musings of some other traders I follow, I am also watching some precious metal related stocks like Seabridge Gold (SA) and Randgold Resources (GOLD). Gold is likely to benefit if the reflation thesis gains hold, and Gold stocks are likely to benefit in this bullish tape if gold makes another run for $1000/ounce.

Outlook for the Rest of the Day
I anticipate the market to continue its choppy behavior, as it digests the actions of the previous week. Individual sectors are likely to have their own cross-currents. I am look ing forward to build

ing some long energy positions on any additional pullback

in that sector with a focus on the oil-services and refiners.

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Weekly Roundup: The World’s Best Campaign Organizer Shows His Skills

Posted on May 8, 2009 by BMWFan

Last weekend I had written that the stress test results would not intimidate the market, and it is likely to be a buy the news event. The markets did not disappoint.

They bought every leak about the results, and then bought some more after the results were officially released. Though I am a bit skeptical about the secretive exercise, as an American, I am glad that we have perhaps the world’s best campaign organizer as our President.

This difficult task was handled in an exemplary manner, with administration having total control on when and how to release information; the banks were sternly told to keep mum.

Information, both good and bad, was leaked in a well thought out sequence, with the nation’s talking heads ready to put the right spin on it.

The whole purpose of the exercise was to restore investor confidence in our banking system and improve public sentiment. The administration succeeded in its goals, with banks successfully raising capital from the public markets to satisfy the government requirements. If the increase in risk appetite in the world’s financial market is a good metric of success, the administration gets an A+.

The WSJ is now reporting that banks won concessions from the Fed regarding the tests.Now that the capital has been raised from public markets, we might get to see some more dirty linen being washed in public
Economic News Bolsters Risk Appetite

The administration’s cause was helped along by better than expected economic news on all fronts. Job losses came in at a better than expected rate, as did the critical non-farm payroll report. Even the Canadian job report, an economy closely tied to the US came in better than expected with Canada actually adding jobs last month.

The exuberance was visible across different asset classes.

The US Dollar, the safe-haven currency over the past six months endured a major sell-off.

The Canadian Dollar is now at a six month high, and the Euro moved up by about 3% against the USD this week. Spreads on corporate bonds tightened. The yields on long dated treasuries jumped up to levels seen prior to the Lehman bankruptcy.

The Equity Markets: Divergence and Sector Rotation
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