For the past few trading having trading hedges appears as a very unenlightened strategy as markets rebound sharply. But these are unpredictable and volatile times where the chances of staging a major rally appear to be very small while the real risk is exactly how much downside do we face in earnings?
On the Bear side of the trade (where I am):
Stocks follow earnings and while earnings for 2011 are almost locked in, earnings for 2012 have now rolled over. Our primary model is now Bearish/Hedge. Earnings in the average recession fall approximately 22% which implies $77 in 2012 earnings. Earnings cannot take that kind of a hit in the hope that stocks hold, they won’t. John Hussman of Hussman funds in his weekly commentary makes note of corroborating economic indicators which we’re experiencing now with 100% sensitivity to economic recessions.
On the Bull side of the trade:
Sentiment is very extreme at this point. I would have to agree that current sentiment based on news that we know at present is likely reflected in current stock prices. In 2008 when sentiment reached the current present level the major waterfall selling was over. However, afterwards there was a second and third wave of selling, a series of events that represents the “process” of forming a market bottom. The Bear ended in March 2009 but you can take only microscopic comfort that the climactic low was in the previous November.
Trading comments: I missed the top in the parabolic move in the Swiss Franc and have begun liquidating our FXF hedge. I’m kicking myself for that one since parabolic moves almost always end the same way……really badly.
I’ve added some additional SDS into client accounts as we’re now at the point where the previous rally faded and sentiment in the very short term is extreme.
Long SDS, FXF