This may not be a good market for investors but its a fine one for traders. Over the past months we have maintained a cautious tone with the expectation of a potential April top for US equities. While we don’t expect anything dramatic in terms of a sell-off, the selling could be substantial at times as the markets begin to flush out newbie momentum investors or those who need a refresher course in market risk.
As for this being a fine time for nimble traders, this has been the case especially in the Nasdaq and small cap sectors as identified by symbols QQQ and IWM, both of which have rolled over and are leading on the downside. We’ve been able (so far) to capitalize on the the weakness by trading the SQQQ and the TZA as both markets appear to be in a “two steps down and one step up” mode.
Eventually this period will pass and fear will be reinstated as a common investor emotion which will probably lead to a strong second half of 2014. At present, we see no signs of recession and weak markets within growing economies can happen but they’re typically shallower and briefer than recession based bear markets. So, assuming the markets remain with a downward bias into the Summer, this will likely lead to an excellent entry point later this year.
Notice the divergence between the stodgy S&P 500 and the NASDAQ and IWM. This kind of behavior leads me to suspect that the outpeformance in the small caps may potentially be over which is one why we’re expecting to lean heavily on Mid Caps when we eventually move to fully invested.
So far we have avoided shorting the SPY via inverse exchanged traded funds, we’re respecting the market strength.
We continue to opportunistically trade the SQQQ, the inverse QQQ ETF as this market shows a bearish trend. I’d expect to sell the SQQQ in the event the QQQ revisits $84.
We are trading the TZA which is an inverse exchange traded fund that mirrors the IWM which is a proxy for the small cap stock market. We expect to sell the TZA if the IWM moves below $111.
To sum it up: For the time being, this is not a market for investors but for traders. This too shall pass.
Brad Pappas
Long TZA and SQQQ
RMHI and OP clients are very well positioned in light of the falling stock prices in the US and abroad, especially in emerging markets (EM).
As mentioned previously we thought risk could happen fast once the new year was upon us but even I’m surprised by the ripple effects of the FOMC’s taper decisions. We had not anticipated that it would throw the emerging markets (Brazil, Russia, China and Asia, India, Turkey, New Zealand) into turmoil. Turkey, New Zealand, India and Brazil all have central banks that are raising interest rates sharply to stabilize their currencies, which will penalize their growth longer term. If we add a slowing growth rate in China, it only compounds the problems. This is a very bearish environment for EM stocks.
At the start of the year the consensus was that interest rates would rise. We took the other side of that argument thinking that the consensus would be wrong…and were they ever. Who would have thought as recently as 10 days ago that not only were rates not going to rise but that the EM banks would be tightening credit and with investors fleeing stocks and turning to Treasury bonds we’d have a full scale rally in Treasury Bonds?
As it stands as of today 1/29/2014 our largest 5 holdings are:
1. Direxion ETF Emerging Markets 3x Bear symbol “EDZ”: This exchange traded fund or ETF will rise in price if the Ishares Emerging Markets Index “EEM” falls. My thought was that the EDZ would be a much better hedge against any residual stock positions we retain since the emerging markets is facing a real threat while the US is merely experiencing slowing growth. In other words I felt there was a better chance the EDZ could rise sharply than a US based inverse ETF.
2. Pimco Municipal Income Fund “PMF”: stable and wonderfully boring in a volatile world with a locked in 7% tax free yield based on our purchase prices.
3. Nuveen Enhanced Municipal Fund “NEV: see above for PMF
4. Blackrock Municipal Income Trust “BFK”: see PMF and EIV
5. Direxion 20+ Year Treasury Bull 3x: “TMF” This is a leverage ETF we bought a few weeks ago when we started to see an emerging rally in 20 and 30 year Treasuries which was based on the extreme negative sentiment regarding bonds at the end of the year. So far, so good. With the worlds economies slowing and markets retreating T-bonds are a logical place for investors who want a safe haven.
Long all positions mentioned.
Be careful out there,
Brad Pappas
Advisers who tell their clients to remain fully invested in stocks, hell or high water is offering systemically dangerous advice. @Jesse_Livermore
We couldn’t agree more!
But we live and work in Lyons Colorado, so “high water” is a poorly timed phrase.
Not since 1995 has the S&P 500 not had at least a 10% pullback. Normally, you can count on a 10% pullback within an ongoing bull market to a great time to add funds or bring new accounts online. But 2013 is the year of the relentless rally where 2% pullbacks are new 5% pullback. Extreme bullish investor sentiment which is normally a good barometer of when to ease up on portfolio exposure has been pointless, as previous blog posts have demonstrated.
So, whats going on you ask? Why is this year different from the others and what does it mean going forward?
Markets are clearly being driven higher by the Federal Reserve current policy of Quantitative Easement and its by product of 0% short term interest rates.
Its no coincidence that when the Fed ended QE1 and QE2 markets fell apart with declines of -16% and -19% respectively in 2010 and 2011.
Its fashionable right now to analyze each economic tick (especially the recent positive employment data) to determine when the Fed will end QE3. But the truth is we really don’t have an accurate guess for when that will happen.
Three things we know for sure at the moment:
1. We are in the midst of the strong season for equities and that will last until March 2014.
2. The economy as measured by employment is improving. Contrary to politically biased media outlets job growth is not coming from part time employment. GDP growth in the 3rd quarter was stronger than expected. This is market friendly.
3. Bob Dieli’s Aggregate Spread and RecessionAlert.com are both at benign/miniscule odds of recession. Market friendly again.
My best guess of what will happen? Eventually the Fed must end QE3 and the markets may anticipate this ahead of time by churning nowhere or showing internal deterioration in strength. My thinking is that the Fed will do nothing till at least after congressional budget talks in January but by the time March comes around and temps here begin to melt some snow we should be decreasing our equity exposure in a meaningful way.
For the past few weeks we’ve become increasingly more cautious as investor enthusiasm has reached euphoric levels. The irony of this is that Jason at Sentimentrader.com has published a study that euphoric investor enthusiasm doesn’t always lead to weakness, it frequently can create a short term top followed by churning market action before resumption of the rally. Churning action is not bad at all and in the past week we’ve seen two of our holdings make extraordinary leaps: FONR catapulted from $11 to $19 and today SGOCO Group rose 47% in a single day.
Combined with this is the fact that we are in the strongest season of the year for stocks. This evening I ran a study dating from 1999 to 2013 where I measured the rate of return for our models from November 19 to March 31 of the following year.
There were 12 time periods measured and I excluded 2008 and 2009 from consideration due to recession. Note there was a recession in 2001-2002 period as well but small cap value defied the recession and posted strong gains. The results are a combination of both real time and hypothetical data.
Average gain November 19 thru March 31 was 18.91% including all fees and expenses.
Low return was 5%. The high return was 30%. Median 17%.
There were no negative returns.
The markets reluctance to sell-off despite high sentiment readings but with strong seasonal strength gives me the sense that holding inverse exchange traded funds may not work this time and they were sold for a small loss.
Brad Pappas
Long FONR and SGOC
A quick update on our current status:
The major market indices are at or near major market highs which will likely be a difficult hurdle to surpass in the near term.
In addition, investor sentiment is extremely positive which has negative implications going forward in stock prices.
To our way of thinking the combination of negative investor sentiment with markets at historical highs implies either a sawtooth churning market with little or no gain or a moderate decline in prices in the near term. We don’t believe at this time that a major market top is playing itself out, we believe based on Ned Davis’s market cycle analysis that a major top is due in the Spring of 2014.
All recession indicators remain in positive territory.
So, we are essentially playing defense for our clients by selling off stocks falling in our ranking systems and raising cash rather than reinvesting on the long side. We have added a significant amount of inverse exchange traded funds that should aid in buffering downside volatility in client portfolios.
Should a decline emerge to the degree that overwhelming positive sentiment is reversed we will reverse our course and liquidate the inverse ETF’s and add new long stock positions for a potential new leg up in the indices that could last to March/April 2014.
Brad Pappas
