Winter Is Coming

October 15, 2012
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“Winter is coming.” 

- Ned Stark, Game of Thrones

Proverbial winter may be descending on heretefore “risk on” central-bank-driven markets. This would make sense given:

  • central bank stimulus fade via law of diminishing returns
  • corporate cost-cutting / fat-trimming profit boost used up
  • record corporate profit margins in mean reversion jeopardy
  • mounting concerns for earnings quality and top line revenue
  • fresh crisis concerns emanating from Europe
  • major bellwethers like AAPL showing meaningful weakness
  • technical deterioration hitting the major indices
  • potential bottom and resurgence in $USD

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 If we had to pick just one instrument to gauge risk-on / risk-off sentiment at this point, it would probably be the 10-year treasury note (IEF).

A resurgence in US treasuries would indicate capital flight from risk assets, and renewed fear of economic crisis (ahem, Europe, cough) and general global slowdown.

Continued bullish action in treasuries would also reflect a vote of ‘no confidence’ (or at least diminished confidence) in the US economic recovery, which still has plenty of doubters.

If you want plenty of ammo as to the skeptical bear case, check out David Rosenberg’s 58-slide “Navigating the New Normal” presentation (hat tip BI).

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Another key question is the Maginot Line of the 50 day EMAs (exponential moving averages). 

The 50 day Maginot Line has already been broken — badly — by small caps and tech, thanks to the $AAPL swoon that has brought much of the rest of tech down with it.

But the big dogs — the S&P and Dow — are still holding their 50s, and a break of that line would spell real trouble.

Note, too, that short sellers have largely given up the ghost here, with S&P short interest near multi-year lows.

This is a danger factor (for bulls) in that, if a sharp break commences, the supportive factor of shorts buying to cover and take profits will not be present in the market.

For as much as long-only types hate short sellers, their counter-cyclical activity provides a certain stability to the market… especially in declines… and the type of vertical drops you see in overbullish markets where shorts are not present give a taste of what happens when bearishness is in too short supply.

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Investors are focused on the marked deterioration in juggernaut bellwether AAPL — and they should be. But warning signs are emanating from other growth high flyers too – LNKD and AMZN prime examples — as capital shows sign of rotating out of high-multiple, high-risk names.

And speaking of AAPL, whose earnings report is coming up on October 25th – how long before AAPL starts competing with itself?

Case in point: Yours truly (Jack) has an iPhone 4s and an iPad 2, both of which are used extensively… but neither of which will be upgraded any time soon. (Both perform excellently, and there is no need for the coolness factor of having the latest model.)

How long before this self-cannibalization factor becomes a real issue, in terms of happy AAPL customers deciding the new version of iPhone, iPad whatever is not worth upgrading for (until Cupertino can figure out something else mind-blowing enough)?

“Trees don’t grow to the sky. Pigs get fat but hogs get slaughtered.” Two old Wall Street aphorisms for AAPL bulls to chew on.

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Another thing for bulls to worry about: Financial stocks are distinctly underperforming relative to the generally positive news out of JP Morgan (JPM) and Wells Fargo (WFC) last week. (WFC disappointed on revenue, but saw record quarterly profits.)

This week another slew of big financial names report: Citigroup (C), Bank of America (BAC), Goldman Sachs (GS), and Morgan Stanley (MS).

Meanwhile, what the hell happened to regional banks? Ouch…

Mortgage boost aside, there is fair reason to believe the major financial players will face serious profit pressures moving forward.

Near-zero interest rates have turned out to be as troublesome for the big i-banks and money center banks as they are for a lot of other folks, via killing the carry (spread between short and long lending rates) that so many banks exist to provide (and the low-risk spread-type trading opportunities related to such).

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In what amounts to an accidental practical joke, the goofballs in Norway have actually worsened the outlook for the European Union (EU) by granting it the Nobel Prize

Apart from the sheer silliness of such a move, the prize allocation decision was clearly a vote of fear rather than a vote of confidence. Consider the rationale from goofball navel-gazer in chief, Nobel committee head and ex-Norwegian PM Thorbjorn Jagland: “We see already now an increase of extremism and nationalistic attitudes… There is a real danger that Europe will start disintegrating…”

The Nobel decision, in otherwords, represents the actions of a useless group of high-minded philosopher kings trying to “do something” about the fact that the EU is coming apart at the seams, by giving a pointless stamp of approval as to the noble morality (ha ha) of the enterprise… because, of course, the political-driven logic of European Union (with a focus on preventing war) never made economic sense in the first place…

Meanwhile, a more rational outlook prevails in Sweden, where Swedish FinMin Anders Borg says Greece will probably quit the euro in less than six months. “It’s most probable they will leave,” Borg said via Tokyo… “We shouldn’t rule out this happening in the next half-year…”

And as EU politicians now talk up “A Third Weapon to Save the Euro” — a third one? Seriously? — we can’t help but shake our heads and laugh. When will this idiocy end? How many “game changers” and fresh “bazookas” will the powers-that-be have a shot at, before investors and austerity-crippled citizens alike say “ENOUGH?”

The following was posted in Monday morning’s “Key Points” summary for the Mercenary Live Feed:

A general stance of caution is warranted, with awareness that excellent opportunity could open up to the downside if bulls lose the Maginot Line of the 50 day EMA. Small caps and tech (via IWM and QQQ) have already broken this Maginot line. A general mood of “risk off” seems to be enveloping markets in general as earnings reactions disappoint and new crisis concerns emanate from Europe.

The purely “safety first” maneuver here would be to rein in risk and wait to see if bulls successfully defend, but this would forego opportunity to be ahead of the curve (by just the right amount) in the event of significant breakdown. The excellent reward to risk of such a proposition — being properly positioned for a possible extended downtrend of weeks’ or months’ duration as central bank stimulus hope wanes — makes it a strong imperative. As standard we are not playing certainties here, but favorable probabilities.

If you’d like to see the trades we’re making in real time, with heaping helpings of our own capital — including position sizing metrics, portfolio composition, the whole nine yards — feel free to check out the Feed

JS (jack@mercenarytrader.com)


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