“Just when I thought I was out… they pull me back in!”
– Michael Corleone
With another bullish reversal the broad market picture has gone back to uncertain. Over the past week or two the major indices (Dow and S&P) had come under significant bearish pressure.
Tech was already bearish — thanks to pronounced weakness in juggernauts AAPL and GOOG — and small caps had also gone red. The major indices then seemed to complete the picture with a clean breakdown on October 22nd. And from there, sideways consolidation in a classic bear flag pattern…
For a period of time, the likelihood of downside follow through looked strong. Corporate earnings fears were building. The technical picture across all risk assets had notably deteriorated.
And yet, reason for caution remained, as these markets have been notoriously reversal-prone for a seemingly endless amount of time now, blocking all budding trends like Dikembe Mutombo stuffing an NBA rookie…
And thus, after multiple days of sideways congestion — and a 2-day weather break for hurricane Sandy, an occurrence last seen in 1888 — the major indices resolved higher on Thursday, rather than lower, shredding the bear flag via the strongest single-day surge in seven weeks.
Semiconductors confirmed Thursday’s “risk on” power-up, via their function as a leading indicator of the market. Many traders watch the semis as a canary in the coal mine of sorts. Conventional wisdom is that if the semis can turn, the whole market can turn.
And on Thursday, turn they did… while at the same time, a host of “risk off” plays — US treasuries, utilities, gold stocks — saw decline.
Call it a Corleone market. Just when you think you’re out, the bulls pull you back in.
Such last-minute reversals cannot give true comfort to bullish investors, however — or at least not those who maintain risk control discipline. The threat of breakdown, along with looming macro and micro tail risks, is enough to keep smart longs in check.
A market that flashes major warning signs, then reverses higher in negation of all negative signals, ultimately rewards no one but the “true believers” who buy and hold with their eyes closed — and that group winds up losing all its money in the end anyway…
There are also strange goings on underneath the surface of this market.
For example: Even as equities catch a bid, the dollar is getting stronger. This is a reversal of the normal order of things, as the buck is generally a negatively correlated “risk off” instrument.
One of the few current longs in our risk-curtailed portfolio is UUP, the Powershares dollar bullish index. UUP is registering a meaningful breakout today (Friday Nov 2nd), even as gold and silver tank.
Speaking of gold and silver… we still think they suck. No offense intended to gold bugs, of course! We are more than willing to be long precious metals when the time and place feels right — but the pieces of this particular puzzle just do not add up.
To briefly recap various elements of our thinking (as they have been spelled out in various places these past few years), gold is an instrument of extremes. Precious metals can do very well when things are “hot” — i.e. when inflation pressures are wreaking havoc on markets — or when market conditions are “cold,” because the icy grip of deflation paradoxically increases the odds of central bank panic and emergency super-stimulus.
But when market conditions are neither “hot” nor “cold” but maddeningly lukewarm, precious metals are not the place to be (in our humble opinion). The surges in gold and silver we have seen of late have been tied to big statements and big moves from Bernanke — but these expectations of some big inflationary drama developing have simply not been matched by reality, or by reality’s future prospects in the near term.
As for internal positioning, we are not anxious to get long at these levels. While the bulls have the ability to “pull investors back in” via refusal to roll over, they cannot shake off increasing concerns of macro headwinds (and a technical picture that has at best reverted to no man’s land).
We remain short QQQ from higher levels, along with a few select individual equities. Our only notable bullish position is long $USD (via the aforementioned UUP). In some market environments the name of the game is capital preservation, as opposed to profit accumulation, and this is one of them.
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