Which Road To Take?

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The last two weeks have been pretty miserable for equity bears. The market’s reaction to news – any news – tells the story. If the news is bad (such as the downgrade of Spain), the market doesn’t really care. If the news is good (like GOOG earnings), the market skyrockets. And if the news isn’t even news (Merkel mumbling something about a plan that they’ll come up with sometime in the future), the market blasts higher still. There was, in short, a lot of pent-up demand to buy riskier assets.

In turn, bonds have been crapping all over themselves. The TLT fell for eight out of the past nine trading sessions, and I believe I read it was the largest sustained drop in such a short amount of time in the history of the long bond. So, if you can’t stand to be anything but a bear, you could at least find refuge in the wonderful world of US government debt.

There are a couple of extremes in how one could view the current state of the stock market:

(1) The market, with its forceful push higher over the past two weeks, has invalidated much of the bearish “case” and has established what will simply be the first of many steps higher. Yes, the bears got their jollies for a couple of months, but now that the market has gotten its bearishness out of its system, and now that Europe seems to be lumbering toward a lasting solution, we can get back to the business of bidding the market back to more richly-valued levels with an eye toward Facebook’s triumphant IPO this spring. Or……….

(2) The recent rally has been nothing but a partial retracement, and a countertrend move, in the context of a larger bearish move down. The “good” news that has given bulls a reason to buy up stocks will soon exhaust itself, and before the year is out, the lows established at the start of October will be taken out, trapping bulls in positions for which they drastically overpaid.

Well, which is it? Of course, I have no way of knowing, and neither do you. The bulls gobbling up stocks on September 1 had every good reason to believe equities were going to continue soaring, and they had their gonads handed to them. The bears last September 1, like me, had every reason to believe the weakness in the market was a precursor to a far bigger fall, and they likewise had the same aforementioned bodily parts dropped into their waiting palms.

The old saying, “you always fight your last battle” is probably truer in the world of trading than it is on the battlefield. For myself, the last “battle” I have to avoid fighting is that I wasn’t short enough during the last tumble. I had a grand time while prices were collapsing, but caution was the enemy, not my friend, and it feels worse to be not short enough during a collapsing market than it does to be short in a soaring market.

I have therefore been cautious in my shorting, since I want to avoid the temptation to “make up” for lost opportunities last time. I have been finding a small number of issues which actually look good on the long side, and I own them, but the preponderance of charts still look better-looking on the short side. I am presently about 50% committed with 12 long positions (20% of my portfolio) and 42 short positions (the other 80%). Boil that down, and you get 10% long, 40% short, and 50% cash.

This entire European affair has completely muddied the waters, and I suppose the big summit on October 23rd may represent some kind of high-water mark in the machinations. Hopefully we can stop obsessing over the Euro and its every pip, since I’ve had just about enough of being an unwitting FOREX trader.

Between now and then, it’s going to be all about earnings. The only big surprise to the upside so far has been GOOG, but that definitely kept the bull fire going strong.

There is a lot of uncertainty out there – even more than usual – and none of us can know the future for sure. But there is one thing of which I am almost as certain as I can be about anything in this lifetime, and it is this – – the tools being used to “fix” the economy and the markets will ultimately fail. In the end, what is being done will not create a naturally-growing, thriving, and prosperous state of worldwide economic affairs. Instead, I think it will end in calamity. The challenge for us as traders is not to get wiped out waiting for this event (or fearing this event), since whether it happens ten years from now or ten days from now is impossible to know for any of us.