Sucker Rally?

July 15th smelled like a bottom and looked like a bottom to many.  But, I’ve had questions since that rally.  I locked in some gains on short positions during that time but in the first few days of that rally saw that it lacked the quality I was looking for in a sustained rally so I added my hedges back on.  But, here we are.  A month has gone by and the market is higher lead by financials, homebuilders, retailers, and good ole beaten down stocks.  During this time, commodities have fallen dramatically and the stocks that are attached to them.  It ranges from natural gas to coal stocks to agribusiness stocks.  I bought some of them on a big dip only to see them fall some more. 

So, has something really changed or is this just another sucker rally similar to the spring rally?  Based on the pure internals, this rally believe it or not is actually weaker than the March & April rally.  So, why does it feel different?  A few reasons.  First, time heals and we’re further along in the recovery than we were then.  The Fed and U.S. Treasury stepped in to do the things they had to do to prevent a financial meltdown.  Some were late and some were predictable but they did do some creative things that no Fed has done before.  I like to use the analogy that the fire has been put out but now we have the clean up.  The economic data will continue to be weak and will cause the market to bounce around for some time.  It’s not an overnight fix.  Another reason this one feels different is because commodities have come down during this time which gives consumers reasons to feel optimistic and keeps the Fed away so they won’t be tightening anytime soon (I didn’t think they were going to tighten this year anyways).

Here’s what I’m seeing right now:

  • The internals of this rally are weaker than the spring rally.  However, I’m not seeing the overconfidence I did then when we began to roll over and head to new lows.  We’re in the middle.  Not too much fear and not too much confidence.  So, this rally could go on for a little bit longer.
  • There has been some change in character because small caps and technology have been very strong as opposed to earlier in the year when they lead the way down.  This shows investors are assuming more risk.  In addition, investors might be anticipating easier credit.  Small caps did well in the early 2000s because money was easy.  Then, it became tight late last year and down they went.  But, the Russell 2000 (small caps) has basically moved sideways the last few days and is at the same place it peaked this spring.  Technicians would call that a double top. 
  • Many oscillators are at their high point rolling over so some downside wouldn’t surprise me.
  • Many of the global growth areas such as agribusiness, steel, coal, drilling, natural gas, & gold are very stretched and are due for at least a counter trend rally.
  • The dollar has strengthened more so because Europe is weaker than us and it’s due for a pullback.
  • The economy continues to show signs of weakness.
  • Small caps are not the place to be short anymore and I’ll be selling my short on rallies.  This doesn’t mean I won’t be short but I don’t believe small caps are the place to be short.

How to play it

I believe we’re at an inflection point where global growth can rally and the averages can pull back.  That may be a better place to re-position if you’re looking to do so.  I’ve had several short positions for 2008 and they’ve been effective.  However, as the economy does recover eventually, the market will anticipate it and we need to be in position for that.  I believe the worst is behind us as far as Armageddon.  That doesn’t mean we won’t go down but we might churn for several months which is where trading will be more effective.  I said whipsaw risk was high and I’ve been whipsawed in the last few weeks.  This has been a tough stretch.  But, to be successful, you have to adapt to a new environment.  I think that we may be entering that new environment.  But, I’m not selling my shorts today.  I’m going to strategically exit stocks and positions that look toppy regardless of where I bought them and buy positions that appear to have upside.  One I purchased this week was Owens-Illinois (OI) which is a container and packager.  They make pill bottles, glass containers, the containers that hold the containers, etc.  Fundamentals are excellent and technically it looks very good to me.  But, I’m treating it as a trade because in this market if you don’t take profits, they evaporate. 

I’m keeping my beta very low and looking at each position individually as opposed to the whole portfolio at this stage in the game.  The bottom line is I need this rally to prove itself to me.  So far, it’s not doing it.  But, I’m optimistic we’ll get there.


4 Responses to “Sucker Rally?”

  1. 1 Mary Ngo August 18, 2008 at 10:26 pm

    Beginning shortly after the march lows, almost 6 months ago, people have been talking about the two strongest indexes: the Russel 2000 (small caps) and Nasdaq 100 (technology). Someone asked you about this on the blog during the April-May rally as a potential tell for investor’s appetite for risk. Why now is it so significant to you? It seems to be old news. Thanks.

  2. 2 keggerss August 19, 2008 at 7:16 am

    The reason now vs. then is because after watching the March & April rally, russell lead the market higher. I couldn’t tell anything from that because it was the first time. Then we got a signficant pullback which the Russell fell less. Then, this rally, the Russell has rallied more again. So, now we have a theme.

    I’m not saying to buy the Russell. What I’m saying is if you want to be short the weakest areas, Russell isn’t it.

  3. 3 James Tran August 19, 2008 at 9:09 am

    I don’t know to what extent this has affected the Russell 2000 performance, but they did recently re-shuffled the index’s make-up, adding a number of beaten up small and midsize banks at there lows (good timing by Russell) and the banks had a pop off the July lows. Ironically, these were large cap banks before.

  4. 4 keggerss August 19, 2008 at 9:12 am

    Excellent point and that could be the case. Now that financials are weak again, the Russell has underperformed the last two days. This is the kind of information that we all need to share to help make money in this market. Thanks James.

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