Change Is In The Air

As the rally from March 9th progressed, it became more selective, the volume declined, and more doubt about the economy came in.  We saw a flattening out of the indices in early May that lasted until just recently.  In June, I took a lot of profits on positions and prepared for a sell off.  We got the sell off.  Most of the indices went down about 10% and many stocks much more.  The risks of owning stocks rose dramatically.  I didn’t want to give back the gains I had for 2009.  Principal protection was key.

I coined a phrase called the gap trade whereby the fundamentals would continue to get better and the prices of stocks would fall creating a gap that we could profit from.  What I didn’t know was how wide that gap would get.  Well, the gap trade happened sooner than I thought and the past two weeks have made many of my indicators change.  Folks have realized the economy is improving and are now buying stocks and becoming more and more reluctant to sell.

Not only have we gone back to the top of the range since May, but we’ve broken through it.  In addition, the most important part of the rally has been the fact that now there is more and more participation (breadth).  In other words, more stocks and more sectors are participating.  In addition, sellers are nowhere in sight.  This is a change in character from what we saw just two weeks ago.  It’s quite an amazing change.  It’s true the volume has been extremely weak but it’s been that way for most of the rally.  Now, don’t get me wrong, the internal conditions are far from ideal and in fact there have been very few rallies the last several years with internals this weak.  However, the key to this is that the internals are improving (not ideal) and the risks of owning stocks is now falling.  As fast as the market was deteriorating it has changed course and is improving.

Given the above improvement and change in character of the market, that doesn’t mean we run out and buy a ton of stocks, ETFs, & mutual funds.  In the very short-term, we’re now very extended any way you measure it.  So, I’m expecting a very short-term pullback but it’s quite impressive on a day like today when big bellweather stocks like Microsoft, Amazon, & American Express disappoint and get beaten up that the Dow comes back from down 70 to finish up 24 on the day.  When a market doesn’t sell off when it’s supposed to, you have to pay attention.

I always write that in this environment, you have to stay flexible.  This is one of those times.  If you’re a perma bear or a perma bull, your results are poor this year.  If you’ve been flexible and willing to trade as I’ve suggested, you’ve made good money (including bonds).  Many people were caught off guard for this rally in the last two weeks.  I wrote that I expected a rally a couple of weeks ago.  “Many of the indicators I watch are getting to the point where we should (key word should) have a rally over the next few days.  We’ve now had almost a 10% correction and the bulls will come in and start buying some “bargains””. What I didn’t anticipate was the strength and the improvement in the technicals.

I also wrote, “Many people keep asking me to give them levels on the indices.  How far can we fall from here?  As I mentioned on my radio show yesterday, I simply lighten up on stocks when the risks rise and I increase my allocation to stocks when the risks fall.  Right now, the demand for stocks has fallen while supply has picked up and the risks are rising to hold stocks.  That certainly doesn’t mean we can’t rally from here.  It simply means I won’t participate until the risks go down.  It’s that simple.” Well folks, the risks rose considerably in early July.  But, looking out over the next several weeks and months, I think the risks are now falling.  As I’ve said, the short-term may be dicey, but I believe we’re in the buy the dip mode.  Use some skill to trade these markets but widen out your stops.  In other words, instead of using a 10 or 20-day moving average for example, use a 50-day moving average if that’s one of the ways you use stop losses.  Begin to focus on the economy more and the day to day volatility less.  It’s turned into that kind of market.

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6 Responses to “Change Is In The Air”

  1. 1 Patty July 26, 2009 at 8:35 am

    Hi Karl,

    I have been out of town for the past two weeks and have not been able to listen to your morning show. I took a small short position a while back when you stated that you were short and had not had a short position since February. My question is are you still short? I currently have a small loss in TWM and SDS. Do you think I should cover now or wait for a small pull back in the near future.

    Thank you so much. I truly value your opinion. Your show and blog have helped me recover most of my losses from the crash. I really can’t thank you enough for what you have done for my family and me.

    Most sincerely,

    Houston, Texas

    P.S. There really is a great Mexican restuarant in Colorado. It is in a small town on highway 6 heading up into the mountains. I never remember the name of the town until I see the sign for it. If you ask around while you are there, someone will know what I am talking about. The food and margaritas are very good. The town is also pretty neat. You and your family would probably enjoy walking through it if you end up going there. I tried to Google it for you but unfortunately I couldn’t find it.

    • 2 keggerss July 27, 2009 at 10:31 am

      Patty, thanks for the recommendation for the restaurant. We’re all about the food when we travel.

      As far as the shorts, I am still slightly short. But, remember, I wasn’t ever net short. I only used the short positions as a hedge against my long positions. At this point, we are overbought in the very short-term, so you might get higher prices for those two ETFs. But, it’s very dangerous in this type of market to hold those, especially because they are double. I haven’t used double shorts since January & February. Thanks Patty.

  2. 3 Tom July 26, 2009 at 3:16 pm

    Karl, what’s your thoughts on TBT and UDN at this time?Thanks

    • 4 keggerss July 27, 2009 at 10:28 am

      I’m worried about TBT in the short-term if equities pullback. Money will go into treasuries hurting TBT. Like it longer term though. I do like UDN right now. Consistently moving up.

  3. 5 Denny O'Brien July 29, 2009 at 11:43 pm

    Hi Karl,

    Dan Frishberg has mentioned several times the trendline resistance on the monthly spx chart would stop the rally.
    Is that resistance at 1050ish or 1120 on spx?


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