Sunday, May 28, 2006

Next week is critical

Kudos to the bulls! The week finished with a third consecutive up day. It must be acknowledged even though the volume of the last two days was much lower than average. The next week is critical in terms of the short term direction. I have been quite forthcoming about my bearish bias, but if the market rallies up strong next Tuesday-Wednesday, I’ll have to admit a retest of the highs of this year becomes probable. It must be noted though that the shortest trading I involve in has a time span of several months, and I’m still of the opinion that we have seen the high for this cyclical bull market.

Despite what may seem strongly held views, I’m fully aware the possibility of being wrong. I constantly remind myself of Warren Buffet’s two rules: 1) Don’t lose money; 2) Don’t forget the first rule. Since I have devoted much ink to the recent closing of long positions and expansions on the opposite side, I may have given the impression that I’m now net short. In actuality, my total portfolio is still slightly net long, as maintaining the gains made so far this year is the first priority. Placing more bets after the market has shown its hand seems the more prudent thing to do.

In The sword of Damocles, I characterized my stance at the time as “long commodities, long foreign markets, especially emerging economies, short housing and short the US dollar”. Precious metals and other commodities still take up 40% of my actively managed portfolio, although down from over 70%. After closing my position in FXI, I no have a small net short position in emerging markets through EEM puts. I’m still shorting housing (BZH and CFC), and expect the US dollar to head lower. The largest hedging positions are in the form of IWM puts and leveraged bear funds targeting the Russell 2000 and Naz 100 (USPIX and UCPIX). In recent days, the commodity stocks had been bouncing in tandem with the general market which meant my hedging strategy worked as planned. As with any cross-hedging, big money is made (or lost) if or when the sectors were to diverge. In this sense, my implementation betrays my long term macro view: that we are in a period analogous to the 70’s where commodities, especially gold did well while the general stock market were mired in a stagflationary bear phase.

One market pundit I should be reading more often is Jeff Saut from Raymond James. In the last weekly commentary, he advanced the thesis that we may be in the middle of one of those 17-25 session down periods punctuated by 1-3 session counter rallies. He is also long term bullish on “stuff” stocks. For him to be correct (not to mention how much I agree with him), selling must continue next week.

The good thing is that we don’t have long to wait. Best of luck and be safe!