Friday, July 13, 2007

New highs!

Alright, let’s extricate ourselves from the euphoria of smashing new highs in both Dow and S&P Thursday and take a deeper look at the circumstances surrounding this rally. Ostensibly, WalMart’s better than expected June sales figure was the trigger for this 280 Dow point orgiastic frenzy. However, as Barry Ritholtz ably summarized in ”This is a bullshit rally!” much of that performance can be attributed to higher food prices while the other retailers posted rather unconvincing results. Barry must be considered one of the high priests of the bear camp; however, he’s in control of his own emotions and this particular post is highly recommended for those wanting more introspection into their own actions.

To flesh out the background, I also want to mention two great articles at Trader’s Narrative. One dealing with commercials’ record long positions as this market has climbed higher, the other with bullish odd lot data. Taken together, a picture of commercials herding retail traders into the fleecing house emerges. Tuesday’s 140 Dow point drop accompanied by the S&P breaking its 50 DMA was unfortunately a great bear trap. It would seem that technical signals on the daily chart are not very reliable at this moment.

Let me frame my opinion with my own biases. I have long wondered the halls of housing bears and to me their message is preaching to the choir. The difference is that I have been expecting new highs with greater volatility in the near term. Thus far, this month is shaping up to be the best in the past year and half for me. Bulls die hard. I expected this cyclical advance to end only in the face of unequivocally bad data, and I believe such data won’t appear for at least one more quarter.

I constantly probe my thought process and the fact that commercials and retail investors remain so at odds has been a sticking point. One possibility is that the so called “sovereign wealth funds”, of which China’s $200 billion fund is the latest and most reported example, are being setting up as the bag holder this time. I can easily see Paulsen peddle this idea to the Chinese as a way of soaking up excess liquidity while tipping off his Wall St. buddies at the same time. But in a Machiavellian world, what do the Chinese get out of it, if they’re to be the bag-holder? Quite simply, by propping up US equities, it can create an appearance of prosperity and keep the US consumer, um, engaged. So they may consider it a reasonable price to buy it time to transition to an internal demand driven economy. Besides, as long as it can own real assets, fluctuations in the market price hardly matter.

Foreign buying of US equities in May was second only to February 2000 (chart courtesy Even if the $25+ billion was all from China, it will still take a while to exhaust its war chest. Who knows, we may even see Dow 36,000!

Speculating aside, we know new highs beget more buying, which is all the reason not to time the top of this market. In fact, I know for certain I’ll miss the top, but the whole point is not to short until the down-trend has been established. This past week has been a perfect example.