A week ago this past Friday, I made the decision to significantly increase my long holdings. I was up or close to breakeven in most positions. Call premiums were skyrocketing higher. I wanted to collect some of those premiums. I added shares and sold calls. This action nearly doubled our exposure in the market.
As you recall, I said in last weekend's letter that I believed the market would move higher even though I also believed (according to the forecast models) that downside risk was increasing. That bullish opinion was exactly correct.
This past week, as you know, was one of the strongest up weeks we have seen in a long time in the market. Our portfolios were very nicely positioned to take advantage of the dramatic moves higher. Our biggest position was a gold ETF and it shot higher.
Thursday, the big news came out from Europe that they had averted the financial contagion for now. The market was overjoyed, which pushed our holdings even higher. I made the decision at almost the top on Thursday to buy back our calls and sell all positions; moving to 100% cash by the close of the day. Here is why...
As you can see from the chart above, the risk is huge (50/50) that we could see as much as a 9% correction in the market anytime between now and November 15. That is just too much risk to ignore.
Now, I am looking to short the market, but not until (or if) that red triangle you see in the chart above, goes away. What that "Bear Bias Inversion" is telling us is this:
- The market (red dotted line) is trending higher when our forecast (purple dotted line) is trending lower. This either means the forecast is wrong or there is an exogenous event at play (Europe?) that is artificially juicing the market higher. But, since the market can remain irrational longer than most people can remain solvent, I choose to sit on the sidelines until I see the Bear Bias go away.
- This current Bear Bias Inversion will likely last, at most, about another 2 weeks. This is interesting since we also have a Bear-Play SuperCycle that begins this coming Friday, November 4. I will be watching the market closely this week as this all unfolds.
- Additionally (and this is non-trivial), instead of a rebound previously forecast for late December (a Santa Claus Rally?), it now looks more like a Santa Clause Nightmare. After a small rebound in mid-November, the market looks to head South for the winter. This is a big move forecast and one that is generally supported by the other major index forecasts. However, this is a significant change over previous forecasts and is not one that I am willing to accept until I see another forecast or two in the future.
Elves will be Elves...
The Elves won't look me in the eye this weekend and I know what that means. It means they are not wanting to crawl out on a limb and tell me what they are thinking. But, when I threatened them with no cookies and milk if they didn't tell me what they think, they caved pretty quickly... especially, when I mentioned the milk is so cold it is sure to give them a brain-freeze... something every Elf dreams of...
So, here is what they said... The Bull-to-Bear ratio is 37-to-1 in favor of the Bulls, which means the rating this week is a needle-pegging [ + 5 ], but the volume of signals is extremely low (in fact, there was only one new short sell signal this week). The market is now in an overbought condition based on a decreasing number of short-sell (red ) signals, the Composite Total of Signals (black line) and the fact that the black line has crossed the red line. The S&P 500 (green shaded area) is trending higher. Taking profits and considering short strategies could be in order. Strong long trades could be in jeopardy.
I asked them what so hard about that forecast and they said, rather Elfishly... "37-to-1 when there is only one new short sell signal is not enough data to provide real conviction." I wasn't sure what they meant (although, I think it means the risk is very high that this could be a market reversal week and that we are at a market top). I gave them warm chocolate chip, pecan encrusted cookies and 32-degree milk. They all have that milk-buzz look on their faces that only babies and Elves get and have gone back to sleep until next weekend.
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