Wednesday, February 8, 2012

Transcendental Blues

Steve Earle's, "Careful what you wish for - you don't know till you try", is the standing refrain in my mind these days. Apparently my estimation of a blowoff differs significantly from the markets imagination of one. A sincere mea culpa on my part for attempting to paint the market's portrait in difficult light. In my defense, I've always been more of an impressionist painter than a realist. To date, the correlation inkwell that I often pen from for shades of relationship colour has run dry leaving the market's throttle wide open to run towards the path of least resistance - which for the entire span of 2012, has been straight up. Momentum, as many great traders will tell you, is a difficult dynamic to appraise - let alone fight. Buy high, sell higher was coined in environments such as these. Sounds ridiculous mind you, but it's a philosophy and style that has merit for the nimble and the trained. The charts can give some guideposts and hazard signals along the way, but just as an oversold market can become more oversold - the same is true with momentum. 

With that said, another week and another 20 handles or so on the SPX. In hindsight, the respective volatility gurus were spot on in anticipating the significant compression in volatility and a return to normalcy -  which if I understand correctly, runs counter to the much darker parallel universe of the "New Normal". And while I remind myself of the caution implied by this autumn's rare occurrence of realized eclipsing implied volatility - the pendulum reflex delivered in mean reversion has ushered in the inverse dynamic. This in hindsight should come as no surprise, however, for those of us approaching things from the top down, the shot across the bow is what matters most - just as the extreme reading in the markets new highs minus new lows was in early October and the swift and traumatic loss of pressure in the precious metals market in December. Who knows what the impetus for the next catalyst will be, but I can tell you that the tail has widened appreciably since this fall. 

In terms of a broad-brush technical picture, overhead resistance was broken last week in the SPX and the XLF, although it shouldn't come as a great surprise - considering the Nasdaq broke out a few weeks before. Certainly with my market posture, it would have been clean and neat for resistance to have held, although I continue to operate through the biased lens that the equity market's are passing through the honeymoon period, imbibed by global easings and similar to the fall of 2007. This approach is not for the faint of heart or traders with very short timeframes, as it can certainly be trying on ones patience and P&L. It is never a straight line, and in hindsight, there is always a better method to capture a thesis. I simply operate from where I sometimes feel comfortable - waiting on a train. Of course like normal, comfort is a relative phase these days. 

The bearish technical du jour for the moment appears to be the Dow Jones Transportation Index, which stalled out last week and has a head or false start on the downside.
I am also closely watching the silver:gold ratio as it appears to be approaching another pivot. Lose silver's approval and the rally should dull to a lead luster. See further rational for this, Here
The dollar also appears to be coming into support. I find the most recent secular pivot in 1995 and 1996 as having some notable parallels to the current market structure in the dollar. 
In the anecdotal department, we appear to have a confirmed name for this blowoff wedgie. Like last April, its named after an esteemed and often bearish economist. Mr. Roubini was nice enough to lend his support for this rally - more than 22 percent off the lows and with sentiment reaching the often uncouth and beer laden cheap seats. If nothing else - they are as consistent as German engineering in markets such as these.  

Further paging through my anecdotal notes, I will leave you with some thoughts from a longtime reader and pension fund manager who sent me this nice note last week.
Erik-

As an aside to your commentary a week or so ago presenting the cash levels of mutual funds
crossing a significant threshold, this is something I thought you might appreciate. 

There is one fund whose position in cash I track each week. I feel obliged not to mention this
one, because I learned this info from one of the portfolio managers when I met w/them a few
years ago. Over a glass of wine at a conference one night, she tipped her hand and threw me
this tid bit (this is a $20 billion + equity fund): "if you want to get an idea for how we feel about
the market, watch the cash position in our XX fund. What you'll notice is that we will begin to
raise cash when we feel the market is overbought, and you'll see that at all major tops (including
end of 1999 and end of summer 2007) our cash position in the fund was ~10% +. You'll also
notice that when the market is completing a selling cycle our cash will typically be at 10-14%
and we'll start buying at or near the low and the cash level will then go back down to 4%."

The reason this is interesting is because it is the only fund in this mega family where the PMs
can actually lower or raise (significantly) the cash position, the other funds must remain near
fully invested. I've tracked it each week since then, and sure enough it was @ 10% in October
2007, and by March 2009 they started buying and by mid April it was down to 4% and then
remained in the 4-5% range.

Well, sure enough, as cash levels are at or near historic lows in the broad universe, the
cash position in this one fund has shot up from 5% to 10% since the end of October. This means
they have sold over $1 billion in equities during this run up, and as they crossed the 10% threshold
in 1999 and August/Sept 2007, they are always a bit early.

Enjoy your work tremendously.
And while the Larry Fink's are dancing with reckless abandon to the market's tune of late, somewhere Chuck Prince is getting goosebumps and thinking, "If I were you, I'd reach for that chair right about now - it's the Transcendental Blues."

In the darkest hour of the longest night
If it was in my power I'd step into the light
Candles on the alter, penny in your shoe
Walk upon the water - transcendental blues

Happy ever after 'til the day you die
Careful what you wish for, you don't know 'til you try
Hands are in your pockets, starin' at your shoes
Wishin' you could stop it - transcendental blues

If I had it my way, everything would change
Out here on this highway the rules are still the same
Back roads never carry you where you want 'em to
They leave you standin' there with them ol' transcendental blues