HOUSTON, WE HAVE A PROBLEM
I have spoken about the fact that during certain periods of market stress, the deception mechanism of the market simply breaks. The trend towards one side becomes so overwhelmingly powerful that the market keeps rewarding either the lucky bears or lucky bulls who manage to stick with the trend, without regard for technical indicators, sentiment indicators, macro indicators, measures of valuation or anything else that takes rational markets into account.
On July 31st, I published this study: http://www.zenpenny.com/?p=2146 to both this website and Forbes. The most important paragraph of the article reads:
The most interesting aspect of this study into the results of excessive pessimism meeting oversold markets is that the last 4 times we have experienced such a dynamic the markets have declined by double digit percentage within the 3 month period each and every time. This is followed, in most cases, by a snap move right back up following a short period of downside volatility.
Just several days after I published the study, the S&P had already fallen by a double digit percentages as the study suggested. And in October we saw the snap back up that the study also said would occur within a 3 month period to complete the cycle.
Well, we have a problem. A big problem actually. The study triggered again today. I'm obviously not prepared for it as I am 45% net long. Not nearly where I am when I am up to my ears in long positions with leverage. However, I am still not comfortable with 45% given the accuracy of this study. I really encourage you to go back and read the stats from study. They, of course, do not take into account the most recent occurrence that triggered during the last week of July.
This leaves me with a series of conflicting studies. I presented the study into 4th quarter rallies during the weekend. It paints a decidedly bullish picture for the remainder of 2011.
My only choice then is to remain with high levels of cash and perhaps raise more cash, taking my net long exposure down, over the next few days. There will be opportunities on the periphery and short-term trades in the major averages.
Today's triggering of the study from July, however, forces me to pull back my guns. The deception mechanism of the market is breaking. The study has just been too accurate to ignore.
Futures down 125. It's a hard knock life.
