THE INTERNAL CONFLICTS FOR THE MARKET THAT LIE AHEAD
This is one of the more difficult spots of the bull market to date given the various crosscurrents that exist. Let's look very logically and unemotionally at what has happened to date: We started the year by having one of the worst first quarters on record midway through, only to bounce perfectly off of a key support area as pessimism was at historic extremes. We have seen a substantial bounce take place that has reconfigured sentiment, although bearish sentiment (or perhaps more aptly an unwillingness to commit to the market on the long side) is still pervasive among investors. Nevertheless, the market paid attention to a very minor resistance point at S&P 500 2100 which has resulted in a very standard pull back over the past couple of weeks. So we're basically stuck between a major area of support down around 1880 for the S&P and a minor area of resistance around 2100. This range-bound action is occurring just as technology is disassociating itself from any general trend in the market with a significant bias to the downside. Other sectors continue to show relative strength, but with the weight of a bearish technology sector the market will inevitably become sloppy. This becomes even more the case during what is going to be an illiquid summer trading season as hedge funds continue to face redemption requests in the midst of general confusion among managers while retail investors remain perpetually absent. Add to that general bearish sentiment among a majority of investors marked by deep skepticism and incessant fear within what is sure to be the Barnum and Bailey's of presidential elections and you have the formula for a stock market that only wants to hurt you. This is not a statement of bearish or bullish significance it's a statement of malicious intent against both sides of the trade. A sideways market that is running 100 miles per hour to nowhere while wearing flip flops, skinny jeans and some stunner shades. In other words, a market that makes no...
HEDGE FUND DYSTOPIA
There hasn't been a period of time since 2000 when the death of hedge funds hasn't been spoken about as being imminent and widespread. Any type of pull back or market calamity is cited as the latest reason for their demise. Just like any other profession based on performance if you don't perform you don't deserve to be in the business. If a wide receiver in the NFL suddenly starts catching only 30% of the balls thrown to him then he will no longer be employable in the NFL. It doesn't mean that the wide receiver position is dead. Elegantly bringing me to my next point. The hedge fund industry has become overwrought with sophisticated salesman in possession of advanced degrees who neither have a passion for the business or the aptitude to be in it. Instead they are in possession of above-average levels of salesmanship and a network of wealthy individuals who become smitten. Their strategy is one that relies on follow the leader in what has become a copycat profession in the midst of a culture that is obsessed with closet indexing. The only passion is for collecting fees without regard for developing real skills or taking well thought-out steps to improve performance. Take for instance the most recent run of the herd at beaten down oil and gas stocks. In what is purely a reversion to the mean trade, hedge funds are playing a game of musical chairs with any energy stock they can get their hands on. There is nothing repeatable about the process of buying energy stocks either now or two months ago. In other words if you ask the average hedge fund manager that has bought into energy over the last couple months to repeat the process in another asset class at some point down the road it will be impossible to do so because there is no process behind it other than piling into momentum. Until investors in hedge funds are able to differentiate real managers with a distinctive investment process from professional salesman that are only in possession of the gift of gab, the cycle of scorned investors and negative publicity will continue....
TURNING SIDEWAYS
Whereas the market environment of January and February was screaming market bottom as nearly every market pundit was manipulated into thinking we were in a bear market, the market environment of today is much different. There is a general sense of awkward suspicion occupying the hearts and souls of investors that need to create returns, yet are afraid to commit for fear of something nefarious in the offing. The result of this distrust is a cloud of neutrality that is beginning to become apparent in the price action of both individual issues and major averages. There is very little correspondence between one asset class and another. For example, while financials looks like they might be getting ready to outperform, technology looks like it is getting ready to move into a general malaise. There isn't much an investor should do in an attempt to cope within such a market environment. Being overactive will result in a grind lower for your equity curve that will create an avalanche of frustration culminating in something much worse down the road. Being underexposed to equities comes with its own set of hazards as this is default position of a majority of investors. The same majority that hated stocks in 2009, loved real estate in 2007 and didn't care what price they paid for Garden.com in 2000. Now they have simply thrown their hands up in disgust, hoarding cash for fear of any asset class that has volatility exceeding that of a certificate of deposit at the local credit union. The best course of action to take then may be to do as little as possible until a market turned sideways reveals its true intentions. There remain pockets of value all over the place. However, tepid market participants have been slower than usual in making the commitment necessary to allocate any substantial capital into these situations. While that may be cause for some investors to pull the ripcord, it will turn out to be a poor decision. When markets get pricing of an asset incorrect, they will make the correction in time, as evidence of the error mounts. In smaller, less liquid names, the correction is often made in a matter of days, as opposed to months or years. You literally have an entire year (sometimes multiple years) worth of gains that takes place in a single week. In other words, the smaller you go in terms of market cap, the more private equity like the investment becomes as the mark to market takes place at greater intervals. While the market may be turning sideways, decisions made by investors should remain constant, realizing that the...
FRONT RUNNING SELL IN MAY
Sell in May and go away is a long lived axiom on Wall Street that encompasses investor skepticism regarding what are typically volatile, low volume trading months of June-August. It is then understandable, especially in today's environment of deeply-rooted bearish sentiment, why investors and traders would attempt to front run such a poetic use of words in a single compact phrase. The front running of sell in May comes just as investor sentiment according to AAII has gone from a little bullish to somewhat bearish to simply throwing up hands and shrugging shoulders in disgust, with the ultimate conclusion being that investors just don't know what will happen from here. Bearish sentiment is again spiking as neutral sentiment shoots through the roof. It is only natural then, all things considered, that investors would be falling over one another to get a jump on the sell in May trade. Unfortunately, markets are rarely so accommodating and not easily impressed by poetic meter. The more investors piling into this trade over the next week or two, the more the chances of a rebellion by the market to challenge the conventional wisdom. While selling in May and going away might prove to have been the correct move given 20/20 hindsight, the trade will be a difficult one to execute with any confidence given the preponderance of bearish participants causing waves to appear due to their piling on in one direction. June - July may ultimately prove a more suitable environment for bearish positioning, avoiding the chop to come....
CLOSURE ON THE QUESTION OF WHETHER CARL ICAHN IS HAVING HIS BILL ACKMAN MOMENT
In 2013 upon the public disclosure of a significant position in Apple shares by Carl Icahn I published an article wondering if Carl was having a Bill Ackman moment by becoming involved in what I thought was at that time and continue to believe is a value trap. Turns out it was not exactly a Bill Ackman moment as Mr. Icahn managed a decent return overall. However, for those hapless souls who decided to follow Mr. Icahn into the AAPL trade believing that if his money is invested then their capital will somehow be blessed, the end result was not that great. One of the most dangerous trades on Wall Street has been and will always be following the hot fund manager of the moment into his favorite investment. Typically these types of scenarios end up with that popular manager suffering from reversion to the mean syndrome right when his popularity achieves critical mass. This in turn results in the manager losing money or not doing as well as investors thought, creating resentment upon the salivating herd as they had no doubt that this investment would pay for a pair of jet skis and a fishing trip to Montana. In the meantime, the very same investors who thought they were getting value in Apple were missing out on "expensive" names such as Facebook (a stock I was talking about being at $100 in 2013), Tesla, Amazon and Google, resulting in tremendous opportunity cost all the way around since 2013. In the end it turns out that being an investor who simply follows your favorite fund manager of the moment into investments is no different then being locked in a small dark room. You have no idea where you are going, what is next, or when you will be...
THE ULTRA LONG-TERM PERSPECTIVE
Let's put aside the the multi-month time frame for the market just for a second and focus on the really big picture. This is a good exercise for the simple purpose of maintaining focus, which is a sorely needed attribute among modern market participants. I presented the chart below in January as a means of assuaging the then persuasive fears of a secular bear market. According to the very simple chart below going back nearly 100 years, the markets are in a powerful secular bull market that really just started recently. With that said, there are going to be numerous corrections (you can even call them cyclical bear markets) between 10 to 20 percent that convince market participants of an impending secular bear market that is both long-lasting and deeper than 25% from peak to trough. We, in fact, just had one. And it worked perfectly in that it completely threw market participants for a loop, causing all varieties of sordid analysis of the septic variety that were more or less a product of fear rather than facts. click chart to enlarge What is important to note about the evolving ecology of the markets over the past 100 years is that secular bears have become progressively shorter in duration while secular bull markets have become progressively longer in duration. There are probably multiple reasons for this, most of which has to do with the involvement of central banks and evolving liquidity experiments. Given this evolving pattern is it too far off to believe that this secular bull may last longer than anybody expects? The last secular bull market lasted about 17 years give or take. The one before that about 10 years. Is it unfair to assume that the unintended consequences of what is really the first global concerted effort at providing liquidity at any cost will be a progression of asset prices along both time and scope of returns? According to the chart above, it is not out of the realm of possibility and is in fact, very...
THE MARKET HAS HIT ITS INITIAL UPSIDE TARGET, NOW WHAT?
After pretty much pinpointing the recent market bottom while the rest of those on Wall Street were running around with their faces melting off screaming bear market, we are now at a point in this upside cycle where things will become tricky enough that further analysis is warranted. When we last left off on March 6th, I pointed to the trajectory sitting around 2100 as the ultimate destination over the next few weeks for the current move up. We are now sitting at this minor trajectory as pictured in the chart below for the S&P 500: click chart to enlarge At the same time, the put/call ratio is hitting levels of conviction, expressed through the purchase of calls, not seen since May/June of last year. This very simply tells market participants that bullish conviction has returned to the markets for the first time during this recent uptrend: The minor trajectory pictured in the first chart paired up with excessive bullish sentiment, as expressed through the put/call ratio, more than likely translates to increased sideways volatility moving forward. It certainly doesn't translate into an imminent decline. The upside just becomes more difficult from here. It is similar to a cyclist who has been traveling on flat ground for ten miles and is then met by a two mile climb uphill. He doesn't stop peddling, his peddling just slows a bit. There is enough momentum in this move up that we could indeed chop up towards 2150 before a top of any significance is seen. My feeling towards this rally continues to be one where I feel it necessary to remind myself that the greatest danger is in becoming bearish too quickly. Despite the put/call ratio, there is a general skepticism regarding the prospects for continued upside among market participants. While somewhat anecdotal in nature, a bearish attitude is certainly pervasive among a majority of market participants to take notice. If you're bearish on the market here you have a very distinct problem in that two factors are working against you: The economic data is not bearish enough to warrant an overwhelming of market dynamics to the downside. In other words, earnings aren't terrible, economic growth is decent, the Fed is slowly removing itself from the picture, emerging markets are improving and commodities have firmed up. Market participants are generally looking to sell at the first sign of trouble. Further, they remain prone to imagining trouble being present in places where it does not exist. When market participants become bearish too quickly, taking down exposure and/or shorting the market at the first sign of trouble, while...
ALLERGAN BREAKS, HEDGE FUNDS BECOME ENTRENCHED
What's happening at the various hedge funds that own AGN presently is a rigorous exercise to determine value post break-up as well as weigh the possibility of a new suitor stepping into the mix. Inevitably , the conclusion that will be reached is that Allergan is undervalued and remains a takeover target. What is missing from this analysis is that the company is now tainted as the result of becoming a convenient target during an election year when candidates will undoubtedly turn their eye towards an issue that easily garners votes - corporate taxes. We can assume then that the market will begin discounting future earnings as opposed to placing a premium on them. That act of discounting tends to reinforce itself through a reflexive relationship that very often surprises on the downside. When a stock breaks technically it's not simply a line on a chart going through another line giving a negative mechanical signal. It's a clear and concise message by the market. It's a message that the market will tend to discount future results regardless of how fundamentally pristine they seem to be. This is what creates value in the markets when the process is finished but it is also what creates value traps as naive fundamental only types buy the entire way down without a clear understanding of the process. Worth noting and worth watching....
THE FINISHING KILL MOVE FOR THE MARKET STILL LIES AHEAD
For those of you who haven't looked over my study from January 16th, it is a good place to start. What we have seen since January 16th is test and minor retest of the trajectory, which has predictably resulted in a convincing rally for all major market averages. Below is my opinion on the S&P 500 going forward: click chart to enlarge The restest of the lows that should occur somewhere in the summer/early fall is a high probability event given both technical, seasonal and macro factors. It should also be noted that the retest has an outside possibility of turning into something more than a retest, which would ultimately resolve around the 1760-1800 level. The situation has the potential to be perilous enough that I have been reviewing various ways to hedge our long exposure coming April/May for the first time in years. I will likely put together a combination of hedges that I will be posting here when I decide to initiate them. I have always been a believer in markets having an inherent tendency towards devious intention. It is rare that a market will witness an open wound among an influential, highly-publicized group in the market without rubbing salt in that wound, while ultimately seeking complete amputation of the limb as the end punishment. Given the fact the market now has its foot on the neck of so many prominent hedge fund managers through devastating results in 2015 followed by equally devastating results to start 2016, a devastating kill move likely remains in the offing. There is simply too much of an opportunity for the market to create the type of loathsome, highly publicized respect it seeks on a frequent basis by finishing what it has started in the hedge fund space via systematic violence in the months ahead. ...
IMPAIRED SOURCES OF INFORMATION ARE INCORRECTLY CREATING CONVICTION THAT WE ARE IN A BEAR MARKET
It is important to keep this one fact in mind when making any observations with regards to the financial markets at present: The predominant factor influencing thinking in the global markets currently is past pain. The current generation of market participants, be they retail investors, fund managers, analysts and journalists have only known struggle in the markets. This type of foundation for the stewards of capital and popular thinking with respect to investing creates unusually adverse reactions to downside volatility in asset prices. A vicious cycle then ensues of fearful headlines, commentary and opinions reinforcing the already existing negativity, which spirals into a black hole of irrational thinking. Against this type of backdrop you very simply have to approach information as if it is emanating from an impaired source. Otherwise, you have no chance to make the most beneficial decisions necessary to create outperformance, as you are mentally blending into unintelligible chaos. In order to discover some clarity and perspective I want to again turn to a source that too few investors bother with: The quarterly chart for the Dow going back 100 years. This chart was discussed most recently in January. Here is the chart provided in the above article: (click to enlarge) If this 16% pullback from peak to trough in the Dow is to be considered a bear market, then what would be call these? 1983 Q4 - 1984 Q2 Dow falls 17%. One year later the Dow is 24% higher at a new all-time high. 1987 Q4 Dow falls 41%. One year later the Dow is 34% higher. The Dow would be at new all-time highs in Q3 1989. 1990 Q3-Q4 Dow falls 22%. One year later the Dow is 35% higher at a new all-time high. 1997 Q3-Q4 Dow falls 16%. One year later the Dow is 31% higher at a new all-time high. 1998 Q3 Dow falls 21%. One year later the Dow is 40% higher at a new all-time high. 2015 Q2 - Present Dow falls 16% from peak to Q3 2015 low. The above are secular bull market corrections that are invariably mistaken for the start of new bear markets. Every single one of the relatively short-lived corrections listed above were accompanied by discussion of various factors leading to the start of a bear market or complete conviction that a bear market had already started. The current correction is the first of this secular bull market. To believe that we are in a bear market is to believe that all of the above highlighted corrections were bear markets, as well. Additionally, to believe we are in a bear market is presumptive,...