Define risk, preserve capital and expect the unexpected.
--Tommy DeVito, Goodfellas
Henry Hill used to say that every once in a while, everyone's gotta take a beating. While he was talking about wise guys and fancy rides, he might as well have been discussing the tape. Few industries allow for open-ended growth and none, perhaps, are as enticing as the financial markets. Folk lore is flush with stories about secretaries with seven figure stock options and taxi drivers turned day traders. Those are the best of times. Those, my friends, are the sirens that lure fast fingers towards flickering ticks and the promises they hold.
Lost in translation is the simple fact that profiting is a privilege rather than a right. The month of May reminded us that no reward arrives without risk as investors revisited the crimson tide of a downside ride after years of relative calm. As emerging markets took it on the chin, the carry trade got carried out and hedge fund traders, many of whom still think LTCM is an over-the-counter telecom play, were awash in losses. That's a problem in a globally intertwined, derivative-laden financial fabric. And that's a problem when the collective mindset has been conditioned to buy dips.
Through a pure trading lens, the bounce last week was textbook. With the market oversold on a short-term basis, volatility levels up an eye-popping 65% in a month and a slew of leadership sectors approaching massive support zones, the late-to-the-party pressers were reminded that nobody makes money in a bear market-not even the bears. The tell-tale sign that a massive decline wasn't ripe for the picking were the financial stocks after they held BKX 108 and steadied the market when it needed it most. Not surprisingly, on the heels of the intuitive but equally painful retest, the bovine are again relying on that level to steady the broader tape.
The brief but widely-embraced late week rally carried the market back to the precise technical pivot point of S&P 1280, where the tape broke to begin with. Alas, the sellers reclaimed control as the dust settled after the Memorial Day weekend and the bears turned the screws anew. The supply side of the equation was again provoked by a growing concern that the era of free money is coming to an end, an unavoidable fact that isn't lost on the ever-dwindling middle class. Indeed, as the growing chasm between the "haves" and "have nots" trickles into the collective consciousness, the burden of upside proof is being shouldered by an increasingly narrow swatch of mainstream America.
As we ready to wave goodbye to May and edge into the summer months, I continue to manicure my personal risk-profile and err to the side of caution. While I've been on the "long energy and metals vs. short tech and financials" bandwagon for a few years, I moved to the sidelines during the parabolic (metal) frolic of April. Last week, into the teeth of the commodity purge, I dipped my toes anew into that trade, buying a slab of Weatherford, Golden Star and Pan American (among others) while slapping on some autumn puts in JP Morgan and Citigroup (among others). It's worth noting (and important to say) that while my horizon is longer-term, I aggressively "trade around" those positions depending on my feel for the tape. The moral of my story, I suppose, is that I want to buy the former sectors on dips and sell the latter complex on blips. And I expect that to be the case for a mighty long time.
We power up this Wednesday pup with a few things on my mind. First and foremost are the FOMC minutes, which are due to arrive early this afternoon. I've long believed that the single biggest risk to financial markets is a crisis in confidence, an intangible metric but one that merits attention with the world on edge and the Presidential approval ratings as they are. The FOMC has made it clear that they're "data dependent," which is curious given that economic data is backward looking and interest rate movements take months to manifest, but interpretation is a thin line, particularly in the financial markets. In other words, if they're stuck between inflation (energy, healthcare, education) and deflation (lack of pricing power), how long can investors remain confident consumers?
My mind's eye is also beginning to wander to Peru, which is due to hold elections June 4th. The metal miners, from Newmont to Barrick Gold to Pan American Silver, all have substantial interests in the outcome of this vote. As I own a few of these names, I'm obviously (and humbly) of the view that bad news is priced into these shares and will review my holdings after the anticipated relief rally. The more pressing concern, from where I sit, is the growing trend of nationalization, which is a fancy translation for "hoarding." To wit, if countries around the world continue to secure the resources within their own borders, I must wonder if physical metals are the only "true play" for commodity exposure?
Circling back to US equities, I expect another retest of the bevy of technical levels from last week (S&P 1246-1257, MDY 136, XOI 1043, DRG 323, RUSSELL 700, XBD 201, BKX 108). From there, my mainstay tells include market internals (breadth don't lie), leadership (the financials, semis and nets), the dollar (a weaker greenback is a likely precursor to any market rally), rotational plays (into energy, metal, pharma and consumer non-durables) and the emerging markets (aggregate liquidity proxy). As discussed above, I continue to feel that a rising tide will benefit the "tangible" boats first and foremost but, on any downside disconnect, we must remember that we can't pay bills with relative performance.
Define risk, preserve capital and expect the unexpected. There are 8,000 hedge funds standing in a circle shooting at each other. A little dry powder today will serve you in good stead tomorrow.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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