Taking Stock of the Stock Market

I constantly have musical or pop culture references on the brain. Thankfully, I have an outlet to channel the madness or I might fall prey to spontaneous human combustion. POOF! Just like that... vaporized.

Yesterday I was vibing Kansas in real-time on the Minyanville Buzz & Banter. Can you blame me? Catch this:
 

Once I rose above the noise and confusion
Just to get a glimpse beyond this illusion
I was soaring ever higher, but I flew too high

Though my eyes could see I still was a blind man
Though my mind could think I still was a mad man
I hear the voices when I'm dreaming
I can hear them say...

You know the rest (if you don't, get with it!). Certain words stick out...

Noise.

Confusion.

Illusion.

I flew too high.

We often say the chasm between perception and reality is where profitability resides. As more and more folks open their eyes, the shelf-life on that trade is getting shorter.

There is a multitude of dynamics in play and it’s always helpful to look at them through the lens of our four primary metrics. In order of perceived importance:

Psychology: We’ve been saying (for years now) that credit of a different breed -- that of credibility -- was the issue at hand for the markets at large. Assurances and jaw-boning will only offset joblessness, bankruptcies, and foreclosures for so long. Social mood and risk appetites shape financial markets and the collective patience is wearing thin. It's amorphous but can you feel it?

More quantifiably, I mused earlier this week that most of the scared bears were in hibernation mode. Yesterday’s 27.5% Investor's Intelligence bearish sentiment confirmed that sense, which implies that a natural layer of forward-demand has been removed (as fewer shorts need to cover their downside bets).

Structural: The big bad wolves that scared the bears -- the FOMC and QE2 -- are in the rear-view mirror and the ursine operated with impunity yesterday. Think about it, the Fed is pretty much handcuffed. If they act above and beyond what they laid out, it will be perceived as a sign of panic. If they don’t, free-market forces will have their way (which is what the bears wanted to begin with).

Technical: For the last few weeks, we’ve been monitoring the “"Big Dandruff-Little Dandruff" formation -- a smaller inverse head & shoulders in the S&P that “worked” to S&P 1130 (we ticked at S&P 1129 last week) followed by the broader head & shoulders that could drive the tape to S&P 860. That’s tracking thus far, as are the lines in the sand that are BKX 50 (above) and VXO 20 (below).

Fundamentals: All's quiet on the earnings front, which puts this puppy at the bottom of our trading totem pole. Second quarter numbers were fine, thank you very much, but the first half of this year wasn’t the problem. Financial markets trade on what will be -- not what was -- and the slowing global growth story is gaining traction as we edge through the back nine.

Minyan Mailbag!

Minyan Shahid writes:
 

I have been following you and the respected Paul Krugman and it seems that you two have diametrically opposite views. The medicine that Mr. Krugman prescribes is drugs for you. Mr. Krugman has laid out a plan of coming out from this hole by running short term deficits. Can you please lay out your plan ?

To which I responded:

The "plan" is time and price, or a deflationary readjustment. I've written on this extensively through the years -- a running history can be found here, and some other thoughts are offered here and here -- which doesn't make it right, it just makes it honest. Mr. Krugman is a sharp fella who has many more degrees than I do (I’m not being snarky, respect Mon). I'm just a trader that writes, so please take this in the benevolent vein with which it’s shared.

Of course, the destination we arrive at pales in comparison to the path we take to get there, which is why we spend our days fitting the pieces of the ever-changing puzzle together. In my (almost) 20 years of trading, this is by far the trickiest tape I've encountered, and I've wrestled my fair share of alligators.

What to do? For me, play smaller, define risk, await edges, and preserve capital. If my greatest loss is that of opportunity, I will consider myself one lucky duck. I continue to sense the next few years will be lean but profound opportunities await on the other side of that ride.

Random Thoughts:
 

• Did you see volume 30% higher than Tuesday’s session (and 19% higher than last week), which continues the pattern of "higher volume" sell-offs vs. "lower volume" rallies? That’s a sign of distribution, all else being equal.
  
  
• The greenback was up almost 2% against a basket (case) of securities yesterday. That's not what one would expect given the FOMC vernacular, which leads to one of two intuitive conclusions. Traders were positioned for more aggressive easing (and/or follow-through to the downside) and covered up -- that's the "mechanical" side. Or the market "smells" the fear of deflation coming out of the Fed and is jumping the shark to arrive at that conclusion.
  
  
• Would a Black Swan in government securities shock you? That's what Nassim Nicholas Taleb seems to think and it's consistent with what we've offered in this space.
  
  
• The VXO (fear index) is up 25% since Monday...
  
  
• Look at me, I'm B-A-C (Bank of America (BAC)).
  
                                           
  Click to enlarge
  
  
• BKX 50 has been one steady tell. Maybe everything else is just noise?
  
  
• In which case...
  
  
• Petty. CSN. Saratoga.
  
  
• Wow, I'm old.
  
  
• Extrapolating that out, what does that mean for online advertising spends? And, are video games still the new frontier on that front? (I think so; captive eyeballs are a commodity in an A.D.D. world).
  
  
• What?
  
  
• How rich is rich? As long as you've got a roof and three squares, it's a state of mind.
  
  
• Do you wanna hear the most annoying sound in the world?
  
  
• Is it so wrong to take five minutes out of a trading day to tell your soon-to-be 90-year old grandmother that you love her?
  
  
• Does Goldman Sachs (GS) $150 still matter?
  
  
• For all ye East End folks, the lovely and talented Minyan Nicole will be hosting "Operation Smile" on Saturday, August 21st. Share a smile -- literally!
  
  
• And finally, keep ye chin up Minyans, it could be worse... a lot worse.
  

R.P.

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