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The Four Pillars of Trading


In search of the ever-elusive quack count


I "see" the market through the lens of four primary metrics: fundamentals, technical, structural and psychology.

When viewed in isolation, each of those approaches has inherent flaws.

1. Fundamentals are best at the top and worst near a low.

2. Technical indicators often trigger buy signals higher, on breakouts, and sell signals lower, after a stock has broken down.

3. Structural factors -- debt, derivatives and currency effects -- can self-sustain in a cumulative manner until such time they overwhelm the system.

4. Psychology, such social mood and risk appetites, can gain momentum until they snap under the weight of the herd mentality.

If, however, you assimilate those four metrics and align those ducks -- something I call the "quack count" -- the odds of an advantageous risk-reward greatly increase.

To wit, a snapshot of our current condition offers the following results:

  • Fundamentals: Earnings were by-and-large better than expected. Of the 422 S&P 500 companies that reported earnings as of Friday, 72% beat analyst expectations, according to Reuters, with 10% matching estimates and 18% missing estimates. Past results are by definition rear-view -- and the market is a forward-looking discounting mechanism -- but perception is reality when trading the tape.

  • Technical Analysis: We touched on the uptrend channel that "held" where it had to last week. On the other side of that ride, we've got layered resistance in the S&P from "right here, right now" through S&P 1150 and should we push through, significant resistance comes into play at S&P 1200.

  • Structural Influences: Cumulative imbalances continue to manifest through state budget shortfalls, unfunded pension liabilities, commercial real estate and European Disunion. We recently touched on this topic, noting that these issues serve as symptoms of the problem rather than the problem itself.

  • Psychology: The most amorphous of our metrics, this is perhaps the most important. The bulls would argue that the building blocks in the wall of worry are in place (the fact that we can so readily shape the laundry list above supports that view). Still, the low levels of implied volatility signals complacency in the marketplace. The VXO, or the "fear index," is trading under 20, versus multiple readings of 50 -- and, at the height of the financial crisis, 100 -- during past periods of market angst.
Random Thoughts:

  • Harvard University Professor Ken Roggoff is featured on Bloomberg this morning, offering that the ballooning public debt will likely force several countries to default and cause the US to slash spending. Rogoff, who predicting the failure of big US banks in 2008 (yes, we were a bit early in the 'Ville), offers that following bank crises, "we usually see a bunch of sovereign defaults in a few years...and predicts we will again." As this is a topic we've covered extensively over the last few weeks, I wanted to bring it to the attention of ye faithful.

  • Given the oversold condition has been worked off as a function of time and price -- and keeping an eye on the all-important $150 level -- should we note that the 50-day is crossing below the 200-day in Grandma Goldman (GS)?

  • Professor Branden "Don't Call Me Metro" Rife draws our attention to this excellent article by Charlie Munger, who built Berkshire Hathaway side-by-side with Warren B. Please note his veiled Mayan-esque reference to 2012

  • I can't shake Hall & Oates from my head. Do you think that's some sorta allergy or something?

  • It's been pretty quiet over the last week, all things considered, which begs the question -- has it been too quiet?

  • Did you see that George Soros weighed in on the European Disunion?

  • Weatherford (WFT) has long been considered takeover bait. What does it tell you that it was effectively flat on the heels of the Schlumberger (SLB)-Smith International (SII) merger?

  • Minyan Mike O'Rourke of BTIG made a salient observation that it would be a case of "enlightened self-interest" for US banks to make sure Greece can sell debt without a hitch. How ironic, right? Whereas the first phase of the financial crisis saw sovereign fingers plugging holes in the financial dike, we may now see financial fingers attempt to plug holes in the sovereign dike.

  • That said, when we're told we need not worry about Greek debt obligations because they don't come due until mid-March -- which, last I checked, was a few weeks away -- I sit up and take notice. It reminds me of that time I ordered a computer in 2000 and received it two days later, right before quarter-end. Sometimes you can learn a lot just by listening.

  • And oh yeah, Greece said they had derivative contracts with upwards of 15 Wall Street firms, according to our friends at Bloomberg. That story isn't gonna go away; bankers are in the cross hairs of the world and it's not only scary, it's dangerous. In the immortal words of Sgt. Phil Esterhaus, "Let's be careful out there."

  • Professor Kru-Cat touched on something I've been noodling for a few weeks; the notion of a stronger dollar and stronger asset classes. While "asset class deflation vs. dollar devaluation" has been our central theme for almost eight years, it got a bit too mainstream. We always wanna see both sides and I suppose the specter of European Disunion could toss a wrench in our thesis that the dollar is our mainstay tell.

  • Hoofy is enthused by the recent traction in the financials (as spied in yesterday's Gate Sniffage on the Buzz & Banter) while Boo whispers to himself, "setting stops remove emotion." If that scene in Animal House comes to mind -- Pinto, tissues in hand, with a mini-devil on one shoulder and a mini-angel on the other -- you've just aptly captured the carnival that rages daily in my crowded keppe.

  • Remember the Big East Tourney last year? I could live to be two thousand years old and I'll never attend a game better than the "Six in the City" thriller at the Garden. With all due respect to the Olympics and the World Cup, March Madness is the best sporting stretch in the world, period.

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