The Novice Bear

The Nasdaq picked up another distribution day today. That makes 5 in 5 weeks. Time to be careful on the long side. The NYSE also has 5 in 5 weeks.

I’ve been learning more of what the Warden Brothers have to offer with their charting software. They put together some great tools and I highly recommend them. The above chart (1988-1995) shows the S&P 500 along with the percentage of stocks in the index that are making new 52 week highs (green), new 52-week lows (red), and the Advance-decline line (yellow). Check out the quick analysis. Without looking at the date, would you buy this index?

The chart below should answer that question. It just goes to show that market indicators can be very tricky. I do think that the red plot has some use though. It looks like big spikes down tend to indicate a bounce up is just around the corner. It is also interesting to note the advance-decline drop before the top in 2000.

I was reading Rev Shark on Real Money today (He is the only one worth reading) and he is in the same boat as I am. We are defensively postured while the market keeps moving higher. I’m not extremely short, but I’m certainly not fully invested either.

Rev Shark mentioned that he feels that today was all about fear driven buying. People are chasing the big caps out of pure fear of missing more of the upside. Looking at the VIX today it seems that his argument has some validity. Now I’m no market veteran (Did you see the blog title?), but this is the first time I’ve seen the VIX rise along with the market indicies.

One thing is for sure. These moves are shrinking the record short interest on the NYSE. That is the only way we can finally get a meaningful pullback that is worth buying. I’m just worried that we are going to go so high that its going to cause another bear market and not just a 10% correction.

Wow, I haven’t been paying attention to the distribution days (as measured by IBD). Here is the current count.

4 for the Nasdaq
3 for the NYSE
2 for the S&P 500
2 for the Dow

Remember, 4 or 5 distribution days in under 4 weeks is very often a warning that institutional investors are selling.

Previous Post

I bailed on ANO today at 2.56. I was feeling a bit greedy here. Overall, a nice trade and my first double.

I have to admit that I’ve been very interested in commodity trading lately. So much so that I set up a simulated trading account with Lind Walcot a few weeks ago to get a feel for it. The thing about commodity trading is the massive leverage involved. One typically only has to put up a fraction of the money it costs to control a contract for the commodity of interest. Such trades offer huge fortunes in a very short time, but also offer huge losses. In my simulated trade account I bought 50 Copper contracts. In a matter of 1 week my account went from $50,000 to over $280,000! I obviously don’t have a trading stake that would allow me to take those kinds of risks, but it was a real eye opener. It isn’t hard to imagine the trading going the other way and being $260,000 in the hole. That is scary! (Commodity trading is how Jesse Livermore lost all of his money. )

So in order to appease my commodity bug (gold has been doing very well for me lately), I purchased the DBA etf 3 days after the report stating that record amounts of corn have been planted. DBA is the a Powershares ETF that tracks the price of corn, wheat, soy beans and sugar. I’m not buying the DBA because I think corn is going up, but because I think that wheat and soy beans are going to skyrocket, mostly because of the record corn planted. If one adds any weather related issues, like drought or severe cold, all of the soft commodities will rise. That is my plan.

I’m reading “My Life as a Quant“, by Emanuel Derman. It is an autobiography of a relatively successful physicist who joined Goldman Sachs and became a relatively successful quantitative analyst. Emanuel worked with Fischer Black to modify the famous Black-Scholes options pricing model to work for treasury bond options.

In the book, Emanuel is hired away from Goldman to work at Salomon Bros. to help model adjustable rate mortgage investments. While reading today (Derman was explaining the complexity of mortgages), the current uncertainty in the housing market hit me like a ton of bricks. I never understood what a house of cards the market really was. Here is an excerpt.

“Banks who lend to homeowners own the mortgage, the claim the the homeowner’s future monthly repayments. Periodically, the banks turn around and sell the mortgages they have acquired to GNMA, FNMA, and FHLMC, government agencies that act as financial intermediaries by pooling together vast quantities of similar but not identical mortgages into more standardized securities. They then resell these pools to large investors–mutual funds, pension funds, insurance companies, hedge funds, and the like–in search of interest-bearing investments. This process of asset acquisition, pooling, standardization, and subsequent sale provides a liquidity that frees the savings bank to make more loans. As a result, the percentage of residents who own their own homes is greater in the US than anywhere else in the world.

Mortgages are messy, though it takes only a little careful high-school math to work out the monthly mortgage payment that will draw the loan down to zero over 15 years. But that’s just the start. Everything about an adjustable rate mortgage pool–the interest payments, the principle repayments, and so on–varies with the future level of interest rates, so an adjustable rate mortgage (ARM) is really a complex option whose payments are contingent on interest rates.”

I never appreciated how interconnected the housing market was. When all of these lender companies start going under the losses are really going to mount. The first dominoes have already started to fall. Who’s next?