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The Trap is set: Last Chance to Reposition

Monday, March 28, 2005 | 11:52 AM

Markets have reached the point where they are so oversold they are due for a corrective bounce. But I expect this bounce to be short. It should be used as an opportunity to exit most long positions, especially those that are cyclical, rate sensitive, or of the high Beta variety.

We suggest using the lift over the next 2 weeks to sell aggressively.

Several factors point to a rally: AAII sentiment shows Bulls at 23%, down from 45% two weeks ago; Bears now measure 41.9%, up from 24.8% over the same time period. Internal measures show moderate short term oversold conditions. NYSE Oversold indicator now measures -58.12 (below -50 is significant). The NYSE McClennan Oscillator reading of –256 oversold (-200 is significant) similarly suggests a pop.

Despite all these oversold signals, we remain concerned about the ongoing deterioration in Market internals and the Macro environment. The Advance/Decline Line continues to soften, as have Nasdaq 52 week Highs/Lows (See chart nearby). Fund Flow is light, and Trend lines have also broken. Upside moves are unable sustain any gains, as Momentum fades.

The Macro-economic environment is also weak: GDP has softened, personal income is not keeping up with prices, just as consumers have lost the ability to do cash out refis. Money Supply has been throttled back, and the Yield Curve has flattened. An oversold market that cannot rally on positive news reveals weakness; The Market’s inability to respond positively to a major upside revision from GE also does not bode well. It also suggests a market lacking leadership, as well as a decreasing appetite for US equities.

We also believe that the counter-trend rallies in the Dollar, Gold and Oil are of a short term, corrective nature. They can run long enough to sucker in lots of traders. Once they resume their prior trends, we will see plenty of players trapped higher, and desperate to stop the pain.

Finally, while everyone suddenly discovered last week that (Horror!) producer AND consumer prices have been going up, we are starting to become increasingly concerned about the macro impact of Derivatives. From Fannie Mae (FNM) to AIG to GE to Bershire Hathaway, too many US companies have turned into heavily camouflaged Hedge Funds. Skipping over the esoteric details, this will end badly.

This is an intermediate top call.

Take advantage of higher prices, as I expect this rally to run out of steam by early April. The Market risk is a sell off into the Summer.