“When would you short the markets?”

Tuesday, September 26, 2006 | 11:45 AM

NOTE:  This Trading alert was originally emailed to subscribers at Ritholtz Research & Analytics on Tue 9/26/2006 2:28 PM EDT;

This is posted here not as investing advice, but rather as an example of a trading call for potential subscribers. We expect to post future advisories in a similar manner -- after the call, but in the correct chronological location on the blog.

Last week, we were asked “What would turn you Bullish?”

This week, we received what is the opposite question: “When would you short the markets?” 

The answer to this question – to both questions, really – depends upon how much further and how fast the internals decay as the markets rally towards the May 2006 highs.

This could be a very crucial phase of the market. The next 5-10 trading days may turn out to be a key period that determines the following few months.

As Markets march higher, we note the short term factors are at work:

1) This is the final week of the quarter, and with it, “Window dressing – funds buying more of their favorite stocks to improve their short term performance. I would expect this to continue for a few more days;

2) The Dow highs are about a 100 points away, and as we have mentioned previously, I expect them to be taken out – likely before the week’s over.

3) Pessimism continues to be thick; The one way to guarantee a correction will not occur is for too many people to expect it.

4) Some sectors may have priced in at least some of the bad news: Neither Lennar’s preannouncement of bad news for Q4, nor Home Depot competitor Lowe's (who sees income at lower end of prior view) led their stocks lower; Indeed, as of this writing, both are higher.

5) There is a surfeit of cash in the hands of fast traders; Expect them to continually chase momentum –until that stops working for them;

6) Technical analysis and intermediate term trend each remain constructive;

Those are the short term factors; These are up against longer term issues of economic softening and market internals:

1) The main engine of economic growth – Housing & Real Estate – continues to decelerate;

2) Market advances have taken place on lower than average volume;

3) Energy prices have become oversold, and are likely to bounce upwards;

4) The May highs represent appreciable resistance – the double top may present formidable barrier; An upside penetration could create a Bull trap;

5) Despite the rally in the Dow, new highs are lagging, while the number of new lows are expanding.

6) Less and less stocks are participating in the advance: Indeed, this table makes it clear that this rally is very Dow-centric, meaning that it is focused more and more on fewer and fewer stocks.   

Note how close the Dow is to its all time high, while the other indices are significantly further away. This is no coincidence:

                                                                     
IndiceAll time highDate of highRecent highPercent off all time high
Dow Indus11,750.28(1/31/00)11647.690.87%
Tranny5,013.67(5/31/06)4413.3411.97%
SPX1,552.87(3/31/00)1333.714.11%
Nasdaq Comp5,132.52(3/31/00)2258.356.00%
NDX 1004,816.35(3/31/00)1656.0765.62%
Russell 2000784.625/31/2006729.946.97%

Most of the positive factors mentioned above are short term in nature; Meanwhile the negatives are longer term and structural.

All this leads us to the answer to the question “When would you short the markets?”  

As we get closer and closer to the May highs, we will look to the internals to scale into various index shorts. We are not there yet, but we expect we could possibly reach that point sometime over the next few weeks.

Our perspective is to be conservative and patient; We have seen too many bears "treed" and forced into coverage their early shorts;  We would much rather wait until the market is gives us its best signal . .  .

Tuesday, September 26, 2006 | 11:45 AM | Permalink | Comments (2) | TrackBack (0)
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Comments

For as long as vol is as cheap as now, I shall be long vol and not shorting or buying index futures. What's the point when the market is just giving away options?

On timing, I am still long index calls, but only Octobers. I continue to constrain my shorting in individual names, though not to zero.

For me, everything turns on the data. I am firmly in the housing-led, consumption-followed, GDP-slowdown camp. For now the data congrue with the initial stages of that thesis, but I am cautious.

Posted by: wcw | Oct 1, 2006 12:50:19 PM

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