Covering Down Shorts

I came into the office this morning wondering if the near-term bottom was in.  I even told a few others in the office that I thought we might bounce.  Several of the averages looked like they were putting in a bottom, and with the market as oversold as they have been in years, I thought the chances were pretty high that the intense selling may be nearing an end.

But then I started flipping through the charts of a couple hundred stocks, and there was no evidence that equities were bottoming.  In fact, it appeared they had further to fall.  The financials especially looked like they were heading lower, and I think we have to stop the bleeding in the financials before the market can bottom. 

However, given the oversold levels and the speed at which stocks have fallen, I continued to cover my short positions, bringing down shorts in REITs (ticker SRS), the Russell 2000 (TWM) and Canadian stocks (HXD.TO).  I am still short the market via these ETFs but decidedly less so. I also sold down my gold position.  I had intended to sell some of my commodities futures contracts, but prices fell too far, so I opted not to.  I expect to continue liquidating my short positions as the market continues to fall, perhaps becoming net long within the next week or two.

I do not think the bottom is approaching, but I do believe that a near-term bottom will occur sometime either this week or next.  However, before the bottom happens, we may have significant downside ahead.

During the last bear market in 2001 and 2002, there were three occasions when stocks broke through their lows, similar to what is occurring in the market now.  On those three occasions, the market fell another 13%-18%, and the decline was fast, occurring in days not weeks or months.  If we do continue to break down, I expect it to happen over the next several days.

I think catalyst for the bounce will be earnings.  Earnings are going to be weak, but I think expectations are so low, as long as the end of the world is not in the cards - and I do not believe it is - we will get a relief rally.

That does not mean everything will be all clear.  I expect the bear market to continue into 2009 as the problems and imbalances in the economy continue.  However, real value is being created in the market, and at some point, investors will begin discounting the end of the turmoil.   

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