Is Something Bad Coming?

Frankly, I do not know.  I do not make big, grand predictions.  I am loathe to make such prognostications.  But I have been wondering if something bad is soon coming in the market.

Everyone is biased by their own portfolio, including me. You must understand that my positioning may be affecting my state of mind.  Thus, this is my personal portfolio:

  • Massively short semiconductors through put options on the SMH
  • Long some small banks
  • The banks are hedged out by a position in a financial services leveraged ETF
  • Lots of cash

That’s it.

Here is what is bothering me.

The economy is decelerating.  There are anecdotes that the economy is doing okay – I am seeing more cars out on the road and fast food restaurants advertising for workers.  However, the data over the past month has not been good.  One proprietary indicator I look at, which called both the deep recession and the recovery, is now showing outright albeit mild contraction.

The politics are deflationary. On Intrade, the odds of the GOP winning back the House is 77%, the highest yet.  A Congress focused on deficit reduction and spending cuts may be good over the long-term, but it is deflationary in the short-term. And deflation is bad for stocks.

Central banks pulling back.  The market was disappointed with the Fed’s recent pronouncement on quantitative easing.  Stocks sold off in Japan today when the market concluded the Bank of Japan was not being aggressive enough lowering the yen.  The central banks may be unwilling, or unable, to support the economy and the market.

Horrendous market structure. The machines control the market.  The high frequency traders and algorithms supply, supposedly, liquidity.  If there is any hint of a breakdown, the liquidity will disappear fast.  I fear what might happen if the 1040 level on the S&P500 does not hold. The risk of another Flash Crash may be high.

Warnings from Cisco and Intel. I started shorting the chips after Cisco’s earnings conference call when CEO John Chambers said Cisco saw a slowdown in orders during the summer.  Intel’s pre-announcement and their purchase of McAfee and Infineon’s wireless business tells me that Intel has less confidence in the PC market.

Breakdown of the semiconductor stocks. When I short, I want to see three things – overvaluation, deteriorating fundamentals and technical breakdown.  We are seeing awful technicals from the chips, not only in the near-term but over the long-term as well.  It appears that the group wants to go back and re-test the lows.  On Friday, Intel reversed and closed higher on the pre-announcement.  That is good.  Today, it gave almost all of it back and closed on the low.  That is bad.  The stock held Friday’s intra-day low, but barely.

Lousy market technicals. Similarly, the broad stock market closed Friday on the highs after selling off in the morning.  It appeared that the market had put in an intra-day reversal.  Friday may have been the bottom.  But to come in on a Mutual Fund Monday, the day before the end of the month, and close at the lows, as we did today, is awful.  We are holding support at 1040 on the SP 500, but if it breaks through, look out below.  The only caveat is that Monday’s volume on the NYSE Composite was a paltry 2.95 billion, lowest of the year.

Banks continue to fall. The action in the banks is just terrible.  Like the semis, the banks have already broken through support.  It is hard to imagine the broad stock market rising as the banks continue to fall.

The VIX wants to go higher. At least that is how I see it.  It appears that the VIX has put in a near-term bottom.  A rising VIX is not good for stocks.

Collapse of bond yields. Government bond yields have collapsed.  Some argue that this is because investors are chasing yield.  That may be correct.  Or, it may be that investors are getting worried and piling into Treasuries.

Strength of the dollar. Increased demand for government bonds means an increased demand for the dollar.  The dollar has been inversely correlated to the stock market over the past few years.  When the dollar has risen, stocks have usually fallen.

Gold at the brink. Gold appears to be at an important inflection point.  I do not know if it is going to go up or down.  I can make a case for gold going both higher or lower if stocks get hammered.  The bullish case is easy – fear drives gold higher.  The bearish case is that the dollar spikes, stocks fall as does gold.  Hedge funds with liquidity problems will sell stocks, and gold, to raise cash.  Deflation is bad for gold, as it is for stocks.  Gold is at resistance.  The chart is developing a pennant formation, which often means a big move.  I have no position in gold at the moment.  I am 50.1% confident that the next move is down.  I will happily change my mind if gold breaks to the upside.

There are bullish anecdotes as well – copper is rising, the market is over-sold, we are going down on light volume.  I do not know what is going to happen.  Maybe we are bottoming, I do not know.  I am just telling you how I am feeling and what I am thinking right now.  And I do not like the market.

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