Thursday, December 24, 2009

57% Long....

I often have received emails this year on why I have so much cash.  Frankly, I've been underweight equities incorrectly since about early summer.  That said, I've been able to put out some large returns this year after some buffoonery (trying to short things) in late April through early June.... despite huge cash stakes.  It's been a very strange year, extremely technical in nature - and a lot of "interesting things" going on under the surface; things that this long time observer of markets finds extremely fishy.  I'm not the only one.

But let's not digress.  For the portfolio, we've been able to take advantage of the same pattern repeatedly this summer and fall - up until about 5-6 weeks ago.  That pattern is the simple "breakout" on the indexes... much of the time a double top breakout.  That is simply put, when the market returns to old highs, and then surpasses it.   Once the old high is surpassed, that is taken as bullish by the markets.  There were many of these opportunities in 2009 since the market has been cut at its knees in 2nd half 2008, and first quarter 2009.  Hence there were many "old highs" to surpass!   Therefore, despite being incorrect in being underweight equities, we were able to jump in and out of the market with both levered ETFs and near term option (SPY calls most of the time) plays to make great gains in short periods of time.  Many times, once an old "double top" was surpassed - the market shot like a cannon for the next 2-7%.  We've caught a few nice downside moves as well with these same instruments.  In retrospect just loading up on levered ETFs and 2010 SPY calls around July 2009 (rather than jumping in and out) would of been the best thing to do - but if only this crystal ball would tell me these things in advance.

Therefore, in the bigger picture, we have had a sort of nirvana situation at FMMF "model mutual fund" - at least in the hedge fund world - that is, risk adjusted return off the charts.  The ability to generate excess returns, while taking little risk (holding a lot of cash) is the holy grail in the hedge fund world.  Which is why I found the questions about my high cash positions a bit bemusing. :)  I suppose it's all about your frame of reference - generating good returns while sleeping well at night is a positive in my book.  A period like this might only come once a decade however - but this is what worked through most of 2009.  In 2010, it might take another strategy - but whatever works in the future, we'll attempt to adjust to.

With all that said, the past 2 months the market has stalled, trading sideways - and build a huge base.  Most of the moves lately have been overnight rather than during the day.  With the base building, and a potential big move to the upside, I've been making more purchases in individual equities (more positions, and larger exposures) since there is still good action in individual stocks, even as the overall index has gone nowhere.  As I hinted many times the past 3-4 weeks, I anticipate a very large move out of this base.  Unfortunately this move out of "the box" has come on a holiday week, with many stocks very overextended - even as the market as a whole is not.  With such lowly volume so it is hard to trust.   But much of this 2009 rally has been on poor volume.  While the 2009 price action has been textbook technical analysis, the volume has not been confirmed - it's like a rally on vapor.   RevShark at said it perfectly this morning:

For the fourth day in a row, we have a holiday state of mind, and the market is set to gap up.

As we wrap up the year, it is fitting that we have this type of positive action. It has occurred quite often this year and consistently caught folks by surprise. We have had a number of streaks where we went up day after day and created great frustration for anyone who was looking for a top. Oversold technical conditions and V-shaped moves were irrelevant once the bulls had the ball and started running.

It has been a year where many of the more basic rules of technical analysis have not worked very well. Volume patterns in particular have been quite peculiar. Just like we've seen this week, we have consistently rallied on a pattern of declining volume. The conventional wisdom is that a strong rally should see increasing volume as institutions jump in to add exposure. For some reason, this market has been able to trend upward even as volume falters, and that has left many technicians on the sidelines.

And that's the state of affairs for many of us who have been watching the market for many years... it acts strange, it moves strange, it is strange.  But it keeps going up, even as old rules we have been using are ignored.  I have my theories why, but it is what it is. 

All throughout 2009, one must respect the price action - even if the volume does not confirm.  Until that pattern breaks, it continues.  I've been waiting many weeks to see if the resolution of this base was to the upside.   The base is so long (1.5 months) I've expected a 7-8-9% type of move once we left the box.  If the move will be to the upside, that would take us nicely from S&P 1120 to 1200. 

With that said, and using the caveat that I will change my mind if we break back down below S&P 1120, I'm pushing a lot more chips in and instead of the normal 5-15% allocation to index positions, I'm more heavily skewed in these instruments as support for the core equity positions.  (mostly in the ETFs for now)  Hence, with one week left to go in our 2009 performance metrics, we've drastically increased long exposure up to 57%.  (I'll spare you the normal Kool Aid man photo here)  If you are a contarian this maneuver might be a signal that the new bear market begins next week. ;)  Since we're only 3-4 S&P points above where the breakout point is, we can handle that risk in the near term; and quickly peel out of a good amount of exposure if things reverse downward.  If however this turns out to be the run for the roses, much of 2010's returns can be captured in the span of a few weeks.  Obviously we have no idea what the next day, or weeks will bring but the market is all about probability, and trying to place the odds in your favor - rather than 50/50.  This is as good of place as any to make this defined 'bet' of a large move, as this has been the first multi month, narrow base we've had to work with since 2007.

And with that have a good holiday, whatever you might be celebrating.

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