Wednesday, January 19, 2011

Still Gliding

If the S&P 500 closes where it is right now it would be only the second drop (on a closing basis) of over 0.5% since Dec 1st.  Remarkable in itself.   A 0.6% drop is a nothing day in a normal market - part of the ebb and flow.  But these down days are so rare now in the new paradigm market, it 'feels' as if is a much more important event than it is.

Recall, this market can not even drop below the 10 day moving average on a closing basis (back in Sept & Oct, it was the 13 day moving average).  Until it can prove to break even those traditionally weak supports, every dip is just a scuff mark.

[click to enlarge]

Keep an eye on reactions to earnings - if you start seeing selloffs to good news, you know "everyone is in".  You'd think with the sentiment indicators at records for weeks on end, that would already be the case but price action is the ultimate tell.  Apple had a tremendous report yesterday and the reaction is muted.  We have a host of multinationals coming up in the next 2 weeks, and I expect them to continue to shoot the lights out - but at what point is this discounted?  Many are up 30-40%+ in 3-4 months.  Meanwhile, story stocks like Cree (CREE) are being crushed, which is another warning for those who are playing high multiple and/or story stocks right now - so many have put 1-2 years worth of gains in 120 days, it's a very dangerous environment for blow ups as expectations are off the chart.  I'd be very wary of even favorites like F5 Networks (FFIV) which reports tonight...


While we're at it, some sage words from Jeff Saut over at Raymond James - recall, this is the strategist who points out most bull move buying spurts in history are of the 25-30 day variety.  He mentioned this was the first one he has ever seen (in 40 years of experience) at 80 days.  That was 3 weeks ago!  (we're at 95 days if you are keeping track at home)

But in a different vein, you have to step outside your own mindset and see how others are thinking (or not thinking, just hitting buy every morning believing in the omnipresent Fed put) and Saut describes the group think.  Agree or disagree with it, you have to respect it - especially with countless computer programs now doing the work that once took 1000 humans.

Indeed, the current mantra reigning on the Street of Dreams is – “I don’t look at so-called values, I look at price action; if they are going up I buy them and if they turn down I sell them” – it sounds simple, and it is. The only difficulty is that game has caught on and is being played among an increasing community of professional players.

He cites a quote from an old hedge fund from the early 90s (when there were relatively few around)

The name of the game most investors play is momentum and relative strength: Buy the strongest stocks and sell them after they have topped. Occasionally I will ask of my friends, “How can a rational person pay 60 times earnings and 10 times book value for a growth company with dubious long-term prospects?” The reply: “How high is high? If a stock can sell at 60 times earnings, it can sell at 80 times or 100 times. I don’t prejudge anything. I don’t look at so-called values, I look at price action. If they are going up, I buy them. And if they turn down, I sell them.” It sounds simple and it is. The only difficulty is that the game has caught on and is being played by an unwieldy number of individuals and institutions. An individual with a few thousand shares in each crazily valued position can get out, but an institution with hundreds of thousands of shares in each position will not be so fortunate. As fast as stock markets go up, they always go down faster. And despite the many trading innovations that have recently been developed, it nevertheless remains difficult to push the proverbial elephant through a keyhole – when everyone wants to sell and there aren’t many buyers.

That was written in 1991, but for those who were around in 2008 you see it still applies.  If anything the elephants try to move at light speed now.  But a lesson I have to keep reminding myself is valuation is relative. What looks ridiculous to me, means nothing to many others. If we all believe in greater fool theory all that matters is someone is willing to pay more than I did.  So I can buy at any valuation, as long as I have someone willing to buy from me at a higher price.

That works.  Until it doesn't.  Then you get trampled by elephants. 

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