When Should Shorts Dive In?

Make no mistake. This is a bear market and we are in a bear market rally. A good one, but it is a bear market rally. For this I am 100% confident. It is mostly created and propped up by changes in M2M, the fed generating low interest rates which creates a mass hysteria for refi's and the promise and hope that toxic assets will be moved off of the books of the larger banks.

Toxic assets are the key. First, they are being hidden by changes in M2M accounting rules. Fine, hide them. It gives the illusion that banks are solvent. Then there is PPIP, which the banks are not interested in and many investment firms have their doubts about only because gov't is much too involved in the process. It gives hope that the *currently* identified toxic assets can be washed away, magically, by moving them to private investment firms and then resold for profit and no longer a toxic asset.

I stress *currently* because the number of toxic assets is ever increasing each month. As unemployment continues to rise, businesses go out of business at a high rate and commercial real estate along with residential real estate continue to fall, the default number on loans and credit card bills will continue to rise, thus increasing the toxic assets on the banks books.

The Fed and the Treasury have been shooting at a target that they would like to believe is stationary. It is far from stationary. This is a moving target and thus, more money, more programs, more nationalization of the banks will need to happen over the next 2 quarters.

But, the bear market rally continues based on short sightedness by investors. Fine, let it rally. But when do bears jump back in? That is a very difficult question to answer. You don't want to fight the fed in the middle of the battle. But you also don't want to miss the next big leg down.

So you have to have a foot in the water. You should have some short positions, but not over extended. As a bear, I like to have short positions hedged by long positions. But in this market, it may be more prudent to have long positions hedged by short positions. Or even better, hedge both ways with no real stake in the market. Or, have mostly cash right now with some short positions and be ready to build on those as the market goes higher.

Well, what the hell does that mean? I gave a lot of options. The key is, if you have short positions that are not over extended, I think you hold those through the storm. As long as you can stomach some more paper losses potentially. If you have no short positions and you are long, you better be hedged short. And if you have no dogs in this race right now, it is not a bad place to be but you should consider some short positions for a longer term trade (30-60 days).

I still think SRS is a great buy right now even if it does go down further from here. SDS has to be a good play too for the 30-60 day trade, if not sooner. Having a little bit of short positions in financials is not a bad idea but I would be underweight on the financial shorts right now until this week is over to let some dust settle and as more analysts realize how much these books are cooked.

Anyways, don't get over extended right now but don't miss out on the next big leg down in the market.