Sunday, April 5, 2009

Winning The Race

When I was in high school, our cross country team was pretty bad but we had a runner on our team (lets call him Joe) who was a good athlete and won or was usually at the front of the pack when the race ended. But in his senior year, he had difficulty finishing in the top 10 in any race. He was still running at his normal pace and normal times, but what he found was many of the other teams used strategies to run together, to draft and save energy giving lessor runners an advantage over a runner like him. Unfortunately, no one else on the team could keep up with him so he had no way to use a similar strategy. He was by himself running against a system.

But the state meet was coming up and he had a plan. Rather than trying to race against the system, he would use the system to his advantage. He was the better athlete and needed to use that to his advantage.

He knew which team was the best team since he had run against them just a couple of months before. Usually he would head for the lead at the beginning of the race and try to define the pace. But that no longer worked. So at the beginning of this race, he tucked right behind the 4 runners from the team he was targeting. The 4 ran in a straight line and at every mile marker, they would rotate. The lead runner would fall back to the back of the pack of 4 and the 2nd runner would lead the charge.

Joe stayed behind all 4 the entire race, drafting the entire time. With one mile to go, Joe made his move and accelerated past the 4 and into the lead. He easily won the race and was state champ.

So, what they hell does this have to do with the market and where we are now? The reality of where the economy is has been lost. Its been lost by a system of media hype, lies by banks, Fed intervention, and politicians covering their ass. These 4, along with others are piling on create a euphoric atmosphere of bullishness while the world economy is barely hanging on.

This bullishness may last awhile, who knows, but the smart money for the longer term is the economy will continue to suffer through the year with GDP falling, unemployment rising, and real estate plummeting. So you have to use patience and caution but you must be ready to pounce at the right time. If you go too early, it can hurt you. Joe waited until the last mile and knew he could get a lead that no could catch him. He was well rested.

You have to be well rested (cash on the sideline) when the timing is right. If you pull too early (as I did last Friday doubling up on SRS) it can burn you. Look for the signals and confirmation of the signals.

While I may have been burnt on Friday, I am not overextended. I actually feel very good about my position in SRS for the longer term. I am not in fear of the uptick rule and I am not in fear of REIT's hiding debt via secondary offerings anymore. I am comfortably drafting behind the bulls knowing they will tire and knowing I have cash in reserve to pounce and take the lead.

I know many of you label me as a perma-bear. I really don't like that tag at all. I am not a perma-bear. I am a realist and unfortunately the economy has some tougher times ahead. The markets will pull back and eventually retest the lows. Might not be until Q3 but in the mean time, the market will correct to the downside. I also will play the bull side once in awhile when I see the opportunity. Last week was that opportunity. I just changed back to the bearish side a tad too quickly.

What I see now is a situation where a bubble is being built. More and more shorts are giving up. More bulls are coming forward. This will and is leading to an imbalance of bulls to bears. In February, there was a heavy imbalance of bears to bulls creating a bubble which lead to the March rally.

Time it right and you will catch the bigger move down. As for now, you really can't jump on the rally bandwagon. That would be a rookie mistake. Yes it is the momentum play and perhaps you can play it on the dips, but not right now, not on Monday.

Erik posted a key chart which shows that the VIX is at a decision point. Hitting the lower trend line yet again in a narrowing wedge pattern. If the VIX falls through that, the trend is broken and I have to believe we are going to go steadily higher in the market for the next week or so. If the VIX bounces off the lower trend line, I believe we see some correction, but we will not see more than a slight pull back unless the VIX can go above the 20dma.

So, these are cautious times right now. Playing long term and playing for safety, I have to believe the non-leveraged ETF's would be the way to go. Perhaps playing puts 2 or 3 months out on some levered ETFs could be a good play as well.

Straddles are going to be a really good play on individual stocks that are entering earnings. GOOG is interesting because their current price prices in good earnings. So I believe if they beat numbers, the move up will be minimal. But a miss and they would fall hard. Straddling GOOG would be tough and may require on imbalanced straddle which I am not a fan of at all.

Tech stocks are all priced where earnings expectations are high. Watch for the semi's to miss though. No big earnings are this week though so I will revisit this next week.


  1. alcoa (materials)

    chevron (oil services)

    start kicking off this week

    about the same time they put in the uptick rule on wed....(last bullet)

  2. Brian,

    As a former cross-country runner, I especially enjoyed your story and analogy. Nicely done.

    Overall, do you see this week slightly up on the uptick rule, but the next 2-3 weeks down (maybe big) on terrible 1Q ERs?

    Are you adding any SRS if it goes under 35 this week?

    Thanks for your views.