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January 5, 2009

Headwinds, Tailwinds

In unusually tame action for a second trading day of a year, the S&P 500 fell a half percent within a total range of about 1.5%. On the positive side of today's session, stocks managed not to slump under the pressure of a slew of overbought indicators. On the negative side, stocks managed not to rally in the face of massive amounts of money draining out of bonds. It almost seemed as if these forces were balancing... without overbought conditions, stocks would have surged or without the sell-off in bonds, stocks would have tanked.

I'm going to guess that in the very near-term, headwinds will overpower tailwinds. For one, we still have some pretty significant extremes in some indicators, especially put/call ratio:

market indicator chart

I highlight this indicator, in particular, because of its extreme. The current reading has coincided with significant tops, not just short-term ones. We should stay on our toes for surprises.

A look at bonds using TLT as a proxy illustrates the severity of the bond market break:

bond chart

The rapid retreat in bond prices begs for a reprise... even if only for a couple days... and such a consolidation could provide an impetus for an equity correction, as well. Bottom line: I expect a moderate fall in stock prices in the next few days. Even if bonds continue to slump, I doubt equities will be able to make much headway in the face of extended readings. To capitalize on these expectations, I sold OTM calls on the SPX. I may add an outright short, depending on the action.

Precious metals showed a bit of weakness today with gold and silver each off about 2.2%. I will most likely short some gold this evening, but I have not decided on scale.

gold chart

That the greenback seems to be well on its way to returning to highs supports both my plays on gold and stocks. Curiously, crude managed a nice rally in the face of dollar strength, and has seen a spectacular 33% gain over the last 6 trading days. It will be interesting to see how it handles itself from here:

oil chart

The first week of the year is also a tricky time to be trading commodities because of commodity index rebalancings, so keep a keen eye on the charts, and keep your stops firm.

 

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