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January 9, 2006

New Week, Same Story

Equities are now 5-0 for 2006. During these first five days, the S&P 500 Index has tacked on 3.5%, nearly matching its gain for all of last year. The Nasdaq 100 has gone vertical for nearly 6%. Even the Dow, which was left out of last year's party, has surged ahead and finally taken out the elusive 11,000 level. The next few days will reveal what psychological animals Dow 11,000 will release. Will we see renewed confidence or profit-taking?

For my part, I have participated in this rally in two ways. First, I have a small long position in GM which I opened last week after my trading model put out a buy signal on the shares. Since I am longer-term bearish on GM, I kept the position very small, but so far it has worked out. It takes a strong signal for me to trade against my interpretation of fundamentals, and I am usually very skittish about getting out of such trades.

The second way I have participated in this rally is by doing nothing, and believe it or not, that is a hard thing to do. As you have doubtless read here in past entries, I have a rather strong conviction that U.S. equities are about to hit the skids in a bad way. I have nevertheless kept myself on the sidelines waiting for the right moment to pounce. I've learned the hard way that is better to lose opportunities than to get ahead of oneself and lose money. So for the moment I am sitting on my hands watching all the stocks I want to short go up. And in a way that makes me feel richer even though my account balance isn't going up.

Speaking of stocks I want to short, housing stocks caught serious bids today with gains of 5-9% across the board. What an amazing rally, and a wonderful time not to be short! I did not see any specific reason for today's action except perhaps a delayed reaction to all the hype about interest rate hikes coming to an end. Momentum players have control of the homeys right now, and when those players exhaust themselves, we will have a shorting opportunity in these stocks that will dwarf the July - October period. Regardless of interest rate moves, the game is over for the housing market. It is very difficult to revive a bubble once players get burned… the psychological damage will prevent people from coming up to bat again… and people are already getting burned in big ways, with asking prices coming down by 20% and more in different areas across the country.

In the tech arena, I am watching F5 Networks go vertical. FFIV provides a perfect example of why shorting is usually not a "hold" type of trade, as the passed three weeks have seen over 20% added to the company's share price. Texas Instruments has also been bid up about 25% since it's October low. Both of these companies face prospects of margin squeezes in the coming months and will be shorted in my portfolio at some point.

But the two star players in today's market remain Google and Yahoo. Wall Street is in love with pay-per-click right now, and I imagine volumes will be written about these stocks in much the same light as volumes were written about the Nifty Fifty of the early 1970s. In a way, I understand the allure to pay-per-click. Many of the clients of my web development shop depend on PPC campaigns to drive valuable traffic to their sites. However, as a trader I also understand that Mr. Market is overvaluing the cash flows. The tremendous amount of liquidity recently released by Sir Alan is providing fuel for the momentum players, but as with the homeys, once a catalyst pulls people out of this game, Google and Yahoo will provide an instant replay the tech bust.

Disclosure: Long GM; Long YHOO Puts


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