Betting against equities - the market - is always difficult. First, the market isn't designed to go down. Companies provide those goods and services for one reason - to turn a profit, and hopefully, such activity can be recognized with a rising stock price. Second, our economic stewards and political leaders (wisdom?) use the stock market as a vehicle that validates all that they do. Fixing a crisis is one thing, but fixing a crisis and having the Dow confirm such actions with a 600 point move is even better. Call this headline risk to any short position because market participants are likely to shoot first and ask questions later on any rumor. When was the last time you heard some elected official say "run for the hills"? There is always the hope that they can fix the problem. For example, this week alone, we have US Treasury Secretary, Tim Geithner, in Europe for "important" meetings. That' 3 days of headlines telling us Europe's problems will be fixed.
Nonetheless, here we find a market hoping for a Santa Claus rally just like they were hoping for the traditional Thanksgiving lift that showed up about a week late. How did that work out for you? Thanksgiving week was the worst Thanksgiving week since 1932. Oh well.
So why I am a bearish? I have 4 reasons.
The first is purely technical. See figure 1 a weekly chart of the S&P Depository Receipts (symbol: SPY). The red and black dots are key pivot points, which represent the best areas of support (buying) and resistance (selling). The SPY is at a prior key pivot point (126.89) that was support but it is now resistance. There is also resistance from the down sloping 40 week moving average. The SPY is at the upper end of its price range. How it got to this point -i.e., a rally built on poor volume and breadth -- is another concern. In essence, I would rather short the market at this point because if wrong I will be shown an exit rather quickly. This would be a "meaningful" close above the aforementioned resistance levels.
Figure 1. SP500/ weekly
The second reason has to do with my belief that we are headed into a recession. This can be seen by my real time recession indicator, which is shown in figure 2 a monthly chart of the SP500. (See this article to read about the real time recession indicator.) The red price bars are those times when there is a risk of the economy going into a recession. As can be seen in this snapshot, the risk of recession seems to coincide with prices being below the simple 10 month moving average. So with the SP500 bumping up against the simple 10 month moving average and with the economy on recession watch, I am willing to say, "prove me wrong". A close above this level would have me re-thinking my thesis. I like to think of the simple 10 month moving average as the line of hope, and in a recession, that hope keeps getting crushed. We shall see if this time is different.
Figure 2. SP500/ monthly
The third reason has to do with trading models that characterize the current trends in the Dollar and Treasury as being bullish. Last summer, when the Fed announced QE2, equities really didn't take off until the Dollar Index sank and Treasury yields started moving higher. The current situation is completely opposite to the Summer of 2010, and every market watcher knows that there are only two trades in this market: the Dollar and Treasury bonds (risk off) or everything else (risk on). Figure 3, a weekly chart of the SP500, shows this graphically. In the middle panel is an analogue chart of the Dollar trend which is currently up. The lower panel shows an analogue chart for the trend in Treasury bonds, and this is up to. The vertical black line is August, 2010, and we note that equities took off when these two trends reversed.
Figure 3. SP500/ weekly
The final reason has to do with market sentiment. Currently, market sentiment is neither bullish nor bearish, and this presents a problem for the bulls for several reasons. If there were more bears, I could make the argument that this is bullish. (This is the traditional interpretation.) If and when the market turns higher, there will be plenty of short covering to fuel any rally, and there will be plenty of investors willing to chase prices higher as they are on the sidelines wanting in. If too many bears is a good thing (and it usually is about 80% of the time), then too many bulls must be bad. But that really isn't the case. Why? At important market junctures, like market bottoms in 2003 and 2009, too many bulls was a good thing. In essence, it took bulls to make a bull market. But in the current market environment, we have neither bulls nor bears. There are no bears to provide short covering fuel for a rally and the bulls don't seem to be particularly interested for anything but a trade.
So let's put it all together. Prices are at resistance. There is risk of recession. There are intermarket headwinds. And investors aren't committed either way. I think this skews the dynamic to the downside even if there is headline risk.
How will I know if I am wrong? As silly as it sounds, higher prices on bullish news. And the appearance of bullish sentiment as investors truly embrace that news and get their speculative mojo back. Until that happens, I am willing to say, "prove me wrong".
