November 2013


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The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.

F. Scott Fitzgerald

This week’s COT index number is +16.4% which suggests that the bull continues to run on Wall St.

Certainly we are entering on a seasonality basis, one of the best segments of the year for stocks. Add to that the emergence of Yellen as the lead choice for the Fed Chair, tepid economic growth, close to negative real rates, and you have most of the ingredients for a continued rally into February.

Technical

Looking first at the 5day chart, we see an uptrend, but price trading at the top of the range. Resistance is at $181.25. The 10day & 15day charts are unimportant this week. The 3day chart has resistance circa $182.25. I would suggest that the 5day chart will likely come into play. Therefore we can expect a pop in prices to open the week, and a decline from the resistance to support around the $179.oo area.

Valuation

Certainly the market valuation is getting a little rich. If you assume earnings growth remains lack-lustre, then valuations become increasingly rich. This has a number of market analysts calling for a decline. With no other options available, money managers continue to allocate cash to stocks. Hugh Hendry being the latest bear to succumb.

Market Neutral

With a market neutral strategy, any decline should it occur, can still provide significant profits to our positions and therefore the actual direction of the market is only of academic interest. We simply require a trend to develop in any given position to generate profits.

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Isn’t it obvious where the excess is? It’s in the currency markets. And just like every other time in history when the crisis hits it’s going to hit where the excesses occurred. The next crisis is going to be in the currency markets.

It began last year with the Japanese yen.

The next in the line to get in trouble will be the US dollar at its three year cycle low, due in the fall next year.

After that I expect rolling currency crises as one after another of the major global currencies begin to collapse under the strain of insane Keynesian monetary policy.

At the moment it seems to be fashionable to use the commodity markets has an indication that deflation is taking hold in the world. Nothing could be further from the truth. As a matter of fact we have massive inflation right now. It’s just that it is being stored in the stock market, bond market, and to some extent in the echo bubble in real estate. Once the inevitable currency crises began, inflation will start to drain out of stocks and bonds and into the commodity markets.

Let’s face it, it’s obvious where the next crisis is going to occur, and currency crises are not deflationary. They are massively inflationary.

US$

The thing is this: does the chart give any indication of the bubble? I would have to say no. The chart, a 25yr chart, looks like a bullish chart.

What about the 10yr Note?

10yr

Again, on a 25yr chart, it looks bearish, but how bearish?

I however agree. The financial excess of the Fed has spilled over into the currency – as it always must, but into primarily the Treasury market which affects the US dollar [and also to a lesser extent stocks]. The charts do not really tell the story, or rather they do not go back far enough.

The CPI does not provide a clear picture of the inflation. It excludes energy and food prices. It weights housing, which remains in a bear market, although bottomed, a 25% weighting which has distorted the CPI so that it is essentially meaningless.

The problem with predictions is in part the timing. If you get the timing wrong, you [i] lose money, [ii] look like an idiot. Therefore, a market neutral position is prudent. You participate in the bull phase, but if it breaks, you also can profit from the volatile downside.

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About the only people gnashing their teeth are short sellers, the investors who make a living betting that stocks will fall in price rather than rise. Short-selling hedge funds are down nearly 15% from the start of this year through October, according to hedge-fund tracker HFR.

Last week was another miserable one for those hedge funds and other grumpy investors who are skeptical of the market’s rise. The Dow Jones Industrial Average rose for the seventh week in a row, finishing at 16064.77. On Friday, the S&P 500 closed above 1800 for the first time.

There are few investors dedicated to wagering against stocks. James Chanos of Kynikos Associates runs a hedge fund that largely places short wagers, but there are only 24 other such firms, HFR says. Overall, these shorts manage about $6.3 billion, down from a peak of $7.8 billion in 2008.

But many more investors place bearish bets as part of their overall investing strategy. There are nearly 3,700 “long-short” hedge funds that invest in stocks, managing a total of $686 billion. Lately, these traders have had to adjust their strategies in significant ways to squeeze out returns during the market’s rally, or to just keep themselves going.

“Clearly, there’s been a tremendous amount of pain on the short side, and people are giving up on shorting individual stocks,” says Alan Fournier, who runs Pennant Capital Management. The hedge fund manages $6.5 billion, buys and shorts stocks, and is up more than 10% so far this year, according to investors.

Pennant has profited from shorts against BlackBerry Ltd., which has faced pressure on sales, and developer St. Joe Co., which has tussled with short sellers over the value of land holdings.

“Funds that are dedicated to short selling are closing, and others are starting long-only funds,” which buy shares but don’t short them, Mr. Fournier says.

Some bearish investors are exiting short positions more quickly than usual when their bets turn negative, trying to keep losses to a minimum. Others are reducing wagers they had placed against the broader market, to avoid further pain if the rally continues. Some of these investors continue to maintain bearish bets on individual companies they suspect will run into trouble. Still others are shifting to shorting emerging-market stocks and pockets of weakness in the U.S.

In any case, these investors have been licking their wounds.

“Being bearish in the bull market has been, thus far, a mug’s game and a hedge against profits,” says Douglas Kass, who runs hedge fund Seabreeze Partners Management in Palm Beach, Fla., and has been wagering against the market.

Lately, Mr. Fournier of Pennant has been avoiding using futures, options or other instruments to bet against the broader U.S. market. He dabbled with some of these bets in June but exited them when he saw indications that the market’s strength would continue.

Some market skeptics see signs their fortunes could be changing for the better. They point to the 37% drop for electric-car maker Tesla Motors since the beginning of October as a sign that some stocks that look expensive relative to their earnings are finally are coming back down to earth.

But other money managers who do their fair share of shorting say the market could grind higher for the next several months, amid continued low bond yields and the Federal Reserve’s pledge to keep interest rates, now near zero, low for a long time.

John Burbank, who runs Passport Capital in San Francisco, which has $3 billion under management and is up 18% this year, says U.S. stocks aren’t expensive relative to corporate and government bonds, which are in a “bubble.” He argues that U.S. companies are doing a better job allocating capital and returning cash to investors, in part because of investor pressure.

That is partly why Mr. Burbank has been wagering against emerging-market stocks, which have done poorly over the last year, rather than the broader U.S. market. Passport is buying exchange-traded funds that will do well if emerging-market companies run into trouble. The hedge fund also is shorting metals stocks, steel companies and others that could do poorly if growth in China or other emerging-market countries slows.

Mr. Burbank is shorting “old tech” stocks that could be hurt by upstart tech companies. He believes stocks like International Business Machines, Cisco Systems and Hewlett-Packard are vulnerable.

Though Passport’s overall portfolio is positioned to benefit from a continued rally in stocks, Mr. Burbank is holding on to some broader wagers on a decline. These hedges have become more inexpensive as the market has climbed, as have investments that figure to rise in value if the market’s volatility grows. He worries that banks don’t play as large a role in the markets as they once did. So if bad news hits the market, a sudden and sharp tumble could ensue.

Many bears say they aren’t throwing in their towels, adding that the market is due for a big correction when the Fed begins to scale back its easy-money policies. Many economists and analysts expect the Fed to reduce its bond-buying program next year.

For now, however, shorts aren’t having much fun, says Mr. Chanos of Kynikos, who nonetheless is trying to stick with his strategy.

“We are attempting, as always, to short stocks that will go down,” he says. “This is proving to be a bit difficult.”

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This week’s duCati Report now in the post.

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An artist is not paid for his labor but for his vision.

James Whistler

The COT index value this week remains positive at +13.5%. This would suggest continued strength in the market.

Increasingly around blogoland you will hear arguments with relation to valuations, bubbles in financial assets, duration of the current bull run, a weak economy, although this can be construed as a bullish argument. They are all true, but also irrelevant.

The market is running on sentiment, lack of alternatives and of course the seemingly unending QE from the Federal Reserve. With Yellen seemingly the front runner for Bernanke’s position, the continued QE looks secure into the majority of 2014. If that is the case, market valuations will continue to rise in the face of almost any data that you care to look at.

Technicals

On all time frames, 1yr, 6mths, 3mths, there is plenty of [technical] room to move higher into what is now blue sky territory. Breakouts from consolidation are largely correlated to the length of time that the consolidation took place. The charts show a consolidation from 2000, so thirteen years. This bull market could have a lot of legs under it still.

In the very short time frames; 3days, once again the market is in a very neutral area, in an uptrend. Therefore, if the market dips on the open this is a definite buy-the-dip opportunity. This would be in the $178.5o range. Should it gap higher, avoid shorting for a pullback, these trades are going to carry excessive risk if the market runs higher fast.

The only time frame that I would watch, where a pull-back could occur is the 15day time frame. Resistance is present at the $180.5o area. I would expect to see this price target hit early in the week. After that, there could possibly be grounds for a pull-back into the end of the week, but, this could be very news dependent, with short-term sentiment carrying the market through the level.

Seasonally we are entering a very bullish time for stocks. This is not a time to be initiating short positions. Rather it is more about holding winners and extracting as much profit as possible from them into late February, possibly even early March.

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I bought some TSLA here.

tsla

I’ll just have to wait and see if the daily pattern holds. It closed lower by the close, so, it might still be too early.

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tsla

The daily chart indicates a bottoming pattern, if, and when, we get an up candle tomorrow.

tslaw

The weekly chart does not yet confirm the bottom, but that is to be expected.

I will add a small position tomorrow assuming that the stock does not trade lower below the low over the last three days.

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