Sunday, January 30, 2011

Monday January 31

So the big question is how will the markets react the next few days.  Have we begun a well needed correction or something bigger or will this be just another buy the dip "opportunity."

Anyone who claims they understand these markets right now is lying to you.  No one has any clue what is going on with risk assets.  Sure they are rising but based on nothing other than the concept of the Bernanke put.  Leverage is at Lehman levels, short interest is at a year low and the effects of POMO arguably are not as strong as back in the August pre-annoucment.

It's important to realize that all of us bears, bulls, whatever you want to call people have been conditioned to buy the dip.  All dips have rallied the past 2 years pretty much.  So to simply say this is the dip that does not bounce would be naive.  There is a chance, a very good chance this dip does not bounce but we can't assume that with 100% certainty.

A majority of people "in the market" don't do their homework.  They read the headlines. They don't question the headlines, let alone read the story.  They take at face value what the media tells them or what some analyst tells them.  Right now the group trade is very long in the tooth and highly participated.  So with that said, many will be ready to deploy any cash that is left to go long.  The same goes for bears who are very tired and timid at this point.  Any signs of strength could easily build into even more strength.  I saw a quote on Friday from a "trader" and I use that term loosely.  Their quote "Egypt is a small country, the market is overreacting."

The easy trade has been buy anything, literally anything, ignore entry price because it will rise in value.  Bill Fleckenstein says it best when he says "nonsense becomes knowledge."  Anyone long anything feels pretty dam smart and the longer this rally has gone on the more their self confidence has been reinforced.  Should this be the start of a larger correction, expect many "smart longs" to fight the tape as the bear did for a while. Expect them to buy any dip they can with any money they have left.  It's worked for two years so why should it not work now they will ask themselves.

To think this is simply about one country in the Middle East is very naive.  Many governments are borderline ready to experience their own Egypt and many more are going to do whatever they can to prevent any increase in discontent within their country.  China is dealing with severe inflation right now and a labor force demanding more income, thus the 10% rise in minimum wage lately.

So there is a very real possibility markets show some strength the next day or two.  You have to ask yourself though is that real?  Personally I think any short term strength is simply a bounce.  POMO is long in the tooth and its strength wearing thin.  From a technical standpoint, lots of damage was done in very heavy volume across pretty much all sectors.  Commodities have been selling off the past two weeks. The USD has shown some firming, especially with Friday's news.  The VIX put in a 24% move to the upside (looks like some people on Friday decided they needed more than the Bernanke put).

The fact that Egypt is gaining in momentum versus quieting down should be worrisome across the world from an economic to policy standpoint.

I'm positioned short via hedged option trades.  I won't be adding to the trade though until confirmation that my assumption of any bounces are indeed just that.  I'm trying to prepare myself mentally though for various options come Monday and into the week. Pretty much everyone who manages money, whether it be their own or a fund is confused right now in terms of market direction.


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