Diary of a Financier

“I buy SPY on pullback”

In Capital Markets on Thu 28 Feb 2013 at 23:29

I haven’t commented on SPX since I turned short term bearish two weeks ago. Since then, markets floated higher for a week before rolling off a top, bouncing off a bottom, and then generally oscillating in a broad range. I haven’t said anything because there was nothing to say–at least not in full form prose. Thus, I thought I’d provide an update.

There’s a real divide among the market intelligentsia (and MSM) right now. One week ago, the noise from spectators was harmonious bullishness. Ignoring the permabulls/bears, I think we’ve reached a 50/50 balance in opinion regarding the market’s next move. Although datapoints still suggest extreme bullish posturing from market participants,¹ more and more of those who have a soapbox are saying they expect a pullback now. I think many base their expectations on baseless hope–an arbitrary call for a pause in the ceaseless rally to fulfill their expressed need for a “buy the dip” opportunity.

Objectively, I find evidence that agrees. I turned short term bearish two weeks ago. SPX is down since my proclamation, but it’s been a meandering tape. With the Dow (DJIA) making front page news by exceeding 14k, 5 year highs, and near alltime highs, I don’t get the sense that the public knows or cares about broader indices’ travails. I’ve taken the opportunity to sell into strength, reducing the portfolio’s beta from 0.89 to 0.62 (vs. 0.76 benchmark).

Peak-to-trough, the descent’s worst mark has already reached -3%. I haven’t re-accumulated my exposures, however, because the SPY 2005 analogue–which has remained consistent–asks me to wait for a lower low first. The daily overlay says we’ll glance oversold territory in the coming week, perhaps reaching new highs before turning south toward a fresh monthly low (down 3-4% peak-to-trough). A compact Head & Shoulders pattern (with a weak right shoulder) was the signal to brace yourself in 2005, for which the neckline would be SPY $149 today:

SPY 2005 v 13 (daily)

SPY 2005 v 13 (daily)

Ratifying its historical precedent, the SPY weekly analogue continues to show the greatest self-similarity to 2005:

SPY 2005 v 13 (weekly)

SPY 2005 v 13 (weekly)

Giving the bigger, longer term picture, the weekly fractal reminds me that this 3-4% short term decline will roll into another rally (+4-5%). After a midsummer correction (-7.5%), SPX should be ready for a real parabolic launch higher. Significantly underweight risk already, our portfolio doesn’t require any changes in preparation for the next 2 weeks.


¹There are a lot of surveys & reports that gauge investor sentiment. As an example, hedge fund net exposure to US equities rose to 52% last week, a 10 year high. Also last week, NASDAQ net longs reached 90%, their highest level since 3/2001 (month the Tech Bubble burst).

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