Fear of Heights

By Jani Ziedins | End of Day Analysis

Oct 28
S&P500 daily at end of day

S&P500 daily at end of day

MARKET BEHAVIOR
Stocks finished modestly higher, setting new all-time intraday and closing highs, as buyers and sellers continue supporting these levels.  The breakout is holding recent gains and suggests we are not on the verge of breaking down.  Unsustainable levels see quick reversals and sitting above 1740 for the last seven sessions suggests this is the real deal.  Markets can do one of three things, up, down, or sideways.  We traded mostly sideways through the summer, but the market is giving every indication we already entered the next up leg.

MARKET SENTIMENT
While not a definitive measure, it is interesting to see the Stocktwits SPY sentiment gauge slip from 60% bulls to 45% bulls over the last week and a half.  No surprise sentiment surged to 60% as prices rebounded from the Default lows, but we are clearly seeing a negative shift even as the market continues making new highs.

Source: Stocktwits 10-28-2013

Source: Stocktwits 10-28-2013

This shows many traders are reluctant to trust these levels and they expect us to pull back from recent highs.  The thing to remember is most of these cautious traders already expressed their outlook by selling the strength.  The market has been resilient enough to swallow this profit-taking and bearish shorting without missing a step,.  Further, if those that don’t trust these levels are already out, that means there are fewer left to sell and the resulting tight supply will keep the rally alive.

Yahoo Finance had another interesting poll showing 27% still think Cash and Bonds are the best place to keep their money.  That ties big-caps and easily outpaces the NASDAQ and Small Caps.  Clearly these last two surveys of sentiment are not “overly bullish”, yet I keep hearing people claim the market is.  “Overly Bullish” is the crowd’s state of mind, not a price level, and is the mistake most of these “experts” are making.  Contrarian investing is going against the crowd and more often than not that means sticking with the trend when no one else trusts it.

Source: Yahoo Finance 10-28-2013

Source: Yahoo Finance 10-28-2013

TRADING OPPORTUNITIES
Expected Outcome:

Why fight what is working?  We expected the market to transition from sideways summer volatility to a directional fall move and is exactly what we’ve gotten.  Countless gurus pointed out how horrible September and October typically are and said we should stay away.  Of course many are the same people that warned us to sell in May.  As long as people don’t trust this market, expect it to continue rallying as the holdouts are forced to chase into year-end.

Alternate Outcome:
The market is running out of things to fear.  We still have Taper and another round of Debt Ceiling talks, but so far those fears are fading into the background.  Bears have been the Boy Who Cried Wolf and they are losing their credibility as each crisis turns into a false alarm.  But rather than become complacent, we must keep an eye out because the wolf is coming.  No one knows when or where, but he is coming.

Trading Plan:
It is tough to buy the market up here, but I have every expectation we will continue higher.  How we get there is a bit less certain.  Maybe we dip on a headline or maybe we melt up as underweight traders keep buying every dip.  Either way, being long is the right call and short is an exercise in futility.  Anyone in the market should keep moving up their trailing stops and ride this thing as far as it will go.

INDIVIDUAL STOCKS
AAPL reported impressive earnings, but the stock sagged after-hours on disappointing margins.  The stock is still holdable as long as it stays above $510.  The one thing that continues concerning me is how pros, amateurs, and analysts all think AAPL is a great buy.  They point to dividends, cash hoard, buybacks, and China as all reasons this stock will go higher.  But if everyone who wants AAPL already has AAPL, who is left to buy?  While I think Apple is a great company with popular products, the stock is entering a mature phase.  We saw this with MSFT, CSCO, WMT, DELL and every other great growth story before it.  There is no reason to think that AAPL is immune from the same decade of stagnant stock price.  Steve Ballmer doubled revenues and earnings at MSFT under his tenure, but the stock was stuck in the $20 for most of that time.  Cook will likely continue adding to AAPL’s bottom line, but is that enough to move the stock back to old highs?  Only time will tell.

NFLX is still suffering from the earnings reversal and Icahn hangover.  The stock is still above the 50dma and is not screaming sell just yet, but any bull better be prepared for some volatility if we slip under this widely followed moving average.

TSLA is a few days ahead of NFLX in regard to penetrated the 50dma.  Last week it tried to rally back above this key level, but failed and slipped back under today.  The stock is down seven out of the last nine days.  For any long-term holders, this might not be a bad place to take some off the table.  Sell half and lock in some profits.  The adventurous can let the house money ride.  We are in this to make money and the only way to do that is selling our winners.

Plan your trade; trade your plan

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About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.

Jay October 29, 2013

Hi. I very much enjoy your daily write-ups. Thanks for publishing these.

One question I have for you is, while markets often only turn bearish once most people turn bullish, does that really apply given today’s market conditions? We have a whole group of skeptical investors who are sitting out of the market because they see the Fed’s policies as irresponsible and/or insane. Are these investors likely to change their mind as the market heads higher? The “smart money” is selling and views it as a bubble (Soros, Fink, Gross, etc). I wouldn’t expect them to suddenly get bullish again or chase unless the Fed makes a significant change to policy (something like start buying stocks directly).

    Jani Ziedins October 29, 2013

    It all comes down to time horizon. We can segment traders into several baskets based on their average holding period. We have HFTs, day-traders, swing-traders, position-traders/year-long investors, and decade/forever investors. Many of the guys you mentioned likely fall into the year-long basket. They are too big to move in and out over small time-frames, but are more speculative and opportunistic than long-term buy-and-hold investors. So while these guys see us peaking in the near-term, for then that means at some point over the next couple months. Most of these guys acknowledge they sell too early, and that is a key part of their success. Because of their position size, they cannot wait to sell on the way down because there will not be enough buyers in a weak market to absorb such large blocks of stock. That is why most big guys need to get out on the way up when buyers are still abundant. For smaller traders like ourselves, we are nimble enough to ride these moves closer to the top and there will be enough liquidity that we can close out on the way down if we wait too long.

    Personally I don’t buy the Fed’s responsibility argument since we’ve been hearing it for three years and so far all the bears predictions have not come true. Inflation remains constrained and the excess money supply is not having any undesirable consequences. Lending and the velocity of money have slowed dramatically since the financial crisis and the Fed’s injection is simply filling the void. That is why we have not seen any of the consequences many were predicting for. Eventually the Fed will be able to take their money out as lending and velocity of money return to pre-recession levels and off we go. While they won’t be able to time it perfectly, it will not be the train wreck many are predicting.

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