Stocks have been working extra-hard over the past two months to throw as many people off the scent as possible. There was the harrowing decline into the early October low, which created one of the deepest oversold conditions in market history. Then there was the epic rebound into the late October high that average investors caught only the tail end of based on sentiment and fund flow data.
Just thinking about it is enough to give you a headache. Professional active investment managers have been whipsawed, too. According to Jason Goepfert at SentimenTrader, these guys went from a net neutral positioning on Oct. 12 to 54% net long earlier this week at a time of meager market gains. Goepfert notes that never before have those money managers "added so much exposure per point gain" in the market. In other words, they tried to chase a market that was running away from them just as it slammed on the brakes.
Now, after trading quietly in a holding pattern over the past few weeks as Europe has burned, U.S. equities are plunging out of technical consolidation on big volume and deeply negative breadth -- a sign of overwhelming selling pressure that's likely to continue over the medium term.
Over the past few weeks, I've talked a lot about the deteriorating fundamental situation: the U.S. deficit-cutting supercommittee's looming deadline in Congress, and Europe's growing inability to raise private cash as it falls back into recession.
Yet even if one were to ignore all that, the charts would say it all: Trouble is brewing.
For one, volume trend suggest that sellers are much more eager to depart with stocks than bargain-hunters are to buy them, with much heavier trading activity on the down days. Negative breadth, or the number of stocks participating in the sell-offs, has reached levels not seen since the drop into the early October low.
More importantly, weakness has been particularly pronounced in cyclical, economically sensitive areas like materials and emerging-market stocks. I like to track this metric as a rough gauge of optimism among investors: When cyclical stocks are doing well, it's a sign people are using real money to bet on a brighter economic future. When the opposite happens, it's time to get defensive.
To gauge this, I use the ratio of the Morgan Stanley Cyclicals Index ($CYC.X) versus the Consumer Staples SPDR (XLP). I've talked about the Morgan Stanly Index a few times. It holds companies like U.S. Steel (X) and Caterpillar (CAT), while the Consumer Staples fund holds stocks like Kraft (KFT) and Colgate-Palmolive (CL).
When makers of mac and cheese and toothpaste start outperforming makers of sheet metal and heavy equipment, it's time to get nervous.
To translate this into a buy or sell signal, I like to compare the nine- and 18- moving averages of the ratio. When you get an upward cross, as we did in early October and in late June, it's time to buy, since stocks do best when the cyclicals are leading the way.
But when we get a downward cross, as we did this week, it's a big fat get-out-of-Dodge signal. When consumer staples and other "defensive" stocks outperform and pull the ratio down as they are now, it's because these issues tend to not fall as much as the rest of the market during times of weakness.
It comes down to this: When cyclicals are leading the way, you want to be in stocks. If they're not, you want to be sitting in cash on the sidelines if possible.
For the traders out there, I continue to like short emerging-market ETFs as the best way to profit from the market pullback. Not only are these stocks ultra-sensitive to global growth, but they are negatively affected by haven inflows into the U.S. dollar. A double whammy.
I've added the Direxion 3x Daily Emerging Market Bear (EDZ) to my Edge Letter Sample Portfolio, but if that's too much leverage there are less risky alternative like the ProShares Short Emerging Market (EUM) and the ProShares UltraShort Emerging Market (EEV).
As for individual short ideas, I think the focus should be on basic materials holdings. Two of the best looking short ideas are Century Aluminum (CENX) and Teck Resources (TCK). I'm adding both to my sample portfolio.
I found these picks with the help of technical screens developed with Fidelity's Wealth Lab Pro back-testing tools, which you can find here. (Fidelity sponsors the Investor Pro section on MSN Money.)
Disclosure: Anthony has recommend EDZ to his newsletter subscribers.
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The author can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
DO like Cramer: buy raw land near a water source that you can grow your own food on and raise kosher animal products because we are about to hit rock bottom and stay there. Off-the-grid before it is too late and please write your Congressman about banning the manufacture of trailer "homes" and the wasteful construction of condos and apartments. People need a victory garden !!!
Looks like "Raging Bull" Mirhaydari has gone the way of Cramer and Jubak. Which is to say, joined the Doom and Gloom club. Suck us in then suck the market out from under us. What a shame. Can't trust anyone anymore. Can't blame Obama for this situation. Too many Americans with not enough money to spend wasting their hard-earned cash every month insuring and fueling gas-guzzlers. Now that the U.S. Postal Service has ended matching their employees' retirement contributions, expect the private sector to follow and a whole generation of Americans to not have enough for retirement. So many wars fought since Reagan over oil and nothing to show for it but a third world United States. Now, all the property values propped up by inflation of building materials caused by BIG OIL's control of Congress will plummet and the states won't have enough to help their own people. Get ready for 10 more years of PAIN. Hope the Holy War for oil was worth it Pres. Bush.
With Monday being effectively the deadline for the super committee to come to an agreement, given that the Congressional Budget Office needs a couple of days to score the agreement and final passage by the committee, of the deficit reduction package .. no wonder the Federal Reserve members are getting nervous.
Full sequester, with across the board cuts .. that ought to put the economy into a tail spin.
To Big to Fail .. I think our elected representatives have failed us .. time to give them a bail out of the chair that they seem to think is theirs and get somebody in Congress that can get something accomplished.
Hey Tony.....what happened to all of the "bull" talk you were printing a few weeks ago??????
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