February 10, 2016

Market showing signs of improvement even while going lower

I remain bearish and net bearish and net short as we get ready for another trading week to begin.

I recently substituted my short of the SPDR S&P 500 ETF (SPY) with out-of-the-money SPY puts. This strategy increases my delta and short exposure as stocks fall, which is what I want right now for a multitude of reasons that I've previously outlined in my diary.

The most important reason is that I believe that for the fourth consecutive year, consensus S&P 500 earnings estimates are simply too high. So are price-to-earnings multiples that fail to incorporate the more-subdued profit picture, the likelihood of a Federal Reserve policy error and the wobbly global growth, political risks and possible geopolitical threats that our flat and interconnected world faces.

And as I've recently emphasized in my diary (and in a recent Bloomberg Radio interview), the "negative wealth effect" of lower stock prices could push the U.S. economy over the cliff and into a recession. My current odds are for a 35% chance of a "garden-variety" recession and a 15% chance of a deeper recession.

What I Expect in Coming Days
I think a $181 "capitulation low" for SPY and a 1,810 intraday for the S&P 500 are still a distance away.

That said, perhaps we'll see a "flush" towards a capitulation low in the days ahead if  we see more disgust and dismay that "clears the air."

I continue to think an 1,810 low for the S&P 500 will hold, but we'll see. The CBOE put/call ratio has dropped from 1.18 to 0.96 over the past three weeks, while other sentiment indicators are exhibiting less bearishness and reduced fear --concerning signs.

Notably, there's been a clear rotation in the last week that investors can take as either a positive or negative. Specifically, the U.S. dollar's weakness has helped the oversold sectors of commodities, energy and materials-and-manufacturing stocks while hurting the TFANGs and technology.

To me, it's still an open question as to whether this leadership change is sustainable, although I recently added exposure to DuPont (DD - Get Report) .

My Take on Friday's Schmeissing

"In terms of Friday's action, sure it was ugly, but it was highly concentrated in those fan faves. The selling barely registered outside of those stocks.

The clearest example I can provide for that is the number of stocks making new lows. Friday's action on the NYSE saw 169 new lows with the S&P at 1,880. The last time the S&P was in this area one month ago, there were 1,375 new lows. Heck, last Wednesday had 227 new lows, so there were even fewer new lows on Friday.

So, ask yourself this: If the S&P breaks 1,875 this week, do you think we will see more than 1,375 new lows on the NYSE? I'm in the camp that says it is unlikely and that would make it a positive divergence."

The S&P 500 shed some 1.8% on Friday to close at 1,880, within 1% of my fair-market-value calculation. I remain defensive on the major trend for now, but like Ms. M, I'm going to be closely watching the "quality" of the decline. I think that could result in a successful test of the S&P 500's recent low.

The NYSE's new-52-week-low list hit 1,395 issues on Jan. 20, the same day the S&P 500 hit an apparent "capitulation low." But the number of new lows on Friday was meaningfully below that. A successful test should consist of substantially fewer new lows.

For most players, this remains a time to err on the side of conservatism. The reason you maintain high cash reserves is for a rainy day -- and it's certainly raining now.

Cash is an asset class that provides a good defense.

And don't forget that T.I.N.A. -- "There Is No Alternative" to stocks -- is B.S.!

via thestreet