Month: October 2011

Expect the unexpected. Just when it seemed that the news from the financial sector could not get any worse as it became clear that a substantial portion of banks earnings over the past 2 quarters were imaginary derivative of creative accounting practices, finnies rallied and in my mind contributed to a technical short squeeze in industries you would not believe:

Residential construction: $TOL $LEN $BZH $SPF $DHI $MDC

Industrial equipment: $GWW $SWK  $STRL

General building materials: $USG $AWI $GFF $NX

We all know that after the excessive 9-day move, a consolidation of some form is natural and even needed, either through time or price. For the rally to continues, we’ll need to see new breakouts sticking and new leadership to emerge. Currently leadership is still thin and represented by old, well-known stocks.

Sentiment continues to be very volatile and driven by short-term price moves. Sitting and waiting a few days until the picture becomes clearer is a sound approach here.

Arguments could be made for both the bullish and the bearish market scenario

Bearish:

– technically extended, which limits risk appetite;

– recently heightened volatility has created a renter’s mindset. No one is willing to commit to big holdings for a prolonged period of time due to the elevated macro uncertainty;

– breakouts are failing across the board;

– defensive groups are still leading – utilities, tobacco, discount stores;

– Market reaction to earnings has been terrible so far.

Bullish:

– The worst case scenario for Europe might have been already priced in, at least for now. (to be honest, it’s still unclear what would be the consequences of a credit event related to Greece aka will the bond holders get scared and require much higher yield for Italian bonds?);

– We are in the 3rd year of the presidential cycle, which historically is very strong in terms of performance;

– With Nasdaq and SPX almost positive for the year, performance anxiety could drive institutional investors’ decision making for the rest of the year;

– the expectations for this earnings season are excessively low, meaning that companies have a low hurdle to meet and surprises could be plentiful.

Recently I received an email from a follower asking me what to do with his $NFLX holdings, on which he is down 40%. I am not going to mention his name as it would be inappropriate, but I am going to share my response as it could be useful to other people in similar situation. I like to receive emails and I always try to answer to the best of my knowledge:

Buying broken momentum stocks is not a sound approach, unless you are trying to bankrupt yourself.

First of all, it is very dangerous to own momentum stocks on the other side of the mountain. When the trends is over and a stock is trading below its declining 50dma, you are playing with fire when you go long.

Second, I’d suggest you to never average down – start with a small position and wait to be proven right, before you add.

Third, when you buy, assume that you could be wrong and always have an exit strategy. You can’t expect that you will always be right. No one is.

Also take into account opportunity cost. While you are waiting to be proven right (it might not even happen), there will be many other stocks that will provide better opportunities. Holding to a losing stock and hoping for it to bounce is like holding to a merchandise that no one wants (the market clearing price is not higher)

Regarding NFLX – it depends on your trading horizon. I don’t know the future, no one does. All I know is that currently the stock is in a downtrend on a daily and weekly time frame, meaning that I could not consider it on the long side for something more than a scalp on a 30min time frame.

I realize that you are down a lot on your NFLX holdings and you are not willing to sell now, because you would realize a loss. Guess what, you already have the loss. A simple question, you should ask yourself: is NFLX the best stock you could buy right now on the long side and why. From my perspective, it isn’t. Even if it rallies in the next few weeks or months, what are the guarantees that it will outperform many other names. There are better alternatives.

Take care,