Author: Ivanhoff

The stock market is bipolar creature, driven by sentiment and irrational expectations. One day, it is an ingenious forward looking mechanism that anticipates and discounts future events beautifully. Another day, it is a stubborn schizophrenic that can’t see further than its nose. It is what it is. You either adopt or leave the scene.

Traders and European politicians have been in a Mexican Standoff for the past few weeks. While the yield on the Italian bonds was rising to record levels, U.S. equities acted like it didn’t matter. Most traders were absolutely sure that at the end of the day, the Germans’ reluctance to monetize will be broken. It is not an accident that gold rallied over the past 10-12 days. Well, traders blinked first and exits were hit.

Today, we are in no man’s land, driven by headlines and an environment where macro issues overshadow individual catalysts. I don’t want to have any market exposure overnight (long or short) and prefer to stay in cash and wait out the storm. If there is an year end rally, there will be plenty of better risk/reward opportunities ahead. There is no reason to hurry and buy dips here. If this is the beginning of a more serious correction, forced liquidations will bring prices much lower and offer better bargains. I consider both scenarios totally possible.

They say that if you understand people’s incentives, you can predict their behavior. At this point, I am not sure I understand what is driving people’ decision making. Is it the fear of underperforming or fear of losing money, Is the Return OF Capital more important that the Return ON Capital. When in doubt, stay out. While it is true that uncertainty is a second nature of the market, there are days when the market fog doesn’t let see you far enough to justify risking any money. Soon, things will get more clear. Until then, I will limit my market adventures to the occasional intraday scalp when a good opportunity presents itself.

Of course, what is good for me, might not be good for you. I manage my capital fairly aggressively, opportunity cost is a huge factor in my decision making and I change my stand quickly. Such market approach requires being very nimble and willing to stay in cash when you have to.

Just 10 days ago, it was announced that holders of Greek sovereign debt will take a 50% haircut. Everyone was basically told that if they don’t agree on a 50% loss, they will have to take a 100% loss. And since the debt reduction was “voluntarily”, Credit Default Swaps on Greek Sovereign Debt did not trigger.

CDS is basically an insurance against bonds going bad (or against defaulting). While it is true that many of the participants in the CDS market are speculators and don’t own the underlying bonds, the not triggering of those instruments is a mistake of major proportions and with potentially detrimental consequences.

If the holders of debt in question are not easily able to hedge, it is perfectly rational to assume that they will not only buy less, but also decrease their exposure. The effect: the yield on Italian and Spanish bonds are near records highs despite the ECB buying directly, which essentially endangers the solvency of two of Europe’s biggest economies.

Personally I think that the most likely solution here is for the ECB to commit to even bigger purchases or with other words, to monetize the debt. The Germans might not like this scenario, but it might be the lesser evil at this point of time.

Despite the spike in yields, U.S. equities are holding the front in a spectacular fashion. As The Fly eloquently noted in one of his posts today: “when stocks don’t go down on bad news, good news is likely around the corner”. Whatever the reason, the resilience of equities is a big tell of current supply/demand dynamics. Gold, Energy and Tech are leading the way so far and just want to move higher.

I am not in a hurry to open any new positions at this point and I am patiently waiting for high probability trades to reveal themselves. Some days are better spent just watching, reading and writing. Out job is to make money, not to trade.

History never repeats, but it often rhymes, at least from psychological perspective. One cannot help but ponder the similarities between 1998 and 2011. In the Summer of 1998, stock markets across the world sold off because of the Asian credit crisis. In the summer of 2011, the sell-off was caused by European credit crisis. Of course, the magnitude of the problem today is much bigger and complicated, but the governmental bodies across the world are willing to take desperate measures and do anything to somehow solve the problem or at least postpone it for as long as possible.

2011 and 1998 have similarities from technical perspective too: major low in August that was penetrated intraday in October, only for the market to snap back and rally 20% in 4 weeks after that.

I am not suggesting in any way that 2011 will be exactly like 1998, but I remain open minded for the possibility. As a matter of fact, I think the markets are overextended here and a consolidation of some sort next week is very high probability. $TZA seems like a good hedge/pick for the next few days. Other than that, the market looks higher for the rest of the year, baring any unforeseen event.

Of course, I will trade what I see, not what I think and I will change my mind if the market tells me to.