How to Play Offense and Defense in Today's Markets

Includes: DIA, SPY
by: Allen Phatimer

I figured I’d share a few quick thoughts on yesterday’s massive rally. If you’ve read my posts you know that I’ve been very bearish for a long time now, especially on banks, energy, agricultural equipment and steel. I’ve been long a few healthcare names and building a position in an industrial name I will discuss in detail soon. In the last week, I tried to get a little cute and play for an oversold bounce and rally in crude which whipsawed me – got long, sold long, got short and covered short at the open yesterday (thankfully did it small). I also have been buying a battery company, caught a nice quick move in GE (not typical for me because I have been avoiding troubled names no matter how apparently cheap; but thought I'd catch a 15-20% move in a couple of days so I took a shot with a 5% stop Friday and sold yesterday morning), and a bought a small bank and Japanese consumer electronic name at the open yesterday.

I also covered half of two small positions in natural gas stocks I’ve been short for a while now (still negative), and covered half of a short position in a steel name. And yes, I wish I covered the whole thing but I’m committed to staying short some natural gas equities because I think many are still too bullish, the market is positioned to keep prices weaker, longer than most expect and sentiment is still not sufficiently bearish given fundamental developments in recent weeks and months. I’ll have more to say on that soon as I discuss more natural gas shorting opportunities in the coming days. I also covered my agricultural equipment short way too early (couple of weeks ago almost 5 points and 25% higher).

Even though I thought the economic and earnings backdrop are as bad as they’ve ever been, and most companies were likely to see earnings and outlooks under pressure, I started covering shorts and taking shots on the long side because I thought sentiment was catching up with reality and the reality of economic unraveling and its ramifications were finally becoming properly appreciated. Thus I felt that oversold conditions, coupled with heightened fear and the capitulation type selling in most names set the stage for a substantial bounce – something on the order of 15%-20%, which equates to a move back to 765 or as high as 800 in a best case (20%) scenario in the S&P500. How low a low this is remains to be seen.

Even though I thought we’d see a sharp rally yesterday, I kept some of my shorts on because I didn’t think the bounces would be as strong as they were in energy and materials and I want to remain short some of these names for the next earnings report and thought it would be too difficult to be nimble enough to do much better trying to hop in and out and back in. It's typically the case that I catch a nice move lower in a short, cover on a 15%+ gain in a few weeks and avoid the couple day 10% bounce and miss getting back in fast enough to play the next leg down that I knew was coming.

So that’s how I played a few volatile days; where I felt the market was very oversold by all measures, and sentiment had gotten extremely bearish. Now the hard part, how long to stay as long as I’ve been since last July and when to add back more short exposure? The short answer (and of course this is subject to change without notice) is not so fast. Given the breadth and strength of the rally with solid participation from Techs, Financials, Industrials and Cyclicals, I plan on staying with a relatively net long position for at least tomorrow and probably the next few days.

So the moral of the story is that I think you have to stay true to well reasoned secular views but also be conscious of market conditions and sentiment and thus ready and willing to act somewhat nimbly (yes I know that’s oxymoronic) when a reversal has a relatively high probability. The high volatility makes it difficult to do wholesale so I scale in and out of positions and net market exposure. So I’m not up as much as I could be on a day like this, but I can usually add risk adjusted out performance on day 2 through 5 or 7.

I think it could take another 3-4 days to get to 765 and think 800 in the next couple of weeks wouldn’t be a shocker so I’ll look to get more long in the first half hour Wednesday (mostly at the open), and I’ll look to scale into some shorts and out of some longs as we approach 765 or more. My biggest mistakes in the last year have been not staying short as long as I would have liked to; trying to be too nimble. In recent weeks, and months I've dealt with that by not completely covering shorts which I'd like to stay in and putting on longs, in spite of my longer term market view. And that's worked very well.

On another note, a friend (who knows I’ve been a gold bug for a while now, but out as of 2 weeks ago) asked me about shorting gold here and my reply was that although I wouldn’t, I wouldn’t be surprised if that worked for a couple of days but I’m not doing that because I don’t think the party is over. I think there is at least one more leg higher, thinking $1150/oz. by year end so I’ll be looking to get long some (of the equities, not the GLD if/when gold hits $850 because I think it can find support there and is very likely to find support near $800). This entry is going to be really tough I think because I'll want to chase strength which could be fleeting in the very short run; we’ll see.

Stock position: Long.