Prepare for an Exceedingly Treacherous Market

Jun. 2.10 | About: ProShares UltraPro (SPXU)

From a letter to clients I wrote only 31 days ago...

Moreover, the market's current position and posture argue for an intermediate term decline. Assuming forthcoming events prove correct my analysis (a decline to SPX 900-850), the possibility looms for a deeper decline based now on a weakening backdrop. But one step at a time. I would be remiss if I were not to mention my conviction that the leveraged short ETF, SPXU, will redeem your patience, and your portfolio, many times over. Markets never are mono-directional forever, oscillations against the prevailing trend do occur, and the current market has many reasons to decline, short and intermediate term...

May 2010 proves to be the worst monthly decline since February 2009 and the worst month of May since 1962; SPXU, in turn, roared higher. The question now is, "What and where next...?" To that end, I study the chart of the SPX... (click to enlarge):


..the ominous Head & Shoulders top identified previously -- and whose crucial trend line (the drawn neckline) the market stubbornly refuses to breach. At least to date. The pattern since March 2009 is not a pretty picture, if you rely solely on its look. Other factors come into play, though -- sentiment, market internals, money flows, geo-politics, etc. -- that to rely on one item is folly. Nonetheless, many gauges and metrics align with a bearish tilt.

Easy to imagine many scenarios:

  • Equity markets plummet now;
  • Markets trade sideways for a few weeks or even a few months before breaching the neckline;
  • The markets stabilize, and the feared correction is more time and shallow price than deep price.

So I exercise patience while I also search for signs of the true break. Easy to imagine my tactics whichever way the market breaks:
● Down -- buy more SPXU;
● Up -- immediately reverse course (cover SPXU and go long)

As of this moment, I still believe the market's intermediate term (the next ~4-6 months) trajectory is down to SPX 900-850, arguably lower. No matter the outcome, the onus remains upon me to identify now those stocks that manifest as excellent long term investment opportunities. Which is largely how I spend my market days: Identifying the new leaders and the true market direction.

I hope you are equally as happy as I am confident that the decision to increase cash to a dominant percentage of your portfolio was the correct choice. The market appears exceedingly treacherous right now, and for the next several weeks and months. Certainly, the systemic peril has never been greater, 2007/2008 included, the opportunities never fraught with more risk than now.

Disclosure: Long SPXU.