We are a bit divided on strategy at this point. We speculate that program trading stepped in when we hit the 10% technical sell off on the indexes. Once this happened, shorts may have come in to cover their bets. On the flip side several weeks of selling may have pushed the indexes into an oversold state and we could see stabilization from here, which means we missed the opportunity to buy.
Currently, we are not in the frame of mind to chase this market. However, we would like to drop our cash position to or below 10%, if the market stays flat before the FED meeting. We also think that there is an additional possibility for the market to drop back toward the 10% technical level, where it would be nice to deploy cash. In the end it may be best to sit tight and watch today’s action.
A quick follow up from a reader on Seeking Alpha. We also look at the economic variables involved and not just the technical side of the market. It is our view that the market is just correcting to the reality of the economic state of affairs and that the bedrock of the economy is still firm. Once the sub-prime news subsides and people realize the world is not caving in, we think there could be upside.
Our current thesis is that the FED will step in sooner than later to start pumping consumer liquidity in the market via the discount rate. This was a shift in thinking from 3 weeks ago. The sub-prime issue has just served to expedite what the Fed was looking to do anyway, drain liquidity from the market. The sub prime issue is causing the shuttering of private liquidity pools and engines. Hence, the need for the Fed to step in as a “lender of last resort” and a soon-to-come rate cut.
This is why we are a bit indecisive. The economy was already cooling and we suspect the recent issue in the liquidity arena could serve to tighten the breaks a bit more. In turn, this could cause the economy to slow a bit more than the Fed would have liked. Additionally, the recent downward move in commodities will really help those future inflation numbers if it continues to sell off, and may serve to untie the Fed's hands a bit.
However, the market is often a future indicator of the economy. Will it catch wind of the economic re-acceleration sooner or later? This is the dilemma. At this point we don’t see another 10% downside. However, there could be another 3% to 5%. At this stage it is not a question of if, but when do we enter the market. Today and the next 2 weeks shall be very telling.