Jan 19, 2011: Looks like an intermediate term top (+ later updates)

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Just a brief update. It looks like we've hit an intermediate term top.

Leading to today:

  • Markets were in extreme technical overbought conditions.
  • Sentiment indicators such as Put/Call ratios, and news headlines have reached new multi-month extremes.
  • Earnings expectations were being revised to over-optimistic levels.
  • Breadth was deteriorating with some sectors like materials/metals and retail already in established 5-day downtrends, and micro caps greatly under-performing
  • QE2 effects were likely full priced in

Usually, under such conditions, it takes only one small spark to ignite the explosive mixture. Such a spark may be some disappointing earnings from one of the market darlings, or some renewed worries about a solvency issue of a large debtor. It doesn't really matter. Every day there are many pieces of news, some good some bad. In a too euphoric situation, where bad news have been ignored for too long, an unexpected spark that gets noticed is a matter of when, not if.

And the spark came in:

During the long weekend we got a spark in the form of Steve Jobs, Apple's CEO taking a leave of absence for medical reasons. This was carefully timed to occur on a long weekend, which precedes the best earnings report in Apple's history.

It was telling that despite absolutely unbelievably great earnings -- which one can assume the smart money already knew about, or at least was reasonably expecting -- Apple has dropped sharply from about $350 at the open to slightly below $339 at the close on roughly 4x normal volume. It is also telling that AAPL closed today at a lower level than it was before the Steve Jobs news came out. You can bet that the sellers were dominated by those who entered AAPL when it was much lower, while the buyers were mostly late-comers who always buy near the top.

Then after the close, another tech darling: F5 Networks (FFIV) came out with earnings that, despite of being pretty good, have failed to meet exceedingly optimistic expectations and the stock tanked 23% in a matter of minutes.

At the time I type this, US market futures are showing a slight green bias. Too small to inspire confidence. In addition: /TF (Russell 2k futures) are weaker than the S&P500 mini futures. Translation: breadth continues to suck.

So if tomorrow we'll see a small uptick on the open, which is typical in downtrends, I would be a seller into this uptick.

My bet is that in what remains of this option-expiration week, the smart money will make sure that people holding calls will see maximum pain inflicted on them. This means, optimistic hopes in early trading shattered in late trading and intensified selling pressure. I'd be very defensive, with a short term bearish bias here.

Update: Tue, 25 Jan 2011

The State of the Union adress and FOMC meeting (tomorrow) have helped holding the market up, but the signs are pretty strong that the run is over for now, IMHO. I think we'll see a break down very soon. I may be wrong but the picture is very dire.

Note how so many leaders are lower than they were 3 months ago: FFIV, AAPL, NFLX, LVS, CREE, VMW, GOOG. Note how one by one they are literally crashing after superb earnings (FFIV crashed 23% and today VMWare crashed spectacularily). Breadth is getting really bad: for the 1st time since March 2009, large caps are outperforming the broad market, and defensive sectors are outperforming risk-sectors, significanly. The precious metal darlings, Gold and Silver are crashing along as well. Couple this with extremely bullish sentiment, in spite of a broad 5-day downtrend of many sectors and broader ETFs: SPY, QQQQ, IYT (only DJI is still in an uptrend)

I sold all my VXX puts some of which I held since November (~48 to ~31 on VXX) for a ~3x gain, last Tuesday, anticipating a significant correction. Today, I bought some March ATM calls on VXX.

Update: Fri, 28 Jan 2011

The correction seems to be in progress. VIX is now in a 10 day uptrend (see right). Small/mid caps and 4 of 9 sectors (XLB, XLV, XLF, XLP) are in a clear 10-day downtrend, while overall sentiment is still too bulish. Two more sectors: XLY and XLU, while still being tecnically on a 10-day slight uptrend, have broken sharply below support and are showing lower lows on the 5-day charts. Finally, another leading sector: transports (IYT) looks almost as bad as small-caps.

The fact that small-caps were not confirming the new highs in the large-caps (DIA and SPY) on Thursday was telling. I believe it is more likely that the large caps will join the small-caps (and transports) down rather than the other way around. The 7-day-apart lower highs on IWM (Tuesday, Jan 18 to Thursday Jan 27) and IYT are the strongest signal.

The events in Egypt and Tunisia which have a potential to spill over into other totalitarian Arab countries, coupled with disappointing earnings from some big names, notably Microsoft, are just an excuse for a sel-off in a market that's still way over-extended.

For the 1st time in many months, VIX (Volatility) contracts are in backwardation:

 Date            Ticker  Expiry  Price   Monthy  per-day
 2011-01-28      VIX             20.04   0.00    0.00
 2011-01-28      VIX/G1  2011-02 19.35   -3.44   -0.16  <<< Feb is negative

 (VXX now has positive pull from the roll-forward.)

My March VXX calls are up over 30% today. This looks like too much too fast, so I won't be surprised to see some RTM relief Monday. However, the 'leaders' trend is now down, and so it is not the time to get long. I would use any short term spikes to get shorter.

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The above merely reflects my own thinking and actions at the time of writing. Every investor should make up his own decisions based on his risk tolerance, time-frames, comfort-zones, convictions, and understanding. Never investment advice.

Any feedback is welcome.

-- ariel