Quick Update

Projection Update:

What projected: S&P 850 -> 956 retest (90% chance) -> 1020

What happened so far: 956 -> 865 -> 956 retest (passed) -> 1017

Today: 999

Within 1 week: more whiplash around the 1000 mark (50%), retest of 956 (50%)

Within 4-6 weeks: retest of the 900-910 range (75%), retest of the 850-865 range (25%)

Within 3-6 months: 870-1020 whiplash (75% chance), 1100-1200 retest followed by a guaranteed large crash (25% chance)

Analysis:

The longer-term projections are virtually unchanged from my last post. So far this trend had played out as if scripted, which means my analysis of the major market movers are close enough.

At this point you should be 10% long. This will be your long term holding and inflation hedge. I made a mistake during the profit taking phase by taking profit on X first before anything else. Likewise, I did not stretch my profit on financials either. Profit on X was taken around the 990 level, and I took profit on financials on the 1005 levels. In general, the mistake was not sticking to "people's favorite" stocks at the end of the trend. Hypothesis: the stocks with weaker fundamentals and earnings, but a higher following of unsophisticated investors due to being "relatively cheaper" on the year term, will whiplash and linger near the top for longer when the trend changes.

Keeping a portion long on US stocks at this point despite the trend turning is an defensible move, as long as a major force driving US stocks is inflation fear. As US stocks drop, the USD's value actually rises, and so dampen your real loss.

What to keep? I still believe in keeping defensive stocks with good fundamentals within each sectors. NUE for steel, WFC for financials, PLD for commercial RE, PHM for homebuilder, etc.

I don't recommend keeping any energy stocks as they are all overpriced. I do like MXY.TO, a new geothermal stock. Apart from having excellent fundamentals, it enjoys the psychological benefit of being a new IPO. Since there was no giant upswing on the first few days of the IPO, the current holders of the stocks are not likely to be mostly day-traders. Furthermore, a new IPO means that insiders and institutions can not sell yet due to their lock-in period. MXY.TO will surely correct like everyone else, but it should be milder than that of other energy stocks.

AIG and a quick status update

A few friends at work was perplexed about AIG and here is my explanation for it:

No! It is not "short covering caused by a reverse-split" like some author on Marketwatch wrote. A reverse split means that if you were shorting 20 shares at $1, now you are shorting 1 share at $20. There is no scarcity of shares to cover since you simply need to buy fewer to cover as well. More importantly, the split happened a month ago, and AIG dropped in half after the split. This 2-day rally had simply brought it back to the $20s level, which is the equivalent to the $1.25-1.50 range it was at before the split.

So why? In the last 2 days, not just AIG, but a lot of "fundamental-less" stocks such as CIT, C, FNM, and FRE rallied massively. In fact, they led the market!

The answer is sector rotation. This is when the "strong money" dump the losers and pick up some winners (defensive stocks with good fundamentals that will survive a correction with minimal damage), while the "weak money" got smacked around by greed and fear to become the other end of the trade. 

I don't use the term "smart" and "dumb" money, by the way. They are nice epithets, but inaccurate. Most investors and traders, excluding the large funds and the trading arms of big banks, are too small. Their firepower is not enough to move the market. They also never act in concert due to being in a constant struggle to outdo one another. They are little tin soldiers fighting among themselves while there are monsters roaming. I call them the "weak money", easily swayed by the psychology of greed and fear, due to an acute self-awareness of their lack of power. It is human nature to be easily swayed when you feel weak, and it has nothing to do with intellect. The "strong" money are players big enough to move the market by executing large orders at key moments to shock the fragile psyche of the weak money.

As for the trend, I think we will whiplash for a while, and we may overshoot the 1020 target by 15-20 points, but I am not adding to my long. However, I am not pulling the rest of my long off the table just yet. I have been taking profit on the long at the 1000-1005 levels for the last few days, reducing my long holdings from 40% to around 13%.

There is an important date coming in 2 weeks, the option expiration day. The movement during that week may change the psychology of the market and we may have to reevaluate our projections. Remember, the "strong money" only starts selling hard when they sense that the "weak money" is steeling up. If they still can milk the market, they will, and we cannot afford to be overconfident.