Monday, March 5, 2012

"Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway." --Warren Buffett

THE MORE INTENSE THE DIVERGENCES, THE MORE INTENSE THE CORRECTION (March 4, 2012): Since I posted my last update detailing numerous negative divergences in the global financial markets, these divergences have increased and intensified. All of the classic leading equity subsectors, including semiconductors, smallcaps, commodity producers, and transportation shares, have been progressively underperforming in recent weeks. Classic lagging assets, including the Dow Jones Industrial Average, the S&P 500, and especially Apple, have mostly been setting new highs almost on a weekly basis. This has caused the average investor to accept media claims that "the market keeps rising", while ignoring the decreasing number of new 52-week highs for both the NYSE and the Nasdaq since February 3, 2012. After doing virtually nothing in January, top corporate insiders have substantially increased their selling. Amateurs who had made net withdrawals from equity funds every single week but one from August through December 2011 have recently switched to net inflows.

It is unclear how extensive the upcoming stock-market correction will be, or how intense. However, it is important to sharply reduce your equity exposure and even to go net short. I unloaded all of my equity fund positions and on Friday (March 2, 2012) made a small purchase of HDGE, a fund of pure equity short positions with a capped expense ratio of 1.85%. I plan to add to this position if it continues to decline in price. Otherwise, I am happy being almost entirely in cash, which is usually underrated.

It is probably premature to declare that we have entered a new bear market. Far too many hedge funds and momentum players are heavily into U.S. Treasuries, or the U.S. dollar, or are short the euro, or remain substantially underinvested in equities. Therefore, following the upcoming correction, you should expect yet another risk-asset rally in order to encourage as many hedge funds and momentum players and chartists and institutions as possible to switch to the long equity side. During the next stock-market surge, probably this spring, I expect U.S. Treasuries and their funds like TLT to plummet to punish the huge number of buyers since late July 2011. Once they are mostly flushed out, while the U.S. dollar index eventually bottoms around 76, we are likely to experience a true bear market in which most broad-based equity indices including the S&P 500 index slump at least 30%. This will happen later in 2012, probably in the summer as it did in 2010 and 2011, and perhaps extending into the early autumn.

Whenever an increasing number of indicators are telling you to get out of the market, while the media are telling you to get in, you know it's time to stand aside.