Lack of Recovery a Bad Sign
January 9th, 2008 by Buck Woodford
Market indexes have been slapped silly in 2008’s first few days — and the carnage in more speculative stocks is, in many cases, several magnitudes larger than the Dow and S&P’s fall.
The markets seemed to be finding their footing after 7 straight down days — but during the 11:00 hour, Countrywide was reported to have falsified some sort of documents. More mortgage mess. The market broke down sharply. A microcosm of the market we currently face.
Coming into the day, we held some exposure to the short side via TWM (an ETF that trades 2x inverse to the Russell 2000 Small Cap Index). Thus the news and downside move was positive for us.
Then, over a 30 minute period, the Put-Call Ratio — the number of puts traded on US option exchanges divided by the number of calls traded — leapt to a number I have never seen before: 18. It usually lies somewhere around 1. That shows intense fear, as everyone and their mother is panicking… which is typically a beautiful time/place to close out a bearish trade.
I decided to close out our short exposure by selling the TWM shares because of the huge Put-Call reading. The risk on that downside-focused trade wasn’t worth the reward that I perceived. I didn’t like the odds. My decision was correct at the time — and correct in hindsight, for several hours.
Later.. The market takes an abrupt, brutal beating starting about 2pm. It’s because AT&T lowered EPS guidance and made some “consumer is soft” comments. That’s how fragile this market truly is. Their stock (symbol T) tumbled 8% in a few minutes. And took everything else with it.
We made money on TWM, but obviously would rather have captured bigger profits from the selloff. That yellow arrow on the chart shows the time/price of of our TWM sale. And the explosive nature of the market’s mini-crash made it hard to re-establish short exposure as I like to — on pullbacks.
The fact that markets could not recover after such extreme early panic is a bad sign. However, the “rubber band” is stretched far to the downside. Conclusion: Either side (long or short) is a dangerous place to be right now. Thus we are less than 10% invested.
Our strategy’s current defensive posture is helping avoid large losses, and we will continue to vigilantly protect capital.
The index charts have nothing to offer right now, but are certainly causing many investors’ jaws to hang open:
