Reader Steve Poses a Holiday Weekend Short-Selling Puzzler

I got a great comment this week from reader Steve, on my post about why the appointment of new Fed Chair Jay Powell just doesn’t matter. Steve wrote:

Lee your commentary is always intended to be fact based and well informed. Thanks. It does appear at the moment that your shorting call based upon liquidity is too early. You originally discussed having a small short position and we have had the short-term LAMP red for weeks. Further, your commentary discussed huge financing requirements for the US Treasury based upon TBA advice. And – diminishing foreign demand for US treasuries. Therefore, where is commensurate the liquidity crunch and the pull back in stock prices.? So far, just seeing record high after record high. For now, it appears that the liquidity crunch is non-existent and at best temporary – if the markets significantly retrench, the Fed will again go back to Q/E. Look at the BoJ – they have expanded their bank balance sheet to 70% of GDP. The US can do the same. Grateful for your view. Thanks.

I read Steve’s comment on Wednesday morning before Thanksgiving, and I knew right away I wouldn’t be able to enjoy Turkey Day until I had addressed it. Steve’s comment touches on a number of important issues, some of which I’ve alluded to in recent posts, but others not.

First, I can’t stress enough that shorting stocks or indices must finally be based on technical analysis. Liquidity establishes context, but the charts rule. If you are not a chart trader, then I would suggest a good technical charting service to guide you before you even think of trying short term trading.

There are several experts right here at Money Map Press, including D.R. Barton and Shah Gilani, who can help you with that. You should be comfortable with their approach before you start trading. It’s a risky, high intensity business that requires some time and attention.

I also offer a short term trading service at my site, The Wall Street Examiner, if you are interested.

Let Me Be Clear – This Market Is Running on Speculative Fumes

The Short Term LAMPP signal does look wrong, but there’s some nuance that at least excuses that mid September signal a bit. Since that time, my trade setup screening algorithm has produced almost as many shorts as longs, until the last 2 days. During the mid September to mid November¬† period, trades on the short side did just as well as long side picks. The market averages rallied, but cyclical momentum and breadth weakened sharply, allowing profits to be made on the short side in the right stocks. The shorts actually outperformed the longs for a couple of weeks. That was not the case before September when only longs were profitable.

In the last 2 days, there has been a massive shift back to the long side. Whether that will prove to be a false start remains to be seen, but we should know within the week after Thanksgiving. The period from then until Christmas is normally strong. If the market falters instead it could be a sign that the jig is up.

There has been an enormous increase in Treasury supply since mid October. I expected that to depress the markets. It has not. That appears due to a couple of things. One is a massive influx of cash from Europe and Japan, as their central banks continue to print money and then punish it for staying in their home markets with negative interest rates. That drives the big institutions to instantly shift cash to Wall Street by purchasing US Treasuries and US stocks. That adds to liquidity in the US market.

The second factor is increased use of margin and other types of leverage as the rally proceeds. That’s dangerous.

Meanwhile the Fed has only begun to pull cash out of the banking system. That draining activity will increase dramatically over the next 12 months. And in January the ECB will cut its QE purchases in half.

As a result of these factors, my target for the market’s peak has been January. The looming revisiting of the debt ceiling crisis is a wild card, but that will only be a short term effect. Ultimately they’ll do a deal that will take that issue off the table for the foreseeable future.

In the meantime, my conclusion is that the market is running on speculative fumes. My technical work using the cycle theory of JM Hurst has for a long time projected a long term top in the 2600-2650 range. We’re there. The probability of a top in this area over the next 3 months is high. I would short the market when the charts tell us that the turn is under way. Not before.

Sometimes Rule Number 2, “The trend is your friend,” or “Don’t fight the tape,”¬† supersedes Rule Number 1, “Don’t fight the Fed” for a few months. Since the Fed has barely started draining funds from the system, this is one of those times.

The short term LAMPP has looked wrong (with some nuance) but the Long Term LAMMP hasn’t gone red yet. There’s no long term sell signal. But it will happen, soon. When it does, the market will be primed for a downturn. We’ll look to the technical charts for specific timing.

I may have been guilty of being less than clear about the issue of timing short sales in past posts where I talked about the issue. I hope that this clears that up.

In the meantime, from an investment perspective, I’d continue to systematically sell small portions of your portfolio to raise a significant cash cushion by the end of the first quarter of next year, if not by the end of January. I’m shooting for 60-70% cash. Your requirements will differ depending on your personal circumstances. Only you can decide what’s appropriate for you, but having a lot of cash will provide protection from loss, and will give you the opportunity to pick up bargains over the next several years.

Just not right away. I would avoid buying anything at these levels. We are getting very, very close to the final top.

Happy Thanksgiving! – Lee Adler

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