{"id":9304,"date":"2011-01-20T07:53:40","date_gmt":"2011-01-20T12:53:40","guid":{"rendered":"http:\/\/www.smbtraining.com\/blog\/?p=9304"},"modified":"2023-08-02T17:06:05","modified_gmt":"2023-08-02T21:06:05","slug":"morning-thoughts-120","status":"publish","type":"post","link":"https:\/\/www.smbtraining.com\/blog\/morning-thoughts-120","title":{"rendered":"Morning thoughts 1\/20"},"content":{"rendered":"

Good morning traders,<\/p>\n

This is somewhat lengthly, but I thought it might be interesting to republish my comments on equities from my morning Waverly Advisors report.\u00a0 Keep in mind that most of the readers of that report are working on a significantly longer timeframe, but this does help to keep yesterday’s moves in context:<\/p>\n

Equities: <\/strong>Equities are in the spotlight this morning.\u00a0 Let us say, up front and very clearly, that the most important thing is to avoid hitting the panic button and to keep this move in context.\u00a0 We have had a good run in equities, and we were fortunate to have our clients heavily long for a significant part of the move.\u00a0 This last trend leg has exceeded our expectations (targets) in terms of both price and time, and the market is overdue for a pullback.\u00a0 Clients following our trading plan should have been stopped out of no broad index exposure yesterday as our first stops should be somewhere between 1,270 and 1,275 (basis S&P Cash) for index products… Rather than paying attention to the emotions associated with a market move like this, we feel it is important to focus on three questions:\u00a0 what does this mean for equities in the short-term (1 week)?\u00a0 What does this mean for equities in the intermediate term (3-6 months), and, perhaps most importantly, how do we manage exposure?<\/em><\/p>\n

First of all, let\u2019s put this move in context.\u00a0 In terms of standard deviations, some of yesterday\u2019s moves were quite dramatic, with Microcap indexes selling off nearly 4 standard deviations (3.2%).\u00a0 (Note that this information is always available on the table in the back of this report.)\u00a0 Two things to consider are that these standard deviations are somewhat inflated because they use a period of exceptionally low realized vol (the past month) as a reference point, and that the selloff had a clear tilt with \u00a0smaller market caps getting hit much harder.\u00a0 The blue chip Dow Jones Industrials were virtually unchanged at the end of the day (-0.1%, -0.3 standard deviations).\u00a0 What has happened here is the same thing that happens to market leaders in any context.\u00a0 Small and micro cap stocks have dramatically outperformed for most of the recent run-up, and are highly overbought by nearly any measure.\u00a0 It is the nature of market leaders that they get hit first and hardest when the market blinks. \u00a0\u00a0They are sold aggressively for any excuse.\u00a0 In many ways, this is no different than high momentum market leading names which may sell off 10% – 15% in a few sessions, and then regain the highs within the next few sessions as standard operating procedure.<\/em><\/p>\n

The key in this scenario is what happens next.\u00a0 Some downside followthrough is virtually assured after a break from an area of compressed volatility, and first targets have already been reached in overnight markets.\u00a0 It is also to be expected that world markets will pick up on our weakness, and follow suit for at least a few days.\u00a0 Our first stops for partial positions (we would recommend these stops be for 40% – 75% of your exposure, depending on your desire to actively manage your risk) will almost certainly be hit, and this is absolutely fine because most of our clients should be holding significant gains at this point.\u00a0 No sense letting profits melt away under the weight of an overleveraged portfolio in a potentially soft market.\u00a0 The key is to see how quickly these smaller cap stocks are able to stop the bleeding, recover, and trade back to highs.\u00a0 It is exceedingly unlikely that this will happen within the next 2-3 sessions; to see the dip bought this quickly would be a sign of incredible underlying strength.<\/em><\/p>\n

We consider it far more likely that this selloff may have some teeth and may run several weeks, so it is also worth considering how you will manage the remainder of your positions.\u00a0 In the intermediate term, we maintain our cautiously bullish stance on equities, but we also do not want to be too aggressive in adding exposure back.\u00a0 You don\u2019t try to catch a falling knife\u2014the correct procedure is to let it stick in the floor, stop vibrating, then pick it up.\u00a0 We will do our best to find turning points if this selloff continues, but, for now, the correct course of action for most active traders will be to work on reducing and managing existing exposures.\u00a0 This is a perfectly healthy move in context of a bigger-picture bull market, but we must always respect the downside risk and the possibility of a much larger than expected decline.\u00a0 Do not get caught without a plan.<\/em><\/p><\/blockquote>\n