Author: Michael Arold
Model: Technical Swing
Disclosure: Long BLX, RAX, SGI, SLV, OII, TTI, TTM
I went into the month of March with a bearish bias. The Middle East crisis had just started, and important market breadth indicators such as the S&P 500 Percent of Stocks Above 50 Day Moving Average had sent out warning signs for weeks and indicated less and less participation of stocks in the rally. Market leading stocks broke down and declined rapidly within days – another warning sign.
Even though I was expecting lower equity prices, I was not able to benefit from the decline on the short side. Even though (or maybe because) many market participants were expecting a much deeper correction, equity markets reversed, while plenty of bad news dominated the headlines: the Japan disaster, Middle East unrest and European sovereign debt problems should have been enough to send stocks lower.
After the sell-off in the first half of the months, investors expected a rebound. It seems like the market is often trying hard to surprise the maximum amount of people. It wasn’t different in March: the rebound turned out to be much stronger than many anticipated and even drove small-cap stocks to new heights. The Russell 2000 Index closed at 840 on March 31 – a 52 week high, according to Yahoo Finance.
I was predominantly in cash during the sell-off, with some minor short positions. There is tremendous opportunity during major declines because the market often reveals strong areas. Many stocks head lower, but some manage to resist the selling pressure and demonstrate what is called “relative strength”. These stocks are often the ones who lead the markets higher. A sell-off presents a chance to recognize them. I went long several stocks that showed this pattern during the second half of the month: Blackstone (NYSE: BLX), Rackspace Hosting (NYSE: RAX), and Silicon Graphics (NASDAQ: SGI) are some examples in my portfolio.
I keep monitoring various developments on the macro-side:
The US Dollar keeps declining, which is usually bullish for commodities and US stocks. The Greenback is considered a safe-haven asset, so his value should increase during uncertain times. But that did not happen in March, even in light of Japan and the situation in Europe. So therefore I would expect more weakness in the weeks to come.
As a result, I opened a long position in the silver ETF (NYSE: SLV) for the model portfolio. The “poor man’s Gold” is intriguing in the short-term for simple technical reasons: Silver has been outperforming Gold and stocks for the last months and is usually inversely correlated to the Dollar.
Various fundamental reasons may also support higher prices for silver, one of them being the potential for a short-squeeze in futures contracts. In a short squeeze situation, a large amount of positions are held short and when prices rise, investors have to cover due to increasing margin requirements. With respect to silver, the number of open short positions is currently higher than in any other commodity asset class. According to a report from Smart Money Europe, as of March 7, it would take 140 days of silver production to cover the shorts of the eight largest traders, a record amount.
Another development in March: Oil moved above $100. High crude prices so far don’t seem to be affecting equities in a negative way. In fact, Energy stocks are one of the best performing sectors in 2011. As of 4/4/11, the Energy ETF (NYSE: XLE) is up approximately 17 percent in 2011, according to Yahoo Finance.
I added two long positions to the portfolio in March to benefit from the trend: Oceaneering International (NYSE: OII), a large cap oil services stock and Tetra Technologies (NYSE: TTI), a small cap oil and gas driller in the US.
Emerging Markets started to outperform again in March after showing relative weakness for the prior months. In order to benefit from the trend, which I expect to continue, I took a long position in Tata Motors (NYSE: TTM), an Indian Automotive manufacturer, who should also benefit from weakness in Japanese auto stocks.
A trade which was not successful in March was the investment in Canada-based Cameco Corp. (NYSE: CCJ), a leading Uranium company. I made the trade after the Fukushima catastrophe, in anticipation of a short-term price rebound. Unfortunately, the scenario didn’t materialize and Cameco did not participate in the recent global stock market rally. I therefore closed the trade with a small loss. Longer term, Cameco still might be an interesting play since it seems unlikely that countries like China or India would abandon their nuclear plant ambitions because of the Japanese catastrophe. However, it is unclear at this point how much further CCJ can fall before rebounding. As long as the situation in Fukushima is critical, I prefer to stay away from the company.
Going forward, I maintain a bullish stance. After the strong March rebound, market participants are likely to buy minor pullbacks in order to “get back into the markets” as long as basic fundamentals do not change.
Sources:
“Short Squeeze! Here Comes 50-dollar Silver” Zero Hedge, 3/7/11. http://www.zerohedge.com/article/guest-post-short-squeeze-here-comes-50-dollar-silver
