New High Before January - Possible

Bulls are celebrating today and there might be more coming for them! The earnings season is approaching to its end and it is way better than investors had feared. The Q3 GDP number is released today, again it is way better than investors had feared. Besides, what happened in Europe and China is also encouraging. European leaders finally become serious about their problem, and Chinese leaders become more growth-friendly. Before January, that is before the next earnings season and GDP number, what will a sensible investor do if a big chunk of his money is still sidelined? Surely there the market will zigzag in the next three months. But when the trend is clear and strong, miss a day will miss a lot.

Up Till November

We see the market will move up till November.

Germany and France vowed to save their banks, and the market is rallying on that news, even if some European countries are still doomed to fail. The catch is that they didn't have a package yet. They promised to have it ready by early November. Coincidentally it's earnings season between now and November. Investors will pay more attention to earnings while waiting for the Merkel-Sarkozy package. Recent fall of the market already priced in a new recession. The market doesn't need to have super rosy earnings to rally. Technically the market already broke 50MA, a major technical resistance. The next stop will be 200MA. We see by early November the market will move up to 200MA where it will face a major challenge. Plus by that time the earnings season is about to end and investor will switch back to the endless European problem. The Merkel-Sarkozy package will make it or break it.

Cheers! Until November.

Closer to Bottom

It's hard to guess the exact bottom when markets around the world are all sliding down. But it should be close to the bottom. For two consecutive days, XLK is stronger than the S&P 500, and XLU led the market down. XLU was the star in the August, September crash. It climbed to a 52-week high recently while every other sectors suffered. Clearly money was hiding in the traditional defensive sector during the market meltdown. Now with XLU being weak and XLK being strong, those money is flowing out the pit where they were hibernating for the harsh winter to embrace a warm spring. I sense the spring is coming.

Fundamentally Bullish, Sentimentally Bearish

Fundamentally now it is much better than 2008: there is enough liquidity in the financial system, and GDP is still growing. Even economists keep lowering their estimates on GDP, they still project growth. The problem is, the market is dominated by bearish sentiment. Many investors simply leave the market and stay on the sidelines. The only players in the market now are computer-driven momentum-chasing hedge funds. In the past two months, quant funds are the best performers in the hedge fund industry. If investors are indifferent and stay on the sidelines, nobody will stop the bearish momentum and we'll see new lows. Thus fundamentally I'm bullish, but sentimentally I'm bearish. I'll just stay with my strategy and enjoy the roller coaster.

RIMM Staged a Break Out, Real Challenge at around $30

RIMM may lead the market up from here if the "Garbage Effect" plays out.

RIMM Up 20% from Bottom, Garbage Effect in Play

RIMM, the most desperate hi-tech company, the loser in the the smart phone war, the orphan of the patent enclosure, rallied 20% from its bottom and stayed there when S&P 500 dropped another 5% this week. Considering it is still 65% off its May top, its latest strength is deafening. This is the so called "Garbage Effect" I wrote before. I've also predicted this to happen months ago in a tweet.

In short, the "Garbage Effect" is that a rising tide lift all boats. But garbage is lifted first than any boats, because garbage is the lightest stuff. If RIMM is rising, it means the tide is about to turn. Buy garbage to profit from the tide's reversal. Big caps and quality names will move much slower and will be lagging far behind.

Stabilizing Signs

OIS-Libor spread, TED spread, and China's A share are stabilizing. The real fear is contained. The sell off is exaggerated. Once the bottom is in, the rally will be equally violent.

Another Piece of the Puzzle: Double Dip Mortgage Crisis

Barron's reported that "AIG is planning to sue Bank of America to recover more than $10 billion in losses that the insurer incurred over mortgage-backed securities". Pieces of proof are just piling up for a double dip mortgage crisis.

Double Dip Mortgage Crisis

As a nice follow-up of yesterday's post where I mentioned the widening OIS-Libor spread, this morning Bank of American reported that its Fannie, Freddie exposure may be worse than anticipated. This sounds a lot like a double dip mortgage crisis. I believe it is the unknown unknown that alarmingly but quietly drove up the OIS-Libor spread and is not covered in the media and embedded into investors' mentality, necessary conditions for a perfect storm.

Wait for QE3 or a Exhaustion Round Bottom

The stock market is like a rubber band. When stretched, it either snap back or is broken. I think it's broken today though many think today is capitulation. Hopefully I'm wrong.

One piece of news concerned me is European banks collapsed today and European Central Bank restarted its bound buying program. I noticed that the TED spread and the OIS-Libor spread both widened significantly lately, which usually means there is a major credit risk down the road. European banks could be it and as far as I know it isn't covered in the media and is beyond imagination of most investors --- necessary conditions for a perfect storm.

Many investors are still hoping for QE3 that, they think, will save the world. But if there is a major risk down the road, the Fed will be careful to save its few bullets, if not the last one. It may take a couple more crashes like today before the Fed jump in. Investors want to act after, not before, the Fed, because the market drops fast, very fast.

Barring QE3, there isn't anything I can imagine that will turn over the economy. Then investors have to be patient to wait for an organic recovery which will be signaled by an exhaustion round bottom. Count years, not days, for this.

Institutions, Dumb Money, and Day Traders

Bespoke opined that the recent rally was driven by dumb money because the market moved higher in the first hour but lost steam in the last hour. I think Bespoke's reasoning is flawed. It forgot to account for the day traders, who trade for very short term and drive the market up and down by enormous amount of liquidity. Dumb money, or individual investors, is the most vulnerable under day traders' attack. I'd imagine that day traders will take the other side of dumb money and because day traders are more sophisticated and powerful, market will move against dumb money's intention. So if we see the market surges in morning, probably it is day traders that move the market up, trying to squeeze dumb money who's selling.

And it is normal that in the last hour the market moves in the opposite direction from that of the first hour, simply because day traders always close all positions - which they opened in the morning - before the market closes.

All in all, dumb money is not supposed to move the market, they are supposed to hold the bags after the market is moved.

Impression, Earnings Reports

It is one weeks into the earnings season and we have developed an impression that the economy is growing. But there is another crucial factor that will negatively impact the trajectory of the market, the Europe debt issue.

We focus our discussion on financials sector and energy sector, as we are long XLE and short XLF based on our ETF ranking system. There are a couple of high profile earnings reports from these two sectors, JPMorgan Chase last Thursday, Citigroup last Friday, and Halliburton today. The numbers are rosy: all of them beat EPS and revenue expectations. Moreover, both JPMorgan Chase and Citigroup’s business loans grew in the past three months ended in June. And Halliburton eyed surging demand and growing margins. All the facts point to a more active economy and GDP growth, and a higher price level of the stock market.

Nonetheless, banks are still under pressure in an unfriendly macro economic environment. Their stock prices moved lower in face of new unfavorable regulation policies, litigation costs, and low interest rates.

The most critical issue is the Europe debt issue. It is reported this morning that “Debt Anxiety Pushes Financials Down as Bank of America, Goldman Hit Lows”. Although the Europe debt issue is already aged in years, it appeared that there is still no convincing solution. The direction of the stock market will be determined by the outcome of the duel between a growth U.S. economy and a deteriorating Europe debt issue.