Stock investing advice has been bullish in the last year or so, thanks to a historic run higher for stock picks — one that hasn’t been seen since the late 1990s. And the markets news has been driven by expectations for more robust economic growth and a surge of easy money from the Federal Reserve’s $600 billion “QE2″ money printing operation.
Just look at this: Through Friday, the Nasdaq Composite has closed above its 50-day moving average for 126 consecutive trading sessions. That kind of consistency has only been seen a few times in the last 40 years. On average, excursions above the 50-day average only last 24 days. The longest consistent rally was back in 1983 at 227 days — a feat that coincided with the triumphant defeat of inflation and the recovery from the double dip recessions of the early ’80s.
But now, these catalysts are coming to an end. And two trades I’m looking at are a long exchange traded fund investment in the Market Vectors Indonesia ETF (NYSE: IDX), and a shorts-side investment in Banco Santander (NYSE: STD).
During intra-day trading on Monday, the Nasdaq Composite has fallen through its 50-day moving average — setting the stage for its first close beneath this important technical level since September 2. Wall Street traders, for their part, are frantically preparing for continued declines. Here’s why.
Unfortunately, we simply don’t enjoy the same tailwinds that were present during the 227 day rally back in 1983. We face the prospect of higher inflation, higher interest rates, and slower economic growth in the months to come; the opposite situation of what was faced back in ’83. Moreover, as the chart below shows, even the epic rally of 1982-83 ended badly over the medium term: Once the uptrend broke, investors faced a year-long selloff.
Wall Street traders have already bolted towards the exits. Equity put option activity has been on the rise for four months, the longest sustained rally since the April-June period last year. Cyclical stocks continue to badly underperform. The list goes on and on.
One really interesting development has been the surge in put option buying by so-called “smart money traders” in S&P 100 option contracts. According to Jason Goepfert of SentimenTrader, put option activity in the S&P 100 — which pay off in a big way when the large stocks in the S&P 100 move lower — has increased to levels not seen in nearly 30 years. Previous highs, in February 2007 and January 2000, marked major turning points for the stock market.
Open interest in S&P 100 options contracts is also reaching an extreme, moving to levels not seen since late 2007. This reinforces the message since index option activity picks up when traders are worried about downside risk; on the other hand, during times of confidence, equity option activity picks up. Traders tend to make bullish bets on individual stocks when things are rising but prefer to have downside protection against the entire market on the way down.
Translation: After a massive, uninterrupted rally investors are panicked on a scale not seen since the end of the last bull market.
Because of the deteriorating situation in the economy and the financial markets, I’ve recommended a net short positioning to my newsletter subscribers — hedged with a select few long positions in strong emerging market ETFs such as the Market Vectors Indonesia (NYSE: IDX). I expect materials and financial stocks to suffer the worst in the days and weeks to come — with Banco Santander (NYSE: STD) looking particularly vulnerable due to its exposure to Spain and Portugal, which look to the the next dominos to fall as part of the eurozone debt problems. Read my previous article on why you should short Santander.
Disclosure: Anthony has recommend IDX long and STD short to his newsletter subscribers.
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