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In
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We've
got a lot to get to today, so we'll do so without any fanfare. On tap for
this mid-week edition of the Micro Cap Press newsletter....
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From the Editor:
Swapping Out Some Stocks - We're adding one to it, but subtracting
two from the editor's 'sandbox' portfolio. Which one is being added?
One of the four discussed on Saturday,
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A Special Offer
for Micro Cap Press Fans - More, better, and faster. If you thought
the free Micro Cap Press newsletter was good....
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Another Bearish
Red Flag - Add a contrarian interpretation of sentiment (with a
twist) to the growing list, as if today's selloff wasn't bad enough.
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From
the Editor: Swapping Out Some Stocks |
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In this past
weekend's edition of the newsletter, I posed four possible new additions
to the sandbox portfolio. I'm pulling the trigger on one of them, though
I'm more than offsetting my risk by pulling the plug on a couple
of existing positions. Let's just work through them one at a time.
What I'm
Buying
 You
may recall American Equity Investment Life Holding (NYSE:AEL) was
the insurance stock with lots of momentum and even more value, with single-digit
P/E ratios supported by very reliable earnings. Though it's off a little
bit today, of the four names I mentioned, this one just seems to
have the most resilience..... which will be important if the brewing pullback
(see below) hits us as hard as I expect it to.
So why buy
any stock when you think you're headed into the wind? A couple of reasons.
One is,
the best of the best stocks can and often do overcome marketwide bearish
tide's. The other reason - this is one of those quirky industries
(insurance) that has a knack for trading independently of the rest of the
market anyway.
That said,
above all else, I'm adding AEL to the sandbox portfolio not
because I know what's going to happen, but because nobody knows
what's going to happen, and we need to optimize our risk/reward proposition
for that unknown. American Equity Investment Life Holding shares have
the best shot at going up in the near future whether the market sinks or
rallies from here.
What I'm
Selling
 I'm
pulling Transcend Services (TRCR) out of the portfolio, not because
I've changed my mind about the company, but because I see TRCR as one of
those stocks that's highly vulnerable to a marketwide selloff. We've held
it through a pretty big runup, and actually have an 18% gain left to protect.
Better to take what we've got and reduce our risk, than let ego and sloppiness
get in the way. Who knows? I may buy it back later.
I'm also making
an exit of Triangle Capital (TCAP). Like Transcend Services, we've
got a profit to protect (a small one of 9%, but still). And, given
the height of the recent daily bars, I've got a feeling we're seeing the
torch being passed from the bulls to the bears; a string of tall bars often
comes at the beginning of a rollover. Today's lower range - and open
and a close under yesterday's low - makes me even more suspicious that
TCAP is going to be one of the selloff's heavily-punished victims.
If my math is
right, we're about 50% invested right now and about 50% cash in the sandbox
portfolio right now.
My allocations
to each trade have been 5% of the portfolio's value, which gives us room
for 20 individual trades.... not that I have to own that many at any
point in time. I know I don't want to own 20 trades and be 100% invested
here at what seems to be a short-term top, but it would be a mistake to
be left completely empty-handed if for some reason the market continues
to roll higher.
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Though it's
been a while, we've looked at the ISE Sentiment Index before. Just
to refresh everyone's memory though, here's the crash course (which
you'll need to understand if the outlook below is to make complete sense).
The ISE Sentiment
Index - obviously - falls into the sentiment index category, along
with the CBOE Volatility Index and the put/call ratios for all the exchanges
that trade options. In fact, the ISE Sentiment Index is the ISE's
put/call (option) ratio.
 What's
not as obvious is that these three indices, along with a few others,
also fall into a category of tools called contrarian indicators.
Quirky 'contrarian' interpretations of conventional data sets allow their
followers to (1) spot extreme bullish or bearish opinions, and (2) take
on trades or positions that are very much in the minority at that point
in time.
Or said in simpler
terms, when the sentiment tools suggest the market is very bullish,
contrarians see it as bearish. When sentiment indices say investors are
stunningly bearish, contrarians start thinking and trading bullishly. Indeed,
in the past when put/call ratios spiked to extraordinary levels because
fear was rampant, contrarian traders viewed it as capitulation. Conversely,
when complacency and confidence was high and put/call ratios reached unusually
low levels, contrarians viewed those periods as short-term market tops.
Oh, and
one more thing.... skilled and experienced contrarians have made small
(and sometimes huge) fortunes, because they're right - and perfectly
spot the market's pivots - a great deal of the time.
While an excessive
number of followers and incredible market volatility have somewhat negated
the effectiveness of using spikes and plunges in sentiment indices as contrarian
clues, another methodology is emerging that is proving to be quite
helpful.
This is where
today's 'bearish red flag' comes in.
 Like
we said, the raw daily data of the ISE Sentiment Index isn't all that helpful
any longer.... it's just too erratic. The TREND of that daily data,
however, can tell you quite a bit about the market's true undertow.
That's what the nearby chart illustrates.
To take the
erratic daily data and smooth it out onto a trend, we simply need to add
a moving average to it. Or in our case, we've added two - a faster one
and slower one (sorry, the settings are proprietary). And just to
cut down on the chart's clutter, we've grayed out the actual daily data
so we could focus on the two moving averages.
The arrows are
the points where the two moving averages crossed one another. The blue
arrows are bullish crosses (short-term under long-term average),
and the red arrows are bearish crosses (short-tern over long-term
average) See anything incredible?
It wouldn't
be accurate to say it was a perfect tool - we saw a couple of fakeouts.
It caught the majority of the big swings though, and usually right
at their beginning.
Though this
type of contrarian interpretation spots the 'move towards a strong opinion'
rather than the apex or trough of an opinion, it's still clearly a valuable
premise. And more important to us right now, we just saw a bearish
cross of the ISE Sentiment Index's moving averages. Add this to the
list of bearish evidence.
Here's
a full-screen shot of the S&P 500 versus ISE Sentiment Index.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
