Separating Truth From Nonsense

The Importance of Sentiment

Dear Bottarelli Research Member,

For most of today’s trading session, the Dow has slowly inched lower and lower. While the recent winning sectors (like gold, oil, and commodities) are taking it on the chin today, I must admit that the bulls are doing a nice job of keeping the losses manageable. As I review my ticker screen, for example, the losses in some of these sector groups could’ve easily resulted in a 200-300 point loss on the Dow. But as it stands, the total losses have only been around 125 points. As it stands right now, here is my read…

When you look at the daily Dow chart, you’ll see that yesterday’s slight move above the 200-day moving average at 8,750 appeared to be a false breakout. Combine this false breakout with today’s drop, and the technical read clearly points to a re-test of the 50-day moving average at 8,250. As I noted in the chart, this would actually be a healthy 500-point correction for the bulls.

Now I admit, this would be the situation under normal circumstances. But as you know, we’re operating in an environment that is far from typical.

For example, anyone with a brain and a sharp pencil can connect the dots between the current economic situation and the fundamentals on the current Dow chart. Those that have done this exercise, in my view, have all been short over the last few weeks. That’s where the conflict between reality and outside influence comes into play.

As I mentioned earlier this week, 70% or our country’s economic growth comes from the American consumer. And right now, we all know that the majority of American consumers are jobless, cash strapped, and without any financial reserves. What’s more, 20% of U.S. homeowners are currently underwater on their mortgage, meaning they currently owe more on their home than it’s worth.

Since this home-based ATM spigot has been abruptly shut off, cash flow for the average American consumer is drier than the Sahara desert. People are just not spending right now, no matter what type of bogus statistics you hear. Case in point, the two hotels I recently stayed at in Hawaii were completely vacant. I would estimate that they were at 25% occupancy, and that’s being optimistic.

The U.S. government will tell you that unemployment is still under 10%. I say, “bullroar!” If you factor into the equation people who have given up looking for jobs, and also factor in those who are currently working a makeshift job just to make ends meet (like bartending or bagging groceries at Whole Foods), you’ll realize that the “true” unemployment rate is closer to 20%. As a point of reference, unemployment during the Great Depression hit 24%. Folks, in my honest opinion, we’re right there. This is truly a modern-day depression. The one trump card, however, is the meshing of the Fed, the Treasury, and U.S. governmental policy. Never before has the line between all three organizations been dissolved by an order of magnitude.

In my opinion, the fact that the market is being goosed by countless trillions of dollars has now caused a snowball effect that has cast major ripples throughout Wall Street. For example, I noted above that anyone with a brain and a sharp pencil can analyze the dire market situation right now and enter into a short position. Many of the top traders that I know have done this repeatedly over the last two months. The problem is, when the U.S. government funnels money into the system, those short players are forced to cover their positions. They’re not going long, mind you. But rather, they’re zeroing out their ledger by covering their shorts.

As a result, this massive “short-squeeze” phenomenon translates into sudden and powerful upside market movements, which have fueled the 3-month upside move that we’ve just witnessed. In other words, the recent rally has been nothing but short-covering induced by outside market influences. Now I admit, CNBC will bring on some talking-head with a skyline photo in the background, who tells you that the market is up that particular day because Wall Street is cheering that only 450,000 jobs were lost last month. They’ll bellow out nonsense like, “losing only 450,000 jobs is much better than losing 600,000 jobs like last month – that’s green shoots baby!”

C’mon, give me a break. There’s a vast difference between a market that’s (perhaps) stabilizing and a market that’s recovering. Right now, we might be in the very, very early stages of stabilization. But until we have job growth (as opposed to fewer jobs lost month-over-month), we’re nowhere near recovery. Ben Bernanke tells us that the worst might be behind us. Heck, after bankruptcies at Countrywide Financial, Lehman, Bear, General Motors – and near implosions at Fannie/Freddie, Citigroup, AIG, and Washington Mutual – that’s not a gutsy statement. But I still refuse to buy into the idea that we’re poised for recovery.

Let me stop myself for a moment. I apologize about the rant above. I didn’t mean to get into all of this, but the words just spewed out on the page. My overall point right now is this: From a trading perspective, market sentiment now makes up 90% of our success or failure. Therefore, it’s critical that we play the market “tape” while ignoring all of the extraneous garbage that’s floating around day after day. This is not an easy task. But lately, we’ve had a small run of success, which is something that I’d like to continue.

For example, we might not intuitively believe in a certain trend, but nevertheless, that shouldn’t stop us from profiting off this trend (no matter how bogus we believe it is). Our recent winners on OIH June 110 Puts (OIH RB), AGU June 50 Puts (AGU RJ), and GG June 38 Calls (GAG FC) have been good examples of this philosophy. For example, I personally don’t believe that oil prices will move lower over an extended time-frame, but that didn’t stop us from hitting a quick downside winner on the OIH. I also love the idea of owning gold for a run above $1,000 per ounce, but right now, we might play gold puts due to an apparent short-term pullback.

The point is, going forward, I’ll do my best to play the sentiment trends in the most successful manner that I can. After all, we’re all here to make money — not to preach our core beliefs on a city corner soapbox. Although it took me 1,135 words to communicate this point with you, that’s my underlying trading mindset right now. So before I launch into another 3-page diatribe, I’ll simply sign off for the day. And as always…

Lock and load!

Sincerely,