Don’t Fight the Tape

Early in our career, we learned the importance of
recognizing when the market was telling you that you were wrong. While some
people dismiss this out of hand, claiming to be only “early” or “late,” we do
not adhere to that philosophical dodge.

You either nail it or you don’t.

That’s why each and every one of our market forecasts has a
built in error detector, a line in the sand where we must acknowledge that the
market is behaving differently than anticipated. Those lines, laid out on May
2nd (and before), were Dow 10,400, Nasdaq 1990, and SPX 1165. The SPX crossed
first, then the Nazz and finally the Dow last Wednesday. That was the signal to
us that a bearish stance was untenable, at least for the intermediate term.
Having those upside triggers performs two functions: first, it creates a stop
loss on any market call. While we are willing to be wrong (and quite frequently are)
we are unwilling to stay wrong.

Thus, these limits prevent the markets from
running too far a field from any positions we have.

Second, this acts as a rigorous error correction methodology
to prevent us from calcifying into a perma-anything. All too many of our peers
who were bullish in 1999 remained that way all the way down, as Nasdaq shed 80%
of its value. Conversely, we are aware of too many strategists who had drunken
the kool-aid, and
ignored the markets when they bottomed and reversed in October 2002 and March
2003.

To our way of thinking, wearing the scarlet letter “P” (for
Perma-B___) is a fate worse than death. As such, it is our ongoing endeavor to
remain flexible, nimble and open-minded to what Mr. Market is saying. And he
has been speaking quite loudly lately.

As we noted several times last week,
with those lines crossed.

The question which remains is how much cash to deploy and how fast.
The speed of the markets lift upwards urges some caution. A short period of
digestion is the likely result of the blast off from April’s lows. However,
that may be offset by the generally under-invested position of much of the
Hedge fund community. They are still licking their wounds following the GM long
short trade, and may be suffering from a combination of excess cash and
performance anxiety. Recall this was potent combo in late Spring 2003.

As such, we counsel legging in here slowly. Of the major
indices, Nasdaq has looked the strongest technically, with SemiConductors
particularly robust. But its overextended, and that warrant a more deliberate
capital deployment, preferably, on dips. Our lines in the sand are now to the
downside: Dow 10,400, SPX 1,181, and
Nasdaq 2005. Those are your hard stops.