They say that a picture is worth a thousand words. If you are wondering why stocks have been rising like crazy since September, look no further than the picture above. After pouring capital of record proportions in US Treasuries in 2008, 2009 and the better part of 2010, investors have finally decided that bonds might not be the safest place to keep their money during periods of rising inflation expectations. When the fear of missing out on a rally becomes bigger than the fear of losing, magical things happen and momentum styles outperform.
For the week, the equal weighted St50 index appreciated by 6.05%, outperforming the S & P 500 by 334 basis points and the Nasdaq Composite by 298bp. This was a record return for the St50, even bigger than the ones achieved in each of the first two weeks of the year. Such returns are abnormal in their nature and we certainly don’t expect them to repeat too frequently. We don’t confuse brains with a bull market and we realize that sometimes extreme bullish readings are a sign of potential danger, not a sign of bigger opportunity.
During the week, Whitney Tilson, who is a well-known and respected value manager, published his quarterly letter. He has been publicly shorting hot momentum names like $LULU, $OPEN and $NFLX, which has ruined his 2010 returns. Here is what he had to say on the subject:
Over time we’ve been quite successful shorting fads, frauds, promotions, declining businesses, and bad balance sheets. Where have had much less success, however, especially in recent months, is shorting good businesses that are growing rapidly, even when their valuations appear extreme. Such open-ended situations, regardless of valuation, are very dangerous, so going forward we will avoid them entirely unless we have a high degree of conviction about a specific, near-term catalyst.
Barry Ritholtz had an insightful follow up on Tilson’s letter, sharing his shorting rules. My favorite line was: “Fundamentals tell you WHY to short something, not WHEN to short it. ALWAYS have some technical confirmation before shorting.”
In the financial markets, the obvious rarely happens, the unexpected constantly occurs. Last weekend was dominated by bearish expectations. Someone on Stocktwits asked what should happen to surprise the majority of market participants? A 200 points rally in DJIA was one of answers. The Dow appreciated by almost 300 points.
There is always something to worry about when you are involved in the financial markets, but the question is do you worry about the right things. The only things you can control are the stocks you trade and position management – entry, size, exit, nothing else. You can’t impact the unemployment number or the earnings report or the civil unrest in Egypt or the weather in Europe, so why worry about it. Focus on what depends on you. You can’t predict the future. All you can do is develop scenarios based on conditional thinking and act based on them.
- If this stock breaks above this level, I am a buyer with a stop here;
- If this stock makes a 3% bounce of its 5o-day MA, I am a buyer with a stop below the 50sma;
- If this stock drops below certain level, I will exit and countless of other scenarios.
At this point, many of the St50 stocks are extended substantially from their latest bases. Last time I wrote this sentence, there was a major destruction in momentum names the following week. Be smart and protect your profits. Anyone can make money in a bull market, but not everyone keeps it when the correction comes.
The ST50 is a powerful equity selection tool. Equity selection is a necessary, but insufficient condition for consistent market success. Disciplined risk management is needed for the latter. Patiently wait for the highest probability setups in the strongest stocks to develop before you commit any capital.
You can easily follow any or all of the stocks in the ST50 on StockTwits by clicking here
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