Mousetrap 2/26/2012 -- less is more

[Timothy Clontz]

Condition Bear Market Rally
S&P Target 1020
Small Portfolio IAU & XLF 14.68%
Hedge XLU -2.62%

Position Date Return Days Call
SE 6/27/2011 19.92% 243 Hold
CLH 7/6/2011 30.86% 234 Hold
GCI 7/14/2011 11.76% 226 Hold
CSGS 10/3/2011 29.28% 145 Hold
NLY 10/25/2011 1.40% 123 Hold
DD 10/27/2011 5.44% 121 Hold
KBR 10/27/2011 24.83% 121 Hold
VG 10/27/2011 -27.09% 121 Buy
TTM 11/30/2011 59.20% 87 Hold
BT 1/4/2012 9.68% 52 Hold

S&P Annualized 2.07%
Small Portfolio Annualized 19.85%
Mousetrap Annualized 23.83%
Hedged Annualized 20.28%

It’s been a fantastic week, but the model is still stubbornly refusing to call a resumed bull market. Again, I can only shrug my shoulders until the sectors properly align into a bullish configuration.

Perhaps the most uncanny aspect about this surge is the lack of sector rotation. XLU (utilities) has been the chosen short sector and XLF (financials) has been the chosen long sector for the entire ride. Even on the full Mousetrap model the industries have remained unnaturally stable in their relationships.

Amazingly profitable, but boring beyond belief.

Because every traditional form of technical analysis is screaming “overbought”, I thought I’d take a closer look at the tea leaves to see what should be long and what should be short in the different markets.

The best long positions are:

EWD Sweden
EWP Spain
EWG Germany
EWK Belgium
EWY South Korea
EEM Emerging Markets

The best short positions are:

EFA Foreign Large Blend
BND Bonds
BSV Short Term Bond
XRT S&P retail
UUP Dollar
EWM Malaysia

Digging a little deeper, SPY and IWM are extremely overbought as well, while IAU (gold) is listed as still a good hold.

I mentioned some weeks ago that the surge in the S&P was also accompanied by a surge in the dollar, and I believed at the time it was a flight to safety out of Europe and into the US. Accordingly, Europe is now oversold and the US is now overbought.

If I had to interpret these relationships, I’d guess that any illusion of an agreement in Europe will create a sigh of relief that will strengthen European assets across the board – including the Euro AND European stocks. This would take money out of the “safe” US holdings, such as the S&P, Bonds, and the US dollar.

While none of this cancels the certainty of default and deflationary contagion in Europe, it appears that in the short term the US and Europe will re-synch their markets. Whether that means a correction in the U.S. or a rally in Europe (or both) is impossible to say. My models are only designed for intermarket analysis, rather than absolute up and down timing. Should the dollar AND the S&P fall together, however, the effects of both should dampen each other – that is, hopefully a mild consolidation period before the long term macro forces can resolve in either a clear bull or bear.

And that brings me to my thoughts for the week…

A lot has been made over the fact that average volume for the NYSE has been declining for the past decade. At first brush that’s puzzling, since most of the volume nowadays is done by high frequency trading algorithms that trade faster and faster. Well, that should drive volume up, and it does. So that means that humans are FAR less involved than a simple look at volume would suggest.

There are two ways to drive up volume: 1) trade larger sums of money, or 2) trade more often. Since volume is going down, that would mean that people are trading either 1) smaller sums or money, or 2) less often (or both).

In a perverse kind of irony, I think that the LOWER volume is a symptom of the FASTER trading of the high frequency algorithms!

Here’s the idea: who are the high frequency traders bankrupting? Long term investors or day traders? Right, day traders. And once bankrupted, a day trader won’t be able to drive any more volume.

Conversely, fundamental investors tend to target imbalances between price and value, and the high frequency trading algorithms are momentum driven – meaning that they create MORE imbalances, rather than less. While the HFTs are bankrupting the day traders, then, they are at the same time making the market more profitable for long term fundamental investors.

Hence, my Mousetrap. I’m looking for long term imbalances CREATED by HFTs, so I can pick up the debris they leave in their wake. But this strategy also means that I trade only 1/10th as often as I used to trade. My own personal volume per year is drastically reduced, and I suspect that I’m not the only one. The market is a Darwinian process. Strategies that don’t work will be fueled by less resources – and less volume. Strategies that do work will be fueled by more volume… UNLESS the strategy ITSELF is a low volume strategy.

In these days of faster and faster competition, slow is the only way for a human being to compete.

Tim

[Timothy Clontz]

Just got a note from my timing expert friend, Len. He went from saying sell to saying it a lot more forcefully.

I won’t be changing any positions, but I do have some discretionary short positions I put in place last week.

Here’s the last part of his note:

“After three weeks of divergence, the averages going up and the indicators down, a market decline appears imminent.
I said “Sell!” two days ago and believe we are at a market peak right now.”