MorningWord 1/11/12: High Times

by Dan January 11, 2013 9:32 am • Commentary

MorningWord 1/11/12:  Well folks, yesterday’s price action was starting to feel a tad giddy. They opened up, flirted with going down on the day and then spent the rest of the afternoon marching within 2 points of the 52 week and multi-year highs and closing on the dead high for the session.   While it appears that new highs are in the cards, and the path of least resistance is up (for now), my sense is that it is probably unwise to chase stocks and sectors (like banks) that are getting severely overbought on a near term basis.  

We have done a fairly decent job in the last 2 weeks to fight back our normal bearish or in some cases contrarian urges to short the market, we have tried to pick our spots where we think the risk/reward relationship seems oddly skewed (XLY trade here & VIX trade here).  Heading into year end, we were very cognizant of the potential spark a cliff deal could add to sentiment, and very aware of the potential seasonal factors that come into play in January.  All that being said, we think we are pretty close to a near term reversal, although I will not make the same mistake as last January and get too beared up, too early, but I certainly am not a buyer at current levels in what will likely be an earnings season that offers mediocre visibility at best.

Lots of attention in the financial press is being given to spot VIX at 5 year lows, vs the SPX at 5 year highs, as most are trying to figure out what it means.   Frankly it doesn’t mean a whole heck of a lot in what could be a “Goldilocks” period for stocks.  As the chart below shows, this relationship has the potential to overshoot for some time as it did in late 2006 into early 2007.

7 yr SPX vs VIX from Bloomberg
7 yr SPX vs VIX from Bloomberg


I bring the above relationship up not to confuse, but to be short too early, on what could be a blow off top coming could be mighty painful.   I would also add that the recent equity inflow data that just hit my email inbox from my friend @cnbcmelloy could be another signal that we are close to a reversal… it always seems that retail goes “all in” right before major tops.

Stat #1: SECOND-BIGGEST EQUITY INFLOW EVER — $22.2bn inflows ($13bn via ETF’s and $9bn via LO funds) wk ending Jan 9


Source: BofAML (compilation of Lipper/EPFR data)

So we remain fairly cautious at current levels. We are not expecting a crash, but the higher we go into earnings next week the more likely we could see a  5% re-tracement or more on disappointment.