It has been a strange, choppy start to 2014 on the S&P 500. After the 120 point emerging market sell-off in January, the index rebounded to hit new highs on March 7th, only to pull back to where we started in January.
We know a lot of traders who are short this market. We also happen to know an equal number who continue to be long. In a normal, rational (read: non-distorted) market, pull-backs are healthy and are required to demonstrate where absolute floors are located so that investors feel comfortable buying. In reality, we haven’t seen a meaningful floor established since 2012, and with 30 straight months of positive gains, investors are understandably becoming more skittish while the VIX index tries to put in a new upward trend. At Intellikon we have no bias other than what we see in terms of quantitative trading patterns and macroeconomic fundamentals.
Quantitatively, the short sellers continue to get steamrolled. Even in our member portfolio, the short positions averaged only 1% gain per trade, while the long positions averaged 3.25% per trade. We have always maintained that short selling is a statistically inefficient way to profit, and this has proven itself in the current market.Fundamentally, our observations as outlined in our 2014 commentary are still in play a third of the way into the year. Foreign capital continues to flow into the market, however as seen in the flat performance since January, not all industries and sectors are rising in harmony as they once were.
From our analysis we see three major themes coming to the fore front stemming from our analysis of hedge fund ownership and sector performance:
1. Health care: Expectations are high that this sector will profit from an influx of new health insurance plan members generated from ObamaCare. Health care had the greatest gains since January, although this sector was the biggest laggard last week, possibly on profit taking and some blowing of froth.
2. Technology/Services: Expectations are also high that, as the economy continues to rebound, capital spending will increase in 2014. The key sectors that benefit the earliest and most overall are Technology and Services (think IBM).
3. Inflation: As the commodity complex collapsed from poor economic performance, many industries were more than happy to capitalize on the increased margins. Apple’s iPhone 3 and 4 were launched at a time when the lower cost of materials lined Apple’s coffers with cash. Now, with higher costs for rare earth minerals that make up electronic components, Apple scaled back the quality of the iPhone 5 to keep their margins in check. In 2013, the airlines saw a double-blessing of profit from an improving economy and the low cost of oil which helped their bottom line, however their operating costs in 2014 may rise along with higher oil prices. We are keeping our eye on companies poised to benefit from inflation including miners, potash producers, and the oil and gas industry.
Which brings us to the S&P 500 action we are currently seeing. Last month we wrote:
All of this shifting of capital is causing an increase in volatility. It has been quite some time since investors were this complacent in markets (by driving down the cost of protective options)… if the index does keep going higher without a healthy correction, we could be looking at one of the greatest short squeezes in a decade – while this scenario would see stocks skyrocket to new highs, this type of price action could also lead to bubble territory, causing money to exit the market equally as fast. What we hope for is a healthy correction. What we may end up with is a huge short squeeze.
Risk-on market sentiment is alive and well, however the volatility appears to be a capital rotation between sectors and industries, and not out of stocks in general. Exacerbating this is headline risk out of Crimea, as well as some troubling speculation on China. However the sell-offs have been slow and grinding as opposed to outright panic in the markets. We also track gains and losses in individual stocks and sectors on our S&P Momentum indicator, and Friday’s sell-off appeared to be over done, likely due to roll-overs happening in Futures and Options which both expired last week.
Given that we now have a down-day to work with along with an upbeat outlook, we have added 4 new long positions to the member portfolio chosen from an algorithmic scan of 700 US equities and narrowed down to the themes above. These are long-only positions with 2% stop loss orders attached. Entries will be taken at the market open on Monday and tracked this way for statistical purposes, but members should follow the entry rules when possible. As always, if you have any questions on any of the above, please contact us at any time.
The content contained in this blog represents the opinions of the authors who may or may not hold long or short positions in securities of various companies discussed in the blog based upon the authors' views. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied solely upon in making investment decisions, ever. It is intended for the entertainment of the reader, and the authors. In particular this blog is not directed for investment purposes at US Persons.