June 18th, 2008

Hedge Fund Liquidations, the Final Straw?

When it comes to the stock market, patience is a virtue. Sometimes, watching this market is like watching honey drip out of a bottle, you know it’s going to happen soon but it just takes so long to get there.

I feel like a broken record having to repeat the same story over and over again and am fearful that all of you are going to get tired of hearing it and will switch channels to some other blog offering a large dose of hope. For example, I love to skim the Newsflashr-Business Blog site to see: 1) whether Stock Chartist has moved up in their rankings (it has!) and 2) what other bloggers happen to be writing about. Of course, you have to take everything you read there (except for this blog) with some skepticism but, all in all, if you read on a regular basis you’ll certainly get a sense of the market’s general tone.

Something you don’t see much about those is the risk of investors deciding to pull their money out of hedge funds around June 30 and causing extensive liquidations and, in turn, stock market declines. If that happens, it could be the nail in the coffin of this market. I feel that we’re setting up for that with the market’s weak action since mid-May when the S&P-500 crossed the 180-day moving average for 2 days and reversed direction and started heading south. Here’s the picture as of today’s anemic action:

This isn’t a picture that should surprise any regular reader. As a matter of fact, just over 2 weeks ago on June 2 in a piece entitled “Dusting of Bear Market Crash Call” I summarized the consistency in my calls since February 15 for caution from what appeared to me to be a very bearish market. Some have written in disputing my call and saying that the market was poised for a bounce. Look on the above chart and you’ll see that the market today was almost exactly at the same level as February 15 …. no, it hasn’t gone down but neither has it gone up.

If the index remains below all the moving averages to the end of June, there’s a strong likelihood that the 60-day average will cross under the 90-day again (as it was prior to May 15) and all the moving averages will have turned and started to head down again. All that would be extremely bearish, would push the Index back down to January and March lows and force a test of that support trendline. My guess is that if liquidations are strong it will lead to the support failing.

And while all this is happening, I hesitate pulling out of my positions because they’re working so well. As mentioned in previous postings, I’m a momentum player and look for those stocks moving out of consolidations, moving into new high territory or having clear positive relative strength. I gave you many of those names in earlier postings.

The economic and political background to the market also looks ominous. Housing and Finance are still on their backs, inflation is on the rise, unemployment is increasing, consumer sentiment is declining and the biggest imponderable still hovers overhead … the high cost of energy. How can the market survive all of this at these current levels. I think not. If what I describe above is realized, I’ll have to join the liquidation parade and cash in my chips and wait to play another day.

Addendum: A reader brought to my attention the RBS report wherein a “strategist” wrote:

The worst of the stock and credit market declines that began last year is yet to come as inflation accelerates and economic growth falters, according to a Royal Bank of Scotland Group Plc strategist.

Central bankers are “in a dangerous corner” where the chance of a “major policy error has just super-spiked,” wrote Bob Janjuah, 42, a London-based credit strategist at the U.K.’s second-largest bank. Any stock rally in the next month “will be the significant opportunity this year to get short stocks,” he said in a note dated June 11.

The Standard & Poor’s 500 Index may plummet 22 percent to 1,050 from current levels, said Janjuah, whose prediction is lower than any from any U.S. equity strategists surveyed by Bloomberg.

For Bloomberg version of report click here.

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