Several weeks ago we discussed the likelihood of a tradable low being put
in place. On January 23, 2008, we thought conditions were in place that
would allow agile traders to play for a bounce — but advised that
long-term investors avoid the sloppy tape. At that time, we suggested an
8, 10, or 12% bounce trade was in the offing.

That has come to pass. We now find ourselves in a situation where the
markets have rallied significantly on lighter volume, and have since
rolled over. This is a significant sell signal.

Consider: Over the past month we have seen one-day rallies of nearly 200
Dow Jones points on four separate occasions. A review of the headlines
shows all too infrequent arguments against the possibility of a recession,
or if there is a recession it being mild and fairly discounted by the
equity markets. The economic news continues to worsen, while the Bulls
maintain a steadfast state of denial. Articles abound, explaining why
there won’t be a recession, or if there is a recession, it will be mild
and is already priced into equities. My favorite piece last week was “How
to play the coming recovery.” These are signs that people are still
speculatively inclined, are buying the dips. The bigger fear is not any on
stocks, but missing the rally. That is not what you see at market bottoms.

These optimistic views are increasingly being proven false. We are now in
a Bear market and are in all likelihood in the beginning quarters of a
recession – one that is potentially deep and long lasting. Housing
inventories are at record highs, the US dollar is at record lows, Oil is
over $100 a barrel, and Gold has set all-time highs.

These are not the sort of conditions that lend themselves to economic
growth or stock gains.

As of leap day, February 29, 2008, you have several choices ahead of you:
a) you can try and catch the falling knife and, an activity that in the
past has proven to be dangerous and painful; b) You can sit tight,
watching your portfolio decrease in value, confident in the belief that
stocks will eventually return to their previous valuations (What is
unknown now is whether that will take months or years to occur; c) Or, you
can aggressively become even more defensive than we have advocated in the
past few quarters. Preserve precious capital, wait out the storm.

We choose “C.”

We will go into greater details on the economy in a future missive, but
for now, from an investor’s standpoint, understand what your role is today
and preserve capital, and be cognizant of risks. Now is the time to Batten
down the hatches to preserve capital and to wait patiently for the greater
opportunities that will exist to play equity’s on the long side. Rallies
are opportunities to exit equities. We are constantly looking for better
opportunities to put your hard earned capital to work, and today, the in a
long side of US equities is not it.

-Barry Ritholtz
February 29, 2008 3:48:27 PM EST

Category: RR&A, Short Selling, Trading

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