T2108 Update – February 7, 2012 (Picking up dollars in front of a steamroller)

(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are posted on twitter using the #120trade hashtag)

T2108 Status: 88% (overbought day #25)
VIX Status: 17.6
General (Short-term) Trading Call: Close more bullish positions. Begin but do NOT expand an existing bearish position.

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)

Commentary
T2108 remains near 2 1/2 year highs at 88%. Overbought conditions have lasted 25 straight trading days, every day of 2012. Moreover, T2108 has been at or above 80% since January 17. This overbought period is truly remarkable now sitting at the 92nd percentile in duration amongst all overbought periods since 1986. No overbought period that has lasted at least this long has ended the overbought period with an overall negative return for the overbought period. Two periods finished with 2.5% returns. All the rest finished with 5% or more in gains. The current overbought period has generated a 5.5% gain. All returns measured from the close of the first overbought day. These milestones finalize my decision to wait to apply the last 25% of the bearish T2108 position in SDS until the S&P 500 has gained at least 10% for this overbought period (IF it gets that high).

In the meantime, I continue to pick up dollars in front of a steamroller. I am borrowing from a phrase I heard used by “Black Swan” author Nassim Taleb. He used it to describe traders who enjoy profits even as some large (unknown) risk slowly but surely bears down on them, ready to flatten out everything they gained (and then some!). The latest trade I closed out was a large fistful of February Best Buy (BBY) calls I purchased after the stock gapped down in sympathy with Radio Shack’s post-earnings disaster. (I posted the trade on my twitter feed and discussed it in my T2108 Update for January 31). At the time, I insisted the selling was overdone. Five trading days later, the market finally agrees with me. I sold the calls after they more than doubled in price. I am still holding the RSH July calls that I bought for “good measure.”

It turns out, I am far from alone in this effort to pick up dollars in front of a steamroller. Nouriel Roubini and his investment team are aggressively chasing the market until the second half of the year when they expect poor earnings reports to take the S&P 500 down to 1300 by year-end (up from a forecast of 1250). Gina Sanchez, Roubini’s director of equity and allocation strategy, discussed the outlook on CNBC.

Sanchez is pretty confident that she can read the tea leaves in the economic numbers to determine when exactly to jump out of the way of the steamroller. At the end of the interview she even says “I think we are definitely seeing risk on, and we should definitely celebrate. We’re celebrating down here and we’re celebrating in the Manhattan penthouse tonight. So, yeah, let’s go!” (Roubini – you’re the man!). My own confidence only comes in my preference for doing very short-term trading when initiating new longs during the overbought period.

Granted, Sanchez has good company for her celebration. When I look at the currency markets these days, they are screaming bullish risk-on attitudes. For example, the Australian dollar has broken out versus the Japanese yen, and even the euro is breaking out against the U.S. dollar.

I strongly prefer playing the Australian dollar to all other currencies. I continue stay net short the euro given longer-term bearishness. It also serves as a useful hedge.

I am almost finished with my extended analysis of overbought periods that will answer the “what next?” after an overbought period ends. Stay tuned!

Weekly T2108

*All charts created using freestockcharts.com unless otherwise stated

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SDS and VXX; net short euro, long AUD/JPY, FXA, long RSH calls, long BBY shares