It Makes Perfect Sense To Be Short Stocks

A funny thing happened in the US Stock Market last week that think is worth noting. I came into the year bearish US Stocks and felt that Treasury Bonds and Commodities were the better place to be. So far that has worked really well, but I think this is just the beginning and we'll see a lot more of this going forward.

The first thing that I believe is worth mentioning is the horrible breadth in the market. It's like onions and garlic and all sorts of nastiness. On Thursday 2/27 the S&P500 closed at a new record high, the highest level of all time. Now, remember this is just the index itself. How many companies actually participated in that and made new highs themselves? 6%

Only 6% of the 500 stocks in the S&P500 managed to close at a new 52-week high on a day where the headlines simply read, "S&P500 Closes at a New Record". What the headline writers don't want to tell you is that no one participated in that rally. Only a few names made new highs themselves. But that doesn't sell. That doesn't draw clicks. It's not sexy. Fortunately for us, we don't care about sexy. We're not here to sell commercials or banner ads. We're here to make money.

Bespoke did a nice job of breaking down the (lack of) new highs Thursday sector by sector:

So we know the breadth stinks, but what about price? What do the freshest daily and weekly candlesticks look like? Has anything changed?

Well I see major topping candles all over the place, especially in the momentum names. Key reversal days and reversal weeks all over that present excellent risk/reward opportunities where one can get short with a tight stop above last week's highs. I'm not going to go over a list of these names, but you can do the homework and there are plenty out there you can find easily. FINVIZ has some good tools for this.

I suggested on Friday afternoon that short-sellers got a nice entry point. So far this is working well:

this is great action in the market today. If you needed an entry point to get short for a trade, you just got it. Nice risk/reward $SPY $QQQ

— J.C. Parets (@allstarcharts) Feb. 28 at 03:01 PM

Here is what I'm seeing right now in some of the major averages. We typically find candlesticks like these at tops. Some call them mouse tails, long wicks (they are candles after all) and long shadows (is what the Japanese call them). Either way, the consequences aren't good. It tells us that the bulls, who were in control, could no longer support the price up there, hence the reversal. Here are two examples, S&P500 & Midcap400, but you can find many more out there in the individual stocks and sectors:

So far this year Treasury bonds are up almost 7%, Commodities (equal-weighted) are up 8%, and the Dow Jones Industrial Average is actually down 2% (coming into the new week). So when I hear how great this stock market is and how easy it is to make money, I have to chuckle. There are barely any names participating and the averages are down after 2 months of trading and underperforming other asset classes by a lot.

Shorts don't just have to be focused on calling tops in the momo names either. There are plenty of underperformers out there that have not been participating for a while. If they've already been weak, in all likelihood those names/sectors will continue to underperform and likely to get hit harder than the rest. An interesting sector to note is Financials. These guys haven't been doing a damn thing. While S&Ps race to all-time highs, Financials on a relative basis peaked last July. LAST JULY. So when the S&P500 closed at a new all-time high Thursday and not a single stock in the financial sector made a new high, I can't say I'm surprised one bit. I would expect more underperformance here.

If stocks take out last week's highs and continue to rock, you want to see participation expanding also. If this doesn't occur, I think you just saw your short-term top. I still have the same mentality that I came in with to start the year. Sell stocks, do not initiate up here, buy bonds and buy commodities. Nothing I've seen so far tells me to change this thesis.

Note: If you're going to be long US stocks I think the best bet is to stick with low correlated names. Run the math before you enter new positions. I think there's a bunch of good ones out there. It's the asset as a group that I don't like. If you follow me on Stocktwits or Twitter @allstarcharts I've mentioned a bunch of these low correlation names lately.

Tags: $XLF $KRE $IAI $SPY $DJIA $DJI