"Water shapes its course according to the nature of the ground over which it flows; the soldier works out his victory in relation to the foe whom he is facing. Therefore, just as water retains no constant shape, so in warfare there are no constant conditions."
Sun Tzu

Monday, December 17, 2007

Game Plan Week of December 16 2007

Let's begin with a review of last week: my scenario played out nicely. The FED cut interest rates by 25 points and the market tanked. I shorted the market right before the announcement. One mistake, though: my position size was smaller than my risk management formula allowed me. So I didn't gain as much as expected on that short trade. At least my thinking was right.

My LONG position on Gold didn't quite work out yet. In fact, I expected a bigger move after last weeks inflation numbers. If I see next week that the correlation between Gold and rising inflation is still intact, I will add to that position.

One more mistake last week: I went LONG GS after positive news (GS' huge trading profits from betting on the subprime mess). I expected the stock to go way higher after that announcement, but it didn't. Earnings will come in on Tuesday, so it can only get worse. I will close that position on Monday.

I expect the dominant market theme for next week to be the stagflation scenario, so I'll look for positions on the short side until we got that scenario priced in. Financials might be in a bottoming process: I'm observing, but don't pull the trigger yet. Let's wait how the market reacts to the brokers quarterly reports.

Sunday, December 9, 2007

Game Plan Next Week: it's Helicopter Time Again!

So: it's helicopter-week again. Fed officials have been preparing the landing approach in the last weeks. A quarter point rate cut is priced in with 100% chance, a half point cut seems possible.

The more interesting question is as always: what will the market do? The Dow had a nice run-up in the last two weeks. In the chart below, I plotted phases of market optimism and fear in the last 6 months. It is very interesting to see, how "dominant market themes" develop throughout the year. The job of the speculator is to anticipate the upcoming driver. Right now, there is probably more potential to the downside, since the FED is unlikely to "surprise" on Wednesday.

So here is my game plan: I'm 100% long, which doesn't make me feel particularly comfortable. I'll trim some positions on Monday and hedge the rest by shorting the S&P with a tight stop in case we get a half point cut on Tuesday. Later the week, it might be a good time to start shorting the homebuilders again after we've seen some short squeeze.

I'm also thinking of shorting NILE. Short story: P/E of 70 with projected revenue growth of 15%. That looks a little bit like overvalued to me. Need to do more homework on this one, though.