Friday flush time again – seems rinse and repeat is the order of the day…

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We posted last Friday that the flushing down the toilet of leveraged players in the market looked to be complete and we managed to find a decent 20 point rally in the S&P almost from the point of posting. Since then, it has been one way traffic this week. In fact, since the correction began, US indices have now lost around 6% from the peak of a few weeks ago. It remains to be seen whether indices will keep falling and some prominent market commentators have been calling for a drop of up to 20 percent. My own personal experience is when there is a growing clamour for the exits you can bet your bottom dollar that we are within a few percent and days of the bottom. Should the fiscal cliff be successfully navigated, then we expect a very sharp year end rally as hedge fund managers in particular look to chase beta given their heavy underperformance so far this year.

Sure, the US reporting season was not fantastic, but then again, it wasn’t that bad. The September quarter also reflected a fairly sedate July with consumers and business globally still severely rattled from fears earlier this year that the Eurozone would fall apart.

The economic data and picture since then has been more positive and we believe this will come through in stronger 4th quarter earnings. US consumer confidence is at 5 year highs. Of course the necessary caveat for this scenario to play out is that Washington will need to get its act together, and we think it will. The final act to play out for this year could well be another mother of short covering rallies as politicians “surprise” the markets and deliver a compromise, providing equities with a strong finish to the year.   

When the consensus heads for the exits and sells the market down it will always make sense to look for the trade on the other side.

Despite the volatility in recent days regarding the noise around the fiscal cliff, the VIX has failed to fire and still remains lethargically trapped in a range below 20. It seems that there is a pattern here. Each respective corrective sell off in the past few years have been accompanied by apocalyptic scenarios which have failed to materialise. My favourite lead indicator the Put:Call ratio is pointing very strongly to a short term bottom being imminent – hover over 1 on the equity ratio for 5 consecutive days now. A very rare occurence indeed. 

The Mining sector continues to offer screaming value and as long as you have the margin to play it, anything beyond a few weeks is likely to reward buyers handsomely in our opinion. It seems that the options expiry in the UK today has pressurised markets to the downside. We are again increasing our UK exposure today.

The RSI measures for the US and Apple in particular are at extreme inflection points. We simply need a catalyst to trigger the short cover. Be aware therefore that there is a meeting today at the White House between President Barack Obama and Republican and Democratic leaders of Congress over the deficit reduction. The market will be listening to the outcome of this meeting closely of course. Any positive noises to emanate from the meeting could trigger a sharp rally from heavily oversold conditions.

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