Rally Free or Crash Hard

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The evidence for a sharp reflex rally is plentiful. The PPT (which since its inception has been as reliable as any other indicator in modern civilization) has already suggested that we are bottoming. Moreover, when I see the $QQQQ down eleven straight trading sessions, with an RSI below 30 and stochastics in the basement, that also leads me to believe that the next broad market move is higher. As far as sentiment is concerned, permabull Barton Biggs is now bearish, while permabear Doug Kass is bullish. Perhaps of even more import, on Thursday the put/call ratio reached 1.30 at one point, a good contrarian signal. Further, the hammer candlesticks that were printed across the board on Thursday were not negated with Friday’s inside day. In sum, the bullish case will be heavily determined by the price action next week, as far as confirmation of the hammers.

Regarding the bear case, the prevailing trend has unquestionably been down since early May. Each and every single rally has been an excellent opportunity to unload long inventory and reload short positions. On the S&P 500 daily chart, all major moving averages are pointing down, and we have finally seen the now infamous “death cross,” with the 50 day moving average slicing down through the (now sloping down ever so slightly) 200 day moving average. Beyond that, the March 2009-April 2010 rally was so sharp that we really do not have heavy support on the S&P until the 950 level.

My analysis of the above leads me to believe that we are setting up for a rally in the short term, while the intermediate trend remains down. Accordingly, I am positioned with that idea in mind, with 56% of my portfolio long and the rest in cash, with no hedges. However, I cannot deny the fact that this market is sick on many levels. The bulls had ample opportunity to run last week, and not only fumbled the ball every time, but they basically made a mockery of themselves. The intraday bounces were laughable, and akin to Jimbo’s brief moment of ecstasy with Nadia in the movie American Pie.

At the risk of being overly dramatic, if we cannot manage a rally this week, then a crash cannot be ruled out, and I may have trapped myself. As I noted last week, adjusting to this type of a market means buying when we become stretched too much to the downside, and then selling and shorting when we see an exuberant rally. Of course, this strategy carries significantly more risk than merely sitting in all cash and waiting for a healthier market precisely because of a situation like this.

I suppose there is the possibility of a sideways consolidation period going forward. However, from my vantage point, when the rubber band gets overstretched, it either snaps back in the other direction…or it breaks.

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UPDATE: Happy Fourth to the great patriot, Jake Gint.

[youtube:http://www.youtube.com/watch?v=limkSboQbhw&feature=related 450 300]

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TOTAL PORTFOLIO:

EQUITIES: 56%

• LONG: 56% ($AAP $NR $NTAP $LULU $CRM $THOR $APKT)

CASH: 44%