Humans are amazing creatures – the turn from greed to fear can happen almost instantly. The market is as always part fundamental, part technical, and part psychological. Monday afternoon we discussed the implications of breaking over and above the 200 day moving average as the S&P 500 hit 1440 and the fact we’d have to ignore all our economic reality and adopt a reluctant bull stance [An Unrelenting Move]. Within half an hour of that post we saw a nasty intraday reversal [Second Intraday Reversal in 4 Sessions] I wrote then

As I wrote in the last entry, it would be poetic justice in some ways for mother market to have drawn in the last remaining bears, forcing them to throw up their hands and go long – just as she was about to drop the hammer. Could it be that dramatic? We’ll soon see if historic precedence means anything anymore. If so, these 2 intraday reversals are a shot across the bow.

Ah mother market… she is wonderful in her pain allocation isn’t she? Sucked in many of the last exasperated bears who have been hammered for weeks on end on that very brief push over the 200 day moving average, before taking a 3% sledgehammer to their cranium. Now, 4 days later, we appear on the edge of a potential breakdown; the bulls need S&P 1380 (50 day moving average to hold). As I wrote earlier this week, I expect this level to at least provide a “bounce” (which I won’t trust) so in a general sense this is what I’ve done. I’ve lowered my short exposure down from around 27% to 20% late yesterday and this AM, expecting this 1380 to provide at least a (minor) bounce.

Here are potential moves from here.

On a break below this 1380 level, I will reacquire this short exposure I just let go – a breach of 1380 on a closing basis would indicate to me we have some serious downside ahead.

On a move up from this level (bounce), I will reacquire this short exposure – I don’t believe in any bounces and think the market is living on borrowed Kool Aid. As the evidence starts to become clear to the wayward bulls that their 2nd half recovery, housing recovery [AP: Unsold Homes in US Rise to 23 Year High] , and all that nonsense is a joke we’ll begin to see capitulation. But it could happen after a bounce, and not right away. Remember, every bull in this market is conditioned to short, sweet, cute recessions – the playbook says buy 3 months in because the Federal Reserve is all powerful and their flooding of the globe with currency (while creating bubbles) soothes the stock market. They do not realize this is the first consumer led recession since the late 70s/early 80s. ONLY when the evidence is so overwhelming will they cry Uncle. And sell stocks.

If this market were trading on reality I believe it would be 15% lower (at least). But Kool Aid is strong with young Skywalker. As I write this the market is around 1379 on the S&P so if we see a continued breakdown later into the day I’ll be getting back my short exposure I sold off the past few hours.

Cash is 32% but that is because I lightened up short exposure quite heavily here – I’ll move about 7% of that from cash to short exposure if we see continued weakness into the day. Risk is High – all bounces are suspect. All purchases on the long side will be small in scale for the near term. I need much lower prices on MOST of my favorite names to really be buying in scale. I continue to hope for a large scale commodity selloff, which would kick us in the groin in the near term, but I want lower prices to build positions back up.

Short Kool Aid

Last 5 posts by Trader Mark

• Weekly Mortgage Applications Of Interest Today; Fed Already Loses $5 Billion on Mortgages - June 3rd, 2009
• CBSMarketwatch: Can Sequenom (SQNM) Make it Back into Investors's Good Graces? - June 2nd, 2009
• Jim Rogers Agrees with Marc Faber - May 20th, 2009
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• HAL9000 Friends Did Not Enjoy the Rally; Hedge Fund Performance 4.2% YTD - May 12th, 2009