China is now officially in a bear market and investors are running for cover, at least in the Shanghai.  If you’re confused about why you keep hearing about a 23% decline in China but your fund/ETF hasn’t fallen that much, it’s easily explained.  The Shanghai Index is down 23%, but the Chinese funds/ETFs you own don’t invest in the Shanghai Index.  Only people that live there can invest in the Shanghai index.  Most funds/ETFs that you can invest in are down about 10% or so during the same time period.

The great debate on Wall Street right now seems to be is China for real or is it just another bubble waiting to burst?  Many believe there’s no real growth there.  They are just stockpiling and that’s why commodity prices have risen.  In fact, if you look at the Baltic Dry Index, it has been falling.  How can we be having a global economic recovery when the price of shipping goods around the world is dropping?  One explanation is that there are more boats now shipping these goods and they can’t charge as much as they did before.  Another explanation is China did stockpile commodities when they were cheap, and now they are not buying as much as prices have risen.  Regardless of the reason, many traders are watching the Baltic Dry Index and China.

The doubt about China has shown up this month.  The iShares FTSE/Xinhua China 25 ETF (FXI) has fallen from $44 to around $39, over a 10% drop.  In comparison, the S&P 500 rose about 3% for the month.  As you can see below, there has been a rotation out of China and into the S&P 500 that really started at the beginning of the month. 

Above is a picture of the relative performance of the S&P 500 (SPY) and the iShares FTSE/Xinhua China 25 ETF (FXI).  Why would this be?  Profit taking is an easy explanation.  But, I think it goes a little deeper.  I believe the growth in China is for real but it’s priced in their stock market for the medium term.  However, the U.S. stock market will move higher and attract assets because the economic recovery isn’t fully discounted.  So, money is shifting out of China and into the U.S.    That could continue for a few months.  Now, I wouldn’t want to bet on the fact that the United States is a better investment for the next few years than China.  But, it’s possible for a few months, especially after China’s stock market went up 100% from the March lows.

That would mean a temporary focus on the dollar, U.S. small caps, U.S. homebuilders, etc.  Putting global growth on the back burner would just be temporary.  So, I’m reducing some of my exposure to global growth for the time being and focusing on the good ‘ole U.S.A.

I came real close today to pushing that button.  You know, that button that would have added some shorts to my portfolio.  This morning, we got what I believe was positive economic news but the market sold off on the open and continued lower.  The stock market was going down on good news.  Not the norm.  I constantly watch how the market reacts to good or bad news.  Stocks have rallied since March on good and bad news.  But, today it was selling off on good news. 

So, there I was around 10:00 a.m. with the Dow down around 70 and the S&P and Nasdaq underperforming.  Surely, the negative divergences I had written about a couple of days ago would finally mean a down day.  All I heard on television was that the Dow would be down more if it wasn’t for Boeing.  Then, I read that Doug Kass who had called the bottom in March had called the top yesterday.  Then, I read there was over confidence by investors and too much complacency.  Then, I saw that only junk was rallying:  AIG, Citigroup, Fannie Mae, & Freddie Mac.  Everybody was bearish.  We’re definitely heading down.  Here I am with 70% of my stock portfolio invested and the other 30% in cash.  Would I go long or short?  My emotions said to start shorting (just for a trade).  Yet, I had to listen to my own advice that I was giving out on my radio show for the past couple of weeks.  Give the market a chance to breathe.  Don’t sell just because there was one day of weakness.  As I was having this internal debate with myself, I saw some technical indicators turning positive.  Was it going to really rally and finish up.  So, I wrote “This is the time for a real rally today from low levels. We’ll see if it sticks. Day traders can go long with a tight stop” on my twitter.

The stock market began to rally and never looked back.  120 points later, the market closed.  It’s 8th straight up day.  My emotions almost made me hit that button.  But, I breathed, sat back in my chair, and trusted what got me here.  It was a lot of things but it certainly wasn’t my emotions.

I have the same emotions you do about trading.  When I’m wrong, I’m frustrated.  When I’m right, I’m on top of the world and feel like the smartest guy.  When I listen to noise, I get distracted and don’t focus.  This is that time to turn off the television (not the radio) and  focus on the economy and the internals.  They are both still improving and at the end of the day, that’s what kept me from hitting that button.

I got back yesterday from a 5-day vacation to Colorado.  What a beautiful state.  Still can’t believe that I can leave the door completely open with no screen and enjoy the breeze with no bugs and no humidity to interrupt dinner.  It was nice for once to take a vacation and not really worry about the market.  I arrived in Colorado Springs on Thursday evening.  I was on the golf course early Friday morning and I tried my hardest to not look at the market.  Even though I wasn’t worried about it, I had to still check it.  Technology got the best of me.  I had my Bloomberg machine on my phone right there on the golf course.  Between horrible shots, I checked my phone only to see the market moving higher.  I was sitting there on hole #2 when I read that Ben Bernanke said “economic activity appears to be leveling out, both in the United States and abroad.”   He also said “prospects for a return to growth in the near term appear good”.  I had to laugh.  I’m glad he’s finally acknowledging what I’ve been writing about and talking about on my radio show for a few months.    The economy is getting better and the stock market is reflecting that.  That’s why we continue to rise.  Persistent buying.  This is the complete opposite of the fall of 2008 sell off where every day there was persistent selling because investors wanted to reduce risk.  Now, they are assuming more risk.

Remember last Monday when it looked as if the market was going to roll over?  We opened down 2%.  China was weaker, consumer confidence was weaker.   But, that bad day was followed by 5 straight days of gains.  I’ve been preaching for a few weeks that we need to give stocks more room to move.  In other words, put up with more volatility.  Last Monday was a perfect example.  A few months ago, I wrote about the bully in school that would flinch.  When he flinched, you’d better duck because one of those times, he might just take a swing at you.  That was then and this is now.  Now, I’d say when he flinches, don’t move.  The summer has come and gone and now you’re bigger and stronger.  He might hit you but it’s not going to hurt.  When he flinches, relax.  I’m suggesting moving out your time frame a little bit.  If you’re looking a osicllators to trade from, use a larger number.  If you’re using stop losses (which I’m not), use a longer moving average.  This would have saved you from selling last week and having to buy back in at higher prices or better yet sitting out right now while the market moves higher.

Given the economic backdrop, I still believe we have another 15-20% left in the averages over the next few months.  I’m not sure it’ll be in a straight line or not.  In fact, I’m starting to see some negative divergences building for the first time in a while. You can see below, I’ve got a picture of the S&P 500 (SPY).  On top of the price, I’ve got the RSI indicator.  It’s been going down while the price of SPY has been making new highs.  This is a negative divergence.  Just one, but it’s something to watch.

Now, this isn’t the first red flag we’ve had since March.  There have been others.  In fact, I have people telling about Elliott Wave patterns and that we’re at a critical level.  I’m not dismissing all the technicals.  But, using anything other than the economic improvement in the past few months hasn’t been as profitable as plain old fundamentals.  There are a ton of traders that are either short or not invested right now.  They’re frustrated and confused.  As I’ve said before, that means there’s plenty of cash on the sidelines ready to come in.  It’s the ammunition to move us higher.

I’m watching these technical divergences just like I always have but as long as the internals remain strong and the economy continues to improve, I’m slowing down my day to day trading and focusing on the medium term (the next few months).  That doesn’t mean I won’t hedge from time to time if I really think we’ll have a reasonable correction similar to the June correction.  But, for the most part, I’m still playing it from the long side.

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Karl Eggerss will be on vacation until Tuesday, August 25th.

We hear all these letters thrown around to describe what our economy looks like or will like going forward.  The latest one is a “W”.  That’s basically interpreted as a double dip recession.  I’d describe it as a “V” that eventually moves sideways.  Regardless which letter it represents, I think we should be concentrating on how the stock market will react to the economy and what letter stock prices will represent.  I think perhaps a “W” is the correct letter.  Not in the big picture but in the medium term.  We started a correction a week ago, we’ve bounced in the last couple of days, and now we may fall again, only to eventually work our way higher.  That’s the “W”.

In the past two days, we’ve seen two pretty good up days on the surface.  But, when we dig down deeper, we see that today’s rally was even weaker than yesterday and both of them certainly don’t erase the damage done on Monday.  I commented on Monday that I expected a rally on Tuesday and Wednesday simply because it would be a reflex rally.  After you get a down day like Monday where almost all of the volume is downside volume and there is so much supply and very little demand, a rally for a few days is quite normal.  But, the rallies in the past couple of days are nothing to write home about.  So, I expect this recent rally to fail based on the internals (short-term).

Ultimately, I think higher stock prices are in the cards because of the economic surprises.  I hate to sound like a broken record but the “gap trade” I mentioned several weeks ago may still be in play.  The market is falling based on technicals and based on everyone questioning economic growth not only here but China.  When they question that, they sell creating a gap that we can take advantage of.  Perhaps this is the 2nd edition of the “gap trade”.

The 940-960 level on the S&P 500 still looks like a logical level for the correction to end up.  But, don’t think the bears aren’t nervous.  We wake up with futures on the Dow Jones down 100 points and finish up 61.  There still seems to be a buy the dip mentality.

As far as my crazy investor indicator, we’re at fear levels we haven’t seen since March.  That’s another encouraging sign for me.  This is generally a contrarian indicator.  In good markets, you buy from scared people and while investors aren’t panicked, they are becoming concerned.  If we churn around for a while and correct a little but we see investors get really scared and we see all the oscillators I watch work off the overbought condition, that’ll be the green light to get remaining cash invested.

For now, I’m exercising patience.  I haven’t made any (equity) trades in the past week or so because I still think the whipsaw risk remains high.  In fact, had you sold on Monday when the market was already down 200 points, you’ve already missed out on about 130 points to the upside.  So, be prudent, patient, but forgiving of day to day moves.

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[youtube=http://www.youtube.com/watch?v=N3MD8mSj3Z0]

I’ll be on Fox Business at 7:40 a.m. CST doing the Fox 50 segment.

At midday, the Dow Jones is down about 150 points and we’re seeing moves down in materials, metals, & stocks.  On the plus side, the dollar & bonds.  Weaker consumer data yesterday and a much lower than expected confidence number today spooked the market and gave investors a reason to sell…for now.

But, you can see below that the S&P 500 is really in a range (yellow box) right now and hasn’t broken down.  For the past 10 trading sessions, the S&P 500 has been moving sideways hovering around 1000.

This is where you have to not get confused by the day to day noise (vibration).  The last several days have been all over the place with conflicting news reports about the economy.  But, slowing down your trading has been the best move.

You know where I stand on the economy.  I think the stock market hasn’t fully discounted the recovery.  That means when we get individual pieces of data that go against that, I view that as a buying opportunity.  In the last couple of days, everyone is questioning the recovery.  This comes off of last week where everyone was sounding like the recovery would last forever.  Neither one is correct.  We are recovering, slowly but surely.  Eventually (possibly several months from now), that recovery will end and we’ll end up in a stagnant economy.  But, we’re not there yet.

For now, I’m not selling my positions but rather looking at a sideways market and determining when will it break out to the upside.  As I stated in my last post, we could easily see a 4-6% pullback but I think the market is re-setting or re-loading with out REALLY going down.  It’s just gyrating.

Holding for now.

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Stock markets don’t go straight up.  This we know.  They bounce around but generally have a direction which is where moving averages can help.  Many of the various moving averages are still moving up right now and the general direction of the market is still up as well.  In the last few days, you’ve seen a tug of war between bulls and bears to battle out the future direction of equity prices.  There’s still no clear winner.  So, is it time to run sell and run for the hills?  I don’t think so.  As a trader, you have to give the markets room to breathe.  You might say, why should I give the market any room to breathe?  Why not just trade in and out and be more active?  It all depends on how much volatility you think there’s going to be in a move up or down.  If the moves are small, you run the risk of buying high and selling low.  That’s whipsaw risk.  That’s the market I think we’re in right now.

In just a couple of days, everyone that was bullish is now turning bearish.  It’s amazing when you read articles and watch various people on television.  “China’s slowing down, the economy stinks, the S&P’s going down to 850.”  Investors are an emotional creature.   

Depending on the market, you have to adjust your trading style.  Several months ago, I was writing that when the market flinches (like the bully in school), you better sell (duck)… just in case (he hits you).  That was then, this is now.  The technicals and internals have improved since then and the indices are higher as well.  But, because the internals are still improving and the economy is still improving, I’m adjusting my trading style and slowing down my trading. 

If the indices continue their pullback, what are some logical levels?  I think the S&P could easily pull back to the 940-960 level.  That’s about a 4-6% pullback.  That’s both reasonable and no reason for me to sell.    So, I continue to watch every position I own but I’m giving them a little room to bounce around.  It’s like letting your teenager stay out a little later.  You are building trust.  The market has proven to me that things are truly better and it deserves a little more of my trust.

With that said, I can keep some core positions but trade in and out of some other securities.  Having multiple strategies in a portfolio is very appropriate.  Despite a 50% move up in equities and my more bullish tone, this still isn’t a buy and hold long-term bull market.  This is a cyclical bull market that is discounting the fact that the economy is gett better.  That’s it, period.  So, we have to manage the portfolio keeping that in mind. 

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I’ll be on CNBC Asia this evening at 6:10 p.m. CST and then I’ll be on Fox Business tomorrow morning at 8:10 & 8:30 a.m. CST.