Getting more cautious, but still strongly long

Covestor model: Technical Swing

In February, not much changed in terms of the trading environment: stocks kept grinding higher on lower volatility. Investors who were waiting for a pullback in order to enter the markets were not rewarded, creating the "lock out" situation I discussed in last month's report.

Going into March, investor sentiment is still not overly optimistic, a positive for stocks. On average, 40% of equity options traded on the CBOE were calls during the last days of the month. I consider the crowd overly bullish when more calls then puts are traded during a 10 day period. So even though the Dow Jones Industrial Average trades around the important 13,000 level, investors don't seem to be overly excited.

However, one measure of internal market health changed: fewer and fewer stocks are participating in the rally. At the beginning of February over 450 stocks recorded new 52 week highs on the New York Stock Exchange. This value dropped to around 300 at the end of the month despite the fact that most major indices are trading higher. By the same token, small cap stocks dramatically underperformed their larger peers, which is one of the reasons for the lower number of new 52 week highs.

Declining participation during a rally doesn't have to be negative. It can also indicate lower correlation among equities, so stock picking becomes more important.

During February, I became more cautious with my investments. My strategy is well known to regular readers: I'm trading short-term pullbacks of momentum stocks, leading to an average holding period of four to ten days. Temporary declines are needed to initiate new positions and obviously there weren't that many opportunities. Still, the portfolio is strongly positioned on the long side.

I also started to hedge gains using the inverse leveraged small cap index ETF TZA. As mentioned before, these stocks underperformed during the month. So trading the spread between momentum names and the lagging Russell 2000 seems an interesting hedging strategy. I do not expect a major decline, but a 3 to 5 percent drop can always happen in bull markets and create a good opportunity to close the hedge and increase long exposure.

Overall, the longer term picture remains positive for equities and especially commodities: Europe and finally Japan started to fire up their printing presses and joined the global race for currency debasing.

As a consequence, my position in Silver (SLV) developed nicely. I still see more potential for the metal. The topic does not dominate public media yet. Similar to equities, euphoria is not yet present, which is of course a bullish sign.

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