The chart above (updated as of Wednesday) is one of many indicators which I believe show that the credit crunch is not over yet. I won't start thinking about the credit crunch being over (or on its way to being over) until this spread declines. I'd consider getting bullish if that spread drops to around 2.5.
The yellow vertical bands mark recessions. Other than the 1998 spike (LTCM) and the 1965 spike, most spikes in this spread coincide with a recession. And I think the current spike coincides with the recession that began in December/January.
Considering that we remain at elevated valuation levels coming into this earnings season, I feel comfortable having a medium to long-term short bias.
This of course does not mean that we can't see higher equity markets and U.S. equities in particular become more overvalued. I have prepared myself mentally for such a move. If you look at any secular bear market there are cyclical bull markets on the way down. My belief right now is that we have been in a secular bear market since equities topped in the tech bubble of 2000. 2003 to 2007 was a cyclical bull market. We're just about ripe for a subsequent cyclical bear market.
I'm currently running two positions. 25% of the portfolio is in RWM, an inverse Russell 2,000 ETF, and roughly 10% of the portfolio is in SH, an inverse S&P 500 ETF. Still currently working on getting a margin account (approved at MB Trading, pending at Interactive Brokers), so this is why I'm using inverse ETF's rather than shorting indeces outright.
Once I am able to trade/invest on margin, I'll look to add international, credit, commodity, and currency exposures. Because of my small capital base I'll probably end up exercising these views through ETF's. And I'll use 15% to 25% of the portfolio for a more active approach which would include shorting and going long individual stocks and utilizing options for trades with a shorter time horizon. I might implement more technical analysis for that part of the portfolio. I'll probably hold 7 to 8 positions when I get fully invested, but I'm not against bringing that down to 3 or 4 positions I feel strongly about.
"You have to recognize that every 'out-front' maneuver is going to be lonely. But if you feel entirely comfortable, then you're not far enough ahead to do any good. That warm sense of everything going well is usually the body temperature at the center of the herd. Only if you're far enough ahead to be at risk do you have a chance for large rewards." ~ John Masters
