I’ve just been idly dipping in and out of the market for the last couple of months, and until Monday hadn’t changed my strategy at all – running a short gold, a short EURGBP position and a bunch of small equity longs, which, frankly, have been pretty static.

But everything has changed in the last 36 hours. I’d been keeping a good chunk of trading capital in reserve, but am now running at full stretch. I’ve been piling on the risk and am now sitting on a heap of long positions. Regular readers will know that I tend to trade like a ‘micro macro hedge fund’, with a fair number of small positions running concurrently, based on what I think is happening in the big global macro-economy. It can be a dangerous strategy to to run lots of positions at once, and it’s not one for the beginner.

I’m long the S&P500 (from 778), long FTSE (from 4130), and have gone heavily into the carry trade – selling the yen and buying Australian dollars, the euro and sterling. And I sold out of the Gold short once the price bounced above 920, and shorted the dollar against the euro and sterling. (In my view Gold has been moving precisely in inverse relation to dollar strength over the last few months).

And I’m even buying resources stocks for the first time since before this crisis broke in Spring last year…

What’s Got Into Me?

I agree that Goldman’s profits are largely the result of what Meredith Whitney memorably styled ‘the government momentum trade’. But nearly all of the big US corporates that have posted results so far have come in ahead of expectations. And if you look at the ISM inventory data it’s at a multi-year cyclical low that is screaming ‘restocking’. That means that firms have aggressively cut back on buying in stuff and at some point they simply have to start manufacturing again.

Here’s an extract from a piece of research from Danske Markets which caught my eye:

• The inventory cycle is a very important cyclical driver and in this downturn it has
been much more forceful than we have seen historically.
• Production has been cut at a record pace in order to deplete inventories. However,
with inventories lean, production substantially below demand and demand rising due
to massive stimulus, we believe the ground is laid for a rapid production rebound in
H2 09.

But what really appealed was the contrarian logic of getting seriously long at this point. Bearish sentiment has been at an extreme, and everyone’s been on the lookout for the next leg down. So the risk/reward ratio of getting long seemed to make a lot of sense. I don’t know if this is just another tradable bounce or the start of something more substantial; whatever, I’ve got my positions protected with stops so I know my capital is reasonably secure. Every single trade I’ve got on is solidly above its entry point, so the market’s telling me I’m positioned reasonably well.

So Why Have I Gone So Long?

Loads of reasons.

Car sales in China and Brazil are up a lot. I’m expecting stats soon that show a rebound in auto sales in the UK and the US as well – the ‘cash for clunkers’ schemes seem to be yielding results in Germany, and I’ve noticed that the car dealers’ yards on my route to and from work seem to have people in them for the first time in a long while. Russell Napier, the excellent analyst who produced must-read tome ‘Anatomy of the Bear’ suggests that an up-tick in auto sales, together with a rebound in copper prices, is a big indicator of a turning point in the markets.

And eve, shockingly, the UK housing market seems to be stabilizing. I’ve been trying to sell a flat for a couple of months and we’ve suddenly had a glut of people interested in looking at it.

I agree that unemployment is going to be a huge drag but remember that it’s a ‘lagging ‘ indicator, Typically unemployment continues to rise even as economies come out of recession. My guess is that as companies realize that demand is picking up there will be a race to restock – they’ve been laying off workers aggressively. If they have managed to cut overheads and labour costs faster than their income has dropped, and they’ve still got the market share, then they could suddenly become very profitable. We could see a very fast rebound – provided that credit continues to ease. That’s not to say that there won’t be bumps and problems over the next year (excessive public and private debt and deleveraging is still a problem), but for now I’m betting on a reflation of the economy, driven by improved corporate profits in the US – perhaps faster than everyone thinks. Nouriel Roubini’s outfit RGE Monitor just published a useful digest of data on ‘turning points‘ in the global economy.

If you want a neat summary of the bull versus bear arguments, then have a look at MrFT’s recent blog for the bearish view, and have a look at this short post from FT Alphaville quoting some research from Merrill Lynch which gives airspace to both sides.

So What Next?

I think it’s the strength in resources stocks that are leading us out of this, and it’s likely to be followed by a second wave of buying cyclicals – particularly financials and technology stocks – and, as ever, I’m still on the hunt for good ‘value’ plays. If you’re looking for equities that look worth buying, you might want to revist MrFT’s excellent article on the economic cycle and what equities get favoured at different points.

I’ve bought BHP Billiton at 1320 (expensive but certainly worth it so far), and BP, at 476. I’m interested in basic materials, steel, and large cap consumer stocks, big supermarkets (Sainsbury and Morrisons are my trusty favourites), and even looking for a bounce in the prospects for airlines, in anticipation of a larger than consensus upswing – so I’m back long of BA (from 121) and JetBlue (from 422).

Now where did I put that hedge? I’m keeping a close eye on the currency positions – and have moved my stops well above the entry points for all of them to make sure I protect my profits. I’ll probably cut back on my short dollar position if sterling breaks above the $1.67 mark. I might also look to short some of the big US retailers and consumer discretionary stocks if they start to look really overbought. And runaway dollar weakness could trigger another bout of increasing bond yields – leading to more inflationary pressure. So that’s one to watch. The key issue is how the central banks exit from quantitative easing – they have to walk the tightrope of keeping monetary policy loose without stoking inflation. But they could choke off the recovery if they increase interest rates and/or take some of the money they’ve printed out of the economy too soon.

Might simply be a bounce, might be something else. Whatever, I’ve managed to make some money out of it, which is always a good thing.