Many investors are confused by the volatile trading in a holiday-shortened expiration week.
The most important factors are bullish:
- The Bear Stearns decision shows the determination of the Fed to act when there is systemic risk.
- The SEC is sounding warnings concerning those who buy puts and spread rumors to create a situation similar to Bear's.
- OFFHEO cut the "excess capital" requirements for Fannie and Freddie. This helps these GSE's raise more capital and also increases the amount available for mortgage loans, an important shift in the demand curve for housing.
- Lehman and Goldman reported earnings. The massive write-downs that had been widely rumored did not occur, and the liquidity position for both companies was excellent.
These elements took the market from a death watch -- everyone guessing who would be the next "Bear" -- to a situation where Punk Ziegel's, Richard Bove, called bank stocks the buying opportunity of a generation.
It is encouraging to see the fundamentals lining up with the signals from the trading systems like our Gong Model.
The Bearish Day
Wednesday's trading, down nearly 300 in the DJIA, was the disturbing factor for the week. This seems to be a source of confusion for many technical analysts as well as the average investor. While selling in commodities would be no surprise in the wake of prior advances, the sudden and steep nature of the declines were outside the experience of most observers. Let us turn to the interpretation from the experts' expert, Art Cashin, who wrote as follows:
The real story I think, is the de-leveraging of the hedge funds after the Bear implosion. We suspect Prime Brokers told their hedge fund clients, “boys, no more 10 to 1, go to 5 to 1.” That gave a kind of massive “margin call” to all things the hedgies played. They were long commodities and short the dollar. The catastrophic selling helped produce real margin calls driving commodities even lower and the dollar even higher. The action was stunning even to old guys who have been monitoring markets for nearly half a century.
Art's daily commentary (see your UBS representative for daily access) usually provides perspective on moves that might otherwise seem mysterious. We agree that there was nothing in the Fed action to generate this reversal, nor the strength in the dollar. There was also broad selling in stocks thought to be part of general hedge fund portfolios.
The ETF Sector approach got caught in some of the selling related to dollar strength and basic materials. Despite this, the Wednesday readings continued to show nine of 44 sectors in the buy zone. Violent reversals are impossible situations for any trend-following model, and the cyclical portion of the TCA method is not going to catch this either. It is a reality of system trading. As we have noted in past updates, if one starts guessing the entries and exits, it is not the same system that was verified through testing.