For the past nine months I have been suffering from severe back pain. I have tried everything to cure it from doctors to MRIs, physical therapy, yoga, massages and acupuncture. Nothing has worked and sitting in front of my computer for 14 hours a day certainly does not help. My wife is expecting a child in the next three weeks and I want to be healthy enough to lift the child when it arrives. I will be taking the next two weeks off to concentrate on getting myself better. I will try to continue to post the Weekly Strategy and give updates if something important occurs. However, I will not be posting 5 times a day. I look forward to returning.
It is painfully obvious that a handful of large financial institutions will be coming to the market in the next few weeks looking to raise tens of billions in capital. Combined with the fact that the market is overbought and sentiment has swung from grim to giddy, it is hard for me to see how the market will make any progress in the next few weeks.
Federal officials are pushing several of the country's largest banks to bolster capital reserves, people familiar with the matter said, as regulators try to repair bank balance sheets and the public image of the U.S. banking sector.-The Wall Street Journal, "U.S. Presses Some Banks to Act After Stress Test"
The capital raises might not come until after the stress test results are officially reported on May 4. Additionally, we might see some markups this week as the end of the month approaches. However, I believe at this point it is the bulls that are picking up dimes in front of bulldozers.
A little over a month ago the investment community was overweight cash and short of stocks. In the past few weeks that trade has been reversing. Eventually, that trade will end. At the same time we are starting to see heavy insider selling and secondary offerings. My vote is with the insiders.
Reading through earnings releases of widely heralded beats, the results are more the result of cost cutting than improvements in the underlying businesses. In many cases, business is still deteriorating. A 30% run up in the market has factored in a lot of cost cutting. However, for now performance anxiety is controlling the markets.
We saw more capital raises last night from two hotel companies. We also saw one from an energy company. Many energy companies levered up when energy prices were high. If oil consumption stays low and the price deteriorates, a lot of those companies might be in trouble if they don't raise capital.
- Ken Lewis tried to pin the blame on John Thain for his bad decisions. Now he is pointing a finger at Paulson and Bernanke. Ken Lewis is done and he seems like a desperate man. Is the stock rallying in anticipation of his resignation?
- Sell in May and go away?
- Robert Toll has been selling shares hand over fist and then he goes on TV and calls a housing bottom. I guess he doesn't like to make money?
- They say never to short a dull tape and today's tape is pretty dull.
- I'm trying to figure out what I would be willing to pay for the new Pfwyeth concoction?
- The time to buy was six weeks ago when all the news was bad. A 30% run in the market discounts a lot of improvement.
- Technology is the only sector whose earnings I have been impressed with. Although I am impressed with the creativity of accountants at financial firms.
- I felt it yesterday. That feeling that the market could not go down. However, I realize that I am nothing more than an overgrown primate who is hard wired to want to chase the herd. Most people like to pretend that they are rational. I have learned to use those feelings to my advantage.
- Once the market relieves its overbought condition I will likely move to the sidelines. While I don't believe this bear market is over, I want to leave room for a Summer rally.
- How much capital will banks need to raise after the stress test? I believe that the answer to that question is vital in determining if this rally could be extended.
Apple will be important tonight after the bell. I will also be paying attention to equity issuance. Have a good night.
- The latest bullish argument I am hearing is that the stress tests will be a positive no matter what the results are, as it will remove uncertainty. This coming from the same people that were advocating shorting everything 6 weeks ago.
- Interest rates have been creeping up recently. Higher rates would be a knockout punch for the economy.
- The REIT sector, which has been a leader in the rally of the past few weeks, is actually down on the day.
- Why is technology outperforming and actually up for the year? Tech companies are not issuing shares to raise capital and some are even using cash to buy other companies (JAVA, ELX). That said, I believe sentiment towards tech is a bit frothy at the moment.
- The bull camp is getting very crowded. This 2 day move up after Monday's move down seems to be converting a lot of bears to bulls. I could see a climactic move over 875 (Friday's high) that sucks the few remaining bears in. But even if that occurs I believe it would be lights out pretty quickly.
The recent action has been converting bears to bulls as every decline gets bought and bears throw in the towel. I believe that this is precisely the wrong time to be buying and that better prices lie ahead.
"The good thing about being bisexual is that it doubles your chance of a date on a Saturday night."
- The above quote basically sums up my approach to the market in the past few months. I am happy to take opportunities on both the long and short side. The market has been even more bipolar than usual this year.
- If the S&P 500 goes below 600, I will become long only as valuations would be close enough to historic lows.
- Why did I sell SPY calls instead of outright shorting the market? If the market goes up there will likely be heavy equity issuance, essentially putting a cap on the market. I am betting that the cap will hold. With valuations not that high, I am not so comfortable being short unless we are at an extreme (like last week).
- Where do I believe this correction will go to? 750-800 on the S&P 500 is my best guess. From that point one needs to decide if this is a correction or a resumption of the bear market.
During this Bear Market, I have done well by buying Annaly below book and selling when it pops above book or by selling puts that would put me in the stock below book. The reason this trade appeals to me so much is that there is truly little economic sensitivity in the business and that the management is very conservative.
Over the course of history Annaly has traded at a 40% premium to book value. However, given our world of more rational valuations I see no reason why they should trade at more than a 20% premium to book. The reason that Annaly has appealed to me is more because of the downside protection, than the upside potential.
Yesterday, the home builder Lennar and Regency Centers, the REIT, announced common stock offerings. While the pace of offerings is slowing down from last week, it is unusual to have any offerings on days when the market is down over 4%. The amount of supply still out there will become more evident if we have an up day or two.
I was surprised that a handful of companies that diluted their shareholders actually flew up after their issuance. It looks like they are giving it all up today and then some. Please see DRE and WRI.
- The S&P 500 dropped 30 straight points with nary a bounce. After the run the bulls have had lately, I expect them to put up some sort of fight.
- We are approaching the level on the S&P 500 that the market bounced off of last week.
- Option expiration often has a negative effect the morning after. As we enter the afternoon that pressure might abate.
- Oracle is buying Sun Microsystems in an all cash deal.
- Pepsi has offered cash and stock to buy shares in its bottlers
Additionally, we are seeing Bank of America sell off on "better than expected" numbers. Credit quality deteriorated rapidly during the quarter. There was a mysterious huge gain from Merrill Lynch after the much larger write down last quarter. It looks like Bank of America took the "big bath" last quarter when they wrote down Merrill's assets. The stock market seems to be looking through those results, which might signal a change in character.
- The 30 Day Moving Average of the NYSE Advance Decline Line will be maximum overbought by the end of the day Tuesday. This is an intermediate term indicator. Peaks in this indicator usually come close to market peaks.
- Insider selling has picked up steam in the past week. This will likely continue as companies report earnings and lockup periods end.
- There was approximately $9 billion in new stock issued in the past week led by the "smartest guys", Goldman Sachs. There is no reason to believe the issuance will stop. Do you want to take the other side of their trade?
- Sentiment surveys are showing that bullish sentiment is high. The Investor's Intelligence bulls are at their highest since June 2008. After this week's rally the numbers will likely be even higher.
- Options expiration often helps perpetuate rallies. Now that expiration is in the rear view mirror this clears the way for a decline.
- This rally will be six weeks old (30 trading days) this Tuesday. The November rally lasted exactly six weeks.
The strength has likely come from the tremendous amount of cash sitting on the sidelines and the huge short interest. It was probably stupid of me to jump the gun and short this market before options expiration. However, that is in the past and I have to decide if I want to stick to my guns or call it quits while my loss is still small.
The most common refrain I hear when people talk about this market is that it just "does not want to go down". However, a few weeks ago I could have said that this market just does not want to go up. The issuance of stock will very likely continue for some time. A large part of this rally has been short covering and I believe that the short base has been pretty much destroyed with expiration being the final nail in the coffin. I am going to give myself until late next week to see if my scenario plays out.
There are probably numerous investors who were short this market via options. They have been getting killed the past few weeks but like deer in the headlights did nothing and held on to their options. As expiration approaches one must decide if they want to keep fighting the good fight and roll the options into the next month or give up. I believe many bears are throwing in the towel. This puts upward pressure on the market.
At the same time, those who were long via options are flush with cash and will likely roll their positions or even increase them. That puts additional upward pressure. This pressure should abate next week.
I have increased my exposure to the PFE/WYE arbitrage trade. This is based on the fact that arbs were being squeezed on Citigroup. Now that the pressure is off this should benefit all arb trades.
The fair value accounting method allows them to show a gain when the value of their liabilities (their debt) goes down. However, the fact that they are less credit worthy and their debt is declining in value is a clear negative and gains from this should be completely discounted by any credible analyst. This company is a slow motion train wreck.
This morning Citigroup and GE reported earnings. GE Capital and Citigroup are giant black boxes where there is tremendous management discretion in the reported earnings numbers. These managements have proven themselves not worthy of investors trust, so buyer beware.
In the past week Citigroup has been on a tear. About a month ago Citigroup agreed to convert their preferred shares into common stock. The conversion was supposed to close before the end of April. Arbitrageurs bought the preferred shares and shorted the common stock. Citigroup has been silent until today, when they cryptically stated that the offering will now happen after the results of the stress test are released. What the stress tests have to do with the conversion is beyond me? But it has proven once again that Citigroup's management can't be trusted.
As a result arbs are being squeezed and the shares have been flying. These are not people who were maliciously shorting Citi's stock. Luckily, the shares were not available to me to short. I likely would have put the trade on.
However , I called an audible after the Goldman Sachs earnings and share sale announcement and initiated a short position. I though I had the market where I wanted it, but I was mistaken and as it sits I am getting squeezed as my entry point was roughly 860 on the S&P 500.
There has been over 8 billion dollars this week in new shares issued. If that trend persists I believe it will be increasingly difficult for the market to make additional progress.
Sentiment has become a headwind for this market, as investors are turning wildly bullish. It seems that even the bears are scared to sell short at this point. The extreme sentiment is evident when looking at recent mutual fund inflows. Yesterday, there was extreme call buying similar to what is seen at market tops.
While investors are storming the gates companies can't sell stock fast enough. Just yesterday four stock offerings were announced. This morning Fidelity National Financial announced an offering.
A few short weeks ago investors did not want to buy at any cost and suddenly they are willing to buy at any price. I was long then and I am short now.
- Goldman Sachs (GS) is doing a $5 billion offering.
- DiamondRock Hospitality (DRH), a REIT is doing a $50 million offering.
- Acadia (AKR), another REIT, is doing $50 million
- First Niagara Financial (FNFG) is raising $300 million
In order to switch to the new fiscal quarters, Goldman had to report December's results separately. Basically, they stuffed a ton of losses into December and reversed those losses in the first quarter. The combined results are very close to analysts expectations. The only division to report better profits was trading, which is largely a black box and those revenues might not be recurring. They also announced a five billion dollar offering. Buyer beware.
Over the past few weeks I have been emphasizing how much stock companies have been selling. For the time being, the mutual fund buying is dwarfing the companies selling. However, like a selling panic a buying panic must also come to an end.
I believe that the news of Goldman's blowout quarter will be sold. I don't believe this financial rally will last much longer than tomorrow morning, if it even makes it that far.
Speaking of 80% run ups, this weekend Barrons ran a bullish piece on American Express basically laying out the same case I did a few weeks back when American Express was trading close to $10. I agree with their case, but would be careful buying a stock that shot up by 80% in the shorter term.
"Big Bath accounting is the process where publicly traded corporations write-off or write-down certain assets from their balance sheets in a single year. The write-off removes or reduces the asset from the financial books and results in lower net income for that year. The objective is to ‘take one big bath’ in a single year so future years will show increased net income ..."It seems obvious to me that Wells Fargo took a big bath last quarter with its acquisition of Wachovia. After all, Wells Fargo said as much in a press release last month:
"By immediately writing down loans and securities at Wachovia through purchase accounting adjustments at close, we have already significantly reduced the risk of loss to tangible common equity. Since these losses have already been recognized, our future earnings will be higher and therefore tangible common equity can now grow faster."I was surprised that Wall Street was surprised that they lived up to their word. However, if accounting rules allow me to tell you that I had 8 fingers last month, would you believe me that I grew two more this month? Viewed objectively, this news is not news at all.
In the past week we saw heavy issuance of new stock, with eight companies issuing new equity. They were only to be outdone by individual investors, who poured over $11 billion into mutual funds during the week, according to Trim Tabs. The issuance of shares is likely to continue as there are reports that Goldman Sachs and other Wall Street firms would like to issue shares. It is anybody's guess if the buyers will remain as enthusiastic.
The current rally is almost five weeks of age. While I am considering a short position, I prefer to start fighting these rallies when they are at least six weeks of age. Like a matador, I would rather fight a tired bull. Wells Fargo is not the only financial company to have taken a big bath so there is likely more "good news" coming. In addition, option expiration might help perpetuate the rally. While I believe short positions at these levels will eventually be shown a profit, I am still debating the timing of such a move.
Goldman Sachs Group Inc., by selling stock to help it repay $10 billion to the U.S. Treasury, may pressure competitors to follow suit or appear dependent on government support, analysts said.
At the same time the Wall Street Journal is reporting that Goldman Sachs is considering a stock sale. The public is buying while corporations are selling. Where have I seen this movie before? And I believe I could guess the ending.
- Today will be my last day posting this week as I observe the Passover holiday. Volume will likely be lighter the next few days as we enter a holiday trading environment.
- I am seeing quite a bit of call buying today, a negative given that the market is only managing a meager bounce. The put/call ratios have not been stellar indicators recently but its worth noting.
- The positives are that market breadth and oil are positive. However, the financial stocks and real estate are lagging.
- I remain of the opinion that rallies are for selling. If one must buy, stay away from sectors where there will be share issuance.
- How long will it be before struggling retailers start issuing shares?
While I have been of the belief that this is a bear market rally, I keep trying to give consideration to the bull case. However, I have a hard time seeing how this market can go much higher with so many companies looking to issue new shares.
The exchange is likely to be done at the end of April. Usually, this would be priced in to the market to some extent as arbs buy the preferred and sell the common shares. However, Citigroup shares can't be borrowed, hence the trade can't be done.
The issuance of over 20 billion dollars in new Citigroup shares will not be positive for Citigroup or the financial sector. Please keep that in mind if you have a longer term time frame.
- While financial stocks are the World's Fair real estate stocks are starting to show weakness today.
- A lot of financial companies would love to raise capital (by issuing stock), but everything is on hold until the results of the Stress Test come out. After that we should see a flood of new issuance and gains in the sector will be a lot harder to come by.
- I had a feeling that Gold was putting in a short term bottom yesterday. Why? Gold has been going down for weeks but suddenly yesterday everybody was talking about it. That usually means a trend has run its course (short term). I meant to put it in one of my posts but kept forgetting.
- Even though the market is declining it does not feel like there is much fear in the market, unless you consider the fear of missing.
While traditional money managers don't generally short stocks they do choose which sectors to overweight and underweight. In general, traditional money managers have been positioned "defensively". That means being overweight defensive sectors like Consumer Staples and Health Care and underweight sectors like Real Estate and Financials. During this latest rally the "defensive" sectors have performed miserably while Real Estate and Financials have been tremendous outperformers.
This situation causes a quandary for both types of managers. Hedge fund investors are generally skittish and will not stand for too much of a draw down. Knowing that clients will bolt if losses get worse, hedge fund managers have little choice but to cover their shorts. At the same time traditional money managers can ill afford to miss out on this rally as clients will want to participate in the rally after participating in all the losses. Traders sensing this dynamic are also piling into these sectors. This causes a virtuous cycle for these sectors as the buying feeds upon buying.
To understand what is going on it is more important to understand psychology than financial matters. In some cases fundamentals might be driving these moves as many stocks were driven to fractions of their book value and were being priced for bankruptcy. However, I have no way of analyzing these companies as understanding their balance sheets are beyond my pay grade. However, I do understand psychology and what is causing investors to buy these stocks.
George Soros, the billionaire hedge- fund manager who made money last year while most peers suffered losses, said the four-week rally in U.S. stocks isn’t the start of a bull market because the economy is still shrinking.
“It’s a bear-market rally because we have not yet turned the economy around,” Soros, 78, said in an interview yesterday with Bloomberg Television, referring to the recent rebound in stock prices. “This isn’t a financial crisis like all the other financial crises that we have experienced in our lifetime.”
...Marc Faber, managing director of Hong Kong-based Marc Faber Ltd. and publisher of the Gloom, Boom and Doom Report, said in a separate Bloomberg TV interview today that the S&P 500 may drop as much as 10 percent before resuming gains.
The late day strength yesterday and Friday has been coming from the real estate, hotels and casino sector as well as other cyclical industries. It appears that hedge funds got themselves caught in a short squeeze. After being caught short the financial sector in March, they are now being squeezed in these areas. This is being exacerbated by money managers who are buying into the highest beta sectors as they play catch up with their benchmark.
- There is clearly a bid under the market as the under invested use dips to build positions.
- The question I am grappling with is how we will know when the under invested are done buying?
- There is an erie quiet from market commentators. They were grizzly a few weeks back. I suspect once the bullish commentary starts getting louder we will know they are in.
- I keep trying to give the bull case consideration but my thoughts keep circling back to the amount of shares companies are about to issue.
- After today's pullback, the near term direction becomes a lot tougher.
- While it has not payed to underestimate the bulls recently, I don't believe they will be able to turn this one around today.
- The strongest sectors are the defensive sectors, pharma and biotech. That is typically not the best sign.
- The heavily shorted sectors, real estate and financials, look like they are trying to bounce.
- The demand for the late nineties bull market came from the public. The demand for the 2003 bull market came from record share buybacks and LBOs. If this is the start of a new bull market, where will the demand come from?
- The IBM and Sun Microsystems deal looks like its falling apart.
- According to the Telegraph, Goldman Sachs is considering a share sale.
I must admit to being a little confused at this juncture. I have spent the past 12 years watching the market and can't recall another time where the market ran 25% without taking a breather. I'm not saying it can't keep going, just that I haven't seen it.
I believe it is imprudent to be buying at this point and this rally is starting to show signs of fatigue. Late in the week the most over leveraged low quality stocks were flying. Once the garbage starts rallying it is usually close to the end of the rally. Another sign of fatigue was the new highs on Friday. Even though the S&P500 and Nasdaq were higher on Friday, there were fewer new 52 week highs on both the NYSE and NASDAQ than on Thursday, a negative divergence.
While many money managers are under invested and the fear of missing is not to be underestimated, I believe that it is a mistake to buy after a greater than 25% advance. While the market may go higher in the very short term, it is very likely that when this market finally does correct that a better entry point will be available.
I also believe that there is a lot of pent up insider selling. Most insiders are in a lockup period where they can't sell stock before earnings are announced. Once earnings are announced insiders will be selling like crazy to take advantage of these higher prices.
The question I am grappling with is have we already seen point 2 for this rally? I thought we would see more of a consolidation, as all previous consolidations reached the red line. What do the readers think?
While I am well aware of how bear market rallies work, I was not as long as I would have liked to have been for the move of the past three days. One difference between this bear market rally and others is that the pullbacks have been short and shallow. The market doesn't like to make things easy by being predictable. That said, I am not planning on chasing this market. If the market corrects I will reassess the situation. However, chasing the market based on government figures is not what I do with my money.
- An announcement of a GM bankruptcy could be a good thing for the market, especially if it comes when the market is oversold. I can't imagine that leaving the issue hanging over the market helps matters.
- There could be a decent sized buy program at the end of the day today as the Rohm and Haas deal is scheduled to close.