The Treasury Trade

A lot of readers were surprised that I went long treasuries on Thursday, especially because I have often stated that treasuries were a horrible long term investment. I still believe that ten year treasuries yielding 3.5% are a poor long term investment. Even if the Fed's money printing does not cause inflation your upside is that you collect 3.5% a year, while it is possible that one will incur a tremendous loss in purchasing power if there is inflation.

I went long treasuries as a pure trade. There are rallies in bear markets and I believed we were set up for a counter trend rally in bonds for the following reasons:
  • Rates were getting to a point where they were completely choking off the mortgage market. That helps treasuries in two ways. It slows down the economy, which is good for treasuries. In addittion, mortgage bonds compete with treasuries for investor money therefore a smaller supply of mortgage bonds is bullish for treasuries.
  • The Summer is a seasonally strong period for treasuries.
  • We were nearing the end of the treasury auctions.
  • I believe treasuries were suffering from an asset allocation out of treasuries into more risky assets. Often asset allocations are done by month end and we were nearing month end.
  • Treasuries are down 25% from the beginning of the year and were deeply oversold.
The reason I decided to pull the trigger was that on Wednesday and Thursday it seemed all everyone was talking about was treasuries. They have been falling steadily for a half a year but suddenly in one day everyone noticed. That helped me with the timing aspect of the trade. I often find when stocks make headlines in non financial newspapers it means the trend has been exhausted and we are close to a reversal.This is a similar concept.

I will likely cash out of my treasury trade on Monday as it was just a trade.

Long Bonds

I have shorted TBT, which is the UltraShort Treasuries. Basically, I am long treasuries for a pure trade. I think they make a horrible investment in the long run.

Blatant Markups

  • The stock market seems to like the bond auction more than the bond market does, as stocks are trading to new highs for the day even as bonds are close to the lows of the day.
  • This activity seems like blatant markups to me. The SEC remains toothless.
  • The spread on the WYE/PFE arbitrage is coming in nicely today. I have a nice chunk of money in the trade. I believe that the sole reason the spread is so wide is that it is a $6o billion deal and there is simply not enough arb money out there to close the spread.
  • Will secondary offerings return next week as market participants return from vacation?
  • I will be taking a three day weekend and will return Monday.

Hedge Fund Managers Best Ideas

The following paper summarizes some top hedge fund manager's best ideas given at the Ira Sohn Conference.
Ira Sohn

No Easy Solutions

This article from lays out the problem we are facing in no uncertain terms. I could not have said it better.

The Bank of America No Brainer

Almost all analysts agree that normalized earnings for Bank of America are in the $2-$3 range. Buying a company trading at 5 times normalized earnings does seem like a no brainer. Investors and analysts are wildly bullish on the stock and the excitement seems justified.

However, I worry when a trade seems too easy and this one fits that category. Michael Steinhardt invented the idea of variant perception. He would only do a trade when he had an insight that others did not. In other words he would ask himself, "What do I know that other people don't?". If everyone agrees that Bank of America is a great buy here than I don't have a variant perception and must stay away from the stock.

Bonds Front Page News

Good Morning. While bonds and the dollar have been falling precipitously for the past few months, they finally made front page news yesterday. In my experience that is usually a sign that a trend has exhausted itself in the short term. I would expect to see a rally in bonds and the dollar starting pretty soon.

Yesterday stocks fell as interest rates rose. However, I would be careful in interpreting rates coming down as equity positive. Stocks have been rising for months even though the dollar and bonds have been weakening. Yesterday was the first day that higher rates had a negative effect. If recent experience (excluding yesterday) is any guide a stronger dollar and stronger bonds will be negative for equities.

We are still in the seasonally strong turn of the month period, which will end Wednesday. The market might be able to hold up until then but I believe this rally is on its last legs.

Manic Trading

Higher rates gave traders an excuse to sell the market today, just as consumer confidence was the excuse to buy yesterday. While I believe that higher rates are a big problem, they have been rising for weeks now. Why that suddenly mattered at 2:30 PM today is anybody's guess. This erratic trading should continue until next week when everyone returns from vacation. Hopefully the Summer will not be like this. Have a good night.

Treasuries Continuing Lower

  • Despite the fact that treasuries are now deeply oversold, they are continuing lower today with the 10 year yield hitting 3.7%. The market is finally taking notice.
  • Bernanke could spit in the face of the Chinese and ramp up the money printing or he could watch interest rates climb higher. A rock and a hard place?
  • From a trading perspective treasuries and the dollar seem oversold to me and due for a bounce. I am tempted to buy some TLT for a short term trade but bonds are not my area of expertise, so I am fighting the urge.
  • Oil prices are now above $2.50 a gallon. Another headwind.
  • The bright side is consumer confidence is up so consumers will be confidently paying higher interest rates and higher prices at the pump.

Not A Care In The World

  • Call buying is heavy once again today and the market does not seem to have a care in the world. This is not the type of sentiment seen at the beginning of sustainable advances. This might be a moot point until we pass the seasonally strong period, which lasts through June 2.
  • Large cap tech has been the best performing sector recently, while the banks have been lethargic. The difference between the two sectors are that tech companies are not issuing shares on a daily basis.
  • Less and less stocks in tech land are compelling on a valuation basis, although some bargains still do exist.
  • There are rumors circulating that Citigroup will increase the size of its preferred exchange so that the government will have a smaller stake in the company. In the short run this would be a negative for the stock (more supply).
  • If I had to own stocks, it would be in the pharma and biotech arena. Market participants have been rotating out of these sectors and into more cyclical sectors. However, the valuations remain reasonable and there is a lot of cash takeover activity in these sectors. These sectors are under owned and could take off if we see a rotation back into them.

Much Ado About Nothing

Much has been made about the nascent housing recovery. There are no reasons to believe that a housing recovery is underway.
  • Home prices are still high when looked at from a price to rent perspective or price to income.
  • Inventories are still above normal, even without taking into consideration the phantom inventory or the fact that many sales are distressed.
  • Another wave of foreclosures is set to hit the high end of the market in 2010.
The only argument the housing bulls have is the record low interest rates. However, recently rates have been on a relentless rise and that argument might no longer be valid.

Bank Of America Issues More Shares

Bank of America announced that it has entered agreements to issue approximately $5 billion in new shares in exchange for preferred shares. This is likely the reason the shares have been acting terribly, as owners of the preferred have likely been selling common shares. It is unclear whether they are done selling.

A Legend Speaks

“The economy is still a scary place. My net feeling is that this rally doesn’t have all that much more to go and the dangers out there remain consequential.”
-Legendary hedge fund manager Michael Steinhardt from Bloomberg

Good Morning. Michael Steinhardt has the best track record of any hedge fund manager in history. He does not share his opinions often, but when he does, I listen. The market is currently trading slightly above its mean valuation, using normalized earnings. Betting on further upside means betting on a higher than average valuation during one of the most uncertain times is US history. It certainly can happen but it does not strike me as a great bet.

Last week, I laid out a case for a possible rally this week during the seasonally strong turn of the month. Many money managers commited money to stocks this month and want to make sure the month goes out strong. After losing so much money the past few years, a lot is at stake. It appears that this scenario is playing out.

Yesterday's rally saw heavy call buying and was based on a Consumer Confidence number that was up based on the fact that the market has been up. Typically, that is the type of rally I would love to short. However, I will wait until this seasonally strong period is over before getting more aggressive. I view any further rallies as selling opportunities.

Capital Observer Jr Has Arrived

I will be taking the day off. I hope to return in some capacity tomorrow.

Summer Reading: Part 1

As we edge closer to the Summer and beach/poolside reading time, I wanted to summarize the books I have found most helpful in becoming a better investor.

I would place investing books into 5 categories although many books may fall into more than one category.
  • Biographies of Successful Investors
  • History
  • Psychology/Sentiment
  • Fundamentals
  • Other
I will start by reviewing some books about successful investors. No two successful investors are alike and many different styles can work. There is no right way to invest like there is no right way to swing a baseball bat. The one similarity I have found among the most successful investors is that they are able to think apart from the crowd. I consider a biography worthwhile if I can pick up one trait or method that the investor has used.

The book, Market Wizards, is a classic and is written in interview format. The author, Jack Schwager, interviews top traders and investors. The most interesting aspect of this book was the trials and tribulations that many of these investors went through in order to hone their craft. I have found that I have learned a lot more from losing than from winning.

A more modern version of Market Wizards is Inside The House Of Money which is a series of interviews with successful hedge fund managers. In addition to learning about the methods of successful money managers, it gives a look into the workings of the hedge fund world.

Anyone who is serious about investing has probably read a book about Warren Buffett. There are dozens of them out there and I have only read a handful. The best one being Buffett, The Making Of An American Capitalist.

I enjoyed reading all of the above books. However, the next two books fall into a separate category. They are books that I got useful information out of, but are not very entertaining. Julian Robertson was able to show amazing performance for many decades. Even after his blowup he returned investors who were with him from the beginning over 100 times on their money. I found learning about where he went wrong (style drift, spreading himself too thin), just as useful as what he did right.

Michael Steinhardt has an equally impressive track record, only he left at the top of his game. The book contains a lot about his personal life. I was more interested in his investing skills and wish there was more about that.


  • Is there anybody out there still reading this or are the computers the only ones left trading?
  • Treasuries continue to get beat down. Mortgage rates are likely well above 5% right now? Why don't we get that adjustable thing going again? Short term rates are really low.
  • The financials just don't seem to want to give the nod to a rally. Healthy rotation or warning signal?
  • Someone should tell Bank of America that their price target was raised to $32 today by Morgan Stanley.
  • Once again we are seeing a takeover today in health care with J&J buying a small biotech. That is bullish for the sector. It is one area where companies are laying out cash to buy each other instead of issuing stock.

No Business Like Monkey Business

  • Call buying is extreme once again. With low volume I'm not sure how to view it, but its definitely not a positive.
  • The financials are mixed, while Apple and Google are down and breadth is positive.
  • All in all a mixed picture, but that may not matter today.
  • Bank of America has caught another upgrade today and is still down. It appears the stock is still digesting the huge supply of shares that were issued.
  • Treasuries are once again lower. If rates go any higher the bull case on the housing market and the banks will be in serious jeopardy. It seems to me that bonds are oversold and due for a rally, but what if they don't?
  • Does anyone even care about the bull case or has this degraded into "I need to get in before everybody else does"?
  • The more things change...

Let The Games Begin

Good Morning. The market has shown clear signs of exhaustion over the past few weeks as it has been spinning its wheels for close to three weeks now. The market has no longer been able to make higher highs or higher lows.

However, I believe the market may have one last hoorah before facing a stiffer test in June. Many money managers have bought into the market recently and simply cannot afford to be wrong again. There will be more incentives than ever to mark up positions for month end. That should not be a difficult task in a low volume holiday environment. The one possible wrench in the equation is if bankers continue to roll out a lot of secondaries next week, but I believe they will stay on vacation.

Additionally, there is strong positive seasonality on the last few days of May and first few days of June. The bears might be better off playing possum for a few more days.

Something Doesn't Add Up

Last night, Bank United was taken into receivership by the FDIC and sold to a group of outside investors. My understanding is that this group of outside investors paid less than 50 cents on the dollar for the loan book, resulting in close to a $5 billion loss for the FDIC.

It amazes me that loans could be valued one day by a bank for $1 and the next day by a group of private investors for less than 50 cents on the dollar. There are a number of possibilities of why that may be.
  • The FDIC got ripped off and the group of private investors paid too little.
  • It was a distressed sale so the assets needed to be sold at a discount.
  • The bank was carrying the loans at too high of a value
I believe that most likely all three factors played a prominent role in the sale. However, the most disturbing part is that the bank could be carrying loans at such a premium to their actual value. That is the reason I can't bring myself to invest in bank stocks no matter how cheap they look. How does anyone know what those loan books are really worth?

The Battle Continues

Both the bulls and bears will likely claim victory today. The bulls will say that they were once again able to hold support and that this pullback is healthy. The bears will point out that the market is no longer making higher lows and is now below the upward rising trend line that has held this rally for two months now.

I believe the real test will come in June after the window dressing is done and everyone is back from vacation. Volume will likely be very light over the next few days. Personally, I prefer to buy when a market is below support. Breaking below support would shake out a lot of the weak holders. Have a good night.


I usually don't talk policy or politics on the blog because the purpose of the blog is to help make investment decisions. But I must vent.

Many of the CEOs and pundits are attacking the government for forcing the banks to raise equity and for the conditions on the TARP money. Without government intervention there would no longer be a banking system. So if the government wants the banking system to be better capitalized now, it is their right. I am tired of people who call for free markets when it suits them and then look for the government to bail them out from every mistake. Have these people already forgotten the position they were in a few months ago?

Added To Pfizer/Wyeth

I have added today to my Pfizer/Wyeth arbitrage trade. The spread has been coming in very slowly and still offers a very attractive return. Not very sexy, but not a lot of risk either. I believe it is John Paulson's second largest position, other than GLD.

Put Call Ratios Showing Some Fear

For the first time in a long time we are seeing some put buying today. It would take a few days of put buying before it could be construed as a bullish signal, but at least some complacency is leaving the market.

Treasuries Getting Smoked

Treasuries are getting smoked today and are testing recent lows. There are likely two catalysts for this.
  1. Yesterday's FOMC minutes, where it was discovered that some members of the Fed wanted to speed up the printing presses.
  2. Great Britain is in danger of losing its AAA rating. The fear that the US could be next.
Foreigners not wanting to hold US Dollar assets, especially treasuries is the nightmare scenario. I'm not saying that is whats happening but we are moving in that direction. The US is playing a game of chicken with foreign investors.

Plus Minus

  • The financial sector is trading green today. That is a market positive.
  • Commodities are down and the dollar is slightly stronger. That is a negative.
  • Google and GS are trading up, while Apple is only down slightly.
  • Market breadth is ugly.


I have repositioned myself slightly this morning. I was short shares of SPY as the result of being short the 87 and 88 SPY calls last month (As an aside, I closed out the trade at approximately break even. This was the worst of my short side trades). I replaced the short SPY by shorting the June 90 SPY Calls. I was planning on doing these trades Monday morning but the market took off and never gave me a chance.

The reason for the repositioning to a slightly less aggressive stance are as follows:

1) I see the potential for month end markups as many mangers got long in the past few weeks and don't want to look foolish so quickly. A holiday thinned environment is great for shenanigans.

2) This positioning gives me more wiggle room to short if we do test the highs again.

3) I am convinced we are in a corrective stage at a minimum, if not in the resumption of the bear market. A corrective stage can be sideways. Selling calls allows me to make money in a sideways environment.

4) My positions were stressing me out a bit yesterday.

Covered SPY Short

I have covered my SPY short and replaced the position by selling more SPY 90 June calls.

Bank Of America Bullishness

There is widespread bullishness surrounding Bank of America based on the fact that the share dilution is now behind us. The thinking makes sense to me as distress sales are often the best times to pick up stock. I believe this capital raise constitutes a distressed sale. I doubt Bank of America is selling its stock for $10 out of a show of strength.

However, I have to question if the logic will work this time around. I have rarely seen a distressed sale with so much bullishness surrounding it. Usually, people are very bearish around the time of a distressed sale. That extreme sentiment, which is absent here, might contribute to the excellent track record of distressed sales. Additionally, Bank Of America is rumored to be converting preferred shares into common stock. The holders of those preferred shares are likely to turn around and sell the shares into the market. While the supply will likely be small compared to what was issued recently, it will still be supply.

I see the upside potential in Bank of America and I have no desire to short it. But I have to question if it is the no brainer that the bulls currently believe it is.

Downside Follow Through

Good Morning. It is important for the bears to get some follow through to the downside today. This would mark another important shift from the way the market has been trading for the past two months. For the past two months the market had a giant rally with two to three day corrections nestled in between. Last week we had a five day correction, which was the first shift from this pattern. If the bears follow through this rally phase will have only lasted two and a half days.

The bears are getting help from the bankers as the deluge of secondary offerings continues. I thought that as the holiday weekend approached that offerings would slow down but that does not seem to be the case. After a long drought it seems the bankers want to make hay while the sun is shining.

Rumors Swirling About JPMorgan Secondary

There are rumors swirling about a JPMorgan secondary. Jamie Dimon has said that he does not want to raise capital, so the rumor makes little sense to me. However, these days nothing would surprise me.

Oh Sitt

If I were a bull I would not like what I saw today. A buying panic in the morning, followed by a reversal and a nasty close. If one were to look up "top" in a textbook, today's action would describe it. On the plus side, at least Bank of America managed to stay up. Have a good night.

The Boy Who Cried Wolf

  • Market leaders GS and AAPL are both in the red today.
  • The financial sector is once again trading in the red today. Financial stocks have been the best leading indicators of market direction.
  • The US Dollar is getting crushed again today. That is helping many sectors of the market that benefit from a weak US Dollar, namely commodities.
  • Is it me or does it feel we have a buying panic every day?
  • This market is testing my patience and my will. I have been debating myself all day whether to give up on the short side?
  • On one hand, I see more signs of a top every day.
  • On the other hand, the thin holiday trading coming up scares the hell out of me.

Both Sides

The bulls will argue that if we have been able to digest $60 billion in new shares in the past few weeks and the market has not so much as hiccuped, than the next few weeks should be a breeze. The majority of the capital raises are behind us and as we approach the holidays supply should no longer be an issue.

The bears will argue that the masses have been converted to the bull camp, as calls for the S&P 500 to go to 1100 are now heard regularly. A short time ago everyone was talking about Dow 3000 and we know how that ended. In addition, all the supply that the bulls have taken down in the past few weeks will eventually weigh on the market once the euphoria is over. The supply might slow down but its not over.

Both sides have valid points but as readers know I am partial to the bear case. However, if the bears don't turn this market very soon it could get dangerous as we head into thin holiday trading.

The Who Cares Rally

Good Morning. Yesterday, housing starts hit a new low for the cycle and Hewlett Packard reported disappointing earnings and gave a disappointing forecast to match. However, it does not seem to matter as this rally has little to do with fundamentals or logic. Investors stampeded into cash as the market went down and are scrambling to deploy it as the market is getting away from them. The purpose of bear market rallies is to clear out the short sellers and suck everybody's money back in before inflicting more pain.

Last night, Bank Of America decided to complete its share sale in a block transaction. They raised a total of $13.5 billion. Their stated goal was to raise $17 billion and it is being speculated that they will convert preferred shares in order to make up the balance. On the morning Bank Of America announced their intention to sell shares the stock was at $15. They sold the balance of the shares last night at $10, a 33% discount. That should serve as a warning to holders of Citigroup stock. The dilution there will be greater once the preferred conversion is done. However, usually investors need to be hit over the head with a club to realize something, so the warning is likely for naught.

I am not blind and I realize that there is a bid under the market and that it does not seem to want to go down. I remember a time not long ago when the market seemed not to be able to go up. Let's see what $8 billion from Bank of America does to that bid today. I will not be posting this morning and will be returning in the afternoon.

CNBC Confirming Rumors

CNBC is confirming rumors that Bank of America is doing a large block transaction for $8 billion. 800 million shares at $10.

Tech Leading

Technology was a leading sector today. After the bell, Hewlett Packard put out earnings that are disappointing investors. The stock is trading down 4% in after hours. While semiconductor companies have been seeing signs of improvement, companies at the front lines have not. This likely means the inventory correction is over but for stocks to go higher end demand will need to improve. Thus far there are few signs of that.

Bank Of America Rumors

I am hearing rumors that Bank of America is planning to do the remainder of its offering in a block transaction. The deal would likely be above $10 billion. The stock retreated late in the day and is trading lower in after hours so I am likely not the only person who heard this rumor.

The Comeback Kid

The bears were left for dead today and came back late in the day to take a small victory. The banks were lagging all day and did not want to confirm the upside before completely falling apart at the end of the day. The REITS were also weak, as it seems the momentum players are moving back into technology. The banks have been the best market tell and gives the bears some hope for tomorrow. Have a good night.

Market Tops and Bottoms

Market bottoms often happen very quickly. In March, the market gapped up off the bottom and did not look back until the market rose 25%. Rarely does something like that occur at a market top. More often than not tops are long drawn out processes. When this bear market began in 2007, the market spent 4 months between June and October topping out. Each time testing the top and dropping back.

If you have ever puked up shares out of fear at the worst possible time than you can understand why bottoms tend to happen quickly. As the market tumbles people sell out of pure panic and fear. They just want the pain to stop and the market tumbles until the sellers are done. That is a bottom. I have certainly been there and have learned more about markets from those experiences than anything else.

However, people rarely buy out of the same fear. People watch the market go higher. It bothers them that they are missing the move but rarely does it panic them. So when the market pulls back a little they buy in. That is what I believe we have seen the past two days. The best way to trade tops is to scale in to shorts as we move towards the highs and slowly take profits on the pullbacks. That is how I am playing it.

29 Again

  • The VIX is back in the 20's. While that is a normal level, are these normal times?
  • It feels a little foolish to be making the bear case, but doesn't it always feel that way at the top?
  • I know I was starting to feel foolish two months ago when I was making the bull case.
  • Bank of Americas has been having a hard time gaining traction the past week, as the company is slowly selling shares into the open market. I suspect we will see the same thing with Citigroup once the conversion happens. The number of shares of Citigroup on the market is set to more than double.
  • Citigroup is waiting for regulatory approval before beginning its conversion. Are the authorities holding up the conversion in order to allow other companies to raise capital first?
  • Am I giving the authorities too much credit?

The Bid Is Back

  • Once again we are seeing heavy call buying today. If everyone is looking for a pullback they are not expressing those views through the options market.
  • Goldman Sachs upgraded the REIT sector "after" a historic 50% + run. The more things change ...
  • Paulson & Cos. filed their positions with SEC. The majority of their money is in GLD and arbitrage positions. The man who saw this crisis coming is not seeing green shoots.
  • According to this Bloomberg article neither are Daniel Och or David Einhorn.
  • When the market was hitting new lows in March everyone was positioned defensively. If you were a tricky bear, wouldn't you want to suck everyone in before hitting new lows?

Its A Bird, Its A Plane

Good Morning. There was a unanimity among traders that there was something strange about the way the market traded yesterday. I heard a bevy of explanations
  • Quant fund blowup
  • Heavy mutual fund inflows
  • Everyone was positioned for a correction/bearishly
The truth is that nobody really knows what happened yesterday. It will be pivotal to see if that influence returns today. My experience tells me that there is a better than average chance it won't, but admittedly that is a guess.

I have been guilty of underestimating the bulls in the past few weeks. The market absorbed close to $40 billion in new shares in the past two weeks and regained much of its losses effortlessly yesterday. That said, I don't believe this correction is over. Bottoms often happen quickly, where the market bounces off the bottom and never looks back (similar to the March bottom). However, more often than not tops are drawn out processes, where the market keeps retesting the highs (or making marginal new highs) before finally giving way.

Bears Mauled

The bears took a severe beating today. The bulls came out swinging and it did not stop all day. Today's trading had a strange feeling to it that I couldn't put my finger on. Sentiment's Edge has an excellent article on what occurred today that quantifies it.

After the bell, we saw a bunch of secondaries announced but not at the level of the last two weeks. Tomorrow's trading will be important and should set the tone for the remainder of the week. Have a good night.

Pump Up The Volume

  • Volume is extremely light today and should get lighter as we get closer to the holiday weekend. There is the potential for serious game playing as volume thins out.
  • Does that scare me? You bet it does.
  • Bank of America traded down to the days lows but the rest of the financial sector did not join it. It seems that the market is distinguishing between banks that already issued equity and ones that did not. This is a positive for the bulls.
  • The VIX is making a new low for this move and trying to bust under 30.
  • Who needs sleep?

Awe Struck

There is nothing like getting caught in a short squeeze to get my blood flowing on a Monday morning. Bears likely remembered the day after last option expiration, where the S&p 500 fell over 4% and pressed their bets on Friday. Some good news to start the week caught them wrong footed.

There is not much to support a turnaround today. Breadth is excellent and the financials are taking the lead. The only negative is that Bank of America is starting to lag. Keep an eye on it as it started the rally today.

Pulled Back In

I was wrong about a 5% down week giving the bulls pause, as they are viewing the drop as a buying opportunity. That is generally not the sentiment that is seen at the end of a correction. I suspect that when this correction is finally over there will be talk about the market making new lows, not about new highs. We are seeing very heavy call buying in the early going.

I have been using this opportunity to rebuild my short positions by selling June Calls. I want to see what the equity issuance calendar for the week will look like before increasing my positions further.

Sold SPY Calls

I have sold June 90 SPY Calls. This is inline with my view the equity issuance will limit the upside.


  • Goldman Sachs is giving the banking sector a boost by upgrading Bank of America. They are also the lead manager on the State Street secondary, which will benefit from a better tone in the banking sector. Coincidence?
  • Why do stocks rally on upgrades and go down on downgrades if analysts track records are spotty at best?
  • Admittedly, I have very little expertise in understanding bank balance sheets. However, aren't two banks on every block too much? How can they all make money in a world of reduced leverage?
  • While the raising of capital reduces systematic risk, can't we revisit the lows on good old fashioned low valuations?
  • Bank Of America is slowly selling $17 billion in new shares into the open market. Why not wait a few weeks until they are done before buying the stock?

Good News, Bad News

Good Morning. The bulls are waking up to better than expected news and higher futures. Home improvement retailer Lowes had less bad than feared earnings and Goldman Sachs upgraded Bank Of America.

The bad news is that stock issuance should continue to remain a major obstacle. Even if no additional companies announce offerings there are a number of companies that are doing "at the market" offerings, where they sell shares into the open market on a daily basis. Bank of America is doing the largest offering at $17 billion. State Street is announcing a $1.5 billion secondary offering this morning. We should get a better idea of how busy the bankers will be this week after the closing bell.

Weekly Strategy- Decision Time Approaching

That the market would eventually pull back after rallying 40% off the lows was the easy trade. However, in the coming weeks investors will need to decide if this is indeed the start of a new bull market or a bear market rally.

I am in no rush to make a decision as I believe that even if this is a new bull market that this correction has further to go. After a two month 40% run, I would expect a correction that lasts at least a few weeks.

In the past two weeks we have seen companies issuing shares at a record pace. The flood of equity issuance is set to continue in the coming weeks, albeit at a slower pace. This supply should keep a lid on the market. Given that I believe that the upside is limited in the short term, there is little harm in waiting a few weeks to see where this correction will take us.

While a bull market from these levels would not likely go very far, I don't want to rule it out. The Obama stimulus should start hitting the economy this Summer, while the Federal Reserve is printing money. There is no precedent for such action. At the same time I don't want to rule out revisiting the lows. For now, I am biding my time and keeping an open mind.

Rest Up

This correction is already different from its predecessors in that it is already 5 days old. All other corrections during the last two months lasted no longer than three days. While we might see bounces I don't believe we are out of the woods yet. We had a 2 month 40% run in the stock market. It is not unreasonable to expect a correction that lasts a few weeks.

It appears as if the market is closing firmly in the red for the day and the week. Recently, the market has been benefiting from a virtuous circle where higher prices, led to more inflows and more inflows led to higher prices. If that circle has been broken we will likely see the S&P 500 break below 875 next week. Then we will see what the bulls are really made of. Rest up. It will be an exciting week. Have a great weekend.

A Chart In Words

There is a chart from UBS that I wish I could share with readers but I don't have permission. I will describe it. It is a chart of equity issuance (IPOs + Secondaries) dating back to 1999. It shows that the recent equity issuance as a % of market cap is by far the highest.

During the internet bubble billions of dollars of stock were being printed as multi billion dollar companies were created out of thin air. The past month has dwarfed any month during the internet bubble.

Closing Time

Is today's closing more important than usual? Mutual fund inflows have been heavy for the past few weeks, helping to absorb a lot of the stock that has been coming to market. Would an ugly close going into the weekend make people stop and think before putting more money into this market?

Expiration Friday

On expiration Friday I don't even try to figure out what the market is going to do. I just make sure I am comfortable with my positioning come Monday when the expiration influences wear off. I am short the 87 and 88 SPY Calls that expire today. If I am forced to deliver the shares of SPY, I am happy to be short the SPY at these levels.

Investment Bankers Get Smart

Good Morning. It was very quiet last night on the stock offering front. It seems the bankers realize that they are killing the market with all these offerings, so they are backing off a bit. They have a lot more merchandise to sell but if they keep flooding the market it is unlikely they will be able to unload much of it.

The way I see it, there are two possibilities to how this will play out. The first is that the damage has already been done to the market and the bankers pulling back now is too little, too late. The other is that the market will be able to regain its footing here. However, once the market starts rallying again the bankers will start peddling their merchandise again. In either case the upside is limited.

Additionally, Citigroup and Bank of America will be issuing over $30 billion in new shares in the coming month. I don't see a reason to buy until those offering have passed. I am sure many readers are wondering why I keep harping on these share issuances. The reason is because I have never seen such large issuances. This source of "supply" is dwarfing other market players.

Its Raining Mutual Fund Money

  • After a greater than 25% drop in its price since Friday morning, Bank Of America is finally bouncing today. I believe a bounce will be limited as Bank Of America is slowly selling $17 billion worth of its own shares into the open market. That should cap the upside.
  • I have no idea how to value B of A on a fundamental basis as they are a giant black box to me.
  • Is today another example of why one should never short a dull market?
  • From the WSJ:
    "Long-term mutual funds saw net buying from investors for the eighth straight week as investors continued pouring into both bond and stock funds, according to figures from the Investment Company Institute.

    Total estimated inflows were $13.51 billion in the week ended May 6, bringing total inflows in the past eight weeks to about $78 billion."

  • Follow the retail investor?
  • This is another WSJ headline from March 7, right before this 40% rally. "ICI: Outflows To Long-Term Mutual Funds $17.08B In Latest Wk"
  • Have a good night.

I Keep Trying To Get Out

"I keep trying to get out; and they keep pulling me back in."
-Michael Corleone, The Godfather

I covered the majority of my shorts yesterday. I was looking forward to a few days of relative relaxation, where I wasn't up to my eyeballs in positions. But if the market rallies much further I will not have a choice other than to reestablish some of those short positions. I'm hoping for a quiet market for the rest of the day.

MGM Sells To You

  • MGM's stock was trading at $13 a few days ago. They proceeded to announce a $1 billion share offering. Last night they sold the shares for $7. I believe that is a great example of how the recent rally has diconnected from reality.
  • While I could see a bounce here (for the reasons outlined in my opener), I believe it will ultimately fail (also for the reasons outlined in my opener).
  • Are the green shoots people putting their money where their mouth is, now that the market is giving them a chance to buy cheaper?
  • Or will they find a reason to turn bearish now?
  • Breadth is positive today on the NYSE and even better on the Nasdaq.

Boston Properties Rolling The Dice

Boston Properties has stopped a couple of construction projects in New York City. That was likely the prudent thing to do given the fact that increasing leverage at this point in time was unwise.

When looking at the projects on an individual basis the picture is different. The cost of the land, planning and part of the construction are already sunk. If one has the equity, it likely makes sense to complete the projects, so that at a minimum it produces some cash flow.

Boston Properties' stock has recently shot up by 50%. A week ago they could have easily raised enough equity to complete the projects but they chose not to. In my opinion, there are two likely possibilities why they chose not to do an offering. The first is that they are trying to sell the properties. The second is that they believe their stock is too low to sell here. The first reason I find understandable. However, if they chose not to do an offering because they thought their stock is too cheap they are doing little more than gambling. They are over leveraged and the market was giving them an out. They are choosing to roll the dice. While they might turn out to be right, I don't believe that is the way to run a public company.

The Good, The Bad And the Wild Card

Good Morning. The good news for the bulls is that the market is fast approaching support in the 875-885 area on the S&P500. While many managers paid up and chased the rally, it is likely that some were waiting for a pullback. A perceived level of support is as good a place as any to put some of that money to work. Additionally, there was a slowing last night of share offering announcements.

The bad news is that a lot of stocks that surged higher on short covering are hitting air pockets to the downside and how far they will fall is anyone's guess. Additionally, even if no other share offerings are announced, Citigroup and Bank of America will be issuing $30 billion in new shares in the coming weeks. Most of the smaller banks have not yet raised capital and will likely be looking to do so. If the market does manage to rally, other companies looking for capital will likely come out of the woodwork.

The wild card is that tomorrow is options expiration. As we approach options expiration, it tends to have a large effect on the market. In my experience, trying to predict the effect options expiration will have is difficult.

Sleeping Like A Baby

  • I am headed out to meetings for the balance of the day. I will likely cover all my shorts other than the 87 and 88 SPY Calls by the end of the day.
  • After waking up at 4AM every morning this week, I will be sleeping like a baby tonight.
  • While I am covering shorts I believe it is way too early to buy, other than for a trade.
  • The secondary offerings have not ended.
  • There is no longer a large short base as shorts have gotten destroyed recently.
  • The market is not yet oversold.
  • If you enjoy reading, please tell a friend about Capital Observer.

Covering More Shorts

I am using this further melt to cover more shorts.

Another Turnaround

At the risk of being wrong two days in a row, I don't believe the bulls will be able to turn this around today.
  • Breadth is absolutely horrible, with over 6 stocks down for every stock up.
  • The financial stocks are once again getting pounded.
  • Generally, turnarounds don't happen two days in a row.
The one caveat is that the S&P 500 has strong support in the 875 area. If we get to that level it is likely that buyers will come out of the wood work.

Why This Pullback Is Different

The market has had some brief pullbacks during the past two months. As soon as the market began to turn down traders started buying puts in anticipation of a correction. The pullbacks proved to be short and shallow. This time we are seeing call buying on the pullback. This correction is different and will likely last longer than two to three days.

Green Shoots Greenspan

Once again Alan Greenspan is out making predictions that housing has bottomed. A good friend of mine asked me, "He said it was impossible to tell that that housing was a bubble or that he might have caused it, but he sees a bottom?"

Taking In a Few Shorts

Im taking in a few shorts in the pre market with the S&P futures down 15 points.

Gap Down

Good Morning. The pattern of companies issuing stock is not slowing down. I counted five companies announcing offerings last night and MGM Mirage is announcing an offering this morning.

At the same time the market is starting to show signs of exhaustion. Breadth was negative yesterday, even though the S&P 500 managed to claw its way back. Defensive sectors like Pharmaceuticals and Biotechnology led the way, while the Nasdaq and Russell 2000 underperformed.

I remain negative on the near term outlook for the stock market and believe that after a 40% run the market will have a hard time making progress during the next month.

Mea Culpa

I did not think the bulls were going to be able to turn this market around today. At midday breadth was bad, financials were getting smoked, support got taken out and there was call buying. In my experience, that is rarely a recipe for a turnaround. However, late last week I raised my position sizes to the point where I have been waking up at 4 AM the past two days. I was sitting on large gains earlier today and regardless of what I thought, discipline dictated taking enough off so I could sleep well. Luckily, I took a little off. I'm signing off for the day. Have a good night.

Sold SKF

I sold my SKF just now. In hindsight I was being greedy and should have taken more profits earlier in the day. That said, I am no longer planning to cover shorts today.

I'm Not A Pig

Not to be greedy, I took in a very small amount of my short sales. I am saving the bulk of my covers for the end of the day.

Its An Ultra ETF World

I will likely take off a bunch of shorts at the end of the day today. At the end of each day the Ultra ETFs rebalance. The rebalancing occurs in the direction of the market. A big down day causes these ETFs to sell more. This exacerbates moves both up and down. I will be looking to cover some shorts into that rebalancing today.

Rebutting The Bulls

I am hearing some bulls argue that these secondaries are a positive because they will allow companies that were over leveraged to make it through this recession. Whereas without this funding they were likely headed for bankruptcy.

In the long run that argument is correct. However, in the short run this new supply of stock is eating up money that would have likely gone in to existing stocks. This is a positive for bondholders in all time frames but a negative for equity holders in the short and medium terms.

S&P 900 Defended

As the S&P 500 approached the 900 level the dip buyers came into the market and have pushed us higher. Its hard to blame them for giving it a shot after the recent market action, but I believe they will ultimately fail. There is simply too much of a supply overhang to get this market meaningfully higher. If we break 900 we should start to see the momentum players hit the eject button. I will likely cover some shorts into that, if it occurs.

SL Green In the Green

SL Green is a commercial REIT that primarily owns property in NYC. Last night they did a secondary offering and the stock is actually trading higher today. They were highly leveraged so many were likely looking for a bankruptcy. Today's move higher is likely a sigh of relief.

However, investors who are looking for cash flow out of this stock will need to be in it for the really long haul. The current dividend is under 2% after yesterday's dividend reduction. The fundamentals of the New York office market are still deteriorating, so there is downside risk to that dividend.

The largest group of tenants in NYC office buildings are financial companies or companies that support financial companies (like lawyers). After the recent implosion, banking is likely to become a boring commodity business again. That means that being a low cost producer will be important, which means controlling rent costs. The supposedly "value added" employees that will only work in NYC, lost corporations more money last year than they ever made. I believe this will have a long term negative effect on the NYC office market.

Microsoft's Bond Offering

I have been giving some thought to Microsoft's bond offering yesterday. I believe the two most likely reasons they are selling bonds is a search deal with Yahoo or a stock buyback.

I believe a search deal with Yahoo will be neutral to the stock. The two companies have so many overlapping costs and their are large cost savings to be had by combining search efforts, that it will be difficult to overpay. Microsoft has had little success outside of software so investors will likely be skeptical at first.

The other possibilty is that they will buy back shares. A few months ago Steve Ballmer said he was against buying back shares (when the shares were significantly lower) and wanted a cash hoard. However, Steve Ballmer has been known to change his mind often. While he might be a great operations guy, I question his financial acumen. That said, I believe a share buyback would be positive for the stock.

Microsoft shares are still reasonably priced. Additionally, I believe the release of Windows 7 will be a positive catalyst. I know a few people (myself included), who are waiting for Windows 7 to come out before buying a new PC. If the market does pull back, this is a stock that I will consider buying.

The Real Test

Good Morning. For the past few months we have seen the same pattern repeat. We get an ugly day like yesterday that gets the bears hopes up and then the market proceeds to destroy those hopes. Market players have been conditioned to expect that pattern. Shorts cover their shorts quicker and bulls buy every little pullback.

This morning we are seeing a knee jerk reaction higher in the futures as traders expect this pattern to continue. This time around the bulls have their work cut out for them. We should see about $7 billion in stock offerings price this morning with a similar amount tomorrow. The bulls will need to absorb all that supply, in addition to trying to push the market higher. You know where my money is.

Secondaries Everywhere

More secondaries are being announced and its not only in financial stocks. We are seeing Ford, SL Green, Bank Of New York Mellon and Anandarco Petroleum all announcing secondaries after the close. This amounts to another $5 billion in supply. That cash pile on the sidelines better be as big as rumored.

Financials Reassert Dominance

It looks like the financials won out on the day and dragged the market lower. I believe that a correction has begun. At a minimum we should see the S&P 500 trade below 900. At that point I will likely cover some shorts. I will be interested to see if there are more secondaries announced after the close. Have a good night.

Strange Day

  • Don't look now but Capital One is getting dangerously close to its deal price. These issuances could get a lot uglier if deal prices start to break.
  • It was really strange that the S&P 500 was up over 5% last week and the QQQQ was down on the week. It is equally strange that the QQQQ is up today. These are not normal times, despite the all clear.
  • The bulls are not going down without a fight. While financials are getting sloppy, other sectors are trying to hold the line. That is scaring me a bit.
  • Could the market rally without the financials? It doesn't usually work that way but theses are not usual times.
  • Why is Microsoft selling bonds? Don't they have enough cash? What do they have up their sleeve? Maybe that is why technology is rallying?

What I Would Own

The most heavily shorted areas of the market have performed the best in the past two months. These also happen to be the areas where companies are in need of capital. If I had to buy something, I would look in areas of the market where companies do not need capital.

I believe that we are seeing a change in trend today as stocks with stronger balance sheets are starting to outperform. The QQQQ is actually up nicely on the day. The rally in junk is over.

The First Dip

Investors aggressively bought that first dip lower as they have been trained that all dips are meant to be bought. The options ratios are showing extreme call buying on both the CBOE and ISE, which is somewhat unusual for a down day.

While I don't believe they will be able to turn the market around today, the real test for the bulls has not yet arrived. Of the offerings announced today, only Capital One has priced. Once the other offerings are priced we will see what the bulls have.

More Offerings

More companies are joining the offering parade. Energizer Holdings, Berkshire Hill Bancorp and KeyCorp have all announced offerings this morning. At what point will investors start asking why companies are so eager to sell?

What's In Your Wallet

Capital One was a $17 stock a short week ago and has climbed to over $31. The government did not require them to raise additional capital but at this price they are gladly doing so. Apparently, they don't want to wait, as they are doing a $1.5 billion offering this morning.

Back To Reality

Good Morning. It feels great to be back and I appreciate all the support I received from readers. I am happy to report that I finally feel that I am on the road to recovery.

I believe that risk is extremely high in the market at the current juncture. The market is extended and there is a strong speculative element to it. Normally, periods of extreme positive sentiment can persist but there will likely be over $70 billion in equity issuance in the coming month. I believe this will be a lethal combination for the market and believe we could see large losses over the coming weeks.

Just this morning I am seeing over $6 billion in equity offerings from the likes of BB&T, Principal Financial Group, US Bancorp, Capital One and Inland Real Estate Group. And its only Monday morning. I am going to go on a limb and say that we have already seen the highs for this rally.

Weekly Strategy - Mission Accomplished

When the initial burst off the bottom in 2003 occurred there was a large sentiment shift, similar to what we are seeing today. At the time, the US invaded Iraq and with each military victory the market shot higher. This time around we have the stress tests, which are proving to be an even easier challenge than Saddam Hussein was. It seems that everyone remembers 2003 and believe they know what happens next.

While the current period bears some similarities to 2003, the differences are far more prominent. In 2003 companies were announcing large buybacks and we were at the nascent stages of an LBO boom. Currently, companies and insiders are selling stock into the market at a pace never seen before. Back then we were at the early stages of a real estate and credit bubble. Every day new methods were being invented on how to turn one's house into an ATM. Today we have massive over capacity in real estate and consumers are delevaraging. Back then corporate taxes were being lowered, while Barack Obama is planning on closing tax loopholes that will likely result in a 4% reduction in corporate earnings.

The rate of decline has slowed, but there is little evidence of an expansion. What sectors are expanding and will lead us? The truth is that the market's rise is convincing investors of a recovery. It is not considered "intellectual" to say that one is bullish because the market is going up. As a result, intellectual sounding stories are concocted to make joining the herd seem like a logical decision.

Bearishness reached an extreme that I have never seen two months ago. The recent rally was an unwinding of that extreme sentiment and in my opinion has run its course. The easy money trade has gone from shorting anything with leverage to buying anything with leverage. My experience with easy money trades, is that one should run in the opposite direction.

Tops are harder to call than bottoms as extreme positive sentiment can last for a while. In contrast, extreme negative sentiment typically reverses pretty quickly. However, I believe that the high level of secondary offerings that is expected to persist will make staying at these lofty levels harder than usual. Additionally, gains are much harder to come by once sentiment has reached an extreme. Even people who believe that this is a bear market rally, believe it is too dangerous to fight it. I am very encouraged by that, as it is the type of sentiment seen at market tops. The time to buy was two months ago, the time to sell is now.

$19 Billion In Secondaries

We saw close to $19 billion in secondaries this past week . And the market was still up 6% for the week. Amazing! The capital raises will likely continue. Let's see if the buyers run out of power.

What is even more astonishing is that the Nasdaq 100 was down on the week, while the S&P 500 was up 6%. Even though the vast majority of the secondaries were in S&P names.

Jam Job

After one of the worst bear markets in history and losses that will effect people for life nothing has been learned. It is arguable that the herding effect has become even stronger. Two months ago the consensus believed there was no reason to own stocks. Now they believe there are no reasons to sell. The only thing that exceeded the speed of price targets dropping was the stock prices dropping. Now analysts can't raise targets fast enough. I expect the same result we saw in March. Am I the crazy one?

Fill Er Up

I am very short right now. Enough said.

BAC's Plan

BAC will be selling shares into the open market rather than doing an offering. This is an unconventional way of issuing shares. It will be done over the next few weeks. Here is the link. This does not change my view but strengthens it. There is a $17 billion seller in the market. That is better than insider information but momentum rules the day.

Simple Math

Morgan Stanley just announced that they sold just under $3 billion in shares at a greater than 10% discount to yesterday's closing price. What type of discount would Bank of America need to give investors in order to do a $17 billion sale?

BAC To Issue $17 Billion In New Shares

Bank of America CEO, Ken Lewis, just announced on CNBC that BAC plans to raise $17 billion by selling new shares, although the timing of a sale is uncertain. Why anybody would be buying BAC stock ahead of such an event speaks as to the madness that is currently gripping the market. From where I sit, the writing is on the wall.

Buying SKF

I am buying a small speculative position in SKF as the financials trade up after the stress test results. I believe they will have a problem rallying with all the new supply.

Interest Rates Rising And China Complaining

Interest rates have been rising rapidly in recent days. China is voicing renewed concern over the quantitative easing being conducted by the Fed. In addition, commodity prices have been rising with oil nearing $60 a barrel. These pose huge headwinds to a still fragile economy. Ask yourself if the people who are now so certain that we are in a new multi-year bull market saw this mess coming in the first place. Are they the people who should be sounding the all clear?

I am not saying that we will revisit the March lows but I believe it is a possibility. I view risk as much higher than two months back. There are no more shorts to cushion the market and there is a lot less cash on the sidelines. At the same time we should start seeing tens of billions in shares being issued by financial institutions in the near future. More on Monday.

The More Things Change

It is hard for me to believe that the media is trying to spin Bank Of Americas $34 billion capital shortfall as a positive because it does not exceed the amount of their TARP loans and because they could sell assets to raise capital. No shit. Is it news that assets could be sold to raise capital? If my house was being foreclosed on, is it good news that I could sell my furniture to pay back the bank?

It never ceases to amaze me how market participants spin news in order to justify chasing momentum. I still plan to return Monday but needed to vent.


I look forward to returning to my regular schedule on Monday and I appreciate all the support that I have received from readers. I wanted to give readers an update as yesterday was a major event.

Yesterday, was an upside panic and was very emotional. In the market panic and emotion are rarely rewarded. While it is possible that this rally could continue, I strongly believe that when a correction does arrive that there will be better prices. Aside from yesterday's panic there are some other reasons to believe that we are close to a turn.
  • According to Jeff Saut, today is day 40 of this buying stampede. The longest buying stampede on record is 41 days.
  • According to the Wall Street Journal, 10 of the largest banks in the country are short of capital. That will mean huge capital raises. While the capital raises will not start until some time after Thursday's stress test results, the huge supply of stock will be a large negative for the market.
  • Interest rates and commodity prices have been moving up with the market. At some point this will become a problem as the economy is still sick and these are massive headwinds.
  • The market is at an extreme overbought reading in the short run.
  • Eight weeks ago, the end of the World was being reported on TV. That was the time to buy. Now the same people are waving the all clear. Get in your bunkers.
  • John Mauldin has a wonderful piece on Sell In May And Go Away.

Weekly Strategy- Still Looking For A Turn

On March 1, over 80% of mutual funds were outpacing the S&P 500 for the year. That is no small feat given that the vast majority of mutual funds fail to beat the S&P 500 in the long run. Hedge funds were doing even better. It seems that everyone figured out the trick to beating the market. Overweight defensive stocks, overweight cash, underweight financials and underweight leveraged stocks. Once everyone was on board for this trade and there was no one left to join the bearish bandwagon the market turned hard.

During the month of April over 85% of mutual funds failed to keep pace with the S&P 500. This move caught nearly everyone wrong footed. What we have been seeing for the past eight weeks is nearly the entire investment community repositioning. The higher the market goes the more people are forced to buy for fear of further falling behind the indices. Not to mention, that as humans we are hard wired to want to chase the herd.

There are numerous reasons to believe that this repositioning might have run its course. Anecdotally, it seems that the vast majority of pundits that go on TV are once again bullish. Sentiment surveys have shown vast improvement since early March.

More importantly, the two sectors that led us to the upside, financials and REITs, were unable to make a higher high this week with the market. On Friday, both sectors were down even though the market was up. Additionally, late in the week two secondary offerings in the REIT sector broke their offering price during their first day of trading. That is in stark contrast to offerings in previous weeks where gains of up to 20% were seen in a day. This signals to me that the repositioning into those sectors might have run their course.

Banks are clearly unhappy with the results of the stress tests. That is the reason the results are being delayed until Thursday. This will likely mean massive dilution in the financial sector. I find it unlikely that Obama will take an easy stance on the banks after forcing Chrysler into bankruptcy. How would that look politically? While an argument could be made that the market could go higher without financial stocks, that is not how the market has operated for the past few years. I remain bearish and continue to expect a turn lower in the broader market.