Sunday, March 30, 2008

The Psychological Rally

The same hedgie contact that so brilliantly called the last down leg in financials (see March 24 post) pinged me again on Friday. This time he had this to say:

This is probably going to challenge alot of the academic folks... but lets face it.. at least in the short term... psychology is 80% of the market volatility.

First off, I refuse to sell any of my shorts… namely SKF, SRS, TWM… But unlike the past 6 months or so I am starting to put more cash to work AGAINST my shorts. Prior to last week I was mostly 40% - 50% cash at most times.

Here are my “psychological” reasons for turning “short term” term bullish:

First off. It is a known fact that markets always bottom BEFORE there is any real economic evidence of a turn. THUS, most investors will be (are currently) looking for any slight reason to turn bullish… They will look for any reason to rationalize and justify buying stocks to GET IN FRONT of the impending (pre-expansion) rally that will ensue BEFORE we officially emerge from the recession. And the media coverage will stroke their confidence. It is also a fact that most of the POST recession stock market rallys are largely OVER by the time we have OFFICIALLY emerged from recession.

That said… I think we have PLENTY of scant evidence all around us that bulls and the media will be able to hang onto to convince us all that we have bottomed and that “YOU NEED TO BUY STOCKS NOW”

1. people seem to want to buy stocks here… that is the sentiment since BSC
2. BSC was the catastrophic BOTTOM of the market
3. Tax refunds are going out
4. $600 stimulus check going out
5. TREMENDOUS liquidity coming from the fed
6. Election year
7. Everybody reads the same “Don’t Fight the Fed” textbook
8. GDP not too bad (yet)
9. payrolls number (will be reasoned that it is a trailing indicator)
10. foreclosure pipeline is growing… but many are still in early stages (bad news still few mos away)
11. a normal seasonal uptick in real estate will be mistaken for the REAL THING
12. the Early cyclical’s trade is already being put on

OF COURSE I think this rally (if we get it) will be proven to be false...and sometime this summer we will get hit on the other side of the head with another two-by-four and resume the downtrend to new low levels as it becomes apparent that this recession is longer and deeper that first thought. It is typical of markets to have false bottoms as everyone trys to game the END-Recession play. I see no reason to doubt that this time is different…. heck, we sure have all the ingredients for it.

Its hard to believe that all these bottom callers really think that we can exit a period of some of the most egregious lending in history… with one of the largest real estate bubbles in history, against an untested explosion of derivatives with a mere 3 month recession, and 14% peak to trough decline in the markets in less than 6 months. But that seems to be what I am hearing in the media these days.

Net net... i really don’t know... this is a veiled attempt by me to gauge sentiment and get out in front of it. it is very hard to get incrementally long in the absence of any positive economic data... but I think that sometimes the hardest trades are the best trades. As counterintuitive that this is... I think I need to be more long. Especially China which tends to track commodities…. Check out this chart:

We shall see but my guess is that by the early summer,late spring.. we begin to realize... that things are worsening... and the wheels will start to fall off the cart again... but in the mean time… I will be getting in position for the HOPE rally.

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