Market Thoughts

A truly massive rally today on Wall St. You had to be in awe especially with all the just horrendous news out after the open yesterday and before the open today. Things are really really tricky right now. I think though that a shift may have occurred. What I mean by this is a couple of things. Look at the first quarter. EVERYTHING was down. The best performing sector in the U.S. was consumer staples down 1.3%. Even materials was down. Three countries in the world had positive returns in the first quarter. 3!!! Mexico, Chile, and Taiwan. It was a three month period where everything went down. Good, bad, ugly, beautiful, clicking, not clicking, didn't matter it was headed lower. You don't see this very often. You made money on the short book and in a few select names. Things may be shifting moving towards a more favorable stock pickers environment. Many long time value investors got their head handed to them so far year to date. Where they wrong? Time will tell but it hasn't mattered if things were undervalued, it was going to get cheaper. The primary reason was the steady drum beat of increasing systemic risk. Systemic risk affects everything. If the world blows up (the ultimate systemic event) every company is a zero. The systemic risk is now declining. It decreased again with the Lehman capital injection. If it truly continues to decline (I still think there is a reason why it could raise its ugly head again which I will get to in a moment) we will start seeing things move differently. The market is not cheap on a historical earnings basis with historical margins but some stocks are cheap. It is also not expensive so to expect another 30% decline just because is foolhardy. It is wishing what the market would do. These cheap stocks will start moving up as the market moves sideways or drifts up or continues to drift down. I still strongly believe that six months from now we will be below the March lows however I will put it close to even odds we test 1400 in the S&P and 30% probability we test the real biggy, 1450. These probabilities are just gut feels nothing more but I think there is a shift. I have said for a couple of weeks now that this feels like September / November. If I am right the shorts will have to buckle down and the market will be very unfriendly towards them.

Now the tricky part. With all that said, there are some reasons to doubt this rally yet again today. 1) The ABX which I look at everyday only ticked up slightly. This is not surprising considering the news today was bad all the way around. I really do not think the market can have a sustained all clear moving towards all time highs until this starts to pick up. 2) We are now in extreme overbought conditions. The last time we were this overbought was the end of February. Remember what happened then? We are still well short of the overbought conditions in mid October. 3) The trade that has worked for months has been buy before Bernanke speaks, sell after he speaks. Tomorrow he starts speaking before the Senate. He will also speak on Thursday. If this is true to form we will be up again tomorrow and start selling into any rally on Thursday. 4) Huge employment number on Friday. For any truly big bullish move up to that 1450 level that number has to come in line or be better than expected.

If you are a fundamental guy it really doesn't matter. I look at this stuff because I trade in and out of protection and work it into initiating and adding or taking away from positions. The key is the systemic risk. I would be much more long if I knew the systemic risk had truly peaked which once again is an art judgment call.

So what is the systemic event that still haunts me. It is still MBIA and Ambac. Say we put on a great counter trend rally over the next few weeks. We work are way up to that 1450 level and then boom, MBIA and ABK start making their way back to the spotlight again as they report earnings at the end of April / beginning of May. The losses I think will be massive and the rating agencies will start demanding more capital raised or they will cut their ratings. Unlike with UBS who they just cut they will give them a couple of weeks which will drag into a month because these guys just can't be cut. If they are, huge systemic risk returns. I don't know how this will turn out. If I had any inkling it would turn out good I would start moving out of treasuries into money markets and be more aggressive on stocks. As it is, I must in my mind continue to play defense.

Time will tell. The short book could get ugly for awhile and I may not be as aggressive as I should be right now. My mantra is not to lose money. If I can accomplish that, I will end up making money. It worked in the 1st quarter.