Kass: Cut the Dead Weight

This blog post originally appeared on RealMoney Silver on Feb. 14 at 7:36 a.m. EST.

On Monday morning, I turned more optimistic about the equity markets, thinking that a 3% to 5% rally (within a bear market) was imminent.

This week's orderly advance of nearly 3% has us very quickly in the shooting range of my expectation, and equities now stand about 8% above the SocGen market bottom.

I expect, as we move to the top of a trading range, renewed optimism (e.g., Jim "El Capitan" Cramer) to percolate a bit and for stocks to leave oversold levels as a larger percentage of investors and traders seem too often to worship at the altar of momentum. Some might even confidently predict a new bull market leg, an assertion I would oppose.

Having said that, this rally remains an excellent opportunity to cull the losing positions and raise cash levels after an abysmal several months.

The S&P 500 is now down by 6.8% year to date and my expectation of a 5% to 10% decline for 2008 remains intact. But, between here and year-end, it is still likely to be a roller-coaster ride, with many opportunities on both the long and short sides. Having above-average cash positions is a necessary reagent to capitalizing on continued volatility.

Overnight, there was more news on what I believe to be the next shoe to drop -- the auction rate preferred market:

• There were more credit writedowns and share price losses at UBS (UBS - Cramer's Take - Stockpickr);
• the largest rebound in Japan's market in six years (I highlighted the attraction of Japan in my surprise list for 2008);
• Ingram Micro (IM - Cramer's Take - Stockpickr) guided down;
• growing evidence that the Fed is "pushing on a string"; and
• Credit Suisse suggests that the FHA help resolve the U.S. housing problem, something I previously recommended.

From my perch, the safest anti-implosion investment and best risk/reward trade remains being short bonds. I am playing this trade via the iShares Lehman 20+ Year Treasury Bond Fund (TLT - Cramer's Take - Stockpickr). Tactically, I plan to expand my short book into further strength.

Doug Kass is the author of The Edge, a blog on RealMoney Silver that features real-time shorting opportunities on the market.