Preopen Extra: Don't Stop Thinking About Yesterday

As the nation turns its lonely eyes to Capitol Hill today -- where Federal Reserve Chairman Alan Greenspan is scheduled to give revised testimony before the House of Representatives -- some additional thoughts on yesterday.

There's an argument to be made that if "everything" hinges on the possibility of an intermeeting rate cut, the fact that stocks fell yesterday despite another swoon in consumer sentiment is troubling. Many traders said the decline was predictable, given the intense anticipation of a Federal Reserve announcement that failed to materialize. But the extent of the drop alarmed some observers, particularly the new 52-week lows for the tech-heavy Nasdaq Composite Index and Nasdaq 100 Trust (QQQ Quote - Cramer on QQQ - Stock Picks).

To Doug Kass, general partner at Seabreeze Partner in Palm Beach, Fla., the action was so disturbing that he upped the odds of the nightmare scenario -- in which mutual funds that hold huge stores of tech stocks sell huge blocks over a long period of time to satisfy redemptions -- to 40% from 25%.

The heightened odds reflect Kass's belief that aggressive investors recently raised their bets on technology stocks. "I don't know a hedge fund that is not long -- in size -- the QQQs, most from materially higher levels," he said in an email exchange. The QQQ's new low leads him to believe "there will be sell stop [orders] for the balance of the week." (A stop order to sell is placed below current market levels and is designed to limit losses on an investment purchased at a higher price.)

"Everyone is long and wrong, which leads to a swoosh down," he said, referring to George Soros' theory of reflexivity regarding how selloffs can become self-fulfilling. "People are getting decimated, and it leads to liquidation. The meltdown will accelerate in the next week or two" if it is going to occur.

Kass reiterated a view that the timing of Fed rate cuts is largely immaterial, given the excess inventory across the spectrum of information technology and, with warnings from Nike (NKE Quote - Cramer on NKE - Stock Picks) and Intimate Brands (IBI Quote - Cramer on IBI - Stock Picks), perhaps in sneakers and brassieres as well.

"I am struck by the unanimity that a rate cut will resolve the bear," the hedge fund manager said. "Seems too pat for this skeptic."

As to what could trigger the "nightmare" scenario, he offered the following possibilities:

1. A well-known New Economy company such as Amazon.com (AMZN Quote - Cramer on AMZN - Stock Picks) or major telecom player such as WorldCom (WCOM Quote - Cramer on WCOM - Stock Picks) or Winstar Communications (WCII Quote - Cramer on WCII - Stock Picks) facing a "liquidity crisis."
2. Preannouncements by industry leaders formerly seen as "invincible," such as Altera(ALTR Quote - Cramer on ALTR - Stock Picks) (which warned last night), Avanex (AVNX Quote - Cramer on AVNX - Stock Picks), Cisco (CSCO Quote - Cramer on CSCO - Stock Picks), Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), Juniper Networks (JNPR Quote - Cramer on JNPR - Stock Picks), Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) or even General Electric (GE Quote - Cramer on GE - Stock Picks).
3. Liquidation of several "tech-only" hedge funds, rumors of which have been circulating since late last week.
4. A run on Janus Capital and/or other high-profile tech sector funds.
5. (I'll add another possibility: disappointment if it becomes apparent the Fed is not going to cut rate prior to March 20.)

Seabreeze Partners is currently short each of the aforementioned stocks, save Juniper which it recently took a long position in.

Regarding the potential run on mutual funds, Kass observed there have yet to be "meaningful" redemptions in tech funds (a point 2000's Guru of the Year Thomas McManus has repeatedly made as well).

Forget redemptions: Aggressive growth funds had net inflows of $7.65 billion in January vs. $2.5 billion in December, while (plain old) growth funds had cash inflows of $8.3 billion last month vs. $6.2 billion in December, according to the Investment Company Institute. Overall, assets of stock funds increased by $129.7 billion in January while money market funds took in nearly $110 billion, ICI reported.

To skeptics, this is not the kind of data "bottoms" are made of.

Although technology's weighting in the S&P 500 has fallen to near 20% vs. around 33% at its peak last year, "we will get to 15% in a panic if we get it," Kass suggested. If a panic erupts in technology, it increases the chance of the rest of the market to experience the same "death spiral" many tech names have undergone, he continued. "In a decline of this magnitude, the 'good ones' get thrown out with the bathwater."

In such a "worst-case" scenario, the Dow could fall as much as 10% from present levels, the Comp as much as 15% and the S&P "somewhere in between," he predicted.

While such declines may not sound so scary given the past year, Kass is suggesting they could occur within a few trading days, which would be frightening to many investors.

The good news is that if the meltdown doesn't happen soon "it's not going to happen and we could see reasonably good up [price movement] from here," the hedge fund manager says. "Either we're going down big, or this is the bottom."

He compared the current situation to late December, when forced liquidations of aggressive mutual and hedge funds led to a huge swoon, which was followed by a "huge snapback" rally.

The better news is that Kass believes whether or not the meltdown occurs, "there are unusual opportunities being created" in stocks such as Juniper and Corning (GLW Quote - Cramer on GLW - Stock Picks), which Seabreeze recently went long after previously being short. "If you can maneuver, it's a great time to get the ducks ready. The greatest opportunity to buy is when people are being forced to sell."

A great opportunity, that is, if you're liquid and can keep your head when those around you are potentially facing the guillotine.