(If we are to take control of our finances, become better traders, better investors, better thinkers about the market, we have to understand the stuff that is in this piece. Everything in here is relevant to what is going on in the market right now, as well as what I suspect will be going on for some time. If you read the excellent column in the Wall Street Journal Thursday about individual investors, and how they can triumph in a world of underperforming mutual funds, you know what I am talking about. The one thing that piece did not cover is that the individual has the almost the same access to information, without the ridiculous constraints of money in/money out and without the demand from management to take in unwieldy billions. Of course, the individual also controls his tax situation better, so, in the end, I think the edge belongs to the individual -- if he or she has done the necessary homework and understands some basic constructs, such as the constructs covered in this piece. I am going to go very in-depth here and try to leave no phrase unturned.)
What causes a rally? Where does it come from? Is it a given? Can we spot the next one if we saw the last one coming? These are the questions days like yesterday pose.
(Rallies, and getting in to take advantage of them, can make you big money. I have spotted more rallies than there have been rallies, but I am pretty adept at keeping my eye out for them. Like so many other aspects of trading, there are no single indicators. Often some indicators flash and others don't. I have followed dozens of "gurus" in the last 19 years, and invariably they get it right some of the time and get it wrong other times. What I want to do is have you be your own guru, have you be critical and give you the same insights and thoughts I have in my head so you can spot these things. I am arrogant enough to believe I can contribute to your critical insight -- and humble enough to know that I learn every day, and make mistakes everyday, so I am not offering gospel.)
A rally, of course, is kind of like a World War II battle: It is the sum total of hundreds of small unit fights, with a backdrop of superiority of men and materiel vs. the other side.
(At any given time there are a million skirmishes between buyers and sellers. Most of the buying and selling takes place in sectors, which I look at as military theatres and individual stocks are battlefields. Occasionally, one side, the buyers or the sellers, has a clear victory in hand. When the buyers overwhelm the supply of the sellers, we have a rally. When the sellers throw the buyers back, we can have a rout. Each side has ammo, in the form of buying power or selling inventory. Each side has to pay attention to the bigger backdrop. Men and materiel here are simply code words for how much money there is to buy stock among the armies of mutual funds and individual buyers. But you can't just pay attention to those logistics. You have to know what is happening in the big competition to stocks, the bond market. When interest rates go up, people ware inclined to buy bonds and sell stocks, and vice versa. Stipulate that. Take advantage of the ingrained nature of it. And don't forget it. Just like the fighter bombers that rendered the Nazi cause moot in Private Ryan, the buyers of bonds can pretty much overwhelm at times whatever might be happening on the ground. )
(When I invoke a military analogy, please understand that I do so just because it is one of the ways to make things clearer. I like to use sports, I like to use movies, I like to use anything that can help you understand. No value judgments -- clarity is the goal.)
(I can't stress this enough. I am determined to use every writing tool in the arsenal to get and keep your interest about this stuff. It is why I started TheStreet.com. I want to reach not just the people who trade for a living, but the people who have felt overmatched by the obfuscation and mumbo jumbo that the professionals in my business fall back on when they can't really explain things. I want to speak and write in English to captivate you. I rotate these devices so as not to be tiresome. If we all played cricket in our spare time, believe me, that would be my mode, if it worked.)
Yesterday's rally was pure D-Day, Omaha Beach. You really didn't know which way things were going to go initially. In fact, things looked terrible for the bulls. A terrible start in equities, with Net and growth stocks looking weak and cyclicals taking the day off, certainly gave no sign that things were about to turn.
(Every day at my shop is like my first day. I have no preconceived notions of what will happen. I have a game plan, both short and intermediate term, and positions that I expect to work regardless. But I am a trader and I don't start from the assumption that the bulls will win or the bears will triumph. In fact, many times in my career I have been bearish, making huge bets against the market. Some times my whole fund has been short. To me, how you are positioned coming in is the single most important determinant of performance. Sometimes I think things are set up for a good solid skein and I want to be megalong. Other times, I think it is a push, and I like to have a lot of cash and a good mix of long- and short-term trades. I always have shorts on. I don't talk about them much because talking about shorts is a difficult and problematic thing. I was not short
(IRID) , and I was long
(MOT) , when I wrote disparagingly of the Iridum phone which I had purchased specifically for my trip to the Caribbean. No matter, I got a huge amount of heat from people who accused me of being short. Same with the
(WAVO) incident last year, where I spoke negatively about the company and suggested, inartfully, that it's stock was benefiting from a short squeeze. I still have the tire tracks from both. Had I been short these stocks, there is no question in my mind that the heat would have been unbearable. I don't want to knock myself out of the box by talking about my shorts. Consequently, I read a ton of articles calling me the quintessential bull. I find that ironic. I typically have much more cash on hand than any mutual fund in the world. I run with puts and shorts constantly. I do that because, even in a bull market, there are things that go down. On a day like the one at hand, it looked right to be very short everything except the cyclicals.)
In fact, the action in a handful of Net stocks, including
:Nasdaq), made it look like disaster beckoned.
(The Net was for sale in the morning. It was so for sale that I think people were willing to lean too hard against the Net. I saw short-sellers and put-buyers all day. How do I see this stuff? I am a professional business athlete. I can spot curve balls versus fast balls. I know better than amateurs when someone is leaning too far toward second base. That's my job. Can I get you to develop a pick-off move that will rival mine? I don't know; but why not try, so at least you can recognize when someone is too far off the base. Some, the more paternalistic among the graybeards, are given to thinking that a little knowledge is dangerous. I come out on the side of those who want to know more, and that's because I am in touch with many of you via email and have a handle on what want.)
But there was one signal yesterday -- kind of like air power, if we are
-izing this tape: the bonds wouldn't quit. Bulls dominated the bonds yesterday, resisting powerful forces that seemed bent on taking the 30-year bellwether to the dreaded 6% level, where many pros think stocks get sold and bonds get bought.
(This tug of war in bonds holds the key to understanding this piece. Bonds mystify more people than they should, in part because they are incredibly inexact. They measure inflation, demand, supply, macro concerns versus the bonds of other countries. The cross currents are immense. You just need to know one thing: everybody watches them. Everybody. So you have to, too, if you want to be in the game regularly. Another way to look at bonds is that at times, they play the role of trump in bridge or whist. Doesn't matter that you may have the ace of equities; a two of bonds might trump you, if a two is a negative. Other times, bonds can be less important. I always approach them as if they are trump until proven otherwise.)
Ironically, the macro numbers weren't that supportive of a case for bonds (the only case is economic weakness or moderate growth with no inflation). For example, we pored over the
monthly binder on economic activity, and I can't say we saw evidence that things had gotten weaker.
(Each day has its own set of macro statistics to reckon with. The media views all of these numbers as pretty important. That's what I find so refreshing about Kathleen Hayes, on CNBC: She is willing to say that something doesn't matter when it doesn't matter. This Beige Book is of varying importance. If it came out that the Beige Book saw rampant inflation everywhere, you bet it would be used to buttress the case of the bond bears. It didn't. It did make some comments that were relevant and somewhat negative. When bonds took off after that, I was heartened. Whenever a subtle or even a pseudo-bear case is made about a subject, and the stock of that subject rallies after the case is made, that's a tell for a bottom. Same with the bonds.)
At the time the Beige Book came out, bonds were up modestly for the day, but after devouring its contents, the bond-market buyers pronounced it benign and came in.
(This is the tell. This was a sign that in this skirmish, on this day, bonds wanted to go higher. That meant you could be more bullish on stocks, which helped trigger the rally.)
For me, I watched the trading both in the bond futures
which are available on your TSC screen, (Big E on the scoreboard there. I meant to say cash, as was corrected)
and in the cash market, the actual bazaar where bonds were traded.
(The cash market is just a synonym for the real market, the one where you can buy and sell the actual bonds. I like to trade bonds like stocks. I buy them, say, at 93 on the long bond, and try to sell them at 94, making a point, on some amount that is worth trading for my fund. I bought $15 million worth of bonds the day after this, when the bonds collapsed after a
speech. It was a bet, to get a capital gain on bonds, which is just like a capital gain on stocks. )
and I watched these so closely for signals yesterday that we actually got into a dispute at the 93 15/32-plus level on the on-the-run 30-year bond. I told him that he should stop looking at the futures, which I think were too dominated by bears trying to press an agenda downward (up in rates), and watch the cash market, which kept ticking up. (As a longtime trader of bonds, I like to stay focused on both.)
(I am a conspirator at heart, and I often believe that people send messages through the futures to influence the underlying commodity's direction. Let's say you wanted the bonds lower. You were rooting against bonds. You might want to just throw in a quick burst of selling in the futures to color peoples' opinions. I don't do this, but I have no problem with it. You have to play your game, and if your game, at least as an institution, is to try to influence the direction of the bonds in a very short time frame, you probably can do it if you have enough fire power. )
The point here is that you could not spot this particular rally coming from watching the flow or the price in stocks. The bonds gave the signal that it was OK to buy some of the neglected drug and slow-mo stocks, and to abandon, for a moment, cyclicals that have had too much of a run.
(Here you have to understand the dance between bonds and sectors of stocks. You don't know who leads the dance. They are strange partners. Sometimes the bonds signal a slowdown and you want to buy stocks that do well in a slowdown. Sometimes they signal a robust economy and you want to buy cyclicals. Sometimes they are so poorly acting, however, that you don't want to own anything. Trust me. It can happen.)
For example, take the action in
:NYSE), a classic cyclical that got downgraded yesterday on price by a major Wall Street firm. It opened higher. That opening was wrong! It drifted lower and then started selling off more aggressively after the bonds showed a convincing rally.
Let's spend some time on this concept of wrong. People keep misunderstanding me on this, particularly journalists. They seem to think I am making some sort of a value judgment about a company when I say a stock is wrong. Nothing can be further from the truth. Companies run businesses. Some businesses are better run than others. We are not speaking about the businesses here. We are speaking about the stocks. Occasionally, management executes well and I want to own the stock of the company. Occasionally, management executes poorly and I want to own the stock of the company. Occasionally, management executes great and I want to be short the company's stock. In order to distinguish the latter, I like to say the stock is wrong. The managements understand this, and they don't take it personally.You shouldn't either. Take the case of 3M. I think management at 3M has executed just okay, not great. (Believe me, others on the Street are much more harsh about these guys.) When the stock was at $85, I thought it was right to buy, meaning I thought it would go up because the market was taking up the cyclicals whether they were doing well or poorly. But when the stock got to $94, I thought it was wrong and shouldn't go up anymore, particularly after a big firm downgrade. These judgments were "correct." That's what I am paid to do, make judgments about stocks. Not about companies. Sometimes they dovetail, but sometimes they don't.
:NYSE), on the other hand, traded lower from the get-go. I know I even pondered buying puts on the once-powerful stock if the bonds failed to hold. But I knew that if the bonds advanced I would take a beating, so I later dismissed the idea. Good thinking -- it would have been a major loss.
(Drilling further down on this right/wrong dichotomy, Pfizer is one of my favorite companies. Its management is fantastic, truly among the top 10 in the world. To which I say, so what. All the good management in the world won't mean a thing if this economy rockets higher, because people won't want to be in defensive stocks like PFE. But the landscape changes fast in these parts. Once the rally began it was critical not to be short Pfizer because the drug company was severely oversold and wanted to lift under any pretense, particularly a bond-related one. The bond move signaled to drug stock players that maybe the economy was cooling and you should be more defensive, as in buying the stock of Pfizer as a proxy for this economic weakness. Pfizer was therefore "wrong" to be short for this rally. It might be right in another session, but remember, we are talking the war of May 5, 1999, and nothing else. The bulls won that war.)
All of the big shifts in these two important stocks were "told" by the bonds ahead of time.
(This is my constant search for clues. Many people have their minds made up ahead of the battle. I worry about the engagement itself and don't want to have a preconceived notion who will win.)
Some of the switches yesterday were exacerbated by research calls. Pfizer, for instance, benefited from a late-day call from
saying that maybe the drugs are not as bad as we thought. Montgomery has credibility on the issue -- it was negative when others were positive -- so its boost bolstered the case for Pfizer.
(When the momentum turns, people pile on whatever the direction. It is very rare that you have someone stand against the tide. Some calls are perfectly timed. This one was perfectly timed for the day. The stocks looked like they were turning and this pushed them. Yet, the really precision day trader probably wanted to blow the stocks out into the call, because the drug picture is still murky.)
(Meaning the conference call with management, open to Merrill clients, got this stock moving back up.)
This stock looked terminal. I can't believe the amount of shelling this stock took at the 117-120 level. If you even came near that level with a limit, you got whacked by it.
(The sellers were trading out of pure fear. They were dumping and dumping and dumping. On top of that were massive put-buyers and short-sellers bent on profiting from AOL's trashing. You can never be too sure, but both Jeff and I felt that a lot of the buying later in the day was from people who were short and uncomfortable. They were worried that they were about to get their heads taken off by a stock that has put more short-sellers out of existence than just about any other stock ever created.)
But the selling dried up when Merrill's Net analyst, Henry Blodget, had Bob Pittman from AOL walk nervous holders and potential buyers through the bull case on cable access. Pittman's calm demeanor reminded me of a soothing general telling his troops not to worry, the win will soon be at hand.
(Most of the time these conference calls are just methods of answering questions that got raised by the triumphs of other companies. Here AOL had to respond to impressions left by T that AOL might be crushed. Some people believe this stuff. There is this guy, Craig Johnson, from the Pita Group, who has some jones against AOL who emails me pretty much every time I say something positive, telling me what a %^&^ I am. I am not some consultant or theoretician. I am trying to figure out whether a stock is right or wrong. For all I know, Johnson may be right about his analysis. But I gotta make money, pal, and I would have missed the move of a lifetime if I had bought into the Achilles heal stuff about AOL.)
The troops bought it. They took the
, the closely followed Net index, with them. When the DOT reversed course and went positive after the beating it had taken, that emboldened buyers in the
:Nasdaq), the pricelines and the deals that had come public within the last few weeks.
(There are now so many .coms that they don't have the snap they once had. In fact, the .com business is becoming saturated. You don't need me to tell you that at some point this supply will sate, glut and crush demand. When it happens, will be the top. Some will say the top has already been reached. I don't like to waste my time with sweeping generalizations. I leave that to the Craig Johnsons of the world, and all of the others who try to suggest that my logic of making money is unrigorous. I am going stock by stock. Merchandise, even bad merchandise, has a price where it may trade higher from. I don't particularly care for
, except when it is right. Got it?)
Others weren't so clear. A massive seller of Yahoo! got to 150 on the stock and didn't appear to be going lower. A tremendous seller of
:Nasdaq) at the 105 level disappeared when the bonds showed their bullish hand. Meanwhile, the selloff in the chemicals accelerated throughout the day, vindicating and verifying the trend change.
(You want to see the cyclicals down and the drugs up, if you are long Pfizer. Sometimes a rising tide lifts all boats. Sometimes everything goes up. Other times a win in one sector is a loss in another. In this session, only the consumer non-cyclicals had real life other than the Net.)
Last to change -- and some would debate whether they have changed at all -- were the financials. Here the
:NYSE) deal seemed to weigh heavily on the market. For example,
Morgan Stanley Dean Witter
:NYSE) got upgraded yesterday and opened strong, only to be tagged badly as Goldman kept going lower.
When Goldman stabilized at the 67 level, not coincidentally at the same time the bonds put in their bottom, Morgan ramped. The bank index firmed. But not all banks rallied -- too much overhang.
(This Goldman deal sopped up a ton of cash. When you couple the worry over interest rates with the massive supply generated by the Goldman deal, you have a really poorly acting group. That can mean opportunity, just not that day's opportunity.)
The amazing thing about this battle is its lack of resolution. It will play out again today. There is very little that will necessarily be carried over from yesterday, because the catalyst, the bonds, will be buffeted by the employment number tomorrow.
(It sure was. The next day was the polar opposite. The bonds cratered, stocks got shellacked. The bears won the battle.)
So D-Day gets played again and again.
(There is a D-Day virtually everyday in this market.)
Which is what makes this history lesson all the more compelling.
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long America Online, Cisco, Goldman Sachs and Yahoo!, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at