Against the backdrop of an awful tape on Wednesday and Thursday, I suggested buying into yesterday's late weakness in the anticipation of an up morning. Here is what I wrote after the market closed last night:
"As my friend/buddy/pal Jordan 'Kahn' Man would write -- 'gun to my head' -- I would be buying in the aftermarket for an 'up' morning. "Indeed, I would be following a strategy of buying the dips and selling the rips. "I continue to hold to the view that last week's drop could define the lows for the balance of the year. "That is not to say that the upside is great. There is a reasonable upside into year-end considering the oversold and other factors I wrote about last week: economic, subprime, sentiment, political and seasonal. "While conditions that I wrote about recently might not contribute to a continuation of Tuesday's rally, the odds favor it. "Nevertheless, smaller-than-average trading and investment positions remain my investment mantra -- in order to take advantage of the increasingly volatile tape. "It is no time to try to hit for home runs -- singles and doubles will be just fine. "Opportunistic trading should be our credo in a maturing economic recession in which earnings disappointments will appear with greater regularity."
So far so good -- and congrats to those subscribers who made the trade -- because judging by the strength of the futures, we should have a good opening this morning.
That said, I want to bring up a pet peeve of mine. In general, there is too much dogma around these parts -- both bullish and bearish. (And I am as guilty as anyone!) From my perch, (particularly) in volatile markets and credit woes, rigorous analysis and observation should supersede gut feels and technical mumbo jumbo.
I bent a little late last week and early this week, and I promise, going forward, to reflect my trading/investing flexibility more in my writings, as the Cassandra-like mantle
couldn't be further from the truth
. (I wish those who appear to be permabulls would begin to bend by recognizing both the severity of the credit problem and its broadening contagion as well as the market's recessionary message.)
The weakness of the last two trading days was anchored on a number of adverse events; it wasn't some mysterious late-day fade grounded in programs or intrigue. Most of the reasons for the weakness are residues of the credit contagion, which, as I have expected, runs deep throughout the world's financial institutions.
One of the foundations for my short-term optimism is that the increased transparency of the credit issues that reside in brokerages, banks and money market funds, though headline-ugly, represent a positive for the markets as the institutions finally are 'fessing up and appear to be more accurately defining their exposure and risks.
Nevertheless, the magnitude, ramifications and long tail of the credit problems help to explain why I believe a year-end rally is likely only a rally within the context of an emerging bear market. In the final analysis, there is a real economic cost of the credit problem, and the ultimate deleveraging of the financial system is now contributing to a recession in the U.S.
Here are some of the factors that brought a halt to Tuesday's market rally:
- Further signs of systemic stress. The three-month London inter-bank offered rate (Libor) surged to 6.34% yesterday. Federal funds also traded up, to 4.80%, as the Fed traded a near record amount of repos. In response, gold was schmeissed, and eurodollars and U.S. Treasuries soared. The smarter stock trades sensed further evidence of recessionary conditions and financial stress (somewhere).
- Evidence of deepening money market fund problems. Over the summer, I argued in "The Edge" over on RealMoney Silver that the next shoe to drop would be problems surfacing in the massive money market business. I was the first to expose Sentinel Management Group's money market failure, which started the ball rolling as, in their infinite wisdom, money market managers (like others) grabbed for yield and ended up buying a toxic combination of structured investment vehicles (SIVs), collateralized debt obligations (CDOs) and collateralized loan securitizations (CLSs). This week, several large financial institutions made moves to shore up their money market funds. The most visible problem surfaced at General Electric's (GE) - Get Report asset management division, when its "enhanced" cash fund fell below the $1 asset value that most money market funds try to preserve. (GE provided investors an "opportunity" to redeem their funds at 96 cents on the dollar). Here is a list of similar efforts: Bank of America (BAC) - Get Report announced that it will provide as much as $600 million to prop up the value of its Columbia Management Funds.Credit Suisse (CS) - Get Report reported $125 million in unrealized losses after buying back notes issued by CDOs and SIVs in one of its money market funds. Legg Mason (LM) - Get Report secured letters of credit worth $238 million in two of its money market funds, costing it about $5 million -- additionally, Legg Mason invested about $100 million in another money market fund to "provide liquidity."SEI Investments (SEIC) - Get Report reported that it will "protect" two of its money market funds from investments in Cheyenne Financial (a troubled SIV).Wachovia (WB) - Get Report booked a $40 million loss on securities it purchased from its Evergreen Fund.
- More bank writedowns were announced.Barclays (BCS) - Get Report announced a $2.7 billion charge, UBS (UBS) - Get Report wrote down $7 billion, and Citigroup (C) - Get Report announced the likelihood of further fourth-quarter losses. And both Barry Ritholtz and CNBC'sCharlie Gasparino voiced suspicion that BlackRock's (BLK) - Get Report Larry Fink passed on the Merrill Lynch( MER) leadership role because the company refused to provide a complete full accounting of its subprime exposure, raising the specter of further writedowns at Mother Merrill.
- The housing depression continues apace.Wells Fargo's (WFC) - Get Report chairman called the housing market "the worst since the Great Depression" and stated that home equity losses would remain "elevated" into 2008. Meanwhile the New York Times' Gretchen Morgenson picked up the story that a judge in Ohio has made a ruling against mortgage foreclosures, which raises economic questions regarding the right of the owners of securitized mortgage pools.
- The potential demise of the bond insurers.Bloombergreported that the AAA ratings of MBIA (MBI) - Get Report, Ambac Financial Group (ABK) and others are being reviewed by Moody's (MCO) - Get Report and Fitch. If this occurs, the credit crunch would obviously deepen.
- Further private-equity woes. On Wednesday, Cerberus terminated its pact to acquire United Rentals (URI) - Get Report; United Rentals' shares plunged by $13 in the ensuing trading day.
- The retail outlook is deteriorating.Kohl's (KSS) - Get Report, Williams-Sonoma (WSM) - Get Report and J.C. Penney (JCP) - Get Report all reported weakening comps and guided earnings lower, and after the close, Starbucks (SBUX) - Get Report announced lower comps for the first time in the company's history.
- Intensifying geopolitical pressures. The Guardianreported that the tension between U.S. and Iran is coming to a head now.
At time of publication, Kass and/or his funds were short BAC, C and MER, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.