Act Now, It's the Psychological Rally

The same hedgie contact that so brilliantly called the last down leg in financials (see March 24 post) pinged me again on Friday. This time he had this to say: This is probably going to challenge a lot of the academic folks, but let's face it, at least in the short term, psychology is 80% of the market volatility.

First off, I refuse to sell any of my shorts, namely SKF, SRS, TWM. But unlike the past 6 months or so, I am starting to put more cash to work AGAINST my shorts. Prior to last week I was mostly 40% - 50% cash at most times.

Here are my “psychological” reasons for turning “short term” term bullish: First off, it is a known fact that markets always bottom BEFORE there is any real economic evidence of a turn. THUS, most investors will be - are currently - looking for any slight reason to turn bullish. They will look for any reason to rationalize and justify buying stocks to GET IN FRONT of the impending (pre-expansion) rally that will ensue BEFORE we officially emerge from the recession. And the media coverage will stroke their confidence.

It is also a fact that most of the POST recession stock market rallies are largely OVER by the time we have OFFICIALLY emerged from recession. That said, I think we have PLENTY of scant evidence all around us that bulls and the media will be able to hang onto, to convince us all that we have bottomed and that “YOU NEED TO BUY STOCKS NOW”

1. People seem to want to buy stocks here. That is the sentiment since BSC.

2. BSC was the catastrophic BOTTOM of the market.

3. Tax refunds are going out.

4. $600 stimulus check going out.

5. TREMENDOUS liquidity coming from the Fed.

6. Election year.

7. Everybody reads the same “Don’t Fight the Fed” textbook.

8. GDP not too bad (yet).

9. Payrolls number (which will be reasoned that it is a trailing indicator).

10. Foreclosure pipeline is growing, but many are still in early stages. (Bad news remains a few months away).

11. A normal seasonal uptick in real estate will be mistaken for the REAL THING.

12. The early cyclical’s trade is already being put on.

OF COURSE I think this rally (if we get it) will be proven to be false. And sometime this summer we will get hit on the other side of the head with another two-by-four and resume the downtrend to new low levels, as it becomes apparent that this recession is longer and deeper that first thought. It is typical of markets to have false bottoms as everyone tries to game the END-Recession play. I see no reason to doubt that this time is different. Heck, we sure have all the ingredients for it.

It's hard to believe that all these bottom callers really think that we can exit a period of some of the most egregious lending in history, with one of the largest real estate bubbles in history, against an untested explosion of derivatives with a mere 3-month recession, and 14% peak-to -trough decline in the markets in less than 6 months. But that seems to be what I am hearing in the media these days.

Net net, I really don’t know. This is a veiled attempt by me to gauge sentiment and get out in front of it. It is very hard to get incrementally long in the absence of any positive economic data, but I think that sometimes the hardest trades are the best trades. As counterintuitive that this is, I think I need to be more long. Especially China which tends to track commodities. Check out this chart:

click to enlarge

We shall see, but my guess is that by the early summer, late spring, we will begin to realize that things are worsening, and the wheels will start to fall off the cart again. In the mean time, though, I will be getting in position for the HOPE rally.

Comments

[Jason Tillberg:]

In many respects, I agree with you that there will be a percieved bottom and there is a lot of money out there still on the sidelines that should be put to work and hence cause a nice rally. But that by summer, the realization that things are not going to get better, will cause for more downlegs ..and I think that these down legs will last till 2010 and could bring the dow to as low as 6,000.

In the meantime, let's rally already!

2008 Mar 31 05:50 AM

[deefree:]

you're not going to simply wait for Q1 announcements? you don't foresee any really negative earnings surprises from banks or from high end consumer products?

2008 Mar 31 11:43 AM

[NARSpin:]

You forgot to mention the historical short interest . Just look at UBS - short interest more than DOUBLED in a two week period from 4,397,821 to 9,728,767 . That's a HUGE move on the short side.

The S&P had the highest short interest EVER. With no uptick rule, and a bunch of noobs shorting for the first time, this isn't unexpected.

www.nasdaq.com/aspxcon...

2008 Apr 01 09:45 PM

[misterchan:]

Excellent article. One of the best I have ever read. And today, for the first time, I found myself getting interested in China. So was happy to see it mentioned. Everything you wrote expressed exactly how I feel about this market, only you said it better than I ever could. Thanks again. I hope a lot of people read it and wake up.

2008 Apr 02 12:44 AM

[The-Yellow-...:]

This is a well written article. It's interesting that before seeing this article I had just written a blog on how this rally was primarily fueled by market psychology. Q1 was over and it was New Year's Eve...

This rally will probably show some legs. Everyone wans to call a bottom and bears are appearing to others (even if they end up being right) as either negative or afraid or both. The fundamentals of a credit crisis that deals in derivatives that are many many times the global GDP will not wash away just like that. I can't even picture somebody saying that if they understood how deep this thing is.
However it is also true that some good companies with international exposure and/or in industries not affected by the economy have been sold down too much because nobody wanted to buy any stocks that would just turn around and go down the next day. These will shine. Eventually the wheels will come off the overall rally and it may happen before the summer, depending on whether there are any more shocks/bankruptcies. In one second the euphoria would fade.
For now though it is a good time for me at least to pare short positions and go long but believe me this will continue to be a profit taking market with large swings because the guys with the big money know that the fundies are not all good.

2008 Apr 02 11:03 PM