Fannie and Freddie's Effect on Changing Trends

As Fannie Mae (FNM) and Freddie Mac (FRE) appear to be dodging insolvency, the market may be at a key inflection point.  Looking at the market over the last 48 hours we have seen what could be an important medium-term swing in the overall equity indices.  The catalyst for this particular turn is actually the bad news surrounding Fannie and Freddie as investors likely capitulated at the beginning of the weak and sold out of remaining positions they saw as having substantial risk.  A wash-out type trade like this often creates an environment where every possible seller has finally exhausted himself and the only people left in the market are buyers

For an example of this, look back to mid-March when Bear Stearns (BSC) imploded.  During this time investors turned out good positions along with the bad with the general “get me out!” kind of attitude.  The resulting market environment turned out to be very good in the short run as the markets put on a good eight week show of rising prices.  The same could be happening right now.

I recently came across two helpful videos that may be of use when looking at general trends in the commodities markets such as Oil and Gold.  The link to the Oil video is here, and you can find the one to the gold discussion here.  As markets such as Oil and Gold reverse their trends, it is having a similar but inverse affect on the equity markets.  While the trend may be short-lived, I expect that we will have several weeks with positive trading dynamics and as such I am reducing my short exposure and looking for select areas to re-employ capital from the long side.

One of the benefits of a more constructive market is the liquidity offered to companies who need to raise capital.  Whether companies who currently trade on the exchanges are selling stock to shore up their balance sheets, or new entrants are pricing their IPOs, there will likely be much more activity over the next several weeks.  This has already been seen this week with the successful pricing of several deals such as MSCI Inc. (MXB), Energy Transfer Partners, L.P. (ETP), and Vale (RIO) (among others).  The calendar for next week is already filling out with a few attractive names including GT Solar International, Inc. (SOLR).

So while playing the market cautiously has been a good benefit over the last 3 months, it may not be time to play offense and begin to build long positions.  Please be careful with exposure and use stops to keep the risk profile low, but at the same time understand that rallies during bear markets can be some of the most profitable.  It doesn’t take much capital in play to make some stable, attractive returns.

Comments

[gabe borens...:]

Let's address the basic fallacy in this article.The FNM and the FRE are not dodging insolvency.The actions and the measures deployed by the treasury and the FED make one thing quite clear-neither of the agencies will be allowed to fail.On the other hand the rumors petaining to the isolvency issues are suspect given the record open short position in these agencies prior to the short covering.
On the other hands I agree that we are likely in the process of creating a major bottom.
The market paranoia had only distorted the fundamentals.The financial debacle has been discussed and correctly addressed by the insitutions involved as well as the Treasury and the FED.
The fiscal and the monetary "jolts" will contrubute to the recovery.The J-curve (weak dollar) will enhance the stimulative impact of the implemented "jolts".
For the viewers who have seen the mob breaking into Karachi stock exchange and destroying everything in sight,perhaps now they will understand the real risk.The record leverage deployed in the emerging market economies turning exchange trading activities into a gambling parlor implies a major implosion ahead.
In the European Union zone ,the ECB's rectrictive monetary policy as the zone is decelerating ,will turn the slowdown into a major recession.
In the Emerging Market economies we will witness a major economic implosion accompanied by unprecedented social unrest.
In Europe ,I will stop at a major recession.
These events will cause a major shift into dollar denominated assets propelling the DOW and the NASDAQ to record highs.
The Housing sector will follow with a major rebound as the economy heads for a major recovery.
These events are only months away.

2008 Jul 18 10:49 AM

[hw2h:]

As I stated on my site, a bottom is usually not formed like this V shape, but agree, the tide might be changing. And I am long MXB

2008 Jul 18 11:33 AM

[Zachary Sch...:]

Gabe, It seems maybe we have differences in our arguments but still both come to the same conclusion.

Thanks for the comments guys,
ZDS

2008 Jul 18 05:35 PM