Lloyd: Come on, give it to me straight. I drove a long way to see you, the least you can do is level with me. What are my chances?
Mary: Not good.
Lloyd: You mean not good, like one out of a hundred?
Mary: I'd say more like one out of a million.
Lloyd (ecstatic): So you're telling me there's a chance!
- From "Dumb & Dumber"
One of the great reads of the past few years is "The Big Short," the Michael Lewis chronicle of the subprime crisis and some of the fascinating players who profited hugely from it. In the section on Dr. Michael Burry - and the book is a must-read for that section alone - we get agonizing detail on what Burry went through as a too-early subprime bear.
One of the points driven home in the book is how aggressively, deliberately and pervasively the major investment banks denied reality, even to the point of refusing to mark positions to market for as long as possible.
Dr. Burry suffered through this extended period in that he knew his bearish credit positions were right… could see the mortgages deteriorating and the housing market going busto before his very eyes… and yet still the major Wall Street houses (which placed end of day values on relatively illiquid credit index positions) held out and held out in fairly marking the positions - as such would have meant losses for them - blatantly pretending the deterioration was not happening, and generally denying reality for as long as they could practically get away with before gravity finally forced a reckoning.
This quick anecdote demonstrates yet again how Wall Street is not rational or "efficient" (in the sense of the efficient market hypothesis) at all. Instead, investors and money managers are driven by a Darwinian process of Cui Bono (who benefits), Ubi Est Mea (where's mine), and Caveat Emptor (buyer beware). If a view is irrational but potentially beneficial to those who hold it because they can get away with holding it, or even pressing it, then "game on"… Taking a darker view of human nature that combines elements of greed, emotional bias toward self interest, and blatant irrationality in favor of desired outcomes results in a more cynical Wall Street view than the one the "perfect mechanism" academics enjoy, but as such leads to a better level of understanding as to why markets do what they do sometimes.
We mention the above in respect to an intact global slowdown meme that centers around Europe and China - not to mention one of the most anemic U.S. recoveries ever - that is now being put on "hopeful pause" once again as a result of China export hopes and Spanish bailout optimism.
To put it another way: For those who make all their money on the long-only side, facts and long-term drivers are not as important as the opportunity to embrace any rationale as to why markets should go up.
That rationale, at least short-term, has been provided by China (and secondarily by U.S. consumers and another sigh-of-relief pause out of Europe) …
On Monday we 1) asked whether the 50 EMA support levels would hold for the Dow / S&P and 2) noted the ten-year note (IEF) as our favored "risk on / risk off' barometer du jour.
On Monday we also noted a potential upside breakout in IEF - which would very much indicate "risk off" - looked imminent.
But then the China export hopes combined with unexpectedly robust U.S. consumer data … the 50 day EMAs on the Dow and S&P did hold … Goldman Sachs (GS) helped out … and the script flipped meaningfully in favor of the "risk on" bulls. (In Lloyd Christmas of Dumb and Dumber terms, this week's news flow was the equivalent of "SO YOU'RE TELLIN' ME THERE'S A CHANCE …")
False trend or true, this move could have legs if no major macro whackage hits markets in the next few weeks. We have responded to such by aggressively increasing our long-side allocation to energy-related names.
We were already bullish on energy as a thesis - noting Hess Corp (HES) as one of our on-deck positions in a previous GMN - and added multiple new energy-related names yesterday and today (Tuesday and Wednesday).
From the October 17th Live Feed Morning Brief:
As bulls reassert control, energy stocks look most attractive as an area to concentrate positioning for multi-week or multi-month upside gains… if Europe can confirm China optimism (at least in short-term perception / hope jag terms, which bulls are notorious for), we could see legs to this move towards positive sentiment… as bearish side of trading book gets trimmed naturally through risk management, we will look to expand bull side opportunities as long as short-term drivers hold…