Was Friday's Rally Just a Hedge Fund Short Squeeze?

I must begin this post by saying I am posing this more as a form of questioning than a statement of certainty. I genuinely hope that the incredible turn of events today were a magnanimous shift in investor sentiment and going forward we will finally see buyers return to the market.

Take a look at the DOW chart:

Bloomberg.com

In this market, the drunken stumbler could be just as easily right as he or she is wrong. But the charts don't lie. Ask yourself, who could have driven that insane incline in such a short period of time - mind you, in the midst of literally (as evidenced by a VIX of over 70!) the most fear based trading environment of all time? Then, consider what many (including myself) consider to be the reason behind the huge declines in the market last week: hedge fund selling to raise cash in anticipation of Lehman's bond auction - and that the auction came in below expectations.

Under the assumption that this is right, how could this incite a huge uptick? There were new reports at 2 PM of the G7 meeting, but would that have spurred a straight line upward, especially when other previous unified government actions did not get such an overwhelming response? Also consider that one other medium through which hedge funds could gain the cash they may need to meet the Lehman settlements, the bond market, had closed at 2:00 PM ET Friday, with very little positive information.

While Treasuries lost value, I also consider this to be more of a response to the supply increase in the past three days than a move to more risk averse investments. I say this because they had been losing value for days while the stock market had been getting crushed. I also am aware of the shift in the gold market:

Kitco.com

This downturn in gold had nothing to do with the timing of the upturn in the stock market. While those two do not need to go hand in hand, it still does not answer the elusive question of what caused such a linear uptick across all types of stocks?

Look at the movement of numerous stocks, financial and non-financial, right around 2 PM:

WMT:

ADM:

GOOG:

NCC:

ANF:

FITB:

K:

I admit that I am searching for answers and I do not hold this as set in stone, and I also want to incite discussion on the subject, but to me, the idea of hedge funds attempting to find another way of making money through shorting a market that has had more downward pressure than any other week in history and then redeeming those gains before they are the last ones out the door (and possibly making simultaneous long positions), makes more sense than an immediate shift in investor sentiment based on an announcement of a meeting that had yet to produce any real actions.

Honestly, have you ever seen charts of completely unrelated companies that look so strikingly similar at the exact same time? Could it just be that electronic trading has taken over? Is that electronic trading a birthchild of these hedge funds which confirm my suspicions? Please, let me know what you all think.

Stock position: None.

Comments

[fatcat:]

In this Wizard of Oz world of trading,the absence of specialist to calm specific issues is very telling...who knows who is pushing the buttons..

2008 Oct 12 07:07 AM

[davenerven:]

So hedge funds had to cough up $400+ billion to pay for their Lehman's CDS positions. The market was very very nervous of more defaults before the settlement last Friday, but it looks like it's all been settled in a fairly orderly manner. Now one side is down $400+ billion and the other side is long $400+ billion. My guess is that the side that's now long $400+ billion is going to use their new cash to squeeze the heck out of the market shorts and make more money. What can be a better time to do this than now? So, perhaps, just perhaps, we can expect the rally of a lifetime soon as the shorts run for cover from a tsunami of buying. But, I might be completely wrong. Still, it is a scenario that makes sense. The world governments have done more than enough to unlock credit but I think credit was tight because of concerns over the Lehman CDS settlements. Now that is out of the way, anything can happen, which means that everything will probably happen all at once.

2008 Oct 12 08:14 AM

[logicalthought:]

fatcat:

Blaming these crazy moves on the "lack of specialists" is just wrong. In the crash of '87, almost all of the NYSE action went through "specialists", and yet the market was down 20+% in a single day. When things are bad, those guys (just like the Nasdaq market makers who stopped answering their phones) will step back in a hurry.

2008 Oct 12 08:28 AM

[CaptainJJack:]

I think the market is so oversold that the stocks above are all screaming bargains. However, I don't think the market is trading on value.

It is trading on emotions: the fear of losing it all, and the greed of not getting in at the low.

When you talk of hedge funds, my honest, ignorant, simple question is:
Where are they getting all the money? Do they not have to borrow it like everybody else? What collateral are they putting up and what leverage can they use?

More simply, if banks won't lend to each other, why are they lending to hedge funds?

From what I can see, the rest of the world is reluctantly going to go along with the British plan to recapitalize the banks and guarantee interbank lending.

While Paulson has not signed on to the interbank lending part, he has no choice if the rest of the world guarantees their banks.

Paulson has signed up to the injecting bank capital part. I think that is the most important thing he's done, and it should have a pretty immediate effect.

While I expect the markets to figure this all out on their own, it would be helpful if Treasury made another announcement about guaranteeing US interbank lending, like the rest of the world, today.

Monday could be a wild ride, but I think that once the fear is addressed, greed will start to take hold and we will see a pretty big rally to levels that are at least understandable from a valuation standpoint.

Where the market goes from there will depend on how much things are going to slow down and how much that slowdown will affect individual company earnings.

2008 Oct 12 08:55 AM

[Georgen:]

Even high yield stocs have tanked. Is this posssibly an Obama factor? Special treatment of dividends would expire under him.

2008 Oct 12 09:07 AM

[Gina reader...:]

smells like a double shot of PPT working with instant monopoly money

2008 Oct 12 09:11 AM

[Jimmy Lathrop:]

Don;t make things more complicated then they are, Banks and brokers made a bunch of margin calls. On the other side, hedge fund clients saw their principal at risk and initiated redemption orders.

When you open the bottom of a grain elevator and the wheat starts coming out, you don't ask when it's going to stop. Only gravity and equilibrium will stop it. When the margin calls and redemptions stop, the selling will stop.

2008 Oct 12 10:03 AM

[BlueOkie:]

Could this be nothing more than the economic cycles happening? Adam's Smith's invisible hand at work.

2008 Oct 12 10:15 AM

[davenerven:]

Margin calls are a distinct possibility but one should be aware that firms behind the Lehmans CDS had to find $400+billion by last Friday to settle their liabilities. The only source of cash is to liquidate stocks, so they did and they have settled. But now their counterparties now have $400+billion and the logical thing to do is to squeeze all the shorts dry. Think about it. Many short hedge funds could be belly up over the next few days.

2008 Oct 12 11:01 AM

[Costard:]

Check the upticks at 9:37 and 2:00. Buying at high volume all day, while the selling action was at low. A "wait a see" mentality with a bullish bias, and extremely vertical action around the 8,000 level.

There's a lot of cash on the sidelines, and it's not going into gold/treasuries. The VIX can only measure those trading; in this environment, it is a poll of the scared and screaming. Again, watch the volumes. Be mindful that not everyone hyperventilates over the news, and in fact, some people pay mind to fundamentals, desirability being a function of price more than political policy. What you're seeing is not a shift in investor sentiment but a shift in who's playing. We will likely see more of the same next week. As well as more articles like this one: expressions of confusion and bafflement over nature's laws asserting themselves.

These times are not short of spectacles.

2008 Oct 12 12:01 PM

[davesilb:]

The hedge funds do not need money to short stocks!!!! It does not take money to short, it only takes money to cover short positions if the price goes up. So the Hedges could be doing what writer thinks is possible.

2008 Oct 12 01:07 PM

[CLH:]

Very important but not talked about is the fact after a huge sell off like last week (done during a panic) there are few sellers left. Many of the sellers already know that they sold at the bottom and want back in. When sellers are gone the buyers will cause the stocks to soar and it could snowball into a huge rally. But dont forget this may not be the bottom but only a huge rally..

2008 Oct 12 02:31 PM

[Stevie:]

Rationality has been elbowed out by raw emotion and unbridled fear. Mix in an almost universal distrust of the current capital markets regulatory architecture and you have a perfect storm. Just wait until Americans get their 401K statements, and we'll will see how enthusiastic they are to 'dollar cost average' and 'buy the lows' as the CNBC cheerleaders encourage. Not so long ago only a small percentage of Americans invested in the stock market, it would not be surprising if a large numbers of investors elect to invest elsewhere. Notice the brisk sales of SAFES. Ah, the subtle manipulation of the masses. As ever, bad money chases out good.

2008 Oct 12 03:56 PM

[vodop09798:]

I don't know about all this technical talk you experts are putting out, but I do know that NCC still has 21.77 short interest (absurd) and only(?) 33% instutitional holdings. Looks to me like there are a lot of individual shorts out there still hoping for an NCC collapse. Whats going to happen to you poor folks if they get bought for $5 - 8 - 10? Going to be a lot of scrambling to cover, I reckon. I hope you all lose your retirement, like I have.

2008 Oct 12 05:43 PM

[Crudeman:]

Personally, as a chartist, a huge head & shoulders top objective was met at 7900 hence the dramatic 1400 pt round trip in the first half hour. Obviously it was mostly short covering as it then settled back to trade sideways until the spike at 2 pm. Having said that, wouldn't it have been nice if Ben and Hank had included Lehman's in all their schemes last week and all these money raising shenanigans might have saved a couple of trillion in equity holdings...

2008 Oct 12 07:35 PM

[DavidB:]

The action looks like someone was trying clean up skeletons to me. Maybe we'll find out next week when those skeletons finally fall out of the closet with an institution still chained to them for all to see but something big was moving around possibly in a death rattle(elephants don't move fast in the jungle without shaking the trees and in trading, volume is the trees and institutions are the elephants). Either that or the government working group was trying to spark a rally and prevent margin calls next week.

We also have earnings beginning next week and big money may well have wanted to get positioned for it

2008 Oct 12 10:53 PM

[MarketLost:]

Gina said "smells like a double shot of PPT working with instant monopoly money "

Hmm, two replies here, and both mention the PPT. Do you believe in aliens, too?

2008 Oct 12 11:52 PM

[extremebric...:]

I watched the market and as many tickers on as many as I could and came to several conclusions. There was massive selling and liquidation going on as the session began, likely a combination of margin call induced selling, hedge fund redemptions (the biggest contributor to the selloff) and some retails capitulating. About 2:00 to 2:30 p.m. the selling pressure seemed to have run it's course and the buying that came into the market seemed to be from two sources, investors and insti's with dry powder buying the exhausted dip and, IMO, most importantly, SHORTS COVERING TO LOCK IN GAINS. It was no "short squeeze" but rather shorts seeing that a pivot point low shelf had been attained, was confirmed by reduced sell side volume and they moved to BUY TO COVER, BTC. Simple profiteering. Calm execution of closing out a good "short" run with momentum on their side, of which was waining. Money was being made, while others lost, or were forced to book their losses.
Things were too orderly and calm in the afternoon. Trading was orderly once the late afternoon buying came in, the tide turned as selling volume abated and it was time to close out short positions. The gains seemed to gain momentum as no doubt cash on the sidelines bottom fished the miseries left behind by those exiting.
This only poses several new key questions. IF, I am correct, then the "safety net upward bias" short covering provides MAY NOW BE SIGNIFICANTLY REDUCED, offering little to no downside protection which begs the next question: That "low shelf" that had been attained and seemed to be washed out, asks do we now set the markets up for another downleg as earnings are revised downward as recessionary factors come into play globally ?
Central banks are throwing virtually everything they have to halt this slide into the morasse. Will it be enough to reboot they credit pumps and generate a continuing business climate, or will this be looked upon as just another rally to make a quick buck or one of the last opportunities to exit?
Traders love the volatility if that is their business, but John and Jane Doe have little time to watch markets and streamers or continue reading the negative monthly statements that have become the norm as they watch their life's savings vehicles depreciate at an unsustainable rate. hgc

2008 Oct 12 11:58 PM

[Moon Kil Woong:]

I like your assumption. Only program trading can have such a high correlation. I assume it was covering of SPoos bets in fear something weird may happeb over the weekend. And it did, the SEC issued orders that banks can declare any value they want to to illiquid paper. That means you get 100% no transparency again. When the market is looking for trust, they shovel us black boxes that you can't open until Christmas 2039. Hopefully, by that time we will be out of the muck they made.

2008 Oct 13 12:10 AM

[libertarian...:]

this stuff won't stop until Treasury has a stake in even the solid banks and the traders have enough to clear out to dubai off of transaction fees from fear filled clients being told to dump all stock and keep the cash in mattresses.....
sheesh, people think O wants to socialize. dudes, were are now socialized.....
Go, Barr!!!!!

2008 Oct 13 07:51 AM