Tuesday, October 28, 2008

The Mother of All Short Squeezes. Farfegnugen.

This rally is temporary. Explanation below.

Alright, I don't have a lot of time tonight because I am actually quite sick right now, but I wanted to get a post out tonight because I imagine some readers are quite dismayed or confused by today's market performance.

If you shorted European or emerging markets last week when I did, you're roughly even on your investment. But if you purchased sometime yesterday, you could be down as much as 40% overnight. This is part of why I so dislike giving stock advice to others. What makes a good investor is temperament, not the right stock tip. I can demonstrate that here, as I tell you this day was meaningless and I hold, but I can't keep others from panicking and dumping positions at the worst possible time. As a result, people can lose money on a fantastic idea. I've seen it happen with my own eyes.

What happened today was this:
1) First, the market started rallying a little on expectations that the Fed would cut rates.
2) Then there was the unexpected surprise that the Federal Government was buying super short-term bonds from corporations (called corporate paper) which sent the markets up quite a bit more.
3)These two things folded on top of themselves creating the mother of all short squeezes, which squeezed people out of positions all over the place.

You'll notice nowhere here did I say there was any underlying improvement in the U.S. or foreign economies. Quite the contrary, the economic news was dismal today. The evidence that this was a massive short squeeze is everywhere. I've seen several companies up 80% or more. The prime example is Volkswagen, the car company. This company has tremendous problems, from overbearing unions on down. It is the most shorted stock on Germany's largest index, because it is such an obvious money pit. Today there was news that Porsche was trying to take control of the company. Hedge funds, which had been short the company because it was such an obvious thing to do, panicked. They all scrambled for the exits at the same time. There was so little float left after all the shares that were short and all the shares Porsche controlled, that there weren't enough shares for the hedge funds to buy to close their short positions. The result? One of the most terrible large companies in existence gained 145% in a single day. For a short while, Volkswagen actually became the biggest company in the world, surpassing even Exxon and Wal-Mart.

Now, I don't need to explicitly tell you that is a ridiculous thing to happen. That can be inferred. This is precisely why I am shorting entire indices rather than any one individual company.

With respect to the three events that happened today; #1 does not make sense. No one should care whether the Fed lowers interest rates. For one thing, the real rate has become completely detached from the "suggested rate" the Fed sets, so what the Fed does means nothing. They would merely be lowering the implied rate close to where it already is in the real world. Second, that the Fed would lower their rate should be entirely expected. With event #2, this doesn't make sense either. It is a smart move by the Fed, but it is just another item affirming that we will in fact not have a systemic meltdown. Why this is cause for stocks to go up is beyond me. We've already established we will not have a systemic meltdown. This will do nothing to help the massive earnings declines and severe recession we will see. It will, however, help to unfreeze things and allow companies to make payroll. Again, this does nothing to curtail the shutdown of the shadow banking industry, the lost of jobs, the huge drop in consumer spending, nor the fall of home prices and sales. As for #3, I have already addressed this. You can look at a daily chart of the Dow and see the short squeeze happening.

So there you have it. A giant short squeeze. Of course, CNN was littered with "expert investment advisers" all over the place saying we have now officially hit the market bottom. Based on what, exactly? And why didn't you say it when your market bottom was hit yesterday before the rally? Stock prices are there to serve you, Mr. Adviser, not instruct you.

Aside from all the economic indicators and the unassailable fact that earnings will decline, the earnings multiple will decline, and therefore the market has to decline in the long term, the very fact that people are glossing over a steady stream of terrible economic news and grasping onto anything remotely positive no matter its effect on the real economy tells you we are nowhere near a bottom.

I remain steadfast in my convictions, and suggest that today was the perfect day to exit your long positions, and enter any short positions you've been meaning to take. Especially in the foreign indices such as EFU and EEV.

1 comment:

Anonymous said...

Don't worry about me Rick. This allowed me to double down on EEV at a much better price than I bought earlier. I am also confident about the coming further decline in emerging markets, but wasn't sure about the best way to capitalize on it without your help.

Walter