Now that Fan-Fred has been put to sleep, we must now assess the impact upon the stock market. Futures begin trading at 6pm eastern time, but until then lets looks for clues in recent action:
Last week, there was a “flight to quality” as money fled stocks and poured into treasuries. That ended at 11:30am Friday. If you look at an intra-day chart of the 10-year treasury note, you will see a dramatic reversal. And that was the same moment that the stock market reversed. So, it looks like somebody big new something about the Fan-Fred deal at that time.
So, Phase 1 of the Fan-Fred short-squeeze rally began at 11:30am on Friday, and then accelerated during Phase 2 in the after-market when the Wall Street Journal broke the news. Of course, many traders didn’t realize what was happening during the day Friday, and weren’t paying attention after the close, so it stands to reason that there should be more short-squeezing to come.
In fact, on “Fast Money” after the close Friday, Karen Finerman, who is short banks, looked like she wanted to vomit. All the other traders who are short banks and homebuilders probably feel the same way. I would expect many traders to take long positions in the futures today to try and hedge their positions. So that would be Phase 3 of the squeeze, and Phase 4 would be after the open Monday morning when the short positions get barfed up.
How long will the rally last? The short answer is: not long. We are in a vicious global recession that is still intensifying. Many big funds are breathing a sigh of relief right now that they will be able to unload a lot of stock into this rally. Do you think that they are buying Paulson’s new catch phrase: “turning the corner on housing?” I don’t.
The end of the July-August bear-market rally had nothing to do with housing. It was Dell saying that global IT spending was grinding to halt that broke the rally. In case you don’t know, IT spending is a crucial economic category that was able to cause the 2000-2002 recession all by itself. Now, this new disaster is being added to the current real-estate disaster. And it ain’t going away just because some deck chairs were rearranged in Washington.
The big crack came on the first trading day of September. Once the big funds finished their month-end window dressing, they pulled their bids and the market went into free fall. At the same time that was happening, the price of oil was actually plunging as Hurricane Gustav approached the Gulf of Mexico.
As the energy sector was blowing up, other stocks fell also proving to traders that falling oil prices would no longer be a support for the stock market.
As the rush for the exits intensified, energy hedge funds saw the jobs report looming ahead on Friday. They knew they needed to be out before it hit, so the big crash occurred on Thursday.
This perfect storm of textbook bear-market action induced the flight to quality and money rushed into treasuries. That made it look like there was a financial panic going on, when in reality it was just a rush for the exits before the jobs report hit.
The surface-appearance of a financial panic caused Bill Gross to wet his pants, announce a buyer’s strike of Fan-Fred paper, and triggered the big bailout today.
In “Ho Hum, Another Bad Jobs Report,” Jim Cramer pooh-poohed the jobs report, and even tried to paint it as a postive because he thinks it gives the Fed cover to cut rates! Crazy!
Cramer also thinks that the hedge funds are done selling. That they had to get it all done before the fifth business day of the month to meet redemptions. So, his position is that it was just a little selling squall in hedge-fund land. That is simply denial.
When the first jobs-bomb blew up the March-to-May bear-market rally on June 6th, it took almost a month for the market to fall to the March low. This time, the drop from the rally highs around 1300 to the July low only took four days! This bear-market rally has been much weaker than the last one, and I don’t think that this Fan-Fred deal can revive it.
As the global economy continues to slow, the news flow will continue to be bad – even in housing and banking. Credit will remain tight, house prices will continue to fall, foreclosures will continue to increase, jobs will continue to be lost, etc. As hard as bulls-in-denial like Jim Cramer look for “the turn,” it will not be found.
The market hit a deep oversold level Friday morning, so a relief rally was likely in the cards anyway. However, I don’t believe that the market will rally as hard as it did off of the July low, the last time Hank Paulson saved the world. The crack came so quick last week that there wasn’t enough time for excessive short interest to build up. So, there is less fuel for this rally.
The financials and homebuilders may rally hard since the Fan-Fred deal affects them directly, but tech and energy? I don’t think so.
SPY closed Friday in the after-market session at $125.85, so we should expect the market to gap up to the bear-market rally breakdown level of 1265. Such a back-test of the breakdown level is not unusual. However, after the gap-up, additional short-covering should begin.
Could the market reach 1300? Perhaps, however by time it gets there it would be very overbought and due for a correction. In the mean time, more bad news is likely to hit, and I would look at such an event as a marvelous short-side entry point to ride down the rest of this bear.
While I believe that the big funds will sell this rally, they are smart traders, and I expect that they would hold back until the short-covering panic reached full-flower before leaning into it. They will likely use recent support areas to scale-in their selling: 1260, 1280, 1300.
And it’s not like the rally won’t have any headwinds. The euro (FXE) rallied after hours on Friday, and the dollar (UUP) fell. Now that the Treasury will be buying up huge amounts of bad paper, just like the Fed, overseas money may want to think twice about remaining in the USA. Also, a cessation of dividend payments on Fan-Fred preferred shares might trigger a wave of bank failures since many banks hold huge mounds of them and rely upon the dividends for a large chunk of income. Things could get exciting for the FDIC.
I have some QQQQ October puts. I will not be barfing them up. I have lots of cash, and I consider myself lucky to have another chance to deploy it short.
Note: For in-depth coverage of the Fan-Fred deal, Barry Ritholtz is on the case.
Note: If oil falls again as Hurricane Ike enters the Gulf of Mexico, be alert for another round of bloodletting in the energy sector.