Turnaround Tuesday Morning???

We are way up in pre-market trading (200 points at 7 am).

Yesterday was a crazy day and at 1:37 (after a very good morning of bottom fishing), with the Dow at 8,550 I had to warn members: "Don’t forget that if you were crying this morning when the pre-markets were down 300 points, this is a good opportunity to add some downside protection!  Watch the 2.5% line on the Dow and 900 on the S&P and you can stop out or cover on the bear side but we need more volume and more reason to put a real rally together."  That was good timing as the Dow dropped 400 points into the close from there but, much like we weren’t buying the rally – we weren’t going for the last leg of the drop either, which we decided looked a little forced at the end.

During the day, as fatigue was setting in among the bottom-fishing crowd, I made my extensive bottom case for the markets (along with what turns out to be the play of the day, picking up FXI at $20) and, at 12:15 I summarized my point by saying: "I’m not saying anything will turn around right now but the point is we can buy low and get paid to wait by selling premiums.  We’ve seen how fast this market can whipsaw up and I wouldn’t be too surprised to see even the anticipated Fed cut Weds boost us 1,000 points by Thurs.  Whether or not we hold it is another story but this is starting to look more and more like rotation out of commodities and into some very beaten down stocks.  Can they get more beaten down?  Sure – but then we buy more and sell more premium.   Don’t forget there is the old saying that "you can’t fight the Fed" but this isn’t just the Fed, this is the entire G7 acting in unison to move the markets.  Perhaps the global crisis is so severe that not even that will help but, if so – then nothing really matters anyway does it?"

So that’s what’s guiding our plays for the past few weeks but we remain EXTREMELY skeptical of rallies that can’t break our levels but it sure does make for an exciting trading environment.  As expected, anticipation of another round of globally coordinated rate cuts is sparking off a rally but the extent of the rally is pretty impressive with the Hang Seng leaping 14.35% this morning and the Nikkei climbing 6.41% and even the Shanghai managed to take back 181 with a 3.12% gain.  Japan’s rally was aided by a ban on the dreaded naked short selling as well as a pullback in the Yen.  Unfortunately, the 1,580 point gain in the Hang Seng was NOT ENOUGH to get the index back to Friday’s close at 12,618, which represented a 2,500-point drop 16% for the week.

So let’s not go crazy and crack open the champaign just yet.  How many Tuesday’s have we had false rallies in the past two months (answer – pretty much all of them)?  Exporters led the Nikkei rally on relief that the Yen finally stopped climbing but a day does not a trend make, although G7 statements seem to indicate that steps will be taken to knock down the Yen.  Over in China, some analysts weren’t ready to call a bottom, saying it was unclear whether the index could hold above 12,000 in the near term. "Even a dead cat bounces," said Y.K. Chan, a fund manager at Phillip Asset Management (must be an ancient Chinese saying).

The DAX cat must be made of rubber as the German exchange pops 8% at 8am, reversing almost ALL of last week’s relentless losses in the first hour of trading.  That would be like the Dow opening up 1,000 points…  Europe got the first hint of a boost yesterday as Volkswagen jumped 200% as Porsche forced a short squeeze by buying up outstanding shares.  Overall, Europe looks to be trading up about 4% ahead of our open and will likely be keying off our markets before we get any real follow-through.  Perhaps there is rumor that the Fed will make an announcement or perhaps foreign traders misunderstand that today is day one of a two-day Fed meeting and it is not likely we’ll get a cut today (but there may be a G7 announcement tomorrow moring). 

While there may seem to be no particular reason for today’s rally, I’m going with the theory that it was the rain delay that stopped Game 5 of the World Series.  This theory is as good as any of the BS being spouted this morning on CNBC and historical data backs me up as the Philadelphia Athletics were the World Series winners in both 1929 and 1930 – victories which led to the biggest economic disaster in US history.  The Phillies won the 1981 World Series and that led to a rapid rise in unemployment that didn’t turn around until the Phillies lost the World Series in 1983.  The Phillies were also kind enough to lose the 1993 World Series, ushering in the best 6 years in market history.  This is the Philadelphia’s first World Series appearance since 1993 and they are ahead 3 games to one – hopefully the Devil Rays can pull it out – for the sake of the markets!

While Trichet is signaling a rate cut, Iceland is facing the cold reality of an economy that needs to attract capital and is RAISING interest rates to a record high 18%.  Lowering rates will only get you so far – and then everyone loses faith in your economy/currency and don’t want to give you any more money (you become a "high-risk" borrower).  At that point, countries that need money (like the US) are FORCED to raise rates to attract capital.  This is inflation, not deflation and it really scares me to see so many TV analysts pushing the deflation story as it strikes me as being dead wrong.  The crush of the commodity markets is not a sign of deflation, it is a sign of long-ignored supply and demand fundamentals finally kicking back in – something I’ve been ranting about for a couple of years.  The biggest supply and demand story in the world is the money supply and good luck to US when the near doubling of the money supply of 2008 runs into lower demand for the dollar in 2009! 

The WSJ attributes much of October’s drop to margin calls and hedge fund redemptions:  ""Such forced selling drive prices lower, which in turn creates more losses for hedge funds and creates more selling — a vicious circle," Mary Ann Bartels, a technical market analyst, wrote in Merrill Lynch’s "Hedge Fund Monitor" research note.  These margin calls are triggered by losses and also by frequent changes in collateral requirements from brokers and exchanges. Another reason hedge funds and institutions have been forced to sell recently: Clients are withdrawing money, spooked by the market losses. Every time the collateral requirement increased or the account lost a critical mass of money, it triggered a "margin call," forcing funds and investors to sell securities to come in line with the new requirement. So every successive drop in the stock market triggered another round of margin adjustments, another round of margin calls, and another round of forced selling.

It is indeed the best explanation of the very irrational selling we see in companies like BUD (who have a $70 offer on the table) and AAPL (who couldn’t possibly make better numbers) along with dozens of other companies we have been bottom fishing who are just too cheap to turn down.  The VIX at 80 signals an expectation that the S&P will move up or down 80% over the next 12 months – that’s either 1,525 or 169.  Our long range outlook is generally targeting something closer to 1,200 for next summer but that’s still nearly 50% up from here.  As I said in the weekend wrap-up, that is dependent on unemployment remaining in check and positive action being taken to stem the still-rising tide of foreclosures.

So we will enjoy this morning’s rally but look at it more as a way to test some upside resistance points.  Failing those will end up giving us nothing more but a chance to pick up some more shorts and a chance to cover some of the upside plays we’ve been picking up while the front month calls are still paying ridiculous premiums.  Does the market really go up and down $2Tn in 8 hours?  No it does not.  Keep that in mind on either side of these swings…