Ramblings of a Portfolio Manager

Is the Bear Case Really That Fragile or is Everyone Just Short?

Friday brought us a very nice rally across the US equity markets with the Dow, S&P500, NASDAQ and Russell 2000 indices all up nearly 2% or more. The rally capped off an odd week—after a strong rally on Monday, fostered by better than expected news from the Basel III bank capital accord over the weekend, where regulators gave firms more time than analysts expected to comply with stiffer capital requirements aimed at preventing future financial crises, the markets slowly began to give back the gains on the back of mixed financial data coming out of the US and Europe. Mixed data on housing starts in the US, a weaker than expected PMI out of Germany (which, of course, caused all the analysts to proclaim “the bloom is off the European rose) and the FOMC refusing to rule out further Quantitative Easing, all conspired to cause investors to start questioning the recent run up in stocks. Even Treasury yields started to head back downward again and the dollar weakened throughout the week. Then came Friday.

What happened on Friday? Thursday’s close saw the markets go from holding in positive territory all day to a strong late-day sell off. Considering that the economic data expected to be released on Friday (Durable Goods Orders and New Home Sales) was of fairly low import on the broad spectrum of impactful data, the market reaction was as odd as it was unexpected. Yet the futures opened strongly Friday morning with the one decent piece of global economic news having been released that morning being the German IFO, their version of our Business Sentiment Index, which came out stronger than expected. So what was with the rally? It may sound laughable and weak peg on which to hang one’s hat, but we truly believe that Friday’s rally was based nearly in whole on the guests who appeared on CNBC. The morning started with Jack Welch, former Chairman of GE and no fan of Obama. His strong opinions on the fate of the Obama machine and the Bush tax cuts come this election period added to the strength of the futures throughout the morning even as he declared “slow growth” in his ex-firm’s business lines. Following Jack came good old Doug Kass, the man who proclaimed the generational market bottom (and was right) on March 6th, 2009. His fairly bullish commentary on the value of stocks and own opinion on the upcoming elections added even more steam to the pre-market futures. You could almost see the shorts playing at home getting nervous as they sat at their laptops, in their boxer shorts, coffee in hand, trading on E-Trade. His final punch, however, was his call that shorting Treasuries would be the trade of the next century. Of course, outlining the reasons for this call gave him the opportunity to present some fairly bullish economic commentary, which certainly did not hurt the gathering strength.

The knock-out punch, however, was the appearance of David Tepper of Appaloosa Management, a legendary hedge fund manager who has been more right than wrong over the years and who made a killing on financial stocks last year when no one wanted them. Tepper rarely gives interviews, certainly not several hour-long appearances on financial TV, so his appearance was closely watched. Tepper didn’t disappoint. According to him, we are in a virtuous cycle (not his words) given the Fed’s stance on QE. Appaloosa typically allocates about 30% of capital to stocks and 70% to bonds and Tepper disclosed that he is still about 10% in stocks but moving more into them as he finds them cheap, particularly amid the current interest rate/Federal Reserve backdrop. To Tepper, if the economy strengthens stocks will do well. Conversely, in that scenario he thinks bonds and gold will not. On the other hand, he believes the Federal Reserve is acting as a put option for his strategy because if the economy worsens, the Fed will step in with quantitative easing, lowering long rates further and then all asset classes (except the dollar) would do well. It was his version of a win-win scenario and one could just watch the futures jump as he built his case.

All this CNBC commentary certainly added fuel to a fire that had started smoldering after the German IFO but the gasoline came at 8:30am when Durable Goods orders came in slightly better than expected, flying in the face of several back-to-back bad Philly Fed reports. Then, at 10am, New Home Sales came out mixed but overall stronger than expected and the fire was lit. Markets jumped and never came back. The funny thing about Friday’s market action was that, after the Dow hit it’s high of around +200, it sat there all day long, barely budging. No trader we questioned is quite sure why the daily stability but so much for 3pm being the most important hour of the day.

Did the favorable market opinions on TV Friday really drive the strong market reaction? And if it did, would wheeling out Nouriel Roubini and a few other bears bring it right back down? We suppose no-one will ever know the true answer but the commentary given certainly was rational, well thought out and made a helluva lot more sense to those schooled in economics (including us) than the knee-jerk “we’re the next Japan” headline grabbers that have been populating the airwaves lately. So, to answer last week’s question, are the elections already baked into market prices, we would have to say not yet. If a week’s worth of hand wringing over the margin by which Republicans will win in November managed to rock the markets back and forth only to be erased by some positive commentary from a couple of smart guys, then we think there is a lot more “kicker” left from certainty creeping into the eventual outcome of the elections and the events beyond. And to answer this week’s question, it sure seems to us like there’s a lot of non-believers out there—whether they are short or just plain underinvested, the case for being so is starting to look a little thin.