Short Squeezed

Aargh. Last week was awful. Terribly frustrating watching my performance go in the tank. Other than gold (which was up&down) all my positions moved against me. The worst move was the S&P/TSX, which is back where it was in the fall (and is a large position). HXD moved more than the index, indicating there may have been a short squeeze. The index itself has moved more than 12% in the past month, also suggesting a bear market short squeeze. Indices do not usually move like that, especially in bull markets, which tend to be slow upward grinds. I get the strong sense right now that people are jumping back into the market, worried that they may be missing the recovery. Perhaps I need to start introducing some stop losses, but I am not sure. I do not want to be stopped out and then miss the turnaround.

Economic news this weak continues to be weak. NY manufacturing survey showed no growth but the forward-looking parts of the survey were poor. Housing starts and Philly Fed were terrible, and initial unemployment claims ticked back up, with the 4 week moving average staying at 375k. The one bright spot was leading indicators, which actually moved slightly higher. I don't want to discount the leading indicators too much, but one up month does not make a trend. The other data still seem to be showing that we are in the early stages of a recession.

Financial data this week was confusing. The problems in the money markets continued, with LIBOR ticking higher and the TED spread and discount rate spread both remaining elevated. The bond market got whacked, with the 2 year Treasury trading well above 2% (up about 100bps from its low), and the 10 year Treasury up over 20 bps in the week, although it rallied strongly Friday afternoon. The bond market seems to have decided that, with inflation high and sticky to the downside, that the Fed may soon be done with its cuts. This could be bad for equities, if the Fed is prevented from cutting more even if the economy is weak. Currencies are showing that risk aversion has gone away for now, as the EUR/YEN is at almost 164, and CHF is also down. The most confusing trend though is the DJ Transports, which have rallied HUGE from their January lows and breached the October highs, even though oil is at $115, airlines are going under and UPS/Fedex are reporting problems. What gives? Is this a sign that oil prices are not sustainable, that the economy is actually doing OK, or is the market on smack? Definitely a trend to be closely watched.

MARKET POSITION: SHORT EQUITIES (10 units); LONG GOLD VS. SHORT HOMEBUILDERS (2 units)

Portfolio Performance

March was a difficult month (and so was the first part of April). There have been numerous reports of well-known hedge funds suffering big losses, but that is small solace. I made two fundamental mistakes last month: 1) not covering my short positions in the aftermath of the Bear debacle, and 2) entering into the long gold / short homebuilders trade. The first I should have known and discussed last week. The second was premature. I had been saying since Christmas that gold was overbought. I still need to work on being patient. There is no imperative to enter a trade. It is acceptable to hold cash.

So far my call earlier this week seems to be correct. But we will not know for some time whether I was truly right. This market is all over the place. It could rally sharply higher next week -- who knows? The price action the past couple of days was good (for me, being short). The market tried to move higher mid-day Thursday but failed, and then slowly ground lower all day yesterday, closing near its lows. But the volume was nothing spectacular, so its meaning is tempered. The news yesterday was bad though -- GE surprising on the downside, after assuring investors everything would be fine. They are very international, too. Consumer Sentiment reaching some of its lowest levels since the early 80s. That was a bad time, and this is a bad sign for the economy. So I watch and wait.

Going out on a limb here...

I am going to go out on a limb here and state that it looks like this rally may be over. But first, I want to quickly comment on the past few weeks. The most important lesson I learned was: trade the market you have, not the market you want. At the time of the Bear Stearns debacle, I stated that it looked like a near-term bottom was close in time (if not in price). But when the market did not collapse, I did not sell. I wanted lower prices, and I did not sell because I did not get them. NEVER be influenced by what you want. Trade the market you have. I learned the same lesson again 2 weeks ago with Agco, which briefly traded in the low 50s due to some margin calls (or so it appeared). Looked like a great opportunity to take a long position, but I wanted a slightly lower price and it got away from me. Now it is trading at $67.

Back to the present: The move over the past few weeks has been fast and furious. Some lingering negativity remains, but there is also a lot of optimism around. Many people are stating that the Bear Stearns debacle marked the bottom, as similar bankruptcies have marked major bottoms in the past. Seems unlikely. There was never a big washout. Sentiment never reached extreme negatives (although it was negative), VIX only briefly touched 36. The consensus now seems to be that there will be a recession but it will be short and shallow. Many people are using the rally to show that technicals are good.

Seems unlikely. Typically, you only get such large rallies in the middle of bear markets. And since when were bear market bottoms called by the consensus only a week after they occurred? True market bottoms are marked by pervasive negativity that lasts even as the market starts to grind upwards. No one believes it will last. Not like now.

On this basis I have increased my equity short once again, diversifying into the EAFE short fund EFU.

MARKET POSITION: SHORT EQUITIES (10 units); LONG GOLD VS. SHORT HOMEBUILDERS (2 units)