8.28.09

Shorts

          As we have been saying for months now, the market has been operating on very low volume. Yes, it is somewhat typical in the summer months, but it is more prevalent this time around. It has been a market controlled by traders, not investors.   The biggest market performers by far have been the very stocks that were by far the most sold short a few months ago; the major banks and financial firms; Citicorp, Bank of America, AIG, Fannie and Freddie Mac, etc. Last week, these stocks accounted for close to 30% of the total volume. So you had a situation where a handful of stocks in a sector that dominates the Dow and S&P 500, had an outsize effect on the rally, creating bullishness and pulling other sectors up with them (but to nowhere near the same degree). AIG up 300%? A company whose debt to the U.S. government alone is many times its market value at its current price. Justified, or just the result of the extraordinary short-squeeze?  AIG is the insurance company that was almost going out of business until the government infused $180 billion to keep them afloat. All the other stocks mentioned above were also kept afloat with billions of taxpayer’s money. AIG had a reverse split of 1 for 20 a while back, thus reducing the number of shares by 80%. A lot of traders started to “short” the stock. In order to short a stock, those shares need to be “borrowed” by the firm doing the trade. As the short interest in the stock increases, the harder it is to find shares to borrow. This has the effect of causing the price of the shares to increase in value. Once this starts to happen, it can be like a run-a-way train. The shorts are forced to buy shares to cover their shorts. That is how a “short squeeze” works.

          Now we are seeing the “shorts” stepping aside and there is no longer the “fuel” available to keep the rally going. A lot of advisors are telling their clients not to short the market and, as a result, the short interest is falling to 2 year lows. With Labor Day just around the corner, we should see the volume starting to pick up and that will be the first step in bringing predictability back into the market.

          It was one year ago that we put out a signal to move to cash and have remained there ever since. When you reflect back over the past year, the market looked more like a Las Vegas casino than an orderly marketplace. Add to that the Bernie Madoff and Allen Stanford frauds, the Auto and Banks and Insurance Companies going broke. For a while there, it appeared as though the entire financial world was coming to an end.

          All in all, things are starting to show slight signs of improvement in some areas of the economy. Employment and housing are the most critical, and until they start showing some good numbers, we will have trouble getting the economy on its feet.

          When we told you to go to cash August 28, 2008, and today, August 28, 2009, the market indices are down 15 to 20%. Being in Cash this whole time has saved us from inflicting serious losses in our portfolios.

          We had a buy signal on March 25^th which we decided to ignore due to the high degree of risk at that time. Had we followed that signal, it would have been profitable but at the cost of many sleepless nights.

          September and October are historically two of the worst months of the year for the market. This year that may not be so. We are looking for some predictability to be working into the market and will be watching for it very carefully.

          For now will remain 100% in cash.

Till next time

The MTA Staff