If this is the Happiness Hotel, I’d hate to see what the sad one looks like! ~Fozzie Bear on the Great Muppet Caper
I was getting my daily dose of the news channel while on the treadmill yesterday when this unlikely headline popped up (paraphrasing): Citigroup CEO Says 2009 Is Actually Turning out to be a Good Year
To which I couldn’t help but reply “If this is a GOOD year, what the heck does a BAD year look like?” I mean come on – Shareholders have lost more than 70% of their investment (after yesterday’s rally), and that is on top of the 77% lost LAST year. The Fed has had to inject capital on an unprecedented level, leaving the taxpayers at risk and sending countless workers to the unemployment lines. But this is a Good Year?
The news, however was enough to spark a sharp market rebound, the likes of which are usually only seen in the context of a bear market. This shouldn’t be too surprising as stocks have been decimated to a point where many companies are now trading below book value and PE multiples are at the lowest levels in recent history. When the panic is at its worst, it usually means the coming rally will be particularly vicious.
At least part of yesterday’s rally could be attributed to short covering. If you think its difficult to hold onto a long position when the market is heading south, its even worse holding a short position when a bear market starts to turn. Since most short sellers were probably sitting on hefty profits, even closing positions at yesterday’s highs likely triggered realized gains. But no one wants to see those profits turn to losses so I wouldn’t be surprised to see short-covering help fuel this rally for several days to a few weeks.
Rules and Regulations
Washington was quick to jump on the bandwagon as well. Bernanke spent some time on capital hill stating that the regulatory system needs to be revamped to prevent another financial meltdown (thank you Captain Obvious) and also made it clear that the government won’t let large banks fail.
The idea of refusing to let banks fail strikes me as having “moral hazard” written all over it. If for-profit institutions are not allowed to fail, then the natural tendency is to take exorbitant risks in search of profits because the negative effects of those risks are assured to be taken by the government. And so the question becomes whether banks will continue to operate as “for-profit” institutions or if they will simply be an extension of the government (nationalized and owned by the people)
I understand the need to protect the overall economy from a failure that would be catastrophic to our system. And I don’t pretend to envy the role of those who must find solutions to our dire situation. But I do think we must be careful in our current path which looks more and more like a socialist solution to a capitalist problem.
Trade ‘em Like You See ‘em
But all political views aside, our role as traders is to profit from the current environment however that can be accomplished (obviously within legal and moral guidelines…). And so with the current environment, I believe there is still opportunity to profit from trading on the long side. The Zachstocks Growth Model has put a bit more capital to work in the last 2 weeks but still holds a healthy 20% plus cash balance. It was encouraging to see the managed portfolio up in line with market levels despite our relatively conservative stance.
The plan from this point is to methodically plug cash into situations that can show long-term growth. These names are the most likely to attract both short-term and long-term capital as we bounce off the most recent lows. A list of recent ZachStocks Long Ideas might be a helpful place to begin your search.
After a few weeks once the rally has run its course, it will be time to review positions for laggards, and maybe add a short ETF to help protect gains. Finally, for those of you with options experience, there may be worthwhile opportunities to sell calls against existing positions if the premiums are high enough. This obviously caps potential gains, but can help to protect against a sudden decline.
As always, use proper risk control and understand potential losses. While the current rally should give us a trade-able opportunity, there is still potential for new lows.
I wish you every investment success!
Zach
FD: Author has a long position in Citi
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