The Uptick Rule

Adam Warner of the Daily Option Report blog has posted extensively and exhaustively on the whole uptick rule controversy (more recently here, here and here). What Adam keeps saying time and again (because nobody else is saying it and that is truly galling) is that those people who are intent on and capable of destroying a stock or "launching a bear raid" to echo the hysterical rhetoric never needed an uptick to get short in the first place. At the proprietary shops I traded in the late 1990's, "bullets" were all the rage. I want to be really careful here but one can make the case (and some have) that many traders were using bullets (long stock and long deep in the money puts) specifically to circumvent the uptick rule. Other strategies were also used to the same effect and by the time the uptick rule was repelled, something that was actually done progressively with intermediate steps and pilot stocks, it really didn't have any impact anymore.

I think what's going on is just another form of a phenomenon that takes place inevitably every single time there's a severe and prolonged sell-off: blame the short-sellers. It has always been that way and one can even argue that the uptick rule, which was instituted in 1934 in the wake of the mother of all sell-offs, was itself the result of a blame the short-sellers mentality. People want, need a bad guy every time there's blood on the street. And scapegoating the minority of people who make money when the markets go down, forgetting that they usually stand to go bust if they're wrong, is just too convenient politically to pass up.

Case in point, this from Thomson Financial (emphasis mine):
"The Chairman of the Securities and Exchange Commission said today that the SEC is closely examining whether market participants illegally colluded in an effort to short shares of Bear Stearns just before it had to be rescued by JP Morgan Chase and the Federal Reserve.In a Senate Banking Committee hearing today, Chairman Christopher Dodd of Connecticut said he is worried that the volume of trading in Bear Stearns shares indicates that illegal trading might have taken place. Dodd told SEC Chairman Christopher Cox that he hopes the SEC is examining this."Your hopes will be, I think, met and exceeded, with respect to the agencies' response to these concerns," Cox said in response, adding that that SEC's enforcement division is "very active on this."However, Cox indicated that he was restricted from speaking further because this process is ongoing."
The highlighted portion speaks for itself. It just means the scapegoats have been found and they shall be punished and made an example of.

Fed Oversight

I'm listening (distractedly) to the Q & A session part of the Bernanke Congress testimony and something funny happened. One smiling, seemingly innocuous, congresswoman asks him a question to the effect that every time he has lowered interest rates lately, the stock market (she specifically mentioned a "New York Stock Exchange index" she follows) seems to take it well at first, goes up strongly but then a few days later retreats and falters to the point where it finds itself lower than at the time of the rate cut. And this is the funny part: in his answer, some boilerplate to the effect that rate cuts take time to take effect, he didn't even bother pointing out that the Fed's rate cut policy is not aimed at propping up the stock market. So was it just an oversight on his part or is it that he so internalized the fact that the Fed does in fact monitor, react to and target the stock market (even though it's not in its mandate and that previous Fed officials have always denied it) that he just didn't pick up on the congresswoman's implication that the Fed's only reason for cutting rates is to support the stock market?

I have just read a pretty stupid (there is no sugarcoating it) article in Barron's calling for at least a 30% drop in commodities and basically making the case that the end in nigh for the commodity bull market. Where do I begin with the stupidity? First, it is not exactly bold to call for a 30% drop (from the top mind you, not from current levels) when commodities already took it on the chin and are already down 10 to 20%. Second, they point out to the fact that commercials (the so-called smart money) are net short on a massive scale, forgetting the fact that they have been so for a year. Every time there is a sustained trend, commercials by definition will hold record counter-trend positions. That's what they do, they hedge their physical positions with opposite corresponding market positions. Obviously, when the trend finally exhausts itself and reverses, they will usually be at their biggest net-short position ever but that's just a consequence of the trend and not a contrarian call by the commercials. In other words this indicator (net-short commercials), like any other indicator, can stay overbought for a very long time. Next the article argues that, should the economy really crumble, the CPI will turn negative thus cratering the commodities. However, and this is where they try to have it both ways, should the economy hold up well, the whole rationale for moving money from stocks to commodities will disappear thus, again, killing the commodity rally.
The truth is that we are in the middle of a secular bull market in commodities and those things tend to last a very long time. Calling for an end to it, using specious and contradictory arguments, might make for good copy but is otherwise a costly waste of time.

Bullish Engulfing

A bullish engulfing pattern, in Japanese Candlesticks analysis, forms when this happens (courtesy of Investopedia):

It is a pretty powerful reversal pattern and suggests the bulls have taken back control of the stock after a downtrend. Its significance is enhanced when it happens after a prolonged downtrend and on very high volume as is the case here for Goldman Sacks (click to enlarge). The fact that this has occurred on a weekly chart lends it a little more weight. Now leaving the candlestick realm, also note the bullish divergence on the RSI: the stock made a new low this week at around 140.27 (previous low was 157.38 reached the week ending on 8/17/2007) yet the RSI bottomed at 32.72, higher than the 30.54 it reached that summer week. A vigorous rally from here and a test of resistance just below 210 seem likely provided the 140 level is not broken. Granted that's about a 30 point potential gain for a 30 point risk (albeit in a high probability situation) but in this ultrabearish environment, that's as good as it gets (or I should humbly say that's as good as I can find it) on the long side!

Since it is fashionable to talk about Keynes these days, I thought I'd take a look at his magnum opus The General Theory of Employment, Interest, and Money (1935) and see what the fuss is all about. One surprising paragraph I came across is this ode to individualism and private enterprise, not something one would expect to find in Keynes' work:

"Let us stop for a moment to remind ourselves what these advantages [of individualism] are. They are partly advantages of efficiency-the advantages of decentralisation and of the play of self-interest. The advantage to efficiency of the decentralisation of decisions and of individual responsibility is even greater, perhaps, than the nineteenth century supposed; and the reaction against the appeal to self-interest may have gone too far. But, above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life, which emerges precisely from this extended field of personal choice, and the loss of which is the greatest of all the losses of the homogeneous or totalitarian state. For this variety preserves the traditions which embody the most secure and successful choices of former generations; it colours the present with the diversification of its fancy; and, being the handmaid of experiment as well as of tradition and of fancy, it is the most powerful instrument to better the future."

Interesting metaphor by former Treasury secretary Lawrence Summers as related by Dow Jones Newswire:
"....an increasing risk that the principal policy tool on which we have relied - Federal Reserve lending to banks in one form or another" may not suffice. He likened it to "fighting a virus with antibiotics."

This, in my view, is the one element of the current financial troubles that could prolong them indefinitely:
According to this week's Barron's, "a new phenomenon of widespread negative equity - homeowners owing more on their mortgage than the underlying property is worth - has wrought a sea change in borrower behavior. Borrowers whether subprime or prime, financially stretched or flush with cash, are walking brazenly from their obligations in stunning numbers" (emphasis mine). How they can just walk away and not face serious legal consequences, I am not too clear about. I read somewhere that it would simply be too costly for banks to actually go after each and every person who sends in the house keys. This new home abandonment fad could become a lasting symbol of this coming (already upon us?) recession.

Editors' Strike

The previous post didn't make any sense whatsoever unless "Go Short The Dollar" was replaced with "Go Long The Dollar" (it is now in its corrected form). Apologies. This goes to show that it isn't easy to be one's own editor. What's needed sometimes is not reading and checking the post over and over, just another pair of eyeballs. But hey, what can you do, that the bane of every lonesome, little read blogger. And now I'll stop whining.

To reiterate and maybe clarify my previous post, the rationale was simply that some traders thought Gisele's demanding to be paid in anything but dollars (in effect going short the dollar) would be a perfect contrarian indicator. They went long the dollar and got burned pretty badly thus indicating that Gisele, far from being a contrarian indicator, was just being a pretty smart operator. Now, when all the fashion models (including the Americans) are done changing the terms of their contracts from dollars to Euros, then it'll probably be time to buy the dollar.