Anecdotal

Since this is my first note on the market since September, I wanted to make it interesting for the reader. Essentially, I was looking for something that was "catchy" and perhaps a note that will help me in better understanding things in the marketplace. After all, a blog, to me anyhow, is a way to organize one's thoughts and develop ideas and theories so that I am able to better understand what is occurring in the various parts of my trading universe.

So taking this into account, how can I draw you the reader into this note? One word: Anecdotal. Anecdotal by definition, according to wikipedia, is "Evidence, which may itself be true and verifiable, used to deduce a conclusion which does not follow from it, usually by generalizing from an insufficient amount of evidence." So what is my premise for the anecdotal evidence that I will present? Simply, "fear reduction."

Fear has dominated the marketplace over the past two months. Whether it is the fear of bankruptcy, the fear of a systematic collapse or generally a fear of losing money, it has trounced any confidence that existed in the hedge fund community and sent many value players wondering what went wrong as the likes of AIG, GE and Goldman Sachs collapsed from high prices even with low multiples. Basic material stocks such as FCX and energy names like Transocean, both sporting single digit PE's, trailing and forward, have found only sellers and historically PE levels have not applied. And do I need to rehash the story of FRE/FNM or LEH?

In short, fear has driven many people to drink, into bankruptcy or out of business. The fear of the unknown arrived from what droves us up the chart: Credit. As risk levels dropped, more credit was used. As the markets fell apart, everyone saw the party ending and dumped credit. Fear took off as people did not know where or what power credit had. When Bear Stearns went out of business overnight, we learned that credit was indeed powerful. When AIG and LEH went down in the same week, we saw that credit was unforgiving. And now with the economy falling apart, we find that credit pounding away again - all contributing to the fear in the marketplace. That fear disappears when the credit contagion ends.

Since the middle of October, financial conditions have begun to improve, as measured by various instruments (I use one that is too complicated for print) which argues that the contagion is losing steam. Sure, the unemployment report for October was pretty rough and the ISM was equally weak but those were backward looking - the anecdotal evidence has been developing over the past week. Is it good evidence? it is just a generalization?

Well, the Japanese Yen and the VIX have both backed off dramatically. They both measure various levels of risk in the marketplace. Given the fact that the Japanese economy already went through a decade of deleveraging and now is just coming back, people ran into the Yen globally thinking it was the safe haven. Also, those who were short, the proverbially "carry trade" had to cover putting even more pressure on the Yen to strengthen. So as the Yen has slowed its rise over the past few weeks and migrated back towards the par level. This represents less pressure to cover shorts as well as to short other currencies in favor of having long Yen exposure. On the side of the VIX, as the dives on the stock market have been met with some buyers over the past few weeks, overall option conditions have become more orderly - thus a more relatively stable VIX.

Now these two variables will not ultimately determine if the S&P 500 will trade higher Monday. However, there were some interesting things that developed late day. First, the Euro/Yen cross remained elevated off its lows - even as stocks dived downward after President Elect Obama's useless press conference and then late day, even as stocks shot higher into the close (with some very key indexes jumping aggressively), the Euro and Yen went downward. Basically, traders were buying the dollar as the stock market rallied - this generally has argued that growth is returning. Now perhaps this was no more than a typical Friday and short covering on the close was the reason for this move. however, if you take these moves, combined with the VIX, JPY and my financial conditions model, you are getting some evidence that things are improving.

The question of sustainability though needs to be mentioned here. Earnings stink. Goldman Sachs trading behaviour is downright strange and the selling in the JPY has slowed over the past few days. The S&P made a nice move past the 925 resistance and now targets higher but it remains in neutral so to speak (925/950 region is basically no man's land). The NDX 100 remains stalled under the 1300 level. The Dow is stuck. On the economic side, long term issues like unemployment and growth are not on a market side. Overall, things are ugly.

However, they are improving and that is a start. I will remain cautious with my trading doing what Doug Kass has been indicating via Real Money over the past few years - buy teh dips and sell the rips. Most importantly, I will be looking for the S&P to get back toward the 1000 level and then hang there for a while. Following that, a continued bounce higher could give us the same bear market low we saw in 2003. So far, the anecdotal evidence argues such.