Bear Market Rallies

"We wished to make this post on a day in which the markets started to rally, so as to give readers the latitude to exit their long positions gracefully should they choose to do so, and not leave them in a panic, which is not necessary nor productive." Jesse July 15

Bear market rallies, or 'relief rallies,' are sharp upward spikes in prices on the US equity markets.

They are fed by short covering. Those who are short, or have positions based on the assumption that the stock market is going lower, are forced to buy stocks either from fear of losses, or because they are undercapitalized and overleveraged. The leverage may be in terms of time (as in the case of stock options) or money (margin).

The bear market rally consists of a violent opening spike. That spike will be up to the nearest strong overhead resistance as the short sellers panic. Then the market will pull back, because there are no serious buyers yet to sustain the prices, and the early shorts have covered. Also, insiders will begin to feed their dog stocks into the public markets.

The prices will pull back to the nearest support. Once the bulls feel confident again, the buying will resume, this time more slowly as naive speculators begin to succumb to the 'good news.' The highwater mark of the opening price spike will be a definite target for this secondary move higher.

Often the initial effort to find support fails, and the bullish sentiment will pull back and try to find stronger support from which to resume the price advance.

Very infrequently there is a 'failure to rally' and a failure to find support at a near support level. Buyers (also known as 'the greater fool') are not to be found, and the dip buyers panic, and a freefall ensues. This also can be quite breath-taking, as the insiders are selling not buying, and the small speculators are exhausted and starting to panic. This is an uncommon event, but can be quite damaging if you are caught on the wrong side of it. This is how we came up with the term 'chasing nickels on the freeway' to describe it. Buying the dip in price in bull markets is easy money; buying the dip in bear markets is for gamblers.

The way we keep our orientation in these market events is to take a slightly longer time perspective. We like to watch the hourly futures chart, rather than the customary ten minute charts watched by daytraders. We also like to plot the support and resistance levels not only on the hourly charts, but also on the daily charts and keep a close eye on them. Why? Because this is how you know if you are still in a bear market or not. Are the longer term trends still in place?

The best way for most traders to play these markets is to stay out. The opportunity to be whipsawed is very high. Take a break. Go for a walk. The market will always be there. The greed of 'lost profits' pulls you back in, and then fear will take you out, on a stretcher if you are not careful.

Controlling one's emotions in volatile markets is the primary challenge for experienced traders.

Bear market rallies can be quite impressive. Wall Street insiders feed these rallies with stories and 'good news.' The financial reporters and many well-meaning people will go along with this because they wish to be optimistic, for any variety of reasons. Fundamentals can mean little in the short term in financial markets. Although in the longer term markets are 'efficient discounting mechanisms', in the short term a market is more like a tug-of-war, or a rugby scrum, dominated by the biggest players with the most money.

These are the trend corrections in which short term traders can make some very tidy profits, and insiders can unload more of their underperforming stocks on the unsuspecting public. The government and other officials are often complicit because they are seeking to calm the public and avoid a panic, so they will take whatever 'good news' they can get.

There is an ethical if not legal question involved. When does avoiding a panic become leading people into losses and bad decisions? If a major tsunami was approaching the eastern coast of the US, would the government be justified in hiding that fact, in telling people to stay in their homes near the coast, to 'avoid a panic?' We hope to see this tested in the courts in the next few years, in particular with regard to the financial news media and chief market strategists.

The way we are playing this market today, just as an example, is to add to some long positions in contra dollar plays on weakness (gold, Swiss franc and other instruments in bull markets), scalp profits from the primary trend of the equity markets, and to spend a little time with the kids, go for a walk, work outside, while we wait for this cycle of greed and fear to subside. (PS. We went into the close on the short side because we approached the end point of a classic short term rally. If we advance further tomorrow we will pull them back. - Jesse)

SEC Kicks Over Financial Stock Manipulation Rocks and Finds... Goldman Sachs

An earlier and related story from April: Secret of Bear Stearns demise revealed: Competitor Goldman Sachs started the run on the bank


Goldman Is Queried About Bear's Fall
By Kate Kelly and Susanne Craig
July 16, 2008
The Wall Street Journal

Goldman Sachs Group Inc. is the envy of Wall Street, navigating the credit crisis relatively deftly as many of its peers have been battered.

Now, the big securities firm has come under suspicion, at least from the chiefs of two rivals who have questioned in recent months whether Goldman, even indirectly, might have put pressure on their firms' stocks.

Alan Schwartz, who headed Bear Stearns Cos. when it collapsed in March, has pointedly asked Goldman Chief Executive Officer Lloyd Blankfein whether there was any truth to talk that in the days preceding Bear Stearns's fall, traders in Goldman's London office manipulated the struggling firm's stock, according to a person with knowledge of the conversation.

Lehman Brothers Holdings Inc. CEO Richard Fuld Jr., whose firm's shares also have been battered, also has contacted Mr. Blankfein. "You're not going to like this conversation," Mr. Fuld told Mr. Blankfein, according to people familiar with their talk, but he was hearing "a lot of noise" about Goldman traders who allegedly spread negative rumors about Lehman. In recent months, Mr. Fuld has contacted traders he felt may have been bad-mouthing his stock, according to someone familiar with the matter. Spreading rumors one knows to be false with the intention of manipulating a public company's price is illegal.

Mr. Blankfein was taken aback by the inquiry from Mr. Schwartz, according to a person with knowledge of the discussion, even though the former Bear Stearns CEO was quick to add that he didn't believe Mr. Blankfein would ever knowingly tolerate misconduct. Mr. Blankfein responded that he had no knowledge of any alleged manipulation, this person said, adding that he told Mr. Schwartz he would respond severely if he ever discovered such behavior by Goldman traders. Through a spokesman, the Goldman CEO says he doesn't recall the conversation with Mr. Schwartz.

Goldman strongly denies wrongdoing. "We went out of our way to be supportive of Bear and were rigorous about conducting business as usual," spokesman Lucas van Praag said. He said Goldman never altered its terms for doing business with Bear, even as lenders pulled their financing and some trading partners retreated during the troubled securities firm's struggles in early March.

The SEC investigation into Bear's collapse partly involves trading documents, which have been reviewed by The Wall Street Journal. The documents indicate that in the weeks before March 16, when Bear Stearns reached its initial agreement to sell itself to J.P. Morgan, Goldman Sachs International, which encompasses the firm's European trading units, was one of the most-active parties in trading securities known as credit default swaps that it had bought from or sold to Bear Stearns -- more than most other Bear trading partners.

Goldman Sachs Asset Management, the money-management division, exited a number of swaps on behalf of clients, the documents show. Mr. van Praag said it would be unwise "to make assumptions about this information without understanding the underlying transactions." He said Goldman's international unit handles trades "around the world, on behalf of clients" as well as for Goldman itself.

The documents show that a handful of other prominent firms cut their exposures to Bear Stearns, including Chicago hedge fund Citadel Investment Group and New York hedge fund Paulson & Co., which is run by a Bear Stearns alumnus.

Dozens of similar securities known as interest rate swaps, originally bought from or sold to Bear Stearns, were exited by Fairfax International Investments Ltd., a unit of Citadel, and transferred to another internal unit, Citadel Equity Fund Ltd., on March 3. An additional 40 or so credit default swaps were exited separately by Citadel Equity Fund; those contracts were taken on by a variety of other brokers. About 40 trades were exited by the hedge fund Paulson, primarily during the week of March 10, when Bear Stearns nearly ran out of cash.

In recent weeks, SEC investigators have questioned Citadel about its moves to unload complex securities contracts it had either bought or sold from Bear Stearns in early March, according to people familiar with the matter. Citadel executives have explained the moves as having been part of a long-planned restructuring in which certain holdings were transferred from Fairfax to another internal entity, these people say.

Senior people at Paulson & Co., run by former Bear Stearns executive John Paulson, have told associates that the swaps bought or sold from Bear during the March 10 week, most of which were transferred to Goldman, were part of the firm's overall effort to curb exposure to financial-services firms.

Comparison of the Market Declines of 2000-1 and 2007-8

This comparison is the number of days from the market high.

SEC Issues Emergency Rule on Short-Selling Financials

How thoughtful of the SEC to come to the aid of the primary dealers, the Wall Street banks, after virtually ignoring the naked short selling problem in the markets for the past eight years.

SEC to fight short selling of financials
By Joanna Chung in New York
July 15 2008 21:31
Financial Times

US regulators will take emergency action to stop abusive short-selling of stock in financial institutions such as mortgage financiers Fannie Mae and Freddie Mac and investment bank Lehman Brothers.

Christopher Cox, Securities and Exchange Commission chairman, told legislators on Tuesday that the agency would issue an emergency rule to stop so-called “naked” short-selling of shares in significant financial entities. The SEC will also consider new rules to extend those trading limits to the rest of the market.

Short sellers aim to profit from share declines – usually by borrowing a stock, selling it and buying it back in the market. But in a “naked” short the shares are sold without being borrowed first. The emergency rule, which would be in effect for up to 30 days, would require anyone making a short sale to borrow the security first.

It would apply to Fannie and Freddie – the government-sponsored entities that own or guarantee almost half of US mortgages – and all primary securities dealers including Lehman, whose shares have been battered by rumours the bank says are false.

The action comes amid intensifying efforts by authorities to crack down on rumour-mongering intended to manipulate securities prices. The SEC has been investigating whether false rumours and abusive short selling contributed to the collapse of Bear Stearns in March and the declines in Lehman’s shares.

It is now working with the Financial Industry Regulatory Authority and New York Stock Exchange Regulation to conduct industry-wide “sweep examinations” of market participants, including hedge fund advisors

“If we are successful in bringing future cases . . . I believe the penalties should be commensurate with the enormous amount of shareholder value that is destroyed by this kind of wantonness toward other people’s money,” Mr Cox said. The agency has used emergency rule-making powers in the past, for instance after the September 11 terrorist attacks, but this would be the first time it has issued an emergency rule on short selling.

Fannie Mae and Freddie Mac closed down 27.3 per cent and 26 per cent respectively.