The Dearth of Buyers

Shawn Baldwin from CMG in Chicago for the 2009 Capital Management Series

The Dearth of Buyers

April 8, 2009 Commentary

Today the triumphant return of the uptick rule was announced and it was passed unanimously. Hurrah! Should we now plow into the market with our life savings? Nope. The tepid +47.85 point close indicated that everyone clearly wasn’t convinced that the bull had returned nor did there seem to be any sense of urgency on anyone’s part to invest in stocks. Conditions still remain very shaky—between FHA losses spurring talk of a bailout, pension funds being severely underfunded and in need of a bailout along with the potential bailout of  the insurance companies (please note that today's WSJ headline was Point 1 one my list of potential negative data on the Uncertainty commentary last week)...I'm not sure that with that much uncertainty you want to bet the ranch just yet. The only group waiting for the precise time to buy are the professional money managers who want to make sure that they don’t miss a tremendous surge because it will cost them their jobs.

As I pointed out in the March 18th 2009 commentary we were firmly in the grips of a bear market rally. In fact we witnessed the worst quarter for the Dow since 1937. In the September 18th 2008 commentary, I focused on short positions for a market about to become unhinged. Unfortunately, shorting the market was being touted as one of the reasons for the demise of the marketplace. Nothing could have been further from the truth (shorting should have been touted as way to generate tremendous returns in a small time frame)—in fact the shorting law clearly showed how not allowing short position traders to fully function actually reduced buyers since there was a reduction in buyers since there was no short covering, effectively reducing buyers and support in the face of selling onslaughts. Oh well, C’est la vie!

On September 18th 2008 we began to decry the demise of the market and said that the market would crash on September 30th 2008 due to hedge fund redemptions, the CDS market and otherwise undefined risk. Our analysis proved to be correct and we deftly maneuvered in and out of the equities market in both long and short positions, although mostly short. I outlined why the eradication of the rule would help to destroy valuation in the short term and prolong a return to higher values. These factors in combination with the Credit Default Spreads assisted in creating a super short position which then met with the perfect storm of the credit crunch. This was a Short Seller’s masterpiece. For these reasons I stayed short for so long. The conditions were perfect for it. What does the return of the uptick mean in real terms? It requires short sellers to have conviction and capital. Shorting a position on its way down magnified your positions wealth by the action alone. Who wouldn’t take that trade? By returning the Uptick Rule a short seller must now have conviction because they are now actually working against their previous position. There is now a need for the rest of the market to trend in a downward direction with them and that requires magnitude—they can no longer create the death spiral themselves. Although that is a very big difference in their tactical strategy, it is not the panacea for the overall problem. Fundamentally-the market is poised to accelerate but this won't occur yet—it lacks buyers of conviction and the oh so necessary strike price in real estate.

Remember: The functions of the market firming are not a function of when but a function of what. Also consider that 2/3rd’s of commercial banking business is real estate lending, whether commercial or retail. This is a large component of the production revenue of the bank and it is also directly tied to the valuation of the bank. Until the strike price is determined by prices from asset disposition which will allow us to get a firm handle on true valuation (on both the bank and its assets) there will continue to be uncertainty and lack of action. The toxic assets must be sold—until this occurs there won't be a true uptick in value. Believe it.

The next important factor is the clearing for the CDS instruments (along with the regulation of the market) this will reduce exponential negative affects that a single trader can do to reduce market value without a market wide downward trend. This critical factor is almost in place and as we are nearer, we will see regulation of the tools of destruction for the recent market carnage along with a systematic reduction of what was essentially unlimited leverage. The third piece of the puzzle to accelerate medium to long term value is short term lending. Short term lending is on the verge of exploding due to the interaction by the political machinations of President Obama and Mr. Geithner, our beloved Treasurer. What remains for a total catapult of the market upwards? The Strike. As I mentioned in the April Preparing for Re-Entry commentary, the strike needs to be set—the TARP/TALF is essentially set to create exit strategies with price stability—those prices are the strike and will finally set everything in motion. When will that occur? When the private capital connects with the TALF money and begins to purchase assets since international money has been sitting quietly on the sideline. This will occur rapidly and in a short time frame.

This will be the new gold rush.

FASB assisted the process when it loosened the restrictions for mark to market rules for the banks—this will help the banks get rid of the toxic assets faster and it will in all likelihood increase bank profits by 20%.  So Buy banks! That's exactly what Tom Barrack of Colony Capital said he wanted to do when he was interviewed in the Financial Times recently and was a champion of the TARP program (Wilbur Ross the famed distressed investor said the same thing as well). It is no question to me why Mr. Barrack might be fully supportive of the program. If he seems prescient it’s because the ingenious money manager (who by the way essentially remade South Beach and the bulk of the money from the sales there along with calling the bottom of the real estate market before Sam Zell) made a killing during the other Greenspan driven fiasco—the Savings and loans crisis of the 1980’s (that’s right the sage Greenspan has 2 major financial debacles on his hands). Barrack made over $100mm in one year by purchasing assets under similar circumstances and unloading them for triple digit returns, whether you are on the Polo field (Barrack is an avid player) or in the markets—-follow Tom Barrack.

Shorting has taken a beating and the short traders along with it—however the shorts have beat the hell out of the market and can console themselves in comfort while they decide which course to take next. The time for shorting is almost over unless you live on a trading desk and have ultra-fast, nano-second trading tools available to you. It is almost time to get long. I conspicuously decided to visibly distance from the practice in the public or through recommendations due to cocktail party reasons—it became too unpopular to say even if it was wildly profitable. It will now become dangerous and unpopular—it is time for a new strategy. I was reminded by a friend once that my "function is to trade profitably and make money” —with that in mind (and the prospect of being popular at cocktail parties) I return to the marketplace with long targets in mind not for sake of being popular but because they will be very profitable. However it is not quite the time just yet.

In this interim as the strike is being devised we will need to look overseas to the Emerging Markets which will for a number of reasons have the highest returns possible. Global and Emerging Market opportunities have been greatly increased as was made evident from the recent G-20 meetings. Globalism will become increasingly important in the future and will dominate trade and value in terms of superior returns. The U.S. markets will return to stability and consistent returns but the dynamic markets will be the ones will be abroad. I will explore those specific opportunities in the Global Trade.

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