“A man looks in the abyss, there is nothing staring back at him. At that moment he discovers his character. That keeps the man out of the abyss.”
Lou Mannheim to Bud Fox in Wall Street

The Cavalry rode into town yesterday, promising to restore law and order to a market that's been dysfunctional at best. Even the most naïve observer can see that we're at the beginning of the repair process - not the end.

Bulls are looking for sentiment to turn from fear to hope, just as it did after 9/11. Though company after company guided earnings estimates down, the hope of re-building America rocked markets higher for the rest of that fateful year. Investors were willing to overlook deteriorating fundamentals, preferring to look ahead to an economic recovery in 2002.

Of course, investors were premature in their analysis: 2002 delivered a one-two punch before bottoming out in July of that same year. Judging from the pre-market action in futures, bulls appear to be waiting on the sidelines.

Want top traders to sit at your desk and share their insight and ideas?
Minyanville's Buzz & Banter- 14 day FREE trial

The next hurdle for this market to negotiate is deleveraging, which started nearly a year ago and will continue for some time. If a bank, broker or hedge fund is levered 20:1, it doesn’t take an Einstein to figure out that it's going to take a lot of selling of longs and covering of shorts to get to 10:1.

For debt and equity managers faced with this problem, it doesn’t matter what you feel about your positions. The choice is simple. You must unwind!

If a fund or broker with $5 billion under management is levered 20:1, you could conceivably have $100 billion in longs and $100 billion in shorts - assuming, of course, a market-neutral posture. To get leverage down to 10:1, that fund is going to be selling $50 billion worth of longs and covering $50 billion in shorts.

What's frightening is that my 20:1 example is conservative.

Quant funds, which use computer models to identify stocks with strong fundamentals, have watched their models get turned upside-down as this deleveraging process unfolds. As a result, they're being forced to bring their gross exposure down.

When I was a kid, I loved Superman comics, which every so often talked about an alternate universe called Bizarro World on the planet Htrea (Earth spelled backwards). Down was up, good was bad, and Superman helped the criminals rob banks.

Quants today are faced with an equally topsy-turvy world where longs go down, shorts go up, and government changes the rules in the middle of the game.