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Nick and Toni Revisit the Tape


How do real traders deal with this kind of market?

A few weeks ago, upon returning from a respite, I shared a conversation I had with a friend from the East end. The frisky fellow, "Toni" in those musings, is a world-renowned short seller. Our dialog occurred while dining at the delectable Nick and Toni's eatery on a summer night.

This past weekend, as the storms unleashed fury and hell on the big city, we reconnected to continue our dialog. The markets, moods and mindsets were in a vastly different place than the last time we spoke and I wanted to share the fare for the benefit of ye faithful.

Nick: When we last connected on July 14th, the market was slipping into an abyss as Hank and Ben furiously tried to stick their fingers in the financial dike.

I spoke at the time of scaling into the despair and buying stocks-in particular, the financials-for a trade. That risk was rewarded in kind.

Now, the "easy trade" is gone-if you can call historically significant socialization efforts in Fannie Mae (FNM) and Freddie Mac (FRE) "easy"-what are your thoughts looking forward?

Toni: With the benefit of hindsight, July 15th looks like it marked a classic capitulation low in the BKX. And what a panic it was-on that date Bank of America (BAC) traded at $18 (it's now $33) and yielded over 11%. Wachovia (WB), for its part, doubled in price since we last spoke

Another Prince-from the Far East-was rumored to be necessary to save Citigroup (C) and Lehman Brothers (LEH) was pulling a Bear Stearns. And, the you know what was hitting the Fannie (one of the "government sponsored agencies" that you mentioned).

I generally agree with your characterization that the "easy trade" in the financials is over. I suspect, too, many have covered their shorts in the crowded arena of banks and brokers – in part due to the strange, convoluted and threatening naked shorting edict issued by the SEC.

But problems, as you well know, linger in spades in the financial complex – and the indigestion will not be cured by two tablets of Pepto Bismol. So, perhaps Bearus Interruptus short term–but not intermediate term!

Remember, just as with the implosion in early 2000, the subslime housing problem was judged by many in 2004 and 2005 as being unimportant to the macro picture.


Nick: As often noted in Minyanville, 25% of the financial universe disappeared during the 1989-1991 recession and only ten percent has thus far vanished during an entirely more daunting credit debacle. So yes, there are some dead men walking out there and the pain will be more pervasive before this period passes.

With that said, I scribed vibe on July 16th into the meat of the heat that offered "The Future is Now" with regard to the structural dilemma we collectively face. I further opined that the market, as a forward looking discounting mechanism, priced those fears into the near-term tape and the stage was set to burn the fur on late-to-the-party bears.

The fact that the trading low-not to be confused with a market bottom-was put in place at precisely the same time Ben Bernanke finally admitted to serious economic issues was serendipitous to say the least.

I look at the market through four primary lenses-nuances, trends, phases and cycles-and remain of the view that we're in a multi-year deleveraging process (bear cycle). This has phased through the homebuilders, banks and financials in drag (such as General Electric (GE), General Motors (GM) and Ford (F)) and the baton has been passed to retail (consumer risk), technology (consumer and enterprise risk), credit card companies and will eventually infect the commodity complex.

Still, and some would say despite that, it is the second lens-the trend-that holds the near-term key to the vault. As I wrote in Frame of Reference, the higher lows (S&P 1235 and BKX 60) can be used as a bovine backstop until they're violated. Technical analysis is a better context than catalyst, I know, but it's a framework with which to define risk.

Toni: In other words, you are letting the market deliver you its message and presuming that the July lows will not be penetrated?

Nick: Not entirely-I'm of the school that there are two types of traders in today's market: the proactive set, which is how I approached the July lows, and the dead set (and I'm not talking about the 1981 live album by Jerry and friends).

The key in understanding the subtle yet important difference lies in the stylistic approach. Into July 15th, due to the massively oversold conditions, I scaled into exposure as a function of price. There was plenty of risk-the wheels felt like they were gonna wobble right off the wagon and if they did, I would have taken quite a hit.

The last two weeks, while primarily trading from the long side, I had a "hit it to quit it" mentality. I set tight stops under my entry levels and kept a close hold of my risk leash. I was stopped out a few times but managed to catch the meat of a few moves as well.

One of the reasons I'm trading this way is that I want to keep overnight risk to a minimum and pound my glove like Graig Nettles each morning. If the tenor of the tape changes, I'm able to pounce accordingly without having an emotional attachment to my positions.

Gun to head, if you asked me for my gut feel, I would say that the upside has further room to run before reality sets in.

Toni: I love the voodoo that you do so well! Let me try to differentiate MY trading from MY investment view.

Quite honestly, this market has more moves than a shortstop batting .110. Last week the Dow Jones Industrial Average moved 200 points on three consecutive days (and missed the fourth by thismuch).

The random and trendless nature of these moves makes for difficult investing but presents unprecedented trading opportunities (particularly the one-day variety). So I think you throw technicals out the door, buy the dips and sell the rips as a short-term tactical strategy.

From an investing standpoint, the situation becomes murkier. As you said to start this session, the credit cycle and its ramifications dwarf everything else. It seems to me that when credit is dear and generally less plentiful, economic growth will diminish and price/earnings multiple expansion will be limited and, more likely, could very well contract.

No economy can live beyond its means in perpetuity. As we are painfully learning, the American consumers' audacious asset-based consumption binge over the last decade is now coming to an end. And if you believe Nouriel Roubini in this week's Barron's, the leading financial institutions might have another $1 trillion+ of writedowns ahead of them.

Nick: You don't have to twist my arm to be bearish on the big picture, my friend. I've said-and I'll continue to say-that we've got five lean years ahead of us as the socioeconomic malaise manifests and societal acrimony percolates.

Social mood and risk appetites shape markets, not the other way around.

It should be noted, however, that many people considered my view-and that of Minyanville in general-to be too bearish throughout 2005 and 2006 (with the exception of energy and metals, which we were steadfastly bullish on).

Just as the crowd was giddy into the Blackstone (BX) and Fortress (FIG) IPO's-remember those?-they're looking to lynch someone now. We'll certainly see tree-swinging stocks by the time this period passes but the destination we arrive at pales in comparison with the path that we take to get there.

As a trader, the last thing you want to do is overstay your welcome on either side of the ride during this furious fray.

As an investor, you'll want to proactively prepare for what's to come by preserving capital, reducing debt and increasing financial intelligence.

Make it to take it, hit it to quit it and discipline over conviction as we find our way.

Toni: You are beginning to sound like The Bearded Prophet of the Apocalypse- a dear old friend of mine who was given HIS pseudonym by Barton Biggs while he was the head of investment strategy at Morgan Stanley "in the good old days."

I thought I, (a dedicated short seller) Toni, was supposed to be the Cassandra! Let me ask you something, Nicki-isn't an intermediate term period of substandard return expectations now very much the consensus?

Shouldn't we consider a variant view-either of an uber-Bear Market or by contrast, a surprisingly healthy Bull Market- as an alternative?

Nick: I'll again point to the time horizon. The path of maximum frustration may very well include a rally much stronger than most expect into the election-shocker, eh?-followed by a period entirely more depressing than a recession.

Remember, in a bear market, nobody makes money-not even the bears!

Toni: Thanks Toddo, er, I mean Nick. Darn-hey, do you think people have figured out that you're Todd Harrison from Minyanville yet?

Nick: Only if they've figured out that you're Doug Kass from Seabreeze Partners!

Good luck my friend-hit 'em where they ain't!

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