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Washington's Legislative Bottom


Have we witnessed the death of capitalism?

Like most front-line money managers, I've spent the past few weeks in a foxhole dodging bullets.

The witch hunt began in earnest last week. The cause of all our woes must be hedge funds and short sellers. From the back of the crowd, someone yells "Get a rope!"

Famed investor and short seller Jim Fleckenstein said it best: "If some financial institutions were so fragile that a decline in their stock price caused the business to implode, then perhaps they didn't have a real business at all. "

Even today, we see evidence that the stand alone brokerage models failed, with the Fed stepping in and changing the status of Goldman Sachs (GS) and Morgan Stanley (MS), making them bank holding companies.

Brokers brought this on themselves while sellers in these stocks concluded they were over-valued with failed business models. If that wasn't the case, where were the Warren Buffet's of the world who step in when there's perceived value? Lehman and AIG (AIG) didn't meet their demise because of short sellers.

Is there another Bear Stearns out there?
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In fact, short positions in financials were quite low. The sellers in the last few weeks of AIG, Lehman, Morgan Stanley and even Goldman were investors who were watching their wealth disappear. Isn't it interesting that SEC Commissioner Cox came out with this plan within hours of a presidential candidate calling for his dismissal?

So we're eliminating short sales. Financials for starters, although I'm sure it won't stop there. General Electric (GE), General Motors (GM) and 4 others were added this morning. The markets soared Thursday and Friday, and may continue for days and weeks. There's talk about bringing back the uptick rule for short sales. Hey, let's go one step further. Let's make it so all stock trades have to occur on an uptick. Wouldn't that be great? Stocks will never go down again!

Wall Street came to the conclusion over the last couple of decades that if you have a model that can turn out a steady 5% then why not borrow as much as you can and earn 10, 20, 30 even 40%. The process of de-leveraging will prove long and painful.

We all know what is going on here. We've begun the process of nationalizing the financial services industry.

I have long thought that the bottom in the current bear market would be made with a 1000 point move in the Dow, or perhaps a couple of 500 point days back-to-back accompanied by massive fear, a VIX spike and headlines of "Financial Crisis" on the cover of every major US publication.

We've seen almost all of that. So, why am I still uncomfortable about going massively long?

Most bottoms are made when deep value investors, confident that the worst has passed, step in to scoop up beaten down stocks on the cheap. Retail investors start pouring money into mutual funds and institutional investors come off the sidelines to put mountains of cash to work. Six months later we start to see an increase in GDP and an improving economy which in turn justifies the current stock market move.

2002 had all the signs of a classic bottom. Like last week, we had the VIX spike, massive fear and huge market moves back-to-back. Six months later we started to see the evidence. The economy started to improve and analysts rushed to raise their estimates. Sure, today's weakness can be explained by normal give back, but somehow what we got last week just doesn't pass the smell test.

Instead, we got a Washington-led legislative bottom. If we're going to lead as a nation, Washington will have to devise a plan to unwind what we are witnessing. Otherwise, capitalism as we know it died last week, along with the short sale.
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