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The Ghost Whisperer

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Markets may normalize in time, but near-term management is key.

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"Indians scattered on dawns highway bleeding. Ghosts crowd the young child's fragile eggshell mind."
-The Doors

Time is the ultimate arbiter of fate. For financial markets around the world, truer words have never been spoken.

A few summers ago at the Minyans in the Mountains Ojai retreat, we were discussing the cumulative imbalances percolating under the seemingly calm financial surface. In the middle of our panel debate, Tony Dwyer, the talented strategist from FTN Midwest Securities, wryly opined "The sun is going to blow up one day but that doesn't mean it's a good trade."

His wise words continued to resonate in my crowded keppe as I weighed the fray from day to day. I've always attempted to operate as an optimist that believes negative energy is wasted energy. As a trader, I'm equally aware that positive perspective and bullish positioning are mutually exclusive dynamics.

With that in mind and given the spirited sprint that has distanced the market from the March lows, I wanted to humbly offer five reasons why "Sell in May and go away" may indeed ring true by the time June rolls through.

Reverse M&A

During the meat of the financial heat since last summer, we offered that increased banking activity would bode well for market psychology. It stands to reason that the unwinding of proposed deals could weigh on the collective sentiment.

Last week, after Bank of America (BAC) mentioned they might not back Countrywide Financial Corp's (CFC) outstanding debt, the S&P promptly put some junk in their trunk. We offered in Minyanville that this might have been a stealth reason why the Federal Reserve proactively increased the size of the Term Auction Facility and shifted its collateral standards.

Over the weekend, the proposed marriage between Microsoft (MSFT) and Yahoo (YHOO) hit the skids after the two tech titans couldn't agree on price. While their alliance would have been an intuitive fit for their digital media aspirations, the value of those eyeballs remained an insoluble source of friction.

While on opposite sides of the industry spectrum, these disparate situations highlight a singular point. Mergers are more than a financial agreement between two organizations; they're a cultural one as well. Given the rough and tumble landscape, societal acrimony has seemingly seeped into the innards of corporate America.

Fear Factor

In Layman's terms, volatility is the opposite of liquidity. Anyone who has attempted to accumulate a sizable position in a thin stock can attest to this fact. Conversely, an abundance of liquidity-such as the trillion dollar Federal injection we've recently seen-flushes the market with supply, which in turn dampens volatility.

This could be cause for pause for stock market bulls. The VXO, widely perceived to be a proxy for fear in the marketplace-has declined more than 45% since Bear Stearns (BSC) imploded and anxiety gripped the Street on March 17th.

During previous fear fulcrums-such as the Thai Baht panic of 1998 and the dot.com implosion of 2000-2001-the VXO peaked near 60. Currently, despite the housing depression, credit contagion, derivative machination and global dependency of a finance-based economy, the VXO is flirting with the teens.

I'm of the view that long volatility (positive gamma) is the smartest bet in the current market with the caveat that only those with a working knowledge of options should assume that risk.

The False Sense of Security

I've long viewed technical analysis as more of a context than a catalyst. In the absence of clarity, however, traders tend to depend on charts and levels as actionable influences.

As a function of last week's lift, the stock market secured technical affirmation above S&P 1405, INDU 12800 and TRAN 5000. Almost immediately, Wall Street sounded the "all clear" that it was safe to wade back into exposure. This, mind you, after a double-digit gain by the mainstay averages in less than two months.

A few points of perspective. Coming into this week, 77% of the S&P 500 stocks-and 85% of the S&P financials-were above their 50-day moving averages, the highest such reading since October. Further to that, Professor Sedacca notes that a combination of annual, decennial and presidential cycles yields a potential "top date" for the S&P on May 8th. Those were, so you know, the same cycles that suggested a low on March 15th.

One of my favorite trading axioms is that we must respect-but never defer to-price action in the marketplace. Investors would be wise to remember that as we edge ahead and make our bed.

Iran

A few weeks ago, Professor Adam Michael mused that the U.S. government was topping off the strategic petroleum reserve during an election year when oil prices were over $100. He also noted that Dick Cheney was in the Middle East at the end of March and President Bush met with Vladimir Putin a few weeks thereafter. Something didn't smell right to him and based on the recent action in crude, we're starting to understand why.

We've since learned that Israel bombed a Syrian nuclear reactor last year, the U.S believes North Korea has been assisting Syria and the Chairman of the Joint Chiefs of Staff accused Iran of increasing their efforts to train and arm insurgents in Iraq and Afghanistan.

With the saber rattling getting loud, it's no wonder crude is back to all-time highs. I'm unsure what the foreign agenda is but it appears that the Bush administration is either attempting to get everyone to the negotiating table or positioning for confrontation. Given the delicate global balance and geopolitical tension, the latter matter could prove quite unsettling.

Dollar

The Federal Reserve lowered interest rates by 25 basis points last week, which was a less aggressive stance than what we've seen since the financial crisis began. We wondered at the time whether they were operating from a position of strength or posturing as a function of need.

One of the great misnomers in the marketplace is that the weaker dollar is a root cause of our current malaise. Quite the contrary, if the greenback catches a sustainable bid, it could spell trouble for commodities and equities through the lens of "asset class deflation vs. dollar devaluation."

To be sure, interest rates are but one of many tools in use by the powers that be. Term Auction facilities, lending windows, shifting collateral parameters, working groups and other policies all point to dollar dilution and by extension, the potential for buoyant equities until such time that foreign holders of dollar denominated assets balk.

We've been conditioned to believe that when push comes to shove, the Federal Reserve and Treasury Department will watch our backs and, if necessary, assume our risk. While this could last longer than some expect, it's important to remember that the resulting imbalances are cumulative and risk remains ever-present.

I, like you, stand to gain from a prolonged period of economic expansion. As hope isn't a viable investment strategy, it remains in our collective best interest to remember that preparedness is a necessary step towards prosperity. As such, risk management-not reward chasing-remains my operating principle of choice.

Good luck.

R.P.
No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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