Is This A Round of Profit Taking Or Something More?

To take a Bill Clinton campaign statement and unashamedly use it to my benefit, "IT'S THE SUPPLY STUPID!"  

A wave of profit taking has begun.   The markets having rallied in excess of 35% since the March lows, we’ve finally gotten a, thus far, slight correction.    This has been looked for and well anticipated by many and may I add many times, as the market continued to rally.  In the early stages of this rally,  day traders and hedge fund managers continued to believe the rally had no basis and sold aggressively into any strength.  The trade obviously did not work out and they were forced into the market to cover their short positions.   Proclaiming to anyone who would listen, we were experiencing a suckers rally.  Soo, on the next leg higher, they re-entered the market, reset their short positions once again, feeling even more emboldened and having a much higher price point to sell into.   Only the market didn’t cooperate, and rallied “blindly” and “without cause”.  “Irrational” they screamed!  “Suckers rally” they railed!  But, cover their shorts once again they did.   Why talk about this now?Because, investors are still, understandably jittery about any signs of weakness in the markets.  Keep in mind nothing goes straight up. 

 

Let’s look at two points in time.  First that day in March when fears of financial Armageddon were raging.  Rumors of nationalizing the banks ran rampant.  Retail investors along with institutional investors were hoarding cash.  That fear has clearly dissipated and nationalization is off the table.   The financial system was pushed to the brink and took a ‘bend,don’t break’ posture and have moved back to firmer footing.   Since that fateful week, we’ve received enough data to show early signs of a return of the consumer.  We’ve witnessed a pickup in home sales, both new and existing.  We’ve made it through earnings season and had a much better showing from corporate america.   We are also seeing feint signs that the trough in the economic cycle may be behind us.   Now fast forward, to the current week.  With all the relatively good news (things need to be taken in context of expectations of disaster to what we are experiencing) why has the market done such a quick about face?   Two reasons I believe.  First, as I started off, profit taking.  We just got through a pretty good earnings season. Also, we’ve come quite a ways off the bottom and people are taking profits awaiting the next catalyst to drive the market.  Second, and most significant, in a terrific sign of the credit market thaw and a return of risk appetite, new issuance is hitting the market like a tsunami.   The Bank Stress tests suggested to many firms they needed to raise capital.  Further, the treasury announced the willingness to allow firms to return TARP funds if they show the ability to raise capital in the private markets without government assistance or guarantees.   What a shock, banks sprinted to the markets to issue new securities.  What we are experiencing, in my opinion is merely a function of the severe imbalance of the supply demand equation.  Too much supply hitting the market in such a short period of time is outstripping demand.   Also, traders and hedge funds, alerted to all this supply, have set shorts quickly, knowing they can buy these new shares at discounted prices.   This rush to tap the capital markets has spread like a swarm of locusts from banks to Real Estate Investment Trusts to Casino's and not to be forgotten, Ford(I can't say auto's anymore, there is only one survivor).   

 

Now, will it turn into something more?  It's early and I do not believe so.  However, I’ll continue to monitor the markets and economic releases for any signs.  As for supply, from where I sit we'll all need to break out the foul weather gear,  because I can hear another wave in the distance.