Thursday, August 9, 2007

The Shakeout Begins

On a day when the markets got whacked, homebuilders, regional banks and REITs were strong on a relative basis. Techs and the oils were the hardest hit on Thursday. That tells you they were dumping high beta issues. Sure sounds like fund liquidation to us. We also don't think those financials got whacked quite enough. If they get sent to the bottom of our short-term index rankings again -- and they make Zone 1 -- we think it'll be time to buy the financials. Then watch out, because the roar upward is going to be almost as breath-taking as the plunge down. This is what it takes to shake all these extra hedge funds out of the market.

We think Friday has the potential to be the largest down day in history, point-wise. The funds don't want to hear the news that comes out over the weekend, so it could look like a general-admission Who concert as money managers stampede out the door. Very few sectors are wiped out now, but we'll have to see after Friday. There is plenty of room to fall. Expected trading ranges have expanded (via implied volatility expansion) as the market has retreated. At these inflated range expectations, most of the broad-based indexes are around one standard deviation below their 90-day means.

Funny article in Marketwatch.com on about how a bunch of market neutral funds are having difficulty surviving the downturn. No explanations were offered as to why the profits on these funds shorts didn't cover the losses on their longs. You gotta wonder which part of market-neutral these guys didn't understand. Yet the guy who spoke for the article, a market-neutral fund manager who supposedly had $1.9 billion long and $1.9 billion short, is down 10% this month. He says it's happening to all market-neutral funds. Yeah, sure.