Every now and again the market goes a little bit loco. This week qualifies as one of those occasions. Traders were falling over themselves to buy on Monday in the wake of the Fannie/Freddie bailout and dizzy market commentators were pronouncing an end to the credit crisis and an imminent return to gazillion percent annual returns (a slight exaggeration but you get the picture). On Tuesday, the butchering of Lehman Brothers saw the market promptly suffer its biggest one-day decline of the bear market that had been given the last rites the day before. Those same traders and commentators were now promising that further falls are inevitable and that the world is coming to an end.
Another slight exaggeration but you get the picture.
The exuberant reaction to Phoney and Fraudey initially surprised me. Was it a cause for celebration that the US government was essentially forced to take over the US mortgage market? Secondly, markets are meant to experience big moves when traders are caught off guard by a major and unexpected announcement. This was major news, sure, but it wasn't unexpected. Both stocks had been tanking on the presumption of nationalisation. Less than a month ago, US magazine Barron's asked 'Is Fannie Mae toast?' Yes, it said, flooring both stocks in the process.
Still, after checking out the plan in more detail and reading what the major players had to say about it (most were very positive), I thought we might be in for another decent bear market rally that would eventually peter out.
I didn't think the market would roll over the very next day. Government intervention has led to shorter and shorter rallies all year but Hank Paulson and co. surely thought they'd get a bit more market mojo from this one.
Me, I garnered a few more quid for the kitty this week but none of it was gleaned from the Fannie/Freddie chaos. I closed the remainder of last week's short position in the days before the announcement - a nice trade that netted me a quick grand. After that, I steered clear of things. Volatility can be good for traders but I couldn't get a handle on this week's craziness. On Monday morning, Rob Hanna discussed how to play the massive gap up in the futures market. He found that of the 16 occasions that the S&P gapped up by 2% or more since 1998, it closed lower on eight occasions and higher on eight occasions.
Other studies were similarly inconclusive. "Hard to remember a time when such interesting action has led to such dull results", Hanna concluded.
No edge, no trade. I made a bundle in a boring but predictable market environment in August. Donkeys looking for excitement might like to jump in and breathe in the excitement of it all but I'd prefer to make money.
Going forward, the market appears poised to take out July's bear market lows. I'm looking for signs of capitulation in key technical indicators but I'm not seeing that yet. If new lows are seen and capitulation appears nigh, then I'll look for a spot to get long. In the meantime, shorting any rallies should boost the coffers.
One overlooked by-product of this week's action has been the ongoing devastation of value fund manager Bill Miller's reputation. Up to 2005, Miller had beaten the S&P 500 15 years in a row. Since then, he's been pulverised and Freddie Mac's implosion is just the latest blow.
Blogger Felix Salmon points out that last December, Miller owned 15 million Freddie Mac shares trading at $34.
By March, Freddie had fallen to $25 and Miler owned 50 million shares.
By July 31, Freddie had fallen to $8 and Bill Miller owned 80 million shares - 12% of the company.
The writing was really on the wall at this stage. Not only did Barron's tell us as much, fellow value manager Warren Buffett had warned that "the game is over" for Freddie. Instead of getting out, Miller's fund last week disclosed it had bought another 30 million shares.
Freddie is now a penny stock.
Is averaging down ever excusable? Yes, if you're a long-term investor and a smart cookie who's spotted something the market's overlooked. Miller's bet, in contrast, made little sense.
Generally, doubling down is done by saps and bad gamblers. Next time you're tempted, think of Bill Miller. Don't do it.
Weekly profit/loss: +€314
Overall balance: €23,592