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Bears about to capitulate?

February 16th, 2011 · No Comments

Now that would be interesting…
First überbear Dr. Doom, now the site with which we used to cooperate and is not known for their bullish views either, Moneymorning.com:

Stock Market Bears Can’t Keep History From Repeating
By Jon D. Markman, Contributing Writer, Money Morning

There’s something in the air – and I’m not talking about spring or young love. I’m talking about a profound sense of déjà vu.

The way the stock market has performed of late has me thinking back to the low volatility bull-market cycles of the early- and mid-1990s. So far 2011 is awfully reminiscent of 1995 – another year that featured a jobless recovery and a Democratic president moving to the center.

Stocks continue to step higher day after day without any incredible catalysts providing propulsion because the motivating force is a quiet but steady drop in risk premiums combined with an upward re-rating of Price/Earnings (P/E) multiples.

This is what a low-volatility bull market looks like, in case you’ve forgotten.

Stocks started weaker last week as investors digested the meaning of China’s rate hike. Investors fear that rising rates will crush growth and curb China’s appetite for the world’s resources. But this sentiment was quickly reversed – as well it should have been – because tightening will have little effect on growth in China.

Once U.S. investors decided not to worry about China – honestly, the jitters lasted about 15 minutes – they resumed their previous program of buying companies most related to an economic recovery. The day gained strength from news of a pickup in small business sentiment, another couple of mergers and a sense that U.S. President Barack Obama is taking steps to repair his relationship with business.

The bears are throwing everything in the book at this bull market. They seized on the revolution in Egypt and took gut-punches at leaders like Amazon.com Inc. (Nasdaq: AMZN). But their attempts failed.

And these bears weren’t day-traders, either – they were a hit squad.

I have heard from contacts in the macro and credit communities that bears intended to make a big stand here at the 1,330-level of the Standard & Poor’s 500 Index, which also served as the top in January 2008.

We’re not talking about amateurs here – this is the real deal. These guys made some very large, sophisticated bets away from the most visible tables in the casino. They bought credit default swaps on big companies and calls on the CBOE Volatility Indexin bulk.

Still, these pros have been stymied and now they have a big problem. They either have to defend the 1,330-level by trying to blast a new hole in the economic recovery story, or hope that more trouble can be stirred up in the Persian Gulf, the Europe sovereign debt markets, or China.

But here’s the thing: If nothing comes through for them they’ll have to cover their short sales, which could lead to some very explosive upside in the weeks ahead.

This is how bull markets get their second, third, fourth and even fifth winds. It’s not because the economy is so great (it isn’t) and it’s not because more bulls are converted (they’re coming, but it’s slow). It happens because short-sellers have to buy stocks and credit to cover their positions – and the bigger the bets they’ve made, the more they have to buy to cover.

Just to give you an idea of what this means, most of the rally in the first part of the 1990s was the result of short-covering following the 1990 bear market and recession. These things can go on for a very long time because well-financed bears have a lot of conviction and it often takes them a long time to give up. The legendary hedge fund manager Michael Steinhardt once told me that he lost $250 million shorting Cisco Systems Inc. (Nasdaq: CSCO) in the early ‘90s.

The bottom line is that the 1,330-level is a tripwire. The bulls have kept the Standard & Poor’s 500 Index above the level for four sessions, and it will not take much more to make bears start to cover in a big way. This could light the fuse on the third stage of this rocket, and many investors will be surprised to see how high it rises.

Tags: The Markets