Sunday, August 17, 2008

More unwinding in small caps

A year ago, the mantra was to short the small caps. The theory behind this was that in an economic down cycle, these stocks would get crushed by their larger and better capitalized companies. What happened? Here's some highlights from a WSJ article:

Since July 15, the Russell 2000 small-cap index is up 13.7%. Those stocks have an average market capitalization of $1.1 billion. In comparison, the Standard & Poor's 500-stock index has climbed 6.9%.

The performance gap between small and large stocks is even wider since the start of 2008. The Russell 2000 is down 1.7%, while the S&P 500 has tumbled 12%, even though small-cap stocks entered bear-market territory months before the S&P 500....

Much of the fuel for small stocks is coming from the mass-reversal of bearish bets by hedge funds, many of them closing out their positions to lock in profits. And since small-cap stocks can be thinly traded, a rush of traders buying back stocks during the summer, when volume typically is light, is increasing the Russell 2000's move.

In the spring, nearly 11% of the shares of stocks in the Russell 2000 were sold short, Mr. DeSanctis says.... In late June, short interest on a widely traded Barclays exchange-traded fund that tracks the Russell 2000 was nearly triple the number of shares outstanding, up from roughly even in January 2007.

We are seeing the unwinding of bad bets made in every facet of this market. Small caps that were supposed to go down, go up. Oil that is supposed to go up, goes down. Financial stocks that were supposed to go down, go up. Commodities that were supposed to go up, go down. Monoline insurers that were supposed to go bust, break-out.

Now if all these conventional wisdom is proven wrong , why does everyone still believe the conventional wisdom that home prices are still going to go down? Because Greenspan says so?

They're not.

They are going to go up, but Wall Street can't get a handle on the foreclosure data. But they don't want to. That would kill the bearish thesis.

And nobody that is short, wants to cover.

But they'll cover when they have to, and not when they want to.

A perfect example is in Barron's this weekend, with the interview with Eric Sprott of Sprott Asset Management.

Regarding the price of oil he says, "Long-term, up... almost forever. What it goes to, I don't know. But I can see it hitting $200 or $300 or $400 a barrel. And if oil goes up, it will drag most other energy-producing products with it."

And with that thesis he said this about the stock market:

We're in a secular bear market, and there are lots of things that might go down for quite a long period, especially if oil starts rising again. Just imagine oil at $200. What happens to the airline companies, car makers, mobile-home companies, destination-resort companies, casinos, retailers?

He also brags about all the financials that he's short, not mentioning that they have moved 40 to 80% in his face in th elast month.

He said the dollar should be weaker. Read my previous post. How right has that been?

He said this about housing:

House prices will fall further. People who I respect suggest it's got a long way to go. If my scenario, in which the banking system deleverages itself, is right, it causes an even greater problem. You won't be able to get the money to buy a house.

He also said that Gold will hit $2,000 an ounce and that we should check back with him in five years.

Last I checked, his lock-up is only six months.

Who's going to wait five years when his fantasy doesn't play out?

But he got his play in Barron's. And he's a good trader and a good tout. Their funds owned over 17% of Timminco, a stock that touted cheap silicon for solar cells, and the stock went from a buck to 30. It's been more than cut in half the last month, as their silicon costs are still 3x what they have expected. But most of Sprott's funds, found the exits in the stock before it cratered, even though he said the stock was heading to 70!

Check back in five years? These macro stories change when the positions do or when the pump is over! And with 80% of his stocks that he owns in commodity related numbers, anyone listening to his Barron's pump could get Timmincoed!

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