Piecing it together

Around lunchtime today Flash started to get an interesting feeling in the pit of his stomach. He spent some of the morning trying to get the measure of the market - it was lurching around and heading down towards new lows, and Flash was beginning to think that going short bigtime was the only way he was going to keep his P/L in the positive zone.

But then he stopped and had a think.

Why was it that his large cap stocks weren't caving in as fast as the financials? Unilever, Scottish and Southern, Firstgroup and BA were all holding it together fairly well. HBOS and Kingfisher were coming off really fast on the back of nasty figures from Home Retail Group and Merv's grim comments on the UK economic outlook, but the whole market didn't look like it was going into a catatonic bust, even though it's not been far off yearly lows. Plus his small caps were actually outperforming the market - Cineworld and Workspace were actually up a bit today. If it was a total bust we were looking at (and Flash had been worrying that it was, especially when around 40% of his gains have been wiped out in the first 3 days of this week), then how come some of his positions were actually doing alright?

Why was it that USD was still rallying against EUR and GBP; why was it that EUR was in rapid decline against JPY and GBP, and gold and oil were still coming down - making the deflationary call even more obvious. And with deflation comes a whole new economic picture - input prices lower, overheads lower, less pressure on household spending, increased margins and a whole new picture on interest rates/currencies which actually could enable an economy to come back into growth quite fast. And some gossip about the Fed cutting rates - well, OK, but Flash thinks that rate cuts will come faster in the UK and in Europe if the disinflationary trend holds.

Lehman had tanked down to $4 a share. So everyone now knows they are bust - either they find a buyer or what? They'll find a buyer, even if they sell at 50c a share. It's the end of the line and the market knows all of this. And if they find a buyer then the market rallies in relief.

And then some interesting figures came out of the US. Import price inflation had tanked; the trade deficit had narrowed; mortage rates were down, and initial unemployment claims were marginally lower. This combined with mortgage applications being up doesn't say that the US has turned the corner, but it does say that the decline isn't as rapid as it has been for the last few months. It also says that things may not be quite so bad as everyone says. And as Flash has been saying for months, it may be bad in the US but it's way worse in parts of Europe, particularly eastern and southern Europe. That's one of the reasons for the strength of the dollar. And there may well need to be eurozone interest rate cuts pretty rapidly. And everyone (except perhaps those with petrodollars) is running out of cash, because it's all been burned servicing debts and buying goods at overinflated prices.

And then Flash thought some more. If the consensus view is to be utterly bearish on equities, what is there to be bullish on? if the long commodities/short financials trade is over there will be a lot of big money geezers feeling quite a bit of pain. They'll have felt plenty of pain from the rally over the weekend and will have wanted to sell that off pretty fast; they'll have been looking for a reversal in USD's fortunes because they've been invested in short USD for the last 3 years, and got caned on that trade over the last 6 weeks; they'll have had not just their fingers but their arms burnt off trying to buy back into gold and the other commods only to see their positions turned to toast within hours of putting them on; they've pumped their cash into oil and commodities and other exotic debt based securities, and absolutely hammered equities and the financials partly as a response to covering some of the losses of the last few months. So the ride down in equities has been as desperate and testosterone fuelled as the ride up was in commodities.

But this is a big adjustment. And if it's a big adjustment then there will be some fast and furious short covering happening. In all the talk about the Fed printing money and taking on all the housing debt of the country, a couple of things have been overlooked. They may be nationalising Fannie and Freddie but they're also putting a backstop on the housing market. There's a big guarantee there. Sure, if the housing market tanks they will be taking on trillions of debt, but if it recovers, it becomes an asset not a total liability. And if everyone gets a bit more cautious about lending money, that's probably a pretty solid adjustment. And everyone is so invested in the short financials trade, the question is - how much shorter can we all be on financials? Isn't this actually the perfect time to be buying some banks? Not necessarily all of them, but there's no way all of them can go bust, can they?

So Flash went long. If he'd had more capital (having burned an awful lot of it in the last three days), he'd have gone heavily long. But he went as long as he could afford on the Dow and the SandP, and then went long on FTSE as well when it hit 5325. And he bought even more HBOS, even more Scottish and Southern, more British Airways and more Kingfisher. He even bought some Morrisons - deeply discounted at 250p - their results actually really weren't that bad, he thinks.

Then he left the screen alone for a few hours, and logged back in at 8pm to find an absolute monster of a 350 pt rally in progress.

There may be some chatter this evening about Bank of America hoovering up Lehman which has helped a rally; there may well have been some boosterist buying, and it may well come off a bit tomorrow, but Flash is as confident about this call as he has been on any other of his big winning trades this year. He's got stops locked in on all the core positions; he may not make as much as he'd like but he won't be losing so much in the next few days as he has in the last few, that's for sure.