Fed dispatches Santa Claus from Macy’s to Wall Street

Santa in Chicago. (Photo copyright Douglas Rahden.
Santa in Chicago. * (Photo copyright Douglas Rahden. See info below.)

WASHINGTON, December 18, 2014 – What a difference a day—and a word—can make. Earlier this week, a 10% stock market correction seemed well underway. But Wednesday, as if by magic, the bulls returned with a vengeance.

It was just this past Tuesday, December 16, that stocks, bonds, ETFs and mutual funds all seemed to have purchased nonstop tickets to hell. Terrified by rapidly declining oil prices, which had already arrived in Hades before everything else, most investors and their investments worldwide seemed determined to follow suit, aided and abetted by a Russian ruble that suddenly seemed as if it would go extinct.

The rapid downdraft seemed to have caught bulls unawares. Sitting around waiting for the nearly annual Santa Claus rally to begin, they rubbed their hands with glee as December arrived, secure in the knowledge that they’d be getting plenty of profits under the tree.

But instead, nearly every investor large and small got a big lump of non-EPA-approved coal in his or her stocking. The Saudi princes donned their Grinch costumes and proceeded to ruin the infidel holiday for investors by helping the price of crude crash to 2009-level lows, simply by refusing to allow OPEC export numbers to contract.

The selling was further magnified by trainloads of selling and shorting courtesy of the headline-driven HFTs, who, of course, provide “market liquidity,” particularly when things are going their way. The shorting and dumping created panic selling, which, when piled onto traditional year-end tax selling, created a situation that put many stocks in free-fall due to an almost complete lack of buyers.

Making matters worse, rumors flew on Wall Street that Janet Yellen’s Federal Reserve would release its report Wednesday without those soothing magic words “for a considerable period of time,” referencing, of course, just how long the Fed would refrain from raising interest rates—something bulls simply did not want, as free money makes investing a lot more fun for the bigwigs who can get it.

In fact, the rumors proved true, as the report, and Ms. Yellen, did change the magic words, deleting the cherished phrase and substituting a single word—“patient”—to describe the Fed’s attitude toward continuing its essentially zero interest rate policy somewhat indefinitely.

The Fed’s word change clearly indicates a high likelihood that interest rates will start to increase some time in 2015. But, given the oil price drop and its ripple-effect on already virtually non-existent U.S. inflation, the Fed correctly deemed that it was still a bit early to goose those interest rates, even a tiny, tiny little bit.

That’s the mistake the Fed’s predecessors made under the Hoover Administration—jacking up interest rates even as the economy deflated. We know what happened back then. So why do that again when current U.S. inflation is still considerably below the Fed’s 2% target rate.

In any event, bulls decided that “patient” was still good news and proceeded to buy stocks, particularly the badly damaged major oil companies. The new Era of Good Feelings spread rapidly to other sectors Wednesday, ultimately igniting a massive short-squeeze.

For the uninitiated, a short-squeeze occurs when a sudden burst of buying scares a significant number of bears and bearish institutions (who’ve sold stocks short) to close out their short positions. But, unlike bulls who buy stocks, hoping they’ll go up and make them a profit, bears often sell stocks short, hoping they’ll go down to make them a profit on the downside.

The mechanism is simple, although the execution is complex. Using margin accounts, bears borrow shares of stocks they want to short and then sell the borrowed shares in the market. If these stocks go down, the bears then close their roundtrip transactions by buying them back, thus pocketing a profit on the down move. Seems perverse, we know. But it’s perfectly legal and actually helps markets to function better in the main.

But, given the fact you can only short stocks in a margin account, if your bet gets reversed and badly, you either have to buy shorted stocks back quickly to avoid disaster; or, in extemis, your broker has to sell you out if you’ve exceeded your margin limitations. (We’re oversimplifying here, but you get the picture.) If this starts happening on a massive scale, most short sellers either head for the exits or get sold out in margin calls. Hence, the selling panic or “short squeeze.”

The results of a short squeeze can be nothing short of spectacular, and that’s what we saw yesterday and today. Stocks were up well over 200 Dow points earlier this morning after yesterday’s spectacular rise. As of 11:30 p.m. EST, the DJI is up 200 points, the broader S&P 500—what professional investors usually watch—is up 24, and the tech-heavy NASDAQ is in the midst of a riotous holiday celebration, up a whopping 63 points.

After two weeks of sheer, money-losing agony, the last two days have been as fun as they were unexpected, justifying our decision to reduce but not eliminate positions entirely. Our only regret is that, for defensive reasons—namely the fact that the Maven is closer to death now than he was 30 years ago—we dumped our otherwise perfectly good oil stocks lest we take a worse beating than we already have.

Oils have rebounded sharply in the past two days, although the rebound, as impressive as it has been, still would not have gotten us back to breakeven at this point.

We did, however, pick up some shares of Exxon (XOM) two days ago, anticipating some kind of snapback rally, and that, fortunately, is what we now have.

It remains to be seen, however, just how long Santa will be distributing gifts from his magical bag of goodies. But we’ll take what we can get, particularly after the recent debacle.

Today’s trading tips

Still holding off. Chasing stuff in a big snapback rally/short-squeeze like this one is generally inadvisable once the train has left the station. A pause or a down day—likely Friday or Monday—might be a better time to tiptoe back into perfectly good stocks well off their highs. But we’ll wait and see.

A bit more on our sudden Exxon gamble above. Exxon (XOM) has not been the most exciting of the major oils for several years. It’s simply too big and too diverse to be regarded as a growth stock any more. But its gigantic size and diversity served it in good stead during oil stocks’ recent, sickening downdraft. Even better, XOM pays a half-decent although not great dividend.

And even better, although natural gas prices are not exactly something to write home about, XOM is big there, too, providing something of an antidote to the plunging price of oil. Winter has already made an early intrusion across much of the country, creating an unexpected early drawdown in previously substantial gas reserves, thus firming prices in a way that had not been expected.

This price firmness has buttressed XOM somewhat from the oil price crash. Thus, the company’s stock never went down nearly has horrendously as did prices for many of its competitors.

Assuming the oil price downdraft slows or slowly reverses in coming months, XOM could prove an excellent bet, at least in the short run. Again, it’s no longer a growth company, and the dividend, while good, is not a record-setting.

However, in an extraordinarily volatile stock market—roiled not only by oil prices but also by international politics and even by the latest, likely Pyongyang-instigated massively crippling cyberattack on Sony Entertainment—boring is sometimes best.

In other words, you could make some decent rebound money on a company like Exxon, even though you might beat it with a more growth-oriented oil company. Unless oil prices start heading for $40 or even $30 bb. In that case, Exxon would hold up better than most.

Ditto its Dutch-based competitor, Royal Dutch Shell (RDS/A). Both are so broadly based that, assuming you want to retain at least a small position in the oil patch whatever, these would be the go-to oil stocks if you’re a conservative investor.

On other fronts, our positions in two short ETFs we’re using as partial hedges—SH and HDGE—are off a bit today after losing yesterday as well. But we’ll hold them for now, just in case the Saudi oil actions turn this embryonic Santa Claus rally into just another desert mirage.

Retail and health, quite strong this year, continue to look positive heading into the year’s end. But after sustaining considerable damage to our portfolios in early December, we’re not quite ready to start committing cash again in a big way.

More tomorrow. Or when it happens.


* Header photo via Wikipedia. The copyright holder of this file, Douglas Rahden, allows anyone to use it for any purpose, provided that the copyright holder is properly attributed. Redistribution, derivative work, commercial use, and all other use is permitted. ©Douglas Rahden.


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