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March 28, 2003
DJIA: 8,201

Those damn hedge funds . . . where would the market be without them. They say being short during a market rally is the equivalent of the two years in business school. Being short during this last rally had to be the equivalent of a doctorate degree. And to think, there’s talk of banning short sales. Where would the market be without us poor short sellers? Who’s going to buy this over-priced and over-owned paper if it’s not the squeezed short sellers? Of course, it’s not that we want to buy the stuff. Indeed, the reason we’re short is because, well, it’s over-priced, over-owned paper. In a sense the buying is a bit Keynesian. Keynes once said, “When things change, I change my mind.” At a more basic level, it seems much more about the feeling of those bamboo shoots slipping under your nails.

The proliferation of hedge funds no doubt has exaggerated the rally. There’s little question but that they had put out their shorts and why not. The background appeared bleak. Similarly it’s probable that last Friday’s triple expiration exaggerated that day’s performance. Apparently there’s credible evidence that expirations don’t make the trend but, rather, they exaggerate it. That said, let us hasten to say there’s more to this rally than just short covering and last Friday’s expiration. For example, we like to short weak stocks. Of course, going into this recent low virtually everything was a weak stock. To further refine out short-selling preferences, we like weak secondary stocks. So let’s take the two Mentors, Mentor Corp (MNTR- $17) and Mentor Graphics (MENT-$9) as examples. Both had been weak and both have rallied. MENT suddenly has become a decent chart, a chart that could be signaling a real turn. MNTR may do the same but is yet to move above the 50-day moving average. At this point that leaves the chart in almost the weak category. Still, and this is our point, both have had decent rallies. It’s hard to say the rallies in these stocks are just about short covering.

It’s not unusual for any stock to have a sharp initial bounce after a market low. But a surprising positive in this rally has been the ongoing positive breadth. Most stocks, good charts or bad, are up most days. Initial rallies are one thing but most stocks have given up very little after those rallies, short covering or no short covering. Thursday was a stunning example in that regard. In a market that had the Dow off 28 points and the NASDAQ off a little, market breadth was positive in both places. That’s surprising strength on the part of the average stock and good markets, certainly bull markets, are as much or more about the average stock as the stock averages. Another subtle plus for this market was Tuesday’s action. After Monday’s drubbing it seemed almost inconceivable that they wouldn’t follow through on Tuesday. A week earlier strength begot strength, but Monday’s weakness is yet to see any follow-through.

Still, these are all relatively minor changes which yet could play out to be unimportant. At a more practical or objective level, the market still has a few issues. There’s the now 74-90 trading that IBM (IBM- $81) has to deal with and, what appears to be a great chart, 3-M (MMM- $131) still is yet to decisively deal with 132. And aside from the individual charts there are the charts of the market averages. After retesting the July 2002 low of 747, the S&P 500 has made a dramatic move. Still, it remains in its nine month trading range, as does the Dow and the NASDAQ Composite. So, are these base patterns following protracted downtrends? Or are they just a respite in the context of an ongoing bear market. Of course, time will tell, to coin a phrase. But with mutual fund cash at bull market top levels, call unconvinced this is more than another move across the range.

Frank D. Gretz

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