The Three Hour Bear Market

Art Cashin ...

Fed Teases, Short Squeezes, A Three Hour “Bear Market” And A Zombie Bank

In Tuesday’s Comments, the summary of the Consensus call was “Has potential to be a whacky session”. Well, it sure lived up to that potential.

The day started out with a gap down, as the unwrapping of the Dexia Bank situation (which we had noted for two days) revealed some extensive and apparently unsuspected problems. That the bank had passed the regulatory stress tests with flying colors only a few months ago, raised real new doubts about the stress tests and the entire European banking system.  U.S. markets then watched markets and events in Europe to see if any nuance might suggest the next move.

They also kept an eye on the Bernanke testimony. It had an almost plaintive tone to it. Mr. B said the economic rebound, that he and the Fed had carefully nurtured through QE1 and QEII, was at risk of  “faltering”. That was as close to a Fed chairman saying “double dip” as we are likely to come to hear.

As a sidebar, we would like to note a rare, perhaps unique, event at the hearing. One of our elected officials asked an intelligent question of the Chairman. He asked if the balance of Operation Twist would be measured in par value or market value. Bernanke responded - “par value”. The rest of the panel looked at each other as if someone had just quoted Shakespeare in Swahili. The same flummoxed looked appeared on the faces of some the “fed experts” covering the hearings on TV. It was a precious moment and I’m sorry I didn’t tape it.

Markets reacted only slightly since the main focus of the day remained in Europe.  A third factor in the drama was the internal technicals of the market itself. As we had also noted in the Comments, the market was badly oversold after back to back 90% down days. They, in turn, had brought us down to some critical support levels. Those support levels were broken by the gap down opening, resulting in some trapdoor style selling in the first hour.

The early break of the support levels brought some interesting exchanges among the trading section of the Friends of Fermentation. Several noted that if a sharp break of important support doesn’t bring on a bout of full, all out, capitulation selling, the bears (shorts) may find themselves too far off base. In some past years, the resultant attempt to reduce risk (cover some shorts) started a panic among other shorts. When those observations were exchanged around the opening, no on realized how prophetic they would be by the closing bell.

With the Bernanke hearing ended and Europe starting to close, stocks began to tip-toe higher in a rather timid attempt to see if the former support had now converted to resistance.  Sure enough the rebound began to sputter as the Dow reached the region of 10,600 and the S&P around 1098/1103.   Seemingly capped by the new resistance, stocks began to drift lower in what looked to be a ritual move to retest the morning lows. Then as the final hour neared, news began to filter out of Europe.

First was news on Dexia Bank. This formerly good bank (stress tests) would put a large chunk of its assets into a “bad bank”, a zombie-like organization whose primary function was to hold toxic assets in a financially lead-lined vault, unmarked to the markets. The importance of the splitting of Dexia was not about the structure but the sense of urgency. Hey! Maybe they finally “get it”. Maybe they realize that action is needed and needed now. Stocks began to rally and then the other shoe dropped. Shoe? Hell it was like a “Seven League Boot”.

The FT carried a story that European leaders were working on a plan to “re-organize” many of the European banks. The story was instantly and simultaneously leaked to a variety of media outlets. The sense that “they finally get it” went from a whisper to a roar in a nano-second. (Forget that Christine Lagarde had suggested this at Jackson Hole.)   Electronic buy programs exploded onto the floor. A rush of short covering then joined the stampede. (That assumption is based on the leading role in the rally played by the heavily shorted stocks - Bank America; Morgan Stanley; SocGen; et. al.)  The pressure on the shorts was unrelenting and the buying never even paused for breath. They closed right on the high tick and in heavier volume. The bears, who had looked so smug at 10:00, limped off to the showers with bruised faces and much lighter wallets.