Monday, July 23, 2007

Stocks Surging into Final Hour on Buyout Activity, Falling Energy Prices and Positive Earnings Reports

BOTTOM LINE: The Portfolio is slightly higher into the final hour on gains in my Computer longs, Medical longs and Networking longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is slightly positive today as the advance/decline line is about even, most sectors are rising and volume is above-average. My intraday gauge of investor angst is around average levels. The NYSE reported late last week that short interest on the exchange, from mid-June through mid-July, rose from 12.47 billion shares to 12.95 billion shares, which is yet another all-time high. Moreover, the 3.9% increase leaves NYSE short interest up an astounding 35% since mid-February, the largest five-month percentage jump since at least 1991, when Bloomberg began tracking. This is even more shocking considering the S&P 500 jumped another 7.3% during that period and the DJIA was breaking records on its way to 14,000. It is also noteworthy that odd-lot short sales spiked into Friday's sell-off to levels exceeding those seen during the peak in sub-prime fears in March. This is just more evidence, in my opinion, that the many bears continue to party like it's 2000-2003, despite the S&P 500's 109% gain from that period's lows. NYSE short interest was basically flat from mid-2002 through first quarter 2005, which is what I would expect considering the extraordinary number of new hedge funds created during that period and a large stock rally off the bottom in October 2002. The recent parabolic rise in short interest is stunning, however, and is symptomatic of the current “U.S. negativity bubble”, in my opinion. Moreover, the only ETF that is ranked in the top 40 NYSE short positions is the iShares Russell 2000 Index (IWM). The rest are all equities. I think this is a direct result of the massive capital that has been allocated to low correlation U.S. stock strategies and the undying belief by the “herd” that the U.S. will continue to underperform all other global markets indefinitely. As well, many investors continue to see a 2000-type market meltdown lurking around every corner. I suspect, given their risk-adjusted underperformance over the last few years, that some low-correlation U.S. stock strategies will see significant redemptions at year-end and that a large percentage of this capital will move into more positively correlated U.S. stock strategies. As well, I think a chain reaction of events has already begun that will lead to a dramatic positive change in perception by global portfolio managers regarding the prospects for U.S. stocks vs. most other global markets. The recent parabolic rise in short interest is unsustainable and only brings the "mother of all short-covering rallies" closer, in my opinion.

Here are the 25 NYSE stocks with the largest percentage increase in their short interest relative to their float from mid-June through mid-July:

1. Beazer Homes (BZH) +18.2%
2. Fortress Investment Group (FIG) +16.5%
3. Hovnanian (HOV) +13.8%
4. Titanium Metals (TIE) +13.8%
5. KBW Incorporated (KBW) +12.7%
6. Talbots (TLB) +11.9%
7. Primus Guaranty (PRS) +11.3%
8. Assured Guaranty (AGO) +11.1%
9. Central Vermont Public Service (CV) +11.1%
10. Novastar Financial (NFI) +10.8%
11. Emergency Medical Services (EMS) +10.4%
12. MVC Capital (MVC) +10.0%
13. Citadel Broadcasting (CDL) +9.7%
14. AZZ Incorporated (AZZ) +9.3%
15. General Maritime (GMR) +9.2%
16. Valhi (VHI) +9.2%
17. TriMas (TRS) +8.4%
18. Cal Dive International (DVR) +8.3%
19. Skilled Healthcare Group (SKH) +8.2%
20. Alesco Financial (AFN) +8.0%
21. Grubb & Ellis (GBE) +7.85%
22. Genco Shipping & Trading (GNK) +7.7%
23. RSC Holdings (RRR) +7.6%
24. Best Buy (BBY) +7.5%
25. Meritage Homes (MTH) +7.5%

I expect US stocks to trade modestly higher into the close from current levels as earnings optimism, buyout speculation and falling energy prices offsets lingering sub-prime concerns and profit-taking.

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