The sharp and sudden moves we have seen this morning are indicative of the volatility we will see as we go into the Fed meeting and the quadruple witching expiration next week.
Much of the Street is short the market, and the sudden short covering moves indicate that shorts are indeed very nervous. Bulls say they have reason to be nervous.
They point to the following factors:
1) Very modest gains for the year (3% for S&P 500), coupled with very low valuations (15x forward earnings on S&P 500), while we enter the period with historically the greatest gains (Q4)
2) High levels of bearishness
3) A stimulative Fed, as well as a Congress and a President indicating they will do what they can to help borrowers who have trouble paying their mortgages. It's not a bailout, but it may help mitigate some of the worst excesses.
4) Most importantly, the global profit picture remains bright despite the U.S. housing recession. Despite the turmoil in the third quarter, analyst estimates of global profit growth have been increasing in the past three months. According to UBS, 2007 global profits are expected to rise 9.8% (7.2% in the U.S.); 2008 global profits are expected to rise 10.0% (10% in U.S.)
Bulls have pointed out that with financial stocks trading at recession levels and mortgage backed securities considered a near-toxic investment, there are huge opportunities to profit from pricing dislocations. Good example: fund giant Pimco is reportedly launching a $2B fund to invest in distressed mortgages.
Investors realize that it is rare that an entire asset class comes up for sale. Another example: Carlyle Group is reportedly considering launching a fund dedicated to buyouts of financial-services firms.
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