The Bearish Case Is Falling Apart

 | Jun 17, 2014 | 3:10 PM EDT
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Have the terrorists in Iraq reached their high-water mark? Have housing starts in the U.S. hit bottom? Has oil peaked? Have interest rates bottomed and now going higher? Do I have to cover my shorts and stop betting against the market?

These questions define today's session, and from the looks of it, investors are answering all of these questions positively.

First, today is the first day I have heard talk that the insurgents in Iraq might have finally met their match. I think that the initial moves by the ISIS rebels were so swift that it took the lame Iraqi government by surprise. The Sunni-dominated areas of Iraq seem to be defended by no one, leading to some very easy wins.

But now the rebels, for the moment, seem to have run into a wall made up of better Iraqi soldiers, Iranian regulars including the fearsome Republic Guard, and the United States Air Force. Now there's a coalition for you.

It would seem, though, with that defense, that unless the rebels have some real reinforcements, they would do best to consolidate their gains. We just had a recent analogue to this. If you recall the coverage of the Russian invasion of Ukraine after the Ukrainian independence movement, all you kept hearing was the phrase "tensions escalate." The only thing is that tensions stopped escalating, even as reporters continued to say they were being heightened. The stock market told you that tensions were easing as the Russians elected not to march on Kiev. Only later did the press recognize that tensions were no longer mounting.

Now I am wondering if the same thing is happening in Iraq. ISIS, like the Russian soldiers in the Crimea and along the border of Ukraine, had a ton of friends in the Sunni areas. Therefore it didn't take many of their number to succeed in taking those areas. It was always pretty much a separate region anyway, with only the U.S. soldiers keeping each side from killing each other.

It's a different story where the rebels are now, and just when tensions are mounting, according to breathless journalists, tensions may be dying down. Plus, it was real hard to use U.S. air power to defend the northern Sunni portions of the country. Bombing the cities to try to kill terrorists is a no-win predicament.

The big oil fields south of Baghdad, though, are a different story. They are on gigantic plains, and rebels do very poorly out in the open on clear sunny days when the U.S. Air Force is roaming around looking for targets. If those oil fields don't fall, then the price of oil is too high. And that's why the airlines regained so much ground today and the oil stocks started retreating. It's also why the retailers such as Home Depot (HD) and Target (TGT) rallied. They were beginning to factor in $5-a-gallon gasoline. That meant they, too, were reflecting rebel victories. If the oil fields are safe and the oil workers are staying at their jobs, these stocks are too low, too.

It's a fluid situation like Ukraine was, but the Russians stopped pressing the offensive. The same might be the case with ISIS.

We had some very disturbing news this morning about inflation and housing permits. We got a pretty hot inflation number, 0.4%, the highest read since February 2013, while the housing numbers simply aren't strong at all.

I know that sounds like a scenario for a declining stock market, and initially it was received that way. But this market develops a mind of its own very quickly: A new narrative that takes hold and doesn't let go. It's kind of comical, nevertheless it is in control, and it goes like this. The Fed is meeting right now and will speak tomorrow about rates. Housing is so weak the Fed will be afraid to stop trying to keep rates low, because it needs mortgages to be affordable so more people can be put to work in the housing sector.

At the same time, interest rates had to go up because of the inflation component of the story. When inflation heats up, big investors sell bonds, and rates go up to a level where more people are enticed to buy than sell. That's been going on all day today.

When rates go higher, the banks go higher. Fact of life, higher rates are perceived as plain old good news for all financials, as more money can be made from those rates. Now, we are at a very important period when it comes to the calendar. There are no earnings, particularly no bank earnings, about to be announced. That means we don't have to let the facts of not-so-hot earnings get in the way of the story that banks are doing better.

Now let's put it all together. If rates are going up, inspiring the key group, the financials, if gasoline is going down because we might be at the rebels' high-water mark, inspiring buying in the consumer-related stocks, and if the Fed is on hold because of housing, then you have really lost a lot of bear cases all at once.

What happens when you lose the bear cases that have worked so well to keep the market down? Then the hedge funds that had bet so hard that the market was going to crack between now and the end of the quarter have to capitulate and bring in their bets against the markets. The preponderance of the bets had been in the momentum stocks which, just a few short weeks ago, were wilting. Now, with a positive economic backdrop as well as a cessation of insider selling and IPOs, plus a dearth of companies reporting and a full slate of mergers, the shorting of stocks has become quite painful.

Hedge funds have seen some of their favorite shorts, such as Tesla (TSLA) and Netflix (NFLX), erupt with good news and boosted price targets. They have seen takeovers in software-as-a-service and e-commerce companies that make them fearful that they will lose their years with these negative bets. At the same time, some of their seemingly risk-free bets against companies, like the ones that were being made against (CRM), have just plain come undone, with no hope of downgrades to create some havoc and bring down stocks. Analysts don't downgrade stocks like Salesforce once they are moving up. They dig out of their foxholes and climb right on the bandwagon. That's how Salesforce, which seemed like it had been overrun by shorts, can stop $3 higher in a session.

Without bad news and beleaguered real sellers to lean on, the shorts just get trampled in a giddy tape that senses some real good news coming.

Now it does seem a shame to see the upgrades now from analysts, as we have been seeing the last few days. Where were they in the abyss of the last few months? And if we were actually in earnings season instead of a vacuum of earnings, I don't think this move could be pulled off. But in this market, no earnings news is good earnings news, and the bulls aren't going to wait around until the press starts saying "tensions are lessening." By the time they do that, the move up will be over. 

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volatility is quite low here, and we could see some downsides here in the short term. ...



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