Bouncing Back, Like Clockwork

 | Oct 10, 2013 | 10:35 AM EDT
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Take two aspirin, wait for three days and then buy. That's the doctor's prescription for the high-multiple Nasdaq stocks, and it is so spot-on it's almost eerie. There goes Netflix (NFLX) on an upgrade as investors also relish comments from Dreamworks about developing content for the anti-cable company. There goes Gilead (GILD), on the curtailing of a Phase 3 study on an anti-leukemia drug, taking up all of the biotech stocks. We get a positive article about mobile advertising in the papers, and that spurs Facebook (FB) to ramp, along with Yelp (YELP) and LinkedIn (LNKD).

It's just the way it works. Now, I have no idea about the staying power of this move if there can be no agreement on the debt ceiling. With the Social Security-Medicare card now being played by the Democrats, if there is no deal there will be no checks sent out, and that will cause a drastic contraction in the economy that will take everything down.

But these stocks are going to be the bounce-backers.

Why is that? Here's how it tends to play out. First, aggressive managers lose their appetite for risk and want to keep their gains for the year. I used to handle these kinds of managers when I was at Goldman Sachs, and then I used to detect their moves when I was a hedge fund manager. They almost all came in at once when the market got ugly and they dumped their favorite equities.

Then, on day two, we get the shorts swarming in. They sense blood. They have waited and waited for this moment when these stocks would be about to crack, and when they see the declines they take action. They do it in two ways, puts and common-stock shorts, and they are aggressive. They are looking at charts. They are talking to the desks. They have good intel that the sellers are back.

The second day is sensational for them. They win. They win huge.

The third day they get real cocky. They sense that the longs are really panicking and that the sunshine patriots of momentum are heading for the hills. But, at the exact same time this happens, the longs say, "Wait a second, this is ridiculous. The downside is overdone." Other money managers, meanwhile, have previously said they would come in and buy if we ever got a 5% to 7% pullback on these stocks. Midday through the third day, you get that level of decline.

So they pounce.

The shorts are caught off-guard. They have pressed too far. Meanwhile, the longs know the drill. They roar in and start buying. At the exact same time, the smartest short sellers -- the managers who started shorting on Monday afternoon -- hear the footsteps. They come in even more aggressively and take the stocks up 2% from the intraday bottom. Shorts and longs are buying. Then you get a reversal of the CBOE Volatility Index (VIX). (Nice call, Bob Lang and Mark Sebastian, proving again how must-read we really are.) The fear has broken. It's a pincer move, an envelopment. When I was on the desk I used to call it a Kesselring, German for a cauldron: an encirclement that cooks the shorts.

And we get a bottom.

Today the remaining shorts see it as game-over, and they have to cover and the cycle of decline is smashed.

Now, I know that we could absolutely have real turmoil again as we get closer to the now-real deadline where the checks don't come out.

Still, the three-and a-half-day plummet has ended and the high-flying stocks are back on course for now.



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