Friday, October 13, 2006

Market Tidbits

From around the web, with notes and emphasis by the FW:

====== the 130/30 strategy =========

A new name for an old tactic: the 130/30 strategy is becoming popular with mutual funds on wall street.

Here's how 130/30 works: Say $100 is invested in a basket of stocks, such as those in the S&P 500. Then, $30 worth of stocks in that pool believed to be overvalued are sold short -- in other words, borrowed and sold in the hope that they can be replaced with cheaper shares purchased later. Proceeds from that short sale are then used to load up on stocks thought to be undervalued -- meaning that a total of $130 is now invested traditional stock purchases, $30 of which was derived from a short sale. (That explains the strategy's name.)

Managers can ratchet up the allocation to 150/50, or go with a tamer 120/20 split.

Roughly $35 billion is now under management in the strategy among portfolio managers of all stripes, according to Morgan Stanley Prime Brokerage. While that represents a huge leap since 130/30 started to gain popularity in late 2004, it remains a drop in the bucket of the roughly $9 trillion managed by mutual funds and the $1.5 trillion in hedge funds.

This is the same sort of thing that hedge funds like Citadel have been doing for nearly a decade. Buy the good stocks with funding from shorting the bad stocks. The leverage opens you up to greater gains and greater losses if you're wrong.

The only difference here is that by loading much of the portfolio with a broad basket, the volatility is damped a little and the strategy doesn't look as risky. But you should be aware if your mutual fund does this that the extra 2% return could cost a large drop if the market goes sour.

==== Market in for another inflationary move? ====

There seems to be a shift in thinking among economists and Federal Reserve officials to reflect a belief that any downturn in growth won't be much more than a speed bump. Today's retail sales figure adds fuel to that view -- excluding autos and gasoline stations, sales were up 0.8%, and while it's folly to exclude certain components to make figures look nice and pretty, the sharp decline in gasoline prices in September more or less warrants it. Excluding both autos and gasoline, all other retail sales increased 0.8% in September -- the strongest climb since January's 2.5%.

"The bottom line is that this is a solid report, indicating that consumer spending is far from suffering the flame-out that many alarmists have been warning of," writes Joshua Shapiro, economist at MFR. "Apart from the price-driven plunge in gasoline sales, spending gains were broad-based, with the best gains coming in the apparel, general merchandise, department stores, Internet retailer, and sporting goods categories."

The report is another bit of evidence pointing to stronger growth, higher rates, and no respite from the Federal Reserve. Overnight, Chicago Federal Reserve President Michael Moskow warned that inflation remains too high and that the Fed will have to "act accordingly." Expectations for a rate cut by the March 2007 Federal Reserve meeting weren't high to begin with, at just 31%, but they're even lower now, falling to 25% this morning.

Today, Oak Associates strategist Ed Yardeni downgraded his odds on a recession to 15% from 30%, noting the recent run-up in economically sensitive stocks such as industrials and restaurants. "Consumer Discretionary stocks have already started to take off, and many of our favorites are back at record highs," he notes. That sector is up 5.1% so far in October, easily the best among the S&P's 10 sectors for the month.

All together this sort of attitude shift points in the direction of continued market peaks.
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