Beware October 3rd, 2008

"There is no squabbling so violent as that between people who accepted an idea yesterday and those who will accept the same idea tomorrow."
- C. Morley

Take a big red marker and circle Friday, October 3rd, 2008 on your macro calendar. For those of you who proactively prepare for market risk, this has unfortunately moved straight up on my probability chart as a potential day for the US stock market to crash.

The old boy network of Wall Street investment bankers who didn’t see this US financial crisis coming are now politically scrambling the US government to make one reactive and emotional mistake after another in order to temporarily stop gap the inevitable, marking stocks, bonds, real estate, and commodities to market. Last night, SEC chief, Chris Cox, was cajoled by the Goldman Sachs and Morgan Stanley brain-trust to ban short selling in the US Financial stocks. Let me repeat that – the US Government IS PUTTING IN PRICE FLOORS across an entire sub sector of what used to be called a free market. These guys seriously don’t get it.

It’s one thing for John Mack and Lloyd Blankfein to cry wolf and call their own prime brokerage clients (short sellers) evil doers. It’s entirely another thing for individual self serving interests to have the ability to strike regulatory and legislative change in the way that this long standing free market operates. John Mack served as Chairman of hedge fund Pequot Capital in 2005. He knows better.

There is roughly $1.5 Trillion in assets in the hedge fund community – that’s a much larger number than what Long Term Capital Management ran, fyi. Under political fire, Cox’s unprecedented and short sighted decision to lead an SEC ban on short selling in the US Financial stocks until October 2nd has massive repercussions to this market. Ahead of this, if they warned their internal prop desks to cover their shorts yesterday, that would be really bad – I hope they didn’t. Regardless, I highly doubt that they consulted Citadel’s Ken Griffin or Renaissance Capital’s Jim Simmons on this rash move, but go ask those sober and reputable risk managers what this forced SEC decision means to the structure of their hedges. The US Government is effectively going to bludgeon the risk management mechanism that prudent leaders in the investment community have proactively implemented. This is like breaking Brett Favre’s legs.

On October 19th, 1987, the Dow Jones lost 22.3% of its value. US market losses from October 10th 2007 until 1:00PM EST yesterday were approaching -27%. For 11 months, by refusing to allow a free market to mark prices to market, the US Government has chosen to enter the game, and make mistakes, at every turn. Last night’s decision may be its worst yet. They have capitulated to said “leaders” who simply do not understand how this story ends, or do, and are attempting to socialize the downside associated with their risk management mistakes. On October 3rd, 2008, this reactive decision has the potential to create selling from both the long only and short selling community in orders of volume that we have never seen.

I am not trying to be an alarmist. I do not have a self serving agenda here either. The ‘Hedgeye Portfolio’ has the transparency that these said leaders of the investment banking community still refuse to give you. In the Hedgeye Portfolio you will see that I covered my short position in Goldman Sachs a few days ago. I am not short Morgan Stanley. In fact, I am not short one name in the US Financial sector. On market weakness, I moved from 84% to 76% cash this week. The futures charging higher this morning will do nothing but enhance by YTD performance. This is not about me. This is about proactively calling out massive tail risk.

Markets across the world are raging higher this morning. Hong Kong closed +9.6%. After being halted for a few days, Russia opened up +18%, and now they are halting it again because the government cannot bear this level of volatility on the bullish side. In London, stocks are +7%, and here in the US, the reality TV sponsors of the largest global stock market mania in world history are as emotionally amped up as I have seen them since October of 2007. These people didn’t understand it then, and they certainly don’t understand it right here and now. Financial historians of this great US system of free market capitalism will remind them all that this October, fully loaded with quarter end hedge fund redemptions that are inspired by this oncoming short squeeze, may very well see history repeat.

Be careful out there,
KM



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