Hope for shorts?

The market continues to be very difficult to trade from the short end. Thursday and yesterday both gave some hope to shorts as equities weren't able to hold on to early gains, but we are still up from Wednesday's rebound levels. IG and HY credit outperformed stocks significantly yesterday and neither faded much into the close and even this morning, credit seems stronger than equities. With all the noise in the market, so many comments/rumors about the Fed, QE2, mortgage putbacks, etc, its hard to pinpoint any particular driver, but yesterday did feel like it was the first time we sold off on good news.

We have certainly seen a lot of rallies on the back of bad news, but yesterday's better than expected Dallas Fed number, actually did seem to trigger a sell off. Our thesis has been that the economy is slowing and may well double dip, and that QE2 won't be particularly effective in stopping that process. Selling off on good news really isn't part of that, and we were wondering what to do, but the reality is that +2.6 isn't really that good. Better than what was expected, and assuming no revisions, its positive for the economy, but well within the range of data expectations for an economy muddling along. Obviously we all continue to watch the data, but we are hopeful that enough QE2 has now been built in that we won't rally on bad news, and that being short can be rewarded.

The other story that gives us hope for the shorts, is that every talking head is now all over the story that weak dollar is good for stocks. On the surface this trend is there. What we find difficult to understand, is why a strong Euro would be good for stocks there? Doesn't it make sense that if weak dollar is good for US stocks, a strong Euro is bad for European stocks? Yet, 8 out of the last 10 trading days, saw the CAC move same direction as SPX, and DAX and UKX moved same direction as SPX on 7 out of 10 days. DAX and CAC outperformed the SPX in that time, and UKX barely lagged. So, it seems that people look at the $, trade SPX based on the $ move, and then trade European stocks on the back of the move in SPX? That doesn't seem sustainable. Is it because Euro is also weakening against EM currencies? The EM story does seem partially intact as Bovespa has moved the same direction SPX "only" 6 out of the past 10 trading, so its not tracking as closely, and is actually down for the period while the SPX is up. I think the strong $, strong stocks, story is getting more complex, and that the smart/fast money is already beginning to figure out what the next key "tell" will be. Once the entire market "knows" the tell, its usually near the end of its usefulness. It may appear to work for awhile, but the reality is that some other data will be really what's driving it. Greek spreads? LIBOR? As usual, we have no clue what to look for next, but the simplicity of the "dollar down, stocks up" seems to be getting played out, and we would be careful following that as main trading cue.

Where is AIG?

Stocks of the monoline insurers are up 10% to 25% in a week as stories of mortgage putbacks have become front page news. Hedge funds, institutional investors, and the mortgage insurers of all types are all making headlines as they try to push back their losses onto the original pools of loans that they insured, claiming that the loans never met the stated underwriting criteria. The robo-signings and the latest foreclosure mess only strengthens the view that banks were not diligent when they originated the loans or created the mortgage pools.

What is shocking, is that so far AIG does not appear to be involved. AIG FP was one of the biggest losers in the CMO fiasco. They (and the taxpayers) have as much as anyone to gain from pushing back on those original pools they insured (or wrote protection on), being in the unique position of having paid out 100 cents on the dollar to unwind the swaps with Goldman, Merrill, SocGen, etc. Why is AIG silent? Is it because they are working on their case and keeping a low profile? Or is the government is so clueless that they aren't investigating the potential to reclaim money for taxpayers? Or is it that they are refusing to rock the "equities" boat, scared to sue Goldman (after the relatively trivial Abacus settlement), or even do not want to sue Citi (which they - or rather we - also own)?