Q&A with Jay Matulich, Septos Capital Management
Q: When we last talked on Oct 23, you were shorting industrial commodities. Tell us what you were thinking and how that played out for you.
A: It has played out very well. My thought process was that we were over eight years into absolute and relative outperformance versus the S&P 500 on a lot of these industrial commodities, including gold and silver. The structured credit environment was such that I thought it would signal some type of slowdown happening globally and that an unwinding of leverage positions would affect this area, and it seems to be that all of this came to pass.
Q: What is your view of industrial commodities now?
A: Right now I'm basically neutral on that group, since the group and the S&P 500 in general have come down quite a bit. You've got mining stocks, for example, that have come down 30-40-50%. I do think that we're very close to some type of reaction-based snapback rally, where December could be a pretty positive month.
Q: What is your overall market thinking for December and the beginning of next year?
A: This past Wednesday the Dow Theory came out with a sell signal, indicating the primary bear market started since the July top. So we're four months into that, and I think you have to respect the Dow Theory signal. Typically, what happens then is you get a strong reactionary move to the upside, which I think we're going to see. Today you had the Citigroup (C) investment, which he market likes it a lot. But you have to wait and see if this rally carries over, or if there's a follow in the next couple days. If we get a follow-through on this price action of today, then I think we've got a green light for the month of December going into the first of the year.
One big reason for this is that all the bad news is priced into the market as far as the structured finance and the sub-prime area goes. For now, anyway. In addition, the Markit Index, which tracks a lot of the bond indices, has essentially dropped straight down from mid-October into November, so there's a tremendous amount of pessimism on that side. 10-year and 30-year bonds were dropping substantially, especially over the last few days. Today it looks to be coming back in, which is another good sign. So I think we could get a good reaction up in this market. My target for the S&P 500 is roughly about 1490-1500. If we hit in that area and end up turning back down, then I would say there's a high probability we have entered a bear market and the first half of 2008 could be pretty tough.
Q: Why 1490-1500?
A: It's the 50-55 day moving average, which has been a pretty good tell throughout this market. If the S&P blasts through that, then we may be back at new highs, and this Dow Theory thing may be completely invalidated.
Another interesting fact is that over the last 20 trading days, the market has not been up two days in a row. That's at the high end of the statistics going back to 1950. So tomorrow I think will be a very important day. If the market is up, I think people will get more comfortable, and that together with seasonal mutual fund flows could be a significant catalyst for the month of December. Also, I think oil has topped out here for the time being. It's in a seasonal period where it usually does turn down, which could be another good catalyst for the market, especially coming into Christmas, giving some relief to consumers and retail. Again, I'm just playing this as a rally in a bear market for right now until proven otherwise. But it is definitely doable and playable.
Q: What are you buying?
A: I'd like to get long and started doing that yesterday in the technology area and a little bit in the finance area. I do think that the finance area has been beaten down so much that we could have a good trading rally there. Having said that, I do think that analyst expectations are still up, and way up, and that's why Q1 of 2008 is concerning to me. We could see some significant downgrades that create some significant downdrafts in the market where we get quite frankly to the 200-week moving average in the S&P.
Q: Internationally, what are you looking at?
A: I have not done much internationally. My thinking has been that things were way overpriced, way overdone. There was way too much momentum there. There's been a lot of U.S. individual investor money not going into US mutual funds but rather into international funds both in the Far East and in Europe, and I've just stayed away from that. I did have a few short positions in China for a while, and covered those.
Q: Our technical analyst colleague Mike Paulenoff today came out with bullish comments on Japan. What do you think?
A: I think he could be right. Japan is down, I believe, 14% for the year. If our markets have some problems after the first to the year, Japan and the EWJ could be a haven of relative, as well as absolute, value.
Q: Any parting shots?
A: I think that the year 2008 could be interesting in the financial area. With the problems we've had with structured finance, and especially the big banks, we're getting higher and higher lending standards now, which will lead to higher margins once the riff-raff is thrown to the side. One interesting thing is that there are well-capitalized smaller and mid-priced banks and financial institutions that are trading at some pretty good discounts. I think as we get into 2008 the bigger financial institutions like the banks and maybe brokers will use these deposits for leverage. They're going to be buying deposits to, firstly, shore up their capital base, and secondly shore up their leverage ratios, which will mean being able to make more money just on their base deposits by lending that money out. So I'm starting to look in that area for a play in 2008.
