Behold the Bin Laden Bounce.

May 16, 2011

Major market indices were lower last week. The DJIA lost 1.34%, the S&P 500 fell 1.72%, and the Nasdaq dropped 1.60%. Growth stocks outperformed value stocks. And the small cap index fell 3.69%. The 10-Treasury yield closed 14 basis point lower at 3.15%.

Not everything occurs as expected. Especially within complex systems. Biology. Physics. Markets. The anticipated can quickly give way to the unexpected.

Following last week's successful Bin Laden mission by Seal Team Six, prognosticators quickly anticipated a "Bin Laden Bounce." However, the markets have not jumped after the deaths of other famous purveyors of evil. Hitler. Stalin. Khomeini. Hussein.

Why should this time be different?

Further, a nervous public anticipated Al Qaeda's retribution. And so markets sold off. Risk assets were shed en masse.

Joe Public, attempting to be clever, figured that precious metals would be a safe haven for investment capital. Silver, up 161% on the year, could only continue to rise.

And so silver declined precipitously. And the commodities route was on.

Silver lost a quarter of its value. Corn popped. Cotton went soft. The rapid fall sparked margin calls which exacerbated the decline. Computer generated selling kicked in (oh no, flash crash!). Fear dialed up, and so worsened the exodus.

Friday's positive employment data lifted the animal spirits and markets recovered some of the week's earlier losses.

Last week's contrarian machinations remind me of four market maxims:

1) "The market will do the opposite of that which is expected by investors."

Everyone woke up on Monday thinking, "Bin Laden dead? Time to buy!" And so the market throws everyone by falling fast.

2) "When profits appear easy--run for the exits."

Joe Public had bought into the idea that silver was set to hit 100. Everyone climbed on. And so the market sends the white metal down by 25% in a few days. Smart investors got out near the top when their sell stops were triggered (you're welcome).

3) "Experience is taken. Opportunities are made, sometimes given."

The economic recovery is again being called into question. Last week saw many investors exit equities and go to cash or risk-free Treasuries. Interest rates will remain low for some time. Core inflation remains low. That being the case, the Fed remains on the side of investors... which leads to the fourth and final point...

4) "Never fight the Fed."

Bill Gross, who runs the world's largest bond fund as chief of PIMCO, recently told Bloomberg that U.S. growth is not sufficient to support gains in assets and labor markets.

Gross thinks that, while employment may be strong the next few months, it is undetermined as to whether it can continue once the Fed ends its quantitative easing policy in June.

Gross doesn't believe so. Nor does he believe that the U.S. government will be able to soon resolve its deficit issues. And so his $241 billion Total Return Fund, long a best-of-class fund, is shorting U.S. government Treasuries (a three-percent short position).

While Bernanke and Geithner continue to express their desire for a strong-dollar, the U.S. currency has fallen to its lowest point since the summer of 2008. In fact, Geithner will regale Chinese students this week during the annual Strategic Conference between the U.S. and China, with his hopes for a strong dollar.

That has been a source of humor for Chinese students since Geithner took his current position. Each year he reiterates his firm backing of a strong-dollar policy. Each year the dollar falls. He's either being disingenuous, not in control of the situation, or both.

The falling dollar contributes to inflation risk. This puts upward pressure on oil prices. And while a weak dollar helps U.S. companies sell products abroad, Geithner's boss will not be re-elected with oil at $4.50.

Volatility has plunged over the last two years. The VIX (CBOE Volatility Index) has fallen to 15 from 80. Sometimes called "The Fear Gauge," this indicates that investors have become less fearful. So, per the four maxims stated above, expect the market to do something about that.

The end of QE2, energy inflation, the politics of deficit austerity in D.C., and the murmurings of Al Qaeda's revenge-all will contribute to enhanced anxiety in the weeks ahead.

And with interest rates and inflation in check, this should-per the maxims stated above, present opportunities. Emerging markets. Energy. Industrials. Mid caps. Healthcare. All at lower prices.

Be patient. If it is to occur, it will arrive when you least expect it. When you doubt its very possibility.

Just when you think things are on the very brink of awful. Behold the Bin Laden bounce. Stay tuned.

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