Portable Alpha Daily: Mid-Week Alpha

On the surface, market action this week appears to be a departure from the typical range-bound summer doldrums, but is it? Not really. Irrespective of the wild swings in the intra-day values of the major indexes, the DJIA is only up 0.73% for the week while the S&P 500 eked out a meager 0.49% gain for the same period. True, volatility is at levels not seen in awhile, but we feel it’s attributable more to thinly staffed trading desks than systemic hysteria. The players in the volatility and arbitrage hedge space, after having warmed the bench the past year or so, are subbing in for the credit- and event-driven players who are completely worn out. This makes for a bumpy but exciting ride.

Over the next few weeks (or even months), expect to hear the same story over and over again on CNBC: the credit crunch is scaring the mess out of investors, who in turn are requesting redemptions from the hedge funds, which in turn are collapsing under the weight of the liquidity exodus. It’s unfortunately a self-fulfilling prophecy of sorts, likely to get worse as funds start to mark-to-market their books.

Those paying attention to the market were probably a bit surprised with how quickly the gains and losses reversed course throughout the day. In our opinion trading volume was the real story. On the NYSE there were 2.42 billion shares traded with advancing volume marginally higher than declining volume. Over at the NASDAQ, volume was even more impressive with 3.01 billion shares exchanging hands and advancing volume clearly outperforming declining volume. Unfortunately for the bulls, breadth remained very bearish on both exchanges.

Aside from hedge fund and credit news, economic analysis fueled the market. The Institute for Supply Management, a private research group, said its July manufacturing index moved to 53.8, from 56.0 in June. While still positive, the decline wasn’t reassuring. Also the National Association of Realtor’s Index, while up year to date, is 8.6% below the level of June 2006 - reflecting the continuation of the housing downturn. Perhaps the most important report this week is still to come, as Employment data is scheduled to be released on Friday.

Another interesting caveat from yesterday’s market activity is the strong performance from the Utility sector. While most sectors positively participated in the rally, it should be noted that utilities were the strongest. Last week, in fact, utilities was the worst performing sector which begs the question of what would cause this defensive sector to jump from worst to first in a short week?

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