Why Bubbles Happen

A good, concise, summary of why bubbles happen:

"[M]ultiple drivers converge and feed on one another and then all invert at the same time the (panic).  An asset class has a few years of positive returns, leading to a perceived lowering of risk allowing for greater leverage allowing more people to buy into the newly discovered "money machine" asset class. Read Kindleberger [Manias, Panics, and Crashes: A History of Financial Crises] to really appreciate how common this is."

Kindelberger's book changed my life. It gave me absolute confidence that there was nothing the government or the Fed could do to stop a deflationary collapse of the massive credit bubble. (Hence the name, Credit Bubble Stocks.)

The only thing the government or a country's central bank can do is the hardest thing - stay out of the way. Warren Harding did this during the recession of 1920-1921 and it worked. But that was a simpler time, when people cared, for example, whether the bank where they deposited their money was solvent or not.

More on the Mergers & Acquisitions Mania, aka "The Greatest Acquisition in the History of Mankind"

Here's a great summary of the recent Mergers & Acquisitions Mania:

The “winner,” to buy 3PAR – Hewlett-Packard – will have the privilege of purchasing a company whose stock flatlined around $10 a share over the past year for $33 a share, a full 242% above 3Par’s closing price on August 13 of $9.65, just before the bidding frenzy began.

For those not paying attention – which is impossible if you have had CNBC on for more than 10 minutes – HP and Dell have been engaged in a spectacular bidding war for a company most people have never heard of.  On August 16, Dell offered to buy 3Par for $18 a share, nearly double the prior trading day’s closing price.  A week later on Monday August 23, Hewlett-Packard offered to buy 3Par for $24 a share.  On Thursday of that week, Dell upped its bid to $24.30 a share.  Like the antsy day trader who just can’t wait to buy, HP offered $27 per share for 3Par eight hours later.  Dell matched HP’s offer the following day.  Determined to show Dell exactly who was the Baddest on the Block, HP offered $30 a share two-and-a-half hours later.  Both sides cooled their heels over the weekend, and with rumours of Dell readying to up its bid yet again, HP jacked up its offer to $33 a share today, effectively bidding against itself.

It seems we have a long way to go before sentiment reaches bottom.

How Much Longer Will this Bounce Last?

Signs that the bounce is getting tired:

• Today's equity put/call buying ratio on the CBOE was 0.56 (yesterday's was 0.49). Those are about one standard deviation below the mean for the last three years. 
• The AAII sentiment numbers turned much more bullish. 
• Fabulous contrary indicator Barton Biggs turned bullish.
• There is lots of crazy M&A activity.
• This bounce has been on low volume - as ever the case with the great 2009-2010 bear market rally.
• Only the "economically sensitive" garbage stocks have bounced significantly. Things that would actually do well if there was a recovery, like the oil&gas sector, have been basically flat.

Thus, I would argue that the market has not bottomed, either in the short-term or the long-term. In fact, I expect the market to roll over again pretty soon.

Remember, the Treasury needs to chase investors into long-term Treasury notes and bonds. The best way to do that is with an equities market that is falling.

Latest AAII Sentiment Data

Lots of people talk about the AAII sentiment numbers, but I don't think many people realize how volatile they are. Last week's reading showed people to be very bearish, but the % bullish popped up 10.1 in a week. If this rally continues for another week, people will probably be uber-bullish again.

Uh oh! Barton Biggs Has Turned Bullish Again!

Why am I wasting my time with other sentiment indicators when we have a perfect contrary indicator like Barton Biggs?

“This is not a time where you want to be underinvested,” Biggs said on Bloomberg Television yesterday. “The  odds of a significant slowdown are one in five, pretty remote.”

If I'm not mistaken, this is the fourth time he has changed his mind this year, and he was wrong the other three times! He was also wrong when he called a market bottom in May 2008!

What Do Sentiment Indicators Say About This Rally?

I have been expecting a bounce in the market. Today the market is up almost 3%. The question is: how much further does this bounce have to go?

Lately, people have been concerned about the resurgence of pessimism and bearishness. But how pessimistic are people really?

On the one hand, you have investor surveys like AAII showing that people are quite bearish. The AAII is a rather goofy survey. I have been unable to determine its sample size. Also, the investors surveyed are flighty and very quick to change their minds. The %bearish went from 57% to 38% in one week this July.

My preferred sentiment indicator is the ratio of equity put buying to call buying as reported by the CBOE. Unlike survey indicators, this one requires investors to put their money where their mouth is. So far today, the ratio has been 0.46, which is about 2 standard deviations below the mean.

Another indicator: think about all the recent M&A activity. Look at Intel's silly acquisition of McAfee for $8 billion, which is 45 times earnings. Or the bidding war between Dell and HP over 3Par, which is not profitable, at a valuation of 300 times EBITDA.

Callon Petroleum (CPE) Presentation at The Oil and Gas Conference, August 25, 2010

Callon Petroleum (CPE) gave a presentation [PDF] at The Oil and Gas Conference on August 25, 2010.