Front Running, More ARB...Then Hammer Time.

The SEC is investigating whether certain Hedge Funds allowed employees and favored clients to liquidate and redeem assets before less favorable clients. Thus less favorable clients/pawns got lower prices for their holdings when the markets went into a tailspin.

If these allegations are true, its just one more black eye the public has with regards to the soft underbelly (Hedge Funds) of the financial markets. I have for years knows this was an acceptable practice alas the SEC doesn't really get involved in frivolous things like rules and regulations.

After digesting the roughly 35% rally in the markets as well as watching the Banking Index more then double, I have come to even more of a conclusion that it was just a severe bear market rally.

I have come to this very conclusion that the bear market rally in equities was the result of an extended short squeeze by quants and other institutional traders trying to achieve massive arbitrage trades in the most fundamentally weak sectors.

There are many variations of the arbitrage trade but the basic principle seems to consist of
the following:

1- Buying bonds on the company in question (at a substantial discount to par) with CDS insurance.

2- Shorting the Common Equity.

3- Buying the Preferred Equity.

This type of trade rang the register quite frequently during the credit crisis, but of late, the painful unwinding of short positions directly led to a huge market rally.

You will notice that the equity rally has been led by the companies with the WEAKEST fundamentals:

-Casinos
-Financials
-Commercial Real Estate
-Luxury Retailers

This action suggests that one of two things is happening:

1- The Long/Short Arbitrage trade is getting crowded from everyone short covering at the same time to take profits or limit losses.

OR.....

-2 Other quants are running short squeeze plays of their own on the most heavily shorted issues by going opposite to the prevailing hedge herd, buying the common equity or more likely taking substantial intra-day futures positions to move the market.

But...all good things come to an end.

The market may in fact try to rally to SPX 900 which is resistance.

Then its HAMMER TIME!