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Potham Partners: Off The Cliff


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Mark?s Market Commentary ? January 22, 2003

 

Today on the open, Maria was huffing and puffing as she was attempting to screech out the opening bids on EK, which was smoked on a bad earnings report. Why doesn?t somebody at GE put her on a stairmaster and get her back in shape? She looks to be over the hill and gaining speed, unable to keep up with her counterparts like Michelle.

 

The mildly aneorexic Michelle Caruso-Cabrera of C.N.B.C. was reporting from Caracas last night, wearing a skin tight short sleeve shirt showing off her outsized breasts. She looked nice and thin. At least from the waist up. But what?s up with the hyphenated name? Is she married or divorced? Or is she a product of unknown parents? Will Hugo Chavez kidnap her and put her into forced labor as his Public Relations Director?

 

It is amazing how the Wall Street pundits have already discounted a statisfactory conclusion in Venezuela, a 5-day war in Iraq, unlimited new oil supplies seized for the SUV consuming public, and a v-shaped second half recovery in S & P earnings. No wonder we have these hysterical buying binges.

 

But behind the curtain, things look different.

 

Al Green is now gripping the levers with both hands, gritting his teeth, in a desperate attempt to save the stock market from a spectacular collapse. With gold trading around $360 and the U.S. Peso making new lows, yet a new crisis is at hand. Al dumped another massive Repo Load into the Keno pit today. I think the $35 billion + which has been spiked into the market must be an all time two-day record.

 

As expected, the speculators saw the FEED and jumped on the Supermodels once again in order to attempt another 10% score on the back of that bogus book to bill report. Unfortunately, the hopers ran these stocks up to a wall of sellers, who were still stuck at the December and January highs. That?s not to say that these stocks can?t be spiked up on KLAC?s report tonight, though.

 

Buddha describes the action:

 

?Apparently some anonymous Book to Bowel Movement report for the Semi track dogs got the race off to decent start this morning. I honestly don't even bother reading the news anymore, it all merely exists for sake of gaming and pistol whipping the greyhounds into change of direction. So instead of further diarrhea, what we get in chip digestion is a one day episode of reverse persitolisis, otherwise known as reflux. The patient is now vomiting up stocks in a semi digested acqeous solution of bile, stomach acid and foul gas. Hopefully this will only be a one or two day bout and not require hospitalization or esophogus surgery. As is, the esphogus is so continuously burned and cankered by these squeezes that the Cancer has metasasized and ultimately a plastic tube will beg insertion into patient. Perhaps a plastic throat and plastic mouth apparatus will be necessary in final stages of Bear. By that time, the acid burn of short squeeze after short squeeze should scorch off all remaining tissue in the inner linings of mouth and face leaving the subject resembling a burn unit level 3 victim.?

 

It appeared that the QQQ?s were being driven up with some heavy HeatMapping on AMGN, which caught some shorts by surprise when yesterday?s intraday wedge failed to break off to the downside.

 

Not much else was moving, as I could see. As usual, the Nasdaq TRIN was hovering around .35 most of the day and the fear gauge barely moved. It appears that longs were loading up on this weakness so they won?t miss the next move to the upside.

 

What was interesting was how the Dow and the S & P could not go anywhere today, yet the speculators piled into the Nasdaq stocks anyway, hoping that FEED accommodation and a surprise relief rally out of Iraq will squirt us up about 300 points.

 

Now, More Than Ever.

 

Nowhere else in history will you find a bear market into its 34th month, and the Global Speculative Sphere is still keenly focused on the riskiest sectors, hoping that a major war will spike up the markets and lead them to instant riches.

 

The Color Commentator describes it this way:

 

?The FEED, the Pentagon, the White House, it?s all the same. Russian intelligence reports this morning that an attack is already set for mid February, the decision has been made, its merely contingent on troops lining up for battle plans. The target as reported by Russian authorities is securing Iraqi oilfields, deposing Hussein is the ruse. Nice to know that one gets their real news from Russian sources now that the Orwellian nightmare is in full swing here in Amerikanna. That and European papers.?

 

?The American media is completely bought off and useless. Spokespeople for the war machine who are covering it like a Super Bowl. The same as the financial media. Shills for the plutocrats running the circus. Al Green is merely an appendage in this whole scheme of things. How to save global disaster by propping the equity markets? It?s like a bad B movie. Only this time you realize not only are you watching it but you are cast in it. No one cares whatsoever at all for the thousands who will die in the first weeks of this coming slaughter. Only that maybe it will be 'bullish' for the Markets. Disgusting. Living in the belly of the beast.?

 

The Dow broke the December lows, and reluctantly dragged the Nasdaq down from its highs.

 

I suppose that the Nasdaq could still make a run to fill the open gap from a couple of days ago. Four down days in a row was probably enough selling for now.

 

Five down days in a row on the Dow? What happened to all that arm-waving and cheering when the Dow was at 9000? Now we are 700 points lower. What will Kudlow and Cramer say tonight?

 

In the meantime, gold continues to make a rather orderly climb to new highs, and the U.S. Peso is dropping to new lows.

 

I noticed in the Credit Markets section of the WSJ that the debt bombs like GE are once again taking advantage of ?favorable? market conditions are are issuing new piles of long term debt. Of course, GE, the largest Hedge Fund on the planet, has been enjoying borrowing short and spread trading long for years now. Now they see the writing on the wall and want to start closing out this ridiculous Ponzi scheme which has maintained its AAA-rating.

 

Note how the airlines are now in a freefall. What happens to GE Capital when billions in structured finance aircraft leases go bad? We?ll soon find out.

 

Everyone must have read Gretchen?s piece in The New York Times over the weekend about the failure of Gotham Partners hedge fund.

 

We we have a Market to Market version of the story, with the names and the story changed a little to provide an example of what we might see as more of the HedgeHogs fold up their tents.

 

POTHAM PARTNERS

 

Mr. Crackman and Mr. Jerkowitz, both hard-driving Harvard Business School graduates, set up Potham Partners in 1993 with just $3 million in assets that, at their peak in 2000, ballooned to $568 million. They had a glittering client list, dazzling reputations and smarts galore.

 

"They were the money managers' money manager," said an investor in New York who knows the Potham principals well. "They had a client roster like you wouldn't believe."

 

Al Green?s massive reliquifaction scheme proved to be a boon for thirty-year old arbitrageurs, borrowing short term at low interest rates and reinvesting the proceeds with 10 to 1 leverage in fancy securitizations such as the CIT Breast Enhancement Receivables Trust IV, yielding 7.9%. There were no shortage of investors, since the Speculative Globe was full of aging men, desperate for fantastic returns in order to finance the spending habits of their twenty year old mistresses.

 

Mr. Crackman, the son of a commercial real estate investor in New York, is a skilled salesman, according to people who know him. He is intelligent, intense and intimidating, associates said. Mr. Jerkowitz is the partnership's grounding force, the anal cyst. He received degrees in science and chemical engineering from M.I.T.

 

Crackman and Jerkowitz skated through Harvard and M.I.T. by bribing professors with gambling profits obtained by weekend trips to Atlantic City. They rarely attended class, preferring instead to stay in their dorm rooms honing their reflex skills by playing Nintendo 64 and Sony Playstation2.

 

Mr. Crackman and Mr. Jerkowitz were relative newcomers to the hedge fund world. They had no prior experience with investing. One night, they logged onto their computers to test their speed at pointing and clicking by opening an online brokerage account and Powertrading bond futures. It was an instant success. They decided to start a hedge fund, for the sole purpose of having fancy business cards made so they could pretend to be Wall Street heavy hitters while seducing high society girls.

 

The fund did well out of the starting gate. It posted a return of 20.7 percent in 1993, dropped 3.4 percent in 1994 and rebounded 38.7 percent in 1995, a person briefed on the fund's performance said. Two years of similar gains followed. But in 1998, Potham lost 2.9 percent. The managers recovered in 1999, their last good year, with a 16.3 percent return.

 

The fund did well by making unidirectional bets on U.S. dollar spread trades. After a brief scare in 1998 when LTCM collapsed, lighting speed trading allowed the firm to quickly load up on the trades which it had unwound during the October panic, particularly when they saw the Fed skip two buttons on the Reliquifaction Blender and turn it up to even higher speeds.

 

But by 2000, they had strayed from their risk-free spread trading focus, after seeing spectacular gains to be made buying tech stocks. "They went long on every selloff, trying to catch bounces," recalled one investor who withdrew from the fund. "This was not their expertise.?

 

As 2001 drew to a close, William A. Crackman and David P. Jerkowitz, hedge fund managers at Potham Partners, were desperate. They were blown out of their long positions just prior to the April 2001 lows and the September 2001 lows, and missed the subsequent rallies.

 

?Both were extraordinary salesmen and gamers. But their technical analysis was somewhat left to be desired, and other hedge fund operators would typically push the market against them?, said PileDriver, a well known short-seller.

 

Potham started receiving a mountain of requests from investors asking for their money back and had suffered a devastating setback in one of their biggest investments, a massive long position in EMC, which they were trying to unwind. The men, who just a few years earlier had been at the top of the hedge fund world, were facing a run on the bank.

 

As the stock market made new highs in March 2002, the fund continued to drag, redemptions accelerated, and their situation grew increasingly dire. They turned to a new strategy called ?HeatMapping? that worked for another hedge fund manager who was close to losing his girlfriend to an Iranian Plastic Surgeon, but was able to ?catch up? by using Bank of America Prime Brokerage credit lines to trade gargantuan positions in a few tech stocks which were gapping up in the PreMarket.

 

During the summer of 2002, the stock market had entered a prolonged downturn, and rallies would last no more than four trading days. Crackman and Jerkowitz decided to abandon the HeatMap strategy and return to spread trading and shorted high risk subprime equities to protect their highly leveraged positions on a multitude of asset-backed securities which financed consumer purchases of chrome wheels, liposuction, furniture, timeshares, and Wade Cook seminar tapes.

 

Unfortunately, they were caught on the wrong side of the market once again. The emergency Fed cuts produced healthy profits from their spread trades, but the hedges designed to protect these profits backfired. Ferocious stock market rallies in August and October quickly ate into most of the hedges, so they started ?hedging the hedges? with more complex straddles, strangles, and collars.

 

?Everyone was exposed to the high risk CDO?s, so everyone was short the stocks of Capital One, New Century, and AmeriCredit. So when some overly leveraged shorts got squeezed, it caused a reverse run on these stocks?, said David Tice, the manager of Prudent Bear Funds. ?Many of these shorts went long on tech stock call options, in order to cover up a mistake with what in my opinion is an even bigger mistake.?

 

What had begun as a simple hedge strategy morphed into a portfolio of illiquid, complicated hedges which failed to operate properly. Tracking the thinly traded ones which had the most volatility made things exceedingly difficult.

 

In the meantime, Crackman was having marital problems and began taking rather large draws out of the firm to finance his nightly habit of attending the most expensive Gentleman?s Club in Manhattan.

 

Mr. Jerkowitz? wife had threatened divorce after receiving numerous ?past due? notices from the Westchester Country Club and the New York Athletic Club.

 

The mood in the Potham trading pits was becoming increasingly strained.

 

In the late fall of 2002, the stock market was once again in a strong rally mode, and the redemptions had abated. Finally, the market appeared to have made the final turn, and the downside in equities seemed minimual.

 

On November 15, Potham was down to its last $120 million, with a full $50 million drawn under its credit lines. Jerkowitz recommended that all spread trade profits be taken, with the balance of the proceeds to be invested in technology stocks which had the highest beta coefficients.

 

Crackman advised against that strategy.

 

He believed that it was time to ?go for the Hail Mary pass?, and thought that the fund should invest in January 2003 call options on specific high risk stocks instead.

 

The firm?s entire trading account was placed into call options on just three stocks: NVidia (NVDA), Genesis Microchip (GNSS), and Cree (CREE). The stocks rallied strongly until December 2, and quickly collapsed.

 

On December 24, the firm received a margin call from Bank of America, and all of the firm?s positions had to be closed out. On Dec. 26, the Potham Web site vanished.

 

Four days later, Mr. Crackman and Mr. Jerkowitz advised investors that Potham's funds would be wound down and their assets sold.

 

It is not unusual, of course, for a hedge fund to lose money. But how did these two highflying managers get into such straits?

 

An examination of Potham's activities in recent years shows a series of ill-timed bets, a surprising lack of diversification and a dangerous concentration in hyperactive semiconductor stocks.

 

As 2003 dawned, Mr. Crackman and Mr. Jerkowitz delivered the bad news to investors: as their portfolios were being wound down and the assets sold, the proceeds might be at depressed prices.

 

Now, as the hedge fund's assets are being sold, its investors must wait to learn exactly how much their holdings have plummeted. Mr. Crackman and Mr. Jerkowitz, who both have major interests in the fund, will be among the biggest losers.

 

Neither Mr. Crackman, 36, nor Mr. Jerkowitz, 40, would comment for this article. Their lawyers also declined to comment. Their wives were unable to be located.

 

While Potham's desperate final moves may have been intended to help it meet redemptions, they have instead brought unwelcome scrutiny. Eliot Spitzer, the New York State attorney general, has begun investigating Potham, its principals and their activities - a move signaling that Mr. Spitzer, the force behind the nearly $1 billion settlement with top brokerage firms over stock research, has zeroed in on the murky hedge-fund world.

 

Suspicious activity includes HeatMapping and end of month tape painting with borrowed funds.

 

It is unclear where the state and federal investigations will lead. But many investors and fund managers are convinced that public scrutiny on hedge funds will increase. And almost no one in this secretive world is happy about that.

 

 

????????..

 

Position Summary:

 

Amazingly, none of my stops were hit.

 

We are 44% short, 32% long, 24% cash.

 

Half Short:

 

MBI at $50

KLAC at $41

CYMI at $39

NVLS at $35

INTC at $18

MSFT at $56

WHR at $56

INTU at $49

 

Quarter Short:

 

FRE at $68

LEN at $56

COCO at $40

NCEN at $28

 

 

Half Long:

 

GG at $11

HL at $4.55

BGO at $1.31

PAAS at $5

DROOY at $3.35

GLG at $9

GSS at $1.72

WHT at $1.05

KGC at $2.35

HMY at $16

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After hours looking very strong after multiple "beat by 3 penny" earnings announcements from TXN, ALTR, PSFT, etc.

 

Three day island bottom?

 

We will probably gap up tomorrow and have about a 40 point move to the upside.

 

Rally should be good for no more than 3 trading days.

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After hours looking very strong after multiple "beat by 3 penny" earnings announcements from TXN, ALTR, PSFT, etc.

 

Three day island bottom?

 

We will probably gap up tomorrow and have about a 40 point move to the upside.

 

Rally should be good for no more than 3 trading days.

Mark, it would be nice to close that gap now that we are near it.

So that we don't have to come back up there again and go to October gaps.

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good thing I listened to my indicators (and not my stupid self) and donged a few. CUB, DELL, VRTS.

 

Should be fun for a couple of days and then "monster style short" after that.

 

I never dis this --> http://www.analyzeindices.com/

 

A great pop-alert indicator. Will short heavily once bullish level is alleviated. Great indicator to keep you out of trouble. It tells you what NOT to do, not necessarily what to do.

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we are heavily over sold in the hourlies, bounce could be really quite sharp and SG will definitely enter the Traders Hall of Fame. I dunno how he does it, but his track record is absolutely fantastic.

 

If i get good entry i will go long DAX tomorrow, will close postion then if we reach the NDX gap, then watch if it will be closed or not. If not, i will go monster style short, if yes, i will go monster style short too :lol:

 

Have strong feeling that this will be last possibility to enter position trade shorts.

 

Also doc said "The 8 day cycle cmap on SPX has dropped to 868-878 and on QQQ to 24.75. The cycle low is overdue". My experience is, when doc says it is overdue then we definitely get a ramp.

 

Summa sumarum:

Gimme that gap close (or at least a move to the gap) and i opne postion trade short postion and will hold for weeks.

 

Good night :)

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Another question traders.

 

What is a Repo and how does it effect us in the bigger scope of things?

 

I've looked up the definition and it's this;

 

'Instrument, basically a loan arrangement, by which a holder sells the securities at a specified price under commitment to repurchase the same or similar securities at a later date.'

 

So who gets the money and what do they do with it?

 

I 'think' I know my way around the markets but I've never really understood all the economic aspects. I've tended on this front to go by the simple rule 'what you don't know can't harm you'.

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Great commentary, Mark! I was falling off my chair laughing at the Potham piece, absolutely brilliant...

 

Looks like we are due for a bounce - which reminds me of Stan Harley's comments on MarketTV.com last week: he believes the market will continue to slide into early this week and then rally into 23rd and 24th, which will be the top of the rally.

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