December 1, 2005

November's Dream Rally A Nightmare For Some Traders

Searching for Alpha, the monthly index newsletter for December

For stock market bears, last month's blistering equity performance was like a B-movie monster that just won't die. Although crude oil closed at five month lows, energy stocks managed a gain. Bond prices rose as well, even though GDP estimates were revised higher. And despite inflation and other concerns, consumer sales buoyed the retail once again.

Therein lies the problem with shorting stocks. One can get all the fundamentals correct, only to have the market ignore them and skyrocket. Short interest in stocks can actually serve as fuel for rallies, as savvy traders that buy heavily-shorted issues are rewarded when their weak-handed competitors are forced to throw in the towel and buy back the stocks they have betted against.

The ability of stocks to rise despite unfavorable fundamentals is the driving force behind sub-par hedge fund returns in November. Although the market scored big gains, many alternative strategies delivered returns in the sub-1% range. Of course, these same strategies didn't suffer as much as stocks and bonds did in October, which underscores their value as portfolio diversifiers.

In our view, equities should be able to continue climbing a wall of worry in December. Most hedge funds have gone from net short to long in November, and will be pressing hard for a rally. Look for buying in the sectors with the most momentum, like banking, basic materials, and technology.

Even so, that doesn't mean that the bull market zombie will be around forever. If the Fed continues raising rates, the current rally will eventually lose style points to fixed income alternatives like CDs. The bottom line: fundamentals always catch up to the market, but it doesn't happen overnight.

The Monthly Index Report for December 2005

Index

Nov-05

QTD

YTD

Description
S&P 500 Index*

3.52%

1.69%

3.10%

Large-cap stocks
DJIA*

3.50%

2.24%

0.21%

Large-cap stocks
Nasdaq Comp.*

5.31%

3.77%

2.64%

Large-cap tech stocks
Russell 1000 Growth

4.31%

3.30%

5.59%

Large-cap growth stocks
Russell 1000 Value

3.29%

0.67%

6.42%

Large-cap value stocks
Russell 2000 Growth

5.66%

1.75%

4.31%

Small-cap growth stocks
Russell 2000 Value

4.06%

1.45%

5.52%

Small-cap value stocks
EAFE

2.25%

-0.73%

5.98%

Europe, Australasia & Far East Index
Lehman Aggregate

0.44%

-0.35%

1.46%

U.S. Government Bonds
Lehman High Yield

0.52%

-0.18%

1.86%

High Yield Corporate Bonds
Calyon Financial Barclay Index**

2.11%

1.79%

3.78%

Managed Futures
3-month Treasury Bill

2.80%

All returns are estimates as of November 30, 2005. *Return numbers do not include dividends. ** Returns are estimates as of November 28, 2005
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