AIG and a quick status update

A few friends at work was perplexed about AIG and here is my explanation for it:

No! It is not "short covering caused by a reverse-split" like some author on Marketwatch wrote. A reverse split means that if you were shorting 20 shares at $1, now you are shorting 1 share at $20. There is no scarcity of shares to cover since you simply need to buy fewer to cover as well. More importantly, the split happened a month ago, and AIG dropped in half after the split. This 2-day rally had simply brought it back to the $20s level, which is the equivalent to the $1.25-1.50 range it was at before the split.

So why? In the last 2 days, not just AIG, but a lot of "fundamental-less" stocks such as CIT, C, FNM, and FRE rallied massively. In fact, they led the market!

The answer is sector rotation. This is when the "strong money" dump the losers and pick up some winners (defensive stocks with good fundamentals that will survive a correction with minimal damage), while the "weak money" got smacked around by greed and fear to become the other end of the trade. 

I don't use the term "smart" and "dumb" money, by the way. They are nice epithets, but inaccurate. Most investors and traders, excluding the large funds and the trading arms of big banks, are too small. Their firepower is not enough to move the market. They also never act in concert due to being in a constant struggle to outdo one another. They are little tin soldiers fighting among themselves while there are monsters roaming. I call them the "weak money", easily swayed by the psychology of greed and fear, due to an acute self-awareness of their lack of power. It is human nature to be easily swayed when you feel weak, and it has nothing to do with intellect. The "strong" money are players big enough to move the market by executing large orders at key moments to shock the fragile psyche of the weak money.

As for the trend, I think we will whiplash for a while, and we may overshoot the 1020 target by 15-20 points, but I am not adding to my long. However, I am not pulling the rest of my long off the table just yet. I have been taking profit on the long at the 1000-1005 levels for the last few days, reducing my long holdings from 40% to around 13%.

There is an important date coming in 2 weeks, the option expiration day. The movement during that week may change the psychology of the market and we may have to reevaluate our projections. Remember, the "strong money" only starts selling hard when they sense that the "weak money" is steeling up. If they still can milk the market, they will, and we cannot afford to be overconfident.