Anytime I see a well-written article by another college student, I pay extra attention. Such is the case with Naufal Sanaullah’s piece on why he thinks this recent rally is unsustainable. It’s quite a comprehensive bearish argument, with good points about the technical aspects of trading and a number of shots at the accuracy of last quarter’s bank earnings – and it will also serve as a good starting point for me to assess my own view of where the market is going. Still, I couldn’t help but be struck by the conspiracy-heavy undertones (most of which were backed by links to Zero Hedge – which provides a lot of thought-provoking pieces, none of them ever being positive).

I’m not going to argue on points about CDS trades with AIG, because there are only anecdotes and circumstantial evidence about what’s going on there. What we do know is that the fear of imminent failure of many financial firms, a disastrous specter which has hung over the market for at least a year, has been lessened in the last two months – at least by judging from the values of the most closely-watched and heavily-traded financial stocks.

What I do want to make a point about is quant funds, whose troublesome positioning is a frequent topic at Zero Hedge and something Naufal focuses heavily on. Specifically, he states:

With such low volume, how is this market continuing its slow, yet upward ascent? Quant fund deleveraging has become the reason of choice to which this market movement has been attributed. Quants tend to short stocks with weak fundamentals and relative weakness versus indices, and quant deleveraging should manifest in weak stocks seeing dramatic share surges as quants scramble to cover shorts to lessen market exposure. And that’s exactly what’s happened. Stocks like XL Capital (XL), American Capital (ACAS), Vornado Realty (VNO), and Liz Claiborne (LIZ) showed massive rallies since March lows, leading the market and far outpacing stronger, more fundamentally-strong stocks, even ones with high beta. Even Crocs (CROX) enjoyed a 50 DMA breakout. This is highly indicative of a “short squeeze” bear bounce, rather than a sustainable bottoming rally, which is characterized by new market leaders and sectors showing relative strength against previous leaders and breaking out of tight bases formed over several months.

First point: what do quants do? Obviously, “quant” is a catch-all phrase to describe a variety of program trading activities.