'It is almost dishonest to build up an accumulated debt for the Congress of the United States to meet in 1980. We can't do that. We can't sell the United States short in 1980, any more than in 1935,' said Franklin Delano Roosevelt about his efforts to fund social security entirely from its own revenues.
Featured Trades: (ANOTHER NAIL IN THE COFFIN FOR GLOBAL MARKETS), (SPX), (SPY), (TNX)
1) Another Nail in the Market's Coffin. I think it was very interesting not to see what happened today, but what didn't. The Federal Reserve announced that it would continue its purchase of $600 billion in debt securities and keep interest rates low for the indefinite future. What did the markets do? The Dow rose by 0.07%, the S&P 500 by 0.42%, and yields on ten year Treasury bonds rose by five basis points. Everyone was expecting a bang, and got a whimper instead.
To me, the muted reaction is another nail in the coffin of the current rally in global asset prices. We could get a bump in markets on Friday when Q4, 2010 US GDP comes out better than expected, possibly as hot as 3.5%-4%. Then you get the new monthly asset reallocation on Tuesday, February 1, which will almost certainly favor paper assets over hard ones. Beyond that, I don't see much on the horizon to keep powering prices higher for the short term. We are at the stage in this party where the waiters are piling the chairs on the tables, flickering the lights, and all of a sudden, the few remaining available women all start to look beautiful. If the S&P 500 does tack on a few dozen points in the next week, I will be inclined to double up, rather than run from the shorts that I already have.
-
-
Featured Trades: (WHAT OUT FOR THE BLACK SWANS)
1) Watch out for the Black Swans. It is not my intention to ruin your day. But I may well do that if you read this piece. While traders pile on their longs with reckless abandon, and retail flows into equity mutual funds turn positive for the first time in two years, I am hearing a rising tide of negativity from the jungle telegraph. There are 'black swans' circling out there everywhere, and the risk is that they alight upon us in great unexpected flocks, like a scene out of Alfred Hitchcock's classic film, The Birds.
Let me give you a list of things that can go wrong this year:
*The ten year Treasury bond spikes to 5% and money gets expensive.
*Crude soars to $120 a barrel and gasoline rises to $4 a gallon.
*Europe blows up again, sending the dollar through the roof.
*Seeing stock prices soar, Ben Bernanke ends QE2 early, paring it down to QE 1?.
*The high frequency traders and quants hungry for a mean reversion smell blood in the water and trigger another 'flash crash.'
*Retails investors conclude they were right to stay away and bail on what they have remaining.
And here is the scariest thing of all. All of these black swans could hit at the same time and reinforce each other, possible around March or April, triggering the recurrent double dip fears. Could this be the third consecutive 'sell in May and go away' year? This conjures up the vision of a 'ground hog year', where 2011 is a carbon copy of 2010.? A strong first quarter is followed by two dead quarters, and then a strong year end finish. This is what 'lost decades' look like. Look at the 20 year chart of the (SPY) below and tell me this isn't happening.
Of course, this is just one of many possible scenarios that could play out this year. As for me, I'm booking my chalet in Zermatt in the Swiss Alps now to beat out the rest of you.
-
Will the Black Swans Come Like This?
-
Or This?
-
A Much Nicer Alternative
Featured Trades: (BEWARE THE COMING COLLAPSE OF GOLD),
(GLD), (SLV), (PPLT), (PALL), (GLL), (DGZ)
2) Beware the Coming Collapse of Gold. Last year's sure thing is rapidly turning into this year's sure loser. After bringing in a torrid 29% return in 2010, the barbarous relic has only managed a flaccid 7% loss so far this year, much to the distress of hedge funds and gold bugs alike. The triple top on the charts that set up over the last three months could not be more clear. What is giving traders ulcers now is the prospect of a much more serious sell off in the yellow metal in coming weeks and months.
They are right to be worried. The shift out of hard assets and into paper ones, like stocks, has been undeniable in 2011. One of the main drivers for gold in recent years has been buying from a newly enriched middle class in emerging nations. They have been joined by their own central banks, which have been scrambling to find alternatives to the US dollar to store massive reserves generated by record trade surpluses.
It's looking like inflation fears are going to pee on this parade. A witch's brew of rising commodity prices, soaring real estate, and increased wage demands has sent inflation over 5% in China. Much higher figures can be found in India and Vietnam. This is prompting governments to sharply raise local interest rates, making gold a less attractive investment alternative.
That's just for starters. The CFTC has already raised margin requirements for the entire metals complex to dampen unwarranted speculation. While JP Morgan and Goldman Sachs managed to get 'grandfather' exemptions to keep the markets open (as I do), most smaller players are having to pay up, increasing the amount of capital they must commit to each trade, reducing returns. Small and medium sized hedge funds and wealthy individuals trading on margin provided much of the juice for last year's bull market.
Have you seen all of those late night ads on TV offering to buy your old gold? These fly by night companies have send scrapage supplies soaring to four times 2009 levels, even though they often only offer ten cents on the dollar. The rise of this new supply has been so fast that many wholesalers are becoming glutted with inventory.
The selling has been so aggressive, that it has spread like an out of control virus to the rest of the entire metals complex. So far this year, silver (SLV) is down 8.5%, and platinum (PPLT) %. To throw the fat on the fire, one large hedge fund was seen yesterday unloading a long term position which took it down to a new three month low at $1,224. Others such hurried liquidations are expected to follow. This is truly the commodity that takes the stairs up and the elevator down.
To prove that I put money where my mouth is, I have been actively shorting gold for the last few weeks. 'Macro Millionaires' who followed me into my options play are now up 25% in ten trading days, and have been up as much as 35%. If you can't, or don't want to put the options trade on, you can look at the 1X short gold ETF, (DGZ), or the leveraged 2X ultra short version (GLL).
How far can gold fall? Let me provide some frightening downside targets:
*$1,324 '? The October and November support level we touched today.
*$1,277 '? The 200 day moving average, the next stop.
*$1,150 '? The summer, 2010 low.
*$1,050 '? The old resistance level that was shattered in October, 2009 by the Reserve Bank of India 200 tonne purchase.
*$1,000 '? Worst case technical support suggested by analyst Charles Nenner.
Mind you, I think gold is still going up long term, and think that the old inflation adjusted high of $2,300 is a chip shot in a couple of years (click here for 'The Ultra Bull Case for Gold'). This is just a little counter trend scalp to take advantage of overly bullish traders who have been caught off guard.
-
-
-
Gold Has Been a Real Killer This Year
Featured Trades: (TOUCHING BASE WITH KARL DENNINGER)
1) Touching Base With Karl Denninger. I managed to catch up with my friend Karl Denninger, the peripatetic founder of the Florida based Market Ticker, a highly entertaining and prescient, if not irreverent daily blog.
Karl is convinced that the current move up in equity markets is a load of baloney and is nothing more than a replay of the dotcom bubble of the 1990's. One of many measures he tracks is the ratio of stock prices to underlying tangible asset value. A low number is good and a high number is bad. It hit two during the nineties, rose to 4 during the crash, and has since soared to 12 today, six times the bubble peak.
Rising values today are being driven by multiple expansion and this will only end in tears. Flavor of the day 'cloud computing' companies are trading at multiples of over 100. Sound familiar? Traditional cost/push inflation, which historically takes eight months to hit stock prices, started in earnest six months ago.
To make matters worse, companies are increasingly being caught between a rock and a hard place. They can either raise prices and squeeze customers, or cut margins and squeeze themselves. To see what happens when this harsh reality hits share prices, look no further than Internet traffic routing company F5 Networks (FFIV), which plunged a gut churning 27% on a modest earnings disappointment.
Karl was the CEO and one of the founders of MCSNet, a Chicago area Internet and networking company which he sold in 1998 for a large, undisclosed sum. Since then, he has been a successful independent trader worthy of one of the larger hedge funds. He also created TicketForum, an online trading venue. In 2008, Karl received the Reed Irvine Accuracy In Media Award for Grassroots Journalism for his coverage of the market meltdown. To learn more about Karl Denninger, you can visit his website at http://market-ticker.org/ . To listen to my lively interview with Karl on Hedge Fund Radio in full, please click here.
-
Featured Trades: (VOLATILTIY INDEX), (VIX), (FFIV), (SPX)
2) Buying Straw Hats in the Dead of Winter. I am one of those demented people who buys flood insurance when the sun is shining and sun tan lotion by the gallon from Costco in the dead of winter. I am such an inveterate bargain hunter that I even buy Christmas ornaments during the January sales when retailers are unloading inventories for pennies on the dollar.
It is such instincts that drive me to take a look at the CBOE Volatility Index (VIX), a measure of the implied volatility of the S&P 500 stock index, which has been in a death spiral since it peaked nearly three years ago at the $80 level. You may know of this from the talking heads and beginners who call this the 'Fear Index'.
For those of you who have a PhD in higher mathematics from MIT, the (VIX) is a weighted blend of prices for a range of options on the S&P 500 index. The formula uses a kernel-smoothed estimator that takes as inputs the current market prices for all out-of-the-money calls and puts for the front month and second month expirations. The (VIX) is the square root of the par variance swap rate for a 30 day term initiated today. To get into the pricing of the individual options, please go look up your handy dandy and ever useful Black-Scholes equation.
For the rest of you who do not possess PhD in higher mathematics from MIT, and maybe scored a 450 on your math SAT test, or who don't know what an SAT test is, this is what you need to know. When the market goes up, the (VIX) goes down. When the market goes down, the (VIX) goes up. End of story.
The (VIX) is expressed in terms of the annualized movement in the S&P 500. So today's (VIX) of $17.64 means that the market expects the market to move 5.01%, or 64 S&P 500 points, over the next 30 days (17.62/3.46 = 5.01%). It really doesn't care which way.
It gets better. Futures contracts began trading on the (VIX) in 2004, and options on the futures since 2006. Since then, these instruments have provided a vital means through which hedge funds control risk in their portfolios, thus providing the 'hedge' in hedge fund.
Now, erase the blackboard and start all over. Why should you care? If you buy the (VIX) here at $17.64, you are buying a derivative at a multiyear low at a technically oversold level. Buying (VIX) here is the equivalent of taking out an insurance policy on the long side of your portfolio. If you don't want to sell you stocks in order to avoid capital gains taxes, you can insure yourself against losses through buying the (VIX) to match your portfolio. You can also use options strategies to create a cheap entry point and to limit your risk.
I am not saying you should rush out and buy this thing today. But you might tomorrow. We have gone up virtually in a straight line for five months now, taking the S&P 500 up 28%. A number of technical programs are giving 'SELL' signals. The great New Year's asset allocation, which I managed to grab hold of with both hands, is now done. An awful lot of people have crowded on to the same side of the boat, assuming that Ben Bernanke will keep printing money forever. Remember what happened to the Titanic?
-
-
-
Does This Come in a 42 Gallon Drum?
-
See Any Connection?
Featured Trades: (DAVID HALE ON THE ECONOMY)
1) The Choppy Road Ahead. Recently, I managed to catch up with my old friend, David Hale of David Hale Global Economics (click here for their site). While swilling a few gin and tonics within the oak paneled walls in the bar at Chicago's exclusive University Club, he outlined his case for the economy for the coming year. Since David is an independent economic advisor to many of the world's top banks and investment firms, I thought his views would be worth passing on.
The economy is currently undergoing a growth spurt, which could deliver an annualized rate of 3% in Q4, 2010. Needless to say, this is hugely bullish for financial markets. Aggressive cost cutting by corporations has taken profitability to record levels. Ben Bernanke's efforts to reflate have also been highly successful.
However, there are storm clouds forming on the horizon. Some $300-$400 billion in financing of state and local governments, the largest portion of the 2008 Obama stimulus package, will soon expire. Given the current make up of congress, it is highly unlikely to be renewed. This could chop some 2.7% off of GDP.
Any truly serious attempt to address our enormous budget deficit will have similar deflationary impacts. The elimination of the tax deductibility of charitable contributions will raise $500 million for the Treasury. Taxing the value of company health insurance benefits will take in another $300 billion. Eliminating the deductibility of state and local taxes conjures up $100 billion in revenues for the feds, while the loss of the home mortgage deduction takes in another $100 billion.
The scary thing about our current predicament is that even if you adopt all of these high contentious proposals, which is unlikely, we will still be left with large annual deficits. That places the sacred cow of defense spending on the altar for sacrifice. Good luck with that. A senior official at Lockheed, the manufacturer of the Hercules C-130 transport plane, once proudly explained to me the firm's strategy of procuring parts in all 50 states, thus creating jobs everywhere and rendering the plane immune to cuts. That's how the Air Force ended up with far more planes that it could ever want or fly. Many other defense programs are similarly dispersed.
The bottom line is that David foresees a coming decade of choppy and volatile GDP growth, which may average out at a lowly 2.5% rate over the long term. That dovetails nicely with my own view that US stocks have not reentered a secular bull market, but are in the process of probing the upper end of a decade long range. Trade, don't own, date, but don't marry. Buy and hold is dead.
Do You See a Trend or a Range?
-
Don't Touch My C-130 Hercules Contract!
Featured Trades: (BIG TECHNOLOGY), (CSCO)
2) Time to Ring the Cash Register on Big Technology. Given the worsening technical picture for the market in general, and technology stocks specifically, I am selling my Cisco Systems (CSCO) March, 2011 $20-$22 call spread at the market. With the stock here at $20.82, I see a middle market for the spread at 98 cents, so I'm using that as my notional exit price. Those 'Macro Millionaires' who came in with me on December 16 when the stock was at a lowly $19.65 are up 66% on the call spread position. Those who shorted the puts with me and covered down 71% three weeks later have made even more money.
Analyze this trade and you'll see what this game is all about. In little more than a month, Cisco Systems stock rose by 5.9%. By risking only 5% of your capital you were able to add 3.31% to the value of your total portfolio.
You found a stock with great fundamentals. You zeroed in on the move with the highest probability of taking place, the next $1 move up, and then leveraged up with a limited risk position that offered much more upside than downside.
This is how you made money on this trade, and will continue to do so on the next one, and the one after that. You could be making your stock picks with a coin toss, and still make money with this strategy. This is how I do it. This is how George Soros and Paul Tudor Jones do it. This is how Morgan Stanley and Goldman Sachs do it. I know because I have been trading with, arguing with, and drinking with these guys for 30 years.
This is not a home run, but is at least a double, and possibly even a triple. Given that in this zero return world, many hedge funds would be happy with an annual 11% return, and would kill for 20%, 3.31% on a single trade is nothing to sneeze at.
I'll probably re enter this trade at a later date with a different set of strikes. On to the next one.
-
Featured Trades: (MY PERSONAL LEADING ECONOMIC INDICATOR)
4) My Personal Leading Economic Indicator.? I just flew over one of my favorite leading economic indicators yesterday. Honda (HMC) and Nissan (NSANY) import millions of cars each year through their Benicia, California facilities, where they are loaded on to hundreds of rail cars for shipment to points inland as far as Chicago.
Two years ago, when the US car market shrank to an annual 8.5 million units, I flew over the site and it was choked with thousands of cars parked bumper to bumper, rusting in the blazing sun, bereft of buyers. Then 'cash for clunkers' hit. The lots were emptied in a matter of weeks, with mile long trains lumbering inland, only stopping to add extra engines to get over the Sierras at Donner Pass. The stock market took off like a rocket, with the auto companies leading.
I flew over the site last weekend, and guess what? The lots are full again. During the most recent quarter, demand for new cars raced up to an annual 12.5 million car rate. Now what? I'll let you draw your own conclusions. Sorry the photo is a little crooked, but it's tough holding a camera in one hand and a plane's stick with the other while flying through the turbulence of the Carquinez Straight. Air traffic control at nearby Travis Air Force base usually has a heart attack when I conduct my research in this way.
-
-
Featured Trades: (THE MUNI BOND MYTH), (MUB), (JNK), (TBT)
2) The Muni Bond Myth. Have I seen This movie before? Two years ago, analysts were predicting default rates as high as 17% for Junk bonds in the wake of the financial meltdown, taking yields on individual issues up to 25%. Liquidity in the market vaporized, and huge volumes of unsold paper overhung the market. To me, this was an engraved invitation to come in and buy the junk bond ETF (JNK) at $18. Since then, the despised ETF has risen to $40, and with the hefty interest income, the total return has been over 160%. What was the actually realized default rate? It came in at less than 0.50%.
Fast forward three years to today (has it been that long?). Bank research analyst Meredith Whitney is predicting that the dire straits of state and local finances will trigger a collapse of the municipal bond market that will resemble the Sack of Rome. She believes that total defaults could reach $100 billion. Since September, the main muni bond ETF (MUB) has plunged from $106 to $97.
I don't buy it for a second. States are looking at debt to GDP ratios of 4% compared to nearly 100% for the federal government, which still maintains its triple 'A' rating. They are miles away from the 130% of GDP that triggered defaults and emerging refinancings by Greece, Portugal, and Ireland.
The default risk of muni paper is being vastly exaggerated. I have looked into several California issues and found them at the absolute top of the seniority scale in the state's obligations. Teachers will starve, police and firemen will go on strike, and there will be rioting in the streets before a single interest payment is missed to bond holders.
How many municipal defaults have we actually seen in the last 20 years? There have only been two that I know of. The nearby City of Vallejo, where policemen earn $140,000 a year, is one of the worst run organizations on the planet. And Orange County got its knickers in a twist betting their entire treasury on a complex derivatives strategy that they clearly didn't understand sold by, guess who, Goldman Sachs. To find municipal defaults in any real numbers you have to go back 80 years to the Great Depression.
My guess is that we will see a rise in muni bond defaults. But it will be from two to only 20, not the hundreds that Whitney is forecasting.?? The market is currently pricing in the triple digit number.
Let me preface my call here that I don't know anything about the muni bond market. It has long been a boring, quiet backwater of the debt markets. At Morgan Stanley, this is where you sent the new recruit with the 'C' average from a second tier school who you had to hire because his dad was a major client. I have spent most of my life working with major offshore institutions and foreign governments for whom the tax advantages of owning munis have no value.
However, I do know how to use a calculator. Decent quality muni bonds now carry 8% yields. If you buy bonds from you local issuer, you can duck the city, state, and federal tax due on equivalent grade corporate paper. That gives you a pre tax yield of 16%, almost as high as the peak we saw in the junk market in 2008. While the market has gotten a little thin, prices from here are going to get huge support from these coupons.
Since the tax advantages of these arcane instruments are highly local, sometimes depending on what neighborhood you live in, I suggest talking to a financial adviser to obtain some tailor made recommendations. There is no trade for me here. I just get irritated when conflicted analysts give bad advice to my readers and laugh all the way to the bank. Thought you should know.
There is one additional instructive thing that is going on in the muni market. The mayhem that we are seeing is but a preview to the real violence that we will see when the US Treasury bond market starts to collapse, possible in a few months. That I can trade, through the leverage short ETF (TBT). This is the real lesson of what is going on in muni land.
-
-
-
This is Not the Muni Bond Market