Today the S&P VIX is sub-17. This level of complacency usually signals that we are topping out or at least due for a correction. Rather than short individual equities, at these levels I find the idea of buying Feb VIX calls (struck in high teens/low 20s) to be a very interesting one. This is not even a bearish call and doesn't require bearish thinking. It should be a prop-bet or hedge and nothing more. It's always important when buying volatility to give yourself ample time. While Bernanke continues to monetize our debt with daily POMOs under QE2 and suggests on 60 minutes that QE3 is a possibility, this market could stay at these lofty levels for longer than a person could fundamentally believe possible (...it already has!) Several months should provide ample time despite the higher costs. Also it is worth noting that options buyers of VIX calls/puts realize that by definition volatility tends to spike higher/lower in short periods of time. Therefore, one must be nimble if considering this idea. The premium, unless very near its maturity date, will be less than the actual in-the-money amount. For example, if buying Feb 20's at 3.00, and the VIX goes to 27, the option is not likely to be worth 7 (as expected) but more likely 5.50 or 6. This is because VIX tends to snap up and come back down almost as quickly.
Other indications that market participants have become too complacent:
1. In the last three months alone, insiders have sold just under $10B worth of their own stock. (Tyler Durden at Zero Hedge.)
2. Valuations of NASDAQ darlings such as AAPL, NFLX, AMZN, OPEN, BIDU, etc are trading at shockling high forward multiples. This is very reminiscent of the low-rate manipulated market that led to the tech bubble in the early 2000s. The marginal buyer here is almost certainly playing a dangerous game of hot potato and is likely only piling in at this point as an inflation hedge and because of some hubristic belief that they will be the first out when Bernanke and Co can no longer successfully prop up the market. If this segment of the market turns sour, it will do so rapidly as there are far more 'renters' than 'buyers' in these names.
3. The Eurozone debt crisis is far from over. The media does an almost fascinating job of avoiding discussing this theme until something dramatic enough happens that it must be reported on. In the days between pronouncements from Merkel, or bond restructurings, the media is happy to behave as though the entire debacle has suddenly disappeared. I assure you, it has not. While I do not personally believe the European Sovereign Debt Crisis will play out in the coming weeks or even months, its very existence will continue to trouble markets for years into the future, which should at least make marginal buyers at these levels nervous about playing the role of the greatest fool...
4. Ditto for tensions on the Korean Peninsula. From headlines suggesting war is imminent to narry a mention the following day, it is almost amazing to witness a) how short-term oriented we've become as a society and as an investor class, and b) how effective the media is at setting the agenda. What is frightening is that the situation in Korea is not developing in a vacuum. With the US engaged in what many central bankers have dubbed a currency war, the price of food in China spiking higher as a result, the US monetizing debt and devaluing China's dollar holdings in the process, one must at least acknowledge that a proxy war between China backed NK, and US backed SK is not an impossibility. It may be mutually destructive and may be outside of the realm of current thinking, but WWI and WWII were economically motivated conflagrations that seemed to escalate rapidly after a tipping point incident that alone shouldn't have caused so much destruction, let alone worldwide participation. Follow the bonds...
5. Margin compression will occur sometime in the near future. If inflation should begin to pick up meaningfully (which it already has) then input costs will also trend higher. Not all of these costs can be materially passed through. Demand for certain goods is relatively inelastic, but clothes retailers, boat makers, household appliance makers, etc will not be able to pass on higher input costs to consumers who have seen their incomes, job security, and net worth all deteriorate. Without wage inflation, it is unlikely that we will see much successful pass-through pricing without a reduction in the top-line. Therefore margin assumptions must begin to be revised downwards.
6. On the topic of demand and inflation, one must consider that higher food and fuel prices will restrict the amount of disposable income that the American consumer has available for more fully priced goods and services. A reduction in the top line is therefore imminent for discretionary service providers and goods manufacturers. The Federal Reserve's goal of propping up the stock market to create a 'wealth effect' is providing an opportunity for insiders to sell and giving officials more time to work out potential solutions, but it certainly is not trickling-down to the majority of American workers, most of whom have very limited equity ownership, and who view a higher stock market not as a sign of a recovering economy but as endemic of a kleptocracy making off with what's left before the whole thing comes crashing down.
There is a notable rise in the 'end the Fed' rhetoric lately and one need look no further than the growing Tea Party movement, the appointment of Ron Paul to head the Fed oversight committee, etc. The political turmoil in this country is not, in my opininon, rooted in foreign policy ideology, or family values issues, but instead mainly represents a class struggle. Somehow the Democratic Party has been colored as the political arm of 'nothern elitists' now seen by populists everywhere as being detrimental to the quality of life of the people in this country. Meanwhile, deficit-hawk Republicans get elected to 'rein in spending' who intern immediately move to deny unemployment insurance extensions to our nations involuntarily unemployed if they are not granted extensions to $600B tax cuts for the nation's wealthy. Really? Is the country too naive or disinterested to even consider how bizzare and hypocrtical that this is? If this Democratic administration had the guts people previously assumed that it did, why not push to end the tax cuts (and the Reaganomics obsession along with it) and redirect this money to at least a less inflationary way to directly create jobs via subsidies and invesment in new secular growth industries such as electric cars, the smart grid, wind and solar, nuclear power plants, rebuilding the nation's infrastructure, etc, etc, etc. Instead our nation's 'populists' decry this idea as 'fascist' or 'socialist' and instead prefer that we provide a shadow subsidy to our wealthy through unaffordable tax cuts and daily POMO operations. Are you kidding me? This will not end quietly. It may not be the coming of another civil war, but the political discourse surely is hotter than its ever been during a period when the equity market was bounding higher and higher.
7. The ability for the US Treasury to sell bonds at record low rates while monetizing our debt will not last forever. At some point foreign buyers will refuse to participate and the pricing will have to work higher unless you believe the Fed and the Primary Dealers can take down every issue from here to eternity. Any material rise in rates will certainly constrain real economic activity and our ability to return to reasonable employment levels and capacity utilization will be pushed out that much further.
8. There has been no real effort to reform HFT market manipulation. In fact, Getco, a leading HFT, was tasked as head market maker on the GM IPO. Wow. I knew it must have been substantial, but with this decision its now guaranteed that HFT lobbying efforts must be some of the most amazingly robust (and well-funded) of any such efforts on Capitol Hill. HFTs, along with the PDs, and the Fed, continue to make the stock market an unsuitable place for retail investors to invest. People are not as oblivious to ramp jobs, and stick saves, and bizarre low volume sell-offs/ramps as TPTB would like to believe. There is a reason that retail money has been steadily streaming out of the market, and that reason is that people don't like to play a game that they know is rigged against them. The flash crash was also a lesson on just how dramatically and rapidly markets can change when volume is dominated by algo traders and fast money institutions and not honest investors seeking to allocate capital to high EVA or ROIC generating businesses. Unless we see meaningful regulation and increased transparency regarding HFT, algo trading, dark pools, etc then those wise enough to have amassed investible wealth, will also be wise enough to avoid throwing it away in a casino.
I could go on and on, but to summarize, the incredible amount of both serious and pervasive issues confronting this market are, for at least the intermediate term, here to stay. It would behoove those with the wisdom to be intellectually honest to avoid being the marginal buyer in any stock which has risen 30%+ in a few short weeks. If you insist on staying on for the ride, at least take the opportunity to hedge yourself when volatility gets this cheap by purchasing longer-dated VIX calls at reasonable strike prices. Willing to discuss hedgining instruments off-line with anyone interested.
Disclosure & Disclaimer: This post should be taken as the opinion of the author only and is in no way a recommendation to buy or sell any security. The author may be long or short volatility at any given time without notice.
Monday, December 13, 2010
Tuesday, December 7, 2010
Market Update
Futures are looking higher this morning as Obama agreed to a 2-year extension to the Bush tax cuts and Ireland prepares to announce an austerity budget with $6B in spending cuts and $2B in tax increases. Amazing that the 'budget hawk' Republicans were able to push through this tax cut extension despite its $600B annual cost. Why not approve a $600B federal jobs program instead? I suppose its for the same reason that Republicans were blocking unemployment benefit extensions without compromise on these tax cuts. If one continues to believe wholeheartedly that trickle down economics is more stimulative than putting people directly back to work, then I encourage them to challenge my position in the comments section. I would be delighted to finally be convinced of the effectiveness of this ideology (if only to improve the flavor of the Kool Aid we are all being forced to drink...)
Last night the EU announced they had failed to reach an agreement to increase the size of their $1T rescue fund. Germany will not be adding to the bailout fund for its freewheeling neighbors (not yet anyway.) The fear is that more funds will be needed should larger nations such as Spain and Italy need assistance. (Does this amount to an admission on the part of EU leaders that the domino rally is already underway?) One would think this would put a dent in the futures, but not so.
China may see a rate hike soon, as inflation in October reached 4.4%, driven by a 10.1% jump in food costs.
With so many positive developments (I kid, of course!) why shouldn't we soon see Dow 36,000? And by the way, did anyone else catch Bernanke on 60 Minutes discussing the possibility of QE3? One would think that increasingly vitrolic commentary from both foreign and domestic leaders surrounding QE2, would make our proud Fed chairman at least somewhat apprehensive about discussing another round of asset purchases a month after the commencement of the current program, but you would be wrong.
Bring on the POMO.
Last night the EU announced they had failed to reach an agreement to increase the size of their $1T rescue fund. Germany will not be adding to the bailout fund for its freewheeling neighbors (not yet anyway.) The fear is that more funds will be needed should larger nations such as Spain and Italy need assistance. (Does this amount to an admission on the part of EU leaders that the domino rally is already underway?) One would think this would put a dent in the futures, but not so.
China may see a rate hike soon, as inflation in October reached 4.4%, driven by a 10.1% jump in food costs.
With so many positive developments (I kid, of course!) why shouldn't we soon see Dow 36,000? And by the way, did anyone else catch Bernanke on 60 Minutes discussing the possibility of QE3? One would think that increasingly vitrolic commentary from both foreign and domestic leaders surrounding QE2, would make our proud Fed chairman at least somewhat apprehensive about discussing another round of asset purchases a month after the commencement of the current program, but you would be wrong.
Bring on the POMO.
Tuesday, November 23, 2010
Korean Peninsula Conflict Heats Up
Futures are looking down big this morning as a flurry of negative news hits the tape.
Last night South Korea failed to inform North Korea that they were practicing a live fire drill. Believing they were under attack, North Korea responded by firing 100 rounds of artillery at Yeonpyeong Island in the Yellow Sea. South Korea responded with 80 rounds of artillery and scrambled fighter jets to stop the firing. Two South Korean marines were killed and 15 soldiers and civilians were wounded. Many think this was something of an accident, but others believe it stems from the sanctions placed on North Korea over the Chenoan incident and because NK was found to have a new uranium enrichment facility. Whether a demand for attention or a mistake (unlikely), the markets have been rattled and rightly so. This is a subject that I have cautioned on this blog numerous times that did not simply go away. The best we can do is hope for international assitance and a diplomatic solution.
Spain had a basically failed 3-6 month bond auction. The sovereign sold 3.2B Euro vs. the 4-5B Euro that had been planned. Spanish CDS is approx 20 bps higher and the 10-year is at all time high spreads. The EUR/USD pair is trading a full 0.0156 lower at 1.3469.
Last night South Korea failed to inform North Korea that they were practicing a live fire drill. Believing they were under attack, North Korea responded by firing 100 rounds of artillery at Yeonpyeong Island in the Yellow Sea. South Korea responded with 80 rounds of artillery and scrambled fighter jets to stop the firing. Two South Korean marines were killed and 15 soldiers and civilians were wounded. Many think this was something of an accident, but others believe it stems from the sanctions placed on North Korea over the Chenoan incident and because NK was found to have a new uranium enrichment facility. Whether a demand for attention or a mistake (unlikely), the markets have been rattled and rightly so. This is a subject that I have cautioned on this blog numerous times that did not simply go away. The best we can do is hope for international assitance and a diplomatic solution.
Spain had a basically failed 3-6 month bond auction. The sovereign sold 3.2B Euro vs. the 4-5B Euro that had been planned. Spanish CDS is approx 20 bps higher and the 10-year is at all time high spreads. The EUR/USD pair is trading a full 0.0156 lower at 1.3469.
Thursday, November 18, 2010
Irish Bailout Talks Begin in Earnest, GM Prices, Fed Orders Stress Tests
Futures are looking significantly higher this morning as Ireland appears to be on the verge of a bailout by the EU and IMF. While Irish administration officials insist that no bailout is necessary, their central bank governor, Patrick Honohan, suggests that a bailout worth 'tens of billions' of euros is likely. Mr. Honohan also suggested he believes the rate on such a bailout loan would be 5%.
Why this is positive news I am unsure. Afterall, this goes to show that nothing European officials have been saying for weeks has had even a smidgeon of crediblity. I suppose this also means that Portugal, Spain, et al are soon to follow. The Euro is rallying on the news this morning to 1.3648 (or +0.0117).
GM priced its 'IPO' at the high end of the range at $33 on 478M common and $4.35B of preferred. With the shoe, the deal could come to $18.1B, the second largest IPO in US history. The Treasury sold $11.8B which reduces its stake to less than 37%. Ford shares are also rallying this morning on the announcement that it will sell a large portion of its stake in Japanese car maker, Mazda.
The Fed ordered new stress tests for the top U.S. banks yesterday, with a request that the top 19 banks also submit capital plans by early next year. The Fed also provided guidelines for banks that want to increase their dividends or buybacks which include meeting higher capital requirements and having shown they pass the current (and ongoing stress tests).
On the economic calendar today, we will have another Congressional Hearing on Robo-Signing and Other Mortgage Issues, this time with Citigroup, Wells Fargo, and GMAC in the hot seat. At 7 am we will get an update on the Leading Indicators, the Fed's Warsh, Kocherlakota, and Plosser will all give speeches this afternoon, along with Treasury's Wolin and Warren. Lastly, the Fed Balance Sheet and the Money Supply data will be released after the market close.
What is obviously interesting is that GM's first day of trading was a sure to be manufactured rally-up day. Reviewing the 'positive' news announcements, one sees little that is a concrete positive: Ireland 'might' be bailed out, GM priced well but the government still owns nearly 40% of the company, the banks are seeing more regular 'oversight' and stress tests prove it (right because the first round was very transparent...does anyone remember CAMEL ratings?? The European version was even more spectacular.) At best the stress tests will be taken as a token vote of confidence in the system with its obvious bias still intact. At worst, the stress tests might show the need for the four horsemen of the apocalypse to raise more capital. I can see it now, "BAC and C need to raise an additional $10B. But don't worry this dilution is no biggie. Especially not a big deal when you consider that they just raised the dividend 100 bps!!"
My non-binding advice would be to avoid buying this rally today. Hold some capital back as its unlikely we'll be able to get a borrow on GM until tomorrow or soon thereafter...
Why this is positive news I am unsure. Afterall, this goes to show that nothing European officials have been saying for weeks has had even a smidgeon of crediblity. I suppose this also means that Portugal, Spain, et al are soon to follow. The Euro is rallying on the news this morning to 1.3648 (or +0.0117).
GM priced its 'IPO' at the high end of the range at $33 on 478M common and $4.35B of preferred. With the shoe, the deal could come to $18.1B, the second largest IPO in US history. The Treasury sold $11.8B which reduces its stake to less than 37%. Ford shares are also rallying this morning on the announcement that it will sell a large portion of its stake in Japanese car maker, Mazda.
The Fed ordered new stress tests for the top U.S. banks yesterday, with a request that the top 19 banks also submit capital plans by early next year. The Fed also provided guidelines for banks that want to increase their dividends or buybacks which include meeting higher capital requirements and having shown they pass the current (and ongoing stress tests).
On the economic calendar today, we will have another Congressional Hearing on Robo-Signing and Other Mortgage Issues, this time with Citigroup, Wells Fargo, and GMAC in the hot seat. At 7 am we will get an update on the Leading Indicators, the Fed's Warsh, Kocherlakota, and Plosser will all give speeches this afternoon, along with Treasury's Wolin and Warren. Lastly, the Fed Balance Sheet and the Money Supply data will be released after the market close.
What is obviously interesting is that GM's first day of trading was a sure to be manufactured rally-up day. Reviewing the 'positive' news announcements, one sees little that is a concrete positive: Ireland 'might' be bailed out, GM priced well but the government still owns nearly 40% of the company, the banks are seeing more regular 'oversight' and stress tests prove it (right because the first round was very transparent...does anyone remember CAMEL ratings?? The European version was even more spectacular.) At best the stress tests will be taken as a token vote of confidence in the system with its obvious bias still intact. At worst, the stress tests might show the need for the four horsemen of the apocalypse to raise more capital. I can see it now, "BAC and C need to raise an additional $10B. But don't worry this dilution is no biggie. Especially not a big deal when you consider that they just raised the dividend 100 bps!!"
My non-binding advice would be to avoid buying this rally today. Hold some capital back as its unlikely we'll be able to get a borrow on GM until tomorrow or soon thereafter...
Tuesday, November 16, 2010
Hang on to your Hats
The Dow is down 200+ pts this morning as a touch of reality is sweeping over the markets.
Ireland has now admitted that it is in talks to seek IMF/EU financial support for its government and banking system.
Finland has announced it does not approve of an Irish bailout.
Portugal admits that it may soon need assistance as it can't borrow on the public market except for at prohibitive rates.
Austra admits that it is witholding a 190M Euro tranche from Greek rescue fund as it continues to fail to meet its obligations under the EU support agreement.
So much for all the glowing things Trichet has been saying about the European economy...
The President of the EU, Herman Van Rompuy, said, "We all have to work together in order to survive with the euro zone, because if we don't survive with the euro zone we will not survive with the European Union. But I'm very confident we will overcome this." Mr. Rompuy also added, "We are in a survival crisis."
It's absolutely not too late to hedge oneself with the EUO which is still sub 20 at the time of this writing.
Yesterday, many economists, hedge fund managers, mutual fund managers, etc wrote a petition to the Fed demanding that it immediately call off its planned QE2.
China moved curb its burgeoning inflation with another rate hike this morning.
At 11:30 am PST today, Congress will begin its, "Problems in Mortgage Servicing From Modification to Foreclosure" hearing.
Also, President of the NY Fed, William Dudley said that the Fed did not obviously know how hard the dollar was going to get pounded on their monetization announcement.
All this and a POMO of $5B+ that has seemed to have had no appreciable effect on supporting the market...Giddy up...
Ireland has now admitted that it is in talks to seek IMF/EU financial support for its government and banking system.
Finland has announced it does not approve of an Irish bailout.
Portugal admits that it may soon need assistance as it can't borrow on the public market except for at prohibitive rates.
Austra admits that it is witholding a 190M Euro tranche from Greek rescue fund as it continues to fail to meet its obligations under the EU support agreement.
So much for all the glowing things Trichet has been saying about the European economy...
The President of the EU, Herman Van Rompuy, said, "We all have to work together in order to survive with the euro zone, because if we don't survive with the euro zone we will not survive with the European Union. But I'm very confident we will overcome this." Mr. Rompuy also added, "We are in a survival crisis."
It's absolutely not too late to hedge oneself with the EUO which is still sub 20 at the time of this writing.
Yesterday, many economists, hedge fund managers, mutual fund managers, etc wrote a petition to the Fed demanding that it immediately call off its planned QE2.
China moved curb its burgeoning inflation with another rate hike this morning.
At 11:30 am PST today, Congress will begin its, "Problems in Mortgage Servicing From Modification to Foreclosure" hearing.
Also, President of the NY Fed, William Dudley said that the Fed did not obviously know how hard the dollar was going to get pounded on their monetization announcement.
All this and a POMO of $5B+ that has seemed to have had no appreciable effect on supporting the market...Giddy up...
Monday, November 8, 2010
Today's POMO: $6.26B
Despite the Fed's $6.26B POMO today, the Dow remains down 60 pts. With little on the economic calendar, we could sell off for the rest of today and tomorrow, until the new POMO schedule for the coming weeks is released on Wednesday.
Week in Review and Week Ahead
Last week the S&P climbed over 3.6% as the Fed announced a $600B Treasury buying program that will focus on bonds between 2 and 10 years. The program will last 8 months and can be increased or decreased at any time. The Republicans took the majority in the House of Representatives and gained a few seats in the Senate, virtually promising two years of Congressional gridlock and the impossibility of further fiscal stimulus. I do however secretly believe that John Boehner is being more than a touch coy when he says that Republicans in Congress will 'listen to our constituents' and deliver what is expected/desired. This could mean that Boehner and Co. run on a platform of fiscal austerity but when push comes to shove may deliver the medicine that the Democrats should have with 'just giving the people what they want' as an excuse. We also got the October NonFarm Payroll number last Friday. Unemployment still officially stands at 9.6%, although the private sector added 159k jobs which was the largest since March 2007. This string of at least technically good news has pushed the three major indices to two year highs. The Dow is now up 9.7% YTD, the S&P up 9.9%, and the Nasdaq is up 13.7%.
This morning, futures are looking down a bit as the market looks to take a breather after last week's surge. A breather, if one occurs, will probably only last until 7:15 am PST, when the FRB NY launches its last scheduled POMO under the current schedule. The amount should be approx $6.5B (assuming the PD's are willing sellers...) at which time the Nasdaq led by AAPL and AMZN takes off and brings energy and commodity prices and equities up with them.
The EUR/USD is below 1.40 this morning as the dollar gains on several major world currencies. World Bank president Robert Zoellick actually suggested that the world's leading economies should adopt some form of modified gold standard. Zoellick, in an OpEd in the FT, called for a Bretton Woods II where countries agree to a system of floating exchange rates. Gold hit $1,398.35 this morning in response.
Also this morning, Zhu Guangyao, China's vice finance minister told reporters that the QE2 suggests that the US "does not recognize, as a country that issues one of the world's major reserve currencies, its obligation to stabilize capital markets...Nor does it take into consideration the impact of this excessive fluidity on the financial markets of emerging countries." Mr. Guangyao also mentioned that he expects China to have a very 'candid' conversation with the U.S. at the G20 meeting in Seoul this weekend regarding QE2. "This second round of quantitative easing is a shock to the stability of global financial markets." With every major world economy - Japan, China, Brazil, Germany, etc - decrying QE2 as essentially insane and combative to our trading partners, I can't imagine that headlines out of the G20 will suggest any sort of successful resolution to the growing calls for the US to change its policy approach or lose reserve currency status.
We have a rather light economic calendar scheduled for the week. We have wholesale inventories tomorrow, trade balance on Wednesday, and Michigan sentiment on Friday.
Also this week will be an announcement of a schedule for the next 4 weeks of POMO, which will be announced on Wednesday.
This morning, futures are looking down a bit as the market looks to take a breather after last week's surge. A breather, if one occurs, will probably only last until 7:15 am PST, when the FRB NY launches its last scheduled POMO under the current schedule. The amount should be approx $6.5B (assuming the PD's are willing sellers...) at which time the Nasdaq led by AAPL and AMZN takes off and brings energy and commodity prices and equities up with them.
The EUR/USD is below 1.40 this morning as the dollar gains on several major world currencies. World Bank president Robert Zoellick actually suggested that the world's leading economies should adopt some form of modified gold standard. Zoellick, in an OpEd in the FT, called for a Bretton Woods II where countries agree to a system of floating exchange rates. Gold hit $1,398.35 this morning in response.
Also this morning, Zhu Guangyao, China's vice finance minister told reporters that the QE2 suggests that the US "does not recognize, as a country that issues one of the world's major reserve currencies, its obligation to stabilize capital markets...Nor does it take into consideration the impact of this excessive fluidity on the financial markets of emerging countries." Mr. Guangyao also mentioned that he expects China to have a very 'candid' conversation with the U.S. at the G20 meeting in Seoul this weekend regarding QE2. "This second round of quantitative easing is a shock to the stability of global financial markets." With every major world economy - Japan, China, Brazil, Germany, etc - decrying QE2 as essentially insane and combative to our trading partners, I can't imagine that headlines out of the G20 will suggest any sort of successful resolution to the growing calls for the US to change its policy approach or lose reserve currency status.
We have a rather light economic calendar scheduled for the week. We have wholesale inventories tomorrow, trade balance on Wednesday, and Michigan sentiment on Friday.
Also this week will be an announcement of a schedule for the next 4 weeks of POMO, which will be announced on Wednesday.
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