A Hot Mess

November 29, 2010

Good morning. The market retreated a little last week as people headed to the malls for what most prognosticators predict will be a solid holiday buying season. The SPY finished down 1.39 (1.2%) to close at 118.80, almost all of which happened during the half-day session on Black Friday. What was supposed to be a sleepy day turned out to be just that, a sleepy day, except the market opened down around 1% and stayed right there until the close. The VIX was up 23% for the week, closing up 3.96 at 23. Obviously there were a lot of important information from points out of the country that continued to evolve during the Thanksgiving Holiday, the Korean skirmishes and the European bailout of Ireland being just two. It would also seem that the “market” has priced in a fairly robust retail season, and depending on which early surveys you read the returns are mixed thus far. I would defy anyone, however, to figure out (since some people have earlier hours and some are open on the holiday for the first time) to get an actual direct comparison of this year to any previous years. I think that when the dust settles we will have seen fairly strong growth over last year, mainly because those still working are a little more confident of continued employment than last year. On a personal level it is hard to get really excited when seemingly everyone is buying flat screen TV’s and accessories, yet no TV has been manufactured here since 2004. I could also cheer a little more for APPL and the rest if they made more (or anything) here.

It strikes me, as I watch the issues unfold in Ireland (and in the rest of Europe as well), that some of the populace (in Ireland for sure) are getting a little more attuned to exactly who is being protected and who is paying for these so-called bail-outs. In this case the Irish government has issues not only of their own, but in their biggest banks as well (Anglo-Irish Bank being the worst). The rest of Europe, mainly Germany and France, seems willing to pony up money ($113B to be exact) as a bail-out loan to save both the Irish government and the Banks, with the understanding that the Irish government will undertake so-called austerity measures of higher taxes and lower services. Some people do not like that deal. They say that those who are either bondholders or preferred stock holders of the Banks (accused to be disproportionately of German descent) or even the bondholders of the Irish government deserve to take some of the hit, even though it would mean essentially a government default. Think about it (as a lot here continue to reflect on Goldman and others paid fully while others pay), why should the average John (or in this case Sean) have to pay increased taxes to send money to a bank while some of the investors (bondholders and maybe preferred stockholders) remain whole. The same could be said for the holders of governmental debt, you surely can understand how no country, in general, would like a default on their paper, but what about those who jumped in at the last minute when the rates reflected the risk? Might be different story in some people’s minds.

Do I think the Irish government should just say “Times are tough, to hell with it, just pay everyone 60 cents on the dollar (like GM) and let’s start over fresh”? Or the Banks, most probably feel a lot like “Let’s squeeze every nickel out of any owner before they get one thin dime.” Probably not, but any other solution does have you running the risk of saving some by taxing the non-involved, or saving the right people at the expense of those that always get the short end. You (meaning governments) do have to worry somewhat that at some point even those happy on the couch will get to the fed-up stage. Maybe the U.S. government borrowing the money so far, and not actually raising taxes or slashing benefits, has effectively put off the outrage until those raises actually occur.  Or maybe people will just accept it and pay, yet again (thank you sir, may I have another).

Do you think we will ever go back to a world when we can actually value companies and trade stocks without looking at the world political news first? Currently we have a European fiasco, with countries being bailed out and the solution going forward austerity in the countries in trouble. In Asia we have economic overheating potentially (possibly brought on and surely aggravated by easy money policies here), now combined with saber rattling and actual shots fired in Korea. In the U.S. we are rapidly printing money to stimulate the economy despite huge deficits and national debt totals (exactly the opposite of the policies we are seeing jammed at Ireland and Greece). We also have determined that we can’t really pressure the Chinese on exchange policies (due to conflicts of interest in large firms here that now manufacture almost exclusively in China) but we can send a carrier attack force to aggravate them in an already hot military situation. What if this Korean mess was to get worse, I can’t think of a worse time? Plus, if something did happen, wouldn’t we want China on our side?

Can the market shrug off all the outside issues and stay steady or rally into year-end? We should have a decent shopping season, but a lot of those stocks are already up in anticipation (M up 45% since July, WMT up 15%). You also have the often-cited phenomenon of retail stocks wanting to sell-off after Thanksgiving, especially AMZN. You surely do not want to fall into the trap of reading the news and thinking you are the only one reading, like “The news looks bearish, I should go short.” Yet we have seen (take the mortgage CDO’s for instance, or the problems at Lehman) that the market has recently had a tough time assessing risk, especially in areas that are relatively new to investors. Can we trust the market to adequately include the risk of the continuing problems in Europe or, and you know it is out there, some real rating agency putting the U.S. on credit alert, or even a brief war in Korea (with maybe the Chinese giving the North some support). Maybe even something simple, like the U.S. government withdrawing 30% (to a mere $700B deficit per month) of the fiscal stimulus it is jamming into the economy per month, or the stopping hiring (with all the new equipment needed) of the useless new regulators and others in Washington. What does that do to computer, or office equipment, or communication equipment sales? I am having trouble trusting the market to value all of this. On the other hand, if these crisis are all somewhat successfully negotiated and profits even grow moderately from here, the case can be made that prices in a lot of stocks and industries are at a low P/E going forward and would be worth some interest.

So how do we trade it? I think you need to stay short-term in the actual “trading” and quick to take a profit. As for investing, we will be putting some money to work in the XLF this week, now trading under 14.50, and possibly the XLE should it go under 61.50 or so. It also appears that the volatility in the new LEAPS, the January of 2013, is a little less that we have been seeing so a good thing for SPY and IWM investing as well. I think there will be some ratio back spreads to do in the weeklies between now and December expiration, but suspect those positions will have to be traded aggressively to be winners, rather than see just one big move. I am tempted to short the retailers, might work up the nerve to at least do something small.