Back to Deja Vu
May 29, 2012
Good morning. It has been a while since I have written, and most have followed the markets and the news by listening to our morning radio show “Stocks and Jocks.” I have been reminded, however, by our new and very bright internet and marketing manager, Lisa Tom, that this blog is very widely read and a lot of our clients and soon to be clients read it and comment on it very faithfully. In addition, I enjoy writing it. So I am back, and welcome to Lisa Tom, as she settles in you will soon be seeing new and interesting things on our website that will incorporate more fully a lot of the advantages PTI has gained through our new Clearing relationship with Royal Bank of Canada (RBC). Please feel free to comment on anything I have written, to either ask for clarification, dispute what I have written, agree, whatever. I will surely try to answer all. There is a lot going on, economically, politically, in the market, you name it, the objective is to stay current (at least) and to constantly try and beat what the market is giving us with limited risk.
Last week the SPY’s were up 1.8% to close at 132.10, virtually all of which occurred during a big rally last Monday. Friday’s close represents a 5.2% increase from the close of last year, but a 7.1% decrease from the (so far) yearly high of 142.21 on April 2. Right now it looks like a rerun of the last two years, with the market having a relatively strong start only to fall victim to slowing economic activity in the late spring. This year the “slowing” of the economy does not seem as acute (in fact a lot of the numbers do not show any significant slowing at all in the U.S.) but it is magnified some by obvious slowing in Europe and a combination of perceived and documented slowing in China and Japan. The question, even on a very simple level is: can the U.S. essentially go it alone and have a recovering economy while other large economies may be contracting? It is possible but not really the standard case. In fact, I believe it would be historically very unusual to have that sort of a bifurcated global growth pattern.
The other issues on the table for the economy are many, and the solutions seem not only elusive but also inconsistent so far. We seem to want to continue pursuing expansionary monetary and fiscal policies domestically, seemingly without limit. Simultaneously, we are vigorously cheering aggressive expansionary policies by the European Central Bank (printing money and bailing out Bank capital issues) while demanding almost instant deep cuts in deficits in individual countries (so-called austerity) that (if you assume the “theys” are right about policy here) is sure to throw those countries in a deep recession or worse. The amount of stimulus in this country has the applied stimulus needle pushing past extreme to almost laughable on the meter.
On the fiscal side we are maintaining an almost $100 B deficit per month, representing roughly 7.8% of GDP on an ongoing basis. Monetary policy is following the same “plan,” with M2 growing at a 9.7% rate in the last 12 months despite a growth rate of the economy at roughly 2.5%. Like I said, expansionary to the extreme, without any regard for the repercussions down the line (increased inflation, increased interest costs to a fiscally challenged government, increased dependency on foreign lenders, etc.). In fact, the monetary stimulus is so severe that some have calculated that over 60% of the net buying of Federal debt has been the Federal Reserve. In other words, one branch of government is buying the debt of the other with manufactured money. Yet we will have people in the Fed speaking on record that the demand for Federal debt remains strong, when, in essence, they and their printing press are the demand. Seems like fiction, but unfortunately not.
So really the conundrum remains the same, short-term economic data and company earnings (especially in industries closer to the applied stimulus and having pricing power) showing progress and pointing towards sustained recovery, while the longer-term prognosis (increased debt, uneven recovery, and inflationary threats) might give an investor a different view. Many also hold the suspicious view that the US Banks will remain vulnerable to any hiccup in Europe despite the unconscionable amounts of money that have been advanced to the Banking system. To those that believe they are vulnerable to the problems in Europe, the recent JPM losses only bolster this view. After all this time their risk seems still undetermined, and they will obviously fight to the death with other people’s money to remain unfettered.
What about the political debate? A lot has happened since my last blog, but it sure seems like we are still in the same place. We have a President who obviously feels that massive governmental programs and hiring is the solution to any problem that arises, clearly not a view that shows any study of economics or history in general. At his side is a group of advisor economists that continue to push for more and more stimulus, regardless of the risk. The alternative is now officially Mitt Romney, a huge fan of big business. He appears ready to impress upon us his own version of the Trickle Down theory, where you concentrate only on making the rich richer, and hope that they throw off enough largesse to bring the rest of us unwashed losers along with them. Neither, to me at least, has shown any sense of comprehending the depth of our economic (and by almost definition the accompanying social and psychological problems associated with it) issues that to me are obviously negative patterns that are at least 20 years in the making. The problems are as complex as anything I have seen or read about since the 1930s. It is hard to imagine the solutions are simplistic or can be summed in a small set of politically popular one-liners. Yet, that is what we are seeing.
How can all the individual problems causing the current malaise (small list might be lack of growth in real median income throughout the population, uneven pricing power due to a wide disparity between competitive, monopolistic, and oligopoly type industries, huge disparity between the haves and have-nots regarding increased governmental business, total demise of the family economic unit in some areas, partial demise in others, ridiculously over-priced education and resultant debt overhang, and many more) be boiled down into a relatively easy to understand series of affordable fixes that begin to move things forward? Or is a total collapse needed before people wake up? Don’t think it’s impossible that it would take something like a governmental default before people get serious about the fix we are in. Then there is the idea of problems just being too big to understand. Can anyone imagine a trillion dollars? I can’t. That inability, as you can tell by the debates on our radio show last week, can cause people to point their finger at their least favorite governmental function and identify its “fixing” as the solution. If you are from the Right you will identify governmental spending on regulation, transfer payments to the poor of various kinds, etc. as the “fix.” If you are from the Left you might pick defense as an obvious place to start, or tax breaks to the rich. In fact, if we got rid of all defense spending and stopped Social Security totally, that would just about equal the deficit. We would have no deficit (assuming an immediate depression did not ensue). We would also not have checks for old people and not one soldier or ship or plane for defense. Anyone really want to go in that direction? Long live the simple one liner, way more palatable!
So how do we trade this mess? There is movement within the ranges, there are weekly options which sometimes have some pricing disparities (earnings sometimes give some opportunity), and we are sitting at multi-generational highs in Bonds (record low yields) that are poised to reverse (someday). I think you need to combine a lot of what is available to stay ahead at this point. What I mean is that you need to trade the ranges, both in the broad market and the individual stocks and sectors, but maybe need to use the option product to find some volatility edge, and maybe use the weeklies to keep the costs down (realizing that the weekly expires very rapidly). Normally I would never ask investors to look at rapidly expiring options (weeklies being the most rapidly expiring). But if you are trading, say, an announcement from Europe regarding Greek debt two days out, you need to get the lowest initial cost position that might work and make use of any disparity on option pricing should it exist. Now more than ever I think it is incumbent on traders to be more sophisticated when they trade, and if they need it, get some help. I am using all the knowledge and experience of 31+ years trading to try and protect clients’ money while increasing the returns over the zero being earned on cash balances, I can’t imagine trying to delve in here and sort of learn as I went. Trading is tough right here, make no mistake, but not impossible. Having said that, we are looking to increase clients’ investments in both the XLE and IWM right in here. The long-term volatility in the LEAP puts is slowly coming in for these two ETF’s, and is now at a point where we have a reasonable chance of paying for that put by managing a corresponding covered write position. It also helps that both the XLE and IWM are significantly off their highs, meaning that even if things go against us, over time we might be able to get back above water. That is really all you can ask for: pricing to line up so that if you are right you profit and if you are initially wrong you have a chance to claw back. Looking forward to your blog comments.