Competing Against Fear

August 16, 2010

Good morning. It was a sharply down week for the market last week, with the SPY closing at 108.31, down 5.08 for the week (3.6%). The VIX, as expected with the market down, ran up 20.7%, closing up 5.5 at 26.23. The close Friday on the September S&P Futures contract of 1076.10 is fairly close to the midpoint of the post-holiday low of 1003 (in the pre-market session on July 6) and the high on August 5 of 1127. Again the market seems to have put the hurt on those who listen to prognosticators that like to be momentum type players. By momentum players I mean those who look for market breakout points as signs of strength and buying opportunities. How many times have you heard someone say with a bold face and the S&P trading at 1090, “If the market rallies and we take out the 1120 number you need to be a buyer as the next stop is 1200?” It is somewhat rare for Dr. J and I to agree totally on anything, but both of us would rather buy at 1090 and happily sell to this fellow at 1120. For the time being, it seems, the market seems range bound, and we should be thinking of getting a little longer in the bottom end of the range, and shorter near the top.

I can honestly say that in my investment life I have never faced the challenges like the ones we are now facing. People are downright afraid, the market shows no signs of making things easy anytime soon, and the social and economic landscape is stagnant in a bad place (and that is optimistic). For years I have happily competed for money management clients, and was (and am) very confident that I can bring more tools and talent to the table in any discussion involving risk aversion, principal protection, and imagination regarding option spreading and volatility management. I never felt I could lose competing for a client on the basis of which money manager was better over the long haul. Now, however, the discussion has taken some ominous turns. In many cases I find I am not competing against another strategy or another person, I am competing against fear. It used to be that people wanted to invest, and were searching for someone to help that had the most grasp of their needs and risk parameters, and to quite truthful I was successful at being that chosen person way more often than not. It is different now, I am competing, in many cases, against “I can’t take any risk, I know 1% in the bank is awful, but that is where we are right now.” Even though our signature PIP Strategy limits risk, and since 1998 those with us from the beginning have never been down, and we have beaten the S&P an average of 5% a year for eleven years, it is still too risky for many in today’s environment.

Why is that? Maybe my brother Dan Haugh said it best in his national TV interview on First Business last week (watch it here). The interviewer asked him essentially why is it that people are reluctant to invest even though all the pundits (maybe they are the problem) are saying what a great buy everything is. Dan’s response (clearly what she did not want to hear) was that people like our clients are experiencing risk in all other aspects of their lives like maybe never before, and it is not surprising that they are not anxious to increase risk in the market. We at PTI have a fairly high net worth clientele, with a lot of small and mid-sized business owners, many people in high paying jobs with kids in college (a serious draw down on savings), and a lot of retirees living off investments and pensions. Every one of those groups is experiencing stress. I used to say in my lectures that the normal investor was happy (or would accept) somewhere in the neighborhood of 10-15% risk on his or her investments if everything went to worst case, and the PIP Program was designed with those risk numbers in mind. Many times I have asked the question “If the market was down 50%, but you still had 85-90% of your investments with no further risk of loss, and were able to take advantage of those low prices, would you be okay with that?” The answer to that question, in normal times, was almost always yes. Now, however, that person may be seeing his business of 30 years being hit with decreased revenues and increased costs from all sides, to the point where survival is a matter of chance. Or maybe the high paying job of many years looks increasingly at risk. Suddenly that 10% risk in someone’s investment portfolio or retirement portfolio looks a little bigger and a lot scarier. It is also possible that the person had multiple investment strategies; some not protected, and has taken portfolio hits from the market. In all, pretty tough times.

Despite the times, the idea of investing is to look ahead. The market, so the theory goes, will look past the current problems to when the economy starts to grow again, and will rally into that growth when the time is right. If you are on the sidelines you will miss that move, or so you are told by virtually everyone. But the current problems are pretty deep. The politics of the situation are horrible, with our elected officials showing on both sides of the aisle the total dearth of any kind of forward thinking. On the one side you have the steroided Keynesians looking to government to be the total answer, despite years of history and studies showing that bigger government in general is not the answer. On the other, you have the just say no to everything except a tax decrease to rich people group, who secretly hopes that we go deeper into a mess so they can get into power and do exactly “What?” In the most bi-partisan thing I have ever seen in politics (I was not yet alive for the near unanimous vote to enter WWII) both sides fell all over themselves to spend hundreds of billions to bail out financial institutions while totally leaving out those on the lower end of the very same loans. No wonder the banks are whole while a real lot of people living in the homes with bailed out loans are still in a degrading state. That will haunt us for decades, as will the ridiculous name-calling of which side was more responsible. Stop the arguing, they both were involved, and it was an abomination.

Why do I say that? I say that because there was a better way, and if the people we hire to govern us would ever take their eyes off the next check maybe they would have seen it as well. If you or I have a problem with a mortgage, and the house we bought for $300,000 is now worth $220,000, two “people” essentially have a problem. One of those is I; maybe I put down $30,000, which I am now out, plus another $50,000 that the home is “under water.” The Bank, or mortgage holder, also has a problem. They have lent $280,000 on an asset that is now worth $220,000, so they are potentially out $60,000. Obviously no one ever thought home prices could decline by that magnitude (or at all) in such a short time, and they are showing no signs of going back up. Everyone was wrong, me for buying it at that price and the Bank for loaning me that much money. If the government wants to help, one choice would be to send a fortune to the banks and buy a bunch of those loans from the Banks for full value, in essence refloating the broken banking system at a huge cost to the public at large. That choice would also totally ignore the problems of those actually in the houses, and that was the chosen choice.

Another way to do it, which was ignored, would have been to try and help both people in the transaction, bank and homeowner. The government could have sent some sum of money (a trillion or so dollars divided by 100 million or so mortgages is roughly $10,000 per mortgage) to each mortgage holder, behind on payments or not, and make the check only payable to the mortgage (or towards a new home for a renter). The money would still made its way back to the Banks, but at least everyone would now owe $10,000 less, how many people could have saved their homes with even that sort of a boost. Why forget about the owner, and just fatten the loan holder? I am not recommending governments generally send $10,000 checks to people, but if you are going to give money out for bad loans, at least give it to both people in the transaction.

All right, what is my solution for dealing with this absurd economic and political mess? One thing is for sure, most of the people we know will get no real help, and we will have to move forward on our own. On the state of the individual business owners and those with jobs they are either worried about or are overqualified for, that is just going to take time and good management to overcome, and we all know that. Whether you are running a restaurant, bar, manufacturing business, small bank, radio show, or, yes, a securities firm, now is the time to use your skills to not only survive but to concentrate a little of your thought process on how to take advantage of opportunity that may present itself. If you are in a job that looks wobbly, you need to broaden the skill set for the dark day that may, or may not, be approaching. I have several friends in the trading business I have advised to take brokerage exams and take some classes to broaden the resume. My significant other, lady with skills in investments and real estate, has taken several qualifying exams recently to be able to deal with foreclosure property. Hopefully it never becomes the mainstay of her business, but you have to be ready.

What can we do to help at PTI? We can again offer our services to those looking to better understand all their investment risks, both in accounts here and elsewhere. Maybe we can help hedge exposure in a 401k that must stay where it is. We can be pretty imaginative. We can also find ways to cut the potential risk in an investment to lower than 10% if that is what it takes for our clients to participate some in a recovery if and when it happens. You have taken the time to identify a firm that has some people with ideas, it is now up to you to use us and tap that talent. I think we can help every person do something better than giving up and giving some Bank your hard earned cash at 1%. I, for one, can’t sleep with the thought of someone using my money at 1%.

So what about some new strategies? One real positive development in the last few months has been the introduction of weekly options in the SPY and some other areas. It has enabled up to go long some premium (looking to benefit by a large move in the market) while tempering that with a short premium position in the weekly. So far these positions have shown promise, and right now everyone in the SPY PIP position is set up to benefit either if we have another bad week like last week or we go flying back up. There are, and will continue to be hopefully, some small short-term positions we can benefit from with very small risk that might sustain us and put some positive return in everyone’s account until the market returns to some degree of normalcy. We have been trading these weeklies more aggressively for those that do trading outside the PIP, and so far we are in the black. It seems like, for the moment at least, the weekly options are a little mis-priced and we will continue to trade them until they are not. I also think that if the market continues lower we will cautiously invest some in the banking, health care, and energy areas. We are also doing some research into a basket of high dividend paying stocks that we would hedge with some broader based options. Again, we are here if you want to talk. Let us not only survive, but also profit, by what is going on.

If you are seeking portfolio protection and would simply like to discuss whether or not we would be able to help you out with our Protected Index Program (PIP) – please give my brother Dan Haugh a call toll free at 800.821.4968 (M-F, 7:30am – 4:30am CST) or e-mail him at Dan@PTISecurities.com with any questions you may have. Information about the PIP can be viewed here .

As of 7/31/10, the Protected Index Program® has beaten the S&P 500 Index by 31.11% and the IWM Russell Index by 23.08%. PTI is planning on having another in-office fall seminar covering the PIP strategies and we will post that date as soon as possible. However, if you would like priority notification, e-mail our Marketing Director, Sarah McNabb at Sarah@PTISecurities.com and be sure to mention that you saw this in Tom’s blog.