Earnings Season

Good morning. It was a very positive week for the market last week, with the SPY trading up 5.76 to close at 107.96 (5.6%). It was an even more dramatic move for the S&P Futures contract, which actually traded down to 1003 in the electronic session last Monday and finished the week at 1072.50, or up 6.9% from the low print. Last week’s positive move almost exactly negated the strong down move the week before, and last Friday’s close of 107.96 is a whole 9 cents higher than the close on 6/25 of 107.87. I have not researched it, but I would doubt very seriously if history has ever seen first a down move of almost 6% leading into a holiday weekend followed by an almost exact reversal in the week following. The question now becomes if the trading range we were in, roughly 1040 to 1120 in the Futures, has adjusted downwards and, if so, by how much? It seems a new range of 1010 to 1090 might be in store for us if the rally were to fizzle out near these levels.

Today is the start of earnings season, with the traditional starter of the season, Alcoa, reporting tonight. Alcoa is expected to make it back into the black (12 cents) after four out of the last five quarters in the red, although estimates keep getting cut due to falling aluminum prices. Aluminum, iron ore, and copper prices keep getting hit due to decreases in China imports of raw materials for three straight months. It is very difficult to reconcile the idea of a recovery and continued growth with both the prices of the commodities and the behavior of the stocks in the basic industries, notably steel, copper, and aluminum. While I feel the prospect of a double dip is stronger than most, in any case we are walking a fine line towards recession if the anemic growth rate we had, roughly 3-3.2%, starts to slip. It is sort of incredible to me that there is no shortage of talking heads opining that the economy is slowing, but that there is no danger of a double dip. Where do they see all this room to move lower from 3% and yet not breach the zero line? They sure could be right, but there does not seem to be a whole lot of maneuvering room there to me. I think a start back down will have trouble stopping at positive 1 or 1.5% gowth.

I think it is easy, maybe too easy; to focus on the figures of the lousy economy and lose sight of what it may be doing to individual people and their view of the future. Last Friday I attended a funeral for the father of one of my friends from Notre Dame. There was a group of roughly ten of us who graduated in 1974 that were destined to be friends for life. We basically lived close together in the dorm, played ball together, did research together, the usual college group. The funny thing is that we thought the friendships were just random happenings, and would still feel that way until this day if something interesting did not happen. At graduation weekend we all planned, and actually moved furniture part time to pay for, a big party for the ten of us and our parents. In most cases the parents had never met, but at the party it was like they had known each other their whole lives. We had not realized how similar our backgrounds were, and how predestined we really were to becoming friends. Virtually all the parents were self-made people, some owned their own businesses, and many had been in the service and took advantage of the G.I Bill. All were seriously honest people, were very pro-education, most had played sports, and all loved a good night out. They all had been able to find a good career, put their kids through college, and save a few bucks, although no one would have been considered rich.

Last Friday was the funeral for one of the fathers, one of the nicest men you could ever meet. I would say that less than half of those there that night in 1974 are still with us, but that is not really why I mention it. As I was at the funeral I was contrasting the widening difference between the life this fellow had led and what is facing young people today. He was an early computer service salesman, found some good clients early, and was tireless in keeping up with the advances in the industry and how his clients could benefit. He was able to live in a nice house (no mansion), take a real vacation every year, put five kids through college, and retire at a decent age with virtually no debt. He did make a serious investment error in putting a large share of his money in Citigroup for the dividend income to last him until he died, not knowing that the firms management had made fraud-like errors that would affect his investment and income but not their pay. Anyway, I was struck with the thought that his children would really have to struggle to do the same thing, and their children would probably have no chance. I will estimate that he was making in the neighborhood of $40,000 to 50,000 per year at the time he was paying $3,500 to $4,000 for Notre Dame, paying $6,000 for a nice car, and $65,000 for a real nice house (early to mid-70’s). Now Notre Dame is $50,000, a nice car is $30,000, and an equivalent house is $400,000 minimum. There is no way in hell his kids are making an equivalent average of $375,000-500,000 a year (although I hope they are), and I can’t even imagine what the situation might be for their kids.

It is not just the difference in money; it is the difference in self worth and attitude that affects people in bad economic times. What are people “worth”, what should they get paid? We could be morons like many and feel that everyone on earth is overpaid but you, and feel that, sure, everyone should be on this “world” scale and be willing to work for the same rate as in rural Mongolia. The fact is that people should be paid some semblance of what they are “worth” in terms of increased profit to the firm, obviously tempered by the supply and demand for labor at the time. I do not want to go into some huge economic proof of what causes wage scales to be what they are (you do not want to read it and I am not sure I could do it properly after all these years) but the bottom line is that if people bring a lot to the table and have some skills they will never be happy (or have a sense of self worth) if they are paid less. For instance, I have personally worked at many jobs through the years (cab driver, janitor, dock worker, etc.) where I was paid per hour to do something, and did it because I needed money for school, etc. There was never any question in my mind, however, that I was “worth” way more than that to the company if allowed to show other skills. If that was a company I was going to stay with, like the trucking company, there is no doubt I could have saved them money in truck routing or delivery protocols, helped in the truck procurement and leasing, helped with sales, etc. to a point where I was “worth” a lot more, and would expect to be paid for it. Now there are a lot of people not able to get into a position to prove their “worth” and be paid accordingly, and it works on the mental as well as the bank account. It is one thing to have a few bad quarters, it is quite another to lose the American dream, and to say that the ability to accomplish the good life like my friend’s father was only a one or maybe two generation phenomenon.

I believe we are not only in danger of a double dip recession, but also in seriously losing our way. We need to strike a balance between government helping in extreme circumstances without becoming a permanent crutch that the rest of society cannot afford. We need to promote not only business but competition; a market economy is not a group of monopolists and oligarchs. I do not think the shift from private hiring to public hiring is healthy, people are happier and more productive “proving their worth” in the private sector and demanding pay commensurate, with the freedom to leave and sell their worth to a competitor if needed. Government needs to assure that there are competitors, then get out of the way. People need to believe that if they improve their skills there will be a return for that effort, not some oligarch plugging you into their hole at their rate. This idea of improvement followed by hard work followed by reward is being degraded by the day. Lose that process and we lose more than just money.

As for the market, how do we trade it? Those in the Protected Index Program weathered the volatility of the last two weeks very well, and those more aggressive clients saw us trade successfully some of the new weekly strikes in the SPY. These appear interesting, as the option pricing models are less accurate the closer you get to expiration, and early on we may be able to continue to take advantage of some pricing anomalies. I am very concerned about the general slowing of the economy in the last six weeks or so, and in the fact that the VIX continues to stay in the mid-30’s even after a positive week like last week. It seems like the market has started to trade like a commodity, just reacting to currency flows on a daily basis with moves being accentuated by a lack of standing orders and low volume generally. In that vain we will continue to look for more opportunities shorter term. Make no mistake, even though the market has gone nowhere in the aggregate in the last two weeks, there was some tremendous movement and some opportunity to profit. We will continue to try and take small bites and try to get some theoretical edge using the weeklies, but we need to be involved in these shorter-term swings. As for individual stocks, I think if the economy does surprise me and begin again to improve, we have to be all over the XLF and XLE, plus individual stocks like in basic industries like AKS, X, and AA, but that is a big if.

This week is the last chance to register for PTI’s In-Office Protected Index Program Seminar on Saturday, July 17th from 9:00am – 12:00pm at PTI’s downtown Chicago office. You must register to attend. View details and sign up here – — I hope to see you there!