August 22, 2011
Good morning. It was yet another week of selling in the market, with the SPY finishing at its lowest level since Sep. 17, 2010 at 112.64, down 4% on the week. That number also represents a yearly decline of 10.4%, and at this point (based on Friday’s closing action) the market is not showing much sign of an impending bottom. The VIX is also indicating increased fear in the market, closing up 6.67 (16%) at 43.03, a historically very high number. It continues to be a somewhat mysterious market phenomenon that the costs to “protect” stock market assets in the form of put prices increases greatly as the asset loses value. In other words, the “market” was not nearly as willing to purchase price protection relatively cheaper during the rally and with a SPY price of over 130 as now when the price is almost down to 112. Those in a program like the Protected Index Program or who do something similar with their individual stocks (a service we provide for many clients) have seen their portfolios perform much better during this period than the general market. I honestly never trusted the QEII induced rally, felt it would be a failure in the end, and it seemed to me just a rerun of the Y2K monetary blast contributing to the dot bomb fiasco or Greenspan’s expansion of several years ago leading to that eventually burst stock bubble. Even though I felt the market had risk, and made recommendations that people to stay protected (making sure those I manage money for were protected), I really did not anticipate this type of sudden collapse. The rapidity of the collapse, and the daily volatility swings, made it really difficult to own extra puts, or to hang on to them for any length of time.
I think that most of my blog readers and listeners might say that I accurately predicted the ultimate futility of QEII and the markets fragility, but to the extent that is true it surely does not feel like a celebration is in order. I know if I had a dollar for every time on the air I said, “Believe me, I really hope I am wrong, but it looks like we are heading the wrong direction, with a problem down the road” I would have many more dollars, but it does not feel as good as predicting something positive that does occur. Just like the wake I attended last week of a dear friend and former partner who was a heavy smoker his whole life, and maybe could be anticipated (on average) to not be as healthy as he aged, it did not feel so good. In fact it felt awful. Plus, if I was so sure of the timing of the market collapse I should have had some extra puts for everyone, including myself. The fact is, every time it is different, yet history also has patterns if you care to pay attention to the small hints. I was thrown off, as were many I am sure, by the split between how well the top 100 companies appeared to be doing (some still seem that way) in the face of an economy that never really emerged (for most of the population) from the recession of two years ago. With enormous growth overseas, cartel or oligopoly like concentration (thanks to our spaghetti spined last four Presidents in regards to anti-trust) in many industries, almost treasonous pilfering of the governmental till by some of those same companies in regards to contracts and tax dodging, I too took a little drink of the Kool-Aid that maybe they (and the broad market) were untouchable. In fact, I had thoughts that I was being old and nostalgic in thinking the market could not prosper forever without the rest of us being on board for the good times. Anyway, I was right enough to keep everyone protected, not confident enough in my convictions to have extra puts. It was better management performance than just about everyone, but not satisfactory to me.
Why no bottom yet? Will we get the save out of Jackson Hole this week, a year almost to the day that the ill-fated QEII came flying to the rescue out of the same conference? First of all, I have two problems with this conference. The first is that I (or probably anyone like me) am not invited. It is supposed to be for only the greatest economic minds, and those that have money enough to act like great minds, or pontificate like someone who is supposed to know something. In fact, I think these great minds, from Bernanke on down, are totally out of ideas, and it has become increasingly obvious over time that they have misjudged this economic calamity, have not addressed the root causes, and are blinded by the “system” to the point of not being able to think outside the system towards solutions. I have said before in this blog that the current economic calamity is not just the normal ebb and flow in the business cycle that most recessions and booms are associated with, it is way beyond that and totally different. At the root are two specific issues. The first is an almost 20 year degradation in income of the average worker versus prices of anything important (despite messing with the price indices and other games played by the government to say it is not so). Very briefly, workers in the late 70’s were able in many cases to make in excess of $20,000 per year, and even when I worked on the truck docks in 1976 I made roughly $8.50 per hour plus overtime (so I could have made it to $20,000 or so). This $20,000 is right now, today, an unattainable goal for a lot of workers. However, in the mid-70’s, a nice car cost around $5,500, a house $50,000, Notre Dame tuition maybe $5,000 per year, health care (guessing) less than $100 per month. Anyone care to try today’s numbers? Car $25,000, house (even now) $145,000, ND $50,000+, and health care in the hundreds per month if healthy, unavailable if not.
So why did it not feel like things were slipping to that extent? On reason was the build up in asset prices, houses continued to run up, and since 1981 the market pretty much (except 1987 where the market still finished up on the year) did likewise. Also any investment in fixed income was a stone cold winner, as interest rates went from high teens to, now, almost zero. We became a nation of owners, not workers, and these asset prices reached very high levels. At one point, one that I actually wrote about before the real estate crash started, we reached the absurd level of a household needing to make roughly $85,000 (with a 20% down payment) to afford the median house. The only problem with that was that (at the time) the median household income was in the $45,000 range. Flip on top of these two issues a long term policy of allowing ridiculous mergers within the same industries destroying jobs and increasing prices, and now a stock market collapse, and “imagine that!’ we have a “sudden” problem.
Is our current political system, complete with the incredible ties to the lead player’s in the economic system (banks, multi-nationals, etc.) capable of defining and moving to solve these issues? A more careful reading of some of the social issues during the 1930’s shows quite a connection between degrading faith in the economic system and lessening faith in the political system. In fact, Armand Hammer’s (from OXY) father was essentially put in jail because he attended a socialist rally in the early 30’s or thereabouts. Despite accusations flying these days about “Socialists” and “Communists” running around, or maybe even in Washington, when the economic system stops working for the many and seems to be working quite well for the few it does not go un-noticed. Is our current system of elected officials, essentially being given big money by the few over a long time, capable of change? I read about the new far right savior from Texas, Governor Whoever, and how much his inner circle was “rewarded” out of the state coffers for supporting him ($25M per year for a race car track owned by a guy giving $400,000 to his campaign) and I think I am Illinois. Can our system work under pressure? Is there really much difference going forward (obviously there still is in terms of some freedoms and certainly in history) between a one party system run by the oligarchs in Russia and a supposedly two-party system here bought by the new oligarchs? Are we really that secure in our freedoms in the “information age?” Would our political system have survived the late 30’s and 40’s without WW II? I think I would like to think so, but am not sure, and I am getting very fearful right now.
Five things have to happen right now, but will not, therein escalating the fear:
1) We must find a way to help those current on their mortgages to refinance to current market rates. Someone, not the slimy banks currently servicing mortgages, needs to contact the owner of the mortgage paper and say, “Here is the deal, the property on this mortgage has a note value of $200,000, the property appraises at $120,000, but these people are willing to stay there if you drop your rate to 4.5% from 6.25%. Answer may be yes, may be no. Next question. We have a group that is willing to give these people a loan (combo mortgage and personal) for $160,000, and we are willing to send you that check as full payment, if you agree. If not, well, you are on your own and the next call might be with the check for $120,000.
You can’t go totally against contract law, but the current mess is nuts.
2) Charter at least 1,000 new Savings and Loans, who would be charged with helping create a new housing system. They would initiate the loans (could be with outside broker) and maintain on their books 15% of the loan. The rest would be graded (with some common sense) and sold, maybe to investors from the area.
3) Stop all mergers of competitors. If some group wants to buy Maytag because they feel it is poorly run and has buried value, so be it. This is America. That group cannot be GE or Whirlpool, however. We are trying to maintain competition, not destroy it. Does anyone think that merger by competitors (at some point) does nothing but cost jobs and raise prices?
4) Force China to let their currency float or boot them out of the list of favored trading nations. That should have been a condition from the start. I realize that owing them way too much complicates this, but it has to happen or tariff here we come. Let’s take a stand while we still have more aircraft carriers than they have.
5) Make the Corporations obey the law, not the slimy little escapes in the law they pay people to write in, but the spirit of the law that everyone else has to live with. Get the money they owe in taxes, from money actually made here, back here or start putting on the cuffs. Sorry, Mr. Clinton, Mr. Bush, and Mr. Obama, most of us are not ready to hand things over to the sovereign state of AAPL, GE, or MRK. Get a pair, and Man UP!! I don’t care if you serve them warm water or whatever you did during the banking meeting during the crisis, be the alpha male in that room and realize that you have 300M pissed off people behind you. Their will always be another company, another U.S. I care not to leave to chance.
OK, enough of that. I would like to hear if anyone agrees with me, however, or whether I should retire to some declining price home next to a golf course with a year round bar. We need ideas and people with courage. Do we have them, and will they surface in time? Anyway, how to trade? I have put a few small positions on for the more aggressive people (including myself) looking for the top in bonds, and the bottom in interest rates. With the prices of goods rising, depending on what index you look at, somewhere between 2.5-4% on an annual basis, and the market rate on the ten year note at 2% it would seem that we have a negative real interest rate somewhere between .5-2%. I think that cannot last, but so far have been early in positioning for a move the other way. I still think this will be the trade we want to have, and am looking to try again with the 30-year over 140 in the September Future. I also think we need to be short gold somewhere here, but maybe can wait as it is quite a rush to run it higher right now. As for stocks, we need to stay protected but maybe will be willing to let out some out of the money puts against our long protective puts in the volatility gets too crazy. Also, for those looking to accumulate some stocks lower, and having the money to take delivery (hence a cash secured short put) it might be time to start looking. It would not surprise me, however, if we did go somewhat lower. Be careful, have the big positions protected, and either speculate or bottom fish small if something looks good, that great buy might be an even better buy next week.