Full Speed Ahead
April 20, 2009
Good morning. Yet another positive week for the market, making it five advancing weeks in a row! Is there anyone out there (except the talking heads on TV who seem able to revise their predictions on the fly) who would have thought that on those dark days of early March? I look at some of the bullish positions I put on at that time and am amazed at both how much those positions made, but also by the very small size I chose to do them. Let’s face it, it was pretty scary even though the prices were very low and the high volatility gave a level of protection rarely seen in just selling covered calls. I would not have wanted to be in any sort of unhedged position when the financial world looked so perilous. Anyway, last week the SPY was up 1.5%, from 85.82 to 87.08, with the bigger story being the continued decline in the VIX, from 36.52 to 33.93, a level not seen since last September. Today, so far, the futures have us in a fairly steep slide. Apparently, the sell-off is in part due to weekend reports that the government is not just going to let banks return TARP money with no further considerations. That story will be one to follow.
As we used to say in the OEX pit, is it time to “Jettison all put insurance, full speed ahead”? Clearly the VIX is indicating that the investment world is not nearly as nervous about the state of the market as it was in March. In fact, the LEAP puts in the SPY (the ones we buy for the PIP program) are now cheaper for the at- the- money puts with the SPY at 87 than they were when the SPY were under 70. Some of that is clearly due to the newfound relative health in the banking industry, as many of the large banks (notably JPM) posted solid first quarters. They have gone from going out of business to being accused of making too much money in a few short weeks. What the rest of us might have done with multiple billions of government money, but we can only dream. Besides, I don’t think my moral code would allow me to use it to extort money from people at effective rates of over 50% (interest + fees can be at least that). But in the immortal words of academic minded Fed Chairman Big Ben “We have worked to make sure that the charges were fully disclosed.”
In Illinois we continue to hear an amazing drumbeat about cleaning up government in our state (we are also hearing about reform in Washington). I mentioned last week that our new Governor, Mr. Pat Quinn, has thrown all the blame on disgraced Gov. Blago, and has vowed to “clean things up!” It is interesting, most people make fun of Economists for their relative inability to agree or to predict the economic future, and I would agree with that assessment. However, Economics in a big way is more of a behavioral science than one designed to predict economic numbers. For instance, in regards to political kick-backs and pay-to-play politics, economics would say that as long as pricing for contracts and other government spending is not competitive there will always be people willing to step in, and that there will always be distribution (kick-backs) of the excess cash. I am not one, when someone shoots someone, to moan and take the liberal view that somehow society has failed the shooter and “really” we are all at fault. I will say, however, that until we (citizens) fix the procurement system on the state level and the definition of jobs on the city and county level we are doomed to real fraud forever, even with the steady stream of people going to jail. Take a look at how putting huge amounts of drug dealers in jail has not stopped the next one from stepping up due to the size of the carrot.
Let me be very specific. In Illinois (and other places, including Washington) contracts for virtually everything are not economically competitive. They are sort of competitive, but the competition is defined by how far you can get your head up the behind of the politician in charge of letting the contract. For instance, suppose we are talking about a security contract at a string of state buildings, or vending machines, or anything. Someone fair could design a bidding process (easily) that laid out how much you could charge, what services would be required, etc. You could also list that contract in the public domain, encourage participation in the bids, etc. The resulting price would then (if you did your job right) be competitive, meaning that there would be little room for graft. If I get a contract to provide security for $25 an hour, and it costs me $20 (meaning, with other expenses I am probably making something fair, not exorbitant) I might entertain a couple of phone calls demanding payment in various political ways, but very quickly I am going to say “Hey, I am not making that much on this deal, and by the way I won it in a competitive process, go buy your own tickets to the Judge’s (who I have never heard of) fund raiser. On the other hand, if some slimy politician was able to “slide” me that contract at, say, $40 per hour and I am still paying $20, there is a lot more room for graft, and a lot less chance that I will say no to the inevitable phone calls. It is that ability for the politician, or his group, to overpay with other people’s money that causes the graft, and the resultant ability to direct whom else can enter power (by being able to direct money to various lower level campaigns) that solidifies the power of the slimy pol. Think Dan Rostenkowski or Eddie Burke, they use (or used) their considerable influence to determine who enters office, and the new office holders all owe allegiance. Until someone, through constitutional convention, armed revolution, or something makes the process competitive; effectively minimizing the available “pool” of graft dollars, putting individual people in jail does really nothing. Next week we can talk about alderman and their special edge, which should be fun.
What about the market this week? My guess would be that our streak of up weeks gets broken. I think the government has effectively (but not efficiently) put a floor under the large banks, and the risks are lessening from that sector. Now we are back, however, to the real problems present all along. People’s wages, due to lack of wage increase or no job at all are still not growing. For the foreseeable future we continue to see job losses the size of a large city every month, and those are only the one’s we count. Most estimates have the real unemployment rate (counting part timers wanting to be full time, contract people, etc.) at over 15%. That is a massive drag, and really being felt at the state and local levels. If the rate gets much higher we will continue to see the initial signs of social unrest. What is worse is that the mistake of raising taxes that the Federal government is at least sensitive to might be totally overrun by increases in state and local taxes (or fees, if you are Mayor Daley and assume all taxpayers are total morons). As for the market, my guess is that we have entered a new range and we may stay here for a while. The challenge will be to fix enough things so that when we break out it is to the upside, not down again. The decreasing put prices mean we will probably put a little more into the PIP, but will keep the calls closer than in the last few months.