Grind Out Some Returns
March 1, 2010
Good morning. The market ended last week down ever so slightly, with the SPY down a whole .40 (or .4%) on the week. However, that weekly summary masks a series of almost violent ups and downs on both an inter and intra day basis. For example, we had a virtually flat Monday, then a surprisingly negative Consumer Confidence number on Tuesday sent us down almost 1.5%. Wednesday brought a snap back rally of almost the same magnitude, followed by bad jobs numbers on Thursday that had us down almost 2% before recovering to almost unchanged. I guess if you were out of town and just read the paper on Saturday it would have seemed like a slow week. This is a very difficult market to trade, essentially range bound with violent moves within the range. The SPY first broke the 110.74 level (Friday’s close) to the upside on 11/11 of last year. It has had almost a classic triple top at 115.13 on 1/11, 115.14 on 1/14, and 115.13 on 1/19, followed by a low of 104.58 on 2/5. Now we have rallied back to virtually right in the middle, accompanied by even more strenuous views by the bulls and the bears than the normal din. Right now you can find opinions on the market ranging from buy of a lifetime due to the recession ending to us being in the eye of a hurricane also known as a double dip recession on the way.
The VIX dropped last week from 20 to 19.5, but still has that very troubling (to retail investors like us) skew to the upside going out. For example, the March 111 calls in the SPY closed at a 17.5 implied volatility, the May’s at a 19, and the far out LEAPS (the ones we like to be long) at a 20. Unless we really feel that we are getting in at a good price on the underlying we do not want to have volatility edge against us, and that affects the PIP and the normal calendar spreads we like to do. Unfortunately it is sort of a perfect storm for retail investors right now, market is stagnant and there are virtually no returns to be had on money balances. I have seen, recently, a growing trend among some people I talk to (some of them clients) towards almost a panic situation in regards to slowing of returns, and a willingness to really ramp up their risk profile to chase even relatively low returns. We must be very vigilant against this. Opportunity in the market is not continuous, it comes and it goes. I can tell countless stories from my trading days of slow markets causing traders to do unusual things to try and maintain income in rough times, only to have the inevitable bad result. Resist the urge to follow undocumented returns in Forex and Gold and those unregistered people on TV touting them.
If the market stays stagnant, and returns to money balances stay almost nothing, my philosophy (and the philosophy of the clients that employ me) is to stay protected and grind out the best income we can by selling calls. If everyone else is either stagnant or trying to find the next Bernie Madoff, and we can stay positive and progressing at all we will be the huge winners when and if things get good again. It is always seems personally odd to me when people accuse me of being too conservative, when I know the amount of risk I was comfortable taking in the trading pit on exceptional days. This type of a market really frustrates me, I want nothing better that to pump out returns of 15-20% a year for ten years (which would triple my money under management in ten years by my count), but right now, today, it is just not there. Right now the cards the market is dealing call for me to maintain capital and grind out some return wherever I can find it, so my clients and I will have all our bullets and more when it is time to fire. It also is possible, maybe probable; that the opportunity may come to the downside, and that the next major move may be down. If that happens, and we get a chance to both participate in the down move and buy in under $70 in the SPY again, we want to have the means to be aggressive.
What is going on? We have a worldwide economy that is arguably still deteriorating, maybe dramatically so if you take away the amazing stimulus injected by virtually every governmental body on the globe. Even before the world economy has righted itself, or early in the recovery process if you are an optimist, the sheer magnitude of governmental and private debt used to fix the problem is becoming the problem. When a governmental body tries to increase spending to combat an economic slow down, classical Keynesian Theory, the idea is for the economy to recover and then be able to repay any debt incurred when things are better. When the sheer size of the debt becomes an issue while the slow down is still happening you (we) have a real problem. The problems in Greece and Spain are just the first ones to surface. They are countries that have, over time, put themselves in a debtor situation, and due to their membership in the EU no longer have the ability to print money on their own as a way out. It is very similar to the situation of states and municipalities here; California and Illinois cannot just print money when they need it. The social fabric everywhere is starting to fray as seemingly everyone is hurling accusations of blame in every direction possible. The rhetoric will continue to worsen, to the point of social unrest, until things improve. The Germans and French (although a plan is surfacing as I am writing this) are reluctant to help the Greeks because they can retire at 61 (or something) and this early retirement age and other social benefits has brought them under huge criticism on American TV as being excessive. The Greeks, on the other hand, feel that this retirement age and other benefits are their right and that they have contributed enough along the way to make it happen (sound familiar). They surely do not plan of giving them up easily (nor will we).
Here the action is just beginning, but virtually no one can be immune to the increasing complaints about government spending, pensions, government entitlements, etc. You hear almost non stop that politicians are all idiots, incapable of balancing anything, spend, spend, spend, Democrats the worst but Republicans not much better, we have all heard countless similar conversations over assorted beverages and in any medium. No one, however, wants to look in the mirror.
Most of the money that the government takes in is spent on various programs for the “people.” I fully understand that there is overspending on earmarks and defense contracts, and huge fraud in Medicare and Medicaid, and the Homeland Security giveaway fiasco, etc., but the truth is most of the money going in is handed back out to citizens. No one wants their taxes increased, but no one wants any benefits (to them) cut either. Maybe governmental bodies are not as unresponsive as we think, maybe they are doing exactly what the collective “we” wants them to do. And why not? Isn’t a lot of the mess we are in due to regular people running up too many charges for “stuff” on their credit cards and for buying houses they could barely afford? Why is it such a stretch to say that the collective “we” has demanded a government that gave out X while taxing something less than needed to pay for X. Does anyone think that the double decision by former President Bush and his neocon friends to fight two wars without a tax increase to pay for them just happened by random chance? No one (or almost no one) had a problem with putting them (the Wars) on the federal credit card). Just like the citizen who puts the new boat on the card instead of taking a second job to save up the cash, they decided that the idea of a ten or twenty percent tax surcharge to pay for the wars would not be real popular. Maybe they would have not gotten their war if they had asked people to actually pay for it? So they just charged it. They received very few complaints.
I am really enjoying some of the political rhetoric by the various groups finding blame for the economy. I have a good friend from college (who will go nameless) that is all over participating in these Tea Parties anti-tax things. I have no problem with that, it is time the citizenry got a little charged up, but in this particular fellows case it seems odd. When Reagan tossed the air traffic controllers my friend was hired on as a controller, nothing wrong with that, and for years (20 to be exact) he had a nice job with benefits in a great area. Now he is retired with full pension in his mid 50’s, and if he lives to be 100 we will have paid him almost 70 years for 20 years work. Seems odd that he is working strongly for fewer taxes. It is not that I am suggesting that an air traffic controller, or a fireman, or a prison guard, or even someone from the armed forces, does not deserve our thanks for dangerous or stressful jobs; I just question how the rest of us can pay for all those people in their 40’s and 50’s with full retirement. I don’t think we can. My sometime co-host on the morning show, Tom Shanahan, was talking the other day how in Florida (where he grew up) virtually every small town policeman he knew had joined the Armed Forces early, retired in their early forties, and now had a full pension despite being totally healthy with another full time job. Some, joining real early, were able to retire from the police after 20 years and had the 2 full pensions while still in their late 50’s. Another friend from my alma mater really has it going. He retired after 20 years as a Captain with full pension, and then was hired back as a consultant in his old job at full consultant salary while also collecting his pension (in his mid-40’s).
It is probably the sacred cow of government pensions; the lifer armed service person getting a pension after 20 years. It stems from the days when people in the armed services made a fraction of private sector pay in sometimes-great danger protecting the rest of us. Now the pay is better, especially for officers, the college and other training provided costs geometrically more, and people live a lot longer. Am I dissing the Armed Forces? Hell no. I just think that maybe if the person is perfectly healthy and easily gets a full time other job maybe the pension should be partial until 65 or something. What I do know is that the economics dictate that we will have this debate someday. Otherwise close to 100% of the defense budget will ultimately be paid to people no longer active and for no equipment or supplies. Does anyone not know someone who has had the government pay in the hundreds of thousands in Medicare bills while they had paid in a small fraction of that amount? Let’s all take a good look in the mirror before accusing everyone else of stealing all the money.
Having said that, people are not looking in the mirror. The stress and conflict between governmental employees that feel “entitled” to benefits that the private sector is rapidly losing is just starting to bubble. I feel that we may have a series of rapid fire Chapter 9 Bankruptcies (governmental agencies) that will serve to strip away many of the benefits civil employees are contracted to receive, with all the accompanying strikes and stress. I do not see it possible for our electoral process to deliver candidates with the courage to tackle these problems. Surely our President has no clue, as it appears that the gap in salary and promised benefits between all his new hires and the private sector is about as wide as it can be (average federal salary is about 50% higher that private sector, with benefits additional). Governor “Arnold” of California has attempted to address these issues, but has failed miserably in light of the fact that his two biggest issues are with his two biggest constituents, teachers and prison guards. It (meaning a solution) will probably not be addressed through the political process, but through the courts, and if that happens we will have real social issues here.
What does all this mean for investors, and why do I keep flying off on these political tangents when all I am supposed to do is invest and make money? Well, it is all tied together. When I have client call and ask me to help place a large sum of money in municipal bonds, I have to be mindful of the shaky ground a lot of the taxing bodies are currently on. In the last two weeks, Harrisburg, PA seems to be indicating they will let an incinerator they built default, as will the Las Vegas Monorail system. What about Illinois, is the single A rating allowing investors here to get one percent higher that a triple A state worth the risk, or is the absurd corruption here making us destined for a disaster. These are not easy questions, my guess would be that single A is way too high in Illinois, as any tax increase high enough to address the deficits without dealing with the two sacred cows of entitlements and corruption either will not pass or will be met by some exodus by those supposed to be paying (Indiana is not that far).
I think we have to be more careful than we ever have to preserve equity, and to grind out some income whenever any opportunity arises. It may involve a little more short-term trading, a little more volatility trading, or just plain waiting for the right time. We have scheduled a Protected Index Program Seminar for March 20th (SEE DETAILS and REGISTER HERE) that will address for current clients some other strategies we might consider using in stagnant markets to compliment the PIP, and this will be followed up by an online conference for those out of town. We are certainly not going to chase returns where there is no opportunity, but adding a few strategies that everyone learns about and becomes comfortable with to our arsenal is surely a good idea.
If we use our heads, and have patience, we will win in the end.