December 20, 2010
Good morning. Even though the SPY had several minor up days last week, as the market continues its gradual but steady rally, it actually closed down 18 cents to finish at 124.30. This is due to the 60-cent dividend that came out on Friday morning. For those not really familiar with the process, the day a stock trades ex (or without) the dividend it will open down the amount of the dividend (and will be considered unchanged at that price) and several weeks later you will see the dividend be added to your account (or get the check if so directed). For example, last Thursday night the SPY closed at 128.82 and went ex on Friday (dividend 60 cents). That means that on Friday morning the SPY would open unchanged at 128.22, and closed up 8 cents on the day at 128.30. What happened to the 60 cents? If long the SPY you will see it in your account in a couple of weeks, so any slight decrease in your account value will be made whole when the dividend is added.
The bottom line on the market, then, is that it continued to move upward. This is due to continued increases in commodity prices (no inflation, however), continued Federal stimulus, increased profits at a lot of firms, and a momentum that has most investors very comfortable and worry free. The VIX closed at 16.11 (down 9%) to close at its lowest level since April 20, 2010, right about the same time that the market started a solid correction of almost 15%. It continues to concern me that it seems like we have seen this movie before, both in 2000 and 2007, when the Fed (inadvisably it turned out) pumped money into the economy only to create a short-term stock market bubble. This time, however, it actually seems to be the Fed’s stated goal, to re-ignite inflation, and if the market gets ahead of itself as part of that, more the better. It helps even more (if you are a Fed member or politician) when those trying to determine if Federal stimulus efforts are working use the increasing stock market as a barometer for success. How many times have we heard recently something like “Clearly the market is voting positively for the program and thinks the economy is on the right track.” That may be the case, or it could be Federal dollars being forced into the market like we have seen before, with the same negative result when the programs stop.
How can there be such disparity among seemingly bright people on their visions of the economic future? Clearly if you look at the corporate earnings results (especially if you look at the results in industries somewhat concentrated) you see good results on the bottom line, some good improvement on the top line, and increasingly some serious pricing power (FDX increasing rates nest year, DOW increasing rates successfully, WMT raising prices over last year). You also hear people opining about the obscene amounts of profits possible when the Fed is injecting cash, concentrated companies are raising prices, and very few employees have COLA (cost of living adjustments) built into their employment contracts. It sounds to me like the final nail in the coffin for the middle class, already beset by higher state and local taxes, falling home prices, falling worldwide wealth due to dollar falling, and stagnant wage growth. For some businesses, however, it is hog heaven.
The other side of the argument is also powerful, the side that questions the health of the “customer.” Some studies have the median household incomes for the counties surrounding Chicago down an average of 10% for the decade. I am not sure I would agree with those draconian estimates, but would surely believe that incomes have been flat and probably behind inflation. As seen on the show “60 Minutes” last night there is massive debt in virtually all levels of government that most would consider a liability going forward, some of us have the sense to figure that they will be paying for it at some time, unfortunately. Then there is the massive deficit that the Fed has, amounting to over $1,000 dollars of spending for every household, that is set to wind down some this year. Will it take all the growth with it, making this recent increase in economic activity just a fleeting bubble, like 1936? How can the views be that different? I think it comes down to how relevant you think the US market is going forward, I look at the underlying weaknesses and say until there is some improvement in the US business growth is surely limited. Others draw the foreign gun very easily, saying, essentially who cares about Middle America and their issues, the new consumer is elsewhere. Am I that much of a dinosaur in thinking the US still matters, and that someone who has to hit me with the “China, China, India, India” rant to justify a stock price is not just a modern elixir salesman? You know what, I could be that much of a dinosaur. Or the incredible overhang of debt and lack of income, maybe banks in China are broke as well, might be the things that are important going forward. One thing I know for sure, when I was studying at the University of Chicago, the market was considered omniscient, it knew all. The last years have proven otherwise, with the market pricing the CDO’s and their risk very poorly. Why should I listen to someone telling me that all the problems I can identify are all properly accounted for in “the market,” given what has happened? Yet he or she may be proven right, all is accounted for and OK, and I could be wrong and worrying way too much?
Just when you think you have seen it all in politics something reminds you that have not, you still have more to learn. This tax compromise, given the tenor of the last election, is something I would be incapable of imagining. It sure seemed like the tone of the last election was to re-focus on responsible spending, yet the result (I know they have not taken office yet except for supposedly fiscally conservative Mark Kirk who voted yes without hesitation) was a tax cut package beyond belief. When I heard about the cut in Social Security taxes, given the state of the Social Security system, I was stunned. I will, I suppose, be happy with the $2,000 extra next year, but I have no thought whatsoever that it will not cost me at least that someday. The thought of this all in, all stimulus, and leave nothing in reserve type strategy seems insane to me, and it does not seem like any political common sense or election can stop it. Does anyone want to be left holding this bag? Does everyone but me have their escape to another state or country already planned? I must be slow.
As far as trading goes, we need to find places to be sneaky long that may not have participated fully in the recent run up. We also need to, and have recently, have a slightly bullish position on in the Protected Index Program to provide some positive deltas and positive time decay for those whose covered calls are deeper in the money than we would like. The idea there is to make some money on the additional position to “pay” for the up and out rolls for the covered calls as we gradually “catch” the market. We also want to be mindful of the potential long-term change in interest rates that seems to be starting. If the Fed does re-inflate the market the value of long-term bonds will continue to decline, and we will continue to play the bonds from the short side. The problem with trading right now is that the cheapest options, in terms of volatility, are the near term at the money calls, the options we usually like to be short. That makes it necessary sometimes to purchase options with not much time left, making it more necessary (and potentially profitable) to be right quickly. It is not my first choice in investing, but if the price gets low enough I will take the chance. This week should be slow and slightly up, we will see.
I would like to cordially invite you to attend our (always complimentary and always no-pressure) Protected Index Program® In-Office Seminar to be held at PTI’s Downtown Chicago Offices on Saturday, January 15th, 2011 from 9:00am – 12:00pm. My brother Dan and I will be talking about how our managed money strategies work within the PIP as well as fielding questions from everyone. Seating is limited but you must register to attend here. I look forward to seeing you there!