INSANITY

June 14, 2010

Good morning. Snap back week for the market last week, as the market looked at some stronger numbers out of Asia and the run on the Euro subsided somewhat, at least for the moment. The SPY’s finished the week up 2.86 (or 2.7%) to close at 109.68, virtually the same level it closed the Friday before Memorial Day. So we had a fairly violent move to the downside, down to 104.65 last Tuesday, before recovering to slightly higher for the two weeks last Friday. This morning the market looks to extend those gains. The VIX was down sharply on the week, closing down 6.68 (or 19%), but still at a relatively high level of 28.79. Again, it seems like the tale of two worlds, with the numbers from Corporate America showing promise and the numbers from individual America still somewhat troubling. There also seems to be tremendous bullishness all of a sudden on the economic numbers this week. Industrial Production on Wednesday is expected to show a gain of a full one percent, and Leading Economic Indicators on Thursday are expected to reverse last months decline of .1% and come in at a robust gain of .6%. The market might run into some head winds if these numbers are not met.

Why is it so easy to have two totally different views of the economy going forward? It sure seems like if you look at Corporate America the future looks bright, we are seeing record large company cash levels, decent pricing power given the state of the economy, some up tick in demand for manufactured goods, and solid margins due to inability of some to demand higher prices for inputs such as labor. On the individual side we are seeing some slight gains in income, some job gains (quality of those gains certainly in question), large increases in some expenses (notably health care and tuition), tremendous future tax burden due to the shift in indebtedness from some private companies (banks and others), huge problems on all governmental levels in regards to solvency, and in general an almost total lack of increased buying power going forward. Even though we look to Europe and chide them on debt levels and demand cuts to bring governmental budgets back into some level of sanity, we choose to define our crazy levels of indebtedness as okay as long as we are able to borrow. That is a very dangerous view, but right now continued ability to borrow is viewed as synonymous with solvency. Yikes!

What about the BP fiasco, and all the mini-fiascos that it has spawned? To me it is just another in the seemingly unending stream of disasters regarding leadership and the enormous bureaucracy regular citizens here continue to fund. Start with the Company’s application for the well, where BP told the government that it was prepared for a worst-case oil spill of 250,000 barrels a day (Bloomberg). Obviously that was fiction, and went unquestioned by our astute group of bureaucrats. Add to that the supposed inspections of the well under construction, some by inspectors (allegedly) interviewing for jobs at the Company. It seems like corners were cut the whole way, up to and including the alleged leaking of fluid out of the emergency blowout preventer. Is it the first time that we have been let down by our relatively high paid and high pensioned bureaucrats? Not at all, just look to 9/11, Homeland Security, and Katrina as examples. The problem is that now it is seemingly endemic, and the rest of us do not have the continued ability to pay offices and buildings full of people that do nothing generally, and even less when called upon to do whatever it is they are supposed to do. The Department of Energy, according to the Office of Management and Budget, has 16,000 Federal full time employees and 100,000 outside contractors as of 2003, and that seems like an awful lot considering what we seem to be getting in terms of service.

Look at the ridiculous way President Obama is handling this crisis. I have no problem with staying on BP in regards to capping the well at some point and stopping the leak, and having them pay for the clean up efforts. That is only fair. To ask them to take the lead on actually orchestrating the clean up is insanity. It clearly, to me, is part of the job of all these people waiting and getting paid handsomely to wait for a crisis to do something. You would think that somewhere in the vast sea of desks at the Department of Energy there are those charged with contingency plans for a disastrous oil spill, that know, or should know, who has all the available cleaning equipment and who has the latest techniques to do so. It is very clear to me that the assembling and management of the clean up effort is that of the Federal Government, not BP. BP is not staffed or capable of making the decision of whether to have the two extra skimmers working the coast of Mississippi or Florida, that is “our” decision. BP should ultimately get the bill, but it is up to our leadership to marshal the forces (seems like a lot are already on the payroll doing God knows what) needed. The question is whether Obama is constantly grinding at BP due to political posturing, or to some belief that if he turns our bureaucrats loose on the project they will perform as badly as FEMA and others. If it is the latter, he better orchestrate a clean sweep of virtually all the bloated bureaucracy he seems so in love with and is increasing by the day.

A fair question might be “Why does someone writing an investment blog constantly talk about political issues?” Or on this morning “Stocks and Jocks” why did Kevin Riordan and I talk so much about the wretched criminality of Illinois politics. It is because the individual people who are the backbone of the investment community and the consumers that Corporate America is counting on are being overburdened by the costs of this incompetence going forward. Not if, but when, the Federal government chooses to, or is forced to, move towards more balanced books it will cut the heart right out if this nascent recovery and the budgets of a majority of the population. Just on the Federal level every household is averaging over $1,000 per month that the Federal Government is spending on their behalf that they do not have. What does this economy look like if every household had taxes go up by that amount right now (forget the incredible amount owed, just make it even right now)? I figure the average household takes home about $3,200 per month before state and local taxes and fees, what if that number became $2,200 tomorrow? It would be a disaster of massive proportions for the economy. If we were getting huge projects, like high speed rail in the right places, or bridges designed to open up commerce going forward, or basic research on things to cure expensive diseases, it might, repeat might, be justified. To just pay handsomely for a bunch of hacks is quite another kettle of fish, especially when we have to pay huge pensions to the fish going forward. Or wait a minute; maybe that makes the rest of us the fish.

So how do we trade this mess? Seems like it remains like we said last week, violent moves within a range, with seemingly 1040 to 1120 as the range. As an investor we are still looking to place some money to work at the bottom end of the range, but so far those good prices in the underlying security have been accompanied by huge increases in the VIX and therefore the price of the puts. In other words, every time the SPY or XLE gets down to where we want to buy it, the cost of protection has ramped up as well. One of these days we will get a little sell-off with not a steep run up in the puts and we will jump in. On the short-term side we have done a little more, due to the normalization of the volatility curve in terms on month to month, and have actually been able to get some theoretical edge for spreads in some of the drillers. These, however, are shorter-term trades and as soon as we have a decent profit we are gone. So I think the plan for the near future is to stay in the market but protected for the long haul, and somewhat more aggressive short term if the opportunity is there.

PTI Securities & Futures will be hosting a FREE In-Office Protected Index Program Seminar at our downtown Chicago offices on Saturday, July 17th, 2010 from 9AM-12PM. My brother Dan and I will be going over the strategies of our managed money program. Did you know that in May the market as measured by the S&P 500 experienced an 8+% loss. Our return out-performed the market by 10+% during May. Even modestly funded accounts benefit from the Protected Index Program. We will be readily available to answer your questions. Seating space is limited. You MUST register to attend. Once registered, you will be directed to a confirmation page which includes parking, hotel and transportation information. A continental breakfast, coffee bar, and classroom materials are provided to registered attendees. REGISTER HERE!