Like a Shout in a Hurricane
December 29, 2008
Good morning. The year end rally continues to be elusive, the VIX is creeping down steadily, the market may be settling into a range at levels no one is happy with, are these the cards being dealt? Right now it seems so. On the credit front we continue to have such fear that the 30-year rates on U.S. Treasury Bonds are 2.6%. Incredible, does anyone know any sane person who would give their money to anyone for 30 years at an interest rate of 2.6%? Does anyone really predict that there will be zero inflation for 30 years? I doubt it. On the other hand, corporations and municipalities are paying fairly high prices for money. We were able to place some money in CAT bonds last week at the 7% range, and high rated munis are in the 4.75% range. Preferred stocks in several of the “too big to fail” banks are priced to pay 7+%. Individuals, on the other hand (the people sending their money to these banks) are still being charged 24% for credit cards or 9% for a car lease.
Where is the trade here? Quite obviously the trade at some point is to go long high-grade corporate paper and short Treasuries, but when? Shorting the Treasuries has been the obvious trade for a while, but if you were early at all you are very bruised. On 12/1/08 the TLT reached the unprecedented height of $110 (corresponding to a 3.2% long-term rate), an easy and juicy short. On Friday it closed at 121, up 10% in three weeks (now a 2.6% rate). The easy short became an early short nightmare very rapidly, but now it is even more compelling. It is compelling both on a pure number scale, and on a common sense (maybe) scale. It does not make long-term sense for people to be willing to give money to a government at ridiculously low prices, yet not willing to give money to those institutions that the government has seemingly pledged to save. Do we really think that all those places will go under without the government taking some sort of hit in its ability to raise money at very low levels? At some point inflation (and higher rates) would step in to govern the current out of control printing press, one would think.
What about the market? In my opinion (remember, opinions are like a shout in a hurricane) the market seems to be settling into a wait and see level, as evidenced by the recent declines in the VIX. The VIX closed over 80 on 11/20, and it closed last Friday at 43, still high but no longer predicting impending panic. At this level in the SPY you can certainly make the argument that the market is cheap relative to historical levels of earnings looking back, but maybe still high considering where earnings might end up at the rate we are imploding. The question is, when does the economy stop accelerating to the downside, and at least flatten out at some level? I think we have a while for that to happen. The amount of debt rocking society is still way too high, from student loans to people being thrown out of work, to construction loans on buildings whose completion dates keep being extended, to credit card loans that somehow loan receiving banks can continue to abuse, etc, etc. These problems increase when people lose jobs, or lose not counted side jobs, or lose overtime, or go to four-day weeks. We will not start any type of improvement until people (not just corporations, real people) start earning, and that seems a long way off. President-elect Obama keeps talking infrastructure, but have we lost the ability to even do that here. Buying a thousand railroad cars from Mexico does not seem to be a real solution. Neither does giving a no-bid road contract to some political hack in Illinois that gives him so much time to finish that no one gets hired.
What about PTI clients? If the year plays out like I think it might, ultimately range bound with historically high VIX, we should have a solid year. For those in the Protected Index Program (PIP), or those in the same strategy with individual stocks the high VIX should mean that we can sell calls at profitable prices while leaving more than normal room for any kind on rally. The good news is that we are finally starting to see some more rational levels in the long-term puts we use for protection. We would love a year where the market staggers up 10-15% while we sell calls further out than that. The rest of the investment world would still be down 25-30% for the 2-year period while we would be solidly up. For those clients doing some of the more aggressive strategies, I would like to see some variation in the VIX on a month-to-month basis; right now the volatility levels are sort of flat, very difficult to get any edge in a position. I would sure like to find some volatility edge in a TLT position, but so far everyone seems to be seeing what I am seeing.
By now everyone should have a handle on his or her tax issues. We will be doing those necessary trades tomorrow, but can do them for those that use trade date up until Wednesday. Let’s not let this matter slip, Dan, Robin, and I will be available today and tomorrow for any necessary consultation.
Lastly, I would like to thank everyone for being PTI clients in 2008. We have taken a severe body blow by the market, and have mostly come away with the ability to fight again. Those in the basic PIP are down less than 5%, while the S&P 500 is down over 40%. Now let’s turn our attention to using our relatively strong position to take advantage of everything the market gives us in 2009, if the market wants to give us money it is only right that we have the imagination and determination to accept it. Again, anyone who may want to take advantage of some of these trades in either Treasuries, corporate bonds, preferreds, etc. be sure to contact us. Happy New Year!