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Look In The Mirror

May 3, 2010


Good morning. Negative week for the market last week, with the SPY’s finishing down 2.87 to close at 121.73 (2.3%). The VIX had a huge move up of 32%, from 16.62 to 22.05.  This followed some sliding markets overseas as mounting concerns of a major China real estate bubble continued, as well as the Central Banks in Europe limping towards a bailout of the debt ridden Greek economy. This weekend the Chinese Central Bank responded by tightening monetary policy yet again, raising the bank reserve requirements for the third time this year as well as strengthening some of the loan requirements for speculative mortgages. News out of Europe has the rest of the European Community actually approving a $147 B bailout plan for Greece, with about $40 B of that coming from the IMF. The agreement does require some serious reforms to Greek spending and tax policies going forward, cutting benefits to governmental workers on all levels and increasing the Value Added Tax (VAT) around 10%, from 23% to 25%. This is all in an effort to reign in Greece’s runaway government spending and get back to the European Union guideline of deficits not to exceed 3.5% of GDP (Greece is approaching 15%).

Go anywhere in America today and ask someone to opine on the merits of the Greek bailout and subsequent actions being taken by the Greek government, and my guess is that you will hear some mixture of “Why should anyone get to retire before 60?” or “How does anyone get 14 paychecks when there are only 12 months in the year?” or “All those union workers want is to go on vacation and get days off.” The big one would be “How can anyone borrow that much money and expect to survive, or have other people bail them out?” To anyone answering like that, from Germany to France to Main Street America I would have to answer “Look in the mirror.” There really are two issues here, and knowing the difference between them is, in my mind, critical. The Greeks have some social issues (very similar to ours) involving the share of wealth that is garnered by the unemployed and retirees versus those in society actually working, and those working for the government versus those in private industry. Those issues are, in many instances, beside the point economically, but cogent in regard to fairness within the system. In other words, if the government (or people indirectly) decides to have some tremendous program for retired people, but somehow pays for it by either higher taxes on others or less benefits to others it really is their own business. What we really need to settle in on, as outsiders and investors, is whether the overall indebtedness is something the country can support, and that is a different issue.

Here is the real conundrum regarding the Greek issue and announced bailout deal. The European Community is saying that the country, by having their yearly budget deficit at roughly 14.5% versus the agreed upon 3.5%, is out of control fiscally and needs to reign itself in (with no shortage of opinions by anyone as to what to cut to get there). If, however, you are a rabid  Keynesian Economist of the kind that clearly have President Obama’s ear and the ears of many of the other economies in Europe, Greece is currently doing exactly what you would want to work their way out of their recession. The new policy being forced on Greece, raising taxes, cutting spending, essentially stopping all or most fiscal stimulus, is exactly the opposite of what all the other countries are doing to help their economies out of recession. In other words, if you take the current policies of the U.S. and Europe as the right one, the “fixes” being forced on Greece will do nothing but drive its economy further into recession, or even depression. Forget the part about whether the high pensions are wasteful, in your opinion, or whether people get too much vacation, it is still stimulus.

Take, for example, some of the policies undertaken here. The cash for clunkers deal, supposedly giving people who bought a new car $4,500 to go out and buy a new car and turn in their guzzler, actually (if you look at how many cars were sold those months compared to what would have been sold anyway) actually cost roughly three times that. By most estimates the program was a fiasco, $13,500 on average for each car that would not have been purchased anyway, but the rabid Keynes boys (Larry Sumner, Jim Galbraith, Pres. Obama) do not care. It is stimulus, despite being wasteful to the point of fraud, and okay in their mind. The $75 B program to help people redo their mortgages, which by most accounts is not well managed, inefficient, and has helped only a few hundred thousand people, will go down as an almost total waste. It would have been way more productive to divide the  $75 B by the, say, five million households that need help and send them a check for $15,000, rather than have the money eaten up by bureaucrats and other hangers on. But again, they do not care; it is all some sort of wild stimulus on crack combined with some odd version of the trickle down theory. Whoever the hacks are within the system that end up with chunks of the $75 B is again okay, they are most likely our favored hacks and they will spend it, so it is good stimulus. The rest of us look at it like waste, and know that when the check comes due those who did not participate will end up paying for it somehow and the fraud will never be addressed. We are clearly not going to put ourselves on the Greek diet anytime soon, we (the administration and assorted hacks with their nose in the trough) are very happy with our stimulus on crack programs that have driven out deficit to over 11% of GDP (long way from the 3.5% imposed on Greece).

What does this have to do with the market? Sort of everything. We have seen the market advance very rapidly, for really two distinct reasons. The first is the idea that the economy is slowly improving and that we are safely far enough away from the dangers of early last year to have some sustainable growth. A big plus for that position is the strong year over year growth in corporate earnings and corporate guidance going forward. The second is that the money the Federal Government is pouring into the economy has to go somewhere, and just like in 2000 and in 2002-2004 it is finding its way into the market without regard to value or risk. The question is which one of these things is doing the lions share of the advance, is it real value or just a big chase doomed to yet another failure? Ask yourself this question, would the immediate injection of a Greek style austerity program, complete with dramatically higher taxes and draconian cuts to government programs and workers, be good for us (like someone is telling Greece) or drive us into a serious double dip recession or worse? I think we have not yet reached the sustainability part of this recovery, and if the government were to pull back substantially here we would be scrambling for any ray of economic sunshine. Hopefully in a couple of months my view will change.

On thing would seem obvious to me. If the administration had any real concern for jobs, or realized that it was expected to enforce even laws contrary to the wants of their check providers, they would do something to stop this absurd United Air/Continental Air merger. I did myself the dis-service of re-reading the Sherman and Clayton Act and wonder where it says that the Chairmen of competing companies in the same industry can spend the majority of their time talking to each other with the goal being less competition, higher prices, and fewer jobs. I will write more on this next week, but can anyone see any positive thing, except less service and higher prices, for this merger? As a matter of fact, it looks to me, as defined by the Sherman Act, as almost a felony on its face. Then again, the Antitrust Division has been so useless in dealing with these issues for so long that only the oldest and grumpiest among us even know there is such a thing as Antitrust laws and enforcement. Or maybe the new President can throw me a bone, if we are not ever going to do anything remotely regarding Antitrust enforcement or oligopoly prevention let’s fire the useless bureaucrats that work there. What do they do all day?

On issues of day-to-day trading we are still facing the same problems of the last few months. There is a dramatic upwardly sloping implied volatility curve in most indices and stocks, meaning that to do any sort of PIP type position we would have to pay a lot more (in terms of implied volatility) for the puts we buy versus the calls we sell. It means that directional trades would be just that, one to one spreads in whatever months we were to pick. There would be no time decay in our favor and little chance to recover if we are not exactly right. Some of this is just the continuing playing out of the almost zero interest rate policy of the Fed, as part of the upswing in option values going forward is people having an increasing view of interest rates going forward. Those clients that are doing some of the more aggressive trades have seen us go short bonds a few times in keeping with our overall view that a few years out we will surely see interest rates higher than current levels. However, even if that is our overall view, any short term reasonable profit will continue to be taken as the bond and interest rate market seem fairly volatile in the short term. In individual stocks we have seen a few notable changes in graphs that, to this point, have been straight up. Check out Google, Goldman, Priceline, Amazon, and maybe even the gold ETF, GLD, to see if you can see any overall tone change indicating possibly lower prices going forward.