Moral Compass of Mayberry

July 18, 2011

Good morning. The market finished down last week despite a late short-covering rally on Friday afternoon. The SPY finished the week down 2.71 to finish at 131.69 (2%) after trading as low as 130.77 on Friday. The VIX soared 23% to close at 19.53 and the GLD (gold ETF) finished the week up 3.3% at 155.19. The market activity can be summarized as a series of fairly violent moves within the range of 130.50-135.50, with a lot of the significant trading taking place outside of normal market hours. The market continues to react in large part to the dual causes of headline news from the various sovereign issues in Europe and news of the negotiations towards a U.S. increase in the so-called debt ceiling here. In short, real tough trading, with every hint of news causing a reaction in the market and markets very thin due to the increased chances of being caught wrong on some news event. No one wants to be a premium seller in the event of a negotiation breakdown or a sudden budget “deal,” hence the spike in the VIX, and a lot of people are searching for currency safe havens and are running to the Gold contract. There were some big winners, as CLX and HK drew some takeover interest, and GOOG soared over $70 on news of good earnings and initial success with a competitor to Facebook. Hopefully some of you participated in those areas.

What is going on here? We see politicians look and act about as un-statesmanlike as anyone can imagine. We are seeing, locally at least, a large increase in seemingly random and totally amoral street violence. If anyone checked out the article in the Rolling Stone entitled “The Real Housewives of Wall Street,” as did Representative Maxine Waters, who was questioning Fed Chief Ben Bernanke about it in his Congressional testimony, there appears to be some anecdotal evidence at least of serious moral questions regarding the Fed and Treasury. For those that have not read it, it appears that the wife of Morgan Stanley’s John Mack and one of her pals seemed to have benefited by a huge low interest loan from the Fed, complete with a no or low risk deal to buy battered mortgages. Everything I read seems to point to some very questionable recipients of large sums of this bailout money (information that had to be wrenched from the Fed by Bloomberg), from European Banks to dubious groups domestically, yet the look on Chairman Bernanke’s face when being questioned was utter astonishment that he was being held to any sort of standard. We have a President (and Congress), while individually maybe very fine and truthful people, that have impressed no one publicly with adherence to the truth or concern about the graft and corruption infecting the Federal piggy bank. To be perfectly honest, to me they would never let the facts (read truth) get in the way of their position or whoever’s palm they want to grease.

There appears to many observers, this observer for sure, that the land that gave us Mayberry is seeing a pronounced shift to the now overriding mantra “If you are not cheating, you are not trying.” I think most that know me are well aware that, maybe because of upbringing, family standards, or belief in fair play on the athletic field, I think we need a solid moral compass to advance as a species, as a society, and surely as a country. We also need a fair and enforced set of rules under which competition can compete and thrive. I am well aware that none of us is perfect (surely me), but I also know that the overriding moral compass for our country starts with the person we all view in the mirror. I have had, recently, very good people close to me ask why I continue to push against the tide of this (to me anyway) moral shift, and why I just don’t use whatever talent, connections, and Southside political acumen I may have to get my immoral (or amoral, can’t be sure which) piece of the handout and head to retirement in Italy or Ireland like many others. I just can’t do that, at least while I still think there are people like the listeners to “Stocks and Jocks” and readers of this blog that want to resist where we seem to be heading.

What are we talking about? Who are all these crooks? What is happening? Let’s look at a couple of examples, and review a little history. First of all, I assume everyone reading this has viewed a few western or war pictures in their lifetime. Remember the part where whenever anyone wanted to really do some stealing or get around the guards in the war picture it was always someone’s job to go blow something up or start a fight? The term is to “create a diversion.” How many people were involved in at least one conversation (heated I presume) during this past weekend regarding the deficit reduction/debt ceiling debate going on in Washington? I suspect several, and inevitably it came down to right vs. left, socialist vs. strong American right, business vs. regular people, whatever. As the available liquor shrunk, the argument no doubt became less quiet. Again, I refer to the Congressional testimony of Ben Bernanke. Did anyone hear the question asked by Rep. Ron Paul regarding the sheer numbers the Fed has funneled to a relatively few institutions (and according to Maxine Waters and others, favored people)? Rep. Paul figured that the numbers spent in so-called bailouts amounted to $17,000 per mortgage, and why did the Fed just not cut the checks and send the money to those affected instead of the Banks? We are seeing a tremendous shift in wealth and power based on where this $3T was sent, how come only a few in Congress even ask the question? How can our President, supposedly this walking encyclopedia regarding U.S. political history, and some of the older Senators, not be aware of the criminal history of the Resolution Trust during the 80’s and make sure it does not happen a second time. Or maybe they do want it to happen a second time, with this generation of the non-deserving ending up with incredible chunks of what used to be other people’s property. The diversion, to me, is the partisan politics, we are arguing instead of watching and prosecuting.

I will throw out another example. Everyone, and I do mean virtually everyone, is so sorry for the poor corporations that have these trillions of offshore monies that the bad U.S. wants to tax at U.S. rates versus what some non-descript country would be willing to charge. How many times have you heard that we (the U.S. of A.) just can’t compete globally with these usurious rates (which just happen to be what individuals here pay). For the record, I would love to see a tax code with a lower rate and less specialized deductions, but we do not have it yet (so this is not about whether our code could or should be better). It is about the national debate being formed (by friendly media, lobbyists, palm up Congressmen) by those wanting to let these corporate creatures bring profits back at something like 5% instead of the normal rate of 35%. Does anyone want to ask the question first “What exactly do you mean by profit made overseas?” Is it money that you earned by putting up a manufacturing facility on Mars, with raw materials from Mars, and products sold to Martians? If it is, I will take the 5%, since you obviously had to pay something to the Martians, and be happy. However, if the products were sold here, and maybe the patents were even granted here, I am not going to be either dumb enough (or influenced enough) to think that those profits were made on Mars. I think those profits were made here, and that you are lying, and evading, and maybe should be fined heavily and be in jail. Listen to the real danger here, and it is not about some multi-national Corporation getting a one-time break. It is about shaping the law to get a serious advantage over someone who produces here. How many people who would argue that these firms should get this “deal” are too busy (tried not to say ignorant) to notice that there might be a business in their area that is competing with multi-nationals that are actually paying 35%, while the competition pays zero or 5%. That is a massive advantage for the multi-national.

We are wrecking what most think is “normal” competition by adding governmental favoritism to the competitive mix. We have a terrific guest periodically on “Stocks and Jocks,” labor Attorney Mr. Lou Micheals (how many guys accused of being liberal are comfortable saying how bright a right wing guest is), who made a memorable quote last time he was on, “People absolutely do not realize how much of what used to be considered competition is now taking place in Washington with getting favors written into legislation or codes in the form of tax breaks, incentives, lower regulatory scrutiny, etc.” Isn’t competition supposed to be innovation and hard work, not having your nose stuck up the butt of some bill writer? While most of us are arguing left vs. right those greasing the left and the right are gaining favor and stealing from all of us.

I could also cite other examples of what is happening, people having large money balances earning no income while banks lend at almost regular rates (no questions from either House or Senate to Mr. Bernanke regarding this wealth shift), mortgages being difficult to obtain while some groups (even overseas groups) seem to have unlimited amounts (from our Fed?) to pay cash and rent it to those who now are paying way more in rent than they could have paid in mortgage payments. These “things” are not just “business as usual” or “normal” political issues to argue about, they represent major shifts in who owns and controls this county, and the direction is not towards you or I. I have read extensively about the cronyism and stealing that was part of the Resolution Trust, and the result (think GE Capital and others) was a serious shift in wealth and power transferred almost totally through government favoritism. The Resolution Trust foibles are looking like child’s play compared to what is setting up now. Maybe we should stop arguing about Democrats, Republicans, and Tea Party people and do something while we can (maybe too late).

So, how can we make some money in the meantime? The VIX is going up, so it is becoming harder to try to benefit by being long premium. Plus, until now at least, these long premium positions (some we have done for the PIP clients), have required a lot of trading (or adjusting the position) to get into the positive. For example, the simplest long premium position is just a long straddle, a combination of being long a call option and put option at the same strike price. For example, if stock XYY was trading at $100 and we could buy the $100 calls and puts each for $1 we would say we bought the straddle for $2. If we do nothing, the stock would have to finish below $98 (call 0, put $2), or above $102 (call $2, put 0) to make money. However, if the market is trading like recently the stock might have been all over the place last week only to be unchanged on the week. For instance, if the stock shot down to $99, we might have been able to sell out our long put at $1.50 and when the stock went back to $100 we could have bought the option back again for $1 (there would be some time decay, but let’s keep it simple). Now, since we have made $.50 on “adjustments” our new break even is now a move of $1.50. If that were to happen three additional times, and then the stock went out exactly at $100, we would have lost the original $2 but made back the $2 through adjustments for a net break even. However, the frustration is that we just did a lot of work and a lot of trading to get back to no profit (better than loss).

So why do it? Well, whenever you have a long premium position you are set up for the big winner if the stock makes a big move. If XYZ were an individual stock it could have been CLX or GOOG last week, and someone could have decided to take it over or the earnings could have been better than expected. If it were the SPY we would stand to gain either by a big move up on a Congressional agreement or a move down on a default. So if you can maintain, through adjustments, something close to break even in times when a big move is possible it is a solid strategy, even though it may look initially like a lot of trading for nothing. We will continue to try to maintain some long premium exposure in the current market unless the VIX just goes straight up and the costs become excessive. We would love to profit by a big move, either way, but there is a limit to how much we will pay for that position.