On The Good Ship “Market”
April 13, 2009
Good morning. A furious rally of 246 points last Thursday made for a holiday shortened positive week in the market, with the SPY finishing up $1.65 or 1.8% for the week. The continued upside move in the market caused the VIX to drop 3.18 points to 36.52, a value the market has not seen since September 26, 2008. The VIX made an initial drop this year, after a relatively sharp year-end rally, to 36.88 on January 2, but has spent most of the year over 40. This morning we are seeing a modest retracement so far of last Thursday’s rally, but nohuge sell-off.
Is everything okay, or are we just seeing the first of the positive effects of the massive amount of money entering the system? Certainly most retail clients feel better about things, as last week the reported money flows into equity mutual funds were solidly positive. The rebound from the March 6 lows on the SPY is now 18.71 points, or 28%, a short-term rally not seen in percentage terms since 1938 (when the absolute numbers were far lower). Why are people much more comfortable buying the market at 85.81 than they were when it was 67.10? It is the mentality, people in general buy stocks because they are going up and sell them because they are going down. You buy because you are afraid you are missing something, and you sell when you are getting hurt (I generally want the other side of those trades).
The good news is that our clients, certainly those in the PIP program, are doing their best to think (and act) in a more rational manner. Let me be perfectly frank, things looked horrible on March 6. It was very difficult to see that as a buying opportunity, as every other “buying opportunity” in the last 18 months had been nothing more than a bull trap. Even our normal and routine adjustments, like rolling the protective put down to somewhere near where the market was trading, were becoming difficult as the question of having any sort of market exposure was increasingly front and center. It was especially difficult to make additional investments, even with the protective cover being provided by (in retrospect) insane volatility levels. We were able to initiate a few covered strangle (buy stock, sell out of money call and put) positions where the effective price of buying the additional stock if assigned would have been less than zero. Virtually every one has been a solid winner. You know what, those trades still were hard to do, the market looked horrible. The point is that that the market was a better buy on March 6 than now, and if you had an investment strategy like the PIP (not totally exposed) you were not forced to sell on the low, and may even have been a buyer.
Again, is everything okay, should we jump on the good ship “Market”? The talking heads are mostly sounding the all clear, and even are (amazingly) singing the praises of the buy and hold for the long-term strategy. I guess when you have no other strategy than to go long the market, you continue to tell people to go long the market without any thought to the risk involved. I am suspicious of (although very grateful for) this rally. It does not seem to me that a lot of the issues that caused the economic problems are being fixed, and many are being made worse by some of the absurd and selective governmental programs and policies. The combination of the market being down so low and the incredible amount of money being pumped into the economy by the Fed pretty much implied some sort of short-term rally. The cartel of large banks still standing has an incredible franchise, given enough government help and guarantees they are perfectly capable of wringing vast sums out of the public through non-competitive credit card rates, investment banking fees, trading spreads, you name it. There has been very little talk of achieving a greatly expanded and vibrant banking system at the end of the day, just fix the same old people (and keep them wealthy).
There is also huge danger in having a very crooked government involved in business policy at any level, especially to this degree. Whoa! How can anyone call the government of our beloved county crooked at virtually every level, especially with our new President (who I support) promising to reform everything (so is the new governor of Illinois, guffaw, guffaw). The fact is the government has totally lost any sort of perspective over where the incredible cash infusion is heading. Couple that with this sort of newfound ability to break contracts that you do not like. For instance, Congress is demanding that the auto companies break every sort of promised pension and health care contract with the auto unions, some new sort of “targeted bankruptcy” were “somebody” gets to walk into court and break only those contracts that are targeted that day. In GM’s case it is the unions and bondholders. The same Congress seemingly is powerless in preventing former Treasury Secretary Paulson from having a semi-private meeting with the Chairman of his old firm (no one can be a former Marine, can you be former Goldman employee?) resulting in having them (and a few others) get paid 100 cents on the dollar for some $60B in over-the-counter trades with AIG. Now that contract is sacred, the hell with those auto pensions, even though the same $60B would pay a lot of pensions (never mind the fact that a lot of the auto companies problems stem from this mostly banking induced recession)!
On the local Illinois front, I listened (dangerously, without air sickness bag close by) to the new governor Pat Quinn talking about the budget challenges facing Illinois. Did you realize, because I had not thought it possible, that every single issue of bad government and the incredible $10+ B in unpaid bills (brought upon by the absurd dodge of using a cash based accounting system) was the fault of one man, disgraced former governor Rod Blagojevich. He must have been an amazing man. None of the budgetary tricks and flat out cheating was the fault of anyone else, House Speaker for life Mike Madigan, State Senate Head Emil Jones (which is no longer an elected seat in his district, it has become the Dukedom of the Jones family), State Treasurer, State Comptroller, some of whom were there long before Blago, were at fault, only Blago. The rest have, now, no choice but to regretfully demand some massive tax increase to cover Blago’s bad deeds. Are we really that stupid? The insult to me is that they think we all are, and just maybe they are right.
Why do I bring up the State issue? I do it because the incompetence of government, and the unevenness of their decisions, has serious repercussions to people we would consider regular. In the Federal case it looks like autoworkers are drawing the short straw, Goldman will be stronger than ever. Here in Illinois, the non-payment of bills has decimated some industries. Gov. Quinn used as an example how much the State owes the business community, and used Walgreen’s as an example, citing, I believe, an incredible number of over a billion dollars in unpaid Medicaid payments. It is no coincidence that I walked by one of the few independent Pharmacies still in existence on Saturday, and found it closed with brown paper adorning the windows. Except for a few big companies governmental bodies, state and federal, have put out of business an entire industry of independent Pharmacy owners. Does anyone care? Probably not, I am sure Walgreen’s contributes way more to campaigns and maybe Wal-Mart is a little cheaper (maybe). As an independent businessman myself, with a lot of clients that are the same way, I care. I also am afraid, as an owner of a small but vibrant Securities firm, who is to say that someone (with contributions jingling in his or her pocket) won’t get the bright idea to brutally tax small Securities firms out of business in some manner. As for people too busy to care, when something similar happens to your job, at least don’t insult the rest of us by being surprised.
As for the market, I think we have it right where we want it. Those in the PIP program now have puts slightly below the market level and (since our rolls of last week) calls slightly above. If the market wants to stay in this range for a while, that would be terrific. I am anxious, due to nervousness about the strength of this rally, earnings this week, option expiration, etc. to take profits as soon as possible on our more aggressive positions. I will remain nervous until the job picture changes a little, the health of the average individual still seems way too shaky to be overly positive here. My guess is that the rally runs out of steam this week, but not bad.