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Our “Brand” of Capitalism

April 6, 2009


Good morning. The market, despite a bad start on Monday, had another strong week as the S&P finished at $84.26, up $2.65 or 3%. Friday’s close represents an amazing 26% rally from the lows set on March 6, and for the buy and hold types it gets you back to roughly where you were on Feb. 10. We are still down about 7% on the year, but it sure feels like up compared to the first week of March. Is this a real rally? Yet to be determined, but it sure is real if you had the ability (and courage) to invest near the lows. It goes without saying that the rally is real if you were short. That would surely have left a mark on your equity to have stayed short the last couple of weeks. It is interesting that the VIX is down from 41.04 to 39.70, but the costs of long-term insurance used in the PIP program continue to remain stubbornly high, in the 20+% range. It would seem that no one is sure enough that the rally is real for them to sell these longer-term puts.

It was a huge week in regards to news affecting the markets, with the President over in Europe for the G-20 meetings and the employment report that came out last Friday. It seems like some spirit of cooperation was achieved at the meetings in Europe among the world’s leaders, maybe in return for the U.S stepping back a little as the dominant world player in the spirit of “sharing” the power (not exactly sure what that means in the long term). It does seem that the leaders of France and Germany, in particular, were all heady with their newfound contributions to overall policy.

As for the employment report, it was reported that 663,000 people lost jobs in the month of March, slightly above the consensus number of 650,000. The headline number does not include a huge negative revision of 86,000 in January. This brings the unemployment rate to 8.5%. Of course these numbers do not include part-timers looking for full time work, or self-employed not able to find full time work (virtually everyone connected with the housing industry). Including those people would probably bring the “underemployed” number to 15+%. As a way of perspective, 663,000 people is roughly the population of Baltimore. The 5.1 million “official” jobs lost since the start of the recession is the equivalent of every person in the state of Minnesota.

So what is it going to take to get people back to work (with a real job) and when will the market have a sustained recovery, and do they have to happen together? First thing, I think you will be able to make money in the market (short term money) long before the economy picks up for those looking for jobs. If fact, there was a lot of money to be made in the last couple of weeks. Many clients have positions in the XLF and have had positions in C and others that have been profitable, but they are responses to very oversold conditions and not really a conviction that the worst is behind us. Some good things are happening in some industries, like manufacturing and retail, certainly relative to the levels where the stock prices were driven. I think industry players like Alcoa and Dow are survivors and were good buys when they traded at around $5 and $7 respectively. Also, even with the government share of equity and other major problems C seemed like a good short-term trade around $1.50, not so good over $3. These types of trades are great, and send some money into client portfolios, but should not be confused with a general economic turn around where all the current problems are solved. I would guess we are at least a year away from a positive jobs number, and hopefully some of the new hires will be to new firms formed by those that have been “down sized.”

I suppose everyone noticed the large demonstrations accompanying the G-20 meetings in London, complete with the “Down with capitalism” and “Down with money” and “G-20 leaders are blind” sort of placards. Everyone on TV here (safe in the studio with six figure plus jobs) opined ad nauseum about how everyone knows capitalism is the best system, what other system is better, etc. It seemed like a lot of the same questions being asked in the Great Depression as things worsened with no signs of progress. First of all, let me be the latest to say that that as an economic system, capitalism has no peer, but it certainly can be brought to its knees by lack of leadership and the lack of a framework in which to function. Our problems with our current “brand” of capitalism are many, but I will address some of the worst abuses (keep in mind that it would be easy to not be so charitable if you were one of those tossed out of work, out of your house, your kids out of school, etc.). I think the first major fix, especially if we do not want government to be the (quasi-socialist) fix is to get control of these corporations. I have said before that the current corporate Board structure is broken, and we have even seen the new SEC Chairman Mary Shapiro trying to make it easier for shareholders to regain some control over the Boardroom. That does not cut it. Where are the shareholders demanding this power, power they never should have lost in the first place? They are nowhere, seemingly happy with the current mess of high priced thieves appointing friends to give them raises in return for perks and stock options. Where was the outrage when SGP was sold at a price that was historically low, yet the management and Board did very well? Nowhere.

On the political front, it is the same thing. Yesterday I stopped briefly to visit a sick friend at one of the University of Illinois hospitals, which happens to do some work for the adjacent Hines Veteran’s Hospital. The streets south of the facility are post cards for urban decay, no buildings or houses of any kind (the land is probably owned by the hospitals now) yet there is row upon row of brand new parking meters consistent with Mayor Daley’s suffocating grip on the city. On a Sunday, on a street without even a building, to visit or work at a Veteran’s facility, you have to feed a meter four times the amount of only a month ago.

Clients in the mortgage business tell me that refinancings are being held up over 50% of the time because the current value of their property does not match the value of the current mortgage. I see no evidence that people’s property taxes have been cut based on their homes “new” value. None of this is the fault of “capitalism” it is the fault of owners and citizens that, for whatever reasons, have collectively stepped back from being counted.

What about making some money? The rally has been good to us. Those doing the extra positions have been well rewarded for stepping in at levels that were pretty scary. Many more are involved in the longer-term XLF position that so far has been taking advantage of both the level and volatility in the financial sector. I am still very concerned about the price of the long-term put protection, and it does not seem like it will be coming down anytime soon. A lot of the big players in the market-making world have been wounded severely by selling puts naked, and some of the problems with finding and keeping stock to borrow is impacting their ability to sell any puts, much less puts out over two years. For example, the stock in Bank America (BAC) has made quite a comeback from its lows of $2.53 to a current level around $7.50. The January $7.50 puts, however, are still in the $3.20 range, meaning the stock would have to decline almost 43% for your protection to have any value. That price does not give anyone confidence in the market’s opinion that the lows are in for sure. I still feel, and have most people positioned accordingly, that we want to be in the market somewhat at these levels, we want to have a significant amount of cash available, and want to participate on any oversold or volatility related opportunity. As the ear goes on and (hopefully) the recovery gains a little steam we can commit more.