Questions and Absurdities
July 27, 2009
Good morning. Market is on a tear, with the SPY up another 4.2% last week, closing up 3.97 to 98.06. That 98.06 close represents a 46% move up from the bottom tick of 67.10 on March 6, quite an impressive bounce. Equally as dramatic is the plunge in the VIX to a close of 23.09 last Friday, a level not seen since 9/8/08. All of a sudden fear, or even concern about the market moving a little too fast, is totally out of favor. To hear the financial press tell it everything is ok, earnings are better than expectations, we will start to grow in the third quarter, etc. Everyone, from government to reporters to stock owners, are eager to declare the last year a nightmare over, and get back to business as usual, even though that business as usual is maybe what caused the nightmare in the first place.
First, regarding earnings, they are coming in generally where most of us would have expected. Those companies, like Intel, who have a semi-monopoly and still some pricing power are coming in down around 12-20% in revenue year over year (17% for INTC), those in more competitive areas like Alcoa with little pricing power down 40%, and some in real cyclical industries like CAT down a similar 41%. I will say that most management teams have managed the revenue declines pretty well, mainly due to the fact that most big corporation balance sheets were in good shape when all this started. The point here is that any kind of “growth” starting in the third quarter 2009 better be more that some nominal 5-10 %, because down 40%, up 5% still leaves you down 37%, a number not sustainable for a lot of businesses. Also, the sobering minus .8% decline in the British economy following the disastrous 2.4% decline in the first quarter was lost in the stock euphoria that was last week. Let us hope that is not our future.
The two states I monitor the most closely, Illinois because I live here and it is the best example (ok, maybe Louisiana) of democracy not working and total corruption, and California, due to sheer size and problems that reflect most other states, passed shaky budgets last week. Both really did not solve one single problem that put them in the budget mess in the first place, other than finding sneaky and stupid ways to steal a little more revenue. Mostly it is going into more debt and placing a really desperate bet that the economy will some how miraculously recover and bail them out. In California the deal is only for two months, hoping against hope that things look better in 2 months. Illinois (again with the history of corruption and mob ties) is trying to bet their future on video gaming in bars and more debt until things get better. Both have managed to put off the grim reaper of a bankruptcy filing for a little while, but forever?
Is the stock market rally real? Did stocks sell down to the point where there were huge bargains even if the recovery is long and tepid? If we retain the recent gains and the market were to form a new trading range around the 95-105 range in the SPY, we would still be down 30-36% from the record highs. Is that a better estimate of where the economy is than the 85-95 SPY range (36-43%) we had been in? Could be. Or is it the latest attempt to inflate asset values as a cover-up to the real problem, lack of real income growth? Is it really possible to estimate the future, given the unprecedented intervention of government into the private enterprise arena? Is the shifting of hundreds of billions of dollars of risk from a few (albeit very large) players in the private sector to the general population a fix, or just a stopgap that the new risk holders (us) will eventually crumble from? One of the mistakes made by the government during the Great Depression was to let the monetary base fall precipitously, a mistake not made so far this time. The other major mistake was to raise taxes, but if you were to count all taxes, state and local increases as well, aren’t we making that mistake (maybe even bigger) this time? Even the ignorant video gaming expansion really is a tax, and a regressive on one those less able to pay and less able to read the odds. As for the new mega-bills, the cap and trade and health care, let us put those off to next week.
What about the market, how do you play it? It has been tough for those in any type of protected program, mainly because the rapid decrease in the VIX has caused the market value of any protected puts to drop very fast. For example, on 3/6/09 the SPY was trading roughly 68, and the Dec 2011 70 puts were around $19, making it very difficult to enter the market in a protected manner. Since then the SPY is up around $30, and the puts are now trading around $6, meaning you have lost almost 44% of your gain on the SPY by being long the puts. Now, the 100 puts in December on 2011 are trading around $17, as compared to the 70 puts trading $19 in March. Then the price of protection was 28% of the underlying asset value, now 17%. That is certainly why we used put spreads instead of outright put buys for funds that were invested at those low levels.
Still, you cannot fight the dynamic that people buy the market because it is going up, and they feel they are missing out on something. There also is no real competing place to put money for hoped for income, Treasuries, money markets, and CD’s are paying next to nothing. The rights of bondholders are viewed to be in a state of flux, at least in high profile cases, so that alternative is also suspect. Does seem a little early, in light of recent history, to go back to the just buy and we will all become wealthy together theory. If it does continue, however, we would sure like to participate in most of it.
As for my trip last week, we will talk later. I will say, however, that the incredible use of taxpayer money to finance individual groups owning monopoly baseball and football teams is a real embarrassment. Every time you think of how you do not want to use government money to sew up an injured person without insurance, think of the amazingly available cash for the owners of the Washington Nationals, Phillies and Baltimore Orioles. Talk more on the absurdities in the coming health care bill later, but look at the other stuff you, the taxpayer, are paying for.