Riddle Me This

October 10, 2011

Good morning. It was a solid week to the upside last week, with the SPY gaining 2.3% to close at 115.71. The “relief” rally also caused the VIX to drop sharply to a level of 36.20, a weekly drop of 15.7%. A lot of this was due to a growing idea that the European debt situation was about to be more adequately addressed by the European Central Bank (ECB) and the governments of Germany and France. The speculation had been that the focus was about to move from the governments in trouble (Greece for example) and maybe their impending partial defaults to the re-capitalization of Banks about to be caught by any default that may occur. In fact, this morning the Belgian government (in a coordinated effort) has acted to protect (take over) an arm of Dexia Bank and inject capital necessary to stay solvent. Rumors now are that the bondholders have been made whole (more on that as the details of the deal become public) and that the brunt of the hit might be borne by the taxpayers (again, full story as it develops). In any case, the news from Europe is better for the market, and maybe the worry this week might shift to China and other developing countries, as their stock markets have declined due to rumors of real estate related slowdowns. Those markets probably need to bounce some this week for the rally here to go much further.

One of the big topics of discussion this past week has obviously been the growing street demonstrations in now roughly 20 cities by people “angry” at Wall Street excesses, or whatever. One spokesman yesterday cited the concerns not only of the growing income disparity in this country but also of the influence in Washington that sort of economic advantage essentially “buys.” I personally have the idea that, not unlike the Tea Party, this group has this vague notion that economically “things” are not working out so well for the average citizen. The Tea Party focused in on the gross amount of government spending and debt, where this group seems to be more focused on the amount of governmental largess bestowed on certain groups with influence. I think it is fair to say that many (Dems and Repubs alike) feel that an awful lot of everyone’s money was spent to save and protect people that did not do a very good job, with very little in the way of reparation or even blame, questioning of those that were charged with preventing those sort of mistakes from happening (like Bank executives and Board members). Just this weekend it was reported that two individuals ousted at Bank of America (huge recipient of taxpayer aid at one point) are being given go away packages of $6 and $5 million respectively (roughly 6 years severance) for a job not well done. This is as the Bank says they will lay off an additional 30,000 regular folks. I am guessing with the minimal package possible, and certainly not 6 years worth. I do not think it is class warfare, but clearly some “group” surely feels pretty entitled, and it is not my group. These two people are employees, never invented anything, never put up capital for the business and had it at risk, never even did a great job (it would seem), yet six years because they are at “that level?” In the words of the nurse whose career was ruined by the hospital big shots in the movie The Verdict “Who are these people, and who do they think they are?”

The Occupy demonstrators (loose knit group that they seem to be) are being criticized by not being knowledgeable enough about that which they are protesting, and I guess that is a fair observation. However, their main target seems to be the Federal Reserve, and most of us “should” remember that the only way we smart guys found out about some of their (the Feds) most egregious actions was after a two year long fight by Bloomberg in the Courts to get documents revealed under the Freedom of Information Act. So many of the actions to “help” and “support” the “system” since the time when Lehman went under are not exactly posted on the wall for all interested to read. As a matter of fact, I will lob one out there for all to see, and I will question whether anyone reading this has connected the dots on the actions of the Treasury and Fed over the last several weeks. I would certainly like feedback on whether anyone might think this type conduct by our government is justified, regrettable but necessary, cause for impeachment, or outright criminal.

Remember the dual responsibilities of the Department of the Treasury and the Federal Reserve? When the government needs extra money to operate the Treasury goes out and borrows money, in the form of auctions through “primary dealers.” There are about ten of these, and from everything I have heard it is a pretty lucrative title to have. So on roughly September 15, the Treasury went out and borrowed money by selling 30-year bonds at an equivalent Futures price of 139.05 (equivalent rate 3.35%). Shortly thereafter the Federal Reserve announced its so-called “Operation Twist” which calls for the purchase of longer-term securities (10 and 30 year) and the corresponding sale of less than 5 year securities. This operation was targeted for last Monday, October 3. Mind you that the Fed conducts these purchases through the same few firms, and now they are essentially telling then that on such and such day they will be giving them orders to go out and buy long term government bonds. As you may have guessed, last Monday the government was a big buyer, driving the Futures price close to 145.52 (equivalent yield 2.76%). So let’s get this straight, on Sep. 15 some segment of “our” government went out and sold stuff (stuff to go out 30 years) at 139.05, and not even three weeks later bought essentially the same stuff back at 145.52, with all the associated commissions added on. Does anyone other than me think the “opportunity” to front run this order by these dealers was about as ripe as it ever gets? Of course, this morning the Futures price is now under 140 again, a week after the government paid the equivalent of over 145.

Last week at this time there was concern over the financial health of a couple of these Primary Dealers, for sure MS and to a lesser extent GS. Now, magically the cost to insure debt on MS has decreased since last Monday. My question, how much do we think these firms made on this horrific trade by our government, plus commissions? Think for a second, if someone from the government walked into the PTI Securities office and handed us an order to buy 10 million shares of, say AA,  up to $12, and that they would look the other way if PTI traded ahead of their order. I think most would think that PTI employees (if would ever agree to do such a thing) should be modeling the orange jumpsuits, along with the governmental types that hatched the idea. That is because PTI has not made it (yet) to the “entitled” level, where it is not front running, or stealing, it is “protecting” the “system.” MS is no longer just a large trading firm, they (like the slimy Belgian Bank) are part of the “financial system” and if we have to feed them some cash in a way that, to others, would constitute a crime, so be it. Maybe someone from the Fed could explain to me how this could have happened by accident (buying the top after telling people you would), and that all the commissions were indeed fair and competitive, but I do not think there are that many martinis in the world for me to believe it.

Our friend Lou Michels, on Friday’s show, when asked why there was seemingly no enforcement of either the laws or the regulations regarding the financial disaster of the last two years, said quite candidly that the reason is that those charged with enforcing the law were either too close to the problems or directly involved. Any real investigation would likely turn right back to them. Does anyone really think that Ben Bernanke wants any part of an investigation of whether the huge spike in bond prices last Monday was due to his favorite firms front running the Fed’s order? I think not. Like I said, the demonstrators for now appear un-educated about the details, and some of those in government and Congress vilifying them better hope they stay that way. We don’t want too many people to know too much, it could get really embarrassing.

So how do we trade it? I think we stay fairly long up to the 1190-1200 level in the S&P Futures, and I think we need to stay short these bonds for maybe a little longer. The market is up almost 10% in a short period of time (last Monday) and continues to move violently in this roughly 1105-1205 range. Unless we feel the world has improved to the point of breakout (I am not there yet) we probably need to be thinking of either lightening up on longs or getting short fairly soon. I like the energy stocks on a relative basis, and maybe, maybe, think it could be time to lightly touch the financials. As most can tell, I think the money being given to the financials is bordering on criminal, but if those stocks move up as a result we want to be a part of it. The Protected Index Program (PIP) has weathered the wild swings of the last few months very well, and we (for the most part) stayed out of the way of the rally of the last few days. Might be time to sell some calls and adjust our puts.