December 8, 2008
Hello. I am writing a day later than usual due to technical difficulties. It turns out that power surges are very bad for old monitors with transformers, even with power strips intact. Look at the bright side, armed with new monitors we can talk about yesterday’s rally. Pretty serious rally, it has now carried the market up 22% from the SPY market low of $74.34 on November 21 to $91 yesterday. We do need to temper the giddiness a little, as it only brings the market back to the close of November 13, and still leaves the SPY down 38% on the year. Some individual stocks that were seriously beaten down (for possibly legitimate reasons) have had dramatic percentage moves. For example, insurance giant Hartford (HIG) is up from $6.40 to $14.84 (131%) in two days, Dryships (DRYS) up from $3.63 to $7.17 (96%) in two days, even the oil index XLE is up in one day from a low of $40.53 to $46.12 (14%). It is easy to fall into the trap of being disgusted with the market on one day, and mad you are not all in the next.
Is everything OK? Is the bottom in? Is it safe to pile back in? Tough questions, and maybe the answers are not all the same. I think the bottom may be in, at least for a while. The $74.34 low on November 21 was the result of an awful lot of retail and hedge fund liquidations, and that seems to have subsided substantially. Margin calls have abated, as the recent rally has given investors on margin some breathing room. Is it safe to pile back in? The market is still pricing options at a high volatility. The VIX is only “down” to 58, still real high, and the price of the LEAP puts normally purchased in the Protected Index Program are still a lot higher that we would like. Despite the huge move in HIG mentioned earlier to $14.84, you would still have to pay $.30 to buy the Jan 5 (yes, 5) puts. So the answer is that it is still real expensive to get back in with any sort of protection.
Is everything OK? I would say everything is definitely not OK. Despite the panic low of November 21 it is very possible that the market has still not priced in the depths of where we seem to be heading. The over 1M recent job losses (those counted and announces by our governments peculiar math) are certainly sobering. By any stretch it seems like the American Corporation, certainly the leadership of a lot of those Corporations is broken with no solutions in sight. The auto makers are embarrassing themselves by the minute on national TV, and the Chicago Tribune, fresh from one of the most selfish and maybe crooked deals in history has declared bankruptcy and may not survive after over 100 years. The specter of our elected officials reading the riot act to auto executives over things like planning, full funding of obligations, etc. given their own record in those areas would make even Ghandi reach for the Jack Daniels. You could not write fiction like that and get away with it.
I could go on with that for a while, but it would not solve much. The question really is “What are we to do?” We have had a couple of opportunities to put some money to work using put spreads instead of outright put buys, and have done some covered strangle writes for those clients in those appropriate risk categories. The basic PIP program has done well, as we did roll the puts down and resisted selling calls as the rally progressed. We, in essence, got about as “long” as we could within the confines of the protected program thinking the market was due at least a bear market rally. Like most bullish moves when the market was selling off it did not feel very obvious that it was the right move at the time, you will never hear me say “Of course I knew the market would rally from those low levels.” The fact is that you stay protected, look at the prices available in a panic, make the “proper” move, and hope you are right. You try and put the odds on your side, but the fact is the SPY could have gone to $60, and still might.
Right now the course is set. We will continue to give some room to the upside for those clients in the PIP, as the possibility of a continuing year-end rally is certainly there. For those sitting on cash we are looking for opportunities to put money to work in a prudent fashion. Too much crazy stuff, too many people being tossed out of work, too many corporate leaders seemingly woefully unprepared for a downturn, and a political and regulatory system in near chaos (maybe Obama will help, to be determined) makes me very reluctant to take excessive risk. We will continue to monitor the corporate bond and preferred markets for some opportunity in those areas and keep you updated. Also, we will continue to look at excessive volatility levels in individual stocks for opportunities in covered straddles.
There is one last item. We need to look carefully at the tax consequences of the crazy markets this year. For those with taxable accounts in the PIP Program there is a possibility of some tax issues that need addressing, obviously depending on your own personal situation. In the next couple of weeks Dan Haugh, Robin Spitalny, or myself will be contacting a lot of you who we suspect have issues. Plan on getting your tax advisor involved early, so everyone is on the same page if some “adjustments” are required. Take care.