The Bottom Line
June 7, 2010
Good morning. One of the few calendar, or seasonal, type plays in the market that has been most consistent since the early 1980’s (time I started in the trading business) has been the relative lack of volatility in the market from essentially the May options expiration through Memorial Day and even until the 4th of July. When I remember the years when I had 11 traders trading in our group on the floor of the CBOE and how difficult it was to not end up long premium entering a time of holidays, time off, graduations, etc. Not this year, it seems. This year I think we would have done very well being long option premium in basically a Holiday week. The market, despite a huge up day on Wednesday, finished the week down solidly. The SPY finished down 2.52 at 106.82 (or 2.3%) for the week, and that represented a 3.5% drop from Thursday mornings high of 111.06. The VIX was up 5.90 to finish the week at 35.47, up over 20%.
What is happening? The first thing is that jobs are not happening; at least in any number that would indicate the economy is beginning to grow on its own. The headline number on Friday of 431,000 jobs created, the biggest jump in ten years, seemed okay on the surface (even though the expected number was over 500,000 and some estimates were over 600,000) but the Labor Department reported that 411,000 of those jobs were tied to census hiring by the Federal Government. Bottom line, a huge blow to anyone in the camp that says the economy is in full self-sustaining recovery mode. Toss in the fact that both the President and Vice-President mentioned in speeches early Wednesday that the number would be very good, partially responsible for the furious rally Wednesday, and you have a serious market shock when the number turns out downright awful. As to why the President and Vice –President feel compelled to opine on a big economic number in advance (in prepared texts so there was no mistake about the intent, and probably no concern over who might have had the speech early) is something that is mystifying in itself, but to be wrong about it is really frightening. They either popped off without knowing the number early, something I cannot fathom, or they saw the number and actually thought it was good, something that would worry me even more. I was actually very surprised at how bad the number was, but was thinking that May did not finish anywhere near as strongly as most had been gloating about.
I actually think, an opinion I have been forming the last couple of weeks, that the delicate recovery has slowed and is in severe danger of fizzling out entirely. If you have been listening to the radio show the last couple of weeks you also would have heard me say how fervently I hope I am wrong for all concerned, but I do not think I am. The first reason for me thinking this way is the Leading Economic Indicator numbers published recently showed a drop into negative territory for May after a big up number of 1.4% in April. In a recovery actually gaining steam that does not happen. Another recent number was the Master Card numbers this past week showing retail sales actually down in May, even though luxury spending was strong. The strongest reason for my negative view going forward was an article in the London Telegraph on May 26th. The article is entitled “US money supply plunges at 1930’s pace as Obama eyes fresh stimulus.” It chronicles that the US Money Supply (M3) has plunged from $14.2 trillion to $13.9 trillion in the February, March, and April time period, an annual rate of 9.6%. I am not sure where they are getting the M3 figures, as I believe the Bernanke Fed does not even publish it, so I decided to check the M2 figures. Those figures confirm a decline so far this year of .07%, or a yearly annualized decline of 3%. In the past whole year the increase has been a paltry .8%. This is clearly not enough, speaking as a University of Chicago graduate schooled in Monetary Theory, to sustain any sort of recovery. My opinion is a little more muted than those writing the above article as to how severe this will turn out, but I surely agree that this is not how recoveries are made and is a severe miscalculation of the Fed.
I have the feeling that the economy has hit somewhat of a wall in May, maybe by some combination of stimulus slowing and just general malaise. Why is the Fed allowing this to happen, and will more stimulus (as now being advised by the Keynesian group headed by Larry Sumners) be the solution? Keep in mind that in this fiscal year so far (October 2009 through April 2010) the Federal Government has spent over $7,600 more per household than they have taken in. That is an insane amount in only seven months, and even with that deficit financing they are allowing the Monetary Base to either languish or actually decline. This could be the biggest Economic experiment in the history of the world, and it appears to not be working. Roosevelt and his group were very wary of excessive governmental spending (or pump-priming) in an effort to recharge the economy, the feeling being that if it was unsuccessful you were now stuck with the situation where the economy was still lagging, but the government is now broke as well. Our guys seem to have no concerns about that, but I think maybe they should rethink the situation. In fact, I think our still young President should sweep out his current Economic Team and start from a totally different direction before the fiasco becomes terminal. We need to put the monetary system back together, and not by just shoveling money to a few zombie banks that are very happy to charge very exorbitant fees and interest to only the select few. Maybe we could funnel some of that cash to a recharged Savings and Loan Industry, a group of new Banks, or an expanded role for Credit Unions, any new idea other than the same reliance on a few failed institutions.
Notice how I have not even mentioned the ongoing fiasco in the Gulf. I think that subject deserves a column on its own. As we continue to hire thousands of people in Washington to regulate anything that walks (or maybe crawls) we surely need to keep in mind that any time we have looked to Washington (and the high salaried, high pensioned bureaucrats that infest the place) for help all we have received is incompetence of the highest level. Connect the dots from the anti-trust group that sees no anti-trust (but will not fire themselves), to those that refused to forward reports of strange guys taking flight lessons in 2001, to the fraud laden Homeland Security experiment, to the performance of FEMA after Katrina, to the stalwart job the SEC and Fed have done in the financial crisis, and now the guys from the offshore well management group performing fictional inspections while interviewing with the firms being inspected. We need to take a breath before sending more money down the same sewer, but we plod on without doing so.
The question, as always is, how do we trade it, or do we? Those in the Protected Index Program are weathering the storm very well, and for most of our clients the cash positions remain high. It has not been easy staying in cash during the almost frantic recent run-up, but I just never really saw the proper opportunity combining good prices of the underlying, decent prices on the long-term puts, and good opportunity for short-term covered write success. That is obviously changing, the SPY is much more attractive at $106 than $121, and the volatility skew having the far outs trading way more than the near-term is abating. If we are entering a double dip, even a brief one, I believe the market will trade somewhat lower, but I doubt (and hope) we will not move to the horrible levels we saw in March of 2009. Those of you in the SPY position may have seen us put on a short-term short position in your account last week. We did that for two reasons; one was to cover the gap between our short calls and long puts, the other was to take advantage of the extreme volatility skew in the near term out-of-the-money puts. I believe we had am almost eight volatility point difference between the puts we bought and those we sold in that spread. Some of the more aggressive clients have seen a few new calendar spreads in the last week, as we also were able to find some volatility edge in some calendar positions, especially in some of the non-effected oil drillers. The good news is that we have largely not been hurt and we are on the hunt.
This week we will be doing a review of all accounts, and looking to assess what each account (depending on the risk profile of every individual) would look to do if an unusual opportunity would present itself. I think our conservative views regarding the market in the last 10 months may have served us well, and maybe the time is ours. We may really get a great chance, and plan on being ready. I would ask all of you to review your accounts as well, and we are certainly here to discuss any feelings you may have in this unusual time we find ourselves. I would also recommend that you tune in to our daily radio show to find out how we are thinking as the market seemingly changes from hour to hour. We can be heard in Chicago on AM1240 or heard at any time on www.stocksandjocks.net.
P.S. If you live in the Chicagoland area and are interested in PTI’s managed money program, PTI Securities will be hosting an In-Office Protected Index Program Seminar on Saturday, July 17th, 2010 from 9:00am – 12:00pm. It is free and my brother Dan Haugh and I will be on hand to cover the strategies, answer questions and have a cup of coffee with you. You MUST REGISTER and can do so at www.PTISecurities.com/Education.htm.