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The Heart of Darkness

February 18, 2009


Good morning. The hits just keep on coming. Last week the market (SPY) was down $4.22, or 4.9%, and yesterday it followed up with another drop of $3.54, or 4.2%. That brings the unhappy totals for the year to down 12.2%, and it is only mid-February. Yesterday’s “official” reason for the sell-off was the continuing stream of bad economic numbers from Asia and Europe. Remember how we were forced to listen to some of the so-called “experts” within the last couple of years ago telling us how Asia was so strong that even if we went into a recession it would not matter to them? How is that theory working? And why were those morons on my TV set?

So what about this sell-off? Obviously those in the PIP program are protected by puts or put spreads, and we have mostly bought in our short calls for the month at a profit. Right now most of us are hoping that yesterday will turn out to be the successful test of the November lows a lot of the technical people have been waiting for. Let’s not minimize what we all are feeling, however, it looks a little scary. When we stop going down, and I think we are close to that stage, does that mean we rally or just bump along at relatively low levels for a while? I suspect the latter, meaning that we will have to be diligent in our call selling to maximize our returns this year.

Obviously we are at the stage where the market is just a small piece of what is happening in the overall economy, both here and around the world. To add to the chaos we have governments trying to affect the situation for the better and no end of “experts” trying to influence policy towards their own best interests. Our new President has just signed a large recovery type package designed to help stimulate the economy, or at least slow the descending spiral. To say that there are large numbers of people opining on the package, and a lot hoping for it to fail, is an understatement. It also has become fairly obvious to all that a lot of the people sent to Washington (or Albany, or Springfield) are in way over their heads when it comes to problems of this magnitude. To be charitable somewhat, these problems are fairly unprecedented. I do wish, however, when our elected people are on national TV they would be mindful of what my freshman high school English teacher used to say, “It is better to keep your mouth shut and be thought a fool, than open it and remove all doubt.”

Will the new “stimulus” package help or hurt in the long run? I could take the “conservative” position and come up with some blather about all we have to do is lower taxes on rich people and corporations and everything will magically be on the mend. I can’t believe they really believe that. Corporations are clearly part of how we are in this mess, and not by overpayment of taxes. I have studies (and I would love if someone could refute them) that show that the corporate share of taxes paid in the U.S. has dropped significantly in the last 10-20 years. I also have a study that says the spread between what corporations report to the public in the way of profits (and on which the esteemed managers are compensated) and the numbers on the usually totally separate set of books maintained for taxes has never been wider. Let us not forget the George Bush tax “holiday” given many multi-national corporations that shoved earnings into European subs, and were able to repatriate those profits at a tax rate of 5%. I actually had a “conservative” friend tell me how much it hurts and how anti-competitive it is, that some corporate tax rates overseas are less than ours, the same argument Paulson gave the SEC when he argued to have the equity ratios at Goldman, Lehman, etc. allow 33 to 1 leverage instead if 10 to 1. How did that work out?

Before I am accused of being pro big government and seeing government as the savior, I have problems with that view as well. Between the banks and the stimulus plan we are up to around $2 trillion in money being spent on all levels, which actually does not include the deficit financing happening in virtually every state and municipality. By simple math, that amount of money just divided up and sent to the estimated 100 million households comes out to around $20,000 per household. I am thinking that if that amount of money was either required to be applied to an existing mortgage, used as a down payment on a new house, used to draw down a student loan, etc. we might be way better off than giving it to Citigroup and others.

Having said that, there is some good stuff in this package. To the extent that we encourage people to go to school we accomplish two things (as proven by the G.I. Bill). You both take people out of the labor force at a time when you have too many, and you provide the type of education that we have been trailing some areas in the world. Is there any doubt that we can use more engineers, etc? I also think the repeal of the Alternative Minimum Tax is a good idea, as is the temporary (should be permanent) break of being able to write off on your federal return the huge chunk of sales tax the thieving states charge on a new car. I think the tax breaks for energy efficient windows, furnaces, etc. is also a good idea. In short, there is a lot of good in this plan. I share with most, however, the serious concerns about giving federal money to the states and municipalities for infrastructure improvements. Especially being from Illinois, I would not give this state a thin dime that I did not monitor every step of the way, but that is another subject. Is any of the good stuff in the bill better than just sending everyone a check? I don’t know, but it is probably better than just lowering taxes to corps. I guess a $15,000 check and a few of these programs would probably be my choice, but I did not get the call asking me.

How do we make money on all this? I suspect that we are near the darkest hour, not only are people being laid off at incredible rates, another 47,000 today at GM, but no one is sure if they are next. Even those who will maintain their jobs are now worried and cutting back on everything just in case. How else do you explain 2-3% of the people losing their jobs and sales of items like cars being down 40%? At some point, hopefully soon, the lay-offs will decrease and those still employed will regain some degree of confidence (keeping in mind their home and stock investments are still in the tank). The next thing is some sort of stability, not necessarily a rally, in home and stock prices. We should see that later this year, especially if the foreclosure process would become more transparent and less crooked. Once these things are in place we can start looking for things to get better, and maybe a rally. I do believe we will end the year in the market higher than we are now, but not much. The money will be made in selling calls, but if the market would like to rally, that would be OK as well. In another month we should probably pick a year ending level and put on a cheap butterfly looking to take advantage of our prediction. For instance, if you feel the SPY will finish the year unchanged, roughly $90, right now we could probably put on the end of year $80-100 butterfly for around $1.80. If we are right we make $8.20 at $90, with break evens at $81.80 and $98.20. I also really wish I could find a nice expiration back spread for this week, maybe the market will cooperate and we can pull some light from this darkness.

I would also like to point out that PTI Securities now has a Wikipedia page, which we think is pretty neat. Check it out here.