What I’ve Learned vs. What I Believe

August 24, 2009

LAST CHANCE TO REGISTER, FOLKS! If you’re a trader or investor in the Chicago area and you’ve never attended a complimentary Protected Index Program® Seminar before, register for our Saturday August 29th 3-hour session from 9:00am – noon at our Loop Office. My brother Dan and I will be discussing how our long-term portfolio strategy works and answering your questions. You will also meet some of our talented staff and enjoy a free breakfast and coffee bar. All handouts and classroom materials will be provided, but you must register.

And, if you cannot attend a Chicago seminar, I encourage you to register for the 90-Minute PIP Teleconference on Wednesday, September 9th from 6:00pm – 7:30pm Central Time – get details here. There is no cost for this session, either! All you need to join in is a phone and PC — participate from anywhere in the U.S. – from your home or office!

Good morning. The market was back in the plus column last week, despite a deep sell-off to start the week last Monday. For the week the SPY was up 2.18, or 2.2%, to close at 102.97, a number not seen since last October 6. The VIX was actually up slightly for the week, finishing up.74 to close at 25.01. This morning, early, the futures are slightly to the positive. So, we have a market (SPY) that made a high of 143.05 on May 19, 2008, not that long ago, riding a huge wave of positive market sentiment and feelings that everyone had to be “in.” From there the market basically fell off a cliff to a low of 67.10 on March 6, 2009, a fall of 53% in 10 months. At this point we were being inundated by news reports of financial Armageddon in markets like credit default swaps and mortgage backed securities, markets relatively few knew existed or cared about. Now we have rebounded dramatically from the March 6 low to an SPY reading of 102.97, up 53% (be aware of the math, down 53%, then up 53%, gets you about half way back). Credit default swaps, mortgage backed securities, what are they? Get in, its going up and you are missing it. Remember, if we all just buy, and no piker ever sells, we will soon all be rich!

I was educated to believe, very popular back in the early 70’s and even 80’s, that the markets had a certain amount of collective wisdom, that somehow all the available knowledge of all the buyers and sellers was contained in the market price. Enough people would always find out whether the economy or a company was doing better or worse than generally thought and the price would move to reflect the new reality. In any case, the market was considered almost a deity as far as knowledge was concerned. Now I am not sure I believe that. To me the market totally ignored a crumbling financial infrastructure in early 2008, and was continuing to ignore the virtually constant decrease in real buying power of the average citizen if you did not include the wealth effect of housing and stock bubbles. From there the market plunged to a level that called into question the very survival of the economic system, and is now rallying madly on some combination of federal stimulus dollars and a mad desire to “get our money back.” Has anyone heard of a credit default swap or mortgage backed security since the start of the rally? Did they all go away? How did this all get fixed? Why didn’t we decide to just run $Trillion dollar federal deficits before, if it works so well and will make us all smart enough to be in the market rich?

Is the market really right this time? Can we really all just pour our money in, or keep our money in, and reap 2% a day in wealth? To hell with this hedging, buy the market, buy calls, and sell puts, it is going up and we are missing it, just like (maybe) May of 2008. Is there no price to be paid, ever? There sort of is a price, but if we put new names on it and stay away from the tax word maybe we can fool everyone for sure this time. Last week we talked a little about fees on the various levels of government going up rapidly, but since they are only fees they do not count as taxes. How about prices going up in non-competitive industries the government has saved/invested in? I will bet that the auto dealers did not discount near as much to a buyer (certainly a non-informed buyer) who was getting $4,500 for his or her old junk from the rest of us. A couple of weeks ago the Financial Times reported major banks charging somewhere in the neighborhood of $35+ Billion in fees for overdrafts last year, and last week I read on Bloomberg where the average interest charged on credit cards has increased almost 2% this year. These are the new taxes, government invests in a business they cannot allow (for reasons of lax regulation and actual pay-offs through the years) to fail, then let that business stay non-competitive and raise all sorts of fees (taxes) so they can have a chance to pay the government back. Never mind the fact that the government is now even more powerless to regulate these people, since they want their money back.

Remember the very forgettable hearings before Congress on the financial system, and particularly the “too big to fail” discussions? Stalwarts like Bernanke and Geithner, saying it is not in the best interests of the country to have institutions get so big that their failure would challenge the health of the whole system. Yet a couple of weeks ago Colonial Bank was in trouble (amazing that the examiners watch these places on a continual basis yet it always comes down to a panic on a particular Friday night) and was immediately merged (at some very preferred terms it seems) with its former competitor, BB&T Bank. Wasn’t this constant merger mania, some voluntary, some forced by FDIC staff, how we all arrived here in the first place? Do you think that the result of this merger for the people in Florida is increased service and decreased fees? If you do, I have a clunker for you. Does the President (if he feels like his two main men, Bernanke and Geithner, and a lot of Congressional smooth talkers) need to sit down the high FDIC staff and fire them all? Or are we just being lied to, the bureaucracy has an easy way for them and they are not changing, now one less bank to worry about and examine. Where is the truth?

Now the real question, how do you trade this mess? Clearly the dramatic moves in a short period of time make being hedged and protected either life saving or insane, depending on the week. I do believe that the relative ease with which retail investors in mutual funds can switch their fund categories is tending to cause the markets to dramatically move in on extended direction. Right now a lot of the same people who went to all cash, either by one phone call or one keystroke, are now reversing that allocation “because we are going up.” Add to that the shameless front running of firms knowing mutual fund companies will be buyers (or sellers) on the close and you have a market that seems to exaggerate in either direction. It is also real difficult for me (since it is very unique in its size) to determine how much of the current run up is due to just Federal money essentially inflating the market. There is no doubt that a new stock market rally/bubble would be welcomed with both hands by virtually everyone in power, despite whether it does nothing but sow the seeds of the next down turn. There also is that added feeling that the government (feelings generated by the ease with which MS bought back their warrants issued to the government, and by recent advances in C, FNMA, and FRE) may be about to forgive some of the terms wrung out of these firms for the saving billions. But that sort of gimmick rally always has always failed, eventually, hasn’t it? But then again, it just might be the real thing.

For those in the Protected Index Program, it has not been a relatively good time to be hedged at all, or worried about any type of protection. Why protect, the market goes up every day, doesn’t it? For the SPY position holders we have put a spread on to give us some long deltas, and will do so in the Russell this week. The trick continues to be to find something that provides some long deltas if the market keeps going, yet can be saved for zero or little loss if it does not. To me, the market seems a little extended, and I really worry about a double dip, but I also do not want to give up on participation should the rally just be starting. Tough to cover all those bases at the same time, but we will certainly continue to adjust to whatever the market delivers.

Stay tuned for more information regarding my “Stocks and Jocks” Podcast which we’re planning to tentatively launch on Tuesday, September 8th from 11am-12pm Central Time. You will be able to listen online or download to an MP3 player and we’ll have an archive of shows. Once we get rolling we will officially announce its launch.