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Will it Take a Musket Some Day?

March 16, 2009


Good morning. A whole different tone in the market this morning from prior weeks, with the stock market staging a significant rally last week. Last week the S&P was up $7.17, from a close on March 6 of $68.92 to a close last week of $76.09, a gain of 10.4%. If you take the low in the S&P Futures on March 6 of 663.30 to this morning’s early number of 763.9 you have a gain of over 100 points, or 15%. The VIX dropped a whopping 14%, from 49.33 to 42.36. The debate is raging; bear market rally or the start of something good, or at least the worst is over?

It is hard to say if the strong rally of last week is the real thing or not. The news that GE was only downgraded to AA+ instead of something lower meant that the company did not have to essentially send extra money (that it does not really have) to clients that are the contra-parties to some of GE’s over-the-counter obligations. One does have to wonder how you, as a company, would sign up for a contract that has you being forced to come up with billions of dollars in cash if your rating changes for the worse. Wouldn’t it make sense that your rating would only change for the worse when business conditions were bad and you probably did not have the money? Did these people get their MBA’s at Kmart, or do they just not care what they do with other people’s money? It sort of is like the out-of-control credit card companies who will raise your rates to 30% as soon as they know you can’t pay 24%.

Obviously the hot news of the day is AIG. They managed to be all over the business press for two different subjects in the last few days. The first was the realization that a lot of the $160 B the government has given them has been paid out for the same sort of reasons GE almost had to pay out, increased collateral for contracts due to ratings decreases. Would it be too much to expect that the Treasury be clearer and more forceful regarding their intentions at AIG. If the government clearly is backing AIG with no caveats, then the ratings agencies need to be informed, and the company should not have to send out checks for a bad rating. It seems like Goldman Sachs was the largest recipient, Paulson was from Goldman, and I am stunned.

The second story regarding AIG is the payment of huge bonuses this past weekend, seemingly to people in the same division of the company that is threatening to take them under. To be fair, people in the financial community (certainly in the trading community) traditionally work on sort of a draw/bonus arrangement where your income is derived by how much you made the company. In some ways your bonus should not be affected by problems in other areas, unless it reached the stage where the company simply cannot pay. Market maker firms on the CBOE traditionally paid market makers a draw against a split of profits; say 50-50 on the profits for the year. If one market maker lost so much that the others could not get their split, you really could not write the check to those profitable, the money just was not there. Obviously, the other people “earned” their share, and probably have a written contract to that effect, and you would try and make it up to them in the future, but you could not write the check without money. In this case AIG needs to understand that they have no money other than what has been lent them by others, and those “others” now have a say in how the company operates. How our lame government hacks have not demanded several spots on the Board of AIG (and others) to “protect” their investments is mind blowing. Someone should have been there to vote against, and argue against, this behavior, not just keep chasing after the fact.

There is no question that it is nice to have a rally. My account looks better, and so does everyone’s that I am managing. From a trading standpoint I have rolled virtually all the put protection down and have resisted selling calls for most of the way up last week. In short, we love this rally. However, there is a part of me that says it is too soon for the market to just start up and go on its merry way. For one, we will be sentenced to the hoard of moronic talking heads speaking of how the buy and hold strategy once again proved itself, as only those weak enough to sell down 50% actually were hurt in the long run (forgetting conveniently about all those in companies like Lehman, which will never come back). The other reason is that we don’t seem to have learned anything, much less fixed anything yet. Most all of the same self-centered chief executives are still in power, as are virtually all Board members. I have seen no really innovative new ways to select real independent Board members, other than having the Chairman pick his hacks. Way too few people have gone to jail, and way too may people in all positions of power seem to have not “seen the light.” For example, Citigroup just added four new outside Board Members this past week, and I suspect without any input from any regular shareholders.

Believe me, it is a conundrum, and I would love your input. I do not want anyone to lose any more money (especially my clients), but I know that we have not come anywhere near the point where the sheep we have all become get mad enough to change something. What does it take for the current population to act? I don’t mean muskets, although I could see where it could get to that. For now I would take huge and angry turnouts at shareholder meetings, competing Director slates, “untouchable” political hacks thrown out of office, something. I had somewhat of an awakening last week when I talked to my new credit card company (Chase). Now everyone should know (if not under a rock or attached by the hip to a video game) that the few remaining banks that finance credit cards have received huge money from the taxpayers, with virtually no guidance as to its use. Well, one use seems to be to raise everyone’s credit card APR. For me, fortunately, it is just an irritant, but if I had a balance it would feel like robbery. Anyway, I had a card through Providian Bank at 7%. Providian became WAMU, and it is now Chase. So I called, and was speaking (after a ten minute wait) to Jay. “So Jay, what is my rate now up to on this card?” Jay replies, “Sir, that would be prime plus 13.5 %, for a total of 17%.” “Jay, without any late payments or other problems, how am I up to 2 ½ times my starting point?” “Sir,” says Jay, “All this has been disclosed to you in various notices and letters, as is our policy.” “Jay,” I asked, “ If I walked up behind you, mentioned I was going to kick you right in the ass, then did, does that ‘disclosure’ make me any less of a jerk or make your butt hurt any less?” Jay replied, “Well no, but that is our policy.”

Do I think John Thain, or Liddy, the fellow who heads AIG, or Robert Rubin, or the political hacks in Illinois or Chicago, or those in Congress, or the Board Members of almost all major firms now “get it.’ Hell no! Will it take a musket some day? I honestly am starting to think it might, but maybe we will leave that, as well as a lot of debt for the next generation.

For now, let’s enjoy the current rally, make some money, and make sure we guard against a further run to the downside. We have a considerable amount of cash in a lot of our managed accounts, due to both being not fully invested and in making money on closed put and call transactions. The market levels are still attractive, and the drop in the VIX has given the cost to protect some respite, so we will be looking to commit some of that cash if the right trades comes along. One thing is for sure; we will look to keep the puts tight in the event that this really is just a standard bear market rally.