Couple thoughts and some questions

It's a beautiful day as summer draws to a close and a fresh new football season is upon us. This is my favorite time of the year, the transition from late summer into fall; weather is perfect, football is back, playoff baseball is starting, and golf season hits its prime. Now if only the markets could be as peaceful as the changing of the seasons...

Couple thoughts/questions

-Brett Farve has tarnished his greatness. The man is a horrible teammate and is the antithesis of a pre-madonna. Would you like someone on your team who skips the entire pre-season, doesn't know the playbook, and has little to no commodore with his teammates? I sure as hell wouldn't. Farve thinks the world revolves around him, which is never a good mindset for someone who goes to war alongside ten others each Sunday.

-Are people beginning to realize that China is the dog that wags the U.S. tail? The Shanghai index is down 21% in the last fifteen calendar days. Why? Like I said before, lending has tightened and taken a good amount of liquidity out of the market. From a structural standpoint, it's better off they tightened their policies, but what kind of ripple effect will it have on global capital markets?...especially as a leading indicator for what's to come in U.S./European markets.

-The Financial Times reports that global bond issuance surpassed the $1 trillion mark for the first time in a single year....and it's only August.

-Oddly enough, a credit analyst at Morgan Stanley issued an alert to investors on corporate bonds after the explosive rally we've seen. The article says...
---September options contracts signal volatility, but corporate bond spreads continue to tighten.
---Credit rallies typically anticipate stocks by about three months, but we're past that stage and the two should be converging now. That means stocks must either rise sharply or spreads must widen to reflect risks.
---Spreads have recovered in just eight months, which it normally takes three years. The credit market is saying the "Great Recession of 2008-2009" was much ado to nothing.

-It's both odd and fitting that those are two of the headlines we see today. Could it be signalling a top for credit markets with speculation of danger ahead?

-Are we churning? Are we basing? Are we working off overbought conditions as a function of time or price?

-What will be the next catalyst to the send market up or down?

-What's up with the huge draw on crude inventories? Are countries, yes countries, not companies, trying to hold it around $70/barrel? If the price falls too much, won't that have a big impact on oil exporting nations...which also seem to have the most political instability? Which will have an effect on social moods....which will have an effect on global capital markets...

-What draft position will I get for next Sunday's fantasy football draft (as the reigning champ)?

-Have the Yankee's peaked too early, leaving room for the Sox to make a run?

-Enough rambling for now. Good luck today!

Complex Outlook

We find ourselves in the midst of major crosscurrents of prices, trends, expectations and psychological effects. On one hand, we have a market which has rallied about 50% since its March lows. Credit spreads have tightened, LIBOR has stabilized, banks have been recapitalized, housing shows signs of bottoming out, cars are flying off the lots, and earnings season was a home run. Sounds like a new bull market to me. But as we look a little deeper into things, every area that has seen improvement has to thank the gov't for propping it up. Credit spreads (gov't guaranteeing debt), banks (TARP, TALF, PPIP, etc), housing (tax credits & mortgage modifications), cars (cash for clunkers), earnings (pent up demand & heavy discounting). Employment is still crumbling. The seasonal adjustments show signs of life, but many people are no longer being counted as a statistic because their unemployment benefits have run dry. This exacerbates delinquencies (credit cards), defaults (all consumer loans), and foreclosures (housing). That doesn't point towards any type of sustained recovery when an economy is 70% leveraged to the consumer.

Next, we have the markets biggest conundrum, China. The newly anointed leader of global growth is having its own problems. Can they be the anchor for the global economy? Seems as if our friends in the east are having a tough time shouldering the load. With commodity prices more or less following the lead of Chinese demand, any decrease in demand will have adverse effect on prices. Thanks to the gov't stimulus, Chinese banks have been lending out money as if were 2003 in the U.S.A. While this money was originally meant to be for infrastructure projects (real estate development, building repairs, roads, bridges, etc), a good amount of the money has leaked into the equity and housing markets, therefore sending asset prices up. Sound familiar? Just in the past two weeks we've seen two near 5% corrections (drops) in the Shanghai index...stability? We're also seeing dissension within the Chinese ranks. The vice finance minister said China will create an "internal mechanism" to stabilize the stock market while a deputy governor of the central bank, on the same day, said they won't consider asset prices when adjusting policies. As Ron Burgandy would say, "Agree to disagree". I guess that go in Hollywood, but in global central banking, it simply doesn't cut it. Add to that, the president of China Construction Bank (2nd largest in China) said they plan on cutting new lending by 70%. Maybe they're realizing it's not a great idea to simply lend out money to anyone who asks for it. Also, China's GDP growth has been due to accounting rules, which vary greatly from the ones we use in the U.S. Too much to go into at this time, but trust me on this one.

Next on the list is Europe. As I noted before, the European banking system is on the verge of demise. You'd think that the Euro would weaken against the USD, but this are no time for conventional wisdom. The EUR/USD has been ripping as of late. Eastern European banks are insolvent. Germany seems to be the only Western European nation that has its head on straight. Thank Ms. Merkel for that. The picture is pretty bleak in Europe as well, but they have seemed to fly under the radar as of late. The UK announced further plans to use quantitative easing and the Pound got beat up pretty good thanks to that. As I've said before, no economy can be healthy if the banking system is sick. The European banking system/model is sick...very sick.

This obviously comes off as a bearish outlook right? Well, those are my medium to long-term ideas. As for the current, I expect this rally to extend. We will most likely have a basing at the current levels while market participants digest the great earnings season and the better than expected news inflow on the economic front. There are two factors I'd like to bring into play. First is the large amount of cash still on the sidelines sitting in treasuries and money markets. If this money comes back into the market it could fuel a liquidity driven rally...simple supply/demand. Second is a psychological factor. With many portfolio managers being underweight equities, the fear of under-performance is setting in. Their "risk" lies in a further rise in the market. This completely changes their mindset. They are waiting for a pull back so they can jump back into a more neutral weight position and gain some ground which they lost from being underweight during the recent rally. They are buying the dips which means that any pull back could be minor at best. Between the cash on the sidelines and the portfolio managers waiting to get back into the market on any meaningful pull back, the likelihood of a short term run up to the 1100-1200 range is inscreasing.

I believe a lot of the markets confidence has come from China. I believe this past 5 month rally to be completely based on psychological and technical factors, nothing fundamental. The fundamentals are deteriorating. With China more or less propping up commodity prices, the market has used the basic material sector as a foundation for the rally. The perception that banks are "out of the woods" is also having an effect of investors confidence. This market is hinged on stabilization of commodity prices. China will stay strong until October 1, its 60 year anniversary of its revolution and founding of the People's Republic of China (communism). That is about 6 weeks away.

China has also been in recent talks with U.S. officials. Hillary has said that China is "comfortable" with its lending to the U.S. I'm glad glad we're taking cues from a communist gov't. If they weren't so comfortable, the Chinese could dump the USD reserves and kill the dollar. They'd be screwed because the money we owe them would then be worthless and their biggest export partner would be dead. They don't want this to happen, so they must have made some type of deal to keep funding the U.S. deficit in return for the U.S. to either raise taxes or cut spending.

There is still so much debt in the "system" still, it trumps the amount of capital available in the entire globe. This debt is going to be reduced or deflated. Debt reduction will strengthen the USD. This is going to go on longer than most people think. As I've said before, when the dollar goes up, equities go down. Actually, anything priced in dollars will go down.

The dollar strength will coincide with Chinese weakness (after October 1) pressuring commodities. When commodities drop this will trigger the rest of the market will follow. This is going then put more attention on the balance sheets of the banks and we'll have a deflationary spiral begin. I'm not saying this is going to get out of control, although it could, but we'll see a more than expected drop in asset prices. With investor psychology so fragile at this point, the change of attitudes is going to have a lasting effect on investment decisions (risk averse in the realm of losses).

Conclusion: Short-term bullish into September - October. Going into that time frame I'll be looking into going long the dollar, long select consumer non-cyclicals, short commodities, short financials, short retail, short China, short European banks.

Just one man's humble outlooks. Good luck today!

Heatlh Care Reform

John Mackey, CEO of Whole Foods, seems to be one of the few practical minds in today's corporate America. His comments are very Atlas Shrugged-esque. A breath of fresh air for once.

Many promoters of health-care reform believe that people have an intrinsic ethical right to health care—to equal access to doctors, medicines and hospitals. While all of us empathize with those who are sick, how can we say that all people have more of an intrinsic right to health care than they have to food or shelter?

Health care is a service that we all need, but just like food and shelter it is best provided through voluntary and mutually beneficial market exchanges. A careful reading of both the Declaration of Independence and the Constitution will not reveal any intrinsic right to health care, food or shelter. That's because there isn't any. This "right" has never existed in America.

Even in countries like Canada and the U.K., there is no intrinsic right to health care. Rather, citizens in these countries are told by government bureaucrats what health-care treatments they are eligible to receive and when they can receive them. All countries with socialized medicine ration health care by forcing their citizens to wait in lines to receive scarce treatments.
Although Canada has a population smaller than California, 830,000 Canadians are currently waiting to be admitted to a hospital or to get treatment, according to a report last month in Investor's Business Daily. In England, the waiting list is 1.8 million

The New Wall St Reality

Courtesy of Zero Hedge...

GM chapter 11 = PRICED IN
125K+ jobs lost from GM chapter 11 = PRICED IN
unemployment @ 9% = BETTER THAN EXPECTED
unemployment @ 10% = DOW SOAR
Sunemployment @ 11% = GREEN SHOOT RALLY
unemployment @ 12% = ALREADY FACTORED IN
unemployment = 35% = DOW DROPS 100 POINTS
housing price =1% = RECESSION ENDING
housing collapses = GREEN SHOOT
Housing falls 20% = STABILIZATION
Government spends 1 trillion of OUR dollars = STIMULUS
North Korea fires nuke = RALLY
Israel bombs Iran = 30 MINUTE END OF DAY RALLY
world explodes = ASIA RALLIES
PMI crashes = HUGE RALLY
No jobs are created = RECESSION ALMOST OVER
U.S. debt overwhelming = TOO BUSY RALLYING TO CARE
Consumer stops spending = RETAIL RALLY
Banks are insolvent = SIGNS OF STABILIZATION
American auto industry BK = GOOD THING
Banks pass scam stress tests = HUUUUUUUUGE RALLY
Banks "only need 75 billion = OUT OF THE WOODS
Banks pass a real stress test = NEVER WOULD HAPPEN
Banks pay back tarp = LATE DAY SURGE
Banks can't pay back TARP = EARLY MORNING SURGE
12% mortgage delinquency = GOOD FOR STOCKS
Hundreds of thousands of mortgages underwater = HOUSING BOTTOMED
Dollar rises = RALLY
Dollar crashes = RALLY
Inflation = BULL MARKET
Deflation = BULL MARKET CONTINUES
REFLATION = MASSIVE SHORT COVERING RALLY
Gold rises = STOCKS RALLY
Gold falls STOCKS RALLY
BIGBanks' fake earnings = SIGNS OF STABILIZATION
CRE stabilizing= 1000 POINT RALLY
CRE CRASHING = STOCKS SHAKE IT OFF TO RALLY
CONSUMER INSOVENT = CONSUMER IS SPENDING
OIL @ 50 = BULL RALLY
OIL @ 60 = GREEN SHOOT
OIL @ 100 = IMPORTANT RECOVERY SIGN
OIL @ 20 = TAX BREAK

And the one we should all interpret correctly:NO ONE IS BUYING STOCKS = BILLIONS ON THE SIDELINES

Walking a thin line

Social mood and the markets seem to walking a thin line right now. You think that's a coincidence? I don't. With the financial media declaring an end to the recession and the beginning of a new bull market, many on "main st" must be scratching their heads. I say give it the eyeball test...do things really seem better? No, but as we all know, the markets are leading indicators for the economy as a whole. Maybe things are getting better; GDP estimates came in better than expected, manufacturing indexes have shown improvement and the SP even made it's way back to 1,000. I believe we may be approaching a statistical recovery, which ties into a couple of my blogs last week about things "appearing" or "convincing" people things are better. Hopefully George Soros' theory of "reflexivity" will play out and perception will become reality and things will go back to normal. Although, it's true that hope is not a viable investment vehicle, so take it all with a grain of salt. The public doesn't know what to believe anymore. They're not convinced things are getting better with a real unemployment rate somewhere around 18%. The dichotomy between the two implies some volatile times ahead for capital markets in my humble opinion.

A couple of scattered thoughts for the first Monday in August of 2009:

-The equity market was strong today mainly in commodities and energy. Why you ask, well because the dollar index moved to a new low for 2009 pushing up anything priced in dollars.

-Being the first trading day of the month, August monthly inflows helped to put a bid under equities. Keep that in mind.

-HSBC caught some heat for not taking enough risk in the second quarter. They didn't acquire any U.S. investment banks unlike its rival Barclays who bought the bankrupt Lehman Brothers. -Read the market message: At bottoms underperforming managers are criticized for taking too much risk. At tops they're criticized for not taking enough.

-Mark-to-market being discussed again? FASB may want to bring it back. Banks say keep it away we want to value our "assets" at what we "think" they're worth, not what they're currently selling at. Makes sense...ehhhh

-Interesting timing for this to hit news stands considering where the tape stands.

-"Cash for clunkers" seems to be a wild success. I was watching yesterday's PGA event on t.v. and it seemed like every commercial was a cash for clunkers ad. Keep it mind it was the Buick Open, but the ad was a bit redundant.

-Initially we bought (not directly) $1 billion worth of cars, that for the most part have little economic value.

-Friday we decided to go long (buy) another $2 billion because the first attempt was so successful.

-This is a one time purchase and doesn't account for long-term savings. (excluding gas)

-To look at it through both lenses: bull - we're (taxpayers) helping the pent up demand in autos. bear - future sales are being diminished because of the incentive to buy now.

-Staying with the automotive theme, Ford's sales were up 2.3% last month. Thanks taxpayers!

-Still feeling the automotive flow...doing the bull dance. Palladium, which is a main component in catalytic converters, has seen a steady rise in price. Thanks to Ford? I doubt it. Tata Motors of India is releasing a car for first time buyers which is priced at $2,053. India's 18 and under population is larger than the entire U.S. population. Do you smell demand?

-Green Mountain Coffee decided to float another 4 million shares to pay back debt. They mustn't have gotten the note from banks that it's a good idea to sell equity to pay old debts. Something bad may be brewing and it's not the coffee so keep your eyes peeled.

-Insider selling is at a 4.16 to 1 ratio meaning that for every 1 share that is bought 4.16 are sold. The last time the ratio was this high...October of 2007 when U.S. equity markets reached their all time highs.

There you have it. A few randoms to hopefully provoke some thought. As a friend of mine always says, think positive because profitability begins within. Good luck tomorrow!

Similarities

Just a quickie that caught my eye.

Financial Times headline today "European equities staged a broad-based rally on Thursday, hitting a fresh eight month high as as string of mostly well-received corporate earnings convinced investors the recent run should continue."

The term convinced and my blog last night about the word appear seem to be interchangable. Whether you're trying to convince investors or whether you're trying to make things appear to be healthy, you are actually trying to fool them. My only question is, how much longer can the situation appear to be getting better; how much longer can investors be convinced this rally has fundamental support? With the SP around the 1,000 level, it could extend to 1,100.

Exit strategy appearing?

It's late, but I wanted to throw up a couple thoughts on some comments coming from Federal Reserve Members today.

First comment was from William Dudley of the New York Fed. Mr. Dudley said, "new Fed asset purchase programs will grow its balance sheet to $2.5 trillion, which is above the peak in December."

Next we have James Bullard from the St. Louis Fed saying, "if you permanently double the money supply, you will eventually double prices. It takes time for price levels to rise."

"The Fed can never and will never shrink its balance sheet. The Fed filled a giant capital hole in the banking system with newly created (printed) money; it cannot "take back" money any more than a surgeon can give a patient a new heart then "take it back" once the patient appears to be better."

The first thing that comes to my mind is, well, so much for the Fed's exit strategy and the good ol' greenback. The bigger the Fed balance sheet grows, the longer this crisis will last. All they are trying to do is buy time for the "toxic assets" to get back to fair value. How are they going to do this? Kill the U.S. dollar and inflate the hell out of the economy. The money supply has more than doubled and as Bullard said, the Fed can't take the money back.

Bullard should have used a better choice of words. Something that stuck out to me was his comment that "the surgeon can't "take back" the heart once the patient appears to be better." Appearing to be better and actually being better are two completely different things. Appearing to be better makes me think of some type of mirage. Sort of like the mirage of wealth people around the world thought they had before asset prices started declining the past two years; or perhaps the appearance that the U.S. economy is stabilizing.

Our authorities want to make things appear to be getting better. From an operations stand point, I applaud U.S. companies for having such strong control over operations management, which is why most companies beat 2Q estimates. This is a bullish sign and a testament to those companies. The quicker companies can get their finances stabilized, the quicker the economy can reach a bottom. Unfortunately, sales in almost all sectors deteriorated sharply....not bullish.

One way that companies appeared to look strong was with the relaxation of mark-to-market rules. Rather than pricing assets at current market values, authorities think they should be priced at some fictional/historical based value. Example: I own a house that could sell for $250,000 at current market prices. I really like this house and just a few years ago it was worth over $400,000, so I think that I'll list its value as $385,000. But wait...if the house can sell for only $250,000 right now, how can I value it at $385,000? Isn't the price of any asset the amount it could be sold for in the market? That's what I thought, but apparently our authorities don't agree.

Mark-to-market mostly helps banks. If the banks balance sheets appear to be healthy, then we're on the road to recovery. What if they banks appear to be healthy, thanks to the accounting rule changes, but deep down are masking a disease? What if the banks just used the last bullet in their gun to beat 2Q estimates. Underwriting equity and debt offerings along with decreased competition (remember Lehman, Bear Stearns, Merrill Lynch?) will provide banks with nice cash flows. Now that the underwriting is going to slow down, where are the cash flows going to come from? Add to the fact gov't wants to regulate the amount of risk that the "big" banks can take.

These appearance games will continue. I think the gov't is buying the perception is reality idea. As long as things appear to be getting better, they must be getting better...right? After all, this is the age of self evidence.

Anyway, I like this quote and I find it fitting to end this blog. Good luck tomorrow.

"People do not wish to appear foolish; to avoid the appearance of foolishness, they are willing to remain actual fools."

Monday Metrics

It's been a while since I last posted. Honestly, it's summer time and while I study the markets all day, it's been a bit of a struggle to focus on writing at night. Either way, I'm back and looking to start fresh with some updated thoughts.

There is an endless number of subjects I could write about, but tonight I'd like to focus on how I'm trying to read the market. I'll start with a trading axiom, which I've grown to find very true: You can pick the direction or the timing of the market, but you'll rarely nail both.

There's four main metrics which I analyze: structural (macroeconomics, currencies, politics), psychological (investor psychology, social mood), technical and fundamental analysis. This is more from a trading point of view. If it were long-term investing the analysis would be a bit different.

1. I'm putting the least amount of emphasis on fundamental analysis. With the consumer deleveraging, rules changes (FASB 157, naked short selling), government interference (Obamacare - Healthcare nationalization, further stimulus, or any acronym for banks to swindle money from U.S. taxpayers), and it's very hard to forecast what future earnings may be and what type of growth companies will produce. It's simply too hard to attach a multiple to a stock and be confident that you'll get it correct. There will be some analysts who are spot on, and may even earn a name for themselves for a quarter or two, but that's simply due to the law of probabilities. When looking at different asset classes (mainly distressed debt, real estate) fundamental analysis plays a much bigger role.

2. Next is the structural metric. This is more of a big macro themed metric, which should always be in an investors mind, but may not be something to necessarily trade on. European banks, predominantly Eastern Europe, are on the brink of failure. Technically they are insolvent due to the fact they are so overleveraged, that many of the banks have assets which range from 4-7x greater than those countries GDP. Think about it. The banks have "assets" which are 4-7x the amount of money the entire country produces in a year. So a bailout is literally not possible...at least not economically possible.

Saying politics are playing a huge role in the markets is an understatement. Many of the rhetoric coming from Washington is a catalyst for a market move each day. With the seeming socialization of many huge sectors of the U.S. economy, politics will continue to play a larger role in determining how this market will function.

Last part of the structural metric is the most important. That is currencies. This is one market which is extremely hard, if at all possible, to manipulate. With the U.S. dollar being under constant fire and our Federal Reserve taking a weak dollar (bailouts, quantitative easing, debt issuance) stance, you have to question how long foreign investors will want to hang out to assets denominated in USD. Also, the dollar is the worlds reserve currency. We've already seen China and Brazil work a deal so that their trades will be settled in local currencies rather than dollars. This is the slow, but seems to be steady, transition away from the USD. This will have MAJOR implications over the global economy. This is a wild card that must be kept on everyones radar.

-The weakness of the dollar since the March lows has been one of the driving factors behind the market rally. This has also contributed to the doubling of oil in that time frame and the rally in commodities as well.

3. Technical analysis is better used in context rather than a catalyst. Much of technical analysis goes in hand with my last and most important metric at this time, which is psychology. Picking up on trends, resistance, and support levels, has proven to be a solid strategy to use during such tumultuous times. The only problem is that many of today's investors are using the same strategy. Like anything else in the the markets, once a trade becomes too popular and the herd starts moving in, that should be your cue to get out.

4. Last and what I currently believe to be most important is psychology. The psyche of investors right now is fragile to say the least. With markets still down around 40% from the 2007 highs and up 47% from the March low of 666, you can understand why. The government has provided drugs to act as symptoms for our disease, but I believe they are only masking the disease or kicking the can down the road. Thanks to government intervention, no one knows what's next to come from Washington. This has created a world of uncertainty and that's the one thing investors fear most.

We've had a euphoric rally in the past five months. Investors were sick of the gloom and doom, 666 seems to serve a psychological turning point (mark of the beast), second derivative data showed signs of deceleration of the downfall, and honestly, the market was just due for a bounce. Many of the biggest market bounces come in the context of a secular bear market, which is what I believe we are still in. A great earnings season (thanks to great operations management, not revenue growth or sales) has acted a major catalyst to send this market close the 1,000 level, but 980 is a huge resistance level.

I believe we are in the midst of a temporal transition which is transition from peak to trough (temperament) and emotions run highest at this point. There are not many economic data points that should send the market higher. A move to 1,100 wouldn't surprise me, but I look to get short in certain names and sectors as this rally moves on.

Without going into too much detail, I hope that provides a decent summary into how I am trying to read the markets at this time. Everyone has their own approach and I'm not trying to influence anyone one way or another, just trying to provoke thought. Hope all is well and good luck tomorrow.