What’s the Frequency Kenneth?

Posted by Ray on September 9, 2010 under Main | Be the First to Comment

It is official, we live in Bizzaro World for sure. In this new normal there is no such thing as efficient markets, price discovery or any rational reason for the erratic movements in the markets from day-to-day. Just a couple days ago Europe was falling apart causing the markets to selloff hard, but today all is good again and the markets are up a couple hundred points. Bad news is now good news while horrible news is temporary, literally.

As for valuations of equities, who knows anymore, but one thing is for sure, price to earnings ratios are under attack, for the second time in a decade. I have read several stories talking about why P/E ratios are so passé and you need to measure a stock via the PEG or some other nonsense. We had this argument in 2000 and the traditional fundamental investors won that argument and I assume we will win it again. The P/E ratios are under attack because, drum roll please, earnings estimates are coming down. So much for the $90+ earnings estimates for the S&P 500 which, if those earnings per share were met, priced the forward P/E ratios, which is an absurd notion to begin with, at an attractive 12 or so right now. However, lower estimates means a higher forward P/E of say 16 or so, that is less attractive.

Fundamental analysis or value investing is about finding cheap stocks and those are getting tougher to find in today’s market. Not only that, but investors are leaving stocks, how many weeks or net outflows have we had? The outflow from equities is, I am afraid to tell you, permanent. Why? The Baby Boomers, it is that simple. They are retiring and making a fundamental, permanent, shift in their portfolios which involve less risk. That means fewer stocks for this group of investors which are the wealthiest generation, dare I say, in the history of America. I always wondered what would happen when the Boomers all started to retire, I always thought that systematic withdrawals would simply lead to wild swings in the market, never did I believe that they would just pack up and leave the market. Well, they are leaving the market after investing through 2 major crashes, plus worthless property now, in the markets they simply want much less risk. I do not blame them.

The big question is, with all this money leaving equities who is buying and why are we still at the current levels? It makes little sense, if you ditch the permabull thought process for a minute and use logic. More sellers than buyers means lower equity prices, that is always the way it worked until now. Today we have more sellers than buyers, based on net fund flows, and the averages are holding their own. We certainly have a ton of volatility, which makes the VIX seem really cheap at this level, but no real movement in the markets, either way. It simply makes no sense whatsoever and I am positioned neutral in the market right now so I have no vested interest in anything that might happen.

If we look at today’s data, for example, it was not good, mixed with the Beige Book it was horrible, we had a huge trade deficit, certainly smaller than last months, but wow, and we had 451,000 initial jobless claims. In what world were that data is good? Obviously in today’s world it is for some reason, but the facts remain that we are losing 1.85M jobs a month, through firings, almost 3 years into this mess. That is unreal. As Rosenberg points out these are the numbers we saw right after Lehman collapsed, so how is this good news? I can hear some people saying, well it is getting better or it could have been worse. Sure, but you have been saying that for a year now and it is the same, bad. At some point you have to realize that it is not going to get better anytime soon and the faster you realize it the sooner you can exit your positions, hopefully at a profit. The retail investor already figured all of this out, hence the wholesale selling of their funds.

That is what it comes down to, who is going to be able to get out before it is too late? I still find it hilarious that market pundits still preach the bull market is here and the sky is the limit for equities. These are the same people who never saw the tech bubble or the housing bubble, both times saying ‘this time is different,’ but now they claim they can see bubbles and everything is now a bubble, gold, bubble, treasuries, bubble, stocks, undervalued. Have you ever noticed that stocks are ALWAYS undervalued? Sorry, but we played this game before and the only one that loses are the investors while the pundits are still on TV making huge money while, clearly, being subpar at their chosen profession.

The bottom line is that computers are running the markets now. This explains the huge outflows from funds and the sideways movements of the markets as computers get the advantage of liquidity rebates and sub-penny pricing. In this environment I cannot explain bad news sending stocks higher other than computers taking over. I have nothing against them, I think they are a problem, but at the same time what kind of advantage does the ordinary investor have competing against algorithms that react in milliseconds. Yes, one can make money, but this action really screws up price discovery and creates a false sense of confidence because we could have another flash crash when the computers decide to back away, again. This is also, in my opinion, another reason why investors are moving away from stocks and heading to bonds, precious metals and dividend yielding stocks.

Based on what I have seen I am not interested in trading right now. I have a select few investments, precious metals and that is it. I had some nice trades, leveraged treasuries and more gold from the beginning of August, but have moved out of those positions. I see no value in this market and think it is merely a matter of time before we see a major move lower, but who knows when that will be. When we have that move lower I believe that will be the time to buy and only then might we see the retail investor come back to stocks. However, they will not be chasing growth stocks rather stocks that pay dividends. I do believe that when the selling subsides we will see a crackdown on HFT, but it will have been too late, as always. Boring is back and that is a good thing, but until we get true price discovery there is little sense to chase this market and those that do will get hurt.

Subscribe to Annuity IQ's Feed

LS Blogs


Sphere: Related Content

Panic hits the market

Posted by Ray on May 6, 2010 under Main | Be the First to Comment

Was it Greece? Was it a fat finger trade? Was it high frequency trading? Was it quant funds run amok? No one knows for sure, but it was ugly to say the least. I believe the selloff was very, very real and a matter of no one left to buy the dip. We fell within 1.5 points away from all trading being halted and we miraculously reversed course and rebounded some 700 points. Some think it was the Fed or the plunge protection team, I would say that is not farfetched either.

The one thing this was definitely not was a fat finger trade, like originally reported. When trades are entered for equity orders they only use numbers, not letters so the whole “B” versus “M” argument is a bit irrelevant and merely makes a good news story. I believe this whole thing was a perfect storm of a hugely overbought market, yes it is and was overbought, mixed with Greece contagion fears sprinkled with a bit of tight orders by HFT or quant funds and no one left to buy, anything. All liquidity was sucked out of the market and when that happens, well you saw what the results are.

I believe this is only the beginning and things will get much worse. It was also odd to see mining stocks remain in the green along with gold. If this was a trading error these stocks should have tanked as well, but they did not. This tells me that the selloff was more than a bad trade or order imbalance and any other ludicrous reason the media can come up with. It was selling, real live selling from people who know what it is like to lose 40-50% of their money and did not want to repeat that again. Watch fund flows to verify this, I bet we see more bond fund inflows in the very near future.

Even if you were short it was a tough market for you, especially option traders who saw the bid/ask spread widen to levels I have rarely seen before. I am long VIX August and September calls and it took an hour to get pricing back to normal and there was no premium being given for being in the money. It was amazing to see the selloff today as I jokingly went to my wife’s office and said the market is crashing, it was down only 280 at the time, and when I turned it to CNBC to show here it was down 400 and moving fast to the downside. It was breath taking and luckily I was hedged, but the talking heads on TV and perma bulls that you talk to probably told you that hedging was not important and the market now only moves up, it doesn’t, sorry to tell you.

I always find it odd that when the market tank there is talk of manipulation, but if the market goes up for 8 straight weeks that is normal, come on now. I do not believe anything about today was manipulated, except for the massive rebound that “just happened” all of a sudden. No one seems to be really looking for the cause of this, in a serious manner I mean, and are chalking the decline up to a fat finger event, etc. I am a bit more inquisitive though and while I do not have an answer, I have some theories.

I have heard rumors that the overnight repo market in Europe is frozen, I do not know if this is true yet, and if you notice the overnight LIBOR has been creeping up and is close to the 1 and 3 month rate, this might mean the rumor of the repo market is true. On top of that the risk of contagion is extremely real, I wrote about that a week ago in the “Greece Does Matter” post, and the next up is Portugal followed by Spain, Italy and France who owns tons of PIIGS debt, $781B to be exact. After that it is anyone’s guess to who is next, but it is more than likely going to be the UK. What is happening in Europe should be a lesson, in advance, for the US who, ever since Obama has come into office, seems to think the European way of doing things is better than our system, it is not.

The reason for the debt crisis is the massive debt these countries accumulated to give away free health care, massive pensions, paid vacations and other luxury things to their populations. Clearly following the European lead is not a wise move, but that will not stop our politicians who are immune to market downturns because, A) they are all wealthy and B) they are paid very well for what little work they do. We are the next Europe and we will suffer the same issues they have now if we do not get our act together. I am fairly certain that the funding crisis which is a rumor today will be public knowledge in a few days and is one of the main reasons for our selloff today.

If Europe cannot fund itself, other than through the printing press, today will seem like good times moving forward. This is bigger than Greece and it is 10 times bigger than Lehman, we are talking about countries now, not banks. Essentially, we decided to save the banks at our own peril and we are now seeing the results of this action. We should have let them fail, all of them, because we now run the risk of major countries failing. Was Goldman Sachs really worth it? I think not.

What really stood out today was gold, it went up and is on the verge of a tremendous break out. Are gold bugs really that creepy now or is it that we knew something in advance? For those of you wondering, it is the latter. Gold is now the new reserve currency, period. We may suffer from deflation when this funding crisis escalates, but that will quickly turn into inflation, very, very fast. When dollars come into high demand and they are not available we will see this deflation, but remember, we have Helicopter Ben at our disposal. He will literally get into his helicopter and drop dollars all over the country. This will seem like nothing as the dollar stays strong, but that will be very short lived.

After the dollars are dropped inflation will be swift and unlike anything we have seen before. You see, even though Ben flooded the banks with dollars over the last 3 years none of those dollars made it to us, the people who spend them. Instead the banks bought treasuries, also a good option for investors right now, and this time the dollars will bypass the banks and hit us directly, think Bush stimulus instead of green energy stimulus from Obama. Putting that money in our pockets will mean people will spend, that is what Americans do, don’t ask me why. There is where inflation begins and that is only the start. I am not sure what they will do after that, but I am confident it will involve more spending and giving us money, thanks china!

There is where the problems will really begin because there will be a global funding crisis at that point. This means that no one will buy our debt so we can buy iPods. Ben will have to print it, literally print it to get it into our hands. Inflation is a funny thing and very misunderstood, but I assure you that we will not enjoy it, we will at first though if we pay off our personal debts. In the end we will merely be left with tons of worthless paper and sky high prices. What happens next is a mystery to even me and I am a doom and gloom guy, but it is not going to end well. This is why you must own gold, in your possession, because it will get that bad. The worst case scenario is the value of said gold drops, but it will still be better than holding only USD’s. I think the biggest risk is not owning it versus owning it at this point.

Perhaps this was a one day event though, I doubt it, and everything will be fine. Tomorrow we will receive news that the government hired tons of people and private companies hired more temporary workers, we know the number will be good because Obama already scheduled an 11 AM press conference to go over the jobs report. However, those who continue to think temporary jobs and government jobs are a good thing will be very disappointed to learn it is not. I believe that we will open up much lower, working off unclosed sell orders, and we will rebound some tomorrow, who wants to be short into the weekend.

The real show might be next week, depending what happens over the weekend. I am not sure of the near-term outcome or what will happen, I am holding my shorts and VIX calls though, but we did get a glimpse of what will happen longer term today. I do not know about you, but I did not think it looked pretty. As far as believing some trader pushed the wrong button, come on we can do better with our excuses than that.

Subscribe to Annuity IQ's Feed

LS Blogs


Sphere: Related Content