The BP Selloff

Posted by Ray on June 1, 2010 under Main | Be the First to Comment

The media is blaming BP for just about everything nowadays including today’s selloff which is absurd to say the least. There is little doubt that BP has had an impact on the oil service sector and sent those shares lower as the government is about to unleash the proverbial Hell on the sector for what amounts to a horrible accident. A word on the spill, it is terrible, awful and I hope it gets taken care of as soon as possible, but BP is doing everything it is supposed to be doing. Even the President admitted that the company cannot make a move without his direct approval, so let’s make sure we spread blame to all who deserve it. However, the leak is not the cause of the market selloff, but only part of the problem.

What I found extremely interesting in Tuesday’s trading was that the Euro made a fresh 4 year low and someone decided to step in and buy the Euro like no tomorrow. It had to have been a central bank because I know of no investor that would be anxious to buy anything that just made a fresh 4 year low on speculation of a rebound, but that is rumor and my own speculation and it does not matter who did it because it happened. The Euro is leading the trading and that is what is important to realize and that in itself is what is interesting because that trend is on again and off again day by day so do not depend on the Euro to always be the guide. To be sure if the Euro is leading the way check the EURO/USD and EURO/JPY pairs and id they are both heading in the same direction with the market the trend is valid, if they are mixed take your own chances trusting the Euro to lead.

What else was extremely interesting today is the fact that the Russell 2000 and the transports had diverged from the Dow 30, S&P 500 and the NASDAQ all day today. It is also important to note that I have mostly thrown my charts away as I feel they are more or less useless at this point, but I do look at them from time to time. Regardless, I always use the RUT, Russell 2000, to gauge the overall movement of the market and where we are ultimately heading for the day, it is fairly accurate as it is a broad based index, and if you are a Dow Theorist you watch the transports anyhow to see where the Dow will go for the day. I guess I am a bit of everything because I watch a lot of things all throughout the day. Of interest was the RUT was down a good 1.7% most of the day as the Dow was positive and the S&P crossed throughout the day and the transports were also down about 1% throughout the day as well.

Having a divergence in itself is not a big deal, it kind of happens all the time and the markets tend to even out at the end of the day, but not today. The RUT and the transports ended down pretty hard, almost 3% and over 2%, respectively, while the Dow ended down 112 and the S&P ended down 18. Typically, when the RUT and transports are down that much the Dow is down about 200+ and the S&P is down about 30 so it was strange trading all day long. It is safe to assume that I merely held my shorts today as I think there is something to this divergence and there is more downside to this market. However, the real catalyst for the selloff was not BP, oh no, it was the EU.

About 10 PM EST last night the ECB released a statement saying that EU banks may write down about $290B in debt, that is a problem. When that news hit it drove futures down 50 ticks and they just stayed there all night long. Considering that it was a holiday that is a pretty big move so I was not surprised this morning when I saw the open, but I was surprised on the turn at 10 AM when the markets went positive and I saw the divergence in the different indices. I kept waiting for the reversal to happen again, but it did not come through until 3:30 which is a bit odd, kind of, but it also shows that this market is not a bull market at all anymore, it is a bear market. A bull market would not be trading like this and we would not get such bearish signals at 3:30 PM, sorry to be the bearer of bad news.

I do expect a rally in the short-term, but nothing to write home about, previously I thought a run to 1,200 on the S&P was possible, but not any longer. I believe we may see 1,120 or so, but that is about it unless the news really turns, which I do not see happening. I believe the ISM data we saw today is the beginning of the official rollover in the data series, leading indicators already rolled, and I am not expecting much more strong economic data as the stimulus money is gone, that was a quick trillion, eh.

Everyone is watching for the employment report on Friday, but no one looks beyond the headline number so why bother? With initial claims in at 460K, 2.5 years into this thing(!), we are in negative job growth territory. I expect to see the unemployment rate climb to 10%+ as people get back into the workforce as extended unemployment benefits are running out and people reenter the workforce. I expect a high number of government employment which needs to be discounted and one needs to remove the Birth/Death model tinkering that occurs because those jobs are simply made up, that is why 880K jobs had to be added to the unemployment roles in February as this model underestimates the unemployment rate. If the private sector is adding only temporary workers at this stage we are in big, big trouble and that is NOT a bullish item, it is very bearish. Overall, I expect a number that is going to be in the 300 – 350K area, I hear of some shenanigans in the numbers, more on that is I can confirm, but until then it is rumor only.

I do not believe there is much upside to this market and the risks run very high with the exception of cash and gold. At this point even high paying income stocks are getting hit hard and bonds are, in my opinion, overvalued at this point and I got very lucky with my exit on high yield. I like short treasuries, 2 year durations, but cash is better at this point. I believe deflation is here and it is going to get very tough going forward which means stocks are way overvalued by 20 – 30%, think 10-12 P/E on $75 earnings on the S&P plus much lower growth. Be very nimble or start looking for entry points for a short position, but you should have been doing that 3 weeks ago so don’t go jumping on the bandwagon now without doing your research.

At this point I am holding high yielding stocks, short duration treasuries, country specific ETF’s, equity income ETF’s, 3x bear ETF’s, put options, gold, silver and platinum group metals. Clearly I am thinking much lower equity prices, deflation followed by inflation at some point. Everyone is a genius when the market is going up, but we are about to hit a very rough market and I expect volatility to remain elevated for some time and the VIX might offer some excitement for you, but you must understand it before you do anything with it. In the meantime my price target is 900 on the S&P 500 which has been my target since the beginning of the year, I think it could go much lower if conditions worsen. Good luck.

What a wild ride

Posted by Ray on May 26, 2010 under Main | Be the First to Comment

The past 2 weeks we have seen the markets do things that simply do not seem natural from freefall flash crashes to intraday 300 point turn around rallies. However, there is one thing that is pretty clear, I would not buy this pull back. As David Rosenberg points out and a few other non-perma bull market strategists, not that there are many left, point out is that these wild swings are not normal in a bull market.

Think back to the market of late 1999 to the early 2000 and you will remember such swings, but do you remember how it ended? If you bought on those dips you never made your money back, ever if you bought the NASDAQ and you would have barely broke even in the S&P 500 if you sold at the peak in 2007. I think it is safe to assume that this market action is a sign of a sick overbought market trying to lure you in to buy one more time before it robs you blind, don’t do it. To be clear, I believe the broad market will move lower, I think 900 to 950 is not an unreasonable target, but we could move much lower than that. Before you say it, no the fundamentals are not so strong that we could not see the lows of last March, more on that in a minute.

I am not saying do not buy great individual companies, not at all, I am bearish on the market, but I like some individual names. I am bullish in the biotech area as there are tons of patents expiring in the next few years and you will see big pharma buy many of these names, but I also like big pharma too. Look at the yields and the rock bottom P/E’s, they are dirt cheap and you should look at some of these names, but biotech is not a prisoner to the business cycle, as long as it is well funded and near approval for a drug. I also like consumer staples that pay dividends, boring names, but they pay you to hold them and no matter what the economy is doing you will always need toilet paper and a toothbrush, I hope at least. I also still like high quality bonds and can make a case for treasuries right now, but use your own discretion, I would stay away from high yield, I sold mine a couple months ago.

Why do I think boring and income is the best model right now? Well, the market is going to correct even more than it already has, kind of a simple explanation. Income strategies, which I have been on the record for supporting since last year, makes sense because we are living in disinflationary, possibly deflationary, times where real yields are much higher than what we think. I am a long-term inflationist, come on look at all the money being printed and Obama wants to double exports in 5 years, you cannot do that with a strong dollar, but right now deflation is the name of the game and income makes sense. Deflation also means stocks need to be trading at much lower multiples than most people think and that is why I think this correction will potentially be much deeper than most people believe. Time will tell who is right about that.

The Fundamentals!

What about the fundamentals? Are they better than a year ago? Sure. Do they support a 20 P/E multiple on the S&P 500? Nope. Do you really think the housing data since the homeowner tax credit implementation was actually real data? No way. How about unemployment, do you believe temporary jobs are going to lead America to the next level of prosperity? Well, all the amazing job growth has been only in the temporary job area, let’s not forget that the actual employment report numbers are tinkered with via the birth/death model which added 188K jobs to last month’s employment report. For those of you who don’t know, the birth/death model are estimates the BLS uses to predict how many new business are started based on how many business died and population growth, it is fantasyland stuff basically.

What about corporate earnings? They have been good, but I do not believe they are sustainable. First, the stimulus is running out, that is a very important thing to remember moving forward. Second, a cool 30% of the S&P 500’s earnings come from Europe and up until lately U.S. companies enjoyed, globally, a weaker dollar which is over since the new sovereign debt issues are driving the value of the dollar higher. In technology a large percentage of earnings came from Asia and I do not believe that will continue much longer because of what is happening in Europe, Greece was a big deal indeed.

You see, Europe represents 20% of the worlds GDP and, believe it or not, China’s top importer is not the U.S. it is the EU. So, if the EU is going to have lower growth because of austerity measures, which they will, it will automatically be a drag on world GDP, but it will specifically hurt China. If China begins to slow down that is very bad news since China is “the recovery story of the world” or some other tag line the media gave it. In other words, China will be buying less from the U.S., exporting less to the EU and the EU will be buying less from the U.S. Also, China will be running, more than likely, trade deficits not surpluses which means they do not need to buy our debt. Can you see the problem now?

Greece is/was a big deal not on its own, but because it was locked in with the other PIIGS which were locked into the EU as a whole. It is all very bad news and no matter what CNBC says we are all still coupled with each other. It is the interlocking of the global economy, especially in the debt markets, that is the problem and there is no escaping it. I am afraid that even when governments guarantee debts that may not be enough anymore because, as the price of gold is proving, people are losing faith in money. Our whole system is based on faith and when that faith is damaged that is when problems get out of control and I believe we are just about at that point. The rumor yesterday was a .50% rate cut, how is that good for the Euro? If anything that would have brought it closer to parity to the USD. Printing another trillion just won’t calm markets because it means nothing. At this point I cannot see much of anything from Europe that will calm the markets.

The only things they can do is let the PIIGS default on their debt and kick them out of the EU, not necessarily in that order. Anything else will just prolong the problem and the printing press is the cause of the problem, not the solution.

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.

Greece IS a big deal

Posted by Ray on April 27, 2010 under Main | Be the First to Comment

Apparently the markets, that wonderful forward looking discounting mechanism, did not see or have fear what is happening in Greece. It is safe to assume that this proves that the markets are not efficient and it fails to see potential problems. What is interesting is that Greece and Portugal were not or should not have been a surprise to the markets since we have all known about the issues with the PIIGS for months now. How anyone could have been surprised by this news today is beyond me. I guess the junk rating on Greece may have been a surprise, but come on, when the 2 year note was yielding 11% how in the world can it be anything other than junk?

The market has gone up for 8 weeks in a row and while the talking heads thought this perpetual “tortoise rally” was normal anyone who has even a little investment experience knew it was not. I still remember Dennis Kneale, last week, calling people who held cash “fraidy cats” because the market is back and it will be a bull market forever. The world does not work like that and the risk trade has been, frankly, out of whack. Money has been pouring in to everything from high yield to emerging markets in the expectation of a steady 1-2% a day. This was verified from mutual fund flow data reported last week which showed investors moved more money into equity funds, for the first time in a longtime, and, in my mind, confirmed we must be near a top, dumb money always moves in after fantastic rallies.

Whether or not this was a top remains to be seen, but it certainly looks like it from my lens. I have been wrong before and might be again, which I admit. However, even though I was wrong it doesn’t mean that the markets were right either. Earnings are better, I still see some misses in revenue though, but the underlying macroeconomic data has merely gone from very bad to just plain bad. When we cheer a 57% confidence reading that is a problem because that it is a horribly low number. The housing data is not verifiably strong when you have, like in October, a rush of people buying for the tax credit right before it expires. If the housing numbers stay “strong” for May then you may say housing is rebounding, but I highly doubt we will see such strong numbers at that time. Housing is a key indicator because it employs so many people and homes were the collateral that were the bad debt sitting on bank balance sheets.

Unemployment remains incredibly high, use the U-6 data not that foolish headline number, which is a severe problem. Given that weekly claims have stabilized at -450K is horrendous at best. That number shows that private employers are still shedding jobs and I am confident that the employment report next week will show “stellar” job creation in the government sector and in the temporary help area, those are not good areas to see growth in. I am a believer that the temporary help is just that, temporary and will not convert into fulltime employment, we would be seeing that conversion by now, but we are not. Housing problems plus high unemployment will keep the economy down for some time.

On top of the squishy soft economic data being heralded as a full blown recovery, don’t get me wrong less bad is a welcomed improvement, we have a sovereign debt crisis. People claim that Greece is only 2% of Europe’s GDP and dismiss their troubles. That is a bad idea because while they are right about Greece they conveniently forget that all the PIIGS account for some 13% of Europe’s GDP and they are all in trouble. Spanish and Italy’s bonds have been trading lower pushing their yields up over 4% and Portugal was officially downgraded, that is all really bad news. Each country, individually, is not a big deal, but combined we are talking about the potential to default on hundreds of billions of dollars worth of sovereign debt.

To put this into prospective, France owns some $781B of PIIGS debt, if they all default what will happen to France? They will be in trouble, of course. Then there is Germany, how much PIIGS and French debt do they have? I do not know, but I assume a lot. What will happen to Germany if they get stuck with declining value of all that paper? They will have to bailout their banks, I assume France would have to do the same for their banks as well. That, basically, puts the banking system in jeopardy again, in less than 2 years. What I am explaining, probably in a horrible way, is what contagion looks like and it doesn’t end there either. The U.K. has exposure to all these countries and they are already in horrible financial shape and the series discussed above makes the U.K. susceptible to the contagion.

U.S. banks have exposure to both European banks and sovereign debt which means out fragile banking system could face another challenge. Let us not forget that the U.S. is also heavily indebted, along with Japan, and people may start to question the safety of U.S. Treasury debt, as they should I might add. From my lens, in a worst case scenario, meaning this all happens, it would be a coin toss as to which country goes next, either Japan or the U.S. given their immense debt loads. This scenario is unlikely or has a low probability of happening, but it is possible and it could trigger a global currency crisis.

This explains why gold went up today in the face of a stronger dollar and a rush of selling from the market. Even silver held its own today in the face of dollar strength. This shows that gold is still a flight to quality, it is also in a bull market as well, and it is a trusted currency. In fact, gold’s rally today is why I think it is possible for a global currency crisis because if this was another credit crisis, like 2008, it would have sold off for liquidity, but it did not. I am not sure if I would be buying gold right now because I already own a position, but if I did not own any gold I would be a buyer.

All is not well in the global markets and people should stay nimble as to where to put their assets until things settle down. I would say this decline is extremely bearish and way overdue, the higher the market went the worse the selloff would be, which could make it worse. It was insane to think that volatility would not comeback and that people went from sheer panic a year ago to such utter complacency this year. The worst part about all of this is if this does trigger another crisis what can the Fed or the governments do to calm the markets or remedy the situation? Nothing, they already spent all their ammo and they even had to borrow some to boot. I am not saying this will trigger another crisis, but it certainly has all the ingredients for one, if you look at the big picture.

It is getting ugly out there

Posted by Ray on April 22, 2010 under Main | Be the First to Comment

Earnings for 1Q10 actually look OK, depending what companies you look at, but there seems to be some weakness in top line revenue, which is what I thought would happen. Even with a few firms not reaching their revenue estimates the EPS seems to look positive. What it looks like is companies are still living off of cost cutting measures which mean that new hiring will be sparse at best. The weekly initial jobless claims still look exceptionally weak, 456K this week which was down from 480K last week, which shows firms are still laying people off, not a good sign, even though there is some stabilization in the claims data. Essentially, we have stabilized from really bad to just bad on the jobs front.

The big issue of the day is Greece, their 10 year is now at 8.7% and rising and the 3 year is at 11%, as they have been caught, again, lying about their debt to GDP. The other PIIGS are also moving into the limelight, Portugal, Italy and Ireland specifically, which is also not a good sign. Why is Greece such a big deal? It is because European banks own a ton of this debt, private banks and central banks, for instance, France holds $781B on such debt and the CDS spread on their debt is rising because of their exposure. In other words, this could be a trigger for another banking crisis and governments are low to out of bullets to fight another crisis.

Existing housing numbers just came out, for March, and the numbers are up 6.8%, but it is because of the closure of the tax credit at the end of April. However, inventories are building, again, which means there will be some downward pressure on home prices in the near future. I am afraid that we are far from a healthy housing market and in my opinion, the government needs to let prices fall in order to clear the inventory and to have real price discovery for real estate. Inventories in the existing housing market is simply too high at well over 3M which, compared to the 5.28M run rate, is terribly high getting closer to a full years worth of inventory waiting to be sold. This is not even looking at the new construction data which will add a significant amount of supply to the market. We need less housing and the only way to clear that inventory is to let prices fall, but that will never happen and look for another extension of the home buyers tax credit.

What is interesting is that banks are reporting stellar earnings, but prices on homes are down, inventory is building and commercial real estate is, literally, blowing up. The question is, how can earnings be so good when the assets are or should be declining in value? Answer, suspension of mark-to-market. Essentially, banks are now practicing the same accounting gimmicks as Enron by using mark-to-model (make believe), but this is legal because the FASB allows it… unreal.

There is little question that the data is getting better, but when we look at why and what levels the data is getting better it is disturbing to say the least. While the numbers are better, the term “better” is a relative term in itself, and we have stabilized from horrible to just bad. In my opinion, all the elements of a double dip or even another serious banking crisis exist in the markets. If we went back to real accounting or factor in a Greece default the markets would get hammered as this would show we have climbed too fast and risk is not priced into this market at all. The longer we refuse to acknowledge the bad debts on the banks books or a default from any of the PIIGS the worse the inevitable correction will be.

While I am bearish on the overall market, mainly due to valuation, I like many sectors of the market. I am partial to biotech, high yield dividend stocks – i.e. MO, PM, VZ, T, etc. – esoteric no correlated assets – frontier markets, country specific ETF’s, precious metals, etc. – and I like bonds, deflation is here folks. I do own MO and PM, I also do not like ‘talking my book,’ but own several biotech’s and PBE, biotech ETF. In my opinion one should be very careful as we are once again looking at new ways to value stocks, this is what they did in 1999. If you cannot value stocks using older methods like P/E multiple and so forth it is not worth owning, in my opinion. I see little real value plays in this market and there is no need to jump into this market right now, your patience will be rewarded. I think one should hold core holdings, dividend paying stocks, high grade bonds and some cash. Cash may be king at the end of the day.